Interfor Corporation

Duncan Davies - President & Chief Executive Officer

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

Thanks, Mike. Good morning, everyone.

We’re here this morning to review our third quarter 2017 results and to discuss prospects for the balance of the year. We’re also going to spend sometime talking about the plans we announced yesterday to move into a new phase of reinvestment in our business, which we think holds some very exciting prospects for our company and for our shareholders.

Joining me this morning, as usual, are John Horning, our CFO; Marty Juravsky, our Senior Vice President of Corporate Development and Strategy; and Bart Bender, Senior Vice President of Sales & Marketing. First things first, I’d like to take a few minutes to review our results for the quarter.

Net earnings were $16.8 million and EBITDA was $60.5 million on sales of $489 million. These results for us somewhat from the second quarter as a result of three main factors.

Lower product prices in the U.S. South, as represented by a $31 per thousand drop in the Southern Yellow Pine composite quarter-over-quarter.

Second, lower lumber production, primarily due to a drop in operating rates in the U.S. South, which in turn was due to a combination of weather-related issues, most notably precautionary measures taken in advance and during Hurricane Irma and project-related downtime at our Eatonton and Preston mills in Georgia.

And third, the rise in the value of the Canadian dollar, which increased $0.06 quarter-over-quarter and served amidst the benefits of higher prices for the western species and impact of the translation of U.S. dollar earnings into our home currency.

In terms of production and capacity utilization in the third quarter, we produced 225 million board feet in Canada and 420 million board feet in the U.S. The Canadian volumes included 39 million board feet on the Coast and 186 million board feet in the Interior.

The U.S. volumes included 139 million board feet in the Northwest and 281 million board feet in the South.

Capacity utilization in the quarter was 49% on the Coast, 99% in the Interior, 87% in the Northwest, and 85% in the South, or 85% overall for the company. The third quarter was another strong quarter from the standpoint of cash flow and debt repayment.

We generated a total of $61 million of cash from operations, spent a little less than $30 million on capital projects, and reduced debt by $40 million in the quarter. At the end of the quarter, net debt stood at $178 million, or 18% of invested capital.

To put these figures into context, over the last 24 months, we reduced debt by approximately $300 million, and the ratio of net debt to invested capital is followed by more than 50%. This brings me to the subject of the program we announced yesterday, which in simple terms is the discretionary investment program, made up of a series of discrete projects, designed to take advantage of the opportunities that exist within our current operating platform, and to pursue opportunities for further growth.

The plan is entirely consistent with the strategy that we’ve employed successfully on a number of occasions over the last two decades, most recently in the BC Interior and placed to one of our core strengths, which is the ability to design and execute on capital projects, which historically have delivered operating gains, financial results in excess of pro forma. Yesterday, we received Board approval to proceed with the plan, which we finance from cash flow, and if necessary, from the company’s existing resources.

With respect to our current operating platform, the plan includes a number of major machine center upgrades, designed to bring technology to current standards, as well as a number of smaller debottlenecking and optimization projects all with very attractive paybacks, most of which, but not all will be in the U.S. South.

Two of those projects have received specific approval. And they will be announced in the coming weeks, once we’ve had a chance to talk with our employees and the communities in which we operate, along with other folks who need to hear about these projects directly from us rather than in our press release.

The two projects have a revolver of approximately US$65 million in capital. One involves the addition of a new continuous kiln and automated grading system along with other planar upgrades, the second project involves a new primary breakdown system along with other sawmill upgrades and a new continuous kiln, an automatic grading system and other planer upgrades.

The two projects are scheduled for completion in the fourth quarter of 2018 and the first quarter of 2019, respectively, and should have something in the range of 115 million board feet of additional production into our portfolio on an annualized basis. Paybacks on the two projects using consumer to pricing assumptions is expected to be less than three years, which is pretty attractive relative to the returns available from other forms of discretionary investment.

We also indicated yesterday that we’re looking actively at opportunities for a greenfield investment. In that regard, we’ve identified a potential location in the central region of the U.S.

South. We’re working actively to run that opportunity to ground.

