Interfor Corporation

Thanks, operator and good morning everyone, and thank you for joining us. I'm here as usual with Marty Juravsky, our CFO; and Bart Bender, our Senior Vice President of Sales and Marketing, to go over Interfor's third quarter's results and to comment on our outlook for the balance of the year.

Joining us as well this morning is Ian Fillinger, our Chief Operating Officer, who’s been appointed by our Board to over as Interfor’s President and CEO in January 1, next year as I step aside. Ian will provide an update on our capital projects and his priorities for the company later on in the discussion.

We’re going to keep our remarks brief and will turn the session over to you for questions as soon as we can. To the extent that you’ve already seen the results of most of others in our sector, there won't be any surprises with our results for the third quarter.

EBITDA was $16.8 million on sales of $486 million in the third quarter, which compares with EBITDA of $12.6 million on sales of $481 million in the second quarter. Lumber prices in the third quarter were mixed.

The Yellow Pine Composite, which covers about one half of our production and sales, dropped by $18 a thousand or just under 5% quarter-over-quarter, although Western SPF Composite was in the other direction rising by $15 a thousand or about 5%. Overall, our average sales realization grew up by $20 in the third quarter.

The negative effects of lower sales returns in the third quarter were more than offset by the impact of higher production and shipment volumes during the quarter, which in turn had a positive impact on operating costs. In addition to our normal operating results, our financial results for the quarter included a $31.8 million per-tax restructuring provision associated with the permanent closure of our Hammond sawmill and the reconfiguration of our Coastal forestry and woodlands operations.

Taking all together, Interfor posted a net loss in the third quarter of $35.6 million after tax, compared to the loss of $11.2 million in the second quarter. Lumber production in the third quarter was 685 million board feet, up from 647 million board feet in the second quarter, an increase of 6%.

Production in the Southern region increased to 348 million board feet from 320 million board feet in the second quarter as the Monticello and Meldrim projects ramped up following the completion of the Phase I capital projects at those mills. Production in our Western region, which includes our mills in British Columbia and [indiscernible] Northwest, increased from 327 million board feet in second quarter to 336 million board feet as higher operating rates in the Interior more than offset a drop of production in the Northwest.

Capacity utilization in the third quarter was 85%, compared to 83% in the second quarter made up of 45% of the B.C. coast, 9% in the B.C.

Interior, 82% in the Pacific Northwest and 92% in the South. During the quarter, we made the decision to reconfigure our B.C.

Coastal business, including the permanent closure of the Hammond sawmill and the reorganization of our Coastal forestry and woodlands operations. A few minutes ago, I spoke about the restructuring provision taken in the quarter to reflect this change, which includes $14 million in capital asset breakdown with $17.8 million of severance and other costs relating primarily to the Coastal decision.

For many years now, our Coastal business had been negatively impacted by log supply issues and other challenges. In addition to releasing significant amounts of working capital tied up in log and lumber inventories in freeing the Hammond property for sale, we believe the reconfiguration of our Coastal business will enable significantly better financial results from that business unit in the years ahead.

Finally, from my standpoint, there isn’t much that I can report today on our transaction with Canfor regarding the cutting rates associated with their former Vavenby sawmill. The transaction, I think as you know, was subject to various consensuses, including that of the B.C.

government. I can tell you that we’re making good progress on our discussion with various stakeholders who remain optimistic that we’ll see the required approval and close the transaction prior to year-end.

At that point, I’m going to turn it over to Bart, who can give you some comments about what’s happening in the lumber market. And then I’m going to turn over after Bart to Ian who can comment on capital projects and other priorities.

So, Bart, over to you.

Okay, thanks Duncan. I’ll provide a brief outlook of the lumber market.

New home construction is gradually increasing, particularly single-family as purchasers take advantage of lower interest rates and approved affordability. The repair and remodel end-use sector is steady.

We expect favorable home prices and interest rates to continue to help here. In North America, in-market inventories as difficult as they are to accurately read, appear normal for this time of the year.

Order files across our network at mills are solid. We expect detention to soon turn to next year, which should bring in a level of our investment and inventories in preparation for seasonal spring demand.

As always, weather will be – weather between now and the spring of next year will be a factor. Overseas, our business has improved quarter-over -quarter from a volume standpoint.

