Catalyst Paper Corporation News
Catalyst 2007 results reflect challenging business climate
Catalyst continued to realize significant benefits over the course of the year from its now long-standing focus on cost reduction. Wide-ranging workforce restructuring initiatives were announced during 2007, including a 15 per cent staffing reduction, relocation of the head office from
Implementation was substantially completed at the end of the year, entailing
"We're pleased with our demonstrated ability to deliver performance improvement," says President and CEO
"The impact of these efforts is becoming more evident in our recent quarterly results," he adds. "However, various business challenges during 2007 erased the gains we made."
Key among those challenges was the 13-week coastal logging strike. While Catalyst was not a party to it, the dispute significantly impacted its fibre supply. This resulted in shortages and cost increases, and necessitated production curtailments at two Catalyst mills.
The rapid pace of currency appreciation - with the Canadian dollar exceeding parity to reach a 50-year high - had a significant eroding effect on 2007 results. Catalyst estimates that the dollar's rise reduced EBITDA (earnings before interest, taxes, depreciation and amortization) by
Positive momentum that became evident in Catalyst's third quarter results steadied the company's fourth quarter results as the continued strength of the Canadian dollar took its toll. At
Fourth quarter net earnings were positive at
Pulp markets remained strong during 2007, and the final quarter saw continued pricing momentum and higher average transaction prices for both pulp and paper products. Overall, however, market conditions for paper products were mixed over the course of the year. Lower transaction prices for most grades, except directory, more than offset the gains realized through pulp sales.
Tightening supply for coated paper grades supported price increases in the latter part of 2007, but average prices for the year remained below 2006 levels. Demand for uncoated grades was on balance flat, with prices slightly lower than last year. Directory demand was steady and average prices rose. In contrast, weak US newsprint consumption and demand drove prices down.
Looking ahead, the current expectation is for improved market conditions for both specialty papers and newsprint during 2008, although the extent and duration of US economic contraction could significantly affect this outlook. In addition, lower housing starts in the U.S. have affected sawmill operating rates and with no improvement in sight, a tight fibre supply situation is expected to continue into 2008 and this could require additional production curtailment.
Catalyst is a leading producer of mechanical printing papers in
Forward-Looking Statements
Except for the historical information contained herein, the matters set forth in this report are forward looking, including statements with respect to general economic conditions, assessment of market conditions, demand for products, pricing expectations, cash flow, anticipated savings and cost reductions, profit improvements, restructuring costs, productivity, manning levels, capacity and capital and maintenance expenditures. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that may cause actual results to differ materially from those contained in these statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following management discussion and analysis ("MD&A") of Catalyst Paper Corporation (the "Company") should be read in conjunction with the consolidated financial statements for the years ended
Throughout this discussion, reference is made to EBITDA, which represents earnings before interest, taxes, depreciation and amortization, and before other non-operating income and expenses, EBITDA before specific items, average delivered cash costs per tonne before specific items, net earnings (loss) before specific items, net earnings (loss) per share before specific items, and free cash flow. Management believes these measures are useful to evaluate the performance of the Company and its business segments. As Canadian Generally Accepted Accounting Principles ("GAAP") do not define a method of calculating these measures, securities regulations require that non-GAAP measures be clearly defined and qualified, and reconciled with their nearest GAAP measure. The definition, calculation, and reconciliation of these non-GAAP measures is provided in Section 9: "Non-GAAP Measures".
In accordance with industry practice, in this MD&A, the term "tonne" or the symbol "MT" refers to a metric tonne and the term "ton" or the symbol "ST" refers to a short ton, an imperial unit of measurement equal to 0.9072 metric tonnes.
In this MD&A, unless otherwise indicated, all dollar amounts are expressed in Canadian dollars, as are the term "dollars" and the symbols "$" and "CDN$". The term "U.S. dollars" and the symbol "US$" refer to
The information in this report is as at
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This MD&A contains forward-looking statements. Forward-looking statements are statements, other than statements of historical fact, that address or discuss activities, events or developments that the Company expects or anticipates may occur in the future. These forward-looking statements can be identified by the use of words such as "anticipate", "could", "expect", "seek", "may", "likely", "intend", "will", "believe" and similar expressions or the negative thereof. These forward-looking statements reflect management's current views and are based on certain assumptions including assumptions as to future economic conditions and courses of action, as well as other factors management believes are appropriate in the circumstances. Such forward-looking statements are subject to risks and uncertainties and no assurance can be given that any of the events anticipated by such statements will occur or, if they do occur, what benefit the Company will derive from them. A number of factors could cause actual results, performance or developments to differ materially from those expressed or implied by such forward-looking statements, including the general economic conditions in the U.S.,
Investors are cautioned not to place undue reliance on these forward-looking statements. No forward-looking statement is a guarantee of future results.
