Interfor : Q3 2022 – Opens application

Interfor Corporation

Third Quarter Report

For the three and nine months ended September 30, 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 and nine months ended September 30, 2022 ("Q3'22" and "YTD'22", respectively). 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 and nine months ended September 30, 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 November 3, 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 Third Quarter, 2022", "Acquisition of Chaleur Forest Products", "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 on www.sedar.comand www.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; Indigenous reconciliation; the Company's ability to export its products; the softwood lumber trade dispute between Canada and the U.S.; 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 Third Quarter, 2022

Interfor recorded Net earnings in Q3'22 of $3.5 million, or $0.06 per share, compared to $269.9 million, or $4.92 per share in Q2'22 and $65.6 million, or $1.05 per share in Q3'21. Adjusted net earnings in Q3'22 were $31.5 million compared to $280.2 million in Q2'22 and $46.7 million in Q3'21.

Adjusted EBITDA was $129.5 million on sales of $1.0 billion in Q3'22 versus $428.6 million on sales of $1.4 billion in Q2'22.

Notable items in the quarter:

• Lumber Production Balanced with Demand
  o Lumber production totaled 986 million board feet, representing a decrease of 30 million board feet quarter-over-quarter. The U.S. South and U.S. Northwest regions accounted for 470 million board feet and 159 million board feet, respectively, compared to 467 million board feet and 163 million board feet in Q2'22. The Eastern Canada Operations produced 198 million board feet versus 211 million board feet in Q2'22. Production in the B.C. region decreased to 159 million board feet from 174 million board feet in Q2'22, in part due to the sale of the Acorn sawmill during Q2'22.
  o Lumber shipments were 1.1 billion board feet, or 18 million board feet lower than Q2'22, leading to a reduction of lumber inventories by 36 million board feet during the quarter. Lumber inventories ended the quarter within our target range.
• Moderating Lumber Demand
  o Lumber demand moderated during the quarter due in part to rising interest rates across North America, contributing to significantly lower lumber prices quarter-over-quarter. Interfor's average selling price was $800 per mfbm, down $304 per mfbm versus Q2'22. The SYP
  Composite, Western SPF Composite, KD H-F Stud 2x4 9' and ESPF Composite price benchmarks decreased quarter-over-quarter by US$127, US$287, US$264 and US$281 per mfbm to US$555, US$550, US$627, and US$657 per mfbm, respectively.
• Financial Flexibility Maintained
  o Net debt ended the quarter at $249.7 million, or 10.5% of invested capital, resulting in ample available liquidity of $601.4 million.
• DeQuincy, LA Sawmill at Full Production
  o The DeQuincy, LA sawmill, with an annual two-shift capacity of 200 million board feet, reached its full production run-rate in Q3 2022.
• Strategic Capital Investments
  o Capital spending was $86.1 million, including $50.8 million on discretionary projects. The majority of this discretionary spending was focused on the multi-year rebuilds of the Eatonton, GA and Thomaston, GA sawmills, a new planer at the Castlegar, B.C. sawmill and upgrades to the Perry, GA sawmill.
  o The comprehensive rebuild of the Eatonton, GA sawmill was successfully completed during the quarter and it is currently ramping up as expected towards the designed production capacity of 230 million board feet per year.
• Substantial Issuer Bid ("SIB")
  o On July 26, 2022, Interfor announced a SIB pursuant to which the Company offered to purchase up to $100.0 million in value of its outstanding common shares for cancellation from holders of common shares for cash. The SIB proceeded by way of a "modified Dutch auction" procedure with a tender price range from $29.00 to $34.00 per common share.
  o On September 12, 2022, the Company purchased for cancellation 3,355,704 common shares for total consideration of $100.0 million at a price of $29.80 per share or 0.72 times book value per share at September 30, 2022.

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• Normal Course Issuer Bid ("NCIB") Renewal
  o The Company announced today a renewal of its NCIB commencing on November 11, 2022 and
  ending on November 10, 2023, for the purchase of up to 5,105,002 common shares, which represents 10% of the Company's public float. The Company continues to believe that, from time to time, the market price of its common shares may be attractive and their purchase would represent a prudent use of its capital to increase shareholder value.
• Softwood Lumber Duties Rate Adjustment
  o In Q3'22, the U.S. Department of Commerce ("DoC") published the final rates for countervailing
  ("CV") and anti-dumping ("AD") duties based on the results of its third administrative review ("AR3") covering shipments for the year ended December 31, 2020. The final combined rate for 2020 was 8.59%, compared to the cash deposit rate of 20.23% from January to November 2020 and 8.99% for December 2020. To reflect the lower amended final rates for 2020, Interfor recorded a $26.1 million reduction to duties expense in Q3'22 and a corresponding receivable on its balance sheet.
  o Interfor has cumulative duties of US$418.9 million held in trust by U.S. Customs and Border Protection as at September 30, 2022. Except for US$124.2 million recorded as a receivable in respect of overpayments arising from duty rate adjustments and the fair value of rights to duties acquired, Interfor has recorded the duty deposits as an expense.