However, inventories remain elevated in most markets and competition from other countries is heightened. On the supply side of the equation, there continues to be some significant shifts and it’s our opinion that the full impact of the 2 billion feet of – or over 2 billion feet of curtailments in B.C.

have not been fully realized in the markets. Canadian shipments to the U.S.

are trending downwards and we expect this to continue. In terms of other regions, we see stable supply year-over-year from imports, Southeast, P&W and the inland impact, no significant increases or declines.

Turning to our specialty business, [this year] in particular, we are in a transition. With the Hammond mill, we have been busy transitioning our customers over to B.C.

Interior or Western red cedar. Our Interior or Western red cedar business has grown to be comparable in size to what we previously produced on the Coast.

Overall, long-term market fundamentals remain favorable and we expect lumber demand to continue to grow. I’ll stop there, Duncan and turn it back over to you.

Thanks, Bart. Ian, if you could make some comments on the status of our capital projects and new priorities for the company going forward?

Sure. So, our Phase 1 capital projects, just to remind everyone, where Monticello in Arkansas and our Meldrim mill in Georgia, and both of those projects are complete, spending done and we’re in ramp up period and very, very close to [decoloring] those projects complete from a pro forma achievement standpoint.

Phase 2 is our Georgetown South Carolina mill, Eatonton in Georgia, and both of those projects are underway with certain phases happening. Georgetown, you know, completing some projects in the sawmill [indiscernible] and Eatonton with some civil and building work underway at this point in time.

And then Phase 3 is really a handful of discretionary projects that are high return and those are being applied and executed on as we speak also. As far the priorities, as Duncan’s alluded to, for us there is completing the – the first priority completing the execution of the capital projects and achieving the post-project ramp ups, priority one.

Two, completing Canfor Vavenby purchase is a top priority for us. Maintaining our financial flexibility, managing our working capitals carefully, scrutinizing our spending, and improving operational efficiencies everywhere we can like we do every day, and then, monitoring market conditions and adjusting as required.

And I think, Duncan, that’s probably is a good summary of our key priorities.

Okay, great. thanks, Ian.

So, in August it was announced that I was going to be stepping down as Interfor’s CEO at the end of this year and that Ian is going to be taking over on the 1st of January. I’ve been in this role now for more than 20 years, and frankly, it's time for change.

Ian’s been with Interfor for more than 15 years and he’s done an outstanding job for us, and in my opinion, will do a great job for the company going forward. I think this is his first time on this call and I thought it will be good to have him provide you an update on our capital projects and his priorities.

But that really brings our discussion here to an end, operator, and I’m going to turn this session over to our guests for questions. So, over to you.

Thank you. Good everyone, and, Duncan, congratulations and all the best for the future.

Thanks, Ketan.

Maybe to start off, Ian, can you just refresh our memory on what kind of returns you’re expecting from these Phase 1 and Phase 2 projects, and sort of rough timeline?

Sorry, was it production?

Returns.

Oh! For returns.

Yes, the returns are – internally our targets are to achieve a 20% IRR, less than five-year payback on the big strategic projects in Phase 1 and Phase 2. Phase 1, the ramp up is really, Ketan, essentially done.

There’s a little bit more work to achieve, a couple of the KPIs that the Monticello and Meldrim team are focused on. At Georgetown and Eatonton are completing.

You know Georgetown, you know, somewhere in Q1, 2020 near the end of that time period. Eatonton, as far as the construction and commissioning goes is mid-2021.

Got it. And then, just to be clear, the IRR that you talked about, 20% that’s post-tax or pre-tax?

That’s pretax. It’s a cash-on-cash pre-tax return.

Okay, perfect. Thanks, Marty.

And then, just switching gears here, this European pine beetle outbreak, are you concerned that lumber imports into the U.S. from Europe could go up meaningfully?

I know that year- till-date we haven't seen much of an impact yet in the numbers, but as you look ahead, do you guys see this as a potential risk?

Okay. Let me comment on that, and maybe Bart can follow up on it.

It’s something we’re monitoring. In the case Europe’s [indiscernible] beetle as opposed to a pine beetle, but, you know, it’s accretive or driven by the same set of factors as we’ve seen here in North America with the pine beetle in British Columbia and in other jurisdictions.

