Interfor Corporation

Duncan Davies - President, CEO, Director Bart Bender - SVP of Sales & Marketing

Hamir Patel - CIBC Capital Markets Sean Stewart - TD Securities Paul Quinn - Capital Markets Robert Winslow - BMO Global Asset Management

Thanks very much operator. Good morning everyone and thanks for joining us.

I'm here this morning along with John Horning, our CFO and Martin Juravsky, our Senior Vice President of Corporate Development and Strategy to provide an overview of Interfor’s second quarter results. Also joining us is Bart Bender, our Senior Vice President of Sales & Marketing, who will comment on the state of the lumber market, and our expectations for the balance of the year later in the call.

I know this is a busy time for you, so I’m going to keep my remarks brief and I will turn the meeting over to you for questions as soon as I can. Let me say right at the outset that we are reasonably pleased with our results this quarter.

The combination of strong product pricing are heavy to the US asset base which provides a heads against increases in value of the Canadian dollar and performance improvement at a number of our operations helped to deliver record cash earnings this quarter. EBITDA reported before changes in long-term incentive compensation provision and one-time items was $56.9 million in the second quarter on sales of $459 million compared with EBITDA of $33.4 million on sales of $434 million in the first quarter of the year.

Higher product prices were certainly a part of that equation. The SYP and SPF composites were up 7% and 15% respectively versus the first quarter and Hem-Fir 9 foot studs which we use at the benchmark price for our stud operations in the Pacific Northwest were up 7%.

Other products were strong as well, benchmark exceeded prices were up a couple of points and claim boards were up 10% versus the prior quarter and green squares for Japan were flat. Production and sales volumes were up 19 million board feet and 21 million board feet respectively or about 3% quarter over quarter.

From a regional standpoint, our production in British Columbia was 218 million board feet, up 8 million board feet versus the first quarter. In the Northwest, production was up 6 million board feet to 149 million board feet and in the US South production was up 4 million board feet to 270 million board feet.

These figures represent capacity utilization of 83% in British Columbia, 95% in the Northwest and 82% in the US South. Most encouraging from our standpoint was the performance gains at a number of our plants in the second quarter following from the business optimization initiative launched earlier this year under the joint leadership of Ian Fillinger who was appointed as Head Of Operations in December last year and Bart Bender who is responsible for our sales and marketing programs.

The highlight for us in the quarter was the improvement in our Gilchrist, Oregon specialty board mill which delivered significant gains and productivity, costs and product value and as a result of significant gain in bottom-line performance in the quarter. Most importantly, we think this considerable additional upside at Gilchrist which we’re looking to deliver over the next 6 to 12 months.

We also believe there is significant upside in our US South platform, we’re in the process of influencing similar initiatives at those operations as we at Gilchrist. While it’s early days, results of that initiative are encouraging and we expect more to come in the next few quarters.

From a cash flow standpoint, we generated $62.6 million in the second quarter after changes in working capital were considered. Capital spending was a little under $16 million in the quarter with $4.5 million spent on the project at our Preston, Georgia plant the biggest single item.

Debt was reduced by $32 million in the quarter. At the end of the quarter, net debt set at $396 million or 35% of the invested capital.

Available liquidity increased to $181 million. Cash taxes continue to be a non-event for us and won’t be for some period of time.

We are currently projecting capital spending in the $80 million to $83 million range for the quarter. Our Tacoma property is on track for sale or for it to close the sale by year end and we’re expecting our debt ratio to move into the 30% to 32% from the current 35% range by the end of this year.

At this point, I'm going to turn the session over to Bart for an update on market conditions and I'll then come back to you and then we’ll take questions. So Bart, over to you please.

Thank you Duncan, I will comment on our short to medium term market outlook. The North American housing markets continuing to show signs of recovery.

In the US, unit starts of 1.189 million couple with new home sales of 592,000 support our outlook for increased demand for lumber in the short to medium term. Our overseas markets are stable in particular we saw consistent volumes and pricing in Japan and we grew our business in China quarter over quarter in spite of increasing competition and declining market share to lumber being imported from Russia.

Inventory levels in North America appear normal and we consider demand above-average for a time when we would expect more seasonal influences in our market. This coupled with moderate housing starts indicate to us that growth is occurring in other market segments, a testament to the demand creation activates of the softwood lumber board.

For [indiscernible], we have consistent interest from both trust manufacturers and traders which has helped to keep our order files full. We expect similar levels of demand for the balance of the year.

Western dimension lumber markets particularly robust for this time of year are expected to see consistent demand for Q3 and Q4. Pricing volatility is expected to continue as seasonal influences react with increases in demand.

