Interfor : Q1 2022 – Opens application/pdf in new tab

Interfor Corporation

First Quarter Report

For the three months ended March 31, 2022

Management's Discussion and Analysis

This Management's Discussion and Analysis ("MD&A") provides a review of financial condition and results of operations as at and for the three months ended March 31, 2022 ("Q1'22"). It should be read in conjunction with the unaudited condensed consolidated interim financial statements of Interfor Corporation and its subsidiaries ("Interfor" or the "Company") for the three months ended March 31, 2022, and the notes thereto which have been prepared in accordance with International Financial Reporting Standards ("IFRS"). This MD&A contains certain non-GAAP measures which, within the Non-GAAP Measures section, are discussed, defined and reconciled to figures reported in the Company's unaudited condensed consolidated interim financial statements. This MD&A has been prepared as of May 11, 2022.

All figures are stated in Canadian Dollars, unless otherwise noted, and references to US$/USD are to the United States Dollar.

Forward-Looking Information

This MD&A contains forward-looking information about the Company's business outlook, objectives, plans, strategic priorities and other information that is not historical fact. A statement contains forward-looking information when the Company uses what it knows and expects today, to make a statement about the future. Forward-looking information is included under the headings "Overview of First Quarter, 2022", "Outlook", "Liquidity", "Capital Resources", "Off-Balance Sheet Arrangements", "Accounting Policy Changes" and "Risks and Uncertainties". Statements containing forward-looking information may include words such as: will, could, should, believe, expect, anticipate, intend, forecast, projection, target, outlook, opportunity, risk or strategy.

Readers are cautioned that actual results may vary from the forward-looking information in this report, and undue reliance should not be placed on such forward-looking information. Risk factors that could cause actual results to differ materially from the forward-looking information in this report are described under the heading "Risks and Uncertainties" herein, and in Interfor's 2021 annual Management's Discussion and Analysis, which is available onwww.sedar.com andwww.interfor.com.Material factors and assumptions used to develop the forward-looking information in this report include volatility in the selling prices for lumber, logs and wood chips; the Company's ability to compete on a global basis; the availability and cost of log supply; natural or man-made disasters; currency exchange rates; changes in government regulations; the availability of the Company's allowable annual cut ("AAC"); claims by and treaty settlements with Indigenous peoples; the Company's ability to export its products; the softwood lumber trade dispute between Canada and the U.S.; stumpage fees payable to the Province of British Columbia ("B.C."); environmental impacts of the Company's operations; labour disruptions; information systems security; the existence of a public health crisis; and the assumptions described under the heading "Critical Accounting Estimates" herein and in Interfor's 2021 annual Management's Discussion and Analysis.

Unless otherwise indicated, the forward-looking statements in this report are based on the Company's expectations at the date of this report. Interfor undertakes no obligation to update such forward-looking information or statements, except as required by law.

Overview of First Quarter, 2022

Interfor recorded Net earnings in Q1'22 of $397.0 million, or $6.69 per share, compared to $69.7 million, or $1.15 per share in Q4'21 and $264.5 million, or $4.01 per share in Q1'21. Adjusted net earnings in Q1'22 were $392.5 million compared to $78.2 million in Q4'21 and $270.6 million in Q1'21.

Adjusted EBITDA was $570.1 million on sales of $1.3 billion in Q1'22 versus $149.5 million on sales of $675.9 million in Q4'21.

Notable items in the quarter:

• • Acquisition of EACOM Timber Corporation

  • o On February 22, 2022, the Company completed the transaction to acquire 100% of the equity interests of EACOM Timber Corporation ("EACOM") from an affiliate of Kelso & Company. The acquisition includes seven sawmills with a combined lumber production capacity of 985 million board feet, an I-Joist plant with annual production capacity of 70 million linear feet, and a value-added remanufacturing plant with annual production capacity of 60 million board feet (the "Acquired Eastern Canada Operations"). The Company paid total consideration of $731.2 million which was funded from cash on hand and drawings on the Revolving Term Line.

