Interfor Corporation

Thank you, Operator. Welcome to our Q4 '19 investor analyst call.

With me today, you have Marty Juravsky, our Senior Vice President and CFO; also Bart Bender, our Senior Vice President of Sales and Marketing. Our agenda today we'll start off with myself providing a recap of our strategic priorities in Q4 themes.

I’ll then pass the call to Marty who will cover our financial matters. And then I'll pass the call to Bart who will cover off the market.

So first turning to our strategic focus. With the recent change in leadership, I thought it would be good to reconfirm our overarching priorities.

Core to our company we will continue to maintain our capital allocation discipline. Our focus isn't changing.

We’ll continue to manage our working capital very closely, and achieving and executing on our Phase I and Phase II strategic capital programs. We’ll also maintain our balance sheet integrity and our strong liquidity.

In Q4, our efforts were balanced across the company in each region. We did a lot of work resetting our business for the future, particularly in British Columbia.

We completed the closure of our cedar mill in the coast. We dealt with impacted employees and other stakeholders in a thoughtful way.

We right-sized our Coastal Woodland's division to reflect the lean marketing logging business and we reduced a significant amount of associated working capital. For B.C.

Interior, we continue to focus with the B.C. government on the timber purchase agreement for cutting rates in the Vavenby area, which is as a reminder near our Adams Lake division.

In the U.S. South, we moved on to our Phase II capital where site and building work and preparation underway at our Eatonton division in Georgia.

And now I’m going to turn the call over to Marty, who will cover off the financial matters.

Great, thanks Ian. Good morning, everyone.

Let me begin by just referring to the cautionary language regarding forward looking information that's on the first page of our MD&A. So the focus for the quarter was improving upon the controllable parts of the business as we navigated our way through a challenging market environment.

We think that a significant amount of progress was accomplished and there is more on to come. So a few highlights from our Q4 results.

From an earnings standpoint, adjusted EBITDA was slightly higher at $17.6 million versus $16.8 million in Q3 2019. And this was achieved despite average price realizations being down at both the CAD 17 per thousand board feet versus Q3.

The factors that contributed to the average price realization decline include lower volumes of high value cedar as a result of Hammond mill shutdown that Ian referred to before. Also, as you're aware, our portfolio is weighted towards Southern Yellow Pine species.

In Southern Yellow Pine prices were down in the quarter whereas things like SPF were slightly higher. Production and shipment volumes were slightly lower in Q4 versus Q3.

Again the Hammond mill shutdown factored in as all of the regions had fairly comparable volumes in Q4 versus Q3. Net realizable value adjustments on log and lumber inventories were negative $5 million in Q4, was a positive contributor to EBITDA in Q3.

So despite those previously mentioned items, adjusted EBITDA was as I said earlier, a bit better in Q4 over Q3, as we started to see some early stage progress from the BC coast business reconfiguration initiatives. Another notable P&L item in Q4 was the $30.4 million pretax provision for capital asset write-down and restructuring charges.

The vast majority of those charges about 29 million are non-cash. 30 million related to the write-down of legacy goodwill and 16 million related to equipment write-downs.

These adjustments are based on normal course yearend analysis, after incorporating our views on operating plans and other macro assumptions. From a cash flow standpoint, as Ian said earlier a big focus for us has been on working capital discipline over the last number of quarters.

More specifically, working capital declined in Q4 for the third consecutive quarter. In Q4 it came down by about $8 million despite some seasonal log building in B.C.

in the coast in particular, as well as the payment of $8 million in severance for Hammond employees. Yearend lumber inventories were near their lowest levels over the past three quarters.

Accounts receivable was also down a fair amount and a large component of the working capital decline over the last couple of quarters is related to the closure of Hammond as working capital repatriation was a fairly large factor in the shutdown decision. So I want to talk a little bit more about Hammond shutdown for a second as it relates to the working capital component.

Often working capital repatriation of mill shutdown scenarios involves a lot of risks, and often results in compromises on value realization. In the Hammond situation, our team did an exceptional job on executing the plan.

And as a result, we have to maximize our working capital values very effectively. More specifically, we expect approximately $40 million of working capital back from Hammond most of that was achieved in Q3 and Q4 with very small balance to go in Q1.

Further on cash flow for the quarter, CapEx was $37 million in Q4, $181 million for the full year 2019. In 2019, we completed the Phase I projects at Monticello and Meldrim and started the Phase II projects spending.

The result of this double cohort year on projects was a relatively high level of CapEx. Therefore, as we cast forward into 2020, we expect our CapEx spending to come down in 2020.

It should be closer to the $140 million to $150 million range of which approximately 100 million will be for discretionary strategic capital projects. From a balance sheet perspective, yearend net debt was $225 million, which equates to about 21% net debt to invested capital, very strong liquidity around $363 million.

