Interfor Corporation

Thank you, operator and good morning everyone. Welcome to our Q3 ‘21 analyst call.

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

Our agenda today will start off with myself providing a recap of our financial results, our strategic focus and our improvement efforts. I will then pass the call to Rick who will cover off financial matters and then I will pass the call off to Bart who will cover off the markets.

Turning to our financial results, our Q3 adjusted EBITDA was $94 million. By executing on our strategic plan, we are generating industry leading margins and returns on capital.

And I encourage you to look through the investor deck that’s posted on our website to take note of these metrics. Turning to our strategic focus, we continue to focus on achieving greater returns on capital through our unrelenting focus on operational excellence and capital deployment.

We continued on our CapEx improvement plans in every region, spending $44 million in the quarter and on track for $170 million by the end of the year. We continue to work hard on our capital allocation discipline to ensure the best returns for our shareholders and we are continuing to see strong performances from our internal projects and our recent acquisition.

I am also very pleased to report that our southern team has made solid progress on the restart plan for DeQuincy mill in Louisiana. We anticipate running the mill on a one-shift basis in approximately 3 months and a two-shift basis in Q4 next year.

Our improvement efforts were again balanced across the company as we made progress in all regions. Our operating teams achieved higher production volumes, primarily driven by our acquisitions in the South and the Pacific Northwest region.

We continue to apply our very disciplined approach to working capital by ensuring we don’t build access to volume in the supply chain and we are lean and mean as possible. Finally, earlier this week on November 2, the BC government announced a proposed deferral of harvesting within 2.6 billion hectares of BC forests.

The proposal deferral, if implemented, has been identified as temporary and is subject to First Nations engagement which is currently ongoing. We will require additional and more specific information to understand the potential impacts.

However, as most of you know our operations on the BC coast and the BC interior account for 4% and 19% of our total lumber capacity and our BC operations are very well capitalized and are very highly competitive within their operating regions. Lastly, we continue to have significant financial flexibility to consider a number of further capital deployment options that Rick will cover off.

In closing, we are focused on maintaining the health, safety and well-being of our employees. We continue to drive cost reductions.

And we are matching our production rates to our order files. That concludes my opening remarks.

And I will now hand the call over to Rick.

Thank you, Ian and good morning, all. First off, I will refer you to cautionary language regarding forward-looking information in our Q3 MD&A.

The third quarter saw Interfor continue its positive operating momentum, with strong performance and results delivered from across our portfolio. And as Ian spoke to, this is a transformative quarter for our company as we added 23% to production capacity through the acquisition of 4 U.S.

sawmills with a strong strategic fit. In terms of third quarter operating performance, we achieved record results, producing 731 million board feet of lumber and shipping 753 million board feet.

These records reflect the ongoing focus and commitment that we bring to operational excellence and demonstrate that our mills continue to operate effectively despite ongoing challenges from the COVID pandemic. From a financial perspective, Interfor generated adjusted EBITDA of $94 million, representing a margin on sales of 14%.

Lower earnings as compared to Q2 mostly reflect the rapid decline of commodity lumber prices early in the quarter, which then began to rebound in the second half. Profitability in the quarter was also impacted by several mostly external factors to our business, including elevated stumpage rates in BC, operational disruptions from BC wildfires, some inflationary pressures on wages and supplies, and $15 million of one-time inventory purchase accounting adjustments and other acquisition-related costs.

In terms of cash flow, we generated $72 million from operations, with an additional $124 million of cash released from working capital, all totaling $3.13 per share. This was driven in part by the collection of accounts receivable from higher priced sales in Q2 and a drawdown of inventories as we sold more lumber than we produced.

We also completed sale of the former Hammond sawmill site, generating $40 million of cash and ended the quarter in a net cash position of $134 million, with ample available liquidity of $836 million. On capital allocation, we continued to take a balanced and disciplined approach in the quarter in line with our longstanding priorities.

We invested $44 million in capital improvements focused on high return enhancements across our U.S. South portfolio.