  • o The Acquired Eastern Canada Operations contributed $5.1 million of Adjusted EBITDA to Interfor's first quarter results, which is net of $68.0 million recorded in production costs related to fair value adjustments recognized at the acquisition date.

• • Record Lumber Production

  • o Total lumber production in Q1'22 was 921 million board feet, representing an increase of 163 million board feet quarter-over-quarter and setting an Interfor production record. The U.S. South and U.S. Northwest regions accounted for 452 million board feet and 173 million board feet, respectively, compared to 409 million board feet and 166 million board feet in Q4'21.

    Production in the B.C. region increased to 196 million board feet from 183 million board feet in Q4'21. The Acquired Eastern Canada Operations accounted for 100 million board feet in Q1'22.

  • o Total lumber shipments were 860 million board feet, or 141 million higher than Q4'21.

  • o The 61 million board feet shortfall of lumber shipments compared to production was the result of ongoing logistics constraints across the U.S. and Canada.

• • Strengthening Lumber Prices

  • o Interfor's average selling price was $1,410 per mfbm, up $588 per mfbm versus Q4'21. The SYP Composite, Western SPF Composite and KD H-F Stud 2x4 9' price benchmarks increased quarter-over-quarter by US$475, US$506 and US$560 per mfbm to US$1,119, US$1,159 and US$1,293 per mfbm, respectively, with the majority of these increases occurring early in the quarter.

• • Strong Free Cash Flow Generation

  • o Interfor generated $378.8 million of cash flow from operations before changes in working capital, or $6.38 per share. This was partially offset by a $97.6 million investment in working capital, primarily related to higher trade receivables driven by lumber prices and seasonally higher log inventories in B.C.

  • o Net debt ended the quarter at $340.2 million, or 15.8% of invested capital, resulting in available liquidity of $483.3 million.

• • Strategic Capital Investments

  • o Capital spending was $50.9 million, including $34.8 million on high-return discretionary projects. The majority of this discretionary spending was focused on the ongoing multi-year rebuild of the Eatonton, GA sawmill and a new planer at the Castlegar, BC sawmill.

• • Restart of the DeQuincy, LA Sawmill

  • o Lumber production at the sawmill in DeQuincy, LA restarted on January 9, 2022, well ahead of schedule. During Q1'22, the sawmill was operating on one shift and increased to two shifts by April 2022. Ramp-up to its 200 million board foot annual capacity is expected by the end of 2022.

• • Normal Course Issuer Bid ("NCIB")

  • o During Q1'22, Interfor purchased 5,026,305 common shares under the Company's NCIB for total consideration of $194.3 million. In April 2022, Interfor purchased 1,015,396 common shares for total consideration of $32.9 million. This completed the purchase of all 6,041,701 common shares allowable under the NCIB for total consideration of $227.2 million, representing an average price of $37.60 per share or 1.15 times book value per share at March 31, 2022.

• • Minority Interest in GreenFirst Forest Products Inc. ("GreenFirst")

  • o On May 2, 2022, a wholly-owned subsidiary of Interfor acquired a total of 28,684,433 common shares in the capital of GreenFirst from Rayonier A.M. Canada G.P., which represents approximately 16.2% of GreenFirst's issued and outstanding common shares. The Company paid total cash consideration of $55.6 million.

• • Sale of Acorn Speciality Sawmill in BC

  • o On April 12, 2022, the Company announced it had reached an agreement to sell its Acorn specialty sawmill located near Vancouver, British Columbia to an affiliate of San Industries Ltd. The completion of the transaction is subject to customary conditions and is expected to close in the second quarter of 2022.

• • Softwood Lumber Duties

  • o Interfor expensed $35.8 million of duties in the quarter, representing the full amount of countervailing ("CV") and anti-dumping ("AD") duties incurred on shipments of softwood lumber from its Canadian operations to the U.S. at a combined rate of 17.91%.

