Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to Western Forest Products' Fourth Quarter and Fiscal 2017 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 a 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 risks and uncertainties in the company's annual MD&A, which can be accessed on SEDAR and are supplementary by the company's quarterly MD&A.Accordingly, listeners should exercise caution in relying upon forward-looking statements.I would like to turn the meeting over to Mr. Don Demens, President and Chief Executive Officer of Western Forest Products. Mr. Devens, please go ahead.

[Donald Eugene Demens]

Well thank you, operator, and good morning, everyone. I'd like to welcome you to Western Forest Products' 2017 Fourth Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer. We issued our 2017 fourth 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 near-term outlook and provide an update on our margin improvement and capital initiatives. We'll then open the call up for your questions.In the quarter, we overcame constrained log supply, which impacted lumber production and a weaker sales mix to deliver record fourth quarter adjusted EBITDA of $38.9 million. Throughout the quarter, we capitalized on improved operating conditions to deliver the highest quarterly log production volume of the year. The improved harvest results and increased log purchase volumes allowed us to substantially rebuild depleted mill log inventory as we headed into 2018. Throughout the year, we leveraged our market leadership position in specialty products to achieve record-realized lumber pricing, largely offsetting the impacts of U.S. lumber duties. We generated record adjusted EBITDA of $152.6 million in 2017, despite weather-related harvest challenges, which resulted in 9% lower log production and 14% lower lumber production than 2016.And just after year-end, we completed the asset acquisition of a distribution of processing center in Arlington, Washington, that will enable us to more effectively service selected U.S. customers. I'll now turn it over to Steve to review our key financial results.

[Stephen Williams]

Thanks, Don. My comments this morning will focus primarily on our financial results for the fourth quarter of 2017 by comparison to the fourth quarter of last year. As previously mentioned, our adjusted EBITDA was $38.9 million despite little opening log availability, which impacted lumber sales volumes this compares to $33.8 million in the fourth quarter of 2016. Fourth quarter export duty expense was $0.1 million and included a recovery of $3.5 million, resulting from a difference between preliminary duty rates and the final all others duty rate. As been the case with past rounds of the U.S. softwood lumber dispute we believe these duties are unwarranted and will ultimately be rescinded and returned. However, as that is not a certainty, we continue to expense duties at the latest applicable rate. To mitigate and overcome export duty risk and capitalize on a strong price environment, we have continued the refinement of our sales and marketing strategy. Our refined sales strategy and strong pricing environment helped to limit the decline in fourth quarter lumber revenue to 6% over the same period in 2016, despite a 13% decrease in lumber shipments. Average lumber price realizations increased 8% from the same period last year as higher prices offset a weaker sales mix and a stronger Canadian dollar.Log revenue increased by 3% as improved pricing offset a weaker sales mix and reduced export volumes. Excluding restructuring and other income and expense, fourth quarter operating income improved to $30.3 million as compared to $24 million in the same period last year. Fourth quarter net income and earnings per share in 2017 were comparatively less than the same period of 2016 as the fourth quarter of 2016 included $26 million in onetime gains.Now moving onto cash flow for the fourth quarter. Low opening log supply impacted our operating results. Cash provided by operating activities, excluding noncash working capital was $31.9 million as compared to $50 million in the same period of 2016. However, our fourth quarter of 2016 cash flows included $14.1 million from the [indiscernible] settlement. We had $22.2 million -- sorry, $22.5 million in capital expenditures in the latest quarter. Made up of discretionary maintenance capital of $14.7 million, discretionary investments in rows of $3.2 million and strategic capital spending of $4.6 million. Dividends of $7.9 million are paid in the fourth quarter for a total of $31.7 million of capital paid to our shareholders in 2017. Also in the fourth quarter, we repurchased $2.7 million in common shares under the normal course issuer bid. For the year, we generated $134 million of cash from operations supplemented by a significant year-over-year reduction in working capital for our trade and other receivables. This compares favorably to the $128 million in cash from operations in 2016. We invested $55 million in capital expenditures as compared to $56 million in 2016 and we returned a total of $31.7 million in dividends to shareholders consistent with 2016. Our liquidity has increased to $269 million as at December 31, 2017, from $218 million in 2016. Cash on hand at December 31 was $35.3 million and we repaid all our outstanding drawings on our debt facilities in 2017. Last month, we completed the acquisition of our distribution processing center in Arlington, Washington for USD 9 million. The acquisition will enable us to more effectively service our selected U.S. customers, while partially mitigating the damaging effects of duties on our products destined for the U.S. market. The stable cash flow from operation and a strong balance sheet, we continue to be well-positioned to execute on our balanced approach to capital allocation.Don, that concludes my comments.

