Interfor Corporation

Martin L. Juravsky - SVP, Corporate Development & Strategy Duncan K.

Davies - President and CEO John A. Horning - EVP and CFO Bart Bender - SVP, Sales & Marketing

Sean Steuart - TD Securities Hamir Patel - CIBC Capital Markets Mark Wilde - BMO Capital Markets Paul Quinn - RBC Capital Markets

Thanks operator and good morning everyone. This is Marty Juravsky and I am sitting in for Duncan on today's call as he is away from the office to attend the BC Premiers briefing to industry CEOs regarding the SLA issue.

And before you speculate on what this means for the trade file, please appreciate that the meeting is just an update. He'll be back in the office later today for your questions.

I am bringing you the same format that we have for the last call which is to provide a brief overview of the quarter for context but I will avoid repeating the details of the press release as I am assuming that most people have already reviewed that information. After the introduction we will open up the line for questions so that we can make the best use of your time.

In addition to myself I am joined by Bart Bender SVP of Sales and Marketing who could answer any questions relating to the lumber markets as well as John Horning CFO. In terms of the second quarter we were really pleased with the results from a number of perspectives.

We had sales of over $500 million for the first time in Interfor's history and generated record EBITDA of $77 million. As a quick note, the EBITDA would have been $85 million if we adopted the same accounting treatment of adding back duties as some other companies have done.

Most importantly we think the quarter reflects the benefits that come from our diversified strategy and the substantial gains that were realized from our controllable business initiatives. In terms of our strategy, over the last decade Interfor created a geographically diversified North American platform with a particular emphasis on growth into attractive wood baskets.

The benefits of this diversification were very evident in Q2. For example this past quarter experienced a lot of market volatility with the introduction of duties in Canada, currency shifts, and even weather related events that impacted the industry.

Amidst the market noise all of our operating regions performed very well with some very interesting quarter-over-quarter shifts. For example our Canadian operations generated very strong cash flow in Q2 but it was up only slightly versus Q1 primarily as a result of the imposition of countervailing duties in May and June which offset much of the benefit from the price increases and the currency shift.

However, we had very significant EBITDA gains in both our Pacific Northwest and U.S. operations as a result of both price appreciations as well as some very strong operating performance.

In terms of the controllable factors of our business we made a number of commitments in late 2015, early 2016 which included one, delivering on the $50 million Castlegar project; two, delivering on $35 million in EBITDA improvements in the South by the end of 2017 and that 35 was irrespective of market price changes. And three, reducing leverage to below 30% net debt to invested capital.

I'm pleased to say that we exceeded each of these commitments. As most of you know, our Castlegar project was completed on time and budget and the performance surpassed our expectations for economic returns.

The $35 million targeted EBITDA improvement in the South was more than fully realized six months ahead of schedule. Our debt has been reduced from over $460 million in late 2015 to a current level of around $280 million.

We are now at a net debt to invested capital ratio of around 21% and net debt to trailing EBITDA ratio of less than one times. This puts us in a very strong financial and operating position to now focus on the next phase for the company.

So now let's talk about this next phase. As we started to realize the margin create gains in our South platform, we continued to uncover incremental opportunities.

That is why the realization of the $35 million in EBITDA gains is less about finishing that initiative and more about starting a new and much larger phase. This larger phase will include both non-capital initiatives and targeted capital investments.

I know that you will want to understand the details related to this next phase of opportunities but, we are not yet in a position to be too specific as we are still working our way through the sequencing and priorities. I can however provide you with a few items that will indicate orders of magnitude and direction.

Number one, in terms of CAPEX our total CAPEX spending should be around $80 million to $85 million in 2017. Of this amount around $50 million to $60 million is maintenance and the remainder is discretionary.

Going forward we expect our total CAPEX number will increase and probably average around $120 million per year over the next few years with that increment being from additional discretionary investments in the U.S. South.

The new discretionary capital investments are part of a long term master capital plan and will involve a series of projects that will be rolled out over several years. These will include smaller items that are less than $10 million for individual projects such as auto grade.

As most of you know we completed one installation in the South, have another one underway, but there are several more installations to go. In addition a couple of dual path building [ph] opportunities are remaining for us on top of the dozen or so that we've completed over the past several years.

