Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to Western Forest Products First Quarter 2020 Results Conference Call. During this conference call, Western's representatives may make forward-looking statements within the meaning of applicable securities laws. These statements can be identified by words like anticipate, plan, estimate, will and other references to future periods. Although these forward-looking statements reflect management's reasonable beliefs, expectations and assumptions, they are subject to inherent uncertainties, and actual results may differ materially. There are many factors that could cause actual outcomes to be different, including those factors described under risks and uncertainties in the company's annual MD&A, which can be accessed on SEDAR, and is supplemented by the company's quarterly MD&A. Forward-looking statements are based only on information currently available to Western and speak only as of the date on which they are made. Except as required by law, Western undertakes no obligation to update forward-looking statements. Accordingly, listeners should exercise caution in relying upon forward-looking statements.I would now like to turn the meeting over to Mr. Don Demens, President and Chief Executive Officer of Western Forest Products. Mr. Demens, please go ahead.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Thank you, Donna, and good morning, everyone. I'd like to welcome you to Western Forest Products' 2020 First Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer.We issued our 2020 first quarter results yesterday. I'll provide you with some introductory comments and then ask Steve to take you through a summary of our financial results. I'll then share with you our outlook and discuss recent developments in our industry. We'll then open the call up for your questions.I'd like to start off the call by discussing the impact of COVID-19 pandemic on our business. At the onset of COVID-19, we created a senior executive task force that together with our operations team helped us speed the implementation of strict health and safety protocols across our business. The protocols were based on guidance from experts, health officials and in compliance with regulatory orders and standards. Protocols included travel restrictions, physical distancing measures, limiting site access to essential personnel only and increasing cleaning and sanitation in workplaces. We also moved to a work-from-home model for those able to do so. We took some operational downtime in the quarter to confirm that appropriate health and safety protocols were in place for our employees and to assess market conditions. The strict health and safety protocols implemented have kept our employees, contractors and communities safe.Being designated an essential industry is something we and our team at Western take seriously, and we understand the responsibility that comes with it. The health and safety of our employees remains our highest priority. I want to recognize our employees, health officials and unions for their commitment to health and safety during this challenging period.So in addition to our COVID-19 health and safety response, we took prudent measures to protect our balance sheet and liquidity as well as provide financial flexibility to our business given the uncertain impacts of COVID-19. These measures have included the suspension of our quarterly dividend. The Board will continue to review the dividend on a quarterly basis. In addition to the suspension of our dividend, all strategic and discretionary capital projects will remain on hold until there is greater operational certainty. We'll continue with any safety, environmental or previously committed capital. We will continue to explore all other opportunities to strengthen our liquidity, including managing expenses and working capital levels, accelerating the receipt of income tax receivables and completing our TFL 44 Limited Partnership sale and evaluating various government relief programs. As we work through these uncertain times, we will continue to align our production volumes to match market demand while, first and foremost, ensuring the health and safety of our employees.Moving on to our first quarter results. Our first quarter results were significantly impacted by the USW strike, which continued through February. The gradual restart of strike impacted operations and the negative impacts of the COVID-19 pandemic on markets in production. As a result of these challenges, we generated negative EBITDA of $17.4 million in the first quarter of 2020. Despite the more challenging quarter, some highlights include, in February, members of the USW ratified a new 5-year collective agreement ending an 8-month strike. We're pleased to have reached a fair and equitable agreement and to have our employees and contractors back to work. The new agreement recognizes the contributions of our employees, provides for improved -- improvements to health and safety benefits -- sorry, health and welfare benefits as well as maintains operational flexibility for Western.In March, we safely restarted operations in our timberlands and sawmills that were impacted by the strike. Through the month, sawmill production continued to ramp up, and we worked to replenish our timberland supply chain. The restart was interrupted by 1 week of downtime as we addressed business challenges related to COVID-19. Also in March, we advanced our strategic partnership with Huu-ay-aht First Nations. We've agreed to sell additional ownership interest in 2 limited partnerships for $36.2 million. The transaction is subject to various closing conditions and is expected to close in the third quarter of 2020. The transaction further highlights our commitment to building mutually beneficial relationships with First Nations.I'll now turn it over to Steve to review our key financial results.

