Good morning, everyone. Thanks for joining us. We're here today to discuss Interfor's second quarter results, our outlook for the balance of the year, and most especially, the announcement we made yesterday regarding the second phase of our strategic capital plan for our mills in the U.S. South. Joining me as usual are Marty Juravsky, our CFO, and Bart Bender, our Senior Vice President of Sales and Marketing. Also joining us this morning is Ian Fillinger, our COO, who also has responsibility for our capital projects activity. We're going to keep our remarks brief, and we'll turn the meeting over to you for questions as soon as we can. Obviously, we're very pleased with our results in the quarter. Net earnings were $63.8 million on sales of $620 million.
EBITDA before share-based compensation was $123.8 million, 38% higher than the previous quarterly record set in the fourth quarter last year. On an LTM basis, net income was just under $150 million on sales of $2.2 billion. EBITDA before share-based compensation was just under $355 million. Our results in the second quarter were positively impacted by higher lumber sales realizations, which before duties were $65 per thousand board feet higher than the prior quarter, reflecting the strength of lumber prices, which set numerous records before peaking at the end of May, and the decline in the value of the Canadian dollar, which was off 2% quarter-over-quarter. Production and sales volumes were also stronger in the second quarter.
Production was up 22 million board feet, or 3% versus the prior quarter, in spite of weather-related curtailments at our Grand Forks mill in the East Interior, and sales of Interfor-produced lumber was up 54 million board feet or 8% versus the first quarter. During the quarter, we shipped 100% of production, compared to 95% in the first quarter of the year. Production costs were essentially flat quarter-over-quarter, as lower mill-level costs in the South were offset by higher log costs in Canada and by the weakening of the C dollar. On a regional basis, lumber production was 325 million board feet in the South, up 23 million board feet versus the first quarter. 148 million board feet in the Northwest, up 2 million board feet.
In the Interior, production was 175 million board feet, down 6 million board feet versus the first quarter, due primarily to the curtailments at Grand Forks. On the Coast, production was 40 million board feet, up 3 million board feet relative to the first quarter. From a capacity utilization standpoint, the South, Northwest, and Interior each operated at 93% during the second quarter, compared with 86%, 91%, and 97%, respectively, in the first quarter. The Coast operated at 50% in the second quarter, compared to 46% in the first quarter. Overall capacity utilization was 89% versus 86% in the first quarter of the year. As mentioned earlier, product prices were very strong across the board in Q2.
The Random Lengths Composite Index, which measures pricing on a wide basket of products, was up 11.5% quarter-over-quarter. More specifically, the Western SPF index was up almost 13%, while the Yellow Pine composite was up 16%. Cedar decking, on the other hand, and pine boards were flat quarter-over-quarter. Looking at pricing in a bit more detail, we've seen more volatility this year than has been the case in the last couple of years, which is a reflection of the relatively tight balance between overall demand and available supply, combined with some logistics constraints that limited buyers' ability to access supply in the early part of the year.
Prices moved up steadily in the first 10 weeks of the year, peaking in the first week of March, then after retreating for 4 weeks, took off again in the first weeks of April and rose steadily until the last week of May, with SPF two-by-four hitting a peak of $655 per thousand board feet in mill and Yellow Pine two-by-four East Side at $621 per thousand board feet. When it began to move back to more normal levels, falling in the case of SPF by $65 by quarter end. Import duties on Canadian shipments to the U.S. in the second quarter were expensed at the full all others rate of 20.23% and amounted to $14.8 million, compared with $12.9 million in the first quarter.
The second quarter was another very strong quarter from the standpoint of cash flow, with cash from operations before changes in working capital of $123.2 million, or $1.76 per share. On an LTM basis, cash from operations before changes in working capital has totaled $340 million, or $4.85 per share. Capital spending in the second quarter totaled $23 million. Net debt was reduced by a total of $93 million in the quarter, coming in at $3.4 million or 3.4% of invested capital at the end of the quarter. The company closed the second quarter with more than $500 million of available liquidity, which puts us in a very advantageous position to pursue a variety of value-creating opportunities.
