Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2019-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to the Western Forest Products Fourth Quarter 2019 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 belief, expectations and assumptions, they are subject to inherent uncertainties, and actual results may differ materially. There are 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 date on which they are made. Except as required by the 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 Don Demens, President and CEO of Western Forest Products. Please go ahead, sir.

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

Well, thank you, Marie. Good morning, everyone. I'd like to welcome you to Western Forest Products 2019 Fourth Quarter Conference call. Joining me on the call today is Stephen Williams, our Executive Vice President and Chief Financial Officer.We issued our 2019 fourth quarter and full year 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 providing an update to our labor disruption. On Monday, we announced that the company and United Steel Workers had agreed to terms of a tentative collective agreement with our employees. The tentative agreement is subject to a ratification vote by USW membership. This ratification vote is scheduled for later this week. The USW bargaining committee is advised they will be recommending that its members accept this agreement. We're pleased to have reached a fair and equitable tentative agreement with USW. As the tentative agreement is subject to a ratification vote by USW membership, we're not releasing details of the agreement at this time.We'd like to thank Vince Ready and Amanda Rogers for their work as special mediators to help achieve a negotiated settlement. As well, I'd like to recognize the Western and USW bargaining committees who bargained through the weekend to reach this tentative agreement.We recognize the impact the prolonged strike has had on our customers, employees, contractors, their families and the communities in which we operate in addition to our shareholders. We're pleased that we're heading back to work for the benefit of all those impacted by the prolonged strike. We're currently working to finalize our operating plan based on market demand and log availability. Operations will commence as quickly as possible following the ratification of the agreement.Moving on to our fourth quarter and full year results. Our 2019 results were significantly impacted by the USW strike, which commenced on July 1. All of our timberlands and most of our BC-based manufacturing divisions did not operate in the second half of 2019 due to the strike. The strike followed a period of weak markets for forest products and a more challenging operating environment in British Columbia. As a result, we generated negative EBITDA of $1.5 million in 2019. During the fourth quarter, we continued to take steps to mitigate the strike's impact on our customers by selling unencumbered inventories, producing lumber at custom-cut facilities and growing our wholesale lumber program.Our U.S.-based businesses continued to operate during the quarter, delivering targeted products to our selected customers. Our success in operations throughout the strike allowed us to end 2019 with less net debt than when the strike began. Throughout the year, we made significant progress implementing our strategic initiatives. Some highlights from 2019 include the growing of our specialty products business with the asset acquisition of Vancouver, Washington-based Columbia Vista Corporation. We advanced our strategic partnerships with First Nations, and continued to reposition our coastal tenure assets with the sale of a 7% interest in a newly formed TFL 44 Limited Partnership to the Huu-ay-aht First Nations. We substantially completed equipment and building upgrades at our Arlington facility, which will enable us to more effectively service our selected U.S. customers. We more than doubled our wholesale lumber shipments to 34 million feet in 2019. Our wholesale lumber business will allow us to offer an expanded product line, making us more meaningful to our selected customers and further enhancing the viability and success of our existing businesses.We continue to execute our sales and marketing strategy, building strong relationships with selected specialty wood products distributors and home centers in North America, which we expect will benefit our business for years to come. We further demonstrated our commitment to top-tier governance practices with our Board leadership transition, appointing Mike Waites as independent Chair of the Board; as well as adding additional independent directors, Laura Cillis and Cheri Phyfer. We published our inaugural sustainability report, which provided expanded environmental, social and governance disclosure, while highlighting our commitment to defining a higher standard and sustainable management and environmental stewardship. We also implemented important foundational systems and adjusted our structure and staffing in support of our growth strategy. And finally, we continued with our balanced approach to capital allocation by returning approximately $50 million to shareholders through regular quarterly 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 fourth quarter of 2019 by comparison to the fourth quarter of last year. We reported fourth quarter adjusted EBITDA of negative $18.1 million as compared to $18 million in the same period of 2019 as the strike impacted the entire fourth quarter of 2019. In the quarter, we sold the majority of our remaining unencumbered lumber inventory, processed certain unencumbered logs at custom-cut facilities and continued to execute on our wholesale lumber program to service our customers and help mitigate the impact of the strike.Our average realized lumber pricing benefited from an improved specialty product mix, which was partially offset by a stronger Canadian to U.S. dollar. Specialty lumber represented 79% of fourth quarter shipments compared to 50% in 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.Operating expenses included $16.7 million arising from curtailed operations and related operating inefficiencies as a result of the strike. Despite our