Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, ladies and gentlemen. Welcome to the Western Forest Products' Second Quarter 2019 Results Conference Call. During this conference call, Western's representatives will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, but the accuracy of these statements depend on a number of assumptions and are subject to various risks and uncertainties. Actual outcomes will depend on a number of factors that could affect the ability of the company to execute its business plans, including those matters described under the risks and uncertainties of the company's annual MD&A, which can be accessed on SEDAR and are supplemented by the company's quarterly MD&A. Accordingly, listeners should exercise caution in relying upon forward-looking statements.I would like now to turn the meeting over to Mr. Don Demens, President and CEO of Western Forest Products. Mr. Demens, please go ahead.

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

Thank you, Sean, and good morning, everyone. I'd like to welcome you to Western Forest Products' 2019 Second Quarter Conference Call. Joining me on the call is Steve Williams, our Executive Vice President and Chief Financial Officer.We issued our 2019 second 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 our outlook and provide an update on developments in our industry and the status of our current labor disruption. We'll then open the call up to your questions.Demand for our products in the second quarter of 2019 remained weak. Reduced demand led to lower prices for our lumber products, and our byproduct chips and forced us to take market-related downtime in our BC sawmills, which impacted operating costs. Despite the weaker demand, our realized pricing was relatively stable, as we increased the sales of higher value specialty lumber. In the quarter, we generated adjusted EBITDA of $15 million, which was lower than the $50 million achieved in the same quarter last year. Our results continue to be negatively impacted by high stumpage cost, which are disconnected from current lumber market pricing. As well as softwood lumber duties, which have a disproportionately greater impact on specialty lumber producers than it does on commodity producers.We responded to more challenging lumber markets and supported our lumber price realizations by leveraging our flexible operating platform to improve our specialty product mix by restarting our log export program, reducing the production of commodity lumber and by increasing our direct end market sales in China. As I said, in response to weaker lumber markets, we took operational downtime to manage production levels to meet customer demands. Our byproduct revenues continue to be impacted by declining BC coastal chip pricing, which is a result of a steep decline in global softwood pulp prices. Despite the weakening markets, some positives in the quarter include our Columbia Vista division, which contributed a full quarter of earnings and is operating as we expected. Columbia Vista expands our Douglas fir specialty product offerings, making us more meaningful to our selected customers, particularly in Japan. We commenced secondary processing at our Arlington facility, where we continue to ramp up production. We expect operations in Arlington to assist us in repositioning our product lines, closer to the final customer. And we continue to return capital to shareholders. Returning $15 million to shareholders via dividends and share repurchases in the quarter and over the last 12 months, we've returned $68 million to shareholders via dividends and share repurchases.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 second quarter of 2019 by comparison to the second quarter of last year. As Don mentioned, we delivered second quarter adjusted EBITDA of $15.1 million as compared to $50 million in the same period of 2019. Results were impacted by a weaker market environment in all lumber segments, which led to an increased inventory provision, temporary sawmill curtailments, lower lumber shipment volumes, materially lower pulp markets, which impacted BC coastal residual chip pricing and higher per unit manufacturing and harvesting costs. Included in our manufacturing cost was $1.8 million in shutdown costs, arising from temporary sawmill curtailments and a $1 million incurred in the operating ramp up of our Arlington division.Lower lumber revenue was the result of a 10% decrease in shipment volumes partially offset by higher specialty product mix and the benefits from a weaker Canadian dollar to the U.S. dollar. The addition of Columbia Vista led to an increase in Douglas fir specialty product sales to Japan, which more than offset weakness in sales of BC coastal hemlock products to Japan. Specialty lumber shipments represented 57% of second quarter shipments compared to 48% in the second quarter of 2018. We lessened the impact of declining commodity lumber prices by increasing our direct sales to China by 31% compared to the same period last year. Log revenue increased 29% compared to the same period last year, benefiting from the resumption of our export log sales program and a stronger domestic log mix. Byproduct revenue declined $9.8 million compared to the same period last year as a result of lower BC coastal production, and a 29% reduction in coastal chip price realizations due to a steep decline in global softwood pricing. The 59% reduction in chip purchase and retail volume contributed $5 million to the reduced byproduct revenue with minimal impact to adjusted EBITDA. Duty expense was $9.7 million, a decrease of $2 million from the same period last year due to reduced U.S.-destined lumber shipment volumes and lower prices. At the end of the quarter, we had approximately $82 million in duties on deposit. Freight expense increased by $3.3 million from the same period last year, as the resumption of our export log program and increase in our direct sales to China and the inclusion of export shipments from our Columbia Vista division more than offset declining lumber shipment volumes. Lumber production decreased 12% quarter-over-quarter as incremental production from our U.S.-based Columbia Vista division was more than offset by market-related curtailments at our BC sawmills. Second quarter per unit manufacturing costs were 14% higher than the same period last year, due to temporary sawmill curtailments and a mix of operations. Log production in the second quarter of 2019 was 7% lower than the same period last year. Decreased log production was primarily due to permitting issues, which resulted in the partial curtailment of our Englewood operations. Our BC coastal per unit harvest costs increased 11% from the same period last year, due to a mix of higher cost operations, including a doubling of heli-logging volumes and an increased sorting cost related to the resumption of our export log sales program. From a profit and loss perspective, net loss was $0.4 million, as operating margins and net income were impacted by weakening lumber and chip markets and lower production and shipment volumes. This compares to net income of $27.1 million in the second quarter of 2018.Looking at second quarter cash flow and capital management. As is typical in the second quarter, due to seasonality in our business, working capital utilization peaks around the end of the quarter. Cash used in operating activities, including changes in noncash working capital, was $10.7 million as compared to cash provided of $26.9 million in the same period of 2018. We invested $13.8 million in our existing operations and returned $15.1 million to shareholders via dividends and share repurchases in the quarter. Our liquidity at the end of the second quarter was $135 million and our net debt-to-capitalization ratio was 17%. We are taking steps to manage our cash during the current union labor disruption through a reduction in capital expenditures and working capital.Don, that concludes my comments.