There are a number of other similar projects of a smaller scale as well. In addition we are refining the engineering work on several larger projects.

These are related to machines that are rebuilds across a few of our South operations. The preliminary economics across all of these projects both small and large should generate an average payback of 2.5 to 3 years.

They are very attractive and we are working really hard to advance them as soon as possible. In total, the incremental EBITDA from these capital and non-capital initiatives is expected to be much greater than the $35 million that we've realized on the last phase of margin improvement initiatives.

The one thing to keep in mind with this initiative is that this is -- that this phased approach in the South is exactly the same thing that we did in the BC Interior. We started with acquiring assets in good fiber baskets and we then upgraded the operations through both non-capital and then through capital initiatives.

This program in the South is literally repeating the Interfor playbook. Lastly the one thing that we have always tried to do is be very transparent, therefore our commitment to you is that we will report out on the progress and status of these initiatives over the course of time.

In closing I can tell you that we are really excited about this next phase for the company. There's been a lot of really outstanding work done by significant number of people across our business over the past several years.

It's really great to see the measurable results from those initiatives and has positioned us very well to take on these new opportunities. Thank you.

Operator, would you please now open up the call for any questions.

Thanks, good morning Marty.

Hey Sean.

Few questions. Thanks for the detail on I guess the broader plans for the CAPEX initiatives.

When do you guys expect to articulate specific plans, is that something we should expect next quarter?

I expect it is something that, that is not going to be a grand unveiling but it's going to be something that is going unfold in a series of discussions that we'll have with you guys over the course of time. You know as they said, this is sort of a longer term master capital plan so there's no great unfold where all happens at the same time.

We have a long term vision and we have a detailed plan in place but, certain things are going to be sequenced over the course of time. So my guess is what we'll probably do is give some directional indication on the broader scale and then as individual projects are rolled out we can be much more specific on the what's and the when's and orders of magnitude for those individual pieces as they roll out.

Okay and just broadly speaking though, when you're talking about 120 million in CAPEX a year post 2017, is that a three year master plan for you guys, just any goal posts you can give us around how long that elevated spend might last?

Yeah, think of it as both three years for now because that’s where we have visibility on how long a number of these projects will take to rollout. But as a frame of reference it's three years, and as we get further into it we will recalibrate where we are at.

In some ways Sean this kind of goes back to the broader theme which is when we bought the assets in the South, we just saw a boatload of opportunities. The first stage was really non-capital, this next stage is both non-capital and capital.

So the reality, we don't have a shortage of opportunities in front of us that are going to be there for not just the next three years but even beyond that. What we do though is we've got some specific things that we're working on that will keep us pretty busy for the next three years.

There will be some other opportunities that we will probably layer on after that though. But for purposes of thinking about it at this point, think about it as the next three years.

Okay, last one from me for now Marty, we saw a large acquisition announcement in the U.S. South last week.

I gather it was competitive process and I imagine you guys at least had a look. Without speaking to that transaction specifically, can you just give a broader perspective on Interfor's appetite for M&A at this stage and how the opportunity set is evolving?

Yeah, it's a fair question, I appreciate your comment about trying not to talk specifically about situations that are out there. So I can speak fairly broadly about it.

We have and continue to look at opportunities that make sense for us. And this isn't a new phenomenon because of what somebody may or may not have done recently but, our criteria hasn’t changed.

And just calibrating that back to these capital projects that we're talking about, our approach whether it's an acquisition or whether discretionary projects it kind of remain the same which is what's our best deployment of capital whether internal or external. So we're constantly gauging internal and external opportunities which is where is the best place to put our people resources and where is the best place to put our capital resources.

So we look at acquisitions and we have continued to look at acquisitions and we will continue to look at acquisitions, it's just a question of does it make our hurdle relative to where we could otherwise deploy people and capital. And, in terms of our balance sheet right now, we've got lots of dry powder.

So from our frame of reference if we see the right situation that mean our financial and operating and cultural criteria, we'll do them. If we don't, if those opportunities don't meet our criteria we've got lots of internal opportunities that are going to keep us busy.

Great, thanks for the detail Marty. I'll get back in the queue.

Okay, thanks Sean.

Hi Marty, can you say how much capacity growth maybe associated with the next phase of capital investment?

Yeah, at the end of the day there's some smaller projects and there's some larger projects. The smaller projects by and large have a little bit of a capacity in production creep associated with them.

