Fletcher Challenge - Consolidated Group Result

CONSOLIDATED GROUP
RESULTS ANNOUNCEMENT AND OPERATING REVIEW
Year ended 30 June 2000

FINANCIAL SUMMARY Year ended Year ended
June 2000 June 1999
NZ$ m NZ$ m

Operating Revenue 7,908 7,743
Operating Earnings (EBIT)
Including Unusual Items 892 445
Excluding Unusual Items 942 396

Net Earnings
Including Net Unusual Items 382 101
Excluding Net Unusual Items 367 121

Cash Flow from Operations 1,560 1,223

Debt to Total Capitalisation (%) 28.5 35.1
Interest Coverage (times)
Including Net Unusual Items 3.66 2.02
Excluding Net Unusual Items 3.86 1.80

Note: All currency amounts are NZD, unless otherwise stated.

FINANCIAL RESULTS

A near four-fold increase in consolidated Group net earnings, to $382 million, has been achieved for the year to June 2000. Net earnings from continuing operations (excluding the earnings of Fletcher Challenge Paper sold to Norske Skog on 28 July 2000) were $416 million compared with $95 million in the year to June 1999. Excluding net unusual items, consolidated Group net earnings were $367 million, compared with $121 million in the previous year.

Unusual items, net of taxation and minority interest, amounted to a gain of $15 million. Major positive contributions were: gains relating to the sale of Natural Gas Corporation ($113 million), receipt of the Chilean forest fire insurance proceeds ($11 million), sale of the turbine marketing rights for the Capstone Turbine Corporation ($61 million) and the release of a previously unrecognised taxation benefit following the settlement of the Forests Distribution In Specie case with the Inland Revenue Department ($93 million).

Major negative unusual items included: a loss on the sale of the Tasman Eucalypt Forests Estate ($10 million), restructuring costs relating to the proposed merger of Fletcher Challenge Paper and Fletcher Challenge Canada ($10 million), costs associated with the separation of the Fletcher Challenge targeted share structure ($23 million), a write-off following the reorganisation of the Employee Educational Fund ($116 million), costs associated with the Fletcher Challenge South American Paper Restructure ($32 million), permanent impairment relating to Fletcher Challenge Building’s Fijian operations and non-core Fletcher Challenge Energy assets ($30 million), and a write-down in the carrying value of the Central North Island Forest Partnership ($42 million).

Group operating earnings (EBIT) doubled from $445 million in June 1999 to $892 million in the June 2000 period. Excluding unusual items, EBIT for the year was $942 million, which represents the best result for Fletcher Challenge Limited in the past 10 years. EBIT (excluding unusual items) for the six months to June 2000 was $577 million, a 58 per cent increase on the six months to December 1999.

The ratio of debt to total capitalisation improved significantly from the 35.1 per cent recorded in June 1999 to 28.5 per cent as free cash flow was applied to debt reduction, and represents the lowest ratio the Group has recorded in more than a decade. The ratio of debt to total capitalisation was also improved by the inclusion in the revaluation reserve ($730 million) of the 30 June 2000 market value of Fletcher Challenge’s investment in Capstone Turbine Corporation in accordance with US GAAP. Subsequent to balance date the disposal of Fletcher Challenge Paper to Norske Skog further reduces the ratio, based on the 30 June 2000 financial position, to 21.6 per cent.

Interest coverage (operating earnings divided by funding costs) increased from 2.02 times in June 1999 to 3.66 times this period. Excluding unusual items, the increase was more than double, to 3.86 times (compared with 1.80 times in June 1999).

The divisional breakdown of net earnings was:

Excluding Unusual Items Including Unusual Items
Year Ended Year Ended Year Ended Year Ended
June 2000 June 1999 June 2000 June 1999
NZ$ m NZ$ m NZ$ m NZ$ m

106 72 Fletcher Challenge Building 63 23
162 27 Fletcher Challenge Energy 261 55
23 6 Fletcher Challenge Forests 81 55
65 7 Fletcher Challenge Paper (34) 6
11 9 Consolidation Adjustment 11 (38)
367 121 Total 382 101
15 (20) Unusual Items
382 101 Consolidated Net Earnings 382 101

DIVIDENDS

Unless the separation process results in a third party sale recommendation, the Directors intend that Fletcher Challenge Building and Fletcher Challenge Energy will declare a final dividend of 8 cents per share and 10 cents per share respectively (record date 29 September 2000). This will bring the total dividend for the year for Fletcher Building to 16 cents per share (an increase of 33 per cent over the prior year) and will bring the total dividend for the year for Fletcher Challenge Energy to 18 cents per share, an increase of 29 per cent. Consistent with past periods, no dividend has been recommended for Fletcher Challenge Forests.

