Interfor Corporation

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Good day and thank you for standing by. Welcome to the Inter4 Quarterly Analyst Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Ian Fillinger. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to our Q321 analyst call. I hope you and your family are safe, healthy, and doing well during this pandemic. With me today, you have Barb Bender, our Senior Vice President of Sales and Marketing, along with Rick Plaza Bon, our Senior Vice President and Chief Financial Officer. Our agenda today will start off with myself providing a recap of our financial results, our strategic focus, and our improvement efforts. I'll then pass the call to Rick, who will cover off financial matters, and then we'll pass the call to Barb, who will cover off the markets. Turning to our financial results, our Q3 adjusted EBITDA was $94 million. By executing on our strategic plan, we are generating industry-leading margins and returns on capital. And I encourage you to look through the investor deck that's posted on our website to take note of these metrics. Turning to our strategic focus, we continue to focus on achieving greater returns on capital through our unrelenting focus on operational excellence and capital deployment. We continued on our CapEx improvement plans in every region, spending $44 million in the quarter and on track for $170 million by the end of the year. We continue to work hard on our capital allocation discipline to ensure the best returns for our shareholders, and we're continuing to see strong performances from our internal projects and our recent acquisition. I'm also very pleased to report that our southern team made solid progress on the restart plan for our De Quincey mill in Louisiana. We anticipate running the mill on a one shift basis in approximately three months and a two shift basis in Q4 next year. Our improvement efforts were again balanced across the company as we made progress in all regions. Our operating teams achieved higher production volumes, primarily driven by our acquisitions in the south and the Pacific Northwest region. We continue to apply our very disciplined approach to working capital by ensuring we don't build excess volume in the supply chain and we're lean and mean as possible. Finally, earlier this week on November 2nd, the BC government announced the proposed deferral of harvesting within 2.6 billion hectares of BC forest. The proposal deferral, if implemented, has been identified as temporary and is subject to First Nations engagement, which is currently ongoing. We will require additional and more specific information to understand the potential impacts. However, as most of you know, our operations on the BC coast and the BC interior account for 4% and 19% of our total lumber capacity. And our BC operations are very well capitalized are very highly competitive within their operating regions. Lastly, we continue to have significant financial flexibility to consider a number of further capital deployment options that Rick will cover off. In closing, we are focused on maintaining the health, safety, and well-being of our employees. We continue to drive cost reductions, and we're matching our production rates to our order files. That concludes my opening remarks, and I'll now hand the call over to Rick.

Thank you, Ian, and good morning all. First off, I'll refer you to cautionary language regarding forward-looking information in our Q3 MD&A. The third quarter saw Interfor continue its positive operating momentum, with strong performance and results delivered from across our portfolio. And as Ian spoke to, this was a transformative quarter for our company, as we added 23% to production capacity through the acquisition of four U.S. sawmills with a strong strategic fit. In terms of third quarter operating performance, we achieved record results, producing 731 million board feet of lumber and shipping 753 million board feet. These records reflect the ongoing focus and commitment that we bring to operational excellence and demonstrate that our mills continue to operate effectively despite ongoing challenges from the COVID pandemic. From a financial perspective, Interfor generated adjusted EBITDA of $94 million, representing a margin on sales of 14%. Lower earnings as compared to Q2 mostly reflect a rapid decline of commodity lumber prices early in the quarter, which then began to rebound in the second half. Profitability in the quarter was also impacted by several mostly external factors to our business, including elevated stumpage rates in B.C., operational disruptions from B.C. wildfires, some inflationary pressures on wages and supplies, and $15 million of one-time inventory purchase accounting adjustments and other acquisition-related costs. In terms of cash flow, we generated $72 million from operations, with an additional $124 million of cash released from working capital, all totaling $3.13 per share. This was driven in part by the collection of accounts receivable from higher-priced sales in Q2, and a drawdown of inventories as we sold more lumber than we produced. We also completed sale of the former Hammond sawmill site, generating $40 million of cash, and ended the quarter in a net cash position of $134 million, with ample available liquidity of $836 million. On capital allocation, we continued to take a balanced and disciplined approach in the quarter, in line with our longstanding priorities. We invested $44 million in capital improvements, focused on high return enhancements across our US South portfolio. We invested $372 million US to acquire the four sawmills I mentioned earlier, significantly increasing our lumber production and improving our go-forward profitability. And last but not least, we returned $83 million to our shareholders through share buybacks, thus completing our 10% NCIB at attractive average price of $26.56 per share. or just 1.03 times book value at quarter end. Looking ahead to our capital allocation for next year, we plan to take the same balanced, disciplined, and growth-oriented approach as we have over the past year. We expect to spend in the range of $220 to $240 million on capital improvement, largely focused on growing and optimizing our US South platform, and we've also just announced a renewal of our share buyback program to purchase up to 10% of our public float, over the next 12 months. To wrap up, we've exited the third quarter with a significantly stronger and even better positioned business, yet still have ample financial capacity for further growth in line with our fundamental commitment to capital discipline. Our focus looking forward is to continue enhancing shareholder value through disciplined execution of our strategic plan as we grow and optimize our business while generating industry-leading returns on capital. That concludes my remarks. I'll now hand the call over to Bart.

