Interfor Corporation

Thank you, operator. Welcome to our Q3 2020 investor analyst call.

Firstly, I'd like to say that I hope you and your family are safe and healthy and doing well during this pandemic. With me today, we have Bart Bender, our Senior Vice President of Sales and Marketing, along with Rick Pozzebon, our new Senior Vice President and Chief Financial Officer.

Our agenda today will start off with myself providing a recap of our strategic priorities and key themes. I'll then pass the call to Rick, who will cover our financial matters and then I'll pass the call off to Bart, who will cover off markets.

Turning to our strategic focus, we continue to focus on operational excellence. This is an underlining driver of our company to achieve greater returns on capital today and through the cycle.

Accordingly, our portfolio status has been adjusted in 2020. We continue to right size the BC Coastal Business.

Earlier this year, we acquire the additional timber for interior BC region, and we have now embedded this volume into our Adams Lake facility. We've completed a major upgrade at one of our U.S.

Pacific Northwest Stud Mills, and we've also divested from one of our specialty mills in Oregon. And in the South, we've completed major projects and three of our nine operations.

We continue to work hard on our capital allocation discipline to ensure best returns for our shareholders. Our improvement efforts were balanced across the Company, as we made progress in all of our regions.

All of our operating region improved their production volumes quarter-over-quarter as COVID and capital improvement projects were addressed and completed. Of note, we recorded the highest production per hour in our mills for the entire company since we started our southern modernization program.

Our conversion and overhead costs both continued to trend positively through our ongoing cost control and increased production levels. We also closed down our Head Office in Vancouver relocated the staff to our Metro selling office in Burnaby.

Our total cash costs decreased $30 quarter-over-quarter driven by relatively stable log costs and lower conversion costs across all of our regions. Our capital spending program continued to advance forward as we continue to modernize and improve not only our operating costs, but also our value extraction from logs.

Last quarter, we spent $23 million to improve our plants across all regions. Working capital and its impact on cash flow continues to be a key focus for us.

We've implemented new discipline procedure earlier this year by matching market demand to both our lumber and log inventories and also our mill operating schedule. This ensures we don't build excess volume into the supply chain and whereas lean and mean as possible.

Turning to our financial results, our Q3 adjusted EBITDA was an all-time record at 222 million. Our lumber margins were very strong and we continue to focus on efficiency and cost across our company.

Lastly, we have significant financial flexibility to consider external capital deployment and also other options, which Rick will address. In closing, we’re focusing in on maintaining the health and safety and well being of our employees.

We continue to drive cost reductions and we're matching our production rates to our older files. That concludes my opening remarks.

I'm now going to hand the call over to Rick.

Thank you, Ian, and good morning everyone. Before getting started, I'll refer you to cautionary language regarding forward-looking information on the first page of our Q3 MD&A.

As Ian mentioned, we generated record adjusted EBITDA $222 million in Q3, improved from $43 million in the prior quarter. This improvement reflects significantly higher realized lumber prices and shipment volumes as well as the continued focus on costs across your business.

Our average realized price was $910 per thousand board feet, up 41% over the preceding quarter, driven by the record lumber market appreciation. As is typical enterprise realized lumber prices lag the key benchmark prices to the timing differences between orders and shipments.

Lumber shipment volume was up 24% over the second quarter, in which sales were limited by production curtailments in response to COVID-19 uncertainty and project related downtime. Cash income taxes have been nominal year-to-date and are expected to remain so over the near term in Canada and over the mid-term in U.S.

based on existing tax loss carry forward balances and current tax legislation. Cash flow generated from operations in the second quarter was $175 million.

This includes a $39 million investment in working capital of which the majority is related to the impact of increased sales levels on trade accounts receivable. In terms of capital expenditures, $23 million was spent in Q3 with approximately $17 million of that related to discretionary projects, which are progressing well.

Our balance sheet strengthened for the quarter-over-quarter, and we continue to have ample financial flexibility. We ended the quarter with net debt of $89 million and available liquidity of $637 million.

Our liquidity is comprised of $301 million of cash on hand in our undrawn revolving term line. In addition, softwood lumber duties on deposit with the U.S.

government totaled $121 million at quarter end, substantially all of which are not recorded on the balance sheet. Regarding capital allocation, our objective over the long-term is to generate returns for our shareholders above enter force cost of capital while maintaining a conservative balance sheet appropriate for the lumber industry.

In this regard, we revised our near-term in small CapEx plans to spend approximately $115 million in 2020 and $150 million in 2021. At the same time, we continue to pursue growth through acquisition, but remain disciplined in evaluating opportunities against our return hurdles.

On surplus liquidity exists after considering these priorities, we will assess the various options for returning capital to shareholders. In this regard, Interfor has announced the normal course issuer bid to purchase up to 10% of the Company's public share float over the next 12 months.