In that regard, for some time now, we've been working on a strategic capital plan designed to capture the opportunities within our existing mill platform, particularly in the US South, and to pursue further growth. The previously announced capital projects at Meldrim, Georgia, and Monticello, Arkansas, are on track for completion in the first quarter next year. Those projects will materially improve the economics of those mills and will add approximately 150 million board feet of additional production to our portfolio. And yesterday, we announced the second phase of the plan, which will see $240 million invested in our plants at Thomaston and Eatonton, Georgia, and at Georgetown, South Carolina, over the course of the next three years.
These projects will increase production, production capacity by 275 million board feet, as well as substantially improve the cost structure, product mix, and grade returns of these mills. The significance of these projects can't be overestimated. Considerable time and effort has been expended over the last 6-8 months to bring the projects to this stage, and I'd like to thank all of the people, both inside our company and outside, who've put in the time and effort to bring these projects to where they are today. The design and construction of capital projects is one of Interfor's core strengths, and we have a track record of delivering projects on time and on budget and achieving returns above pro forma. I'm completely confident that we're going to do so again with these projects, and I'm going to be excited to watch them come to fruition.
I can also tell you that we have a number of smaller machine center upgrades, either planned or on the drawing board, at mills throughout our system in Canada, the Pacific Northwest, and in the U.S. Southeast, over and above the plans outlined today, which will be undertaken at the same time and will also deliver very attractive returns. We also continue to look at opportunities to move forward with a greenfield facility in the South. And while we continue to advance our assessment of alternative locations in the quarter, our primary focus was to put the finishing touches on our internal plans, which resulted in pushing off the decision on the greenfield strategy to later this year.
In anticipation of the ramp-up of capital spending over the next few years, including the possibility of a greenfield project, we took steps during the second quarter to modify our debt financing arrangements to extend the repayment terms on a portion of our US dollar fixed-rate notes to begin in 2027, versus the current commencement date of 2021. This refinancing is scheduled to close in 10 days or so. Turning now quickly to an outlook for the market, it's, it's apparent to everybody that product prices have continued to normalize through the first 5 weeks of the third quarter. But while the composite is off almost $120 a thousand from its peak, and some of the main commodities are off more than $170, I think it's important to keep things in, in perspective.
In all the discussions we've had with our largest customers, takeaway levels continue to be good, and inventory levels are reasonable for this time of year. Probably most important, prices are even higher than they were last year, which was not a bad year. Quite frankly, I think pricing is much healthier today from a long-term grow the market standpoint than it was two months ago. So there will be continued volatility in product pricing. We believe the market will continue to grow, the pricing will continue to reflect demand and supply balances, which we believe are tight, and well-performing, well-run companies with quality assets will continue to deliver above-average returns. On that cheery note, operator, I'm gonna turn the meeting over to our guests and take their questions. Thank you.
At this time, I would like to remind everyone, in order to ask a question, please press star and the number one on your telephone keypad. Your first question comes from Hamir Patel from CIBC Capital Markets. Your line is open.
Hey, morning.
Good morning.
On the greenfield front, it looks like maybe the language had shifted, but I'm just curious, are you looking at still one opportunity or potentially multiple opportunities?
Well, we're looking at a variety of different sites, and if the economics and the opportunity present themselves, we have the capacity and the interest in doing more than one. But I prefer to look at it from a sequential standpoint, Hamir. And if we can get one, we'll do it, and if we can find another one after that, we'll do that too.
Fair enough. And, maybe just a question from Marty with, you know, all the projects underway, excluding any potential greenfields, what level of CapEx should we be budgeting for 2018 and 2019?
Well, for 2018, we were talking about something in the zone of $150 million for this year up until now. The odds are it's probably gonna be a little bit shy of that, and it's more or less a function of timing of capital spending. Some of the spending that might have otherwise happened in the fourth quarter is probably gonna filter into the early part of next year. So it's more of a timing issue. In terms of 2019, I mean, the biggest chunk of it, Marty, is related to the strategic capital projects, the phase two strategic capital projects that Duncan articulated.
