Interfor Corporation

Thank you, Operator. Welcome to our Q1 2020 investor analyst call.

And firstly on behalf of Interfor, I'd like to say that I hope you're safe and your family safe and healthy and doing well during this pandemic. With me today, you have Bart Bender, our Senior Vice President of Sales and Marketing, along with Rick Pozzebon, our Vice President and Corporate Controller.

Our agenda today, we'll start off with myself providing a recap of our strategic priorities and key themes. I'll then pass the call to Rick, who will cover our financial matters and then I'll pass the call off to Bart, who will cover off the markets.

Turning to our strategic focus, this year has been one heck of 2020 start, but as I talked about on our last call our overarching priorities have not changed. In the quarter, our company is maintaining our capital allocation discipline and ensuring our balance sheet integrity and strong liquidity.

You'll hear this from me both in good times and in challenging times like we're in now. This approach is in our DNA here at Interfor and it's served us well over the years, allows us to control our destiny, weathering the tough times, but also taking advantage of both internal and external growth opportunities when conditions improve.

Our efforts were again balanced across the company, as we made progress in all regions, In British Columbia we secured additional long-term timber rights for Adams Lake operation, completing the acquisition of 349,000 cubic meters. All of our B.C.

Interior mills are well positioned, have been capitalized and have secured fiber volumes and profiles. In the Pacific Northwest, we are near completion on one of our Phase 2 strategic projects at one of our stud mills which will improve recovery, productivity and costs.

In the south, we advanced on our Phase 2 strategic capital plans at our Eatonton Georgia operation and South Carolina at our Georgetown operation. Our balance sheet, we improved our liquidity by completing the US$100 million long-term debt financing with Prudential.

Just want to note this. This is proactive on our part, put in motion well before the COVID business conditions.

Our available liquidity increased to 431 million at the end of Q1. Want to turn to COVID impacts and forward plans.

Production and sales were slightly down for the quarter reflecting our C-19 related curtailments that were implemented in the last two weeks of March. In regards to the market, 2020 started off well.

Weekly order volumes were strong from late December through early February, once the full impact of C-19 hit, we saw order volumes rapidly declined and decided to proactively shift our operating plans to match both demand and price. We continue to monitor the situation and see no need to take on any working capital risk by trying to guess how and when things will improve.

We believe that lumber pricing has somewhat stabilized and are similar to those seen in Q4 2018 and 2019. However, the situation is still unfolding.

We are planning very conservatively to ensure we maintain our financial flexibility regardless of the economic outlook. In closing, we are focused on maintaining the health, safety, and wellbeing of our employees, protecting our balance sheet by running our most competitive operations, reducing costs, reducing CapEx spending, repatriating working capital.

However, all of these initiatives and tactics are continually being evaluated and if required will be implement – we'll be implementing even more aggressive plans if necessary. That concludes my opening remarks, I will now hand the call over to Rick Pozzebon.

Thank you, Ian and good morning everyone. Before getting started, I'll refer you to cautionary language regarding forward-looking information on the first page of our Q1 MD&A.

I'll start with an update on our balance sheet. As Ian just mentioned, maintaining a strong financial position as core to our company.

Fortunately, we're in very good shape to weather the COVID-19 related uncertainty ahead. With net debt of $322 million, net debt to invested capital at 27% and available liquidity of $431 million at the end of Q1.

We proactively bolstered our liquidity in the quarter by adding US$100 million of long-term debt at attractive rates. Our long-term debt now has a weighted average interest rate of just over 4%, with maturities principally in the years 2024 to 2030.

Our $350 million revolving term line further strengthens our liquidity. It was undrawn at quarter-end.

It has a maturity in 2024. It's also worth noting that we had US$102 million us of softwood lumber duties on deposit with the U.S.

government at quarter end. Substantially, all of which are not recorded on the balance sheet.

In terms of Q1 2020 earnings, adjusted EBITDA was $37 million improved from the $18 million in Q4 of 2019. This improvement reflect stronger average lumber prices combined with relatively flat unit cost quarter-over-quarter.

Average realized prices were $592 per thousand board feet in the first quarter, versus $566 in the preceding quarter. In addition, Q1 results benefited from the recent reconfiguration of our B.C.