1.0 OVERVIEW AND HIGHLIGHTS 1.1 Overview of the business ———————————— Catalyst is a leading producer of specialty printing papers and newsprint in North America. The Company also produces market kraft pulp and white top containerboard and owns Western Canada's largest paper recycling facility. With five mills located within a 160-kilometre radius on the south coast of British Columbia, Catalyst has a combined annual capacity of 2,403,000 tonnes of product. The Company is headquartered in Richmond, B.C. The Company is the largest producer of specialty printing papers and newsprint in Western North America. Catalyst's specialty printing papers include lightweight coated, uncoated mechanical papers (soft-calendered and machine-finished hi-brites and super-brites), and directory paper. The Company is one of the largest producers of directory paper in the world and the only producer of lightweight coated paper in Western North America. The Company's business is comprised of three business segments: specialty paper, newsprint, and pulp. Specialty paper ———————- The specialty paper segment consists of lightweight coated ("LWC"), uncoated mechanical papers such as soft-calendered ("SC") and machine-finished ("MF") hi-brites and super-brites, and directory. These specialty printing paper grades are manufactured on ten(1) paper machines in British Columbia at Crofton, Elk Falls, Port Alberni and Powell River. The specialty paper business segment has a total production capacity of 1,123,000 tonnes. Specialty paper represents the Company's largest business segment, generating 54% of 2007 consolidated sales revenue. The Company's customer base consists primarily of retailers, magazine and catalogue publishers, commercial printers and telephone directory publishers. Specialty printing paper products are sold primarily through the Company's sales and marketing personnel in North America, and through distributors and agents in other geographic markets. In 2007, 90% of specialty paper sales volumes were with customers in North America. Specialty paper is shipped by ship, barge, rail or truck - or by a combination of some or all of these transportation modes. Newsprint ————- Newsprint is currently manufactured on five(1) paper machines at Crofton, Elk Falls and Powell River. The newsprint business segment has a total annual production capacity of 606,000 tonnes. Effective September 1, 2007 the Port Alberni # 4 paper machine ("A4") was indefinitely idled, displacing 134,000 tonnes of newsprint on a 45.0 g/m2 basis. Newsprint sales generated 20% of 2007 consolidated sales revenue. The newsprint customer base consists primarily of newsprint publishers located in Western and Central North America and in Asia. In 2007, 82% of newsprint sales volumes were with customers in North America, Asia and Australasia. Newsprint is shipped overseas by deep-sea vessel and inland by ship, barge, rail or truck - or by a combination of some or all of these transportation modes. ————————— (1) The Company has 11 paper machines. The number of machines noted in the segments above reflects the ability of the Company's machines to switch between newsprint and specialty paper grades. Pulp —— The pulp segment consists of Northern Bleached Softwood Kraft ("NBSK") pulp manufactured at the Crofton mill and sawdust- based pulp and containerboard manufactured at the Elk Falls mill. The pulp business segment has a total market production capacity of 674,000 tonnes. Pulp and containerboard sales generated 26% of 2007 consolidated sales revenue. The pulp customer base is located primarily in Europe and Asia and includes producers of tissue, magazine papers, woodfree printing and writing papers and certain specialty paper products. The containerboard customer base consists primarily of corrugated box manufacturers. Pulp and containerboard products are sold primarily through sales and marketing personnel in Canada, and through a network of agents in locations throughout the world. In 2007, 79% of pulp and containerboard sales volumes were with customers in Europe, Asia and Australasia. The Crofton and Elk Falls pulp mills are located on tidewater and have deep-sea vessel loading facilities. Pulp and containerboard are shipped by both break-bulk and container deep-sea vessels. The Company also owns the largest paper recycling facility in Western Canada. Operated in support of the business segments described above, the recycling facility has an annual production capacity of 175,000 air-dried equivalent tonnes of pulp per year, the majority of which is consumed internally. The chart below illustrates the Company's principal paper and pulp products, their applications, and annual 2008 production capacities: ————————————————————————————————————- PRODUCT PROFILE ————————————————————————————————————- Segment Specialty paper ————————————————————————————————————- Uncoated mechanical —————————————— Category Soft- Machine- Lightweight calendered finished Coated Directory ————————————————————————————————————- Brand names Electrasoft Electrabrite Electracote Catalyst Electracal Electrastar Electraprime ————————————————————————————————————- Basis weight (g/m2) 45 - 52 45 - 66.5 44.4 - 63.6 28 - 40 ————————————————————————————————————- Applications Magazines, Magazines, Magazines, Telephone Supplements, Supplements, Catalogues, books, Catalogues, Inserts, Inserts, Airline Inserts, Flyers, Flyers, schedules, Flyers, Direct mail, Direct mail Catalogues Direct mail, PR and Directories