Interfor Corporation

Duncan Davies - President and Chief Executive Officer Bart Bender - Senior Vice President of Sales and Marketing

Ketan Mamtora - BMO Capital Markets Hamir Patel - CIBC Capital Markets Sean Stewart - TD Securities Paul Quinn - RBC Capital Markets Daryl Swetlishoff - Raymond James Moji Kuye - TELUS Corporation

Thanks very much, operator. And good morning, everybody, and thanks for joining us.

I’m here this morning along with John Horning, our CFO to discuss Interfor’s third 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.

Marty Juravsky, our Senior Vice President of Corporate Development and Strategy, who normally joins us on these call is travelling today and is not available. I’m going to keep my remarks brief, and will turn the session over to you for questions as soon as I can.

Let me say at the outset that we are reasonably pleased with our results this quarter. Net income was $15.1 million on sales of $458 million versus net income of $23.2 million on sales of $459 million in the second quarter, excluding long-term incentive compensation provisions net earnings in the third quarter were $22.8 million compared to $20.9 million in the second quarter.

EBITDA adjusted to exclude long-term incentive compensation set a record for the second consecutive quarter at $58.1 million compared with $56.9 million in the second quarter. Lumber production in the quarter was $628 million board feet, made up of $239 million board feet from our Canadian operations, $248 million board feet from our operations in the U.S.

South, and $141 million board feet from our operations in the U.S. Northwest.

The strength of our results in the third quarter can be tied directly to the gains and performance at our B.C. Interior and U.S.

Northwest operations, stemming from the capital investments made on those regions in recent years and from the business optimization initiative launched earlier this year, and were achieved in spite of mixed price movements in the quarter. Western SPF was the strongest product category in the quarter with composite up $11 or 4% quarter over quarter.

The Southern Pine Composite and Hem-Fir studs went in the opposite direction, coming off $8 and $19 or 2% and 5% respectively in the quarter versus the second quarter. Good progress was made in the South in the third quarter as well, as a series of small capital projects and other initiatives were undertaken focused on mill reliability, debottlenecking and product mix.

Production in that reason was constrained by an 8% reduction in operating hours taken to enable the capital work and to increase the focus on mill level reliability, which is an important initiative underway in that region. The combination of these factors had a negative impact on production volumes, conversion costs and margins in the third quarter.

That said the initiatives in the South to capture the gains available within our operating platforms, well on track to meet or exceed the $35 million target that we’ve set by the end of next year. From a cash flow standpoint we generated $67.7 million in cash from operations after changes in working capital and spent $23.3 million on capital projects.

Net debt was reduced by $49 million in the quarter to $346.9 million representing a net debt to invested capital ratio of just under 32%. Available liquidity increased in the quarter to $233 million.

I can also tell you that Tacoma property sale has cleared all the required approvals and is scheduled to close later this month. The proceeds which will be in the range of about US$20 million net to Interfor will be used to repay debt.

At this point, I’m going to ask Bart to provide an update on the current state of the market and then we’ll turn the session over to your questions. Thank you.

Bart?

Okay. Thank you, Duncan.

I will comment on the short to medium term market outlook. The North American housing markets continue to improve.

In the U.S., September single family starts at 783,000 are trending positively. Repair and model sectors are showing strength.

In Canada, housing starts remain stable. Overall, outlook is for increased North American demand for lumber in the short to medium term.

Our overseas markets have performed well. Last year, supply shifts caused by weakening currency seem to have stabilized.

We expect lumber demand from both Japan and China to remain steady for quarter four 2016 and continued growth from our other Asian markets. Inventory levels in North America appear to be reasonable, as we enter what can be a seasonally slower time of the year.

Both our Southern Yellow Pine and Western dimension lumber markets are expected to show high volatility as we enter the fall/winter period. For example, the South in October and so far in November, we have seen decompression between narrows and wides, highlighting the influences fueled primarily from less demand from our treater segment, which you can see in the fall/winter period.