OPERATING PERFORMANCE

Detailed reports of operations within each Division are contained in the separate announcements of Building, Energy, and Forests.

Fletcher Challenge Building recorded net earnings (excluding a $43 million net in unusual losses) of $106 million, up from $72 million in the previous year. The result reflected higher earnings from operations, as cost reductions and productivity improvements combined with robust New Zealand market conditions.

The woodpanels operations delivered a very strong result, taking operating earnings to $11 million compared with a $3 million loss last year. Steel businesses recorded operating earnings of $29 million compared with $8 million a year earlier. In parts of South America, severe economic contraction impacted on operations there, producing disappointing results.

For Fletcher Challenge Energy, a strong commodity price environment and near record production levels contributed to net earnings of $162 million excluding net unusual items ($27 million previously). Gross operating revenues increased 31 per cent to $1,564 million. The strength of the West Texas Intermediate (WTI) oil price and narrow differentials between Canadian heavy oil and WTI enabled both New Zealand and Canadian oil production to benefit from the commodity price improvements.

High gas demand in New Zealand contributed to a 13 per cent increase in volume, to a record 129.2 bcf. This was accompanied by lower condensate levels as the key reservoirs mature, and the condensate-to-gas ratio reduces.

The rollout of the Challenge retail stations in New Zealand continued strongly, reaching 98 branded stations, three times the number of a year ago. A 17,000 tonne oil products terminal, opened in October 1999 in Timaru, formed the beachhead for growth in the South Island.

Fletcher Challenge Forests’ net earnings excluding unusual items increased 92 per cent to $23 million, from $12 million (excluding unusual and non-recurring items) in the previous year. Manufactured product sales increased to 53 per cent of sales and 43 per cent of operating earnings (before unusual items) as stronger demand, improving prices, and effective branding combined to improve results in several markets.

The launch of the Origin brand range of products in North America, initially Origin Project Panels and Origin Project Boards, contributed to a 17 per cent increase in sales revenues in this market. Ramsey Roundwood, marketing the Origin Outdoor range of products, increased sales by 43 per cent, mostly in pole exports to Asia, and posts for the vineyard industry.
Modest investment in capital equipment continued, with new kiln capacity installed to meet strong demand from the consumer shift to machine stress-graded kiln-dried construction lumber.

Log markets continued their recovery with firmer demand across most geographies. Prices for indicator grades for Asian markets (A-grade to Japan, K-grade to Korea) averaged 9-11 per cent higher in New Zealand dollars, compared with the previous year.

Fletcher Challenge Paper recorded net earnings (excluding net unusual items) of $65 million, up from $7 million the previous year. The result reflected gains in pricing that had been achieved in pulp as well as the continued strong trading results from the southern hemisphere newsprint operations.

STRATEGIC HIGHLIGHTS

Key strategic initiatives during the year were focused on the sale of Fletcher Challenge Paper and the Board’s announcement in December 1999 that it would pursue the full dismantling of Fletcher Challenge’s targeted share structure.

The sale of Fletcher Challenge Paper to the Norwegian producer, Norske Skog, was completed on 28 July 2000. Shareholders received $2.50 for each Fletcher Challenge Paper share, and control of operations in New Zealand, Australia, Canada, South America, and Malaysia passed to Norske Skog on 28 July.

Fletcher Challenge Building generated $30 million of cash flow from divestments in the period. In China, the Xinda steel plant in Shanxi province was sold, completing the exit from this operation, and Fletcher Pacific was sold as a going concern, finalising involvement in construction in the USA.

