Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2019-Q3

[Operator]

Good morning, ladies and gentlemen. Welcome to this Western Forest Products' Third 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 outcome 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 risks and uncertainties in 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 now like 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, Valerie. Good morning, everyone. I'd like to welcome you to Western Forest Products' 2019 Third Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer. We issued our 2019 third 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 provide an update on the status of the labor disruption, share our outlook and provide an update on developments in our industry. We'll then open the call up to your questions.So our third quarter results were impacted by a combination of the ongoing strike action by the USW and weaker product markets. All of our timberlands and most of our BC-based manufacturing divisions were unable to operate in the third quarter of 2019 due to the strike. As a result, in the quarter, our adjusted EBITDA was a negative $16.6 million.During the quarter, we focused on taking steps to mitigate the impact of the strike on our business and customers. We managed the impact of the strike on our balance sheet by selling unencumbered log and lumber inventories and managing expenditures. We attempted to mitigate the impact on our customers by growing our wholesale lumber program and processing unencumbered logs at custom-cut facilities.Some highlights in the quarter include the performance of our U.S.-based Columbia Vista division, which continues to perform in line with our expectations and has been a positive addition to our business and product mix. We continue to ramp up production at our Arlington facility, although the facility is currently operating on a reduced basis due to the lack of lumber supply caused by the strike. Despite this, we expect our Arlington operation to assist us in repositioning our product lines closer to the final customer over the longer term, and by acting as a critical component to our logistics and distribution platform. And finally, despite the strike, we were successful in reducing our debt levels, while at the same time continuing with our balanced approach to capital allocation, returning $10.3 million to shareholders via dividends and share repurchases in the quarter. Since 2018, we've returned approximately $100 million to the shareholders via dividends and share repurchases.So with that, I'll 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 third quarter of 2019 by comparison to the third quarter of last year. As Don mentioned, we delivered third quarter adjusted EBITDA of negative $16.6 million as compared to $32 million in the same period of 2019, as the strike impacted the entire third quarter of 2019. In the quarter, we sold the majority of our unencumbered inventory, processed certain unencumbered logs at custom-cut facilities and grew our wholesale lumber program to service our customers and help mitigate the impact of the strike.Despite product pricing declines across all our segments, our average realized pricing -- lumber pricing increased 8.5% due to an improved specialty product mix and weaker Canadian to U.S. dollar. Specialty lumber represented 64% of third quarter shipments compared to 50% in the same period last year. In order to support our selected customers during the strike, we redirected available inventory to active divisions and operated on a suboptimal basis, resulting in higher transportation and operating costs. We incurred $19.2 million of expenses arising from curtailed operations and related operating inefficiencies as a result of the strike, including $1.2 million of third quarter benefit costs paid on behalf of the USW for its striking members.Leading up to the strike, we drew down inventory at USW-certified operations to supply our remanufacturing and custom-cut operations. Despite these efforts, certain inventory volumes remain encumbered by the strike and degraded over the third quarter of 2019. As a result, we expensed an additional $1.7 million provision against our restricted inventory. We are monitoring any potential log and lumber degradation as the strike continues. Our remaining lumber inventories represent a weaker mix of products than what was realized in the third quarter of 2019.From a profit and loss perspective, net loss was $18.7 million as compared to net income of $15.1 million in the third quarter of 2018. Looking at our third quarter cash flow and capital management, with the strike impacting the majority of our operations in the third quarter of 2019, our primary focus was on managing our balance sheet, cash flow and working capital. Cash provided by operating activities was $22.3 million as compared to cash provided of $40.1 million in the same period of 2018. We reduced our noncash working capital by $38.2 million in the quarter to partly offset significantly reduced cash flow from operations resulting from the USW strike.Cash used in investing activities was $1.4 million during the third quarter of 2019 as compared to $19.9 million invested during the same period last year. We reduced our capital spending in order to manage cash flow and incurred only safety, environmental and committed capital expenditures. Despite the challenges faced in the quarter, we returned $10.3 million of capital to shareholders via dividends and share repurchases and were successful in reducing our net debt by $7 million compared to the end of the second quarter of 2019.Our liquidity at the end of the third quarter of 2019 increased to $141 million, and our net debt-to-capitalization ratio was 17%. 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]