Our cedar business is showing no signs of slowing down this quarter with momentum going into Q3. With uncertainty surrounding ourselves for lumber trade file, we’re expecting limited impacts in Q3 with the potential for greater degrees of uncertainty in Q4.

Back to you Duncan.

Thanks Bart, so as I look forward to the balance of this year and into next year with the uncertainty that comes from seasonal factors, softwood lumber dispute and other geopolitical considerations it’s clear to me that we have to stay focused on capturing the opportunities that were available to us within our existing platform of assets. Performance improvement has always been a fundamental tenant of our business streaky.

In the offering we see particularly in US South are considerable. We've made some progress in the last few quarters on this initiative but there’s lots more to come.

We’re looking forward to reporting to you on those gains in the quarters ahead. And operator what I'd like to do at this point is stop and I'd like to turn the session over to our guests and respond specifically to any questions that they might have for us.

Thank you.

So, congrats on a strong quarter, first question, when I look at the second quarter, EBITDA improvement quarter over quarter, it seems like about 11 to 12 million of that appears to have come from productivity improvements. Can you one, confirm if that’s accurate and then if you can just parse out how much of that improvement was at Gilchrist versus may be US South or where else you saw strong productivity?

The improvements in EBITDA are a combination of both price volumes and productivity, and you haven't broken out exactly what those components are. In the Gilchrist one is important but it would not be the majority of that improvement, it’s just is a significant improvement for us because it was a plant that was causing us some difficulty as part of the initiative that we had to reposition that facility.

What we've seen is a very nice turnaround in what’s ineffective fairly small plant for us but important from a product line standpoint and important from a customer positioning standpoint. So let's - it's really quite a significant turnaround for us.

The other gains which were widespread across all different regions, our Castlegar plant which we rebuilt last year had a really good quarter. Productivity gains at that facility were considerable in the quarter.

And in terms of aggregate improvement, Castlegar was performing well for us prior to this quarter and so what we saw is gain off of a decent base in the first quarter. We also saw some significant gains for example at our Port Angeles stud operations where the product levels continue to ramp up.

At the Swainsboro plant in Georgia, following the installation of an automatic grading system, we saw some considerable gains at that facility. We also saw good gains at Georgetown in South Carolina and there are number of other plants are located.

So I don't want to overemphasize in aggregate terms the contribution from Gilchrist financially but it was a part of those and for us internally given some of the challenges we’ve had there, it was really quite significant and we’re really quite pleased with how that plant is positioned now. And with the opportunities that we see to drive additional gains in that facility as we move forward.

Just sticking with productivity and operational improvements, how far along are you in that improvement in your US South operations. I mean last year you had kind of some saw mills had taken kind of capacity down.

So where are you with that and if you think there will be additional CapEx required, I know last quarter you said it's more of an operational improvement but it if you can comment on that?

In terms of specifics, we've identified $35 million of gains non-price related gains in US South operation, this is our initial target for that facility. What I can tell you is that I think we are 18 to 20% along on that initiative so far.

So very early stages with lots more to come. And everything you see down there tells us that those gains and those opportunities are realistic if not conservative.

So we are excited about the potential is in the south. I think, I indicated that we ran at about 82% of capacity in the South in the second quarter which is fairly consistent with where we were in the first quarter.

And we will be looking at moving our capacity utilization of figures upwards by adding ours until we are convinced that we've got the reliability consistency and performance characteristics that will support additional activity. And while there are opportunities for our capital in the South in a number of areas we want to make sure that we've got the proper organizational structure, the proper operating practices, the right level of reliability and consistencies in our facilities to build off of before we simply try to ratchet ours up on a go forward basis.

So, again I sit back and say the potential on opportunities there is tremendous, we just need to be focused and systematic about realizing on that opportunity.

And when do you think you can get to the 35 million run rate kind of gain level?

We said by the end of next year

End of next year. Got it, and just one last question sort of demand trends in China, what are you seeing right now and if you’re volumes are kind of flat or down year-over-year at this point?

Our volumes in the second quarter were up a bit, and we have a specific initiatives to continue to move the active participants in the Chinese market. Interesting enough we are moving additional volume from the US South into that area which we think is a really nice step and really good strategy from a long-term standpoint for us and quite frankly for the region to be able to move increments of production out of the continental US into the Chinese market.

So, we’re watching it carefully, we see the statistics that everybody else sees about incremental volume from Russia into China and so our focus on the ground there are reporting back to us on a regular basis but so far it hasn’t impacted us, we're watching carefully.

What would be the magnitude of exports out of US South for you guys at this point?

I think we are - we might be in the 5% range, 3% to 5% range.

Got it that’s very helpful. Got it, very helpful.

I will turn it over, good luck in the back half of the year.

Sorry, what was that?