efforts to draw down inventory at USW certified operations leading up to the strike, certain inventory volumes remained encumbered by the strike and degraded over the fourth quarter of 2019, as a result, we expensed an additional $2.4 million against the restricted inventory. We continue to monitor for any further potential log and lumber degradation.From a profit and loss perspective, net loss was $29.2 million as compared to net income of $5.3 million in the fourth quarter of the prior year. Looking at fourth quarter cash flow and capital management. With the strike ongoing, our primary focus remained on managing our balance sheet, cash flow and working capital. Cash provided by operating activities was $6.8 million as compared to $5.6 million in the same period of last year. We reduced our noncash working capital by $24.9 million in the quarter to partly offset significantly reduced cash flow from operations resulting from this strike.Cash provided by investing activities was $0.8 million during the fourth quarter of 2019 as compared to the cash use of $29 million 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. Our capital expenditures in the fourth quarter of 2019 were more than offset by proceeds from noncore land sales.In the fourth quarter, we returned $8.5 million of capital to shareholders via dividends. And despite the challenges of the strike, in the second half of 2019, we have been successful in reducing our net debt at the end of the year by approximately $3 million as compared to before the start of the strike. Our liquidity at the end of the fourth quarter of 2019 was $137 million and our net debt to capitalization ratio was approximately 19%. We expect that 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. I would now like to provide an update on our markets. Our long-term view of market fundamentals remain unchanged. In North America, rising lumber consumption will be driven by increased new home construction, a robust repair and renovation sector and the growth of mass timber building technologies. Growing demand and reduced supply due to North American sawmill curtailments is expected to improve market fundamentals and benefit the industry long term. The supply impacts of these curtailments are expected to support lumber pricing in 2020.Moving on to specific lumber products segments. We're encouraged by the positive market sentiment in our Western Red Cedar and appearance Niche segments, and we anticipate improved pricing as we move through the spring. We expect our Niche timber in industrial markets to continue to benefit from large-scale industrial oil and gas projects. In Japan, we expect steady demand for our Douglas fir products, however increased competition from European engineered wood may pressure pricing. We anticipate market share erosion and weaker pricing for BC Coastal hemlock lumber in Japan due to the strike and increased competition from Japanese government subsidized domestic species. We'll look to regain our Japanese hemlock lumber market now that the strike is resolved.And in the short term, the coronavirus could result in a temporary slowdown in log and lumber consumption in China. However, over the longer term, a government commitment to housing and continued positive economic growth should support demand for logs and lumber in China.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 in 2019. The plan includes various policy initiatives that will impact the BC coastal forest sector. These new policies include the creation of fiber recovery zones, approval for 10-year transfers and a targeted fee in lieu of manufacturing for certain exported logs. The government is now also undertaking an old growth review.In addition, on January 21, 2020, the BC government announced changes to the Manufactured Forest Products Regulation, which should come into effect July 1, 2020. The regulation reduces the size of timbers and any species that can be exported and requires Western Red Cedar or Yellow Cedar lumber to be fully manufactured to be eligible for export. Fully manufactured is defined as lumber that will not be kiln-dried, plained or resawn at a facility outside of BC.So in our view, the reduction in the size of timbers able to be exported will have no impact on the business. The details of the policy with respect to the lumber restrictions have yet to be released, but the regulation, as proposed today, could have negative implications for global customers of BC coastal lumber products, who through their purchases support thousands of jobs and communities in the coast of BC.We're surprised by the potentially punitive nature of the proposed regulation on coastal businesses, which are already being disproportionately impacted by the application of U.S. software duties. We continue to evaluate the impacts of the various government policies may have on our operations. Overall, we remain committed to working with the government to support our industry in creating business hosting conditions in an operating environment that will keep business on the BC coast globally competitive, while avoiding policies that add cost or restrict supply to our global lumber customers.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 for shipments for the years of 2017 and 2018. The preliminary revised all others combined rates for countervailing and anti-dumping were set at 8.37% for 2017 and 8.21% for 2018. These rates are well below our current combined rate of 20.23%. The final rates for 2017 and 2018 will be determined in August of this year.Cash deposits will continue to accrue at our combined rate of 20.23% until the final determinations are published in August, at which time, the 2018 combined rate of 8.21% will apply to deposits on lumber shipments to the United States. 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 appeals process at the softwood lumber dispute concludes.So looking to what's next. We're anxious to resume operations for the benefit of our customers, employees, contractors and in the communities in which we operate. Our long-term focus remains the same, implementing our strategic initiatives to strengthen our foundation, grow our base and grow our business.And with that, operator, we can open up the call for questions.