[Stephen Williams, Executive VP & CFO]

Thanks, Don. My comments will focus primarily on our financial results for the first quarter of 2020 by comparison to the first quarter of last year. We reported first quarter adjusted EBITDA of negative $17.4 million as compared to $18.1 million in the same period of 2019 as the strike, gradual restart of our operations and COVID-19 impacted results. We continue to operate our U.S. assets, process logs at custom cut facilities and execute on our wholesale lumber strategy to service our customers and mitigate the impacts during the strike. We increased wholesale lumber shipments in the first quarter as compared to the same period last year.Our average realized lumber pricing benefited from an improved specialty product mix and a weaker Canadian to U.S. dollar. Specialty lumber represented 73% of first quarter shipments compared to 52% in the same period last year. Although the average Canadian to U.S. dollar foreign exchange rate declined just over 1% over the same period of 2019, significant foreign exchange volatility in March 2020 resulted in a 5% reduction in the closing exchange rate compared to the same period last year. To support our selected customers during the strike, we were forced to operate suboptimally, which resulted in higher transportation and operating costs. An incremental $13.8 million of strike-related operating expenses was recognized in the first quarter, including curtailment costs during the strike, production inefficiencies on start-up due to lower log quality and additional safety and maintenance procedures required to resume operations.Operating expense was also negatively impacted by $2.9 million of incremental timberlands provisions for degraded log inventory and silviculture. The majority of the incremental silviculture provision was due to the decline in the discount rate applied to the liability. We also incurred $1.1 million of COVID-19-related operating expenses in March 2020.First quarter selling and administration expense was $6.4 million as compared to $8.8 million in the same period last year due to lower share-based and performance compensation expense and as a result of minimizing expenses during the strike. From a profit and loss perspective, net loss was $21 million as compared to net income of $1.9 million in the first quarter of 2019.Looking at first quarter cash flow and capital management, cash used in operating activities was $12.5 million as compared to $9.2 million in the same period of 2019. We reduced our noncash working capital by $6.2 million in the quarter to partly offset significantly reduced cash from operations resulting from the strike. Cash used in investing activities was $0.5 million during the first quarter of 2020 as compared to $47.7 million during the same period last year. We reduced our capital spending in order to manage cash flow during the strike and to address uncertainty caused by COVID-19.In the first quarter, we returned $8.4 million of capital to shareholders via dividends. Our liquidity at the end of the first quarter was $113.5 million, and our net debt to capitalization ratio was approximately 23%. Liquidity remains a key priority and near-term focus. We continue to explore all opportunities to strengthen our liquidity, including managing expenses, CapEx and working capital levels, accelerating the receipt of our income tax receivables and completing our TFL 44 Limited Partnership sale as well as evaluating various government relief programs. We expect sufficient liquidity will be available to meet our ongoing obligations.Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Thanks, Steve. So I'd like to start off our outlook section by discussing the impacts of COVID-19 on our business. The onset of the COVID-19 pandemic brought to a virtual standstill what was a promising start to the 2020 North American building season. Government actions to limit the spread of the virus, including stay-at-home orders and restrictions on construction, have caused significant demand disruptions in North America and in some of our key offshore markets. The disruptions have caused some customers to divert shipments and other customers to limit purchases. As government restrictions are being lifted, we're beginning to see some improved activity, but I should caution it's early days.In the United States, the strong market sentiment for cedar products at the beginning of the year faded and demand slowed as we closed the first quarter. In the last couple of weeks, however, we've seen some encouraging signs from the home center segment. How this