[Donald Eugene Demens]

Great. Thanks, Steve. So I'd like to start off our outlook section by touching on first quarter seasonality. In typical first quarter, our harvest can be periodically impacted by winter weather, which can restrict our ability to harvest timber. Harvest volumes are often skewed at the end of the quarter when the weather and light conditions support greater activity. To-date, harvest conditions have been much improved compared to last year. However, we're experiencing snow this week across much of our operating area. We're hopeful this blast of winter weather is short-lived, and we'll get back to building our log inventories ahead of the spring building season.Looking to our markets, let me begin by talking about the U.S. softwood lumber dispute with Canada. Last December, the U.S. put in place final duties on Canadian lumber shipments. Western is subject to the all others duty rate of 20.23% on our lumber shipments into the United States. We were disappointed that the U.S. International Trade Commission did not support our view that Western Red Cedar appearance grade lumber is different than commodity lumber and does not injure U.S. producers. We disagree with the ITC ruling and Western will be filing an after trade challenge in an effort to have the commission come to the logical conclusion that cedar lumber from Canada poses no threat to U.S. manufacturers. Regardless of the outcome of our appeal, we believe that Western has the financial capacity and market diversity to withstand the application of duties. In addition, our acquisition in Washington state will help to partially mitigate the damaging effects of duties on our products destined for the U.S. markets. Globally, we expect log and lumber markets to remain strong over the near term. Constrained supply combined with improved demand from the recovery in U.S. single-family home construction and increased wood consumption in China should support firm pricing for our commodity products as we move through the year. The fundamentals in our Western Red Cedar business remains strong, consistent demand, limited supply and lower inventories are supporting pricing. Demand from lumber in Japan has been stable. The pricing has lagged other markets. We expect this to change over the next couple of quarters as Japanese buyers will be forced to pay more for imported lumber to meet market demand. Volumes in our niche segment had declined as the U.S. market has been unable to absorb the full amount of the duties. We expect this situation to improve as we head into the spring and U.S. customers find it more difficult to source their needs at current pricing.Now let me update you on our margin improvement program. We continue to be encouraged by the progress we have made with respect to noncapital margin improvement. As discussed last quarter, we reduced the number of log shorts used across our timberlands operations for more than 140 to less than 40. We are further leveraging our investments in the mapping of our standing timber inventory with LiDAR technology and streamlining the harvest planning and engineering process. These changes have supported the simplification of our log supply chain and will pay dividends through permanent cost reductions this year. In addition, we've made progress in our mills through a performance management initiative, improving uptime and reducing spending. We expect to realize further gains through 2018. Combined savings since inception of the program totaled $10 million on an annualized basis. In respect of our capital program, we continue to invest in and consolidate our operating base to position our mills as the most cost-competitive facilities in the coast of BC. In the fourth quarter of 2017, we completed the $4.2 million Chemainus timber handling upgrades. This project will allow us to produce a greater percentage of high-quality timbers, positioning Chemainus as the leading Western Red Cedar timber mill in the coast of BC. At Duke Point startup of the autograder has progressed well and we expect further productivity improvements in the first quarter of 2018. The autograder installation completes the $17 million Duke Point planer modernization. We've continued to invest in our people through targeted safety and financial training and our management information systems to lay the foundation for improved operations and future growth. The MIS investments include the addition of business analytics, which will support margin based decision-making in our operations. In mid-January of 2018, we completed the acquisition of the distribution and processing center in Arlington, while there is much work to do to bring Arlington up to standard, we're excited about what this acquisition means. We expect to utilize Arlington as a platform for change. Not only do we expect to be supplying more targeted finished products of scale, but also the facility will allow us to service our selected customers further down the distribution channel allowing us to capture additional margin. Our focus currently is on upgrading the structural components of the facility, which is on 18 acres has over 170,000 square feet of coverage storage as well as a 7 car rail siding. We expect to begin using a site sometime in the second quarter.In summary, we continue to systematically implement our strategic plan. First, we said we would strengthen the foundation of our company by investing in our current manufacturing assets to improve competitiveness and upgrade our systems to support growth. Secondly, we said we would grow our base by consolidating our assets to improve utilization and focus on targeted products of scale for selected customers, which should improve margins. And finally we said we would seek opportunity to make acquisitions aligned with our goal of growing our specialty product offerings and the increasing market share in key segments to drive improved returns. Arlington represents our first acquisition and is consistent with the plans we've communicated.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 few questions. Don, can you give us an indication of what you're budgeting for general fiber cost inflation on the coasts in 2018?