Great, Steve. Thank you. So first, I'd like to start off by providing an update on the current USW labor disruption occurring at our BC operations. On July 1, 2019, the United Steel Workers, the union representing approximately 1,500 of the company's hourly employees and 1,500 employees working for our timberland contractors in BC, commenced the strike. The strike is ongoing for all our USW-certified manufacturing and timberlands operations.We understand the impact the strike is having on our employees, customers, communities and shareholders. And we remain committed to reaching a reasonable collective agreement that creates certainty for our employees while maintaining Western's globally competitive position. To achieve this outcome, Western offered to go to binding arbitration with mediator Vince Ready to resolve the dispute. The USW refused to preaccept this proposal that would see employees return to work. Earlier this week, we agreed to return to the table with the mediator. However, the union is yet to confirm their attendance. We continue to seek ways to get the USW back to the table.I'd now like to turn to a discussion of our markets. Our long-term view of market fundamentals remains unchanged. In North America, rising lumber consumption will be driven by increased new home construction, a robust repair and renovation sector and growth in the use of mass timber building technologies. Growing demand and reduced supply due to North American sawmill curtailments is expected to benefit the industry long term. At the same time, we expect lumber demand in China to continue to grow.Despite these positive long-term growth drivers, lumber markets have remained challenged in 2019, as North American weather events and skilled labor constraints stalled the U.S. new home construction and muted growth in repair and renovation spending. We expect the recent commodity lumber market volatility to continue through the rest of 2019. But we're cautiously optimistic heading into 2020 that the combination of improved lumber consumption and reduced supply due to permanent production curtailments will lead to better pricing.Moving on to specific lumber product segments. Recent BC Coastal cedar permanent manufacturing closures should benefit our Western Red Cedar product pricing going forward. In Japan, we expect demand to remain flat for our Douglas fir products. However, increased competition from European engineered wood may pressure pricing. We expect market share erosion and weaker pricing for BC Coastal hemlock lumber in Japan as a result of the USW strike and increased competition from Japanese government-subsidized domestic species.We anticipate demand for appearance niche products to remain muted in China due to the trade friction between the U.S. and China. In contrast, we expect demand in North America to remain steady for timbers and industrial products. Going forward, we'll continue to align our production volumes to match market demand.So I'd also like to provide you 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 impact the BC 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 harvesting for secondary users, mostly pulp mills.Western estimates that approximately 70% of our timberland 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 late 2019. The BC government has stated they do not want to see unintended consequences from the policy implementation. We continue to collaboratively engage with the BC government and other stakeholders to ensure the desired outcome of the policy avoids these unintended consequences.Overall, we remain committed to working with government to support our industry in creating business hosting conditions and an operating environment that will keep business on the BC coast globally competitive while avoiding policies that add costs or restrict supply to our global lumber customers.Moving on to the softwood lumber dispute. During the quarter, we notify -- we were notified that our cedar separate-like-product NAFTA challenge would not be remanded back to the USITC. The lack of remand effectively ends our ability to challenge the USITC's finding that Western Red Cedar and Yellow Cedar products are not a distinct product group, but rather are interchangeable in their use with commodity lumber. We're obviously disappointed with the NAFTA panel decision. Separately, as the broader softwood lumber dispute drags on, we're not anticipating a resolution in the near term. We'll continue to leverage our flexible operating platform to partially mitigate any challenges that arise from this trade dispute as well as continue to evaluate opportunities to diversify our business.Looking to what's next. With the USW strike still ongoing, our near-term focus remains on reaching a reasonable collective agreement that creates certainty for our employees while maintaining Western's globally competitive position. Until the settlement is reached, we will continue to take all necessary steps to protect our balance sheet, manage our cash flow. This will include increasing our marketing efforts with respect to our noncore assets. Our long-term focus remains the same: implementing our strategic initiatives to strengthen our foundation, grow our base and grow our business. We remain committed to a balanced approach to capital allocation, including returning capital to shareholders while also considering internal and external growth opportunities through a long-term shareholder value.And with that, operator, I can open up the call to questions.

[Operator]

[Operator Instructions] Our first question is from Hamir Patel with CIBC Capital Markets.

[Hamir Patel]

Don, just trying to understand the motivations on both sides of the strike here. If you were to give the union everything they wanted, what does that represent to annual EBITDA? Because it seems like the strike is tracking at sort of an 18 -- $80 million a year loss of EBITDA.

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

Yes. Reasonable question. Can I actually identify what the motivation is with the USW? That's -- I'll let them decide that. I think all I can say, Hamir, is we understand the impact the dispute is having on our employees, our customers, shareholders and the communities. We're committed to reaching a reasonable agreement. We understand the cost implications of the strike, and we can compare that to the demands from the union. I think, as I said, we're committed to reaching a reasonable settlement, and we've demonstrated our commitment by offering to go to binding arbitration with the union, which, in effect, puts people back to work now. So we've informed the mediators that we're available to meet on dates that they've suggested over the next week for resumption in bargaining, and as of yet, the USW hasn't agreed to come to the table. I'd say like, with over 6,000 USW members having already reached an agreement, we believe everyone knows where a reasonable settlement zone lies.So to conclude, we recognize the impact the strike is having. And in reference to your question, the cost of the strike as well as the demands of the union, we're ready to negotiate or enter binding arbitration that would see people go back to work and see a resumption of the business. But we're waiting for the union to respond to the mediator's request to meet.