corporate communication books/manuals ————————————————————————————————————- Total capacity (tonnes) 540,000(1) 231,000 352,000(1) ————————————————————————————————————- % of total capacity 22% 10% 15% ————————————————————————————————————- ————————————————————————————- PRODUCT PROFILE ————————————————————————————- Segment Newsprint Pulp ————————————————————————————- Container- Category Newsprint board Market pulp ————————————————————————————- Brand names Marathon Silverliner Elk Prime Platinumliner Crofton Chromiumliner Kraft Bronzeliner ————————————————————————————- Basis weight (g/m2) 43 - 48.8 127 - 270 n/a ————————————————————————————- Applications Newspapers, Packaging Tissue, Inserts, applications Freesheet, Flyers, Specialty Supplements, paper, Directories, White-top Timetables linerboard ————————————————————————————- Total capacity (tonnes) 606,000(1,2) 131,000 543,000 ————————————————————————————- % of total capacity 25% 5% 23% ————————————————————————————- (1) Capacities expressed in the above table can vary as the Company is able to switch production between products - particularly newsprint, directory and machine-finished uncoated grades. (2) The Company indefinitely curtailed A4 effective September 1, 2007, displacing the equivalent of 134,000 tonnes of the Company's annual newsprint production. The capacity noted in the table above has not been adjusted to reflect this indefinite curtailment. The chart below illustrates the annual 2008 production capacity by mill and product line: ————————————————————————————————————- CAPACITY BY MILL LOCATION AND PRODUCT LINE ————————————————————————————————————- Specialty paper ————————————————————————————————————- Mill Number of Paper Uncoated Lightweight location machines mechanical Coated Directory ————————————————————————————————————- Crofton, B.C. 3 - - 246,000 Elk Falls, B.C. 3 153,000 - - Port Alberni, B.C. 2(2) - 231,000 106,000 Powell River, B.C. 3 387,000 - - ————————————————————————————————————- Total capacity (tonnes) 540,000(1) 231,000 352,000(1) ————————————————————————————————————- ————————————————————————————————————- CAPACITY BY MILL LOCATION AND PRODUCT LINE ————————————————————————————————————- Newsprint Pulp ————————————————————————————————————- Mill Number of Paper Container- Market location machines Newsprint board pulp ————————————————————————————————————- Crofton, B.C. 3 150,000 - 343,000 Elk Falls, B.C. 3 373,000 131,000 200,000 Port Alberni, B.C. 2(2) - - - Powell River, B.C. 3 83,000 - - ————————————————————————————————————- Total capacity (tonnes) 606,000(1,2) 131,000 543,000 ————————————————————————————————————- (1) Capacities expressed in the above table can vary as the Company is able to switch production between products - particularly newsprint, directory and machine-finished uncoated grades. (2) The Company indefinitely curtailed A4 effective September 1, 2007, displacing the equivalent of 134,000 tonnes of the Company's annual newsprint production. The capacity and number of machines noted in the table above have not been adjusted to reflect this indefinite curtailment. Geographic Sales Distribution ——————————————- The Company's products are sold on five continents. At 62% of sales, the North American market continues to be the Company's principal market, and is followed in significance by Asia and Australasia, Latin America, and Europe. 1.2 2007 Annual Overview After four consecutive years of improvement in operating earnings, 2007 was a particularly challenging environment for the Company, resulting in the Company's earnings declining versus their prior year. A Canadian dollar that reached 50 year record highs against the U.S. dollar in 2007, a price downcycle for most of our paper products, a constrained fibre supply, and the impact of a strike further affecting coastal fibre supply in the third and fourth quarters, all combined to create significant headwinds. However, on the positive side pulp prices increased rapidly during the year and towards the end of the year most groundwood paper products started to see positive price momentum. In addition, the Company took action to improve profitability through the indefinite closure of newsprint capacity and the reduction of approximately 15% of the workforce through the Company's restructuring program, which contributed the largest part of another successful Performance Improvement Program that delivered $81 million of benefit to operating earnings and EBITDA in 2007. The Company recorded a net loss of $31.6 million, compared to a net loss of $15.9 million in 2006. EBITDA was $27.0 million, compared to $211.0 million in 2006. The Company's results in 2007 included restructuring and change-of-control costs of $64.7 million and were also negatively impacted by $25.0 million related to a disruption in fibre supply resulting from the United Steelworkers of Canada union ("USW") work stoppage. EBITDA before these specific items was $116.7 million, compared to $211.0 million in 2006. Restructuring Initiatives and Change-of-Control The Company announced and implemented, in phases during 2007, a restructuring program to eliminate approximately 565 positions across the Company, relocate the corporate office, and centralize certain mill administrative functions. This program was substantially completed during the year and is expected to deliver total annualized cost savings of approximately $67 million. In 2007 total restructuring costs for this program were $58.3 million, including $3.0 