  • o Interfor has cumulative duties of US$362.1 million held in trust by U.S. Customs and Border Protection as at March 31, 2022, including US$161.2 million of duty deposits related to the Acquired Eastern Canada Operations. Except for US$104.7 million in respect of overpayments arising from duty rate adjustments and the fair value of assumed rights to duties acquired related to the Acquired Eastern Canada Operations, Interfor has recorded the duty deposits as an expense.

Outlook

North American lumber markets over the near term are expected to remain above historical trends driven by continued strong demand from new housing starts and repair and remodel activity, albeit with volatility as the North American economy adjusts to inflationary pressures, rising interest rates, logistics constraints and labour shortages.

Interfor expects lumber demand to continue to grow over the mid-term, as repair and renovation activities and new housing starts in the U.S. benefit from favourable underlying demand fundamentals. However, the potential for elevated interest rates exists, which may reduce housing affordability and slow the growth in demand for lumber.

Interfor's strategy of maintaining a diversified portfolio of operations in multiple regions allows the Company to both reduce risk and maximize returns on capital over the business cycle. Interfor is well positioned with its strong balance sheet and significant available liquidity to continue pursuing its strategic plans despite ongoing economic and geo-political uncertainty globally.

Financial and Operating Highlights1

For the three months ended

Mar. 31,	Mar. 31,	Dec. 31,
Unit	2022	2021	2021
Financial Highlights2
Total sales	$MM	1,349.0	849.3	675.9
Lumber	$MM	1,212.5	762.4	591.5
Logs, residual products and other	$MM	136.5	86.9	84.4
Operating earnings	$MM	512.7	355.6	99.2
Net earnings	$MM	397.0	264.5	69.7
Net earnings per share, basic	$/share	6.69	4.01	1.15
Adjusted net earnings3	$MM	392.5	270.6	78.2
Adjusted net earnings per share, basic3	$/share	6.61	4.11	1.29
Operating cash flow per share (before working capital changes)3	$/share	6.38	5.73	2.19
Adjusted EBITDA3	$MM	570.1	392.1	149.5
Adjusted EBITDA margin3	%	42.3%	46.2%	22.1%
Total assets	$MM	3,081.4	2,159.7	2,603.5
Total debt	$MM	403.1	377.3	375.7
Net debt3	$MM	340.2	(236.0)	(162.9)
Net debt to invested capital3	%	15.8%	(21.7%)	(11.1%)
Annualized return on capital employed3	%	86.8%	79.2%	18.2%
Operating Highlights
Lumber production	million fbm	921	687	758
Lumber sales	million fbm	860	666	719
Lumber - average selling price4	$/thousand fbm	1,410	1,143	822
Average USD/CAD exchange rate5	1 USD in CAD	1.2662	1.2660	1.2603
Closing USD/CAD exchange rate5	1 USD in CAD	1.2496	1.2575	1.2678
Notes:

• 1 Figures in this table may not equal or sum to figures presented elsewhere due to rounding.

• 2 Financial information presented for interim periods in this MD&A is prepared in accordance with IFRS and is unaudited.

• 3 Refer to the Non-GAAP Measures section of this MD&A for definitions and reconciliations of these measures to figures reported in the Company's unaudited condensed consolidated interim financial statements.

• 4 Gross sales before duties.

• 5 Based on Bank of Canada foreign exchange rates.

Summary of First Quarter 2022 Financial Performance

Sales

Interfor recorded $1,349.0 million of total sales, up 58.8% from $849.3 million in the first quarter of 2021, driven by the sale of 860 million board feet of lumber at an average price of $1,410 per mfbm. Average selling price increased $267 per mfbm, or 23.4%, while lumber sales volume increased 194 million board feet, or 29.1%, as compared to the same quarter of 2021.

Increases in the average selling price of lumber reflect higher prices for Southern Yellow Pine, Western SPF and Hem-Fir in Q1'22 as compared to Q1'21. The SYP Composite, Western SPF Composite and KD H-F Stud 2x4 9' benchmarks increased by US$204, US$224 and US$131 per mfbm to US$1,119, US$1,159 and US$1,293 per mfbm, respectively.