A total of $115 million was invested in capital expenditure. This included the acquisition of minority interests in Bolivia, bringing all South American activities to 100 per cent ownership. In market development activity, the introduction of new premium products and growth in export sales helped to capture increased sales volumes for Pacific Coilcoaters, and higher margin performance boards now represent an increasing portion of Winstone Wallboards’ sales. Technological innovations such as new roller compaction at Humes pipes, and the Mode concrete housing strategy at Firth will underpin ongoing performance.

With a slowing in demand for residential construction, non-residential work remains important, and a backlog of $565 million, plus additional projects won since balance date, indicate a positive environment for Fletcher Challenge Building’s construction activities.

Drilling of the Pohokura prospect by Fletcher Challenge Energy confirmed a major gas condensate discovery off the coast of Taranaki, the largest in New Zealand since the Maui find some 30 years ago. As the operator and holder of a 33 per cent equity interest, Fletcher Challenge Energy sees Pohokura as an important focus for growth in New Zealand.

Disposal of its interest in Natural Gas Corporation for a gain of $113 million strengthened the focus of Fletcher Challenge Energy as an oil and gas exploration and production company. This will be further enhanced with the agreement, completed just after year end, to take an equity interest in the operations of the Australian explorer, Petroz NL.

As the largest shareholder in Capstone Turbine Corporation, Fletcher Challenge Energy had its investment revalued to $781 million following the successful IPO of Capstone in late June 2000.

Debt levels in Fletcher Challenge Energy have been reduced significantly following the sale of non-core assets and released debt obligations totalling just under $500 million during the past 18 months. The Division is now positioned to pursue its commitment to growth, through reserves and production, as well as stronger cash flow and profitability.

This year the joint-venture entity, ArborGen, was established as the global vehicle for advancing Fletcher Challenge Forests’ ongoing development and commercialisation of tree seedlings which improve productivity and downstream costs. The involvement of Westvaco and International Paper, as well as Genesis Research & Development, will accelerate activity in this area through pooling of both resources and intellectual capital.

Distribution of repair and remodelling finishing products through DIY chains in North America was strengthened through acquisition of a one-third share in The Empire Company, a key supplier in the field. In New Zealand, the establishment of Woodlink has created a substantial trading presence in third-party processed wood products.

The development and launch of the Origin I-beam utilised the vertical integration of Fletcher Challenge Forests, and brought together different parts of the forest output to create a premium product for the domestic construction market.

Fletcher Challenge Forests has now completed the process of seeking certification by the international Forest Stewardship Council (FSC) for the management of its forest estate, and an outcome is expected early in the new financial year. Achievement of an eco-label verification is an important strategic move, especially for the North American market.

FINANCIAL POSITION AND LIQUIDITY

Cash generated from operations during the June 2000 period was $1,560 million compared with $1,223 million in the previous year. Cashflow from operations in the second six months to June 2000 was $870 million, compared with $690 million in the first six months.

The divisional breakdown of cash flow from operations was:

Year ended
June 2000
NZ$ m Year ended
June 1999
NZ$ m

Fletcher Challenge Building
Fletcher Challenge Energy
Fletcher Challenge Forests
Fletcher Challenge Paper
Consolidation Adjustment

172
640
127
565
56
142
512
122
383
64

Consolidated Cash Flow from Operations 1,560 1,223

Capital expenditure for the period totalled $816 million, considerably lower than the $1,269 million in the previous period. Offsetting the expenditure were divestments totalling $569 million, including the remaining interest in Natural Gas Corporation ($268 million), deferred settlement relating to the sale of the South American Forests ($84 million), the remaining receipts from the Gold River newsprint machine ($33 million), and the sale of the Tasman Eucalypt Forests Estate ($43 million).

Group equity and capital funds totalled $9,431 million at 30 June 2000, compared with $7,451 million at 30 June 1999. The main increases were from net earnings ($382 million), an increase in reported capital ($119 million) due primarily to the reorganisation of the Employee Educational Fund, an increase in reserves arising from currency translation variations ($708 million), an increase of $714 million relating to the revaluation of investments (primarily the investment in Capstone Turbine Corporation) and an increase in minority equity ($266 million). Offsetting these increases was a reduction in capital funds ($56 million) and dividends and distributions ($153 million).