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

Thanks, Steve. So I'd like to start by providing an overview of the current union labor disruption occurring at our BC operations. On July 1, the United Steelworkers Vancouver Island Local, which represents a majority of our BC-based mill and timberlands employees, commenced the strike against Western and the majority of our timberlands contractors. The strike is ongoing for all our USW-certified manufacturing and timberlands operations. We continue to operate our Ladysmith sawmill, value-added remanufacturing facility and our U.S.-based Arlington and Columbia Vista divisions. Western has been in negotiations with the USW since April 2019 for a new collective agreement to replace our previous agreement, which expired in mid-June. Western is committed to reaching a reasonable agreement that respects the contributions of our employees and ensures we remain globally competitive. We've commenced work -- we've commenced our work stoppage contingency plan and are working to mitigate the potential impact of the strike on business partners and customers. This plan includes a strategy to reduce unencumbered log and lumber inventories in order to manage cash and support our customers. The Labor Relations Board ruling that the union had engaged in illegal picketing at some locations where we store logs will help support our strategy. However, the strike is expected to have a negative impact on our third quarter results. We're disappointed the Vancouver Island-based USW Local has decided to have its members off the job during this period of difficult market conditions and despite the fact interior members of the same union have already ratified an agreement. Since June 25, we've requested the Labor Relations Board support the collective bargaining process, by appointing a mediator to help bring the parties together to deliver a reasonable settlement. As of today, we're still waiting for the appointment of a mediator.I'd now like to turn to a discussion of our markets. Our long-term view of market fundamentals remains unchanged. In North America, we expect rising lumber consumption will be driven by increased new home construction, growth in the repair and renovation sector and the adoption of mass timber building technologies. At the same time, we expect lumber demand in China to continue to grow. Despite these positive long-term growth drivers, lumber markets have been challenged in 2019 as North American weather events and labor constraints have stalled U.S. new home construction and muted growth in repair and renovation. We expect recent lumber market volatility continuing through the rest of 2019. To manage through these challenging times, we'll continue to lever our flexible operating platform and specialty product mix.Moving onto specific lumber product segments. We anticipate a normal seasonal slowing of demand in our Western Red Cedar segment. Pricing is likely to become more volatile as we move through the fall season. In Japan, we expect demand to remain flat for our Douglas fir products. However, increased competition from engineered wood products may pressure pricing. We expect continued market share erosion for BC coastal hemlock lumber in Japan due to increased competition from Japanese government's subsidized domestic species. We anticipate demand for appearance quality niche products to moderate due to the trade friction between the U.S. and China. In contrast, we expect demand to remain fairly steady for timbers and industrial products. Going forward, we will continue to align our production volumes to match market demand. I'd now like to provide an update on a couple of developments in the industry. As discussed last quarter, the BC government announced its coastal revitalization plan earlier this year. The plan includes various policy initiatives that will affect the BC coast forest sector. As part of their revitalization initiative, the BC government announced the creation of fiber recovery zones, which are intended to increase the supply of residual fiber from primary harvesters to secondary users, mostly pulp companies. Western estimates that approximately 70% of our timberlands operations will be impacted with the creation of fiber recovery zones. The impacts to our business include the potential for higher costs and lower log harvest volumes. We expect the impacts will start to be realized in the last part of 2019. The BC government has stated they do not want to see unintended consequences from their policy implementation. We continue to collaboratively engage with the government and other stakeholders to ensure the desired outcome of the policies is met without these unintended consequences. Overall, we remain committed to working with government and stakeholders to support our industry in creating business hosting conditions and an operating environment that will keep business under BC coast globally competitive, while avoiding policies that add costs or restrict supply to our global lumber customers.Moving onto the softwood lumber dispute. As discussed last quarter, we have filed a NAFTA challenge to contest the U.S. International Trade Commission's finding that Cedar lumber products were not a separate-like product group from commodity softwood lumber. In May 2019, we presented our case to a NAFTA panel in Washington, D.C. Through our challenge, we're seeking ITC recognition that appearance grade Cedar lumber and structural commodity lumber differ in end-use application. A successful challenge could result in separate-like product classification and will require the ITC to rule its Cedar lumber shipments from BC injure U.S. producers. We do not expect a ruling until later in the year. Looking to what's next, despite the more challenging market and operating environment, we remain focused on implementing our strategic initiatives to strengthen our foundation, grow our base and grow our business.With respect to our capital program, in response to weaker market conditions and a more challenging operating environment in BC, we're further reducing our capital investments to approximately $50 million in 2019. We remain committed to a balanced approach to capital allocation, including returning capital to shareholders, while also considering internal and external growth opportunities to grow long-term shareholder value. And we continue to evaluate opportunities to monetize our noncore assets. As Steve indicated, our near-term focus is on managing cash and working capital. With that, Sean, we can open up the call to questions.