Those are gonna be spent over a multiyear period, but I think directionally, if you're thinking something in the order of magnitude of around $200 million for next year, that gives you a frame of reference.
Great. So Marty, that's, that's helpful. And just now turning to the markets, Bart, could you comment on, you know, what you're seeing in China on the demand side for both SPF and southern yellow? And, you know, with all the trade rhetoric with China heating up, what % of the southern yellow pine exports that go to China, and where's the rest going?
Okay, good question. You know, my take on China is they've been a bit slow to react to what's happened in North America, and you can expect that. They have lots of options. We are managing to sell the volumes that we're willing to allocate into that marketplace.
... So Q2 actually was an improvement over Q1 in terms of volume. But year to year, we're allocating less to that market than we have. And that's just due simply to the fact that there is a gap between the prices that you see in China versus the prices that you see elsewhere, including other export markets. For Southern Yellow Pine, we continue to be actively improving our position in China on that product. We see that as a real growth opportunity for us. We're continuing to focus specifically on that market. But, you know, I think it's important also to acknowledge the other Asian markets.
We've had tremendous success in other areas other than Japan and China, you know, the other Asian countries in introducing Southern Yellow Pine and growing our sales there. So, we've actually, you know, done very well year to date with the volumes that we've sold in those markets.
Great. Thanks for that. That's helpful. And just with, you know, with SPF prices coming off, what do you think is the level at which maybe the European producers pull back?
Oh, you know, I can't speculate on the European market. You know, my understanding is that they continue to see robust demand over there as well, and so markets will have a way of sorting that out. But obviously, the pullback in North America is gonna close that gap with what we're doing overseas. And so we should start to see more SPF, more Doug fir, and quite frankly, more Southern Yellow Pine making its way over to China in the next quarter or two.
Great. Thanks. That's all I had. I'll hand it over.
Thanks, sir .
Our next question comes from the line of Paul Quinn. Your line is open.
Yeah, thanks very much. Good morning, guys.
Hi, Paul.
Second to you. Spending $240 million in phase II, maybe you could go through some details of what you're upgrading at each of the mills. Have you, do you have any idea identified?
Yeah, I'm not gonna get into the specific dollar amounts at each of the mills, Paul, but I can tell you we're looking at very significant modernizations of both the Thomaston and Eatonton mills, and a somewhat more modest program at Georgetown. We think in each case, it's going to, you know, move those mills from a performance standpoint, from a volume standpoint, and from a product and mix standpoint, very nicely, going forward. So we're pretty excited about these. We've put a lot of time and effort into them over the course of the last six to eight months.
We've put a whole variety of different options, and I'm quite comfortable that what we've got planned for these operations is very consistent with what we've done in the BC interior when we rebuilt those facilities, and it's gonna deliver the same kinds of gains for us that the investments at Adams Lake, Grand Forks, and Castlegar have done for us.
So again, it sounds like the Thomaston and Eatonton, that's a whole rebuild, not just, you know, front-end, back-end planer kind of thing?
They're significant rebuilds for both mills, yeah.
Okay, and then-
Paul, Paul, I'm sorry. Just to augment it, one thing to put also a frame of reference around in terms of these projects, these projects are much more than just capacity. When we actually think about the impacts of these projects, Duncan talked about 275 million board feet as impact, but the reality is, a fairly significant part of the returns are associated with grade outturns, product mix, improved recovery, lower conversion costs. So these projects are fairly comprehensive in terms of what they're gonna do from an economic standpoint.
No, I understand that. Just the $150 million and the $275 million in phase II, how should we model that out? Is that - would we capture that, you know, after 12 months, after 18 months, or, you know, how would you model that out?
