Western Forest Products' (WFSTF) CEO Don Demens on Q2 2016 Results - Earnings Call Transcript

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Western Forest Products (OTCPK:WFSTF) Q2 2016 Earnings Conference Call August 4, 2016 11:00 AM ET

Executives

Don Demens - President and Chief Executive Officer

Steve Williams - SVP, Chief Financial Officer and Corporate Secretary

Analysts

Hamir Patel - CIBC Capital Markets

Sean Steuart - TD Securities

Paul Quinn - RBC Capital Markets

Operator

Good morning ladies and gentlemen, welcome to Western Forest Products Q2 Analysts 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 in the company’s annual MD&A which can be accessed on CEDAR and are supplemented by the company’s quarterly MD&A. Accordingly listeners could exercise caution and relying upon forward-looking statements.

I would like to turn the meeting over to Mr. Don Demens, President and CEO. Mr. Demens, please go ahead.

Don Demens

Thank you, Catherine, and good morning everybody. I’d like to welcome you to Western’s 2016 second quarter conference call. Joining me on the call today is Steve Williams, our Senior Vice President and Chief Financial Officer.

We issued our second quarter results yesterday so I’ll provide you with some introductory comments and then ask Steve to take you through the summary of our financial results. I’ll then share our outlook, over the next few quarters with you provide a review of our capital projects. Then we’ll open up the call for analysts to ask questions.

So start off by with, I’m going to say, I’m pleased to report that we successfully capitalized in the strength across all of our market segments to deliver adjusted EBITDA of $43 million in the second quarter, a 47% improvement over the same period last year.

Our ability to increase production and sales of specialty lumber combined with an improved commodity lumber market allowed us to deliver our highest quarterly average lumber pricing and revenue ever.

In our log business, improved pricing and improved sales mix and increased sales volumes supported revenue growth of close to 40% compared to the first quarter of 2016.

Operationally, we achieved a number of operating successes including a continued record safety performance, 4% growth in lumber sales volumes compared to last quarter, our 5% improvement in lumber production at our own saw mills as we continue to ramp up our volumes in our increasingly modernized operating platform. And finally, 52% increase in saw-log purchases compared to last year which underscores our increased competitive position.

Almost 20% of this volume came from our first nation’s partnerships. The higher log purchases allowed us to position our log inventories ahead of the third quarter when hot dry weather can reduce our ability to harvest timber.

So, to summarize, we capitalized on strong demand for our products to deliver the highest quarterly EBITDA since 2013, while we continued to balanced approach to capital allocation, continuing to invest in our business, and by returning $7.9 million to our shareholders through our quarterly dividend program.

So, with that I’ll now turn it over to Steve to review the numbers.

Steve Williams

Thanks Don. And let me start by discussing our Q2 EBITDA results. As previously mentioned adjusted EBITDA for the quarter was $43 million, a 47% increase over the second quarter of 2015 and 20% increase over the first quarter of 2016.

The increased adjusted EBITDA was a result of improved specialty log and lumber pricing, a strengthening commodity lumber market and an increase in lumber sale volumes.

As compared to the second quarter of 2015, lumber revenue increased 10% reflecting strong specialty and commodity lumber markets, a 3% % increase in shipments, and the benefit of the Canadian dollar that was 5% weaker on average compared to second first quarter of 2015.

Log revenue decreased 10% as a low opening log inventory limited lot sales early in the quarter. This was partly offset by a 32% increase in average log price realizations driven primarily by an improved log sales mix and escalating pricing for selected specialty domestic logs.

Byproducts revenue declined by 9% as compared to the second quarter of 2015 driven by a 4% drop in realized ship pricing and the timing of shipments. From a profit and loss perspective, second quarter operating income was $32.7 million in 2016, up 60% from $20.5 million in the same period last year.

Net income of $23.8 million or $0.06 per diluted share was growth in operating income was partly offset by deferred income tax expense of $7.8 million, this compares favorably to $19.1 million or $0.05 per diluted share in the second quarter of 2015.

Now moving on the cash flow for the second quarter. Cash provided by operating activities excluding non-cash working capital increased to $40 million in the second quarter compared to $26.1 million in the second quarter of 2015.

