Interfor Corporation

Duncan K. Davies - President and CEO Bart Bender - SVP, Sales & Marketing

Ketan Mamtora - BMO Capital Markets Sean Steuart - TD Securities Paul Quinn - RBC Capital Markets Daryl Swetlishoff - Raymond James Hamir Patel - CIBC Capital Markets

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

I'm here this morning along with John Horning, Marty Juravsky, and Bart Bender, to discuss Interfor's first quarter results. We are going to do this session a little differently than we normally do.

My assumption is you've all had a chance to read our press release that was issued yesterday afternoon. Rather than summarizing the contents of the release, as we normally do, I'm going to leave you with three or four key takeaways, then I'm going to turn directly to your questions.

First things first, markets were strong in the quarter. The combination of growing demand and concern over supply led to higher prices across the board, led by the Western species, which were up more than 10% quarter-over-quarter.

Equally important, prices gained momentum as the quarter progressed. Second, in general terms, we performed well from an operating standpoint during the first quarter.

Production and sales volumes were up 5% quarter-over-quarter, with the biggest gains coming in our Southern region where we're making good progress capturing the gains available to us in that area. Operating rates in the South were 86% in the first quarter, compared to 78% in the fourth quarter, and significantly increased to 91% in March.

Third, not everything went according to plan in the quarter. Difficult weather early in the quarter impacted logging operations on the B.C.

Coast and had a negative effect on log sales revenue and profitability. It also led to curtailments at our Acorn mill in Vancouver during the quarter.

Difficult weather also impacted operating rates and profitability at our Gilchrist board mill in Central Oregon. And finally, there was a number of logistics issues which impacted shipping activity early in the quarter and contributed to a one-time build in lumber inventory and working capital during the quarter.

Getting to the bottom line, Interfor generated earnings of $19.7 million on sales of just under $457 million in the first quarter. EBITDA, excluding share-based compensation and non-recurring items, was $60.3 million, which was another record for us, the third in the last four quarters.

Finally, the other item worthy of note, and I'm sure an area that you're going to want to spend some time discussing, was the rendering of the preliminary countervail duties by the Department of Commerce last week along with the bizarre ruling on 'critical circumstance'. We remain of the view that the U.S.

case is without merit and that never has and never will stand up to objective scrutiny. It's simply a negotiating tactic designed to put political pressure on the Canadian government that at the end of the day will be paid for by American consumers.

And I think once that becomes clear, there will be an opportunity for more constructive dialog, as it has been the case up till now. So operator, that's it for my prepared remarks.

I rather open the session to questions and respond specifically to items of interest of our guests.

First question, on the balance sheet side, obviously net debt is – balance sheet has improved dramatically, net debt is now down below your targeted range of 30% to 40%. Can you just at a high level talk about how you all are thinking about managing cash, whether it's investing in your business, you see opportunities there, or kind of M&A, whether it's in U.S.

South or some other regions, any thoughts you can provide on that?

That's a good question and we like to operate with a net debt to invested capital ratio in the 30% to 40% range. There will be times where it will drop below that, such as where we are right now.

And we are in an environment where we're generating a fairly significant amount of cash. And all that does is it continues to result in reductions in the net debt to invested capital ratio and broadens the range of opportunities that we are able to take advantage of.

So, we look at a combination of internal investment opportunities, that we have a number of those, we look at external opportunities as well, and determine which we think is going to generate the best long-term return for our shareholders and create the most value for our shareholders over time. So, we have a combination of things.

We have indicated that our capital program this year is somewhere in the range of $85 million to $90 million. Our view of that at the end of the first quarter is consistent with what we have said last time around, so we think it will be in that range.

And as we maintain our profitability or improve our profitability going forward, we expect that our financial capacity is going to continue to increase, which just broadens the range of opportunities that are available to us. So, I can't give you any specifics at this point beyond what I've indicated from a capital plan this year, but all I can tell you is that we are in very good shape financially, we got lots of ideas of what we can do to create value, that just becomes a question of which opportunities we take advantage of first.

Okay, that's helpful. And then second question, on your Southern performance, it's improved quite a bit over the past few months and it seems like March was really strong.

If you can, two or three things kind of where you are seeing the most gains, and then if you think there is further room to run beyond the 35 million target that you all have set?

Let me deal with the last item first. Let's get to the 35 million and then we'll talk about what's next.

We have always said that the 35 million was the first stage of our overall plan for the region. It is primarily non-capital related.

We're making really good progress on that. And I'm just delighted with the gains that the guys are making in that area.