It's pretty, pretty easily over the three-year period of time. The Monticello and Meldrim projects will be completed in the first quarter. We've built a ramp-up period into our pro forma, so we would expect to see both of those facilities operating pretty much capacity by the third quarter of 2019. And then, as we take on the other projects, we'll be phased in over the course of 2019, 2020, and 2021 period of time, and so we'll ramp up over that. We won't see the full increase in volume until the back end of 2021, which we think fits in pretty nicely with the expectations that the market's gonna continue to grow over the course of the next few years.
Okay. And then just, you've got a lot of capital projects on the go here. What's the, what are your conversations like with the equipment suppliers, and how constrained are they in bringing in additional capacity to the marketplace?
From my standpoint, I think they're very constrained. But we've been talking with them, you know, through this whole piece. We bought slots, some time ago knowing that these projects were on the drawing board. And so, I think we're in pretty good stead in terms of being able to undertake these projects in a sequenced way, and bring them on board using quality equipment, quality support and contractors, you know, through this piece. Is there any more after that?
No, I think you kind of covered it, Duncan.
All right, that's all I had. Best of luck, guys. Thanks.
Thanks, Paul.
If you'd like to ask a question, please press star one on your telephone keypad. Your next question comes from Sean Steuart from TD Securities. Your line is open.
Hi, everyone, it's Sasha . Happy Friday.
Hi.
Back to CapEx, that $240 million, how much will you spend this year and next year?
Well, we won't spend any of it this year. It's a 2019 through 2021 project scope. We're spending currently on the Meldrim Monticello project is I think a combined total of $62 million or something. And that was U.S., which will be spread over the latter part of this year, but a significant portion of that will be spent in the first quarter of next year. The projects that we've announced here today will be moving through the planning phase of those projects. Well, what we've been doing up to now is, you know, conceptual design and engineering and economics on the plants.
But when we now need to move into the detailed planning phase of each of those projects, which, you know, takes a fair amount of time, and we wouldn't expect to see any commencement of construction until the middle part of next year on the first of the plants. And then those will wrap up over the course of the next year, year and a half from a construction standpoint, with the last one completing in 2021.
And so, Tak, for planning purposes, for modeling purposes, you know, what I said earlier on the call is think about next year being around $200 million, plus or minus, with it not being split evenly between the front and back half of the year. So it'll be less than that in the front half and more than half in the back half of the year.
Okay, got it. So I'm assuming construction commences kind of mid-year next year, like Duncan mentioned, maybe a quarter of that $240 million for next year, so I would say for function?
Well, you have to look at it in aggregate to other things that we're doing as well. So there's a whole bunch of components. Duncan articulated some other spending. So if you don't focus just on the $240. If you're looking for the aggregate number for next year, some of that $240 is coming in next year, but there's other things as well, including maintenance spending, including some smaller discretionary projects. But in terms of the $240, some of that will be next year, but less than half of it will be next year.
Got it. Okay, that's really good detail. Thanks. And that less than 5-year payback that you guys mentioned that was, underlined by conservative lumber price assumption. What is, what is exactly the Southern Yellow Pine, price assumption that you guys are using in that estimate?
Well, we don't disclose that, but let's just say it's well less than where it is today.
Okay, got it. It's an east side price, right? You guys are-
Pardon me? Pardon me.
It's side price or what side?
Yeah. What, what we tend to use is if you're using a frame of reference, what we put in our, in our public disclosure is the Southern Yellow Pine composites.
Okay.
But regardless of what-- whether you're using East Side, West Side, Central, whether you're using composites or specific products, to Duncan's point, any of those references, what we're using in modeling it out, is less than current spot.
Okay, that's helpful. All right, that's it for me, everyone.
Okay, thanks.
Your next question comes from Mark Wilde from Bank of Montreal. Your line is open.
Good morning, Duncan.
Hello, Mark, how are you?
Good. Let me just to kind of start off on some of these capital projects, is it possible to give us a sense of how much just capital costs have moved up over the last couple of years? Like, if you were doing these projects three years ago, and you bid them out, would it have been $240, or would it have been something less?