[Operator]

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

[Sean Steuart, Research Analyst]

Few questions. The contingency plan, the deal was to strike, which I guess entails leaning on inventories, both lumber and logs, to keep servicing your customers. Can you give us an idea of where your inventories stood entering the quarter? Just to get a sense of what shipments might look like this quarter as you curtail a lot of the operations.

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

Yes. So I think -- and I read your piece today, and I think you nailed that your inventories seasonally peak at this time of the year. I think year-over-year, we're estimating $38 million in inventories, both in logs and lumber. And so I think there's an opportunity to draw that down, but it's only drawing down on the unencumbered volumes that we have access to. I'd also like to highlight, we're still operating a couple of our operations. So as is seasonal norms and even in this nontypical time, we expect to see inventories decline and us to capture some of that money that was trapped in working capital as we go forward.

[Sean Steuart, Research Analyst]

And Don, do you have a sense of how long it will take to get the mediator in place?

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

Yes. Sean, I think as we said, we've been requesting the mediation and the mediator since June 25. And have been -- have not been rewarded with our requests. So I can't indicate when that might occur, it could occur very quickly, might be pushed off, I just can't hazard a guess as to when it will occur.

[Sean Steuart, Research Analyst]

Understood. And last question from me for you, Don or Steve. You still got quite a bit of financial flexibility, but your leverage is creeping higher. Can you talk about prioritizing the current dividend in light of the headwinds you're facing right now? It's a rich yield at this stage, arguably you're not being paid for it at this point, how do you think about the dividend in terms of capital allocation priorities?

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

Yes. Great. Let me take a run at it and Steve might jump in as well, but -- look, we continue to take a balanced approach to capital allocation. As noted on the call and as your previous question, we're going to take steps to manage our cash and working capital. And that includes the strategy we discussed, which is to reduce the unencumbered log and lumber inventories. I have to make it clear, any decision to declare or pay dividends in the future will be made at the discretion of the Board, after taking into account operating results, financial conditions, cash requirements, of course our financing agreement restrictions and any other factors the Board is going to deem relevant. But we certainly believe the current labor disruption's transitory in nature. In the near term, given our market conditions, current labor action, we're going to likely prioritize cash over share repurchases and of course, we've implemented this strategy to go and get out the cash that we have. Longer-term view, as I think I indicated, dividends are at a discretion of the Board, pretty comfortable at the current level, debt levels, and we think our flexible operating platform allows us a unique opportunity to manage through these choppy markets.

[Stephen Williams, Executive VP & CFO]

And let me just highlight again, I think we talked about our net book to cap at 70%, Again, seasonally, this is our typical peak in working capital utilization. So again, we're mindful of that. And again, just to highlight, Don talked about reining in capital expenditures for the rest of the years.

[Operator]

[Operator Instructions] Our next question is from Mr. Paul Quinn from RBC Capital Markets.

[Paul C. Quinn, Analyst]

You guys have been around for a while and been through many, many strike actions. What's different about this one?