Coastal business and a strong coastal log market. In terms of lumber volumes, production in all regions was proactively reduced to balance with demand, which was impacted by COVID-19 in the second half of Q1.

627 million board feet were produced in Q1 versus 668 million board feet in Q4 2019, while total shipments were about 6% lower quarter-over-quarter. From a cash flow perspective, we continued with our enhanced focus on working capital.

Cash flow from operations after working capital in the first quarter was a positive $19 million. There was a seasonal working capital building Q1, albeit smaller than in prior years as higher log sales on the B.C.

Coast balanced the seasonal bill that B.C. Interior log decks.

Repatriation of approximately $40 million working capital from the Hammond sawmill was essentially complete by the end of Q1. On the investment side, we closed on the acquisition of B.C.

Interior Cutting Rights from Canfor in the quarter for $57 million. This acquisition solidifies a long-term log supply and operating platform of items like sawmill in British Columbia.

In terms of capital expenditures $28 million was spent in Q1 with approximately $21 million of that related to our Phase 2 and other strategic projects. In response to the prevailing environment, we will remain disciplined in our approach to capital deployment.

We've made plans to reduce the capital program through 2021 and currently expect expenditures to be approximately $100 million in 2020 and substantially less than $100 million in 2021. We continue to have significant flexibility to adjust our capital program depending on how market conditions evolve.

In summary, and of course balance sheet is in very good shape and we will continue to be proactive in making decisions that position the company well for the longer term. That concludes my remarks on.

I'll hand the call over to Bart.

Thanks Rick. Good morning everyone.

Q1 2020 started-off with much promise. It felt like 2020 would be a year with a more traditional spring season lumber market.

By early March, it was clear that COVID-19 was going to get in the way. Access to markets in North America generally been open, however, certain areas like Washington State, Northern California and the Northeast have placed restrictions that impacted our ability to sell or ship in those areas.

We are seeing signs that some of these restrictions are easing; however market access remains a risk. Looking at the lumber markets, there has been a wide range of impacts on demand with differences across end-use sectors, geography and customers.

Looking at the end-use sectors, new home construction has seen significant adjustments through Q2 so far. The extent and magnitude of the decline and the recovery are debatable.

However, there are some positive signs that some home builders that face sharp declines in business in March and April maybe – those maybe short-lift. However, at approximately 30% of lumber demand in the U.S.

declines thus far have been significant. Turning to repair, remodel activity.

This sector is essentially stayed steady overall. However, some reasons are showing much more activity than others.

[indiscernible] is the Southeast where box store business is strong. Similarly, the industrial market segment has also been relatively steady thus far, but it's likely to fluctuate with overall economic activity going forward.

Looking outside of North America, our both business overseas has been consistent. Shipment volumes into Asia are essentially the same as Q4 2019.

Looking at this regionally, there are significant differences between the markets for our lumber produced in the Southeast relative to the West; the West saw decreased demand for lumber well before the Southeast, which we attribute to longer transit times. So higher rail car shipments, higher percentage of products sold through traditional distribution and end-uses for the product.

In the Southeast, the products have a much shorter supply chain, predominantly truckload shipments, which carry less market risk. Additionally, southern yellow pine lumber has greater access to an users such as trust manufacturers and treaters who have generally remained busy throughout the COVID-19 situation.

Notable supply chain inventories, in the back half of March there was significant focus on reducing lumber inventories at the distribution and manufacturing levels. For a period, a good portion of customers were completely off the spot market for lumber and driving down their own working capital through reductions and inventories.

Quite frankly, we were doing the same thing. I can tell you our inventory today are less than 50% of what they were towards the end of Q1, it’s a big number.

In order to accomplish this and align our operations to lower demands and therefore reduced production by 40 million feet in March, which essentially translates to an 80% run rate and 160 million feet in April, which essentially translates to a 25% run rate, that's a companywide. We will continue to match our production to our customers demand.

We expect prices for lumber products will continue to be volatile throughout the quarter as we all figure out a very dynamic situation on our lumber markets. I think we'll stop there and turn it back to Ian.

Thanks Bart. So operator, we're ready to take analyst calls or questions at this point.

Thanks. Good morning everyone.

Just a couple of questions to start with. You touched on, Bart the downtime you took in March and April.

Can you give us a sense of what curtailments look like heading into May at this point?