Well, it would have been something less. I mean, it's a fairly significant inflation. The steel prices have obviously increased significantly over this last period of time. And just from a pure demand supply standpoint, there's more folks looking at doing projects, which has translated into, you know, higher costs of projects, currently than was the case six months ago, a year ago, and most certainly two years ago.
Mm-hmm. And also turning to just the greenfield, can you give us some sense of sort of what the kind of the critical conditions are around a potential greenfield for you?
Yeah, sure, Mark, and we've said this continually, and it's got to be an appropriate fiber basket. You've got to have a pool of people, both from a labor force standpoint and from a management standpoint, that you can access, skill trades that you can access. So, in our view, it needs to be reasonably close to a decent-sized center where you can access the supply of labor. You need appropriate byproduct offtake arrangements with creditworthy customers, and you need the logistics piece—you need to be able to move the product. And I think as production ramps up in the Southeast and declines in some other areas of North America, it's our view that product is gonna move farther than it has historically from the Southeastern region.
So whether it's additional access to rail or highway systems or ports, Bart talked about our strategy to move Yellow Pine offshore, which is a big part of our strategy. So trying to find a combination of all those factors and economics that make sense, given the inflationary environment we're in from a capital cost standpoint, are all the key factors. And we've got lots of things on our plate from the standpoint of our internal projects, which is our priority, obviously.
But if we can, if we can find a situation that fits those criteria, that we're comfortable with taking on, whether from a financing capacity or from a, from a management capacity, we're prepared to go down that path because it's consistent with our long-term plan to grow the value of the company.
Okay. Are—just taking a step back, I mean, we've seen, I would say, since probably the, you know, July or August last year, a really marked acceleration in the number of southern lumber projects, whether it's bottlenecks or a, you know, kind of a growing list of green fields. Does this concern you?
No. We expected it. I think it's gonna take longer for production to ramp up than most people think. I think lead times on equipment and contractors and others are gonna be more difficult than I think a lot of people assume. I think you've got an environment where the market is continuing to grow at, you know, whether it's 1.5-2 billion feet per year. And the ramp up of capacity I think is necessary to enable North America to be able to meet its own demand requirements.
So we're, we're totally comfortable with it, Mark, and right now, don't see the number of additions of capacity or greenfields or whatever it is to match what we think is gonna be the growth in demand for the product over the course of the next three or four or five years. So we're completely comfortable with it.
Okay. And then some of the TIMOs that I talk with and the REITs are talking about sort of, you know, in some areas where they're seeing kind of sawmill capacity being added or maybe close supports where they're starting to export more. They are pointing to some tensioning in the log markets. Are you guys seeing this at all?
Well, we haven't seen it yet. You know, we've done very detailed analysis of the various timber baskets throughout the southern region. And the areas that we are looking at have significant inventories of standing timber, and they've got growth-to-drain ratios that are really quite favorable. And so my expectation is, one of the primary beneficiaries of the added capacity in the South will be the landowners, more by way of increased volume as opposed to inflationary pricing arrangements.
Okay.
That said, we've taken, just like we've taken a conservative approach on the lumber prices, we're not naive either about the potential impacts on log costs. So as we look at the various alternatives available to us, we're constantly looking at what we think lumber prices might be and constantly looking at what we think log costs might be, and constantly looking at what we think by-product revenue might be, and adding it all up. And unless we're, you know, completely comfortable that we've got a circumstance that's going to suit our needs, we're just not going to proceed.
Yeah. But you've got a lot of moving variables in those equations. The last question I have is really just on kind of current markets. And I just wondered as these transportation bottlenecks kind of ease on the rails out in Western Canada, whether, you know, sort of backed log orders hitting the distributors right now or hitting the retailers, whether that is actually, you know, bumping their inventory levels and hence, kind of contributing to some of the turmoil we see in the market right now, if you follow me.
Because I assume that a lot of these guys have had orders sitting out there and that, you know, orders had been sort of lagged in terms of rolling into them, and all of a sudden, the whole thing is going the other direction now, and orders are coming in an accelerated pace.