We invested $372 million U.S. to acquire the 4 sawmills I mentioned earlier, significantly increasing our lumber production and improving our go forward profitability.

And last but not least, we returned $83 million to our shareholders through share buybacks, thus completing our 10% NCIB at attractive average price of $26.56 per share or just 1.03x book value at quarter end. Looking ahead to our capital allocation for next year, we plan to take the same balanced, disciplined and growth-oriented approach as we have over the past year.

We expect to spend in the range of $220 million to $240 million on capital improvement, largely focused on growing and optimizing our U.S. South platform.

And we have also just announced a renewal or a share buyback program to purchase up to 10% of our public float over the next 12 months. To wrap up, we have exited the third quarter with a significantly stronger and even better positioned business, yet still have ample financial capacity for further growth in line with our fundamental commitment to capital discipline.

Our focus looking forward is to continue enhancing shareholder value through disciplined execution of our strategic plan as we grow and optimize our business, while generating industry leading returns on capital. That concludes my remarks.

I will now hand the call over to Bart.

Thanks, Rick. Okay, I will give my Q3 2021 market outlook comments.

After a volatile Q2, lumber market stabilized in Q3 and entered Q4 with positive momentum. Market fundamentals remained intact.

Solid housing starts and permits interest rates remain at historical lows. Household balance sheets are strong.

Housing stock average age continues to increase. And new sectors showing solid participation this quarter, new home construction continues to be robust, again with solid housing starts and permits year-to-date.

Repair and remodel has reset, with lower lumber inventories, more attractive pricing and a reengaged customer. Industrial and non-residential are stable.

On the export side, participation has increased. We haven’t seen that for some time.

Our Japanese business has always been consistent and supportive and in Asia with more competitive pricing, shipments increased throughout the quarter. No markets are well challenges.

And looking forward, we see supply chain as an area requiring more attention. Within North America, truck availability remains tight resulting in slightly longer lead times within some lanes.

Real estate service has been consistent and we have great support from our Class 1 carriers. On the export side, port congestion, container availability has limited our participation to an extent.

Over time, all of these areas will settle down. However, we expect the current situation to remain through Q4 and into 2022.

In Q4, we expect seasonality to have a slight impact on lumber markets. However, early indications are that our customer’s order books are healthy going into Q1 and Q2.

Therefore, expectation is for robust albeit volatile lumber markets to continue into 2022. I will leave it at that and pass it back to you, Ian.

Thanks, Bart. Thanks, Rick.

Operator, we are ready to take questions at this time.

Thank you. Good morning, everyone.

Good morning.

Few questions. Ian, we have seen recent M&A transaction in the U.S.

South. Arguably, it locked the evaluation parameters.

Can you give us some updated thinking on the opportunity set there? What valuations are looking like in the region, how that affects your bias for continued growth in that region?

Yes. Sean, I agree with your opening comments there.

I would say, Sean, that for us – excuse me, for us, the capital program that we have laid out, especially bolting on our new mills in DeQuincy really got us internally focused for the next period of time. And so from a timing perspective, I think that the acquisition pipeline at this point, a little bit too expensive in the south.

And I feel good that we have got our project [indiscernible] and all of our capital projects lined up for the next few years. So, I really see us concentrating on that and onboarding the mills that we bought in the short, mid-term and they are getting DeQuincy up.

So for us, the planning in advance capital project pipeline, along with the acquisitions, we did, I think we are in good shape to kind of monitor possible acquisitions in the south, but I think it’s kind of awkward period of time after that last acquisition. So, I would say that, Sean, if that helps you hold on, Interfor’s view from short to mid-term.

It does. Thanks for that.

And following on that, with respect to the discretionary CapEx program, we have seen some of your competitors deferring some of the spending based on equipment backlogs, contractor availability. Any updated thoughts on the 2022 CapEx budget, presume it’s still going to be a busy year, but has thinking on the pace of spending changed at all in light of some industry headwinds?