Thanks, Rick. Okay, I'll give my Q3 2021 market outlook comments. After a volatile Q2, lumber markets stabilized in Q3 and entered Q4 with positive momentum. Market fundamentals remain intact. Solid housing starts and permits. Interest rates remain at historical lows. Household balance sheets are strong. Housing stock average age continues to increase. And new sectors showing solid participation this quarter. New home construction continues to be robust, again with solid housing starts and permits year-to-date. Repair and remodel has reset, with lower lumber inventories, more attractive pricing, and a re-engaged customer. Industrial and non-residential are stable. On the export side, participation has increased. We haven't seen that for some time. Our Japanese business has always been consistent and supportive. And in Asia, with more competitive pricing, shipments increased throughout the quarter. No markets are without challenges, and looking forward, we see supply chain as an area requiring more attention. Within North America, truck availability remains tight, resulting in slightly longer lead times within some lanes. Rail service has been consistent, and we have great support from our Class 1 carriers. On the export side, poor congestion, container availability has limited our participation to an extent. Over time, all of these areas will settle down, However, we expect the current situation to remain through Q4 and into 2022. In Q4, we expect seasonality to have a slight impact on lumber markets. However, early indications are that our customers' order books are healthy going into Q1 and Q2. Therefore, our expectation is for robust, albeit volatile, lumber markets to continue into 2022. I'll leave it at that and pass it back to you, Ian.

Thanks, Mark. Thanks, Rick. Operator, we're ready to take questions at this time.

Thank you. As a reminder, to ask a question, please press star 1 on your telephone keypad. Again, that's star 1 to ask a question. Please stand by while we compile the Q&A roster. Your first question comes from Sean Stewart from TD Securities. Your line is open.

Thank you. Good morning, everyone. Two questions. Ian, we've seen a recent M&A transaction in the U.S. South, arguably at lofty valuation parameters. Can you give us some updated thinking on the opportunity set there, what valuations are looking like in the region, how that affects your bias for continued growth in that region?

Sean, I agree with your opening comments there. I would say, Sean, that for us, the capital program that we've laid out, especially bolting on our new mills into Quincy, really got us internally focused for the next period of time. And so from a timing perspective, I think that the acquisition pipeline at this point is a little bit too expensive in the south. And I feel good that we've got our project Gantt chart and all of our capital projects lined up for the next few years. So I really see us concentrating on that and onboarding the mills that we bought in the short, midterm, and then getting to Quincy up. So for us, you know, the planning and advance, you know, capital project pipeline, along with the acquisitions we did, I think we're in good shape to kind of, you know, monitor possible acquisitions in the south. But I think it's a kind of awkward period of time after that last acquisition. So I would say that, Sean, if that helps you out on. you know, interforce view for the, you know, short to midterm.

It does. Thanks for that. And following on that, with respect to the discretionary CapEx program, we've seen some of your competitors deferring some of the spending based on equipment backlogs, contractor availability. Any updated thoughts on the 2022 CapEx budget? Presume it's still going to be a busy year, but has... thinking on the pace of spending changed at all in light of some industry headwinds?

No, Sean, the, you know, it was a few years ago and, you know, you've been covering this with us for, so you'll recall we had, you know, phase one, phase two, phase three. And so I believe it was around 2017-ish when we, you know, implemented that. So we really did have a five-year capital plan. And so our, project team has been able to engineer in advance what you need first before you can order any equipment and then line up the vendor commitment. So from our perspective, it's what we're presenting that we feel is accurate. Having said that, there could be something that we don't see, which is possible. But I would say that we're solid on on what you're seeing in our press releases and in our material that we're putting out. I wouldn't adjust it at this time.