If the larger projects worth of decent incrementalzation orders of magnitude will have continue U.S. south rate now about 1.3 billion board feet.

So those large chunkier projects that are in that one to three year horizon probably have the ability to add in the order of magnitude 200 million to 250 million a board fee of the incremental production.

Thanks Marty, that’s helpful and then I just want to get your perspective on lumber prices in the South. And I know you don't like the term but spread versus SPF and what's been driving the both products?

Why don’t I turn this one over to Bart in terms of the lumber side of things.

Thanks Marty. You know the South obviously has shown some declines of late.

However, without speculating too deeply it does look like that market has stabilized for us. We've got strong order files and in terms of our customers it's universally their business is quite active and strong.

And so I think that it's more or less a process of reestablishing the trading levels and going forward from there. We feel like they've stabilized, however, there is still lots of volatility expected in the market with weather events and with GAAP period showing up and going away.

So you never know exactly but we feel pretty good where we are today.

The other thing to keep in mind too Hamir, you talked about Southern helpline [ph] market and you comment about spreads, we've had this discussion before. When we look more broadly across multiple species on a short-term basis you do have some pretty wild swings and sometimes those wild swings are driven by very, very specific things that are happening at a point in time where it's the fire related dynamic that is playing out in BC right now or other dynamics that have happened from time to time.

So we try to get not too hung up on the short-term dynamics because often times they are driven by just near-term aberrations that we have no control or visibility over. But the core of it is we have had pretty good demand across most of our products.

Great, thanks Marty, that’s all I had.

Great, thanks Hamir.

Marty, I have to say that was a pretty enviable Duncan imitation you did there.

I tried to imitate his voice but I could only get...

Yeah, I think you had the voice and the cadence both down pretty well. A few questions, can you away from this bump up in the capital spending, can you talk with us about sort of capital allocation plans because you really had a very impressive improvement in the balance sheet over the last 18 months?

Yeah, well we're pleased with the balance sheet being recalibrated. It gives us the ability to do a lot of good things.

So, in terms of capital allocations, growth is still important for us whether it's internal or external. And so we think there's going to be some opportunities for us external in addition to the internal stuff that we've focused on.

So for us in the near-term we're continuing to generate really nice free cash flow and will probably continue to build up some additional dry powder to where we are right now with notwithstanding where some of the volatility is in the market. So we will probably continue to build up some incremental dry powder.

Even the CAPEX programs that I was talking about, the realities by the time that we're actually spending money on those projects it's into 2018 before some of that stuff starts to happen. So in the near term as Sean was talking about earlier, we're going to continue to look at acquisition opportunities if they make sense and if till these pop themselves up that's something that we can be doing over the near-term.

If not we're going to continue to build up some dry powder and that will allow us to roll up his capital project with a lot of internal flexibility. Beyond that if you're talking about capital allocation to things like share buybacks or dividends we don't really have dividends on the horizon right now but, it's always something that we could revisit down the road.

We've put a share buyback program in place, a normal course share buyback program in place a couple quarters ago I guess it was. And we'll opportunistically we look at deploying that if the situation makes sense.

Does that answer your question Mark.

That does answer the question. Just turning to kind of the business in the South right now, what would you guess your operating rate is at the moment?

Yeah, we're around 90% operating rate in the U.S. South right now.

And we're not done yet in terms of some of our ramp up plans so we probably got some inching forward to go. The lion share of bringing some of that capacity back that we took out of the market a couple years ago, we brought most of that back and actually my hat was off to Bart and Ian because it was a long term program in terms of how to bring it back prudently into the market and it took a great deal of coordination between operations and sales and marketing to make sure it was done properly and that we weren't throwing a whole bunch of volume into the market at the wrong time.

We did it in the right way so hats off to those guys in terms of how it was done. And so we made substantial progress in bringing that back and we've got a little bit more to go and we've got some very specific mill by mill plans over the course of next couple of quarters.

So my guess is when the dust settles we’re around 90% operating rate today. We will probably be closer to 95% by the end of the year.

Okay, that's helpful. And would then would you say these capital projects in the South are more cost reduction or more incremental volume, if you want to characterize it like that?