In the West, wides and narrows have not seen the same impact and have tracked consistently in past months. Most recently, we’ve seen lumber markets react to increased uncertainty as the SLA standstill period ended and U.S.

elections draw to a close. That said, we are encouraged by the continued reports from our customers of increased lumber demand in their businesses and their outlook for 2017.

Lastly, with our cedar business, we continue to experience strong levels of demand which are expected to continue through the balance of 2016 and into 2017. Duncan, those conclude my comments on the short to medium term market outlook.

Great, Bart. Thanks very much.

At this point, I’d like to turn the session over to our guest for questions. So Operator, if you could open up please and we’ll move through those questions.

Thank you. Good morning, Duncan.

Good morning.

First question just starting off with Softwood Lumber Agreement and the trade dispute, can you provide any update on what you are seeing right now, and what you are hearing. And also sort of how open is Interfor to some sort of a hybrid solution between quota and export taxes?

Well, I don’t know any more than what anybody else does about the current state of affairs. And quite frankly if I did, I wouldn’t say much.

So we’re at a pretty important period of time here in those discussions. Ketan, I appreciate the question, but we are interested in what we would call a constructive solution here that addresses issues and allows the industry to position its product successfully with this grow-the-market initiative.

So I am not going to provide much more detail on what our particular point of view is. But we have been constructive through this whole piece.

We’re going to continue to be constructive, but we want to make sure we find the solution that allows the industry in North America to continue to grow the market. And I have some concerns that some of the suggestions or proposals that we’ve seen with work in a fashion that would be from a long-term standpoint not a very constructive or, frankly, a very intelligent approach in my view.

Got it. That’s helpful.

And then just turning to U.S. South, Duncan, can you provide an update on kind of where you stand with the optimization efforts and how much of the $35 million that you all have talked about you’ve already realized so far?

Okay. Ketan, the numbers tend to move forward and backwards quarter over quarter.

And I am not sure it’s particularly helpful to try to quantify it in any particular quarter. What I will tell you is we are totally confident that we are moving in the right direction, and then we’ll be able to realize the targeted number of $35 million or more by the end of next year.

Okay. And where are you seeing the most opportunity, Duncan?

Opportunity for what, Ketan?

In terms of just improvement.

Well, our operations in Canada and the Pacific Northwest are operating exceptionally well. We are really pleased with the progress that’s been made in those areas, both in terms of operating productivity and our ability to extract value from the resource through some of the initiatives that Bart and his group and Ian Fillinger, the operating group have underway.

So we are really pleased with that. The biggest opportunity for us by far is in the U.S.

South region and we’ve got a very active focus on dealing with some of the fundamental issues that have your constrained performance in that area. And we’re just - as I said, just we’re learning more and more and more about that business every day.

And we’re making, I think just really good progress in putting things in shape to where they need to be, to be the type of contributor and to generate the kind of returns that we believe are available in that area.

Okay. And one final question.

What are you seeing in terms of demand in China and what are your volumes so far this year to China?

I can’t remember exactly offhand what are our volumes are. But the market is reasonably good in China.

And we’re continuing both in terms of China and the other Asia-Pacific markets. We’re continuing to increase our volumes into that market this year, compared to what’s the case last year.

Got it. That’s very helpful.

I’ll turn it over. Good luck in Q4 and into 2017.

Yes. Sorry, Ketan, what was that last bit?

Oh, thank you. Thank you very much.

I appreciate that.

Hi, good morning. Duncan, it looks like you’re starting to de-lever now quite nicely.

I’m just wondering maybe how actively you’re starting to think about that next sort of round of M&A opportunities and curious what that pipeline might look like in South without going into any sort of specifics.

Well, we’ve repaid something like a $105 million of debt so far this year. I think we performed pretty well from an operating standpoint, and clearly, with two quarters in a row of record cash profitability, like the spring capital program has generated of significant amount of free cash flow that resulted in reductions in debt, which is one of the objectives that we had going into the year.

And as we increase our financial capacity, it obviously opens up opportunities for us to do things, which I would call more strategic types of initiatives. And so - but at the same time our focus right now is - focus is driving the improvements in performance in the U.S.

South and getting that business operating at the same level of performance as our businesses in B.C. Interior and in the U.S.