Acquisition of Chaleur Forest Products

On October 3, 2022, the Company announced it had reached an agreement with an affiliate of the Kilmer Group to acquire 100% of the equity interests in the entities comprising Chaleur Forest Products ("Chaleur") for a purchase price of $325.0 million, which includes $31.0 million of net working capital. In addition, Interfor will assume Chaleur's CV and AD duty deposits at closing, for consideration equal to 55% of the total deposits on an after-tax basis. The acquisition includes two sawmill operations located in Belledune and Bathurst, New Brunswick with a combined annual lumber production capacity of 350 million board feet, and a woodlands management division based in Miramichi, New Brunswick that manages approximately 30% of the total Crown forest in New Brunswick.

The transaction remains subject to customary conditions and regulatory approvals for a transaction of this kind and is currently expected to close in the fourth quarter of 2022.

Outlook

North American lumber markets over the near term are expected to be volatile as the economy continues to adjust to inflationary pressures, higher interest rates, supply chain constraints, labour shortages and geo-political uncertainty.

Interfor expects that over the mid-term, lumber markets will continue to benefit from favourable underlying supply and demand fundamentals. Positive demand factors include the advanced age of the U.S. housing stock, a shortage of available housing and various demographic factors, while growth in lumber supply is expected to be limited by extended capital project completion and ramp-up timelines and constrained overall fibre availability.

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.

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Financial and Operating Highlights1

			For the 3 months ended		For the 9 months ended
		Sept. 30	Sept. 30	Jun. 30		Sept. 30	Sept. 30
	Unit	2022	2021	2022	2022	2021
Financial Highlights2
Total sales	$MM	1,035.6	664.3	1,389.1	3,773.7	2,613.3
Lumber	$MM	837.8	559.6	1,190.8	3,241.1	2,334.9
Logs, residual products and other	$MM	197.8	104.7	198.3	532.6	278.4
Operating earnings	$MM	75.9	54.8	385.9	974.4	978.7
Net earnings	$MM	3.5	65.6	269.9	670.4	749.4
Net earnings per share, basic	$/share	0.06	1.05	4.92	11.95	11.61
Adjusted net earnings3	$MM	31.5	46.7	280.2	704.1	750.9
Adjusted net earnings per share, basic3	$/share	0.58	0.74	5.11	12.55	11.63
Operating cash flow per share (before working
capital changes)3,5	$/share	(0.02)	1.09	4.43	10.86	14.42
Adjusted EBITDA3	$MM	129.5	93.9	428.6	1,128.2	1,097.3
Adjusted EBITDA margin3	%	12.5%	14.1%	30.9%	29.9%	42.0%
Total assets	$MM	3,294.6	2,488.7	3,269.5	3,294.6	2,488.7
Total debt	$MM	396.4	375.3	372.6	396.4	375.3
Net debt3	$MM	249.7	(133.8)	102.0	249.7	(133.8)
Net debt to invested capital3	%	10.5%	(9.3%)	4.6%	10.5%	(9.3%)
Annualized return on capital employed3	%	5.6%	16.0%	52.9%	47.8%	69.2%
Operating Highlights
Lumber production	million fbm	986	731	1,016	2,918	2,133
Lumber sales	million fbm	1,064	753	1,082	2,989	2,133
Lumber - average selling price4	$/thousand fbm	800	744	1,104	1,084	1,095
Average USD/CAD exchange rate6	1 USD in CAD	1.3056	1.2600	1.2768	1.2828	1.2513
Closing USD/CAD exchange rate6	1 USD in CAD	1.3707	1.2741	1.2886	1.3707	1.2741

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 including duties.
5. Financial information has been adjusted for a reclassification in the presentation of unrealized foreign exchange loss (gain) within cashflow from operations resulting in a $/share change of $(0.06) - Q3 2021; $0.45 - Q2 2022; and $(0.06) - YTD Q3 2021.
6. Based on Bank of Canada foreign exchange rates.