Okay. That's all I have for now. Thanks very much, Ian. I'll get back in the queue.

Thanks, Sean.

Our next question comes from Maya Weld from Bank of Montreal. Your line is open.

Thanks. Morning, Greg. Ian Barton. you know, I do want to just open by saying, you know, I'm really impressed with the thoughtful job you guys have done on capital allocation this year, kind of across the spectrum, whether it's the special dividend or the repurchases and the acquisitions. Moving on from that, though, can you just, can you give us a sense for the timing ramp up at DeQuincy? It does seem, first of all, like it's coming a little earlier than you'd initially indicated. And then, What's the just cadence from a kind of a financial standpoint in terms of when the mill would turn profitable? And finally, kind of costs and expenses of the restart and the net effect of those after considering any incentives you might be getting from the state of Louisiana?

For sure. So I just wrote this down. So from a timing, Mark, you're bang on. It is advancing significantly. quicker than we had previously outlined. It was a bit of a bad estimate on hiring, but we currently actually have the first shift substantially hired already, even though we haven't turned the mill at this point. So that gives us a huge level of confidence. We had a very welcoming response in the community. and from former employees that wanted to come back to the mill after we purchased it. So we were very, very surprised that we had that very strong response. So that's great. And yeah, we do anticipate running and testing equipment within the next four weeks at that mill. So if you can imagine, we've got to go through a lot of restarting protocols. Our first load of logs actually rolled in earlier this week. So everything's lining up very nicely for a Q1, you know, one shift there. And of course we'll be hiring the second shift all the way along. I think we're being a bit conservative, you know, on the Q4, but we don't want to change that at this point, but we're, I'm hopeful that the efforts that the southern team is putting in may bring that up sooner, but we don't want to commit to that at this point. The investment cost to get the mill back operational is under $10 million. So very low-cost investment as part of that acquisition and for 200 million board feet you know, is the capacity of that mill. So, Rick, as far as profitability goes, you know, we can guess, Mark, but, you know, jump in, Rick, if you think I'm off base. But one shift, you know, I would expect, you know, with trend margins, you know, would probably be, you know, a break even on a trend basis. And then any incremental hours over the one shift, I would say, just based on past experiences, that starts to add. Yes, in value. That's fair.

That fits in for sure. And then in terms of state incentives, Mark, we don't have it quantified exactly yet, but I would say it's on the same level as Greenfield would receive in the state. So quite significant.

Okay. All right. That's helpful. And then I was just struck when I went through the MD&A that you're Southern lumber production in the third quarter was only up about 24 million board feet, which seemed kind of small to me, considering you added two sawmills for most of the quarter. Is that because of downtime, or did you have kind of issues with labor and supply chain? Just trying to understand why that relatively small quarter-to-quarter gain when you had such a significant addition to capacity.

Yeah, for sure. Mark, I'll hit it and then Rick can jump in if I missed anything. But I would say there's two major factors. One was the weather that, the wet weather that hit the south. And I don't think we're the only ones, but in some of our regions, you know, us and competitors got hammered pretty hard and that caused some disruptions. COVID definitely took an impact on some hours. It hasn't been behind us, so we're still kind of hand-to-mouth on some shifts on that as that works through. And then the capital deployment, particularly at Edenton and Baxley, so both two mills in Georgia, took downtime as we had to tie in different components and decks and low projects to bring those projects to their completion. So that would be the top three, weather, COVID-related, and then capital project upgrades.

Okay. Last one for me, Ian. I'm just kind of talking with some of the big private Timberland asset managers. It does seem that there's a little more of a pickup. in southern log prices than is showing up in Timber Mart South or even in some of the public company reporting yet, I think because there's some lags in there. And I'd like to know if you agree with that. And then also just give us a sense of, you know, how you thought about southern log prices, you know, as you built your southern position over the last 10 years. I'm sure you looked at these log prices and knew that they were quite low by historic terms, so you probably – didn't underwrite at the pricing levels we've had over the last 10 or 15 years in the South. But maybe you could put a little color on that.