No, Sean, the – a few years ago and you have been covering this with us for – so you will recall, we had Phase 1, Phase 2, Phase 3. And so I believe it was around 2017ish when we implemented that.

So, we really did have a 5-year capital plan until our project team has been able to engineer in advance, which you need first before you can order any equipment and then line up the vendor commitment. So, from our perspective, it’s what we are presenting we feel is accurate.

Having said that, there could be something that we don’t see which is possible, but I would say that we are solid on what you are seeing in our press releases and in our material that we are putting out. I wouldn’t adjust it at this time.

Okay. That’s all I have for now.

Thanks very much, Ian. I will get back in queue.

Thanks, Sean.

Thanks. Good morning, Rick, Ian, Bart.

Ian, I do want to just open by saying, I am really impressed with the thoughtful job you guys have done on capital allocation this year, kind of across the spectrum, whether it’s the special dividend or the repurchases and the acquisitions. Moving on from that though, can you just – can you give us a sense for the timing ramp up at DeQuincy.

It does think, first of all, like it’s coming a little earlier than you had initially indicated? And then what’s the – just cadence from a kind of a financial standpoint in terms of when the mill would turn profitable.

And finally, kind of costs and expenses of the restart and the net effect of those, after considering any incentives you might be getting from the State of Louisiana?

For sure. So I just wrote this down from timing, Mark, you are banging on, it is advancing quicker than we had previously outlined.

It was a bit of a bet estimate on hiring. But we currently actually have the first shift substantially hired already, even though we haven’t turned the mill at this point.

So, that’s – that given us a huge level of confidence. We had a very welcoming response in the community and from former employees that wanted to come back to the mill after we purchased it.

So, we were very surprised that we had that very strong response. So, that was – that’s great.

And we do anticipate running and testing equipment within the next four weeks at that mill. So, if you can imagine, we have got to go through a lot of restarting protocols, but our first load of logs actually rolled in earlier this week.

So, everything is lining up very nicely for a Q1, one shift there. And of course, we will be hiring the second shift all the way along.

I think we are being a bit conservative on the Q4, but we don’t want to change that at this point. But we are hopeful that the efforts that Summerville team is putting in may bring that up sooner.

But we don’t want to commit to that at this point. The investment costs to get the mill back operational is under $10 million, so very low cost rate investment, as part of that acquisition, and for 200 million board feet is the capacity of that mill.

So Rick, as far as profitability goes, we can guess, Mark, but jump in, Rick, if you think I am off base, but one shift that I would expect, with trend margins would probably be a breakeven on a trend basis. And then any incremental hours over the one shift, I would say just based on past experiences that starts to add some value, if that’s fair.

That’s good, Ian for sure. And then in terms of the incentives, Mark, we don’t have quantified exactly yet, but I would say it’s on the same level as a greenfield would receive in the state, so quite significant.

Okay, that’s helpful. And then I was just struck when I went through the MD&A, that your Southern lumber production in the third quarter was only up about 24 million board feet, which seems kind of small to me, considering you added two sawmills for most of the quarters.

Is that because of downtime, or do you have kind of issues with labor and supply chain, just to kind of understand why that relatively small quarter-to-quarter gain, when you had such a significant addition to capacity?

Okay, last one for – last one for me, Ian. I am just kind of talking with some of the big private timberland asset managers, it does seem that there is a little more of a pickup in Southern log prices than it is showing up in Timber Mart South or even in some of the public company reporting it, I think because there are some lags in there.

And I would like to know if you agree with that. And then also just give us a sense of how you thought about Southern log prices as you have built your Southern position over the last 10 years.

I am sure you looked at these log prices and knew that they were quite low by historic terms. So, you probably didn’t underwrite at all – at the pricing levels we have had over the last 10 years or 15 years in the South.

But maybe you could put a little color on that.

Yes, for sure, Mark. We subscribed to all that benchmarking info and the average log costs increased.