million of capital expenditures. The Company indefinitely curtailed operations of A4 on September 1, 2007. Production of directory paper made on A4 was moved to Crofton and displaced the equivalent of 134,000 tonnes per year of the Company's least profitable newsprint business. The curtailment also reduced the Company's highest cost fibre and power requirements. Significant management changes occurred during 2007. Richard Garneau joined the Company as the President and Chief Executive Officer and David Smales, formerly Vice-President of Strategy, was appointed Vice-President, Finance and Chief Financial Officer replacing the former President and Chief Executive Officer and the former Vice-President, Finance and Chief Financial Officer respectively, after they exercised their rights under change- of-control agreements and left the Company during the first quarter of 2007. The Company recorded $8.3 million in severance, pension-benefit and stock- compensation expenses related to these change-of-control agreements plus $1.1 million relating to certain employee retention agreements. Performance Improvements The Company continued to deliver on its performance improvement objectives, including the restructuring program, and realized a year-over-year operating earnings and EBITDA increase of $81 million from performance improvements. A discussion of the 2007 Performance Improvement Program's results is provided under "Progress on 2007 Strategic Initiatives" in Section 1.5, "Strategy". Canadian Dollar The majority of the Company's sales are denominated in U.S. dollars. As a result, the strengthening Canadian dollar, which reached its highest value against the U.S. dollar in more than 50 years during 2007, had a significant negative impact on the Company's operating earnings for the year. The average spot rate for 2007 was US$0.930 compared to US$0.882 for 2006 and US$0.825 for 2005. Despite the mitigation provided by the Company's hedging program, the currency movement in 2007 reduced EBITDA by $48 million when compared to 2006. Product Demand and Pricing Market conditions for the Company's products were mixed in 2007. Coated mechanical demand was higher in the year largely due to substitution of coated mechanical grades for coated woodfree. Supply in the coated market tightened late in 2007, primarily due to significant North American mill closures in the latter half of the year combined with lower mill inventories. These factors led to improving LWC prices in the second half of the year. In December 2007, the Company announced a third consecutive US$60 per ton price increase for its LWC paper grades, bringing the total announced increases by the end of the year to $180 per ton since July 1, 2007. Despite the recent upward pricing momentum, the average LWC benchmark price was 6% lower in 2007, compared to 2006. Overall uncoated mechanical demand remained flat. The increased demand for high-gloss grades offset the decrease in demand for standard grades. Prices softened during the first half of the year, but started to reverse in the fourth quarter. The average soft-calendered A grade ("SC-A") benchmark price was 4% lower than the previous year. After robust growth in 2006, directory demand was steady in 2007 due to slower growth in the number of independent books printed and flat total page and book circulation for incumbent publishers. The average directory benchmark price was 3% higher than in 2006. Newsprint demand continued to weaken at a significant rate during 2007, leading to an average newsprint benchmark price decrease of 11% from 2006. Prices began to stabilize late in the year as capacity closures reduced supply and a US$25 per tonne price increase was implemented in December 2007 in the U.S. Pulp demand continued to be strong in 2007. The combination of strong demand and tight supply resulted in US$ prices increasing to their highest level since 1995. The average NBSK benchmark price in 2007 was 17% higher than in 2006. For containerboard markets, supply and demand remained in balance, with low inventory and healthy export levels despite flat demand. The 2007 benchmark price was 4% higher than in 2006. Fibre Costs and Supply A combination of factors made 2007 a difficult year with respect to fibre supply. Coming into 2007 low inventory levels throughout the fibre supply chain due to lower log volume harvested in the fourth quarter of 2006 was made more challenging by continued poor weather in Q1, 2007. This resulted in higher fibre prices in the first half of the year. Although harvesting conditions returned to normal by mid-2007, the three month USW strike that began in late July and reduced sawmill activity as a result of poor market conditions for lumber kept fibre prices high all year. Overall, increased fibre costs and the total impact of the USW strike had a negative impact of $103 million on EBITDA in 2007 when compared to 2006. Fibre lost to Catalyst during the USW strike was 284,000 bone dry tonnes, although the impact was partially mitigated through higher than expected logging activity and increased supply from other suppliers. This loss of fibre led to production curtailments in the third and fourth quarters of 106,100 tonnes of paper and 44,200 tonnes of pulp and containerboard at the Elk Falls mill; and 10,500 tonnes of pulp at the Crofton mill. Liquidity and Capital assets The Company's available liquidity was $241 million at the end of 2007, compared to $324 million at the end of 2006. Of the $83 million decrease, $41 million was due to a reduction in borrowing base on the Company's revolving operating facility as a result of lower accounts receivable and inventory following curtailment related to the reduced fibre availability in Q4, and the indefinite closure of A4 in September, 2007. Lower EBITDA, in large part due to restructuring and change-of- control costs and the impact of the USW strike, further reduced the Company's liquidity. In September 2007, the Company sold the Port Alberni # 3 ("A3") paper machine and ancillary assets. The Company received proceeds of $1.3 million and recorded a loss on disposal of $7.5 million. 