All of the above. And part of the reason I say that Mark is because when I look -- when I am thinking just through the specifics of the projects it will range from things like the smaller projects are probably a couple easy data points auto grade.

As we put one auto grade in and it swings for a little while ago. We've got another one that's being installed right now and we've got another couple there.

Those -- the auto grading does a variety of things and it covers off both costs but it also improves productivity and it also improves great out turns. So checks the box on a variety of things.

So you know that's one piece. There is also some quelling [ph] work that we still need to do on a couple of mills and that helped debottleneck the drying part of a couple of mills but it also improves lumber recovery and product quality.

So it checks the box on a couple things. Some of the larger projects and again I apologize for not being too specific but they're a little bit different in each case.

By and large each of them will involve production increases, so they'll involve debottlenecking various parts of the mills but hand in hand with that debottlenecking and speeding up the lines in some cases will be also a reduction in cost. Some of it comes from putting a fixed cost over a higher production base, some of it comes from just actually having a more efficient machine center.

So I apologize for not answering it specifically because in many cases it's really and all the above in terms of how it checks the box and in some ways because so many of these projects hit multiple key performance dynamics for us, it would drive some really good payback because it's not just adding volume or it's not just reducing cost, it's not just helping on a greater out turns. Most of these projects are checking the box in a variety of factors.

Yeah, okay that make sense. Just a couple of other ones, are you seeing any upward pressure on your log cost down in the south?

No, no. One of the things we've tracked really carefully as we've been going through the margin improvement program over the last little while is also input log cost and they've been remarkably flat on average.

From time to time there's a little bit of pressure in some with baskets but we've also actually seen a little bit of decline in some other baskets but across our nine mills in the South it's pretty flat.

Okay, then the last one, is it possible for you or Bart to give us just some update on where you think the trade negotiations are at right now?

Why, don't I take a shot at that and if I drop the ball on this one Bart can pick it up where I missed it. Short answer Mark is we have no clue.

There's lots of people in the political realm who are shouting things but I'm always old school which is until there's a deal there isn't a deal. And so with good there's conversation is good that there's all that kind of dialogue and it's interesting that people are speculating.

But these things are pretty complicated and until I's are dotted and t's crossed there's lots of things that can fall off the rails. Often times the speculation revolves also around what happens with market share for example if there's a market share deal.

But there is so many other components of it including the dynamic of what happens within Canada in terms of how things work. So the way I characterize it is, it is nice that there is conversation, you want to be optimistic that there's conversations.

But it's really hard to handicap the path and likelihood and timing and substance of what an outcome would be.

The only thing I would add to that is that the uncertainty obviously isn't good for anyone. It's difficult to run our businesses like this and its difficult for our customers to truly understand how to buy it.

And it does seem that every time we get a step closer to being certain about some component of this it brings about a number of other questions that create other uncertainties. And so it's a difficult process to work through.

Our customers are doing what they can, watching their inventories closely. And I guess the good news as Marty mentioned it earlier, the good news is on the demand side.

We've still -- we've got a fair degree of stability there and improvements and so I think that that's key to kind of seeing us through the uncertainties that are created from this file.

And Bart are you expecting any impacts on the market just as we approach kind of late August and that preliminary CVD goes away? I mean it's only certain about 20% so I guess what we're trying to figure out is whether there are people with enough inventory that they can kind of back away from the market for a couple of weeks in the expectation that kind of pricing drops after the CVD is eliminated?

Yeah, again it's certainly a topic from our customer standpoint on how they should procure. But there's a number of factors out there that play into this beyond simply that percentage of CVD.

It's -- we've obviously got the fire situation in BC and that’s creating a ton of uncertainty in terms of what actually are the impacts on supply and I really don't -- I'm not sure that the market fully understands the impacts of that. I truly don't and then on the other side of it is from an inventory standpoint and demand standpoint in the marketplace inventories are stable to low and demand is high.

So I think it's really difficult to see exactly what that GAAP period might do from a pricing perspective.

It's interesting, you talked it through Bart. The one thing that if we look back over the course of time and the volatility of the lumber business, there's not necessarily a clear line between cause and effect because there is usually multiple factors going on at any point in time.

And with the domino effect of those multiple factors that plays into pricing. So clearly the CVD GAAP period is one factor but it's only one factor.

Yeah, that's a good answer guys. I’ll pass it over.

