Fletcher Challenge Forestry - Financial Results

FINANCIAL RESULTS
YEAR ENDED 30 JUNE, 2000

Results Overview

 Net earnings of NZ$81 million, an increase of 47% over the NZ$55 million last year. The current year result includes net unusual items totalling NZ$58 million primarily from the recognition of taxation benefits less a forest write down.
 Net earnings (excluding unusual items) of NZ$23 million, nearly double the NZ$12 million (excluding unusual and non-recurring items) in the previous year.
 Total revenue increases 14% to NZ$623 million.
 Strong product demand boosts manufacturing results – revenues up 16% to NZ$308 million, and operating earnings (EBIT) excluding unusual items up 58%.
 Export log markets are steady, with some recovery in prices.
 New Origin™ branded products launched in the New Zealand and the United States markets.

Results (NZ$ million)
Year Ended: June 2000 June 1999 June 1998
Operating Revenue 623 545 487
Operating Earnings (EBIT) 77 132 48
Net Earnings 81 55 (15)
Cash Flow from Operations 127 122 118

2000 Dividend

There is no 2000 final dividend for Fletcher Challenge Forests shareholders.

Stock Exchange Listings: New Zealand (FFS), Australia (FLCFS), New York (FFS)

Chief Executive’s Review

Net earnings were $23 million (excluding unusual items) compared with the previous year's $12 million (excluding unusual and non-recurring items). Earnings for the second half of the year exceeded those for the first six months by a considerable margin ($19 million compared with $4 million) and represent a considerable improvement over earnings for the second half of last year ($9 million). Unusual items, primarily the release of previously unrecognised taxation benefits, less a write down of the value of our investments in the Central North Island Forest Partnership, increased net earnings by $58 million to $81 million.

Asia's continuing economic recovery has played a part in this improvement, providing a lift to the global wood markets and to prices compared to the previous year. But it is more revealing to examine our performance in terms of what we are able to control and influence more directly: productivity and efficiency, market development, customer service strategies - and the evolution of our Origin brand.

The collective impact of these strategies is best illustrated by the growth in manufacturing to 53% of sales and 43% of operating earnings before unusual items.

In North America we increased exports to our 50% owned principal distributor (American Wood Moulding), and also acquired a one-third share of a complementary distribution company (The Empire Company). As a direct result, our Taupo mouldings plant increased production by 22% and the total managed sales revenue of our North American business unit increased by 17%. Ongoing innovation will deliver additional strategies to tap the enormous potential of the US market. There are many opportunities in other sectors of the US market where Radiata has not before been considered an option.

Our focus on innovative wood solutions has created new products such as the engineered Origin I-beam manufactured at our Mount Maunganui plywood plant. Geared specifically for the New Zealand and Australian building industry, the I-beam is a combination of plywood and finger-jointed flanges.

Products like the I-beam carry the Origin brand, which market research shows has now achieved a major presence in the New Zealand and Australian markets. The brand has also just been launched in the North American market. Its guarantee of quality, innovation and service will take on an additional dimension with environmental certification, which we anticipate will be achieved in the next few months.

Following two years of major adjustments to the organisation's operational infrastructure, we have spent the past 12 months cementing the changes. SAP, the enterprise resource planning system installed throughout our processing plants in the last 24 months, has begun to provide substantial operational improvements.

We have also continued to invest modest amounts of capital to sustain incremental operational improvements. The immediate impact of these improvements is reflected in the 14% increase in production across our managed processing operations, compared with the previous year.

This year the joint venture ArborGen was established as the global vehicle for advancing our biotechnology programme for the development and commercialisation of tree seedlings which improve productivity and reduce downstream manufacturing costs. In New Zealand, the trading organisation Woodlink was established to develop a substantial trading presence in third-party processed wood products.
The developments outlined above represent an organisation in good health, with a strong market focus and excellent prospects. To optimise those prospects, there are two important issues to be resolved. These are the separation of Fletcher Challenge Forests from Fletcher Challenge’s targeted share structure, and the settlement of the dispute with CITIC New Zealand Limited (our 50% partner in the Central North Island Forest Partnership).

Another issue which arises if the Forests Division is separated as a stand-alone entity, is the appropriate level of consolidated and look-through gearing. This is being addressed as part of the evaluation of separation options.