Well, you know, what all you're seeing right now is the reverse of what we saw in the first quarter and the first part of the second quarter. You know, what, you know, the logistics constraints, combined with a tight, tight demand supply balance, created a situation where buyers are bidding up product and trying to access it. You're just seeing the reverse. I, I think the best way to look at it is, is to, you know, look at it across, across the board and say, "You know, you had the run up, now you got the run down. What does the average look like, compared to last year or any other reference point you want to look at?" All in all, it's a pretty good market. The market continues to grow.
Pricing is better today, even after the, I call it the normalization or the correction that's happening. It's a pretty good situation, and so we're not at all uncomfortable with what's happening. We think it'll shake out over a period of time. I think it just continues to be quite a positive situation. I think there's a view out there that prices are going to zero. Well, I'm not an advocate or supporter of that thesis. I just don't think that makes any sense. You know, we'll move through volatile times, but overall, I think the circumstance for the industry right now in terms of long-term fundamentals for a well-positioned producer are pretty darn good.
Yeah, I think that's pretty calm, pretty rational. We haven't ever seen zero before. We have a lot of people who worry about that. I'll turn it over. Thanks, Duncan.
Yeah, thanks, sir.
Your next question comes from Hamir Patel from CIBC Capital Markets. Your line is open.
Thanks. I just had a couple follow-ups for Ian. You know, following the flooding in Grand Forks, I think you had to reference some ongoing transportation issues at that site. I'm just wondering if that's still the case, and when do you expect that to be resolved?
Actually, I'll answer, Bart, here. I'll take that. Yeah, the San Poil line was affected by the floods coming into Grand Forks. That line's owned by OmniTRAX, and they have announced that they're going to repair it. And I'd say we've probably got about five or six weeks before that line is fully prepared and back operational. In the meantime, we have other means of accessing you know both the BN and the CP to keep that product flowing. So we haven't seen you know any issues on inventory builds and whatnot currently you know going through the reloads that we've set up.
Great. Thanks for that. Thanks for that, Bart. And then I just had a question about labor. So, for Duncan or Ian, just, you know, what are you seeing in terms of availability of workers in, in the various regions, and maybe what sort of wage inflations you think may need to kind of factor in, in, particularly the U.S. South?
Yeah, sure. So, I guess on a positive side, we've had a couple of our operations in the South that were, you know, not running on a two-shift basis. And over the last, six or so months, we've been able to get those up to two shifts with the labor pool. You know, we're working, you know, real hard with our recruiting department, a number of different niches, which I think are really neat. They're starting to bring a new pool into our operations. And then when we look at the capital investments going into the South, and it really does create a different story, both from a management and recruiting standpoint, and from, you know, a frontline employee and trades employee.
You know, I think these investments that we've announced are, you know, gonna change the story of job security and, you know, professional positions that become available. So, I think we're in very good shape and positioned well, and our brand in the South over the last number of years has continued to improve. So, having said that, it's tight, and we're always looking at ways that we can access talent pool through wage adjustments or other means.
You can hear great.
Yeah. You asked a question about inflation in wage rates, and I think in an unemployment situation like we've got in the U.S., you know, labor is tight, and I think we're going to see additional inflation in wage rates. But part of the capital strategy we've got is to position ourselves with higher productivity, greater levels of efficiency, and greater ability to pay higher wages to people over time, just because of your relative competitive position. So it's all part and parcel of our strategy based on what we see coming forward in the industry.
Fair enough. Actually, that's, that's all I have.
Okay. Thanks, sir.
There are no further questions in the queue. I now turn the call back over to the presenters.
Great. Thanks, Kim. Thanks, everybody. We very much appreciate you attending the call today. Appreciate your interest in our company. Myself, Marty, Ian, and Bart are available if you have follow-up questions. And if not, we look forward to talking to you again at the end of next quarter. Thank you.
This concludes today's conference call. You may now disconnect.