1.3 2007 highlights ———————- - Realized year-over-year operating earnings and EBITDA benefits of $81 million from the Company's 2007 Performance Improvement Program, of which $29 million was related to workforce reductions. - Implemented a restructuring program which is expected to deliver annualized cost savings of approximately $67 million through: - total workforce reductions of 565; - relocation of the corporate office from Vancouver, B.C. to lower cost premises in Richmond, B.C., and - centralization of certain mill administrative functions in Nanaimo, B.C. - Indefinitely curtailed A4, displacing 134,000 tonnes of the Company's least profitable newsprint production. - Made high-return capital investments totalling $56.5 million, including $8.1 million to facilitate receipt of de-inked pulp ("DIP") in more efficient crumb form at the Crofton mill. - Received a national energy efficiency stewardship award from CIPEC, an organization founded by the federal government in conjunction with business, to promote energy efficiency. - Recognized for environmental and social responsibility programs including: - Launched Catalyst Cooled, a product line whose manufacture results in no net carbon emissions - on which Rolling Stone magazine prints and for which the Company received the Metafore Innovation Award in the products category. - Recognized as the only forest-products company on the Conference Board of Canada's Carbon Disclosure Leadership Index (CDLI), in recognition of transparency regarding emissions and reduction efforts. - Received - "Gift to the Earth" recognition from the WWF, in connection with the conservation and management agreement reached for the Great Bear Rainforest. - Recognized by the United Way (BC Lower Mainland) for 15 consecutive years of "gold level" employee giving, calculated as 80% of an organization's one-day payroll. - Received the Canadian Institute of Chartered Accountants award of excellence for financial and corporate reporting in the forest products category. 1.4 Selected annual financial information ——————————————————- ———————————————————————————————- (In millions of dollars, except where otherwise stated) ———————————————————————————————- 2007 2006 2005 ———————————————————————————————- Sales $ 1,714.6 $ 1,882.5 $ 1,823.9 Operating earnings (loss) (149.4) 3.9 (25.1) EBITDA(1) 27.0 211.0 155.2 EBITDA before specific items(1) 116.7 211.0 161.9 Net earnings (loss) (31.6) (15.9) (25.6) Net earnings (loss) before specific items(1) (89.3) (25.0) (64.6) Total assets 2,453.4 2,637.7 2,695.9 Total long-term liabilities 1,195.4 1,338.6 1,396.8 ———————————————————————————————- EBITDA margin(1,2) 1.6% 11.2% 8.5% EBITDA margin before specific items(1,2) 6.5% 11.2% 8.9% Net earnings (loss) per share (in dollars) - basic and diluted $ (0.15) $ (0.07) $ (0.12) Net earnings (loss) per share before specific items (in dollars) - basic and diluted(1) (0.42) (0.12) (0.30) ———————————————————————————————- Sales (000 tonnes) Specialty paper 1,054.8 990.2 942.9 Newsprint 496.3 699.1 707.1 ——————————————————- Total paper 1,551.1 1,689.3 1,650.0 Pulp 603.2 626.2 603.0 ——————————————————- Total sales 2,154.3 2,315.5 2,253.0 ———————————————————————————————- Production (000 tonnes) Specialty paper 1,055.4 983.7 949.3 Newsprint 472.8 703.7 699.5 ——————————————————- Total paper 1,528.2 1,687.4 1,648.8 Pulp 601.8 624.3 590.9 ——————————————————- Total production 2,130.0 2,311.7 2,239.7 ———————————————————————————————- US$/CDN$ foreign exchange Average spot rate(3) 0.930 0.882 0.825 Period-end spot rate(4) 1.012 0.858 0.858 Effective rate(5) 0.917 0.872 0.807 ———————————————————————————————- Common shares (millions) At period end 214.7 214.6 214.6 Weighted average 214.7 214.6 214.6 ———————————————————————————————- (1) EBITDA, EBITDA before specific items, EBITDA margin, EBITDA margin before specific items, net earnings (loss) before specific items, and net earnings (loss) per share before specific items are non-GAAP measures. Refer to Section 9 "Non-GAAP Measures" for further details. (2) EBITDA margin and EBITDA margin before specific items are defined as EBITDA and EBITDA before specific items, as a percentage of sales and adjusted sales, respectively. Refer to Section 9 "Non-GAAP Measures" for further details. (3) Average spot rate is the average Bank of Canada noon spot rate over the reporting period. (4) Period-end spot rate is the Bank of Canada noon spot rate on December 31. (5) Effective rate represents a blended rate which takes account of the applicable spot rates, the Company's revenue hedging program in the period, and translation of US$-denominated working capital at period opening and closing rates. See Section 8, "Summary of Quarterly Results" for further details. 