In June this year, Paul Fowler, the Chief Executive since 1996, left the organisation. Paul has led Fletcher Challenge Forests through very challenging times and he was instrumental in our evolution to a market-led organisation. Safety in the workplace was a particular focus of Paul’s and the dramatic improvements in our performance in this area are testimony to this leadership. Paul can feel very proud of what the Fletcher Challenge Forests team has accomplished during his tenure and we express our thanks for his considerable contribution.

Results Summary: Trading results in the second half of our financial year to June have showed a steady improvement over the first half. This can be attributed to increased sales and operational gains, as well as an improvement in the overall state of the markets.

Net earnings excluding unusual items for the year to 30 June 2000 were $23 million, a 92% increase on the $12 million (excluding unusual and non-recurring items) recorded in the previous year. The comparative figure also includes earnings of $3 million relating to the Chilean forests which were sold at the end of last year. Net earnings excluding unusual items were $19 million in the second half of the year compared with $4 million in the first half.

Unusual items increased net earnings by $58 million to $81 million compared with $55 million in the previous year. The net unusual items (after taxation) were primarily insurance proceeds of $11 million, following final settlement of the Chile fire claim from 1998, a taxation benefit of $93 million due to the release of previously unrecognised taxation benefits, less a write down of $42 million ($62 million pre-tax) for our share of an expected shortfall in the realisable value of some forests within the Central North Island Forest Partnership (the Partnership). The taxation benefit of $93 million follows a Court of Appeal decision in Fletcher Challenge Forests’ favour which confirms a higher forest cost basis for taxation purposes. The Partnership write down is primarily the result of the continuation of weak Douglas fir pricing in the Japanese market against expectations, leading to a reduction in future price expectations. In the previous year net unusuals included a gain on the sale of the Chile forests ($108 million) less write downs of the Partnership forest and other assets ($59 million) and non-recurring charges of $6 million, totalling $43 million.

The current period result includes a net after tax operating loss, excluding unusual items, of $22 million from Fletcher Challenge Forests’ interest in the Partnership compared to a $26 million loss in the previous year. The loss was $8 million in the second half of the year, an improvement on the $14 million loss in the first half.
While prices and margins in the Partnership have improved, they are not yet back to the level necessary to cover the high depletion charges based on the price paid by the Partnership for forests in 1996 - a time when the near-term outlook was strong.

Cash flow from operations rose by 19% to $127 million compared with $107 million in the previous year (excluding Chile).

Trading Results: Operating revenue grew substantially to a record $623 million this period, from $545 million in the previous year.

The success of our growth strategies in target markets in New Zealand, Australia, Japan and North America is demonstrated by a 16% increase in processing and distribution revenue to $308 million, compared with $266 million last year. Strong housing markets in the first half of the year in New Zealand and the US provided a good base, although demand did ease in both countries in the second half of the year. Average price realisations increased 9% partly as a result of a higher value product mix.

Processing and distribution consolidated revenue from North America rose 11% to $109 million, which represents 35% of manufactured product sales. During the year we expanded our customer base and distribution infrastructure in North America.

New Zealand is our major market for manufactured product at 48% of sales. This year saw a sharp cycle in building activity, with record growth in house construction in the first half, followed by a much softer second half. Throughout this period the reputation of our Origin branded products has continued to grow.

The Australian and Japanese housing markets both provided 6% of manufacturing sales.

The total volume of processed product sales from all managed operations, including associates, reached 954,000 cubic metres, a 14% increase over last year. The volume from the Fletcher Challenge Forests consolidated operations was up 6% to 612,000 cubic metres compared with 575,000 cubic metres in the previous year. Of this total, remanufactured products, such as finished mouldings and laminated posts, comprised 16% or 95,000 cubic metres.

Revenue from New Zealand Forests rose 30% to $315 million compared to $243 million in the previous year. A 21% increase in the volume of sales from our third party trading activities was the main driver. Prices for the indicator grades for Asian log demand (A grade to Japan and K grade to Korea) averaged 9-11% higher in New Zealand dollars than last year, with approximately half this movement being due to the exchange rate.

New Zealand Forests revenue also includes $42 million in accrued interest income on loans to the Partnership, compared with $34 million in the previous year.

Revenue from the Partnership (which is not consolidated) was $475 million, an increase of 10% over the previous year. Harvested volumes were relatively stable so the increase relates to log price movements as discussed above and to the growth in manufactured product sales, which rose 36% year on year to 279,000 cubic metres. This is reward for a major focus on productivity at the Partnership’s manufacturing plants, combined with the marketing strategies which have created the demand.