Hey Sean, this is Ian. I'll just jump in, Bart's here and can fill in anything on this also.

But we're operating, you know, May and I'll just sort of clarify that this is a week-to-week review that we do, but we're in that 50% range for company-wide and by region. The South is a little bit better than that; the West is a little bit behind on that.

So rough and dirty at this point, that's where things are at. But again, we're meeting as a senior team on a regular basis and as Bart alluded to, as we have confidence in market demand and pricing levels we do have the flexibility to be nimble and move that up or down on a week-to-week basis, but that's where we're at today.

Thanks, Ian. And can you give us a sense of, as you take the downtime, the fixed costs you're carrying and just trying to gauge the unit costs impact as you take this downtime?

Any math you can give us there?

Sean, the way that we're allocating our business right now is to take that market demand and applying that to the most competitive mills in our system. So where we are taking downtime, they are at the mills that don't have the demand, don't have the cost structure in place given the environment that we're in today.

And so the mills that are running are our best competitive mills on that basis, for 0.1, 0.2 would be, there is a bit of a mix in demand and in some cases, some mills have a unique product mix or species mix that is off random lengths or off print pricing. So we do have some mills running on those programs.

But I'll just leave it at that. What we are running?

We're running well and the mills that are our best performers at this point.

Thanks for that. And second question I guess is for Rick.

Wondering if you can help us understand some of the other leavers you can pull for a balance sheet preservation over the near term and you touched on inventory declines through the second quarter, but other factors stumpage deferrals, tax refunds deferrals, those types of things. Any quantification you can provide on that front?

Yes, Sean, I'll kick it off again, Ian, and then I'll hand it over to Rick to fill in a couple of other points he has. But which leaves the main beavers are – as you well know, working capital made tremendous progress on that over the last several weeks; reducing our CapEx, which we talked about.

And then the idea of what do you run, when demand isn't there. So just minimizing any kind of operating losses is really – the other main lever.

So that decision point of, you know, if you're going to add eight hours into a week or 10 hours or a second shift making sure that goes into the right plan so that when we're looking at any kind of operating losses, minimizing that just has a double whammy as far as a positive impact on balance sheet and financial flexibility. So, the capital and then just making sure that we're minimizing any losses that we might see, it's been our approach and those are the big ones.

But maybe Rick, if there's anything else that you can help Sean with there.

Yes for sure. Thanks, Ian.

In terms of CapEx, we've got lots of flexibility on this looking through 2021. In terms of working capital as Bart mentioned, we've made really good progress on this since quarter end.

We had $170 million of logs and lumber at quarter end and as Bart mentioned on the lumber side, we cut that by over half, on the log side Vancouver coastal log market continues to be quite strong. So we participate in that, and interior log levels will come down and the race depending on our operating schedules.

In terms of deferrals on costs, we've been participating and those where it makes sense and they're really just cost deferrals. They're not going to change your overall cash profile for the rest of this year.

Okay. That's useful detail.

Thanks very much guys.

Hey Sean,

Hi, this is Jesse Brown on for Mark, good morning guys.

Good morning.

First question, can you give us more of a sense of what you're seeing in the distribution channel now on the inventory side?

Sure. I'll take that on, it’s Bart.

So inventories are always an interesting question. I mean, they're difficult to be precise.

Really there's no reliable data that exists. I can say though through March and April supply chain was actively destocking.

Whether from the manufacturer level or the distribution level. Our customers essentially stopped buying on the open cash market and instead focused on managing their commitments and driving down their own inventories.

In general, when I have conversations with customers, they talk about keeping 30 to 45 days of consumption in inventory and sort of strategic levels. However that, how that translates into actual volume, really depends on what your view of consumption is.

So obviously those two go hand-in-hand. For us we're not any different.

We quickly responded on the operating rates and started to reduce our own working capital. As I mentioned, our inventories are down less than 50% of what they were.

And our focus is really quite heightened on managing these levels. We’re making sure that we're aligning the production rates to our ability to sell – to sell at a pace that supports that operation and also at a price that supports that operation.

Overall though I think that the key – the key point there is, is what your view of consumption is. And I think, we’ll tell you whether or not the inventories in the market are adequate or not.