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

Well, I'd like to say you've been around quite a while, too. So you've seen as many probably as I have. But what's different this time? That is a good question. I think, what strikes me as different is the fact that you've got really significant headwinds in BC, and you've written a number of articles about that. And you've got the interior union, the same union, different local but the same union already settled. And so those would be 2, kind of, key elements. We're faced with a tough operating environment for BC companies, and we are in a global marketplace and we seem to be centered on other focuses, at least at the union local here.That would be the primary differences from my perspective. It is also a bit surprising to me that we have not been successful at the Labor Relations Board in trying to drive a mediation to try to get out some of the underlying challenges with the offer the union has put forward and of course, our counter. So those would be the 3 points. Really tough markets, we would think that we'd all be kind of working together to try to work through this for the betterment of everybody, a benefit of everybody. We've got the interior already settled and the coast is on strike, and we've got the LRB applications which have yet to bear fruit from our perspective.And I guess the last one, sorry, is unlike some of the other disputes, Paul, we're, of course, stuck in this environment of duties, which disproportionately impact our coastal business and subsidies in Japan, which are causing us challenges with market share for hemlock, which of course is critical to the coastal business. So maybe there's 4 items there.

[Paul C. Quinn, Analyst]

Okay. And then I guess as a follow-up on that. Is there a material difference from the contract you're looking for on the coast different from the one that gets settled in the interior? Then on the Labor Relations Board, my understanding is that's a government-appointed body. Have you gone to the government and said, "Hey, what's up with your Board? It's been over a month, when can we get a mediator in place?"

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

Yes. So maybe I'll turn around and try to answer the first question first. It is -- the Labor Relations Board is appointed by the government. It is a quasi-judicial board. And I'll have to leave it at that to -- it's up to them to make their decisions. I think with respect to the details of the contract, we've been pretty clear. I mean the -- I estimate 60% to 70% of the USW workers in the province are already settled. I think it'd be reasonable to assume that, that is the agreement, that others also live by.

[Paul C. Quinn, Analyst]

So no material difference between your contract on the coast and the BC interior, which is settled?

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

The only aspects that might be different is providing choice to employees on some of their benefits, that would be it.

[Paul C. Quinn, Analyst]

Okay. And a choice, okay. And then just a -- I was questioning you on the fiber recovery zones, and I thought I picked up something, maybe it's wrong but it sounded like the fiber recovery zones are going to lower harvest. And I just don't quite understand that comment.

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

Why? I think it's a risk and probably an unintended consequence of the government's policies, but the fiber recovery zones, a component of it will require harvesters to pay 3x stumpage on what is deemed to be calculated waste, which I think we've kind of learned that the pulp companies may not even want. So in the event that, that is the way it is implemented, that you're paying 3x on deemed waste that is not really a product, harvest cost would increase. And so our assertion is if that were to occur, harvest cost would increase in an environment where pricing is not robust, and it may have the effect of reducing harvest, which will just be countered to the efforts and the goal of this endeavor. So I guess it'll end up reducing volumes to pulp companies. So that's what we -- is a potential outcome here. Government is committed to managing unintended consequences. I think that would be a pretty material unintended consequence. So we'll see what they do.

[Paul C. Quinn, Analyst]

And it sounds like the government is going to make a couple of tweaks to their new program.

[Operator]

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

[Hamir Patel]

Don, can you give us a sense as to what sort of EBITDA generation you'd expect out of the U.S. assets in Q3 and 4, just when I think about as we start with this -- what the generation would be south of the border?

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

Yes. So -- sorry, Hamir. Having trouble hearing you. But I think what you're asking is just sort of what results and -- were we expecting out of Columbia Vista and Arlington, as Arlington is just ramping up and will be dependent upon production volumes there. But from a Columbia Vista perspective, it has performed in line with our expectations and we've been really happy with the acquisition. Business is safe, well managed by our team in Vancouver, Washington, couldn't be happier with the positive reception Western has received in the community and from local officials. We're achieving production targets and continue to provide excellent on-time service to our customers, both Japan and the U.S. And from a profitability perspective, which is really at the heart of your question, we're meeting our investment thesis with what we believe is more upside to come as we capitalize on the strategic location of the facility. So you're aware of what we paid for the facility, and we're happy with the results thus far.

[Operator]

So there are no further questions registered at this time. I would like now to turn the meeting over back to you, Mr. Demens.

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

Great. Thanks, Sean. Well, I'd like to thank everyone for their continued support and interest in Western. We appreciate the interest in our company and your time on the call this morning. Steve and I are both available if you have follow-up questions, and we look forward to sharing with you our third quarter results in November. With that, have a great day. Thanks.

[Operator]

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