External log and chip sales from all sources were 7.1 million cubic metres, compared with 6.8 million cubic metres (excluding Chile) in the previous year, with the increase coming from third party supply.

Operating Earnings: Operating earnings before interest, tax, depreciation and depletions (EBITD), excluding unusual and non-recurring items, were $138 million compared with $120 million in the previous year (excluding Chile).

Processing and distribution EBITD rose 34% from $29 million in the previous year (excluding unusual items) to $39 million. Higher volumes and lower manufacturing costs both contributed to the improvement.

EBITD excluding unusual and non-recurring items for New Zealand Forests was $99 million, a 9% increase compared with the $91 million in the previous year. The sales volume from the Fletcher Challenge Forests’ estate remained at 1.6 million cubic metres. The benefit of slightly higher prices was partially offset by pressure on harvesting and transport costs due to higher fuel prices and the more difficult terrain being harvested this year.

Operating earnings before interest and tax (EBIT), excluding unusual and non-recurring items, were $70 million compared to $55 million in the previous year (excluding Chile). Processing and distribution EBIT rose 58% from $19 million to $30 million, while New Zealand Forests increased 11% to $40 million compared with $36 million last year.

Financial Condition: Net investing and operating cash flow for the year was $33 million. This included $85 million from the sale of subsidiaries and assets, being primarily the balance of proceeds from the sale of the Chile forests last year. There was an adverse working capital movement of $59 million, which includes the accrual of unpaid interest income ($42 million) on the loan to the Partnership.

Capitalised forest maintenance and interest costs were $73 million compared with $77 million in the previous year (excluding Chile). The purchase of plant and equipment totalled $29 million, up slightly on the $26 million (excluding Chile) in the previous year.

The purchase of investments required $18 million and represents primarily a refinancing of our Argentinian joint venture and the purchase of our interest in The Empire Company.

The debt-to-book capitalisation ratio improved to 35% at June 2000, from 37% at June 1999.

CITIC Litigation: During the year Fletcher Challenge Limited was named as a defendant in an action commenced by CITIC New Zealand Limited (CITIC), the Group’s 50% partner in the Central North Island Forest Partnership (the Partnership). The claim relates to a number of issues in connection with the management of the Partnership.

Fletcher Challenge Limited is working with CITIC in good faith to directly resolve the issues and will report progress as it is made.

At this stage it is not possible to estimate the possible financial impact, if any, arising from this dispute.
Dividend: Fletcher Challenge Forests’ current dividend policy is to distribute approximately 50% of the free cash flow that is expected to be sustained over a 3 - 5 year period. Fletcher Challenge Forests last paid a dividend in April 1998. Wood product prices within the wider Asian region are still below historic long-term average levels and this situation continues to have a significant negative impact on cash flow. As a consequence of this and also in view of the current restructuring plans for Fletcher Challenge Forests, no final dividend has been declared this year.

Outlook: Building activity in New Zealand is likely to remain in the lower half of the cycle for the coming year, especially in the residential segment. Key indicators such as housing stocks and existing sales are not positive for the near term, although interest rate increases appear to have slowed.

Our key demand driver in the United States is the repair and remodelling sector rather than new housing starts. We expect demand to remain quite steady for our higher value products despite the current weak pricing environment. The broader US market is suffering from both demand and supply side pressures and any improvement will be linked both to internal factors, such as interest rate expectations, and external factors, in particular a continued Asian recovery fuelling global industrial wood demand.

The continued decline in the availability of natural forest, from which most of the world wood supply still originates, will increasingly be a factor in the long-term demand for plantation species such as Radiata. However in the shorter term our growth strategies will continue to drive improvements in our operating performance, in both the established markets, where opportunities for new high value Radiata products are constantly being developed, as well as in the emerging markets such as China and India.

Ian Boyd – Chief Operating Officer and
Acting Chief Executive

Details on Fletcher Challenge Forests and its operations for the year ended 30 June 2000 can be viewed on the website at: www.fcf.co.nz.

Information on the financial performance and position of the Fletcher Challenge Group (including the Financial Statements) is contained in the Fletcher Challenge Group Results Announcement.

Footnote: Comments in the Outlook section, about anticipated market conditions and activities, are forward-looking and are made pursuant to the safe harbour provisions of the US Private Securities Litigation Reform Act of 1995. Refer to page 33 of the Fletcher Challenge Forests 2000 Annual Review for an explanation of the factors that could cause actual results to differ materially from those expressed.

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