That said, I mean this week we're seeing signs in some regions that that inventories are very tight and there would have – it looks like there could have been, I think a bigger adjustment on the supply side and an underestimate on what the demand side looked like. So we've got little short-term disconnects, I think that are going to take place over the next while as the supply chain figures out what the new norm is, I'll leave it at that.

That's helpful. And then as you kind of think about bringing production back online, what kind of indicators are you going to look for?

Is it just simply talking to your customers and what real supply demand is? Or is there other indicators you guys are watching?

Yes. Jesse Ian here.

So one component is the demand security to bring back an operation or to add to it. How confident do we feel around that demand and how long does that look?

So that's one thing. The other one is as Bart alluded to, what's the pricing level?

But the other one is making sure that given the situation we're in with the market that we're not building risking inventory. So very carefully considering what lumber working capital might look like if we start up or add hours.

In some cases, in some of the regions what the blogging profile or operating might look like. So we are very, very conservative on making sure that we de-risked from a working capital standpoint.

So that would be, other than the demand and price, that would be the other main driver that we talk about internally.

Okay. That's helpful.

And then just lastly anything else you can kind of give us on the state of the export market in the Asia?

Yes. Maybe Bart, you can take that one.

Sure. So on the export side Japan has been fairly steady for us quarter-over-quarter, does look like we're getting some improvement in that market as we enter into Q2.

So we're pretty positive and that for us is, it's again [indiscernible] grade play. China, I guess I'll kind of group China and other Asian countries.

The inventories got fairly low in the marketplace, coming into [indiscernible] obviously these issues a little earlier than we did in North America. And so over that China New Year period, the inventories got quite low.

And there was a number of countries that pulled back their import volume – sorry, export volumes into those markets. And once they were coming out of that, the business for the main commodity type species really ramped up and I think there's some significant volumes that were put together, which we would have played a role, but I'll talk a little bit more about that in a second.

But those volumes are now in transit or close to arriving, and I think the inventory levels are now starting to come back up. So we're – I guess our view of the export market is a little bit cautious.

I think that – I think that the inventories are starting to climb back-up. My earlier comment about the main commodity products are – which is essentially SPF, that’s the big volume over there.

And that represents 8% of what we produce from a value perspective. So it's just not a huge item for us.

We have more business on other species, I suppose into those markets, then there are sort of niche lines and not subject to the, I think the volatility that we sometimes see and volumes that go over there. So hopefully that helps you.

Jesse, I'll just add it to you in here. Just one thing that I think is strength of ours is the balanced portfolio that we have.

We really do have five different, operating platforms with the South, obviously that region Washington and Oregon and the Pacific Northwest, we have the B.C. Coast, which is a largely export market as you're referring to.

We have the B.C. Interior and that's really the southern interior and then we have the B.C.

Coastal log market. So in times like these there's pluses and minuses but having that balanced portfolio is something that we're appreciating definitely in some of our regions right now.

That's super helpful. Thank you, guys.

I'll turn it over.

Thanks, Jesse.

Hi, good morning. Ian, just wondering, what's your sense today as to how much of North American lumber capacity is down?

I know there's been a couple of mills here and there that have been ramping up.

Yes. Yes, Hamir, that's a great question.

We're trying to figure that out all the time, also. I mean, there is published a few weeks ago is somewhere around 25 and we kind of took an estimate that it could be as high as 35, maybe even 40 at some point, but we definitely think that given some other recent pricing levels that's starting to change, I would think it's probably in that 20% range somewhere there plus or minus.

But yes, quite a shift from where it was a number of weeks ago.

Great. Thanks again.

That's helpful. And Next question for Bart.

You know, we've seen a kind of just pre-COVID but there was, it looked like the export market, Southern Yellow Pine was going to come back with the tariffs going away. So what do you think over the medium to long-term, is that a potential for Southern Yellow Pine exports to China and would you, what portion of your, your volumes, do you see that going to?

Yes. Okay, good questions.

Yes, I think, the way that tariffs were working out over there and it was a tailwind for us. I think certain distributors that apply can get exemptions, so that kind of opened up the market a little bit further than what it was for us.

And we anticipated being able to sell more volumes over there and I think our volumes have been fairly steady. When you get into the market that you have today that in China its very price sensitive and so obviously the pricing in the last, call it three weeks in the Southeast is generally a pretty big headwind for doing anything significant.

So we'll continue to maintain the distribution lines that we have set up with customers and feed that market. But we'll be pretty conservative given where pricing has gone lately.