Again as Ian said earlier, balance sheet is important having a rock solid but financial position will continue to be a core principle for us. Lastly, I'd like to quickly mention the recent announcement by the Department of Commerce from earlier this week regarding the reduced preliminary countervailing and anti-dumping duty rates that would apply to 2017 and 2018.

We recognize that these are not final and are subject to change, but reducing the combined rates from approximately 20% to approximately 8% is very sizable and very notable. To put an order of magnitude around it, we paid duties of approximately US$94 million through to the end of 2019.

The portion of the past duties paid that related to the 2017 and 2018 years is around US$60 million, virtually all of these amounts were previously expensed and are therefore off balance sheet items for us. With that being said, why don't I now turn it over to Bart to provide some market context.

Thanks Marty. I'll talk about three general areas here this quarter.

Firstly, the demand. Secondly, I'll get into a bit on the supply side.

And then lastly, I'll talk about inventory and pricing. First demand, some positive signs obviously, we've seen some good headline news on housing starts throughout the quarter quite frankly, which has been very encouraging.

The aging housing stocks in the U.S. and increased equity in existing homes continue to support growth in lumber usage for home improvements.

Macroeconomic factors such as employment, interest rates, wage grew all seen as positive. How that translates the order files for Interfor, we've got a solid order file across the network with vast majority of inventories that are sold and in the queue to be shipped.

On the supply side, the low-single digit net growth in lumber production in the Southeast has been more than offset by the significant permanent curtailments in Canada. The export markets are challenged by trade negotiations, however, still very meaningful volumes for the industry in the overseas markets.

For us, our export business has been steady quarter-over-quarter. Imports from Europe essentially the same year-over-year, and looking at North American lumber production it declined in 2019 versus 2018 again primarily as a result of the massive permanent curtailments in BC.

On the inventory side, always difficult to gauge. We continuously put the market to try and find out what the inventory situation is, our customers are telling us end market inventories are in the range of 30 to 45 days of consumption.

I would say that that's a bit below average as we head into the spring building season. For Interfor again, our inventories centrally committed and tied to how fast we can ship them quite frankly.

In terms of buying patterns, I would say they've changed in 2019. It's what I've termed as just in time buying.

And that's encouraged by ample availability and stable logistics, which we've seen pretty much throughout 2019. On the customer side, they've been able to find what they've needed, and for fairly quick shipment.

So far, seasonal dynamics haven't played much of a role. I think that's beneficial from a logistics standpoint, both in terms of shipments to the market, but also in the construction activity in the market.

So we're having a decent winter, when it comes to producing and shipping lumber, but also consuming lumber. We're encouraged by the fundamentals that we're seeing so far in the marketplace.

We look forward to these translating into higher lumber prices in 2020. With that, I will turn it back to you Ian.

Okay, thanks Bart. Carol, operator, we're ready to take questions.

Ian, it seems like there's been some discussions in the BC industry that the province may look to modify the lag in the stumpage equation later this year to make it more market based. How meaningful would that be and in any sense as to when the likely timing of that could be?

Thanks Hamir. Yes, I guess Hamir the way that I would answer that is there's ongoing discussions with the BC government, both on the coast and the interior with different dynamics and different drivers on costs and efficiencies and what have you.

But there hasn't been anything significant or concrete that has changed relative to the stumpage calculation. But industry is working closely with the government to look at all those variables on how we can get cost back in line with where we think it needs to be, I mean just as a reference, I believe that coast is operating at 30% of capacity right now.

So very, very challenging with 70% down, so just ongoing, I don’t have any other information other than that.

And just one for Bart. Any sense yet as to how the coronavirus is affecting takeaway of both lumber and logs in China?

Yes, obviously a subject that's front center for us, it's a little hard to say, I'd say that that file is kind of emerging. We haven't got really the industry back in and working yet that's due to be next week.

The biggest concern I think from my standpoint is the backing up of the supply chain. We've got that adding an extra week before people come back.

You've got a bunch of ships that are queued up to go into port. And obviously, the efficiencies of the port today are very low.

So that's my biggest concern. And I think that that could cause some delays in some shipments not only in lumber, but and all the products that are imported into China.

And so I think that's, that's the focus item today to make sure that we're managing that and minimizing any risks on product on the water. And then in the next couple of weeks, couple of three weeks, I think we'll have to gauge what the market impact is, at this point we’re not sure.

I want to just to start-off in, do you think that this change in the duties will alter kind of plans in terms of any potential further capacity rationalization or whether it might actually bring some capacity back into the market?

Mark, we've talked about a lot with this recent announcement. I think that the fundamentals of investment in running your operations are just going to come down to what the price outlook is.

So at this point, I don't know of anything that would change. I haven't heard of anything that's going to change.