We believe that the purchase of Interfor shares may represent an appropriate allocation of capital, depending on the market price. In summary, Q3 financial results were exceptional and we are well positioned with a strong balance sheet to execute on our priorities and maximize returns for our shareholders.

That concludes my remarks and I'll hand the call over to Bart.

Thanks, Rick. I’ll give some market comments.

The strengths in our lumber market seen in late Q2 '20 continued through Q3 '20, demand was elevated in all new sectors, most notably residential construction and repair and remodel. Seasonality in Q4 with has prompted all parties to take a breather as we ready for 2021.

We're expecting price volatility to continue through the quarter and into 2021. In North America, the market fundamentals are encouraging.

Residential construction is showing no signs of weakness and in fact the 2021 outlook from the major homebuilders start to continue to strength in their market. It seems the desire for space is prompted new entrants into the housing markets and the shift away from higher density urban areas.

With repair and remodel, activity levels from our customers remain above the recent averages. However, while slightly from the peak seen in Q2 and Q3, seasonality will play a role here, our expectations are continuing to strengthen, repair and remodel as we enter 2021.

Our export markets have been less active for us in Q3, both from Japan and other Asian countries. Japan is largely attributed to a reduction in housing starts to the year.

Recovery has started in this regard, so expect our business will improve in 2021. Our customers in China have options for lumber beyond North America.

So when faced with significant price increases, they have an ability to source elsewhere. Activity has picked up in Q4 as our ability to compete has improved.

With respect to inventories, always difficult to pinpoint, our intel continues to tell us that the levels in the market are at seasonal lows and can be best described as weak. Further from Interfor perspective, our own inventories are 30% lower end of September 2020 versus the prior year.

It's worth noting these inventories are substantially sold. We only have operational levels of unsold and support all mills with older homes.

I would suspect this is a similar situation to our competitors and really tells us the supplies at mill level should also be regarded as lean. Overall, we're optimistic the fundamentals that drove the demand for number 2020 will continue in 2021.

And with that, I'll hand it back to you, Ian.

Okay, thanks, Bart. Thanks, Rick.

So, operator, we're good to open up the call to any questions from analysts.

Thanks. Good morning, guys.

Two questions. The 2021 CapEx guidance up a little bit year-over-year from, I guess, low levels and 2020.

Ian, can you give us specifics on where the incremental discretionary chunk of the '21 spend is going? I know you guys have sort of gotten away from the Phase 1, Phase 2 of U.S.

self-modernization. Any detail you can give us on larger projects that will be in the mix next year?

Yes, Sean. While we will complete Phase 2, which is largely Eatonton, Georgia and then Thomaston down in Georgia, which is our major project that we've approved years or so ago, but we're re-scoping that actually down.

And the rest of the capital is pretty balanced across the organization. There's projects at several mills in the South, there's a project in British Columbia that's on the books that we're just getting out to finish the final budget on that.

So I would say it's heavily into the South to complete a few of the major ones down there. And then, it's smaller strategic projects in the other regions.

Let's so in the Pacific Northwest after the project that we just completed there, which was substantial.

Ian, can you just give us some context on fiber cost trends, I think, we have a pretty good sense of what will be happening in BC, early next year. But Pacific Northwest and U.S.

South, what trends are you seeing? Or are you expecting in those regions?

Yes, for sure in the South, pretty stable, Sean, quarter-over-quarter in the past. Going forward, we're not seeing price appreciation there, so that looks solid and balanced.

And then in the Pacific Northwest, in this short-term, there's some actually views in what we're seeing relative to the fires that happened in Oregon, in Washington, that there is some price relief in the Pacific Northwest, regarding the salvage wood, that's happening now. So, in the shorts from seeing a decrease, we do think that the Pacific Northwest, eventually, once that salvaged wood is consumed and dealt with it, it will be a little more responsive to the whatever the lumber price is doing at that time, but in the short-term, it's actually flat or down in some of our operations in the Pacific Northwest.

Thanks for that detail. Just one last question for me.

Rick, you mentioned with respect to the cash tax profile, you gave some generalities around the transition in Canada and in the U.S. I wonder, if you just dial in a little bit more and give us a sense of where your overall tax shields are in each country?

For sure, Sean. Good morning.

In Canada, we've got $54 million Canadian or been well at September 30th. And in the U.S., we've got $94 million U.S.

at September 30th. And just watching out in Canada, it's possible depending on lumber markets could be paying cash taxes in the next 6 to 18 months, it really just depends.

And in the U.S. given some of the legislation down there that allows us to accelerate our CapEx right off like we won't be for one or two more years although depending on the market.

I want to ask you about in the U.S. South, it seems like there's a lot of composite decking capacity coming on in the U.S.

over the next few years. Do you think that could start to weigh on demand for lumber from your treating customers as kind of as we move through 2021?

Yes, I think we're I'll probably pass that over to Bart to hit on that particular segment.