[Operator]

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

[Hamir Patel]

Don, I was wondering if you could give us your sense as to -- for the last 8 months, your cedar customers, where did they go for their product. Did they switch to other wood species? Did they move to composites? And as you look to ramp back up, do you think you may have to be more aggressive with pricing initially to regain the market share?

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

Sure. So maybe a couple of quick things, Hamir. One, while our cedar customers -- our Cedar volumes were down substantially, they were down less than any of our other product lines. So we're -- the guys were successful, and our team was successful at continuing to put product into the market. I think as you recall, if I go back, recall 2019 got off to a very difficult start with poor weather across much of North America, impacting lumber consumption. And that weak demand led to more competitive pricing especially in narrow width and decking products for cedar.Over the strike period, the inventories at our distribution were wound down, and I think the market itself became a lot more balanced position. So while there was some erosion and some market share loss in the narrows and decking, a combination of the strike, I think, a combination of the fact that duties are applied to cedar. Cedar is very high-value, making the pricing of the products high. Therefore, we lost some market share. We're expecting a better 2020, and the interest we've seen from the customers have been really encouraging. But time will tell as to how much market share the strike has cost our business and the coast of BC.

[Hamir Patel]

Okay. That's helpful. And I just wanted to turn to the changes you referenced for the manufactured forest products regulation. So post July 1, how does those changes affect how you would look to run the Arlington facility?

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

Okay. So just maybe I can begin with, Hamir. I've got to say, I really worry about the cumulative impacts and effects of the multiple policy changes that have been advanced by government. Given the fact that the coast through the whole industry hasn't run very much, I think it's really unknown as to how significant the impacts these policy changes will have on the coast. When it comes to the manufacturing lumber rig, the proposed amendments are going to require Western Red Cedar or Yellow Cedar to be fully manufactured. Fully manufactured is defined as lumber that's going to be kiln-dried, plained or resawn at a facility outside of BC. I think that as the regulations has proposed today could have some significant unintended consequences for the entire coastal forest industry, and of course, our global customers who, through their purchases are supporting all the jobs here.As I said, we're pretty surprised at the potential punitive nature of the proposed regulation, and we're working with industry partners to deal with that. With respect to Arlington, as we've always said, it is a distribution hub that is going to be able to improve the service to our existing customers and our targeted -- or selected customers in the U.S., and we're growing other businesses there now. And we'll see where this goes. It's -- I think the government is going to take a look at it and determine when the right time to implement something like this is. Our view is restricting volume and products to customers is not a way to grow the business.

[Hamir Patel]

Okay. Great. Just a final one for me. You also, in the release, referenced some of the policy changes under consideration with respect to First Nations and how that may result in reduced forest tenure for yourselves. Do you have a sense yet as to the potential impact of that? And would you expect to get compensation if there's changes on that front?

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

Yes. So I mean I'm not -- I think I understand your question, Hamir. The -- maybe I'll rephrase it to the -- maybe the application of UNDRIP and the desire of government to have more First Nations participation in the forest sector lead to a risk for our business. And our view has been -- for a long time has been that we see that as positive.First Nation's participation in the industry is positive. I think that's why last year, we reached an agreement with the Huu-ay-aht First Nations to transact on 7% of TFL 44. We're -- as we said at that time, we're open and willing to discuss business relationships with other First Nations along those lines. We think it's a template that will work and work well, and we're anxious to grow that. So while it could be viewed as a risk, I think for us, getting First Nation's participation is a way that business can participate in reconciliation and can make the business stronger. In the event that there was a take back or something in that nature, which is what you -- I think you inferred, absolutely, we'd expect to be compensated.

[Operator]

Our next question is from Sean Steuart with TD Securities.

[Sean Steuart, Research Analyst]

A couple of questions. I jumped on the call a bit late, so I apologize if you went over this. But can you give us a sense of how fast you think you'll be able to ramp things back up?

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

Sure. Let me give that a try, Sean. Just start with the over -- maybe I'll just give you the full overview of the next step. So a tentative agreement is going to be subject to ratification by the USW membership. It's our understanding that, that ratification will take place this week. Once the contract is ratified, we'll begin calling employees back to work for safety reviews and a safety start and then preparing the operations itself for start-up. Yes, I would estimate that process is going to take about a week or so.I think at the mills, we expect operations will begin in early March at those mills that have the logs available and the market demand to support production. In the timberlands, we'll be getting back to operations based on location and snow impacts. So timberlands' ramp up as it would be in this time -- this year at any year, kind of be dependent on snow, but we'd like to get the teams back out and picking up some of the fell and bucked inventory we have right now. So to conclude, kind of we expect a ramp -- and I guess, to conclude, we expect a ramp-up of production through March and be operating more fully in April.

[Sean Steuart, Research Analyst]

Okay. That helps. A question on the trade file developments. When the duties were imposed, we saw a pretty immediate pass-through of the duties for translating over to Western Red Cedar prices. When the duties get cut, can you give us a sense of what you're expecting for the price response? I always think of it as easy pass-through in the way when they're imposed and maybe a slower give back on the other end. How are you thinking about it?