Estimated capital costs, including pre-startup and working capital is in the range of US$115 million. Potential returns obviously are not as high as they would be for capital upgrades to existing facilities, but they appear to be very attractive on a risk adjusted basis relative to other alternatives.

Our plan is to be in a position to make a decision on that project early next year. Finally, a few comments on our outlook for the balance of the year and then we’ll turn the meeting over to you for questions.

Normally, we would expect to see a softening of prices as we move towards year-end, but this year we’ve seen the opposite. Western prices remain very strong, partly fueled by the supply disruptions associated with the fires on the West Coast during the summer.

We’ve also seen stronger prices in the South during the first part of the year – oh, sorry, during the first part of the quarter, although we’ve seen some softening in the last week or so. Probably most encouraging for us is the fact that our mills have ramped back up after the disruptions last quarter and are delivering very nicely relative to the targets we set for them earlier this year.

Mike, at this point, I think, it would be more efficient for our guests return the session over to them. So I’m going to end my formal remarks and happy to take questions at this point.

Thanks. Good morning, everyone.

Hi, Sean.

A few questions, Duncan. First on the greenfield study.

How much of the cost would be working cap, and I guess, startup costs of the total $115 million? I suppose, it’s quite small, but just trying to understand the breakdown of the equipment versus those other buckets?

Yes. Sean, I prefer not to get into the details at this stage, it’s still pretty early.

But I – we just wanted to signal the fact that, we look at it on a holistic basis, but I don’t really want to get into the details.

Okay. Maybe you want to answer this one as well, but if you do make the decision to go ahead, what’s your thinking on timeframe to build it and ramp it up?

Decision time, we hope it would be in – sometime in the first quarter, first-half of next year. And then with all the additional planning that would likely take place, it would most likely be a construction program that will begin in 2019.

Okay. And the discretionary capital program that you touched on, you’re saying $65 million for those two projects, $100 million in discretionary spending in total next year.

And I think, when you talked about this in broader terms last quarter, you had mentioned $200 million over a couple of years. Should we think of this is sort of an evolving program that is not necessarily moving targets, probably not the right word, I know, you guys have specific investments.

But the implication would be that you would see a slowdown ex-greenfield spending into 2019 and 2020. Is that the right way to think about it?

I think, your first characterization was right, it’s an evolving process. We’ve had lots of work underway.

You’re looking at each of our plants looking at the opportunities that exist within each operation, not just in the U.S. South, but everywhere in the organization looking at those opportunities.

And we look at it as a whole series of discrete projects that you’ll make the decision on – based on a whole set of criteria that we’ve got, one of which is payback to set the priorities on the various projects. So I think that’s going to evolve over a bit of time.

The visibility that we’ve got over the course of 2018 and 2019, I think, it would be fair to say, we would be looking at a similar level of spend in 2019 and to be determined of what transpires after that, Sean.

Okay. Thanks, Duncan.

I’ll get back in the queue.

Thanks.

Yes. Thanks very much, and good morning.

Hey, Paul.

Hey, I got on the call late. I heard, Sean, asking some strategic capital questions, which I had, but – so I’ll save those for after.

But maybe just take you back to yesterday’s decision on Softwood Lumber final duties, is that the rate you expected, does that change your operating plan going forward?

Well, it won’t change our operating plan. I learned a long time ago that trying to guess at what the Department of Commerce might or might not do was a bit of a tough process.

So I didn’t spend a lot of time trying to translate what I thought those duties might be. But I can tell you that, it won’t change our plan when I hold in terms of what we’re going to do.

Okay. A little bit on the strategic front, the duties came down on average just over 20%, it seemed a little bit higher than I expected.

But I think, the duties are way too high anyway. So that sort of a given, does that change the strategy where you look at doing M&A activity in some of your capital projects?

No, I don’t think so. I think, people know that I’ve been an advocate of trying to find a settlement of the trade matter for the simple reason, an ongoing dispute in the litigation associated with the dispute that creates uncertainty that makes it difficult to calculate with any degree of precision what relative returns are in capital allocation in one jurisdiction versus another.