Beyond the non-capital initiatives, there is a number of opportunities embedded in the Southern region for smaller high-return capital projects, and ultimately there will be opportunities related to some more significant capital opportunities. But first things first, you got to lay the foundation before you can realistically expect to gain the return from any discretionary investment activity, and that's the way we approach these things.

So let's put the structure in place and build from there. What I'm really happy with is the systematic approach that's being taken under Ian Fillinger, who is the Head of our Operations, in the South in areas like plant maintenance programs, quality control programs, mill reliability, product quality factors, there's just a whole bunch of gains being made across the board.

There's been some specific gains in individual mills. We have got a group of specialists that we employ in the area that work with our regional operating folks and our mill operating folks.

We have used them in a couple of our facilities, and just most recently in our mill at Monticello, Arkansas, and we saw some dramatic improvements in reliability, productivity and profitability of that facility as a result of that initiative. And that's the kind of approach that we are taking in the area, and as I said, I'm just really pleased with the progress that's being made.

That's helpful. So just on that point, Duncan, do you think that that structure is largely in place at this point and you all are close to turning your attention to the second leg, which is kind of a capital-driven project, or do you think there is still kind of, you want to see how this runs for a few more quarters to get that confidence?

Yes, I want to see how it runs for a few more quarters. We've made good progress in the previous quarters since we started this, but we're really starting to see the momentum build during the first quarter and I want to give it more time.

There's a number of specific things that the guys are working on. I want that momentum to continue to build.

And as it builds, it just develops more and more momentum. So it just sort of builds on itself and I want to let that unfold here over the next little while.

Okay, that's very helpful. I'll turn it over.

Thank you and good luck for the rest of the year.

A couple of questions. Duncan, want to get your perspective on pricing for lumber.

Since the preliminary CVD announcement was made, we've seen prices hold up really well, which I'm a bit surprised by just given the fact that a good chunk of the industry wasn't assessed with the retroactivity and the overall rates weren't as penal as some had thought. Maybe just a bit of context on the tension in the market right now and the pockets of demand that are really keeping this market tight?

One of the really important things that work, Sean, here that people often forget is the market is continuing to grow and your housing search is continuing to move in the right direction. There is growth in other segments of the marketplace.

So there's a strong underlying demand that work. And so, that on its own right is a good thing.

You superimpose over top of that the speculation relating to various potential duty scenarios, we have seen the initial run of the countervail duties, we've got this idiotic ruling on 'critical circumstances' that creates more uncertainty in the marketplace. We haven't seen the anti-dumping determinations yet, and we won't see those for another month and a half at best.

So, I think the uncertainty that you've got is going to continue to affect the market, and I think that's all part of the game plan in the U.S., is the more uncertainty that you can create, the more political difficulty it causes for the folks here north of the border, and I think that's going to continue. And so, until you get some clarity around what the other side of this thing is going to look like and whether critical circumstance is really going to hold, I think you're going to have ongoing volatility in product pricing depending on both what the psychology is at the time, but also what the takeaway levels look like inside the marketplace, and I think it's just all part and parcel of the program that you've got to go through here.

Okay. And then do you have any sense yet on the willingness of the U.S.

to re-engage in negotiations with this preliminary ruling in the rear-view mirror?

You know what, Sean, I've watched a bunch of the press conferences that have been held by U.S. If anything, I'm not sure whether we are talking about lumber or milk or NAFTA or all three or whether it is something else.

Up till now there's been nobody home down there to talk to. The Secretary of Congress has confirmed, but my understanding is there are still some issues around the confirmation of the U.S.

Trade Representative. I'm not sure there is an absolute alignment between the various groups in the U.S., and from the leadership standpoint, depending on the day or the time of the day, you can get a different sense of the direction things are going.

And so, I know that the Canadian authorities are really willing and able and have been attempting to engage to find a more constructive solution here. I think there is a pile of political theater we get in the U.S.

Again, I'm not sure what the real issues are. But we've been really willing and able to work to try to find a constructive solution to this thing, not just for the last couple of months, but for at least the last 18 months or two years we've been prepared to engage in constructive dialog and haven't found anybody that's prepared to talk about it.

So, that's kind of the past. Now, assuming now that this thing is launched and the confirmation process is unfolding and the U.S.

is getting its plan to the extent you call it out, getting their plan in place in some of the trade issues they want to deal with, I would like to think here over the not too distant future we're going to be able to engage in some constructive discussion to put this thing behind us and turn our attention to more constructive elements like growing the market and running our businesses.

Thanks for that. And just one last quick one, following up with the previous question on your progress in the U.S.