And I think it's just too early to tell where this is going to go, but at the end of the day, where the lumber prices and the fundamentals are really, I think are going to drive those decisions on the outlook, Marty, do you have anything?

Yes and Mark remember also, like when we look at the rationalization that happened in BC last year, there were a lot of drivers, the single biggest driver was log availability and log costs. And so the fundamentals haven't changed in terms of the contraction of log availability.

So I can't speak for all of the situations but a good chunk of the mills that have rationalized just didn't have to book adequate log supply. And frankly, some of them have been dismantled.

So we see a scenario where those permanent curtailments aren't anything other than permanent.

Just on that Marty, I thought in some places in the interior, there were a number of mills in the fourth quarter that were down kind of running a single shift. Are you aware of any kind of changes at any of those single shift mills?

They seem like they would be the things that are on the bubble.

Yes, and it recognize also some folks will take a path to permanent rationalization in steps and taking down a shift taking down a line. It's not meant to be a temporary it's meant to be a step towards something more permanent.

So yes I don't see any shift back in those that we have visibility on.

And just again on the kind of supply side. Can you give us a little more information on where we're at with the 10 year transfer, I see that you're still kind of pointing to first quarter resolution, but it just seems like these things are often windup getting tied up and stretched out from a timing perspective.?

Well, I think your last comment is pretty accurate characterization stretched out. We announced that deal with Canfor back in the summer of 2019 and we kind of working very collaboratively with them communities First Nations, various folks, the government.

And so the application is in the government's hands. They're working it through and there's continuing feedback, but we haven't had a decision yet back.

So, we're still waiting that they've indicated to us it should be shortly. Shortly is all in the eye of the beholder I guess.

And then Bart I wondered, is it possible for you to talk about sort of the ways in which you think this Central European spruce beetle will affect the industry and affect Interfor?

Big topic, so there's a number of ways I mean there's obviously the impacts on the lumber market. There is also the impacts on the log market, I think that there's - we're hearing that there's a fairly short lifespan of these logs once they’re impacted by the spruce beetle.

And so, I think that that's tempering the industry from spending too much money on lumber capacity and lumber production capacity. And so, I think there is a limit on how much of that can be done.

Bottom line is, is that it's going to drive a higher level of low grade. And so, we're going to end up competing with that low grade in our overseas markets.

It will also I think, encourage the producers to target the U.S. market on dimension.

And I think they've been doing that. So we're seeing the impacts of that today already.

And I'd say so far, those volumes have been - while they've been steady year-over-year, essentially the same and the growth that certainly is being forecasted for next year is fairly moderate. It's the log side I think that's probably the bigger impact as they try to get some economic value out of that timber.

And so, I think that, the primary market for that is China and that's where we'll see the most impact. For us at Interfor, that's fairly small I mean, that's not a huge part of our business.

But for other countries it's lot more significant.

Yes I guess like a New Zealand.

Correct.

Yes just curious does the beetle damaged wood does that compete directly with a lot of the stuff that you guys had been exporting into China - sorry your own lower grade stuff some of it maybe still beetle damaged from BC?

Well I mean, the low grades a lot of that's used in - whether it's packaging or concrete forming or things like that. I would say that the low grades that you'd see out of Europe would be similar in terms of how they'd be used.

So that's yes we expect some impact, their ability to ship into certain parts of China a little bit different than ours. And so, I think the markets will sort all that out on where you would be compete and where we're not.

Yes, just as a reminder Mark, its Ian, I mean as you know our southern interior mills are really green fiber with no beetle kill affects. Our grade offering to China is, different than Northern BC caribou area.

We just have higher quality fiber in the Southern interior.

And finally Ian, just - I guess what you are in your second month in the chair there. Can you just talk with us about what we might see shift even if it's a kind of a subtle shift at Interfor under your leadership?

Mark I mean, I obviously we thought about this a lot and - internally if communicated, what I believe and my team believes is our outlook and frankly it's not a lot. I think, we've got a good strategic plan that has been refined over all of the years.

I think it's always an opportunity to - take a fresh look at the portfolio and what needs to be invested in and what opportunities might be out in the field. So the great thing about I think our company is particularly over the last decade or so we've got a playbook.

We feel comfortable with it and there's not a lot of changes. In my opening remarks, I mean capital allocation is something that we think about a lot and maintaining that focus is probably the biggest thing that we're always talking about is are we doing right when it comes to use of capital.

And so, I think I don’t if that it sounds boring, but I don't see a lot changing.

Follow-up question on the timber 10-year acquisition hypothetical, I suppose. But if the deal isn't approved, how long do you envision Adams Lake being able to sustain two shifts?

How is that thinking evolving?

Yes so the Adams Lake mill it was built to - its super competitive. It was built to compete on the open market for fiber and with the rationalization in that area of Southern B.C.