So, it’s – we’re seeing – starting to see ramped up harvest levels and production levels in Europe and we’re starting to see our product both logs and lumber in the different markets of the world. And we had one of our senior people over in Europe last week talking to the people over there and trying to get an understanding of just exactly what’s happened, what the shelf-life looks like, what’s the harvesting plans are and where we’re likely to see that product in the various markets of the world.

So, it’s something we’re paying attention to for sure.

Yes, the only thing I would add to is, you know, within the markets, lots of discussion talking-place with our customers. I think it’s an uncertainty on the magnitude side of the equation, but I think it's worth pointing out that the constraints that they have there is, you know, in some respects are the same constraints that we have here when it comes to people and equipment and mills.

And so, I think that there is an ability to flux our volumes, but it's not intended. So, there are some constraints on just how much can be produced under those logs.

Alright, that’s helpful. And just one last for me – one for me, when I think about 2020 CapEx, what’s kind of a good kind of ballpark number from now?

Yes. Hi, Ken, it’s Marty.

We haven’t finalized our budget for next year, our capital budget, but if you look at this year, we’ll probably be spending a little less than $200 million. In 2020, we’ll be substantially less than that, probably in the $140 million, $150 million zone.

We’ll refine that over the next little bit. But for planning purposes, you can use that as a frame of reference.

Got it. that’s very helpful.

I’ll turn it over and good luck as we get into 2020.

Thank you.

Thanks, Ketan.

Hey, good morning. Ian, I just wanted to follow-up on the capital projects, can you give us a sense given the sort of staging of everything?

How much lumber output growth would you be expecting in 2020, and then, you know, looking beyond that as well?

So, the Phase 1 projects, Monticello and Meldrim, will add in the neighborhood of, you know, 150 million to 155 million feet to our South platform. And then, the Phase 2, which is Georgetown, Eatonton and Thomaston, will add 275 million board feet.

That’s over several years, so the impact for 2020 is probably about 100 million feet increment over 2019.

Greta. Thanks, Marty, and Bart, just wanted you to get a sense as to where inventories are in the channel?

And also, any indication you have from the big box stores about what sort of volume growth they might be planning for next year?

Okay. Well, that’s a difficult question.

The inventories are always difficult to gauge and really, aside from the occasional that you see, it's all a matter of just discussions one-by-one with your customers. And I would say that – I would characterize inventories today as normal for this time of the year, maybe just a [tad] below that and the reason I say that, as you can see that in our purchasing behavior, when they’re buying things and of course you could tell that there are some holes in some areas.

But overall, I don't think the distributor level has a lot of pressure at this time in terms of their inventory levels. Looking at the big box stores, you know that is a – you know your information is probably as good as mine.

Our business with the box stores is not as overly significant. We have just a couple of very small programs with them and those programs are continuing.

The volumes that we’ve been selling them historically have been very steady. That’s all I can really say about that.

Great. Thanks, Bart.

That’s all I had. Duncan, all the best in retirement.

Thanks, Hamir.

Yes, thanks very much. Good morning, guys.

Maybe I’ll start with congratulating you Duncan on the retirement. I actually thought you’d never retire, but, you know, congratulations.

Thanks.

Maybe from your perspective, 20 years in the chair, and a lot of the leadership on the softwood lumber file, how do you see this all progressing going forward here?

Well, I think we’ve said consistently, Paul, not much is going to happen on the trade front until the legal process starts to work its way through the system, and that’s – you know that’s happening now. I don't think there’s going to be much more that’s going to until we get some clarity on that side of things going forward, so nothing quickly.

In fact, that the Federal election is now out of the way, I think is helpful from the Canadian standpoint. I said on this call before how much regard that got for Chris Griffin, and how she's handling things from a Canadian standpoint.

I think she’s been great. But I think we also need to recognize that we’re about to move into another political cycle in the U.S., and nothing else, the whole softwood files are – is a political file.

So, I think you’re going to be bucking some headwinds from a U.S. political standpoint.

If we think we’re going to find a resolution of this. So, my guidance to everywhere that I talk to is this thing historically takes time.

The arguments are – we have, are good. We just need to have the patience and the wherewithal to be able to work our way through the system and find those windows of opportunity when economic or political realities and legal realities allow opportunities or solutions to be devise.

So, I think the net message is, you know, don’t expect much to happen here in the near term.

Okay. So, is it safe to say the legal will be wrapped up in 2020 and maybe you get a political decision or a compromise negotiation in 2021?