South, you got to 43% of your target, 35 million in EBITDA, by taking operating rates up on average 8 points quarter over quarter. Should we think of that as sort of a linear relationship going forward if you exit Q2 in low to mid 90% range, similar magnitude of gains on that plan versus what you achieved in Q1, is that a safe assumption?

I'm not sure it's a perfect linear relationship, Sean, but it's obviously highly correlated, and our intention is to continue to ramp up our facilities in the area. We are seeing our operating rates, our productivity rates, which are in our opinion the key to the whole piece, and based off of that we have plans to add additional hours for our operations in the area.

But it won't be additional hours every week, it will be hours added at a particular facility at a particular period of time, and we'll gain from that. And our expectation is, it will just continue to ramp up in a fairly common fashion over the balance of this year.

Okay, that's all I had. Thanks very much, guys.

I just had a couple of questions. So following up on Sean's volume question, do you have a target for U.S.

South volume in 2017 or where you think you'll end up?

We expect it to ramp up. We had said earlier that our target was to by the end of this year – the $35 million was based on being able to hit an operating rate of 90% plus by the fourth quarter of this year, and we have already passed through the 90% rate in March, and our expectations will continue to edge it up from there, Paul.

And I think the rated capacity is 1.3 billion, so you can do the math on that.

Okay. Maybe turning to Asian market conditions, maybe you could just give us an update on where that's sitting and what your expectation is on pricing in that market?

Now that we have got the preliminary CVD rates and soon to get the anti-dumping rates, the price is going to fall in the market to offset.

I think I'm going to let Bart comment on that.

Paul, good question. I think, directionally, the demands that we are seeing for products out of Asia is very positive.

We had a decent quarter relative to previous quarters. And I do think though that the introduction of the CVD duties is causing some uncertainty on where the market prices will end up, and we just think that over time market discovery will point a way to us.

And so, right now just like any other non-U.S. markets, we are seeing a stage of discovery and over the next little while we'll figure out exactly where that's going to land.

The positive thing from my standpoint is that the appetites from our Asian markets are real. There is some demand for our product, and so the business is to be had.

Okay. And then just, I think you referenced pretty strong U.S.

housing market, but we also know that we've had very favorable weather, and you guys have known that directly with your U.S. South operations.

Do you think the current pace of starts is sustainable through 2017 or do you think that slows down here, what are you hearing from your customers right now?

All the customers that we've talked to are pretty optimistic about 2017, Paul. So, my expectation is, in the short-term demand is just going to continue to inch up.

The figures that we hear are gains of somewhere in the range of 2 billion to 2.5 billion feet this year compared to last year, and there's nothing that we see that suggest anything other than that, which is a really interesting conundrum that is being faced here. As the U.S.

industry looks to restrict Canadian supply into that market, their ability to ramp up to meet growing demand is constrained. And so, the U.S.

housing recovery, I know is a big thing from a U.S. economy standpoint, and some of these actions that are being taken on the trade front have the potential to have a negative impact on that activity, and I have just a hard time reconciling how these actions against Canadian producers make much sense in a broader economic context in the U.S.

with respect to the growth of their economy.

Fair point. And maybe just sticking with that softwood lumber dispute or file, do you have an estimate of what your retros preliminary CVD deposits are, and I guess do you consider just because they have found critical circumstance on that, the AD deposits will also be retro and you'll be forced with that till the beginning of April as well?

We think they are coming back. We don't think – we know what the number is.

We don't think they're going to stand up to any kind of scrutiny. I think it's just a completely bizarre and idiotic ruling.

And so, we just don't think they're going to hold up as it moves through the final stages of this process here over the next six months or thereabouts. So, I'm more focused on what the whole prospective total of duties will look like.

So I want to see what the ADD number would be. If they play the game by the markets at Queensbury rules, I mean the result would be de minimis or very low single-digits.

If they play the game like they tend to want to play the game, it would be some outrageous number, that we'll then have to challenge in the review process. So, I just think there's a pile of uncertainty, I think there is a pile of uncertainty about the whole trade issue, which I think is part of the broader strategy that the U.S.

uses to try to create negotiating conditions that are more favorable for themselves.

And Paul, one thing just to remember is the frame of reference, and we included this in the press release this time around. The amount of lumber volume that we sell from our Canadian mills to the U.S.

is about 100 million board feet for the quarter. So, to put that in context, it's about 16% of our total lumber sales.

So, there is an impact on that. You can do the math on what it does to 100 million board feet.

But we have a substantially larger piece of our business that is non-duty impacted.

So what is that number?

Which number?