Pacific Northwest. So, well, we will continue to be open to look for opportunities that will add to the platform.

Our near-term focus is on realizing on the gains that are available inside the platform, that we already own, Hamir.

Yes, sure enough. And just a question for Bart, I was curious to get your perspective on what you think might happen to the spread between Southern Yellow Pine and SPF if duties end up coming in.

Well, that’s a difficult question to speculate on. So I’ll avoid going there.

I will say though that the Southern Yellow Pine markets and the SPF markets, although some overlap, are under different influences, different demands. So it’s very difficult to tell what the trading environment will look like under some kind of negotiated or forced duty situation.

Yes, sure enough. Thanks, Bart.

I’ll turn it over.

Thanks, Hamir.

Thanks. Good morning, everyone.

Hi, Sean.

I have a few questions. Duncan, can you give us more context on the volume gains you saw in Canada this quarter.

And I’m just trying to gauge how much of this is Castlegar ramping up versus gains across the rest of the platform in Canada?

It’s a combination of a number of things. Castlegar, which was completed about a year ago, it’s just run exceptionally well.

And we see gains quarter over quarter over quarter. But it was really good performance across the board in all of our operations in Canada, Sean.

Okay. And I want to make sure I’m thinking about the $35 million incrementally EBITDA target in the States the right way.

Is that target premised on you bringing back all of the idled capacity down there or a chunk of it? How should we think about volumes?

Some of it.

Okay.

So not all of it, some of it. And we think it will take a little longer to bring it all back.

But as I said continually; what’s more important for us is the reliability levels at the various mills and the productivity levels at the various mills. And only when those - only when we are comfortable that we’ve moved those factors to where we believe they should be, will we start look at - start looking at adding any significant number of hours.

It will also in turn depend on what the state of the lumber market looks like at the time. So between now and the end of next year, we would expect to see some fairly significant improvements in productivity driven by both a modest capital, but more importantly, more structured maintenance and management programs at those operations and existed historically.

And then we will start looking at adding ours to those facilities.

Understood. Last question for me, Duncan, you touched on bias towards, I guess, discretionary CapEx versus M&A.

Any updated thoughts on how - or if returning capital to shareholders via buybacks or regular dividend? Is that coming into the Board’s thinking in terms of overall capital allocation policy?

Sean, the Board certainly talks about those kinds of questions on a regular basis. All of the feedback that we get from investors is that debt reduction is really important, so rebuilding financial capacity, positioning ourselves in a way that we can start looking at broader strategic initiatives is a better way of creating value for shareholders than other approaches.

Now, we’re going to stay flexible on that. We’re going to revisit on an ongoing basis.

But our DNA always has been and it’s - I think it’s been nicely supported by investors, is to manage that capital allocation internally and with external initiatives that broaden the platform, and increase our revenue and profitability.

Okay. I got it.

Thanks very much, guys. That’s all I had.

Thank you, Sean.

Yes, morning, gentlemen.

Hi, Paul.

Just trying to reconcile, when Trudeau and Obama got together and there was that joint statement. There was - one of the key features was on the SLA’s future structure was to design, maintain Canadian exports out of bloated [ph] and agreed U.S.

market. I’m just trying to reconcile that with, Duncan, your comment of the grow-the-market solution.

So what’s the bridge between those?

Well, it really boils down to what the market share is, Paul. And Canadian volume going into the period - leading up to 2006, Canada was shipping about 34%, had about 34% market share in the U.S.

That number dropped during the period of the SLA to low of about 26%. I think it was in 2009 or so, and is currently running in the 30% to 31% of that market.

And the demand-supply situation in the U.S. is reasonably balanced under current circumstance.

And the U.S. has tabled a proposal that we think it’s nonsensical in terms of what an appropriate market share will be from a Canadian standpoint.

And Canada’s tabled similar proposals, which I think make more sense to go to that market. What I don’t want to see is a situation where the U.S.

market shorted significantly of available volume, which just will do two things. It will create a bunch of disruption in the marketplace.

It will increase volatility of product pricing. And it will open the door for third-country imports, which I think this is just nonsensical.