improved picture will impact the overall demand for cedar products in the U.S. remains to be seen. Demand and pricing for our industrial niche products have been fairly resilient. We expect pricing and demand to remain stable through the second quarter provided there are no additional COVID-19 related disruptions.In contrast to the COVID-19 challenges faced in North America, Europe, Australia and New Zealand, lumber and log demand has improved in China as the country emerged from its COVID-19 lockdown. As a result, we've been successful at building order files in that market. In Japan, demand for Douglas fir and BC Coastal hemlock products through the second quarter is expected to be stable, unless there are unforeseen developments in Japan with respect to COVID-19. With respect to our operations, typically, in the second quarter, our log harvest volumes increase as snow recedes and expand operations across the complete timber harvesting land base. As harvest volumes increase, our log inventories tend to peak. That said, while we expect to see a build in log inventories by the end of the second quarter, we are going to be diligent, aligning our working capital and inventories to match market conditions.As we look forward, the COVID-19 outbreak has led to near-term market volatility and reduced business visibility. We will take all the necessary steps to match production to market demand and manage our business through these uncertain times.I'd now like to provide an update on a couple of developments in the industry. On January 21 of this year, the BC government announced changes to the Manufacturing Forest Products Regulation. The changes are to be effective July 1 of this year. The amendments to the regulation require Western Red Cedar and Yellow Cedar lumber to be fully manufactured to be eligible for export. Fully manufactured is defined as lumber that will not be kiln dried, planed or resawn at a facility outside of British Columbia and is subject to certain exemptions. The province is working with industry stakeholders to develop the right exemptions to meet its stated objective and help define a workable process. We continue to collaboratively engage with the province to ensure that the desired outcome is met without unintended consequences to our global customers or employment in British Columbia. The details of the policy have yet to be released, but the regulation as proposed today could have negative implications for global customers of BC cedar products who through their purchases support thousands of jobs and communities in the coast of BC. It can also have negative implications for the coast lumber business as it's already being disproportionately impacted by the application of duties on our high-priced cedar shipments to the United States.Moving on to the softwood lumber dispute. On February 3, 2020, the U.S. Department of Commerce issued preliminary revised countervailing and antidumping duty rates in the first administrative review of shipments for the years of 2017 and 2018. The preliminary revised all others combined rates for countervailing and antidumping duties were set at 8.37% for 2017 and 8.21% for 2018. These rates are well below our current combined rate of 20.23%. In April of 2020, the Department of Commerce announced a COVID-19 administrative review extension that could delay the final rate determination until late September 2020. Cash deposits will continue to accrue at a combined rate of 20.23% until the final determinations are published, at which time the final 2018 combined rate will apply to deposits on lumber shipments to the U.S.Despite the lower revised preliminary rates for 2017 and 2018, no duties paid in excess of the revised final rate will be refunded until the entire appeal process at the softwood lumber dispute concludes. Currently, Western has over USD 72 million on deposit with the U.S. Treasury, which at current exchange rates is more than CAD 100 million.Looking to what's next. Our top priority remains the health and safety of our employees, contractors and communities. We'll continue to adapt our procedures and protocols as necessary to ensure we keep our people safe. We'll also remain focused on maintaining financial flexibility and a strong balance sheet. And as the COVID-19 pandemic evolves, we'll continue to align our production volumes to match market demand. Despite the near-term uncertainty, we remain focused on implementing our strategic initiatives to strengthen our foundation, grow our base and grow our business over the long term.With that, operator, we can open up the call for questions.