The retro deposits, can you share that? Because then that will give us an idea so what your ongoing preliminary CVD deposits be.

It's US$5.6 million in the first quarter.

Excellent. Thanks.

That's all I had. Cheers.

Just following up on the softwood stuff, given the way lumber prices have reacted to the CVD on going higher and increasing costs to homebuilders and the U.S. consumers and reducing affordability, we have seen some commentary supporting the Canadian position by the NAHB.

Duncan, why haven't there been more support from some of the larger homebuilders in your opinion?

Daryl, I think you'd have to ask them that question. I don't think people pay much attention to this until it becomes a reality, until the duties are announced, and then you get a number of people reacting to the situation.

And I know there is a lot of concern amongst the larger homebuilders and a number of the smaller homebuilders, represented by the NAHB. So, they are much more active today than they were three months ago or six months ago, and I would assume that they are making their views known, as we would encourage them to do, to the U.S.

administration, not because it's a good thing to do for Canadian producers, but it's a good thing to do for themselves, because the volatility in pricing and the impact on pricing of these kinds of measures by the U.S. government is going to affect their business and I would expect them to stand up and speak out on their own selfish behalf to their government.

I agree. A question for Bart; Bart, what are you seeing in terms of realized cedar pricing post the preliminary CVD?

Good question. Our cedar business actually has been very resilient under the circumstances.

And obviously with the high values that are on cedar, the duties are meaningful and punitive. But we've seen a response from the market.

We've seen the ability to capture those additional costs. And also I think that our position in the marketplace and the fact that we have a remanufacturing facility located in Sumas, Washington puts us in a strong position to further mitigate any of those potential duties.

So, we're in a good spot when it comes to that, Daryl.

Thanks, Bart, it's helpful. And lastly, Duncan, as you go through the efficiency gain exercise in the U.S.

South and you're seeing your operating rate creep up through your target already, does that change the 1.3 billion capacity number as well, are you finding opportunities to debottleneck and will your capacity be something higher?

It might be, but I'd rather just stay focused on the targets we have established with the capacity rates that we have published for now, and we have a little bit more experience on this and we can see what the individual facilities are able to do, then we can come back and visit that later. But I just – we own this opportunity in the Southern region.

We have established a preliminary target of $35 million. I think there is significant additional opportunity beyond that as we go forward and start looking at the potential for discretionary capital allocation opportunities down there.

Thanks so much. I'll turn it over.

Duncan, I wanted to hear your perspective on European imports. I mean this trade step seem to suggest there's been a big increase year to date, particularly from Germany.

Curious what your thoughts are as to maybe how much your feet board can come in and perhaps where does it cap out at?

I think if you go back into – go back 10 years when we were in the last, in the run-up of the market in the early part of the 2000s, I think offshore imports were a couple of billion board feet product. We've been dramatically less than that over the last 10 years.

I don't know exactly what the number is, but I think it's somewhere in the range of 0.5 billion board feet currently. But we are seeing more and more interest from European producers and potentially from South American producers to move product into the U.S.

market. And that's the risk that the U.S.

industry has if they restrict Canadian supply and can't satisfy their own requirements. Doesn't necessarily mean that they're going to capture all of the potential gains from that initiative, the economics are that the Europeans and the South Americans can move product into the U.S.

as well. And we are seeing some increasing volumes coming in.

We actually participated in that for a period of time, of moving some European volumes into the East Coast of the U.S., and we concluded that it was a distraction for us, so we ended up putting an end to that business. But there's other folks that I'm sure will want to take advantage of those opportunities of product in from offshore as well.

Thanks, Duncan, that's helpful. And just a final question I had for Bart, I was curious what sort of pricing discount Canadian customers are receiving right now for SPF, given the CVDs?

Okay. So when we look to price the individual markets, we don't base it off of one market versus the other.

So we simply price on the ability for that market to pay. And so we are really avoiding the discount question and rather concentrating our efforts on servicing the customer and deciding whether or not the business is worth doing or otherwise.

And so I think that there is a real stage here in the near-term where the markets figure out where the supply is going to go or the production is going to flow, and that's opportunity and we'll explore those markets based on their willingness to pay as opposed to picking any sort of discount.

Thanks Bart.

Certainly the markets are sorting themselves out as we speak.

Correct.

Thanks Duncan.

Okay, great. Thanks, operator, and thanks everybody.

We very much appreciate your interest in our Company, enjoy these discussions and we're all available here if you want to follow up with us individually, happy to provide comments. And if not, we look forward to talking to you again at the end of the second quarter.

Thanks everybody and have a good day.