[Donald Eugene Demens]

Sure, Sean. Our view on fiber as we look forward is probably similar to most other fuels views. As the market goes up, we expect to be paying higher prices. I would say, that 3% to 5% is reasonable, depending on the source and the qualities of the fiber that we're able to acquire.

[Sean Steuart, Research Analyst]

Okay. Interested in your thoughts on additional M&A opportunities in the Pacific Northwest. Would this further add-on M&A been the same types of the markets as Arlington? Or would you look at sawmills to complement it? Any thoughts on your further growth ambitions in that region.

[Donald Eugene Demens]

Sure. So when it comes to acquisitions. I think we want to go back to our capital allocation, which, again, Steve highlighted as our balanced approach. So we're going to continue to invest in our current business to grow margins but as you pointed out, we're going to see growth opportunities that increase our share of specialty product markets. So to answer your question directly, it could involve sawmills, it could involve product lines that we're able to acquire, it could involve further processing facilities that allow us to not only access fiber in the Pacific Northwest, but maybe bring in fiber from other parts of the globe and leverage our position, at least down the sales channel our position with cedars, which is the most sought-after softwood product for exterior applications. So -- and I think, Sean, any one of the items you mentioned is a possibility. Maybe just to conclude on the capital allocation piece. So we're going to look to improve our margins internally, we're going to seek opportunities. We've gotten NCIB in place. And each quarter we're going to review our dividend policy. And we'll continue to review our capital allocation, both in the context of our cash flows generated from our operations, but also from the potential source of funds from divestiture of noncore assets.

[Sean Steuart, Research Analyst]

And on that front, Don, you guys have been pretty transparent on the northern timberlands, but any update you can provide on the Orca Quarry royalty stream and thoughts towards potentially monetizing that asset?

[Donald Eugene Demens]

So Sean, on many of the bigger components of our noncore assets. We continue to look at opportunities that will allow us to capitalize on a differential between how the market values those assets versus how they value specialty lumber producers. So we're actively in a process. And really want to comment more than that, but wherever we can, whether it's northern private, Orca or other noncore assets be able to capture that differential in multiple, I guess, and value, we will do that. In addition, just before we leave that, we are targeting another $5 million to $10 million of smaller noncore divestitures this year. And as you know last year we did $8.2 million.

[Operator]

The next question is from Hamir Patel from CIBC.

[Hamir Patel]

Don, I think it was maybe a couple quarters ago you guys announced another noncapital margin improvement program. And I think the target at the time was sort of $25 million run rate some time in 2018. Could you comment on how are you progressing towards that? And maybe how much has been realized already?

[Donald Eugene Demens]

Sure, sure. So I'll just -- I'll try to cover some of that off, but you're exactly right. At the end of second quarter, so beginning at third quarter last year we said that we could identify and had plans in place to achieve a $25 million noncapital margin improvement program and that was the target, $25 million. To date, we've made significant changes in streamlining our log supply chain and the key elements there are reduced log sorts to simplify the business and to smooth the flow and lower costs. And also, to improve and really kind of modernize the way we go do planning and engineering, leveraging even more from the investments we've made in LiDAR. Also we've got a performance management program in our mills that is designed to reposition the mills from an uptime perspective. So utilization perspective. And right now, with annualized the gains made thus far at $10 million, but we can see the opportunity to get the other $15 million and we're implementing programs as we speak.

[Hamir Patel]

Great. And do you think you'll get the other $15 million sort of run rate by the end of this year or...

[Donald Eugene Demens]

Oh absolutely. By the end of this year, for sure. And we'll continue to just update you and everybody in the market on our progress each quarter.

[Hamir Patel]

Great. Definitely appreciate that. And Don, I wanted to get your perspective on, there was a story in one of the Vancouver papers this week that the NDP government is looking at bringing back, I guess, it was called like the appurtenancy, I don't even know how to pronounce that, policy that used to exist with respect to log exports. What's Westerns take on any potential change there?