[Hamir Patel]

And if the strike were to persist, are you thinking about things you could do to help support the contractor base that is going to be kind of critical when things get going again?

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

Well, I think we're all in this together. Many of the contractors are represented by another bargaining agent there, and they should be out actively bargaining, I think. Our business is a challenge, of course, with the strike, as theirs is. We should be all working together. I think we've put a reasonable proposal together that would see people go back to work and have us stay at the table to reach an agreement. I think that's probably the area everybody should focus on.

[Hamir Patel]

And Don, with the reduced cedar shipments, what's your sense as to those customers? Have they switched to composites? Has it just been an inventory work-down in the channel? Any idea how that's played out?

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

Yes. So I guess there's a couple of points there with cedar. Certainly, cedar was not a great -- it was not a great market for cedar through 2019 mostly because of delays in getting started in consumption through the year driven by weather events throughout the U.S. That said, there's been a couple of positive developments here. We've seen a permanent production closure, their announcements. We've also been on strike. And I can tell you the tone, much more positive tone in cedar markets over the last month or so as a result of probably both working down inventories as well as the permanent production curtailments announced. We haven't seen a significant improvement in pricing currently because I think it's just the time of year people are not putting more cedar into their inventories in the distribution channel. But we've certainly been encouraged by the outreach we've seen from our selected cedar customers as they've been a lot more anxious to discuss their needs for the spring. So I guess to conclude, the tone in the market is better. Prices haven't moved yet, but we're expecting a better year next year in cedar.

[Operator]

Our next question is from Sean Steuart with TD Securities.

[Sean Steuart, Research Analyst]

Two questions. Just housekeeping first. Was there any unencumbered inventory left at quarter end to sell into Q4?

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

Yes. So I mean not as much as there was, obviously, at the start, but we still have a significant volume of logs and a lot less lumber, sub-10 million feet of lumber, probably over 400,000 meters of logs. I caution you not to extrapolate anything on the log front simply because Western has been really the only company over the last number of years to invest in sawmilling capacity on the coast, and we're the only one that's really suited to manufacture a significant portion of those logs. So having those turn into cash and deliver products to customers will be a challenge, I think all of them, but certainly, some of them.Inventory levels, in general, Sean, are certainly lower than they were at this time last year. But I think the market is not as active either. So I think we're maybe a little more in balance overall in inventories, if you take encumbered and unencumbered, but we'll do everything possible to move our unencumbered inventories over the near term.

[Sean Steuart, Research Analyst]

Got it. And there was mention made of potentially expediting noncore asset sales to, I guess, shore up the balance sheet through this tough time. Any idea what you're prioritizing there? Any context you can provide on what you're prioritizing and, I suppose, scale and time frame of what you're thinking on that front?

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

Sure. So Steve, I don't know if you want to comment.

[Stephen Williams, Executive VP & CFO]

Yes. Sure, Sean. I mean I think probably over the last 5 years, we've highlighted 3 key areas being our private timberlands, the quarry and other few simple properties that we have that are noncore. I think, as Don mentioned, we've stepped up our marketing efforts. I don't necessarily want to speculate on timing here. But in totality, I mean, I think you said those assets are somewhere in the $80-plus million range.

[Sean Steuart, Research Analyst]

And is the idea, Steve -- this has been a long time coming, and you haven't needed the cash. So I guess there's no urgency to it. But should we be thinking of this process unfolding over the next year, 2 years? Any context you can give us there?

[Stephen Williams, Executive VP & CFO]

Yes. I would just -- I think I would say we're active in marketing. So we can't control the timing, but fair to say that we've stepped up our efforts. So...

[Sean Steuart, Research Analyst]

Okay. And then last question just on -- in terms of capital allocation. The dividend was sustained. Any context you can provide on what the Board's thinking on the commitment to this level? Presumably, you don't want to cut just related to a labor stoppage. But how is the Board thinking about the dividend in terms of the overall pecking order for capital allocation here?

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

Sure. So I mean that's a good point, Sean. We don't -- I don't think the Board is going to look at things and adjust our approach to capital allocation based on transient events here. But I think we've consistently noted in our public disclosure, the directors will and our Board will review the amount of the dividend on a quarterly basis as they take into consideration company's financial, operating performance, liquidity and our needs -- ongoing needs for capital. So dividend has long been part of our balanced approach to capital allocation. So despite the current strike situation, we would expect the Board to continue to go through that rigorous process we go through each quarter and reviewing our financial performance and ensuring that there's proper coverage for the dividend.