[Operator]

[Operator Instructions] And the first question is from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

A couple of questions to start with. Don, your comments on cedar markets, I guess I'm trying to reconcile those comments with what we're seeing in pricing because it does look like there's been relative strength and resilience for a number of Western Red Cedar lumber grades that we track even through the whole COVID onset, and I'm trying to gauge how much of that is just the coast not operating until very recently and just very tight supply versus resilient demand from the repair and remodeling end-market channels.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Okay, Sean, so as it relates to pricing, maybe I'll just talk about demand first. I think the R&R channel really drives the consumption of cedar, as you pointed out. And I think we've seen some encouraging signs out of the home center segment for the R&R market. Another key component of the R&R market, however, is through the distribution channel and through the pro dealers and on the contractors. So specifically, when we see cedar, we see kind of the 2 things happening in the market. One, demand from the home center has been really strong for us. I think it's probably 20% ahead of the same pace last year. However, the business in the distribution side of the business and through the contractor and pro dealer market has been slow. So while we're encouraged on the home center side where pricing is firm, [ churn ] and probably going up, the demand on the other side of the market has been weak and there's probably, if anything, a little bit of price weakness. So I think why you're seeing -- to conclude, while you're seeing prices showing some resiliency, you've got this divergence in the market. And we're hopeful that as the states start to reopen, we'll see a reenergized distribution business and as contractors get back to work, and we'll see some more demand there.

[Sean Steuart, Research Analyst]

That's good detail. And a question for Steve regarding balance sheet durability and other levers you can pull to bolster liquidity. Is it safe to assume that beyond the Q3 asset sale that you've already lined up, have other noncore asset sale processes essentially come to a standstill in the current context? Are you able to advance any of those initiatives?

[Stephen Williams, Executive VP & CFO]

Yes. Maybe just for everybody's benefit, just as we've communicated in the past, I think our larger noncore assets include the Northern Island Private Timberlands on Vancouver Island, a royalty we receive from a quarry near Port McNeill on Vancouver Island and other feasible private lands and properties. I think right now, we don't have any further updates at this time, but we continue to look for opportunities that will allow us to capitalize on the differential between how the market values those assets versus how they value specialty lumber producers. So I think right now, that's probably all I can add, Sean.

[Sean Steuart, Research Analyst]

And Steve, there's the tax receivable on the balance sheet, you mentioned expediting the collection there. Can we assume that all comes over the next couple of quarters? How should we think about that?

[Stephen Williams, Executive VP & CFO]

Yes. I would think so. We're working on that now. I think, obviously, there's been some, I'll call it, government delays in terms of what's going on with COVID. So I would expect that, yes.

[Operator]

The next question is from Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

Don, the press release referenced some I guess new agreements you guys had with the home centers and pro dealers in the quarter. Can you speak more to that? And is -- how should we expect that ramp up in the coming quarters?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Sure. So what we've been able to do over the last few months is to solidify our relationships with key specialty distributors and home centers, both sides of the border. What we're doing is we're trying to work collaboratively with our customers, investing in marketing to drive demand going forward. That has been our focus for our cedar products, establishing specialty branding and supporting the -- supporting that branding with marketing initiatives. So that's what we're currently doing. And as I said in the previous answer, we've been pretty darn encouraged by the results thus far out of the home center business. I think to put it in perspective, home center business in the cedar side was probably about 15% of our business. And -- but we're seeing substantial growth there right now, and we're looking to grow that. Our estimate is about 40% of cedar is now consumed in the home center segment, and we would like to see our position increase there. So the genesis of the work with our customers is in establishing product lines -- sorry, marketing initiatives that can drive more demand for products from Western Forest Products through the segments.

[Hamir Patel]

Great. And Don, do you have exposure to both of the big box stores? Or have these changes resulted in maybe exclusivity with one on...

[Donald Eugene Demens, CEO, President & Non Independent Director]

No. We've got exposure to both big boxes in the U.S. Actually, and another one as well. So it's actually all 3.

[Hamir Patel]

Okay. And then just a question for Steve. Could you give us a sense as to the likely CapEx budget for the year? And just remind us on what your sort of bare-bones maintenance could be.

[Stephen Williams, Executive VP & CFO]

Sure. So -- and I think we mentioned this on the last call. Our typical maintenance in roads CapEx historically had been between about $30 million to $40 million on average with about another $30 million to $40 million of strategic investments. So due to COVID and its impact on global markets and operating through this, we plan to only incur safety, environmental, maintenance and committed capital. So for 2020, we estimate our maintenance in road CapEx will be in the neighborhood of $25 million to $30 million, depending on how COVID evolves, right? So -- and as Don indicated, strategic and discretionary capital projects will remain on hold until there's greater operational certainty.