1.5 Strategy ———— The Company's long-term objective is to achieve higher sustainable earnings and maximize cash flow by strengthening its position as a leading producer of groundwood printing papers, including specialty printing paper grades and newsprint. Key performance drivers ———————————- The Company believes the following key performance drivers are critical to achieving its strategic goals and creating value for its investors. Market position Market position is a significant driver of the Company's success. As one of the largest producers of specialty printing papers in North America, market penetration and diversification is important. The Company's brand names are well recognized in the marketplace and it has built a reputation for reliability, value and service: Product mix In recent years, the Company has expanded the number of grades manufactured in the market. The Company has introduced new product lines which include Electraprime (an "SCA" alternative), Electrastar (a super-brite), Electrabrite Lite (a lightweight hi-brite), Silverliner (a kraft paper whitetop), and Elk Prime (a sawdust-based pulp). These newer and more specialized products generally provide higher margins than standard commodity grades. The Company also manages fluctuations in demand for its products through its ability to switch production capacity between products, particularly newsprint, directory, and machine-finished uncoated mechanical grades. In addition, market pulp, sawdust-based pulp, and white-top linerboard further diversify the product mix. Supply chain Distribution costs have a significant impact on net sales realizations. The Company's strong and flexible distribution network optimizes all transportation modes available to it, such as truck, rail, and container and break-bulk shipping. The mill sites directly ship break bulk paper and pulp to offshore customers via regularly scheduled vessels. The Company operates a central distribution centre in Surrey, B.C. which receives volumes from its four manufacturing sites and then ships via rail, truck and container to its customers. This allows the Company to choose the most cost effective transportation mode in conjunction with customer requirements. The Company leases 980 rail cars to ensure damage free, on time delivery to its rail customers and the Company leases five paper barges which it uses to transport its products to the Surrey distribution centre. Controlling key elements of its supply chain have allowed the Company to achieve a high on time performance and low damage level. Combined with its focus on lowering costs and the reduction of inventory levels, the Company improved its service delivery business processes and further centralized its organization in 2007 to provide cost-efficient and reliable transportation to customers. Cost-competitive manufacturing The Company's manufacturing costs are key to being competitive over the long term, particularly with respect to fibre, energy, and labour costs and the Company is focused on reducing these costs and improving margins. Over the past five years, capital expenditures of approximately $423 million have been directed primarily towards shifting production towards higher-margin printing papers, reducing unit production costs, increasing machine productivity, improving product quality, increasing capacity, and meeting or exceeding environmental regulations. In addition, over the last several years, the Company has developed expertise in the production of lightweight papers. Lower basis weight papers reduce the Company's costs by decreasing fibre, shipping, and storage and handling expenses. Production and capacity utilization The ability to increase production rates and minimize production downtime impacts the Company's per unit cash costs. Over the last several years the Company has been focused on improving machine productivity through several initiatives such as implementing an asset reliability program, operator technical training, and increasing focus on reducing machine dry end losses. These and other initiatives from the Company's Performance Improvement Program have been instrumental in improving machine productivity. Corporate social responsibility Corporate social responsibility is one of the Company's core values. The Company judges success in this area through the safety and well-being of its employees, the vibrancy of its communities, and the sustainability of the Company's practices with respect to their impact on the environment. A complete description of the Company's commitments and progress in corporate social responsibility is provided in the Company's 2007 Sustainability Report, produced concurrently with the Company's 2007 annual report. Key performance indicators ————————————— The Company believes the following key performance indicators are meaningful for measuring the Company's progress in achieving its strategic goals and creating value for investors: Safety The Company's first priority is the well-being of its employees. Key metrics include the medical incident rate ("MIR"), which is the number of incidents requiring medical attention per 200,000 hours worked, and the lost-time injury frequency ("LTI"), which is the number of lost-time injuries per 200,000 hours worked. The Company's overall safety performance declined on these and other key safety measures during 2007. Additional details on 2007 safety results are provided in the Company's 2007 Sustainability Report, produced concurrently with the Company's 2007 annual report. Performance Improvement Program One of the characteristics of