Okay, thanks Mark.

Hey, thanks very much. Good morning Marty.

Hey, Paul.

Just staying with the trade file, do you believe that all eyes and ears and tongues will be talking about NAFTA when August 16th rolls around, so really if there's going to be a deal on softened lumber it really has that deadline?

I wish I can tell you anything with confidence when it comes to political speculation on how NAFTA and politics work. We're a little bit in uncharted territory.

So I will default to what consensus seems to be when consensus seems to be suggesting that NAFTA trade file picks up at some point over the next month or so. And if that picks up that’s a longer term process and that’s a broader conversation.

So I don't have any more visibility on it than that Paul. But again it really comes back to trying to handicap and predict political dynamics, trade file dynamics.

It's a bit of a mugs game for us. And that's why we just -- we are just going to say I'm bad to say it but we don't really spend that much time internally trying to figure out what the nuances are going to be over the next month or two months or three months because there's just -- it's so murky to figure it out.

And it would truly be speculating as best to figure out how the NAFTA piece does or doesn't mesh into the soft wood lumber piece.

Okay, it does sound like Duncan's spent a little bit of time on it. Maybe I could just try to summarize the capital plans.

Sounds like you're doing about 25 million to 30 million in discretionary right now and then you add an incremental 40, so you're kind of 65 to 70 over the three years, it's kind of a $200 million plan, is that kind of decent summary?

That is a very good summary.

And then you are looking really for in terms of incremental production about a 15% to 20% increase in production and they're all sort of 2.5 to 3 year payback?

Well they're not all 2.5 to 3 year republic. It averages 2.5 to 3 years.

Some of those projects are frankly less -- and they tend to be the smaller items, tend to be very quick payback often times around the year. Some of the chunkier projects are closer to the three times payback.

But the average in the zone of kind of 2.5 to 3 years across the whole portfolio of projects. And sort of what was the number you threw out again then Paul in terms of capacity you said

15, well you know I just said 200 to 250 on the 1.3 kind of comes out to 15% to 20% capacity?

That's correct. That’s about right.

Okay, then last question I had was just you look over the portfolio of your assets, is there anything that you consider if you got the right offer to be not as core as other assets i.e., I look at the BC cost of assets that you've got, it doesn't really mesh in well with the rest of your portfolio, is that something that you look to shell if you had an offer?

Well, we're in growth mode we're not in sell mode and one of my comments that I made and we really look to believe that the diversification has helped out a lot. And there's been times if we look back over the last six, eight, ten, twelve quarters when we've had different regions that have been our best performing regions.

So if we look across BC Interior, BC Coast, Pacific Northwest, U.S. South I can point each one of those four regions as our best performing regions or a mill in each of those regions as our best performing mill in different quarters.

So the diversification has helped reduce the volatility broadly speaking. Specifically when talking about the Coast, what's interesting is our Hammond mill for example, we make cedar out of our Hammond mill.

We also make cedar which we don't talk an awful lot about out of our Interior as well. So there's -- we have operational synergies between the cedar business in the interior and the cedar business in the coast, we like that.

And so it works out pretty well from that perspective. So we're not really spending these huge amount of time thinking about things other than how do we build on our existing platform and improve our existing platform.

You can never say never, but we like the diversification in cost to portfolio.

Okay, and then when you say you are a growth company is that strictly limited the U.S. South or where do you look at other areas like the B.C.

Coast?

Well, the best opportunities frankly and again when I'm talking of growth I'm using internal growth, external growth, just how do we add margin. We've optimized in BC pretty well both in the interior and there's always stuff that you could do on a continuous basis to the Coast as well.

Pacific Northwest there's always some incremental opportunity but we are running pretty well in that area. In terms of the best opportunities going forward, whether it's internal or external there is still probably remain in the U.S.

South. Again back to my comment before you never say never but it kind of you go fishing where the fish are swimming and there's more fish swimming in the U.S.

South in terms of opportunities.

Okay, best of luck fishing I guess.

Okay, thanks Paul, appreciate it.

Okay, well thanks operator. Well look again we appreciate everybody calling in and taking the time this morning.

I know it's always a busy time of the year for you folks with everybody else reporting. So we appreciate the time, we appreciate the support, and if there's any follow up questions just reach out to us at any time.

Thanks again.