Yes. I mean, anytime you get in a very high priced environment, there's always the possibility of substitution that can take place.

So, composite decking adapting is it's one of those things. So, it's always a possibility.

However, from what we've seen from the markets and the indications that we see from our customers, we expect the demand for those types of items to continue strong. I think there's room for everyone in the market that we're currently in.

Yes, thanks Bart. That’s helpful.

Just one last question I had was. Just want to follow up on the Hammond Mill, any update on timing of the likely sale?

Sure, I can take that. So we're still working through a sale process and in terms of timing likely won't be in 2020.

And any idea sort of magnitude of the potential proceeds?

Not at this time.

Fair enough. That's totally idle.

I'll turn over. Thanks.

Good morning. It's nice quarter guys and I think good capital decisions.

But I wonder, if we could just talk about sort of what you're seeing in the market right now. It seemed to me that the commentary in the trade papers last night was a little bit more constructive.

What's your read of the situation?

It's a good question. Obviously, the markets are shifting around quite a bit.

So far in Q4, I think the market needs to build some inventory. It's very lean out there, it's very lean at the mills, and there's just a reluctant subdued at the high prices that we add.

And so, there's been adjustments made, and I think we're now establishing what I would call investment levels. And that's bringing some people off the fences and they're now starting to purchase for whatever consumption they're going to have for the balance in the year, but probably more importantly, the Q1, Q2 season next year.

I think the expectation is that the business should be fairly decent, and so, there's some woods that needs to be bought. One thing I'd point out, when you look at the how pricing is moved, I mean, that's the speed, the different species have really moved differently.

If you look at Southern Yellow Pine and SPF, and those seem to be the big sort of commodity species that saw the most volatility. There's others, obviously, very important for us, the jump for them and those types of things that didn't see the same degree of volatility.

And we're seeing the same adjustment take place, but it's now getting reestablished in investment levels that are different for each of those species.

Okay. Can you give us a sense of kind of where your order books are at this point?

You mean in terms of an order file?

Yes.

We always have an order file for the mills. We very seldom get below week and often we're north of two weeks.

And a real aggressive for a market, we're three to four weeks. So order files are possible.

It's just a matter of meetings the price levels that you need in the marketplace. So right now, we're -- I would just call it right around two weeks to two and a half weeks, somewhere in there.

Okay, all right. That's helpful.

And then the final one, I was curious about, was just -- you addressed export markets out of Western Canada, but I know you've had a plan and others to try to develop export markets out of the Southern U.S. more.

And perhaps you could just give us a little update on that?

Yes, that's it's a good question. I would say the impacts have been fairly similar.

The overseas market seems to be able to compete on the lower grade type products. And so, that business continues whether it's in the South or in the west.

It's more than two and better than that there was really a competitive issue. And for the South, when we get into situations where there is a big gap between what can be achieved in North America versus overseas, we get strategic and kind of reduce our business to what we call maintenance levels.

And this is simply keeping our strategic distributors and customers in some supply, but not as high of a supply as you would get normally. The gap -- if you look at the gap in Q3, it was just -- it was too significant, there was too much of an opportunity cost.

And so, there was a general pullback and I would say that that would be the case for many of us quite frankly.

Okay.

Go ahead.

No, I was just going to have one final question I have. Usually, the industry builds some inventory, kind of fourth quarter, early first quarter.

And I'm just curious given that there just don't seem to be a whole lot of inventory out there right now. Are we going to be able to get back to some kind of a normal level by midway through the first quarter?

Or is it the potential that with the strongest housing seems to be right now that we entered next year with inventory still on the low side?

Well, you're kind of hitting $64 million question, right there. The market would like and needs more inventory.

It's fairly lean ready, but I mean, you have to kind of put yourself in the distributors' shoes. I mean, it's -- they don't want to build inventories at these kind of levels.

So, I think it's pretty much handled what they need short term, until they determined that they've got something that they can feel fairly risk adjusted for them to put on the ground for future business. So, I think largely the volumes that are getting bought today are sold or they're going against business needs in Q1 or balance of this year.

So, it's a really tough question to ask. I mean I think that we're going to end up going into Q1, quite similarly to how we went into Q1 last year at the lower end range of inventory levels in North America.

And how that's going to translate into pricing through Q1 is kind of anyone's guess, at this point, but I would say that we're encouraged with where we are.

Okay, all right. I'll turn it over.

Thanks, guys. And again, I'm happy to see both CapEx not ramping up sharply which is often happens with been getting good markets and then the return of capital shareholders.

Thanks Mark.

Okay, just some concluding remarks. I'd like to thank everyone for dialing in for dialing-in and participating in our update call this morning and obviously the interest in our company.

If you have any further questions, just track down myself, Rick or Bart, and we'd be happy to address those. Thanks everyone.

Have a great day.