[Hamir Patel]

Great. And Steve, is there any risk that the transaction with that First Nations group doesn't close? I'm just thinking, it was -- it came together sort of pre-COVID, what's the -- what's your thoughts on that right now?

[Stephen Williams, Executive VP & CFO]

Listen, this is the third transaction that we've been working on with Huu-ay-aht. We have a great relationship and things are moving ahead. Obviously, COVID played a role right now in terms of people getting together and advancing things, but things are moving ahead.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Operator?

[Operator]

Sorry, Mr. Demens. We had a little bit of a technical issue. The next question is from Paul Quinn.

[Paul C. Quinn]

I just had a couple of follow-up questions. So on the cedar side, Don, you said 15% home centers; 85%, I guess that's distributors, pro dealers. But the vision is to get that to 40%, 60% over time. And how long do you expect to take to get there?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes. Paul, probably a couple of years. But I think just to highlight, that's sort of the distribution. We expect to be growing our cedar business coming out of the strike. And if I could add to what I've already said, we're pretty encouraged by the results thus far. And we've been -- we're on strike for 8 months and not able to necessarily provide the full suite of products that we normally would. So we're pretty encouraged by the results coming out of the 8 months strike with our home center business and look forward to seeing it growing further. And also seeing the distributors -- distribution business through the pro dealers get back up and going as the COVID-related shutdowns end.

[Paul C. Quinn]

Okay. And then just overall on the quarter, I mean I expect a lot better results given that you had 1 month. Is there anything in the start-up of operations that you didn't anticipate or that was large that kept the results almost unchanged quarter-over-quarter?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Maybe at a high level, I'll just talk about the start -- restart, and then I'll push it over to Steve, and he can give you some financial details. But Paul, yes, I mean we're really pleased with the restart. The employees came back very supportive. We've done a lot of training with our supervisors, and we got off to a very good start. That said, whenever you're down for that long, there's a significant amount of maintenance on the -- in both the timberlands and manufacturing you have to go through to ensure that you can have a safe restart. On the timberland side, it would be ensuring that we've got roads and -- accessible and in good condition and safe condition would be one of the larger developments. It also takes quite a while to get your supply chain back up and running, getting the flow of logs through to the dry line sorts and then into a transportationable, I guess, form. In the mill side, we had to invest in some specific small investments to ensure that we could come back in a safe manner. But Steve's got the actual numbers to that. What interrupted us, of course, is a weaker downtime in the middle of a restart after 8 months of downtime due to COVID, but -- which added additional costs. I don't know, Steve, do you want to comment?

[Stephen Williams, Executive VP & CFO]

Yes. Paul, and I highlighted on that I think as I was just going through the overview in terms of basically 2 months of shutdown. We also had other provisions in timberlands that I touched on there as well that had a -- and the COVID week down in March had the impact -- negative impacts on results.

[Operator]

And the next question will be Hamir Patel.

[Hamir Patel]

My questions were -- I already asked my questions.

[Operator]

[Operator Instructions] And the next question is from Paul Quinn.

[Paul C. Quinn]

Maybe a question around this. I'm quite confused on this Manufacturing Forest Products Regulation. I mean this is a real game changer. And it doesn't sound like you've got any information on what the regulation looks like. And it's kind of 3 months before implementation really or less actually. Is there -- in your discussions, is there a willingness on like part of the government to push this off given the current situation with COVID?

[Donald Eugene Demens, CEO, President & Non Independent Director]

So we would share your analysis and concern, Paul, that we're 3 months away from what would be a major change to customers that have supported the BC industry for many of them, maybe 50, 60 years. And with just 3 months to go on this lack of clarity, yes, it's a bit perplexing. We're aware there's been a request need to defer. That hasn't been answered yet by government. And I can't respond or provide any more insights than that. We haven't heard anything else other than what we've provided.