What’s the number Marty in that area?

About 1 billion board feet

About 1 billion board feet of capacity has been permanently taken out around that area. So yes, the timber transfers very important for us for the long-term view of Adams Lake.

But it also is the most competitive mill in the region and over the last year or so we've - obviously had the benefit of a few tough decisions that other companies have made in that area with rationalization. So we feel very good about Adam Lake running on full shifting.

Question for Bart just want to touch on the Southern Pine market and a little bit more details than a relatively sluggish start to the year. And you mentioned European imports being a factor of the margin.

Can you talk a little bit about capacity growth in the region, your sense of all the Greenfield mills that were built, how those are ramping, Brownfield expansions and including some of the work you've done? How is that affecting the operating rate environment in the region?

If you look at the information that's published by the Southern Forest Products Association, They talk about year-to-date shipments out of the South being 2% above the same period in 2018. So really it's the expansion of volumes has not been that significant.

And I think there is a couple of things. One is that when you're allocating capital and putting in equipment down in the South, mills are not as productive through that process.

And then also when you ramp up, they take a little bit longer than I think people anticipated. So we just really haven't seen the - I suppose the production come online, compared to all the announcements that were made.

And I think we'll see some of that continue in 2020 it's a little uncertain to say. In terms of the self, I talked earlier in my comments this whole just in time buying, I think it's probably most evident in the South, predominantly truckload shipments.

So the order files are generally fairly low and the shipments very quick. So I think that the buyers down there have gotten used to being able to get what they want.

And I think the weather so far this year has been a little bit wet down there, but you're seeing some of the bigger markets really, really pick up. And so we're quite frankly, we're a little bit surprised that the self hasn't come hadn't seen a little bit more tension especially when you compare that to the West mean in particular, how the stud market in the West is very strong.

And so if you look at the historical trends, I won't make any sort of forecast. But if you look at the historical trends itself has really shown an ability to respond to the price increases in the West.

There have been disconnects every once in a while. We have one right now, but historically, they don't last very long.

So hopefully that answers some of your questions. I mean, it's a big topic, big discussion item.

Just following up on this SLA potential reduction in August. What's your view on an implication if we get the 20 down to eight, the effect of that on lumber prices?

Okay, over to Bart.

Yes, so that's I’ve been asked that question a lot in the last little while and really it's a cost item, just the same as logs are a cost item. And when you look on the revenue side, price is obviously an impact as well, the magnitude of that reduction, although meaningful, it doesn't really change how we would approach the market.

I mean our efforts in the marketplace are to price our lumber at the highest possible price if the customers willing to pay. And so we've tried to keep that duty influence out of it.

I think it does bring a little bit of uncertainty from the buy side. But really, if you consider all the inputs and variables that are that are involved on the cost side of lumber, this is just one of many that quite frankly have been very volatile over the last one.

Okay, so net-net, do you think it'll go down?

Let me chime in on that one. You're asking what the market is going to look like in the month of August.

There's all kinds of variables. So in some ways, you almost have to strip away the soft, the soft wood lumber duty, and just say given the cost curves that exists, does the current price environment makes sense.

The current cost and price environment doesn't make sense, given the cost environment so you sit back and say, okay, something's going to change. Something will change at some point.

We just don't know exactly what the path is. So trying to predict what things look like in August.

It's probably a bit of a mug's game, Paul.

Okay.

Yes, just to add to that, the only thing right about a forecast is that it's wrong.

That's my job. Maybe to flip over Ian, you mentioned the coast operating is 70%.

What is Interfor’s coastal operations, are they running right now?

Yes, Paul for our Coastal and Woodlands is operating and our Acorn Mill is operating on its normal operating cadence.

Okay, and then just I know you guys are focused on executing on Phase 1 and Phase 2 capital projects, but just whatever the M&A side whether this year has got-off to a sluggish start, especially in the U.S. So just wondering if you see more opportunity to acquire mills or mill owners actively marketing their facilities?

Yes, it’s hard to answer, Paul. Yes, I don’t know, I think it's the environment is going to dictate that one-offs.

But whether we monitor that, and there's always inbound calls, but I don't know.

I mean, the reality is we’ve looked at lots of situations all the time. So just the current environment doesn't really change the fact that there's always stuff that's out there.

There's a pretty strict set of criteria that we have. So sometimes you get buyer and seller who have alignment, sometimes we see situations that don't meet our criteria, and we don't spend an awful lot of time on those situations.

So it’s pretty hard to handicap other than to say we look all the time and have been looking all the time, but we're going to stick to our criteria.

Okay. Well, I'd like to thank everybody for dialing in and participating in our update call this morning and your interest in our company.

If you have any further questions, please feel free to reach out to myself or Marty anytime. And thanks again and have a great day.