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

We like the way you're looking at it, I would say, but a couple of key points. The final determination is not going to occur until August. So up until August, we'll keep accruing at that 20%. So we would see no immediate changes to pricing. I would also say, prices have improved recently across all cedar product lines. I think I discussed earlier, some of the product lines, especially narrows and decking have been -- we haven't been able to maintain the prices we initially received or achieved in 2019 when we implemented -- or actually before them, when we implemented higher pricing due to the duties. So I think it's going to be -- going forward, picking prices is not an exact science, but I'd expect for certain product lines where we've established track record and where there's a few possible substitutes, I'd like to think those prices are going to remain. And for the narrow widths and decking, I think we've got to be competitive. And we do have market share pressures there. So we're going to have to -- those prices may be more at risk.

[Operator]

[Operator Instructions] We have a question from Paul Quinn from RBC Capital Markets.

[Paul C. Quinn]

Just maybe start with capital programs going forward here. It sounds like reading through the release that you want to scale back given the uncertainty, which I think is -- which is very prudent. But just trying to understand how you get around this manufacturing regulation now, that would suggest that you should be building kilns on the coast to be able to fully utilize that Western Red Cedar and cypress. So how do you combine those 2?

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

Yes. So maybe let me start with capital, and then I'll get into the kiln concept and a few other things. Our annual maintenance in roads CapEx has historically been around $30 million to $40 million. We're going to start operations here, basically 3 months in. So for modeling, you can adjust that. I think clearly, we do $30 million to $40 million on maintenance and road CapEx. We typically were doing $30 million to $40 million on strategic investments. But I have to say, given the challenging operating environment in the coast and due in part to BC government policies, we have to scale back our strategic capital plans until there's an improved operating environment and/or greater clarity. That said, we're going to continue to evaluate opportunities to invest strategic capital in jurisdictions that create opportunity to grow long-term value. So I think that should answer your question on capital.With respect to adding more kiln drying capacity and others, we are fortunate. We have significant capacity in kilns already. And I would just make the point that when it comes to the manufacturing regulations, most of the products we're talking about are finished and are not kiln-dried. By -- and so that's not the issue. That's not the restriction. We have customers around the world that want the products as we provide them, typically unseasoned, typically in sizes and shapes that allow them to then further process for selected individual projects, and that's where they generate the value. And that's what generates the maximum value back to the province and to allow us to run our business. So it's not a matter of going out and investing in more capacity. We have capacity here. It's a matter of, in my view, providing products to customers around that world in the form that they want them.

[Paul C. Quinn]

It doesn't sound like BC government is going to allow you to do that. But well, best of luck on that one. Maybe just moving on to the old growth strategy that you mentioned in the report back, when is that due?

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

Our understanding is sometime in the spring. I don't actually have the final date. We've made some significant contributions to that effort. I would like to point out that in our view something like 70% of the [ overall ] on the coasts are already protected in manors and parks. They're in different management zones, and so I think BC should stand up and be proud of the efforts we have accomplished already in preservation and be even more proud of how we sustainably harvest on the land base and work on the land base. So we'll see what transpires from this. There are a lot of people throughout, at least Vancouver Island, whose livelihoods rely on accessing the timber harvesting land base that is made available for the industry and they do it really well. So -- but we'll see what happens.

[Paul C. Quinn]

Okay. And then just lastly, I guess, on stumpage, what happened with the January 1 stumpage change? Are rates coming down? And then how material is your felled and bucked inventory in the woods?

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

Yes. So the impacts on the update to the equation of the data, we estimate over time it's going to be 2 things. It probably did drop or will reduce stumpage rates somewhere in the neighborhood of 20%, I guess, which would be in line -- it's actually probably a little more than that, in line with what happened in the lumber market. I think equally important is the fact that the equation on the coast now is tied to lumber markets more, which is beneficial. In the past, it was tied to log pricing in the Vancouver log market, which, as you know, can be highly variable. So that is -- I think we look forward to the gradual implementation of the new stumpage formula on our 10 years harvest.Our F&B inventory and our total log inventory, I think, is probably better way to look at it. It's probably about -- down about 30% or so from where it would have been last year. There is -- we have a lot of work to do to fill up our supply chain going forward, and that's what we will be focused on. And don't underestimate the challenges there, given government policies. The industry wound down through the third and fourth quarter last year, and I think all the participants, including government on the coast need to get together to figure out ways we can jump-start the business and get more and more harvesting going.

[Operator]

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

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

Thanks, Marie, and thanks, everyone, for your continued support. We appreciate your interest in our company and your time on the call this morning. Steve and I are both available if you have follow-up questions. We certainly look forward to sharing with you our first quarter results in May, and we look forward to getting our employees back to safely starting up and producing our products for -- our selective products for our customers. So with that, have a great day. Thank you.

[Operator]

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