Overall I'd say, our target in the south would be in that 10% to 15% range of our production to be going overseas. Not necessarily just to China, but just generally outside of North America or outside of the U.S.

quite frankly. We're not there yet.

We're at times we're there, but we're not we're not there yet, probably maybe in around that 8% mark today.

Great. Thanks.

Thanks, Bart. That's all I had.

I'll turn it over.

Yes. Thanks so much, good morning guys.

Can't hear you Paul.

Sorry, good morning.

Good morning, Paul.

I got on the call late. It looks like you guys are pretty popular in the line up to get home this long.

But [indiscernible] when you were talking about May operating levels and maybe you could just help me out and review that again.

Yes, for sure. It’s Ian.

May offering levels right now company-wide or in and around that 50% rate. But we have a bit higher in the south and a bit lower in the west, but generally it's bad and we are – I mean, our strategy is to be conservative and be operating where we have confidence in the market order file and the pricing.

So we're reviewing that almost on a daily basis, but we're making decisions on a weekly basis around, either adding or subtracting to that. But right now, things are looking fairly positive.

And I expect there'll be some changes to that level, but today that's where we're at.

Okay. And then just on the liquidity side, what's your a working capital billed in Q1 and how quickly do you think you’ll come out of that?

No, overall, it’s a fairly minor working capital build around $19 million in the quarter, Paul. On the log side, we had a seasonal build as you'd expect in the B.C.

Interior, but that was offset by a strong log sales on the coastal side.

And Paul, just to add to that, it's Ian, big focus of ours over the last number of weeks as you can imagine was just really drawing down our working capital, both on logs and lumber and we've made decent progress on that for sure.

Okay. And then just lastly, just on capital spending deferrals is there any issues associated with that or how – when you defer projects does that increase the overall cost?

Is that what you've found in the past?

Yes. Paul.

So I'll jump in again. So the – with the exception of one project which is a turnkey, which commits you to a contract and it's a fairly small project, all of the rest are managed internally by our CapEx group and when you're in times like this, being able to throttle forward or throttle back spending, paying dividends, so there are commitments that you are able to make or you have to make to vendors to build equipment and do those sorts of things, but we have a very low exposure on that.

And in some cases where there's like equipment, we have the ability to shift a piece of equipment to a project that might already be on your way. So we've very low exposure to future commitments on that side of it.

We are continuing to engineer all of our strategic projects, which is the basis for completing those, you need to get that work done. And we're continuing to do that, we're committed to our projects and we don't see any material cost changes coming our way.

[indiscernible] Are you guys surprised at the discount Western SPF has got a selling alpine right now, or is this something you anticipated once you saw what was happening in the marketplace?

Ian, you want to support there?

Yeah. well those markets, we obviously attract the compensates or whatever benchmarks do you want to pick and they don't generally state disconnected for too long.

But generally you see the Western species are more volatile than Southern Yellow Pine has been. And I always look at that in terms of supply chain risk and with the Western species, the fact that a majority of it gets put in our rail car and shipped off to customers and they don't receive it for a couple of weeks.

There's probably a couple of weeks lead time, just even before the shipment. There's a fair bit of time involved in that.

And whereas the south is predominantly truckload, order files are generally a week to two weeks. Shipment takes a couple of days.

So it just represents a different risk in the network. And also it's only a truck truckload versus having to buy a rail car.

So there's a different amount of dollars involved. So I think that when you get uncertain at volatile markets like this, you can see certain regions getting more attention than others, just based on that.

Yes. Paul, Ian here, I would just – 1as you know our Western mills in particular in British Columbia has multiple species that in different product lines off print pricing.

So in certain times and given the log inventory build that we had for breakup, it does give us flexibility to bring in alternate cut plans and species where there's demand. So that's again pays dividends in times like this when you have that type of flexibility in your species profile and that flexibility built into the mills.

That's great color. Thanks.

Good solid quarter. Best of luck.

Thank you. Thanks Paul.

Okay. Thanks operator.

On behalf of the three of us we'd like to thank you for dialing-in and participating in our update call this morning and your interest in our company. And if you have any further questions at all, feel free to reach out to Bart or Rick or myself at any time and stay safe and healthy and all the best to you and your families.

Thank you.