Yeah, for sure, Mark. So we subscribe to all that benchmarking info and the average log cost increase. We haven't seen that. We're below that increase. So we're pleased with our log supply increase. relative to the industry average. But I will note that there's a couple of things. The log prices on the coastal regions in South Carolina and Georgia, we did see and we have seen pickups in those areas. So when we blend our log costs, we're below the average increase, but we do have a couple of... operations on the coast that have seen a slight increase through competition or wetter weather on the coast. But we're pleased with it. It continues to be one of the best regions when it comes to log costs and just gives us that confidence that it's the right area to invest. I don't know. That's probably the best I can give you on an answer on that mark at this point.

Okay. All right. I'll turn it over. Thanks, Ian.

Again, to ask a question, please press star 1 on your telephone keypad. Our next question comes from Paul Quinn from RBC Capital Markets. Your line is open.

Yeah, thanks very much. Good morning, guys.

Good morning. Good morning.

Hey, you made some significant acquisitions during COVID, which might have compromised your normal due diligence. Just wondering if there was any surprises to the positive or negative that you've seen with the former GP in West Rushfell Mills.

So, Paul, we did not compromise our due diligence at all. intent to focus on that as we have before. And in fact, I would say that we've kind of improved with every deal on due diligence. So the surprises have been around positive surprises. So these acquisitions were not independent. And so when we bought the Somerville operation off West Rock, very well run acquisition. Great infrastructure being part of that company. Great people. Wasn't any spending that needed to get done that, you know, for safety or other things that you sometimes have to do when you're maybe taking an independent mill over. Safety was great. People plans were great. Management leadership was great. And I can say the same thing for the GP mills. All of the ones that we picked up have been, we've been positively, I wouldn't say surprised, but we've just been positive impact to everything. And again, professionally run organization, great standards, great procedures and policies and teams. And, you know, we've been able to retain all key leaders as we've integrated all of those, which hasn't always been the case. When you're bringing two companies together, sometimes you lose good people. And we are just very pleased that we've retained all of the key leaders. They're embedded into our company, and we continue to work very closely with them, and we're sharing best practices. We've picked up best practices. This so far has gone very well for us, and that's been a very pleasant, I wouldn't say surprise, but benefit. We'd hoped that, and we're realizing it now.

Sounds pretty positive on the labor side. What about, you know, labor's been a consistent problem in the U.S. South and probably other areas as well as things tighten up. Any other issues on the labor side? Is that situation getting better or worse, or how do you view that going forward?

Yeah, I don't think it's changed much over the last while, but we haven't had, other than some COVID-related, when one or two people might get it, and then you've got to quarantine a few people, you might lose a shift here or there, but the normal challenges or you know, that I think us and others have and still exist. So, you know, no material changes, all that, you know, that I can think of. I don't know, Bart or Rick, if you got anything to add to that.

I wouldn't say internally, but externally, obviously, some challenges around trucking capacity and labor there. But other than that, things have been going well.

Okay, and then just on, you did a great job detailing your log cost inflation expectations in the U.S., so just wondering what you're thinking about the Pacific Northwest and B.C. going forward.

Yeah, well, Pacific Northwest, we have seen some increases as the fire salvage volume starts to decrease, but on a trend basis, looks good. We did have obviously benefits, which is great for diversification in our geography to participate in those, you know, reduced log costs in the Pacific Northwest, but we're seeing them come back to trend. You know, BC, obviously, you know, its stumpage has really, you know, impacted many people. But we do see, as I know you, as I know you know, Paul, that we see that stumpage decreasing coming into 2022 in the first quarter.

Okay. And just lastly, just on a softwood lumber file, we get the rate doubling towards the end of the year here. Well, the expectation anyways, any movement on that file or, or, you know, especially in light of, you know, BC government's announcement on, on old growth.

Hey, good morning, Paul. It's Rick. On that file, we haven't seen any movement. We'd like to see some, but we haven't yet. The timing is, is, unknown at this point.

All right. That's all I had. Best of luck, guys. Thanks. Thanks, Paul.

Thanks. There's no further question this time. I would now like to turn the call over back to Mr. Egan Fillinger for closing remarks.

Thank you, operator. I'd like to thank everyone 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, Bart, or Rick at any time. Be safe, take care, and thank you again. Goodbye, operator.

This concludes today's conference call. Thank you all for joining.

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