After taking into account, non-cash working capital, cash provided by operating activities was $9.7 million compared to $20.6 million in the second quarter of 2015. This was largely due to significant increase in our saw-log purchases and the inventory as we position our log inventory heading into the third quarter.

Our capital expenditures totaled $17.6 million in the current quarter, made up of discretionary maintenance capital of $8.5 million, discretionary investment inroads of $3.5 million and strategic capital spending of $5.6 million. Our second quarter strategic capital includes investments in the continued modernization of our Duke Point sawmill, ongoing appropriate systems replacements and the mapping of our forest inventory with ladder technology.

Also during the second quarter, we distributed a dividend to shareholders of $0.02 per common share totaling 7.9 million. The strong cash flow from operations and a strong balance sheet, we continue to be well positioned to execute on our balanced approach to capital allocation.

Our strength and our approach will help mitigate potential uncertainty in the markets, including the end of the 12-month standstill period following the expiry of the software lumber agreement and any outcomes of trade discussions.

Don that concludes my comments.

Don Demens

Great, Steve, thank you. Let me start off of outlook section by touching on third quarter seasonality. Typical third quarters can be challenging operationally for us, as high-dry weather causes to curtail harvest activity, reduces log volumes and increases costs. This year, we haven’t experienced any significant curtailments to date but I’d like to point out we’re only half way through the season.

Looking to our markets, our mid-to-long-term global market outlook remains positive. We’re pleased to see the strength in new home construction segment in the United States. And we’re encouraged by industry promotions focused on increasing use of wood in non-traditional markets.

In the third quarter, we expect demand for commodity lumber to continue to improve driven by rising housing service in the United States and steady demand from China.

We expect our CEDAR and new specialty segments to continue to benefit from strength in the North American repair and renovation segment. And in Japan, we expect to continue to increase our market share even though pricing will remain competitive.

Before I leave our lumber market update, I should comment on the negotiations underway to reach our lumber trade agreement with the United States. We support the work of the two governments and industries have undertaken to deliver a mutually beneficial agreement for the benefit of our shared customers.

However, the closer we get to the expiry of the standstill period, the greater the uncertainty that will exist. In the event that a settlement is not reached, increased uncertainty would likely meet the greater if market volatility moving into the fourth quarter as suppliers and distributors position their inventories ahead of any potential trade actions.

Let me turn to our log markets. We expect saw-log markets to continue to perform well in the third quarter of 2016. In the domestic market, strong demand for specialty log surfs will continue. However, we expect our third quarter realized pricing will be impacted by our lower quality log mix.

In our export log markets, we anticipate increased volumes and marginally better pricing in the third quarter. In contrast to the positive side of the saw-log markets and the pulp log market will remain under pressure due to excess supply.

So, let me update you now on our capital plan. We continue to implement our strategic capital program. Our goal is to position Western as the only company in the Coast of British Colombia capable of consuming the complete profile of the coastal forest and competitively manufacture diverse product mix.

Our capital plan will further support our abilities to sustainably harvest our 10 years, which is critical to our long-term profitability. We’ve announced approximately $98 million of approved projects as part of our original $125 million strategic capital program. And those projects are now in various stages of implementation or being completed.

Through the second quarter, we had invested $86 million of the $98 million that have been approved. In the third quarter, we’ll continue to commission the timber deck at our Duke Point sawmill and install additional equipment to support the processing of till-dried product at our Duke Point Planer.

We’ll also continue to map our Timberlands’ inventory utilizing ladder measured skinning technology to deliver a more robust and detailed forest inventory.

Our guidance on capital investments remains consistent with our previous calls. This year we’re expecting to invest about $40 million in discretionary maintenance capital including roads. In addition, we’ve been guiding that we’ll invest about $40 million in strategic capital each year.

The next round of strategic capital will be targeted at cost reduction in the processing and specific product lines. We have these projects in the queue, but given the uncertainty around the trade file, we feel it is prudent to deferring the announcements on larger capital projects until there is greater clarity.

In the meantime, we’ll focus our energies on ramping up the projects we currently have underway and some smaller fast low-cost, low-risk and higher return projects that improve efficiencies.

During this period of uncertainty we’re continuing our balanced approach to capital allocation, by continuing to invest in our business and provide ongoing returns to our shareholders through our quarterly dividend program.

So, in closing, we remain encouraged by the demand for our products and pleased with our ability to access the log volumes necessary to support our newly capitalized operating platform.