Summary of Third Quarter 2022 Financial Performance

Sales

Interfor recorded $1.0 billion of total sales, up 55.9% from $664.3 million in the third quarter of 2021, driven by the sale of 1.1 billion board feet of lumber at an average price of $800 per mfbm. Lumber sales volume increased 311 million board feet, or 41.4% and average selling price increased $56 per mfbm, or 7.6%, as compared to the same quarter of 2021.

Increases in the average selling price of lumber reflect higher prices for Western SPF, Southern Yellow Pine, and Hem-Fir in Q3'22 as compared to Q3'21. The Western SPF Composite, SYP Composite and KD H-F Stud 2x4 9' benchmarks increased by US$71, US$87 and US$69 per mfbm to US$550, US$555 and US$627 per mfbm, respectively.

Sales generated from logs, residual products and other increased by $93.1 million or 89.0% in Q3'22 compared to Q3'21 due mainly to the Eastern Canada Operations I-Joist plant sales and an increase in volume of chips produced and sold.

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Operations

Production costs increased by $352.4 million, or 64.0%, compared to Q3'21, explained by a 41.4% increase in lumber sales volume, inflationary impacts on costs, higher log stumpage rates in B.C. and a weaker Canadian Dollar on average.

Lumber production of 986 million board feet in Q3'22 was 255 million board feet higher than Q3'21.

Production from the Company's U.S. South and U.S. Northwest sawmills increased by 59 million board feet and 2 million board feet to 470 million board feet and 159 million board feet, respectively, versus the comparable quarter of 2021. The increase in the U.S. South is primarily related to the restart of operations at the sawmill in DeQuincy, LA in Q1'22. The Eastern Canada Operations acquired in February 2022 contributed production of 198 million board feet in the quarter, while production from the Company's B.C. operations of 159 million board feet represented a reduction of 5 million board feet compared to Q3'21. The production from the B.C. operations decreased mainly due to the sale of the Acorn sawmill during Q2'22.

Interfor recorded a net recovery of $12.4 million of duties in Q3'22 compared to an expense of $6.1 million in Q3'21. The net recovery resulted from the $26.1 million recovery related to the finalization of the CV and AD rates by the U.S. DoC for AR3, partially offset by higher shipments to the U.S. from Canadian sawmills related to the acquired Eastern Canada Operations.

Depreciation of plant and equipment was $40.6 million in Q3'22, up $14.7 million from Q3'21, due primarily to the acquired Eastern Canada Operations and the start-up of completed capital projects in the U.S. South. Depletion and amortization of timber, roads and other was $9.8 million, up $2.4 million from Q3'21, primarily due to the acquired Eastern Canada Operations and increased conventional logging on the B.C. Coast.

Corporate and Other

Selling and administration expenses were $15.6 million, up $1.9 million from Q3'21 primarily related to the acquired Eastern Canada Operations.

Long-term incentive compensation expense was $2.5 million in Q3'22, down $2.3 million from Q3'21, primarily as a result of the impact of a 3.9% decrease in the price of Interfor common shares used to value share-based awards during Q3'22 compared to a 6.6% increase during Q3'21.

Asset write-downs and restructuring costs in Q3'22 were $0.8 million, primarily related to 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 Q3'21 were $1.0 million, primarily related to non-cash impairments on right-of-use assets related to the sale of property, plant and equipment at the former Hammond sawmill.

Finance costs decreased to $1.5 million in Q3'22 from $4.4 million in Q3'21 primarily as a result of interest income accrued on the long-term receivable for the CV and AD duty rate finalization for AR3.

Other foreign exchange loss of $46.9 million in Q3'22 and gain of $9.1 million in Q3'21 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. The foreign exchange loss of $50.7 million recorded on intercompany funding in the quarter remains unrealized, and there was an offsetting gain recorded in Other comprehensive income for a net nil impact on Equity.

Other income of $11.9 million in Q3'22 primarily relates to the sale of a forest license, partially offset by the change in the fair value of the minority interest in GreenFirst Forest Products Inc. Other income of $22.6 million in Q3'21 primarily resulted from the sale of property, plant and equipment at the Company's former Hammond sawmill.

Income Taxes

The Company recorded income tax expense of $35.8 million in Q3'22 at an effective tax rate of 91%, comprised of $27.5 million current income tax expense and $8.3 million deferred tax expense. The effective tax rate exceeds the statutory tax rate due to the tax effect of the appreciation of the U.S. dollar on U.S. Dollar denominated short-term intercompany funding.

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