And so it really boils down to, if the current round of discussions is going to move towards some kind of market share arrangement as the Prime Minister and the President indicated, making sure that that number makes sense, and works in everybody’s long-term best interest is a key element of what may happen here going forward. And so, we’re just going to have to wait and see where that ends up.

So based off the history of higher market share than we got currently, a deal based off the current share is considered a bad deal in your opinion?

Say that again, a deal based on what?

Based off the history that we had a lot higher market share than what’s currently, if we get a market share quota arrangement at the current share, would you consider that a bad deal?

I’m not going to comment, Paul.

Okay. And maybe just a question on the Canadian performance, if you could break that out, between the interior and the coast whether it was the same, both the very good performance in both units or - what is the coast running out right now versus the interior?

I’ll say, there’s very good performance in both regions. The interior in particular, but coast performed very well as well.

Okay. And then, lastly, you made the comment that Canadian housing market is stable.

I’m just wondering - I’m just trying to understand that I mean really it looks like from my perspective that we’ve got two markets that are doing pretty well, Toronto and Vancouver, and a huge mix shift in the multi-side and some mortgage [ph] around Vancouver. Where do you see the stability?

Bart can answer that.

Just in terms of total volume - total demand.

Okay. So we’ve seen volume drops this year and but you think it’s stable at this level is that the comment?

Yes, I do.

All right. That’s all I had.

Thanks, guys.

Thanks, Paul.

Thanks. Duncan, third-party industry data provider show relatively large increases in U.S.

South lumber production over the next couple of years. Given your experience in ramping up mills like Thomaston and others, what kind of production increase and lift in the U.S.

South as a region do you see over the next couple of years?

Well, it’s an interesting question, Daryl. And I can tell you from personal experience.

It’s an awful lot harder to do - drive increases in production than folks might think is the case. So we are going to see some incremental volume increases.

But whether it is capacity or mill performance or labor availability or whatever, it’s more difficult to ramp-up volume than people think. And so, that’s one of the reasons why I got concerned about - I have some concerns about highly restrictive trade agreements that short markets as I just don’t think they work to people’s best interest.

And we are kind of focused on what we are doing. But I don’t think we are going to see much forthcoming in terms of additional volumes from either the Southeast or the Northwest in the near-term for sure.

Thanks for that, Duncan.

Thanks, Daryl.

Good morning. My question is related to the Softwood Lumber Agreement.

Given that, I mean, production volume in BC is going to drop off anyway, how much of the market share can Canada really keep?

Yes, Moji, I can’t get into that. We are in the middle of a negotiation being conducted between Canada and the U.S.

And I don’t think speculation by anybody is very helpful. And I’m certainly not going to publically state a figure right now.

I mean, my guess is our friends in the coalition are listening to this call, so the last thing I’m going to do is tell them what I really think.

Okay. That’s fair.

Yes, if you want to talk - Moji, if you want to talk about it, call me, and I’ll be happy to chat with you. But I’m not going to say anything on a call like this.

Okay. That’s fine.

So on a go-forward basis then, if I kind of look at the income statement, in terms of tax recovery, can you - is there be any improvement in that or should we just kind of use the now coverage rate.

Okay. So we have loss carry-forwards in both Canada and the U.S.

quite significant over a CAD$100 million and US$172 million. So we are protected from a tax perspective for quite a period of time from a cash basis.

Okay, okay. That’s it.

Okay, thank you.

Thank you. Thanks, Moji.

Great. Thanks, operator.

Thanks, everybody. I appreciate you taking the time to come on the call and your interest on our company.

I apologize for being evasive on the Softwood stuff. But I think you can understand there’s a limit to how much I can say and I just don’t think the speculation that we are seeing is particularly helpful.

So I’m not going to add to that. So hopefully, we’ll see a resolution of this thing before too much time goes under the bridge here.

But anyway, thanks very much, appreciate your time. If you’ve got any questions that you want to follow-up with, give me a call.

Marty also will be available later today. We can go there, thanks.

So thanks very much, everybody. Have a good day.