As you saw in the last quarter, we expect our strategy to deliver improved operating margins over the longer term.

And with that, Catherine, we’ll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Hamir Patel of CIBC Capital Markets. Please go ahead, your line is now open.

Hamir Patel

Hi, good morning. Don, your release mentioned a contractor dispute and that that was resolved subsequent to quarter end. I’m just wondering when in Q3 was that resolved and what sort of impact do you expect that to have on both harvest and shipment volumes for the remainder of the year?

Don Demens

Yes, great, good morning. Thanks for the question. As most of you are aware, we had a contractor rate dispute in our TFL 44 beginning I guess January. And we did resolve it at the end of Q2. And so I think as we look forward, we’ll see harvest volumes in Q3 returning back to what we say a normal volume.

I should be clear that can be impacted by any type of weather disruption. And in addition, I think we reached, to be clear, it was an interim agreement that will remove the volumes of logs off the hill-side today and we’re working towards a more sustainable long-lasting agreement. And I would expect to have that concluded in the next couple of months.

And to answer your question directly on how much more volume you can expect, I think couple of hundred thousand meters would be a pretty good estimate for this quarter. And we’ll see if we can deliver that lasting and sustainable solution to the issues over in TFL 44 for the fourth quarter.

Hamir Patel

Thanks, that’s helpful. And just on the SLA front, I was just curious if any of the various proposals have been floated by both sides, whether they’ve been incorporated in other value cap to reduce the duties to specialty lumber the way that prior SLA did? And also just curious to your thoughts about I guess confidence levels that weather future SLA whenever that maybe be would likely incorporate high-value cap?

Don Demens

Yes, so, there have been a lot of potential solutions suggested, recommended and forwarded as you pointed out. I think everyone is aware on both sides of the importance of recognizing the high-value products. Certainly our view that the high value products do not in of themselves are not really the problem in the dispute. And we would expect that that would be recognized through any type of agreement both in our prudential government, federal government and our negotiators understand the importance of recognizing high-value.

I think also just on the principles around pricing and how that impacts any software lumber agreement, it’s clear that price is the best indicator of demand and supply. And we’re talking about products here in the high-value category well in excess of $1,000 a 1,000 - at prices like that, there would be limited injury or impact in the U.S. producer. And therefore it’s our view that based on the principle pricing, reflecting demand and supply, there should be, that should be recognized in any future agreement.

So, we’re reasonably confident that message has been sent. And we’re hopeful that the two parties are going to continue negotiations and come up with a resolution.

Hamir Patel

Okay, great. Thanks Don, that’s all I had. I’ll turn it over.

Don Demens

Great. Thank you.

Operator

Thank you. Our next question is from Sean Steuart of TD Securities. Please go ahead.

Sean Steuart

Thanks good morning guys, couple of questions. Your Q2 lumber price realization gains were better than we expected. And I guess it could be a case of random links and other periodicals maybe understating the relative strength of the market for some of the specialty niche grades. I guess, it’s either that or your mix was rich. And I’m wondering if you can maybe reference the ladder and how your sales mix this quarter might have compared to the general lumber split that you guys give in your marketing deck?

Don Demens

Good morning Sean, that’s a great question. I would say that we’re seeing - so, on the pricing side we are seeing improved pricing for our class, our segments. In particular I’d like to highlight on the commodity side where we’re seeing significant improvement and we have significant leverage to commodities that are about 45% of our volume.

In this last quarter, we were able to ramp up production of CEDAR, so we had a couple of percentage points from the mix perspective on the CEDAR front. And you would see that, you’ll be able to see that of course in because it’s impacted our overall pricing but also you’ll see that in our log purchases. And we’re able to access more CEDAR in the open market. And again that’s partly due to our competitive position in the market.

So, to answer your question, we’re pleased to see good demand and improved pricing across all of our segments. And the mix did play an impact and probably a couple of percentage points on CEDAR.

Sean Steuart

Okay, that helps Don. Second question, little bit more context what you’re seeing in Japan right now and I’m wondering if the deferral of the consumption tax like next year has changed, buying patterns that you’ve seen over the last couple of months since that announcement was made?

Don Demens

Sure. So, in Japan, I think you’ve identified a real key element to the market and that is there has been a change in buying patterns there. We’re seeing an increase in purchase into there or shipments into the Japanese market by European, Russian producers, mostly driven by currency.