Looking beyond the trade matter, when we made our first decision to invest in the U.S. Southeast, we did that partly as a hedge against currency and trade matters.

But we also did it, because we just saw significant opportunities to acquire a platform of assets at an attractive going-in price, opportunities to improve performance of those assets through our own system of operating businesses, but also significant opportunities to upgrade technology and performance in the facilities through the use of discretionary capital sequence properly. And so there’s nothing that we’ve seen since then or that could result from the trade matter that would change our view on the attractiveness of those investments.

So now after the last couple of years, we’ve reached the stage where we’ve made tremendous progress in the operations in embedding our operating system. We’ve got significant cash flow and balance sheet capability.

So we’re in a great spot to be able to move forward with the discretionary capital program that we think is going to generate some very attractive returns for us on a go-forward basis.

Okay. And the last question I had is just on lumber pricing.

Over the last two years, we’ve seen Southern Yellow Pine traded at significant premium to Western SPF. Now we’re seeing the reverse and Western SPF continuing to gain while Southern Yellow Pine comes down in price.

What’s keeping the markets where they are now and what’s the expectation going forward?

Well, I think, we’ve seen a situation with the western species, in particular, with – where supply reductions resulting partly from pine deal issues over time, but partly, because of fire issues, this summer where supply was limited. And so we’ve seen the tightening of demand supply balances for the western species, it has resulted in significantly higher prices for those products here currently.

I think, for Yellow Pine, we’ve had a number of weather-related disruptions in demand over the course of the summer that’s created a bit of a bifurcation between western prices and southern pricing. Our sense going forward is supply restrictions in one form or another will continue to impact product available in the U.S., particularly for the western species and to some extent from our I expect the issue Canada as well, whereas there’s opportunities in yellow pine to both increased production, which we think fits really nicely with the growth and demand that we think will occur naturally in the U.S.

market housing recovers and the economy continues to expand. We think it just fits really nicely.

And over time, I think, you’re going to see both increased production at better pricing in the southern region as a result.

Great. That’s all I had.

Thanks, Paul.

Thanks for taking my questions.

Hi, Ketan

So I wanted to come back to this – the greenfield announcement that you all made yesterday. So obviously, there are a couple of other companies that are also studying a potential for greenfield.

As you think about it, Duncan, just puts and takes around M&A in the U.S. South versus greenfield, how you guys think about it, because obviously on one end, it’s a question of sellers’ expectations versus from your standpoint, how much incremental capital you might have to put into those mills to get it to kind of the level that you feel comfortable with?

So just talk us through kind of how you all think about it?

Well, I guess, there’s a couple of things that play on us. And it’s all about how you can generate the best potential return on capital employed over time, and how you can position your individual assets from a relative competitive position in the marketplace.

And so we said on a number of occasions in the past that relative to other investment opportunities that were available to us, we had a difficult time of penciling greenfield opportunities in a way that made sense relative to the other opportunities. We’ve seen in the last while, where acquisitions have become increasingly expensive.

And we just feel that the return is potentially available on greenfield facilities, if they’re structured properly and derisked as much as possible, can be superior use of capital relative to other opportunities that we see available to us at this point in time. And so we’ve had a group of guys led by Marty, who’ve spent a bunch of time looking to identify opportunities that would fit our criteria.

And we think, we have a situation here now that that has potential to be very attractive. And so, you want to be careful.

We have made a decision to go ahead with this. There’s a number of other things that need to fall in the line before we go.

But I can tell you that, what we’re looking at is a very encouraging opportunity and we think easily financeable given the cash flow that we’re generating and the strength of our balance sheet currently.

Thank you. That’s very helpful.

And one follow-up on that. Is it fair to say that just looking at the choice of the location, you’re thinking about kind of diversifying your locations of saw mills in the U.S.

South, or am I reading too much into it, and this is a specific opportunity that came up, which was interesting to you all?

No, it’s a combination of both. We’ve got a concentration of mills on the east side of the south currently.

We’ve always been interested in opportunities, both on the west side and the central part of the south. So we do have a strategic interest in broadening our platform in the region to include more central and western components, Ketan.