[Donald Eugene Demens]

Well, yes. So it's appurtenancy and I don't want to underestimate the government's ability to make changes, but it'd be hard to figure out how they would be able to bring back the appurtenancy with so much of the tenures on the coast allocated to people that don't have mills, including the government itself under its BC Timber Sales program. So I'm not sure how they will do that, but when we look at Western and what we've been doing, we have the largest manufacturing base and investment on the coast of BC, as you know. Our volumes of export have continually gone down over the last number of years. And I think we're in the best position possible to assist the government in achieving what they're trying to get maybe out of our appurtenancy, which is more manufacturing in the coast of BC. So it remains to be seen whether the government wants to seize that opportunity and they work with us to do that, but we're not fearful of those types of ideas. And I think, we're -- as an exporter, I think you'll notice we're -- we do about 9% of the timber we handle and the vast majority of -- well, everyone else is at significantly higher levels of exports so...

[Operator]

The next question is from Paul Quinn from RBC Capital Markets.

[Paul C. Quinn, Analyst]

Couple of questions. One, just on your filing for NAFTA trade challenge on the ITC decision. What's the expected timing around that and maybe more broadly what's your expected timing on the overall file? Do you see any change over the next 1.5 years, 2 years?

[Donald Eugene Demens]

Yes, thanks, Paul. So the overall timing is very dependent on being -- having the 2 parties, U.S. and Canadian governments to be able to pick the panelists. I wouldn't see any conclusion on NAFTA panels until 2019, the earliest. First half of 2019, but it's very, very difficult to tell the actual timing, because they still haven't got. I'm not aware they have the panelists selected and the whole process is going to continue to move slowly through the different administrative review processes, which we've seen in the past, Paul -- we think we're in this type of litigation process and cycle for the foreseeable future, at least a couple of years or more so...

[Paul C. Quinn, Analyst]

Okay. And then given that, does that constrain your CapEx going forward and I'm sorry, but I dropped off, I think, when I tried to ask a question. So you might not have gone through it, but maybe you can outline your CapEx budget and then what you're going to spend at Arlington in '18?

[Donald Eugene Demens]

Yes, no, that's no problem, Paul. So you're absolutely right, and over the last few calls, we have said we're going to slow our investments due to the uncertainty in the softwood dispute. Our view is there's not very much uncertainty anymore. We know the duties we have and we know the process ahead of us. So we're going to estimate capital investments will be about $80 million this year, $40 million of it will be in discretionary maintenance and business investments, including capital roads and about $40 million will be in strategic capital investments. The strategic capital investments will include about $10 million in business streamlining and consolidating and the balance will be focused on improving manufacturing of targeted products that support our strategy moving up the value chain, included in that, that balance will be upgrading Arlington. Our first steps in Arlington, Paul, are to get the infrastructure up to our standards. And then we'll move on to upgrading the kilns that are there and the plant. But it will be encompassed in that envelope of about $30 million or so of strategic capital.

[Paul C. Quinn, Analyst]

Okay. And then just 2017 was obviously -- you had some issues on the harvesting side and it ran through for lumber production. What are our goals in 2018 in terms of lumber production as well as log sales?

[Donald Eugene Demens]

Well, for sure on the production and -- so you're right, last year, a real tough year harvest-wise, 3 quarters of really difficult operating conditions and it delivered about a, I guess, 14% reduction year-over-year in lumber production. We would like to get back up to the previous levels and more. What that will entail is internalizing more of our log supply that was probably going export back into our mills and internalize more supply as well as purchasing more. So we're still confident that this switch, because of the way the lumber markets are that we will maintain and grow margins and so we're looking forward to a better year financially for sure in 2018 and more lumber production, some of it with less log sales.

[Paul C. Quinn, Analyst]

Okay, then just lastly there has been a new sawmill development on the BC coast starting up right now. Do you expect that to have a meaningful impact on your ability to buy logs? And operate going forward?

[Donald Eugene Demens]

No, I don't. I think I think you're referring to MacKenzie. MacKenzie investments and prior to the rebuild many years ago, I think, I ran that mill. So we're well aware of the capacity the mill has and the operators there, and we don't foresee any challenges or conflicts with our business.

[Operator]

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

[Donald Eugene Demens]

Well, thank you, operator. To close this, I'd like to thank all of you for your attention and support of Western. We continue to be encouraged by the strength of our markets and the progress we've made in repositioning our targeted products, selected customers. We look forward to sharing our first quarter results with you in May. Have a good morning.

[Operator]

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