The Group maintains a policy of holding its assets and matching debt in the dominant functional currency of the business units. During the year the New Zealand dollar weakened against the United States dollar (by 13 per cent, from $0.5286 to $0.4686). As a result, on translation for reporting purposes from the functional currency, both asset and debt values in New Zealand dollars increased, with the net variation being an increase in reserves of $708 million.

Net interest-bearing debt was $3,763 million, down from $4,022 million at 30 June 1999. Excluding currency movements, the reduction in net interest-bearing debt was $701 million. Subsequent to balance date, and following the sale of Fletcher Challenge Paper to Norske Skog, net interest-bearing debt of Fletcher Challenge was further reduced. Based on the 30 June 2000 financial position, the sale would have reduced net interest-bearing debt of the Fletcher Challenge Group from $3.8 billion to $1.5 billion and improved the debt to total capitalisation ratio from 28.5 per cent to 21.6 per cent.

Cash coverage of gross interest (operating cashflow excluding funding costs, divided by funding costs plus capitalised interest) rose to 5.04 times compared with 4.02 times in the previous period. Cash coverage of net interest (operating cashflow excluding funding costs, divided by funding costs) was 7.39 times, compared with 6.56 times for the 12 months to June 1999.

PRODUCTIVITY IMPROVEMENTS

A series of initiatives have been implemented this year which have significantly improved the productivity of operations in each Division.

In Fletcher Challenge Building, implementation of procurement and information technology infrastructures has been achieved across the businesses to ensure the improvements captured in the Fletcher Challenge Group procurement initiative are confirmed. Installation of a new press for Fletcher Woodpanels in Australia will increase ability to service customers in this market, while amalgamation of Fletcher Aluminium’s production capacity in Auckland will provide cost benefits in the future. Lower unit costs in cement and concrete provided the platform for the improved performance in Concrete sector activities.

Diversification of the exploration portfolio of Fletcher Challenge Energy is being achieved through exit of higher-cost properties in Canada, and acquisition of higher-margin properties with a specific emphasis on gas. In Brunei, increasing asset utilisation in the non-operated Maharaja Lela field is a key feature of the objective of managing unit costs and improving unit production margins by 20 to 30 per cent.

In Fletcher Challenge Forests, Project MaX continued to deliver improvements in productivity and cost reduction, as the last site involved completed the process. An ongoing productivity champion process is designed to ensure the emphasis remains and the gains are continued.

We have also continued to invest modest amounts of capital to sustain incremental operational improvements. The immediate impact of these improvements is best reflected in the 14 per cent increase in production across our managed operations, compared with the previous year. At the same time, reported lost time injuries reduced to an industry-leading level of 8.8 per million hours worked.

FLETCHER CHALLENGE SEPARATION PROGRAMME

On 3 April 2000, the first major step in the dismantling of the Group’s targeted share structure took place with the announcement of the agreement to sell Fletcher Challenge Paper to Norske Skogindustrier ASA. The Transaction was subsequently approved by shareholders and the sale successfully completed on 28 July 2000.

Good progress is being made on the separation proposals for the three remaining Divisions - Building, Energy and Forests. A full range of options for each Division is being explored, including listings as separate “stand-alone” companies or sale to third parties.

The Board remains committed to delivering the best value outcomes in the separation process, and will keep shareholders informed of progress.

OUTLOOK

Productivity improvements and consolidation of operations within Fletcher Challenge Building have positioned the New Zealand business units to take advantage of a continuing firmness in non-residential building construction. This is supported by a significant number of major infrastructure and commercial projects; increased government spending, particularly in the hospital sector, and strong growth in rural and manufacturing sectors of the economy. Residential construction has slowed, and is unlikely to resume a growth trend until late in the fiscal year. In South America the Peruvian economy is showing clear signs of recovery. Bolivia remains depressed. Strong market positions in New Zealand coupled with a tight focus on operational performance and a commitment to product innovation should enable this Division to continue to deliver sound results.

Sound fundamentals underpin a continued positive outlook for Fletcher Challenge Energy. Oil prices remain at high levels with OPEC demonstrating considerable resolve to keep prices strong. In North America gas prices are trading near record post-deregulation levels. The strategy to aggressively grow gas production in Canada has positioned the company to take advantage of these levels.