Duncan, it seems like Castlegar is coming in better than planned, I know you’d previously pointed to $10 million annualized uplift from the project, has that number changed?

Well, we did say $10 million, what I can, I haven’t looked at it in those terms, and all I can, oh sorry Hamir, all I can tell you is that Castlegar is performing very, very well from a productivity standpoint. There is still more to go and when we get to the point where, you know, things start to plateau, we'll go back and re-examine the returns off of that investment, all I can say right now is we’re extremely pleased with what transpired there as we were at Castlegar, as we were at Adams Lake.

Another example of a major project really well executed and delivering above pro forma estimate of returns.

Then just turning to the US South, as you got the $35 million target on a run rate basis by the end of next year, you referenced you’re sort of, I think you said 18% to 20% along, I didn't know if that was referring to the actual dollar of EBITDA or if that was just sort of in terms of the initiatives, maybe if you could just clarify for us how much of the 35 was in your Q2 results and sort of what was the run rate going into Q3?

18% to 20% EBITDA.

Really, Okay. Yeah.

That’s higher-than-expected. And then on Gilchrist, you mentioned the impact wasn’t as significant on a EBITDA basis in Q2, but just looking forward, you referenced further upside there, how meaningful could that be for the balance of the year, operational improvement at Gilchrist?

Well, if you look at it from a Gilchrist standpoint, very meaningful. If you look at it from an Interfor standpoint, relatively small.

Great, okay. Fair enough.

And then just turning to the operating regions in the South, it looks like it's around 82% right now. If we see duties come in, I would imagine we would see production across the south go up, what sort of range, how high do you think you can run that platform next year?

The new business and the duties have got nothing to do with what our operating plans are for the South. Our operating plans in the South would be determined by performance of those assets from a productivity standpoint.

Okay, fair enough. And just the final question I had was just touching on the M&A environment, some of your peers have commented that the pipeline seems to have slowed.

Just curious what you're seeing out there, both generally and then more specifically within the US South?

Well, at this point, we’re focused on internal matters, realizing the opportunities that exist inside our existing portfolio, which we think are the best returns for us and for our company and for our shareholders. And so I'm not spending a lot of time currently looking at the pipeline of acquisition opportunities.

With what’s going on or what might go on, our focus is on internal matters more than anything else.

Okay, fair enough. Thanks, Duncan.

I’ll turn it over.

Thanks. Good morning, guys.

A couple of questions. The 80 million to 83 million in CapEx, that’s 2016 guidance, correct?

Sorry, Sean. Marty was making some noise in here.

What was the question again?

The 80 million to 83 million in CapEx guidance, that’s for 2016, correct?

Yes. That’s right.

And any visibility on 2017 on the CapEx side yet?

We’re working through that now, Sean. I don't think it will be dramatically different than that, but it’s a bit early to say.

Okay. And at the risk of beating a dead horse in the South and your plans there, just if I can understand a bit more context, that is my understanding some of what you're doing there is getting the right personnel in place and right configuration to add the extra shifts.

Are you guys actively recruiting new talent down there and how much of your plans to take this slow and steady to get the right configuration in place, is there an element of this where you want to keep tension in the market in the South as well and keep price, support pricing, is that an element of what you’re thinking there is well?

Well, I think, we saw last year, how sensitive pricing can be to operating activity in the region. And as we work with our customers, we want to make sure that we’re providing them with the product that they need, not trying to push products down their throats that they’re not looking for, but market demand has been pretty good and our primary driver is getting conditions in place to drive improvements in bottom-line performance from those operations that come from productivity gains, cost reductions, better realizations on price relative to product benchmarks and things of that nature and there is lots for us to do in that regard.

And as we talked earlier, we’d identified an initial target of $35 million that we wanted to deliver over the course of what’s now the next 18 months and we're just very focused on that piece. What we've been able to do under the reorganization that we undertook here at the end of December last year is we’re able to lever the expertise that exists in other regions of our company more effectively than maybe in the case before.

And so we’ve been using some of our project expertise that had, for example, previously involved in the Castlegar rebuild. We have been able to move some of those folks down in to the US, so to assist us with the initiatives that we’ve got underway at some of the facilities down there.

And so that's working really well from our standpoint and our intention will be to continue to do that as we move forward.

Got it. And then lastly Duncan, any updated thoughts on the trade file vis-a-vis your discussions with negotiators, any comments you can give us on the ongoing dialog at this point?

Are you asking how high my frustration level is?

Something like that, yes.

I continue to be disappointed. I don't think the issue is that complex.

I think the solutions are pretty apparent and I'm frustrated that we haven't been able to drive forward and find that solution and move on. There is potential to create significant uncertainty for producers on both sides of the border, if we don't get the things sorted out.