[Operator]

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

[Paul C. Quinn, Director of Paper and Forest Products]

So obviously, a difficult quarter given the strike. You're looking for a reasonable settlement. Is a reasonable settlement to you, is that the agreement that the BC Interior concluded with? Or is it something less than that?

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

So I would say there has been a history over the, I don't know, 40 years of pattern bargaining in British Columbia. And as I noted, and as you're fully aware, 6,000 USW members in interior have already settled an agreement. I think interestingly, you may not be aware that the pulp mill in Nanaimo, Harmac Pacific, just concluded an 8-year agreement, starting with 2% wage increases in the first 2 years and then an industry pattern after that. So I think there's a lot of precedent out there as to what a reasonable agreement is. I'd refer back to the comments previously. We are mindful of the impact this is having on employees and communities and our customers and, of course, shareholders. So we're -- we've been willing to go to the table and talk about things. We've demonstrated that willingness by even putting our hands in a mediator through binding arbitration and have yet been unable to get the union to come to the table. So to conclude, I think there's been a reasonable -- we kind of know where a reasonable settlement zone lies. There's been lots of precedent agreements. And we'd just like to get back to the table, get people back to work and start providing products for our customers.

[Paul C. Quinn, Director of Paper and Forest Products]

Good. I don't know if it's right, but in the press, it seems like binding arbitration is rejected by the union because of bad track record. Do you feel that's fair? Or do you feel it's -- maybe that's the best way to get a negotiated settlement?

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

Well, I think what it does is it indicates that Western is open to anything. So we want to get back to work. If the union is refusing to go back because of poor results in the past, I recall the last time they went to binding arbitration was at the request of the union. So I think everyone's got to kind of get focused on what's important, and I think you have to focus on employees here, customers, communities and our shareholders and get back to work. And we don't want to lecture anybody, but Western has been the only company for the last 25 years that have invested this amount of money in the coast to try to build a business that can generate reasonable returns and support employment. So I think it's time we all got back to the table, got a resolution and moved on.

[Paul C. Quinn, Director of Paper and Forest Products]

Okay. And just lastly on labor. I mean I've been constantly surprised at how long this has lasted. Is there anything specific in what you're asking for? And I would say something coming from the union side that would say that you're looking to cancel seniority rights. Is there something specific that they're -- obviously, don't want to agree to? Is there something from the BC Interior that's -- the concluded agreement that would be different from what you're proposing on the coast?

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

Yes. So I'm not familiar with any seniority rates we're canceling. We've been pretty transparent about what we've offered. We sent letters directly to our employees to explain our bargaining position. There was an issue around pension, I believe, Paul, where we had offered -- suggested it was time, from a retention and recruitment perspective, to offer choice in pensions. I think younger workers who we're trying to attract at the industry are looking to have a more portable pension option. That is what we heard from the people. We've put that forward. That was soundly rejected from the union. They want to -- they don't want to change the pension. And we've taken that off the table. So I don't -- I'm not sure about what seniority rates we're trying to cancel or if that's rhetoric. But -- and then I think we've been public in what we have offered. And again, I think the focus should be on getting back to the table, getting people back to work.

[Paul C. Quinn, Director of Paper and Forest Products]

Okay. And then just I guess moving off that and say we -- you guys collectively solve this labor issue and get back to work. It sounds like with the BC Coastal revitalization plan, you're getting back to a situation that is not as favorable. How material is that -- the fiber recovery zones to you? And what's your confidence that the BC government actually will mitigate any kind of deleterious effects from it?

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

Sure. So as we noted, 70% of our harvesting tenures are in the fiber recovery zones. The fiber recovery zones require us to pull out more fiber. Waste is measured on a challenging, I don't know, set of criteria. And there's punitive penalties if there's excess waste in the block. So that gives you a perspective of what we're facing with. We've been engaged with government identifying some of the issues, some of which include safety and concerns we have and the way waste is measured. I think it's important to note that we'll see, over the next period of time, where they go with this. I don't think anyone expects or wanted to see a new policy come in that actually reduced supply to pulp mills, but that's what's at risk here. And we're hopeful that the government will review the proposals we've sent forth and adjust the policy where they need to.

[Operator]

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

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

Great. Thanks, Valerie, and thanks, everyone, for their attention today and support of Western. And we look forward to, I guess, better news at our next quarterly call. Thank you. Have a great day.

[Operator]

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