The other piece of the puzzle, which I think is really important when you look at greenfield is ensuring that you’ve got that not only the timber supply, but the labor pools that make sense and the byproduct off-take matters that make sense. And we think we’ve got an opportunity to identify that fits both of those criteria.

So it’s a combination of strategically wanting to move in the westerly direction in the south. But also an opportunity that we’ve been able to identify that helps us derisk that particular investment we think quite nicely.

Got it. That’s very helpful.

And just one follow-up on Q3, Duncan, if I could. I mean, if I just look at Q3’s southern lumber pricings, your performance came in much better than those headline numbers would have suggested.

I understand some of it is kind of the cost benefit on translation of U.S. dollar cost, but also just talk about how the different regions perform without getting into specific numbers, because I know you all don’t provide the regional EBITDA.

But just talk us through some of the nuances among different regions, which might have helped Q3.

Sure. The western regions from a bottom line standpoint all performed really well and better than they did in the second quarter.

The southern region did not perform as well as it did in the second quarter in broad terms, partly because of the reduction in sales returns that fall of the yellow pine composite, but also because of the reduction in production for the reasons that I mentioned. Within the context of the decline in yellow pine pricing, we’ve had an initiative to extract more value per unit of production relative to movements in the benchmark pricing through things like quality control programs and some of the other initiatives that Bart Bender and his team have been putting into place from a sales and marketing standpoint.

And there’s really nice progress being made in that respect. And so relative to what happened just to the benchmark alone, our numbers would be better than that because of the success that the team is having in those initiatives.

And to be fair, it’s not just Bart and his guys, it’s also our operating guys that have done a really nice job of dealing with both product mix and great outturns at our various facilities through the initiatives that they’ve been able to bring to bear in those operations.

Got it. That’s very helpful.

I appreciate it. Good luck into 4Q and 2018.

Yes. Thanks, Ketan.

Hi, good morning. I got on late, so apologies if this has been asked already.

But I think, it was last quarter you – when you first unveiled the capital plan. You’re pointing to do a potential production uplift of sort of $200 million to $250 million board feet by 2020.

Obviously, you’ve today – yesterday you’ve announced the two projects that get you $150 million of that. Just curious whether the greenfield is – was baked into that initial $200 million to $250 million number, or whether that would be additive.?

Additive.

Additive, okay. Thanks.

That’s helpful. And Duncan, what are your thoughts on log cost inflation next year, both in the south and then in BC, both for the Interior and the Coast?

We don’t see an awful lot in the south. I mean, there’s still an oversupply situation in the south and with the pressure on lumber prices.

I’d be surprised if we see much upward movement in log costs in that region certainly for the near-term, Hamir. In British Columbia, contrary to what our friends in U.S.

Lumber Coalition think, log costs have increased quite significantly in that region. Over the last number of years, we would expect that would continue.

One of the benefits for us and I think for some other operators in the BC Interiors, we benefited significantly from the investments we’ve made. And our mills tend to run better in those regions than they do in other areas of the country and for other companies.

So even with log costs going up, we expect to be able to generate very attractive levels of profitability in our business again, as a result of how well those mills are run and the level of capital investment that exists in those facilities.

And any sort of thoughts on the Coast specifically versus the Interior?

In what respect?

In terms of sort of log cost inflation?

There may be some. But I think as the duty effects come into play in the early part of next year, that will be a factor, I think, in determining what direction log costs will go in.

Okay, great. That’s all I had.

Thanks, Duncan.

Thanks, Hamir.

Thanks, Mike, and thanks, everybody. We very much appreciate your attendance this morning.

I know this a busy time for you. We’re currently in Savannah, and so we’re all going to be traveling this afternoon.

So it will be difficult to reach. But early next week, we’re happy to take any calls.

Marty just showed me his phone and said he’s going to be available on his phone this afternoon. So if you want to chat with him, he should be available.

We really appreciate your attendance here today, really appreciate your interest in our company, happy to answer any questions that come up over the next little bit. And if I don’t have a chance to talk to you again, in a next little bit, I look forward to talking to you again at the end of the next quarter.

Thanks, everybody, and have a good day.