When we get closer to home in North America, we’re seeing a reduction in North American supply, which I think is really consistent with what we’ve been saying in our investor deck for quite a while. We anticipate as the U.S. market improves, there will be less lumber flowing to Japan as U.S. producers in particular redirect volume into the U.S. market.

So, we think we’ve seen from publications like the Japan lumber importers association and U.S. supply into the markets, are off by 9% our shipments in the first half were up 9%. So, we’re seeing an opportunity to do kind of what we said, which was replaces that U.S. supply with our own production out of our revamps on those. And we’d expect to see that continue.

Sean Steuart

Great. Thanks for the context on.

Don Demens

Sure Sean.

Sean Steuart

Yes.

Operator

Thank you. Our next question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Paul Quinn

Yes, thanks and just had a couple of questions. One; I think Don you mentioned pulp logs pressure from oversupply. Maybe you could comment or I haven’t seen the data for a while. But interior chips still coming down at the coast with some volumes and do you expect this issue to balance that over time with lower interior harvest?

Don Demens

Yes, so good morning Paul, good question. So, for those others in the call, I would say about a third of the volume consumed in the coastal pulp mill business comes from the interior, about a third from residual chips produced on the coast and maybe a third from pulp logs. Those are kind of round numbers of course.

The pulp log market itself, the pulp mills haven’t been operating at the levels I don’t think they like or would like to. And therefore we’ve gotten an oversupply of pulp logs we also have pretty active harvest throughout the coast. So, there is high - and additional volume on the market which is depressing prices.

In the near-term we didn’t expect to see a significant reduction in interior chip supply but over the long-term we will. And why that’s important is because the delivery cost of an interior chip is similar to the price of a whole log chip from a pulp log. And so the pulp mills will be able to replace to reduced supply from the interior with the pulp logs here on the coast.

So, we see this as a short-term, relatively short-term issue that will resolve itself over a period of time as volumes reduce out of the interior.

Paul Quinn

And you highlighted your ability to purchase more open market wood especially logs in Q2. What is responsible for that, is there been a drop in processing from other manufacturers or was there just a pick-up in harvesting rates?

Don Demens

Well, certainly the pick-up in harvesting rates has helped us but I think we’ve got a long-term, it’s our view it’s a long-term trend as we are the only company investing significantly in our operating base in our saw mills. And we’re improving our productivity, driving down our cost and being more competitive in the market.

And so, we believe that our ability to purchase more logs, is all part of our, key part of our strategy. And we’re demonstrating it and have been demonstrating it over the last period of time.

So, our harvest has been strong on the coast that means volumes are available and we’re taking advantage of our competitive position to go and access more fiber and put it into our saw mills.

I think materially Paul, we increased the production in our own sawmills by 5%, that’s increasing our utilization rates and we’re going to see similar volumes and similar improvements in the coming quarters as we continue to ramp our production in our own mills.

Paul Quinn

Okay. And then lastly, I think you guys cited higher harvesting cost and I’m just trying to understand what percentage of that increase is due to I guess higher cost operations like heli logging and what percentage is on the sort of inflationary pressure side?

Don Demens

So, absolutely and as you’re aware, the prices and the log prices on the coast increased, we’re inclined to go further the field to access timber harvesting land base. We do that to ensure we maximize our EAC. And we do that through increased use of helicopter logging and year-over-year we’ve probably doubled our helicopter logging volumes. And as you’re also aware helicopter logging is quite twice as expense than our conventional.

So, rough estimates, about 80% of our increased costs in the harvest costs would have been just because of where we’re operating, where we choose to operate on heli logging. We’re still seeing some increase in, an increased cost pressures. And over the next period of time, we expect to work really hard at mitigating conventional harvest cost pressures through our performance management program and working on streamlining our supply-chain.

Paul Quinn

All right, great results. Good luck.

Don Demens

Thanks Paul.

Operator

Thank you. We have no further questions registered at this time. I would now like to return the meeting over to Mr. Demens.

Don Demens

Great, Catherine. Thank you very much. So just to close, I’d like to thank everybody for your attention and your support of Western. We continue to be encouraged by our most recent results and we look forward to sharing our third quarter with you in November. 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.

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