the Company's culture is that of engaging its people in projects that challenge the status quo. The Company has for several years aggregated these initiatives on an annual basis into a Performance Improvement Program. Performance improvement initiatives challenge the Company to create innovative and cost-effective business solutions. In 2007, the Company launched its sixth consecutive Performance Improvement Program, which included the 2007 restructuring program. A detailed summary of the 2007 Performance Improvement Program results is available in this section under "Progress on 2007 Strategic Initiatives". EBITDA and EBITDA before specific items EBITDA and EBITDA before specific items are widely used in the financial community to compare the profitability of corporations, and are used by management as an indicator of relative operating performance. Further analysis and discussion of these indicators are provided in all discussions of operations and in the "Non-GAAP Measures" section. Average sales revenue per tonne Average sales revenue per tonne for each core business provides key insights into how the Company maximizes its market position and product mix. The main factors in revenue growth are U.S. dollar transaction prices, and the relationship between the Canadian and U.S. dollar. Details on 2007 results are provided in the "Segmented Results - Annual" and "Segmented results - Quarterly" sections. Average delivered cash costs per tonne and average delivered cash costs per tonne before specific items Reducing cash costs while maintaining product quality is essential to sustaining profitability in each of the Company's core businesses. The Company continually examines all areas of its business for cost reduction opportunities. Details on 2007 results are provided in the "Segmented Results - Annual" and "Segmented Results - Quarterly" sections. Free cash flow Free cash flow is a measure of cash that is generated by operations and available after capital expenditures, but before changes in working capital items and proceeds from divested assets. Further analysis and discussion of this indicator is provided in the "Non-GAAP Measures" section. Leverage and interest coverage The Company's success also depends on its liquidity and continued ability to finance its growth. The Company focuses on total-debt to total-capitalization, net-debt to net- capitalization, net-debt to EBITDA, and EBITDA to interest ratios in order to assess its debt position. Further analysis and discussion of these indicators are provided in the "Liquidity and Capital Resources" section. Greenhouse gas emissions ("GHG") The Company takes its environmental compliance seriously and focuses on continuous improvement of its performance through operational efficiency and process innovation. The Company has achieved a 69% absolute and intensity reduction of GHGs since 1990 (as measured by direct emissions), and management believes the Company is well positioned to meet emerging regulatory objectives and market expectations. The Company received third- party recognition for the transparency and depth of its reporting on greenhouse gases in 2007, and launched a manufactured carbon-neutral product line. Further details are provided in the Company's 2007 Sustainability Report, produced concurrently with the Company's 2007 annual report. Progress on 2007 strategic initiatives ——————————————————— (a) Performance Improvement Program ———————————————- The Company's achievements relating to specific performance improvements in 2007, 2006, and 2005 were as follows: ———————————————————————————————- Performance Improvement Program Initiatives ———————————————————————————————- (All amounts are pre-tax 2007 2006 2005 and in millions of dollars) Realized Realized Realized ———————————————————————————————- Workforce reduction $ 29 $ - $ - Product, grade, and customer optimization 21 11 19 Productivity improvements 6 20 - Reduce energy consumption 6 12 10 Furnish costs 5 12 12 Optimize chemical usage 2 5 4 Other 12 14 39 ———————————————————————————————- Total Performance Improvement Program $ 81 $ 74 $ 84 ———————————————————————————————- Early in 2007, the Company commenced its sixth consecutive annual Performance Improvement Program. Improvements were targeted in the areas of workforce reductions, product, grade, and customer optimization, and other cost reduction initiatives. In 2007, the program delivered $81 million in realized improvements by the following means: Workforce reduction Workforce reductions related to the 2007 restructuring program resulted in savings of $29 million. The Company reduced its workforce positions from 3,673 on January 1, 2007 to 3,038 on January 1, 2008. The reduction to date includes 551, or 98%, of the 565 positions targeted for elimination, in addition to employees laid off as a result of the indefinite closure of the A4 paper machine. Product, grade, and customer optimization This strategic initiative involved the marketing of higher-value specialty printing paper products, allowing margin optimization compared to standard grades. In 2007, the Company realized EBITDA improvements of $21 million as a result of its various product, grade, and customer optimization initiatives. Sales of Electraprime were of particular relevance in 2007. This is a soft-calendered high-brite paper grade designed to compete as an alternative to SC-A grades and is used primarily for advertising flyers, inserts and direct mail. It continued to be well