Sales generated from logs, residual products and other increased by $49.6 million or 57.1% in Q1'22 compared to Q1'21 due mainly to the Acquired Eastern Canada Operations I-Joist plant sales and an increase in volume of chips produced and sold.

Operations

Production costs increased by $301.7 million, or 69.8%, compared to Q1'21, explained by a 29.1% increase in lumber sales volume, inventory purchase accounting adjustments for the Acquired Eastern Canada Operations, inflationary impacts on conversion costs, higher log stumpage rates in B.C. and a weaker Canadian Dollar on average.

Lumber production of 921 million board feet in Q1'22 was 234 million board feet higher than Q1'21.

Production from the Canadian BC operations decreased by 12 million board feet to 196 million board feet in Q1'22, compared to Q1'21. The Acquired Eastern Canada Operations contributed production of 100 million board feet in Q1'22. Production from the Company's U.S. South and U.S. Northwest sawmills totaled 452 million board feet and 173 million board feet, respectively in Q1'22, up 114 million board feet and 32 million board feet, respectively compared to Q1'21. The increase in production is due primarily to the acquisition of five sawmill operations, Summerville, SC acquired in late Q1'21 and Bay Springs, MS, Fayette, AL, Philomath, OR and DeQuincy, LA acquired in Q3'21.

Interfor expensed the full amount of CV and AD duty deposits levied on its Canadian shipments of softwood lumber into the U.S., which totaled $35.8 million for Q1'22, up $23.4 million from Q1'21. The increase is due to higher lumber sales prices, higher shipments to the U.S. from Canadian sawmills and higher cash deposit rates as compared to Q1'21.

Depreciation of plant and equipment was $33.1 million in Q1'22, up $11.6 million from Q1'21, due primarily to the start-up of completed capital projects in the U.S. South, the acquisition of sawmills in 2021 and the Acquired Eastern Canada Operations. Depletion and amortization of timber, roads and other was $9.1 million, up $2.2 million from Q1'21, primarily due to increased conventional logging on the B.C. Coast.

Corporate and Other

Selling and administration expenses were $17.6 million, up $4.7 million from Q1'21 primarily as a result of transaction costs related to the Acquired Eastern Canada Operations and accruals for short term incentive compensation.

Long term incentive compensation expense was $3.7 million in Q1'22, down $4.0 million from Q1'21, primarily as a result of the impact of a 3.7% decrease in the price of Interfor common shares used to value share-based awards during Q1'22 compared to a 10.6% increase during Q1'21.

Asset write-downs and restructuring costs in Q1'22 were $3.2 million, primarily related to severance and non-cash impairments on certain plant and equipment that were replaced in conjunction with the Company's strategic capital projects. The asset write-downs and restructuring costs in Q1'21 were negligible.

Finance costs increased to $5.2 million from $4.5 million in Q1'21 primarily due to higher borrowings during Q1'22 to fund the acquisition of the Acquired Eastern Canada Operations.

Other foreign exchange gain of $12.8 million in Q1'22 and loss of $2.3 million in Q1'21 result primarily from the quarter-end revaluation of U.S. Dollar denominated short-term intercompany funding and U.S. Dollar cash held by Canadian operations.

Other income of $8.7 million in Q1'22 primarily relates to insurance proceeds the Company expects to receive from a business interruption claim related to fire damage at one of the Acquired Eastern Canada Operations. Other income of $2.0 million in Q1'21 primarily resulted from the sale of surplus land on the B.C. Coast.

Income Taxes

The Company recorded income tax expense of $132.0 million in Q1'22 at an effective tax rate of 25%, comprised of $122.6 million current income tax and $9.4 million deferred tax. The Company recorded income tax expense of $86.3 million in Q1'21 at an effective tax rate of 25%, comprised of $83.2 million current income tax and $3.1 million deferred tax.

Net Earnings

The Company recorded Net earnings of $397.0 million, or $6.69 per share, compared to $264.5 million, or $4.01 per share in Q1'21. Operating margins and Net earnings were positively impacted by higher lumber prices and higher sales volumes. Net earnings per share was positively impacted by share purchases under the Company's NCIB.