[Paul C. Quinn]

Okay. And then a question on what are the options that are -- what's your running footprint right now? What do you expect through the balance of the year?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes. Sure. So on the timberlands side, we're running at a reduced rate just -- but we are running in all our operations. The reduced rate is just reflective of limited markets and some of the cost challenges that we currently have on the coast from a harvesting perspective. And the mills, we've got 6 mills running at -- and Alberni is running on a 40-hour configuration right now, so 1 shift. We've got Duke Point, Saltair, Chemainus and Cow Bay all running on 2 shifts, and we've got our mill down in Vancouver, Washington and Columbia Vista running on a 60-hour week. All total, that's about 75%, Paul, I would say, at least in the kilning operations to where we were when the strike began, if that helps. We -- and I guess to add, we will continue to operate based upon order files. So if we see that we aren't able to meet and match our production with order files, we'll have to take downtime.

[Paul C. Quinn]

Okay. And then maybe a question on the Huu-ay-aht agreement. I'm pleased to see that partnership continues to grow and it's good. I just had a couple of questions. There's a quote in that agreement, I guess the initial press release that says you may sell an additional 26%. And I'm just looking at this from a liquidity standpoint to be able to monetize that. So why is it limited to 26%? And why couldn't you sell the majority of your position?

[Stephen Williams, Executive VP & CFO]

Yes. Paul, this is a term of the agreement right now. And again, it's part of the reconciliation process. It's to encourage greater First Nations involvement.

[Paul C. Quinn]

Okay. And then the valuation on the 7% of APD for $1 million, how did you come up with that one?

[Stephen Williams, Executive VP & CFO]

Yes. Paul, I don't want to get into the details on that right now. Like I said, I think it's an opportunity of expanding the relationship and for the way to participate in the manufacturing side of the business.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes. I think the only thing I can add, Paul, I mean the idea is to get -- have the way to get exposure on the manufacturing side. And it's part of -- it fits with their strategy of trying to come up with a vibrant forest products business, not just harvesting, but also manufacturing in the region. So we're certainly anxious to have them become partners in the operation and go forward with them to try to achieve their objectives.

[Paul C. Quinn]

Okay. So the $1 million isn't really reflective of the value of $12 million to $13 million for the sawmill, right?

[Stephen Williams, Executive VP & CFO]

Yes.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes.

[Paul C. Quinn]

Okay. And then just lastly, working capital build in Q2, how much do you expect that to be?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well, yes. So I can take it on, Steve might want to jump in. But I think the biggest working capital build, and you know this very well, will occur on coastal operators in the second quarter because we're going to build up log inventory to be able to operate through typical third quarters where we have fire closures and the like. So if you look at the first -- as we close the first quarter, we're going to need to rebuild the log inventory given the impacts of the strike. We're going to be diligent and prudent about that, but you can assume that as we look at the first quarter, we were about 30% lower than historic levels. You can expect us to build about $30 million I guess in log inventory through the second quarter. But that said, the build in working capital is going to be offset by its corresponding growth in like accounts payable and other expected things like maybe income tax refund. So I think to conclude, we're going to -- we'll try -- we'll keep the lumber inventories about where we are. We will build working capital on logs, but obviously, they'll be offset by some recoveries elsewhere. And all that said, of course, I've got to caution you that the current market conditions are much different than they were in prior years. So we're going to be prudent. And if we have to take curtailments to manage working capital and align our production with markets, we will do so.

[Operator]

There are no further questions registered at this time. I'd like to turn the call back over to you, Mr. Demens.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Great. Well, thanks, Donna. And thanks, everyone, for your continued support. I appreciate your interest in our company and your time on the call this morning. Steve and I are both available if you have any follow-up questions, and we look forward to sharing with you our second quarter results in August.With that, have a great day. Thanks.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time and thank you for your participation.