Fletcher Challenge Forests may also be impacted by a reduction in residential building activity in New Zealand in the coming year. In the United States, demand for higher value products for the repair and remodelling market is expected to remain steady. Economic activity in Asia is still recovering, and although demand for lower-value products is stronger, prices remain soft, and are expected to improve only slowly. Product innovation and continuing improvements in operational performance will drive the shorter-term outlook.

Comments in the Outlook section, about anticipated market conditions, are forward looking and are made pursuant to the safe harbour provisions of the US Private Securities Litigation Reform Act of 1995. Refer to the separate announcements for each of the three divisions for an explanation of the factors that could cause actual results to differ materially from those expressed in this section.

DIVIDEND SUMMARY

Unless the separation process results in a third party sale recommendation, the Directors intend that Fletcher Challenge Building and Fletcher Challenge Energy will declare a final dividend of 8 cents per share and 10 cents per share respectively (record date 29 September 2000). If the dividends are declared and paid it will bring the total dividend for the year to 16 cents per share and 18 cents per share for Fletcher Challenge Building and Fletcher Challenge Energy respectively.

Dividend Information (if declared) Building Energy Forests
NZ cents per share

New Zealand resident shareholder
(plus DWP credits) (if declared) 8.0000 10.0000 Nil
Non-resident shareholder 8.0000 10.0000 Nil
Conduit Tax Relief Additional Dividend 3.9403 4.9254
11.9403 14.9254
Less 15% Non-resident Withholding Tax 1.7910 2.2388
Net Dividend for Non-resident Shareholder
(if declared) 10.1493 12.6866

American Depository Receipt Holder (ADR)
(if declared) 101.493 126.866 Nil

As individual shareholders’ circumstances may differ, the above New Zealand Tax and Non- resident Withholding Tax calculations are a guide only.

If a dividend is declared:
Shares quoted cum dividend on New Zealand Stock Exchange until close of business on 29 September 2000. Dividend entitlement date: 29 September 2000. Payment date: 12 October 2000.

Shares quoted cum dividend on Australian Stock Exchange until close of business on 25 September 2000. Dividend entitlement date: 29 September 2000. Payment date: 12 October 2000.

ADRs quoted cum dividend on New York Stock Exchange until close of business on 26 September 2000. Dividend entitlement date: 29 September 2000. Payment date: 13 October 2000.

DIVIDEND PROCEDURE

Resident shareholders have their dividends fully credited with Dividend Withholding Payment credits. Dividends paid to non-resident shareholders are credited with Conduit Tax Relief (“CTR”) credits. Non-resident shareholders receive an additional dividend equal to the amount of the CTR credits attached to their ordinary dividends. The additional dividends are paid at the same time as the ordinary dividends. Both the additional dividends and the ordinary dividends are subject to 15 per cent New Zealand non-resident withholding tax.

Resident shareholders are not eligible to receive CTR credits.

Payment date is 12 October 2000 and for American Depository Receipt holders, 13 October 2000.

DIVIDEND REINVESTMENT PLAN

Fletcher Challenge Limited has a Dividend Reinvestment Plan (DRP) for holders of Fletcher Challenge Building Shares and Fletcher Challenge Energy Shares.

Shareholders are given the opportunity to reinvest their dividend in additional shares of the specific Division. The prices at which shares will be issued will be the weighted average selling prices of the relevant shares sold on the New Zealand Stock Exchange for the five business days immediately following 29 September 2000.
The last date for receipt of election notices for the DRP is 29 September 2000.
Shareholder Statements for DRP Shares will be despatched on 12 October 2000.

Fletcher Challenge Limited also has a DRP for American Depository Receipt (ADR) holders in respect of Fletcher Challenge Building ADRs and Fletcher Challenge Energy ADRs.

ADR holders are given the opportunity to reinvest their dividend in additional ADRs of the specific Division. The prices at which shares will be converted into additional ADRs will be the weighted average selling prices of the relevant shares sold on the New Zealand Stock Exchange for the five business days immediately following 29 September 2000.

The last date for receipt of election notices for the ADR DRP is 27 September 2000.

Details on the Fletcher Challenge Group and its operations in the year ended 30 June 2000 can be viewed at the company’s World Wide Web site, at http://www.fcl.co.nz

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