No. Well, I don’t know whether we’ll get a decision in 2021 or not, but the legal process usually takes somewhere between three to five years to work its way through the system to the plan, we’re getting some ultimate clarity on the case itself.

So, I think we’re still in the early innings or if you want to use a football analogy, we’re somewhere between probably the first quarter and the second quarter of the whole process, Paul.

Okay. Thanks very much.

And then, may be over to Bart on markets, Bart you’re commenting that overseas volumes were up, but lots of competition, what has it done for price? And what’s your outlook going forward?

Well, it depends on market I suppose, Japan being very different market than China, but I have joined, you’re asking mainly about China, and, you know, we’ve been dealing with excessive inventories in that market as well. And so, whenever you get that kind of a situation, it tends to put a blanket on your ability to flex on price.

So, we added variable there is the European volumes that are alluding their way in and competing against SPS type products at various levels, so at the low-grade level and the mid-grade level. And so, I think, you know, the Chinese – we don't anticipate a lot of price appreciation.

You know obviously the North American market pricing isn’t really encouraging us significantly to do anything there. So, you know, we think it's going to be a matter of companies deciding to what degree they want to participate at the growing market prices in China.

Okay. And then, just, Duncan, you referenced the Canfor transaction, but we’ve seen the counter effects [happen] approved by the government, is yours next in line?

Have you submitted your request?

We have submitted the request. We are – I would like to believe we’re next in line.

I think our situation is quite bit different for a variety of reasons than the Hampton Conifex transaction, either to two well-positioned, well-financed companies in Canfor and Interfor, and we’re working our way through this process in a very systematic way; very good corporation between ourselves and Canfor; very good progress dealing with the various stakeholders in the area and we just wanted to be very careful as we worked our way through that whole piece to make sure that we got the – if you mentioned, set up properly. And now, we’re moving into the formal part of the discussion with the Provincial government, which is happening as we speak.

Alright, that’s all I had. Best of luck, guys.

Yes, thanks, Paul.

Thank, good morning everyone. Just ask one question for me, Marty, the messaging around the lock of activity in the buyback has been – you’re going through an extended, really deep cash flow troughs.

You’ve got a lot of money to deploy towards CapEx and hopefully the 10-year acquisition as well. I guess the question I have is, all dependent on share price I suppose the valuation, but what sort of visibility would you need on cash flows improving?

And what sort of liquidity cushion would you be comfortable with proceeding with buyback activity? What sort of backdrop do you need or confidence do you need in the market recovering to get busy again?

Yes. You know it’s a great question, Sean, and I’ll give a non-answer answer to it, how’s that, because there’s no one variable we’re constantly looking at all of those things that you talked about, some of which are quantitative and some of which are frankly quite qualitative in terms of our judgments of how much dry powder do we think is appropriate given, you know, what is frankly a fairly unpredictable market from time-to-time, and also, fairly unpredictable in terms of the opportunities that present themselves in those periods of market volatility.

So, we’re constantly recalibrating those things. We like the flexibility that we have right now.

We like the dry powder that we have right now. So, we’ve been inactive under our share buyback program as you’ve pointed out for a [last while] a bit, but it is really all about part of trying to balance off various opportunities that are in front of us.

And there’s no formula that we have per say, we’re just constantly looking at all those variable and right now, we just think it’s appropriate. Given the market conditions and the opportunities that are in front of us, both internal and external, could keep that dry powder as we have it right now.

Well said. Thanks very much.

That’s all I had. Congratulations Duncan and Ian as well.

Thank you, Sean.

Thanks, operator. I normally end these calls thanking people for their interest in our company and saying that all, see you again at the end of the next quarter, but that’s not going to be the case for me.

This is my last call as Interfor’s CEO and I’d like to thank, personally I’d like to thank everybody who’s attended this call and the other calls that we’ve had over the last couple of decades. You folks have been very fair with us and very fair with me.

I’ve enjoyed working with you and hope you folks feel the same. So, thanks everybody.

The group around the table. [Ian’s] leadership with Marty and Bart will be here at the end of the next quarter to review Interfor’s fourth quarter and 2019 results, and to talk about the future of the company.

So, thanks everybody. Have a good day.

Both Marty and myself and [indiscernible] later on today if you’ve got any follow-up questions, thanks very much. Take care.