received in the market with sales of approximately 125,000 tonnes in 2007, an improvement of approximately 22,000 tonnes, or 21%, from 2006. Electraprime was introduced to the market in 2003 and the Company intends to continue growing this business. In addition the Company sold approximately 57,200 tonnes of additional directory paper in 2007 versus 2006 and reduced newsprint volume to take advantage of stronger directory pricing and weaker newsprint pricing in 2007. Productivity Improvements The Company's productivity improvement initiatives in 2007 were focused mainly on increasing asset reliability, improving machine speed and efficiency by cutting operating and maintenance-related downtime, and reducing dry-end paper losses. These and other initiatives resulted in savings of $6 million in 2007. Reduce energy consumption The Company is a significant consumer of electrical energy. The Company focused on a number of electrical energy initiatives that reduced overall electrical consumption which included a demand management program with B.C. Hydro. This and other energy reduction initiatives resulted in savings of $6 million in 2007. Furnish costs The Company continued to optimize its furnish mix during the year by substituting lower-cost furnishes. These and other initiatives resulted in savings of $5 million in 2007. Optimize chemical usage The Company had a number of initiatives to reduce the usage and costs of bleaching and additive chemicals during the year. These and other initiatives resulted in savings of $2 million in 2007. Other The Company also completed a series of smaller initiatives, primarily with respect to freight, procurement improvements and its maintenance practices. Approximately $12 million in savings were realized as a result of these initiatives. (b) Other strategic initiatives —————————————- Preferred supplier Quality initiatives In 2007, the Company focused further on advancing its preferred supplier status with key customers by continuing to improve the consistency, runnability and reliability of its products, and its on-time delivery service. As a result, the Company was able to maintain low quality claims in 2007. Catalyst Cooled In 2007, the Company launched "Catalyst Cooled", a product line whose manufacture results in no net carbon emissions - on which Rolling Stone magazine prints. The product is designed for customers who do not want their paper to contribute to carbon emissions. The Company intends to keep growing this product. Chain-of-custody certification The Company has implemented an "independent chain-of-custody" system to certify its wood fibre supply. The PricewaterhouseCoopers standard is a third-party audited system that verifies fibre is derived from a forest managed in accordance with the requirements of a major sustainability certification program. The independent chain-of-custody system tracks the fibre from source to finished product and provides a valuable tool to assure customers that paper contains fibre originating from well-managed forests. It is expected to continue to result in additional sales opportunities. 1.6 Consolidated results of operations ————————————————— Year ended December 31, 2007 compared to year ended December 31, 2006 —————————————————————————- Sales ——- Sales in 2007 decreased $167.9 million, or 8.9%. The decline in sales was due to lower sales volumes due to curtailment relating to the USW strike and curtailment of the A4 paper machine in September 2007, the strong Canadian dollar, and lower transaction prices across most paper grades, particularly newsprint and LWC. The decrease in sales was partially offset by the positive impact of average transaction prices for pulp and a more favourable product mix. The following table highlights the factors that affected the Company's sales by segment: ————————————————————————————————————- Sales ($ millions) ————————————————————————————————————- Year ended Increase (decrease) from December 31, 2006 as a result of —————————————— —————————————————- Total 2007 2006 change Volume(1) Price Mix F/X —————————————— —————————————————————— Specialty paper $ 919.6 $ 918.4 $ 1.2 $ 61.8 $ (21.4) $ 4.8 $ (44.0) Newsprint 338.0 529.8 (191.8) (154.6) (29.0) 3.1 (11.3) —————————————— —————————————————————— Total paper 1,257.6 1,448.2 (190.6) (92.8) (50.4) 7.9 (55.3) Pulp 457.0 434.3 22.7 (16.0) 58.7 1.8 (21.8) —————————————— —————————————————————— Total $1,714.6 $1,882.5 $(167.9) $(108.8) $ 8.3 $ 9.7 $ (77.1) —————————————— —————————————————————— (1) Decrease in volume is due to curtailment of certain assets in the third and fourth quarters related to the USW strike and curtailment of the A4 paper machine effective September 1, 2007. EBITDA ——— EBITDA before specific items was $116.7 million, a decrease of $94.3 million in 2007 compared to 2006. The negative impact of higher fibre costs, weaker newsprint and LWC prices, inflation, and the stronger Canadian dollar, more than offset higher transaction prices for pulp products, and the realization of benefits from the Performance Improvement Program. Including the impact of restructuring and change-of-control costs, and USW strike related costs, EBITDA decreased $184.0 million in 2007 compared to 2006. The following table summarizes the key changes in EBITDA from the year ended December 31, 2006 to year ended December 31, 2007: EBITDA Reconciliation 2007 v 2006 EBITDA Before Specific ($millions) EBITDA(2) Items(2) ———-
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