And I think we've got the ability to look at it from a different perspective than a lot of folks do, given our involvement in Canada and in different regions of the US and the solutions are pretty apparent here. But for whatever reason, whether it’s political considerations and in Canada, last year, political considerations in the US this year or the inability to get folks to zero-in on the key issues effectively has been quite disappointing.

So, that said, I continue to be -- continue to work on it and continue to be hopeful that common sense will prevail here before things get off the rails, but time will tell. We will see.

Okay, thanks for the context guys.

Yes. Thanks, guys and good morning.

And I think I’ve run out of questions to ask as everybody is asking their questions, but I would ask you about how your seminar is going, but I guess based on the results, that must be going pretty well. Maybe we could go back to the trade file and I think one of your Eastern competitors, if it is a competitor, was expressing actually a high level of, maybe the word is not confidence, but probability in the negotiated settlement, do you feel the same way or the sides completely a part at this point?

I think if you’re talking about, I was talking to him yesterday about where we fit and we have and this is really good working relationship that exists, both amongst the Canadian guys, but also between some of the Canadian guys and the US guys and it is like I say I’m frustrated that we haven't been able to drive forward, because the solution just seems so obvious. What we can do to move this thing down the line.

There are opportunities, I mean there is various pinch points that are going to occur over the next while on this, and I know that there is lots of activity between the folks at Canada, trade folks in the US, there is lots of discussions taking place. I continue to be hopeful that the two industries are going to be constructive and contribute to a solution, but frustrated that’s taking this long.

But I guess that's the way it always is, and we’ll just have to wait and see what transpires.

Okay. And then maybe moving into some of the smaller markets, what are you seeing in Japan right now and how is Cedar shaping up in ‘16?

Well, Cedar is great. I guess there has been sufficient reductions in available supply and enough improvement in the R&R market that Cedar has been really good and has been for some time and I expect it will continue to be quite good over this next period of time.

Japan is fine, some of the currency swings create some issues in Japan, but our markets have been pretty good in that marketplace.

Alright, that's all I had. Best luck going forward.

Good morning. I think this is my first call as a buy side analyst, so forgive me, I'm a little rusty on this, but gentlemen, I'm looking at the EBITDA margins here.

12.4% for Q2 16, we have to go back about 18 months since we've seen EBITDA margins of these levels. So we’ve been frankly well below 10% over that 18-month period.

So what I'm trying to understand here is could we just have the stars aligned in this quarter in terms of all your operational improvements and no delivery delays and no operational hiccups, and why I'm asking is I'm trying to understand if this now is the new normal, this level of EBITDA margin versus what we’ve seen tracking in the last 18 months or so? Thanks.

Well, I think you have to look at the pricing environment that's taken place over the last period of time. The pricing environment in 2015 wasn't very good and product prices, there was an over inventory situation in the early part of 2015.

There were some shifts in global supply patterns that resulted in oversupply in the US market in a very, very difficult pricing environment through the latter part of the first quarter, the second quarter and into the third quarter of last year. In addition to that, we have a couple of our facilities that were creating difficulty for us.

Gilchrist was one of them, which we talked about a little bit earlier on, but the Tacoma mill which we ultimately closed permanently in June of last year was a significant cash negative contributor for us in the early part of last year. So the combination of better pricing environment, the elimination of some facilities that were troubling for us, productivity and performance improvements at places like Gilchrist, the Castlegar plant was in construction in the middle part of last year, it's now operating and operating very effectively.

Currently, all of those factors have contributed to the kind of results that we've seen in the first quarter of this year and then into the second quarter, we started to align and we feel good about things. I guess what makes me most excited about is the opportunities that we see inside the existing platform of assets to drive additional performance improvements without any impact from product pricing at all.

And so looking at our US South base and you start saying, let's talk about adding on an annualized basis, $35 million of additional EBITDA to that business without price improvements. That adds a considerable amount to the quarterly earnings of the company and then if you look forward from there and say, in addition to that, we would expect the pricing environment to continue to improve as market conditions in North America improve and similar supply in North America, particularly in British Columbia and in Eastern Canada are constrained.

It starts to set up an environment where a company like ours can realize on the potential that we’ve created through our acquisition activities, a little less number of years.

Okay. And do you have any planned outages over the next six months that we should think about?

Outages for maintenance.

No.

It's good, thank you very much.

Thanks, operator and thanks, everybody. We appreciate the time that you’ve spent here.

I'm going to be available over the course of today. John is here, Marty is here and we’d be more than happy to respond to any specific questions that you might have.

So thanks everybody. We look forward to talking to you again at the end of the third quarter.

Take care and enjoy your day.