We haven’t seen that. We are below that increase or pleased with our log supply, relative to the industry average.

But I will note that there is a couple of things, the log prices on the coastal regions in South Carolina, in Georgia, we did see and we have seen pickups in those areas. So, when you – when we blend, our log costs, we are below the average increase.

But we do have a couple of operations on the coast that have seen a slight increase through competition or weather on the coast. But we are pleased with it.

It continues to be one of the best regions when it comes to log costs and just gives us confidence that’s the right area to invest. And so that’s probably the best I can give you an answer on that Mark at this point.

Okay. Alright.

I will turn it over. Thanks Ian.

Yes. Thanks very much and good morning guys.

Good morning.

Good morning.

Ian, you made some significant acquisitions during COVID, which might have compromised your normal due diligence, just wondering if there was any some surprises to the positive or negative that you have seen with the GP – deployment of GP in WestRock sawmills?

So Paul, we did not compromise our due diligence at all. We had intense focus on that, it’s we have before.

And in fact I would say that we kind of have improved with every deal on due diligence. So, no – the surprises have been around positive surprises.

So, these acquisitions were not independent. Until when we bought the Summerville operation of WestRock, very well run, great infrastructure being part of that company, great people wasn’t any spending that needed to get done that for safety or other things that you sometimes have to do when you are maybe taking an independent mill over.

Safety was great, people plans were great, management, leadership was great. And I could say the same thing for the GP Mills.

All of the ones that we have picked up, have been – we have been positively, I wouldn’t say surprised, but just been positive impacts to everything. And again, professionally run organization, great standards, great procedures and policies and teams.

And we have been able to retain all key leaders, as we have integrated all of those, which hasn’t always been the case. When you are bringing two companies together, sometimes you lose good people, and we are just very pleased that we have retained all of the key leaders.

They are embedded into our company and we continue to work very closely with them. And we are sharing best practices.

We have picked up best practices. So, Paul, this so far has gone very well for us.

And that’s been very pleasant. I wouldn’t say surprised, but benefit, and we hope that and we are realizing it now.

It sounds pretty positive on the labor side, what about labor has been a consistent problem in the U.S. So, in probably other areas as well as things tighten up.

Any other issues on the labor side, is that situation getting better, or worse, or how do you view that going forward?

Yes. Paul, I don’t think it’s changed much over the last while, but we haven’t had other than some COVID related when one or two people might get it, and then you have got to quarantine a few people, you might lose a shift here or there.

But the normal challenges or that I think us and others have still exist. So, no material changes Paul, that I can think of larger.

Rick, if you got anything to add to that?

I wouldn’t say internally, but externally, obviously, some challenges around trucking capacity and labor there. But other than that, things have been going well.

Okay. And just on you did a great job of detailing your log costs inflation expectations in the U.S.

So, just what you are thinking about the Pacific Northwest and BC going forward?

Yes. Well, Pacific Northwest, we have seen some increases as the fire salvage volume starts to decrease.

But on a trend basis, it looks good. We did have obviously benefits, which is great for diversification in our geography to participate in those reduced log costs in the Pacific Northwest, but we are seeing them come back to trend.

BC obviously, stumpage has really impacted many people, but we do see it’s I know you – as I know, you know Paul that we see that stumpage decreasing coming into 2022 in the first quarter or so.

Okay. And just lastly, just on softwood lumber pile, we get the rate doubling towards the end of the year here.

Well, the expectation anyways, any movement on that pile or especially in light of BC government’s announcement on growth?

Hi, good morning, Paul. It’s Rick.

On that pile, we haven’t seen any movement. We would like to see some, but we haven’t yet.

The timing is unknown at this point.

Alright, that’s all I had. Best of luck guys.

Thanks.

Thanks Paul.

Thank you, operator. I would like to thank everyone for dialing in and participating in our update call this morning and your interest in our company.

If you have any further questions, please feel free to reach out to myself, Bart or Rick at any time. Be safe.

Take care and thank you again. Goodbye operator.