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Western Forest Products announces first quarter 2018 results

Operating income prior to restructuring and other income was $32.6 million in the first quarter of 2018, compared to $23.9 million in first quarter of 2017, and $30.3 million reported in the fourth quarter of 2017. Improved product pricing and lower manufacturing costs more than offset the impacts of rising stumpage rates and $9.7 million of US export lumber duty expense in the first quarter of 2018.

The company generated revenue of $291.6 million in the first quarter of 2018, as compared to $287.7 million in the first quarter of 2017, and $283.1 million in the fourth quarter of 2017. The company increased first quarter revenue despite the current suspension of its export log sales program in support of supplying logs to its coastal sawmills.

Q1 2018 HIGHLIGHTS

• Delivered adjusted EBITDA of $43.0 million, a 26 per cent increase from the same period last year
• Completed the acquisition of a distribution and processing centre in Arlington, Wash.
• Returned $7.9 million to shareholders via the Company’s quarterly dividend
• Announced a 12.5 per cent increase in our quarterly dividend to $0.0225 per common share

“Markets for our products continue to perform well, and I’m encouraged by the progress we have made in lowering manufacturing costs and delivering improved operating margins,” said Don Demens, president and chief executive officer. “We successfully rebuilt log inventories in the quarter which we expect to drive further improvements in our manufacturing operations leading into the spring building season.”

Net income of $21.7 million ($0.05 per diluted share) was reported for the first quarter of 2018, as compared to $16.2 million ($0.04 per diluted share) for the first quarter of 2017 and $18.9 million ($0.05 per diluted share) in the fourth quarter of 2017.

The company’s board of directors has approved a 12.5 per cent increase in the company’s quarterly dividend to $0.0225 per common share, payable June 15, 2018 to shareholders of record on June 1, 2018. The dividend increase aligns with the company’s balanced approach to capital allocation.

First quarter 2018
We delivered first quarter adjusted EBITDA of $43.0 million in 2018, overcoming US lumber export duties of $9.7 million and rising stumpage costs. Operating income prior to restructuring items and other income increased to $32.6 million from $23.9 million in the same period last year. We leveraged improved log inventories to support higher sawmill uptime which delivered lower manufacturing costs.

Revenue
Lumber revenue was $228.2 million, compared to $225.6 million in the first quarter of 2017, as rising price realizations offset lower sales volumes. Strong global lumber demand drove a six per cent increase in lumber price realizations despite a weaker sales mix and the impact of a stronger Canadian dollar (CAD), which was four per cent higher on average against the United States dollar (USD). Commodity lumber increased to 50 per cent of total lumber shipments in the first quarter of 2018, from 42 per cent in the same quarter last year. The first quarter of 2017 included a higher mix of specialty lumber as we expedited the sale of U.S.-bound lumber in anticipation of the application of export duties in April 2017.

First quarter log revenue was $41.2 million in 2018, a decrease of $4.3 million from the same period due to a weaker sales mix and the suspension of our export log sales program to supply our coastal sawmills.

By-products revenue increased to $22.2 million in the first quarter of 2018, from $16.6 million in the same period in 2017. Improved pulp markets drove a 36 per cent increase in chip sales price realizations, which more than offset the impact of a stronger CAD in 2018.

Operating costs
Lumber production was 209 million board feet, consistent with the first quarter of 2017 and 14 per cent higher than the fourth quarter of 2017. In addition to our production volume, we provided 14 million board feet equivalent of custom cut manufacturing services for a key pulp customer in the first quarter of 2018. Increased sawmill uptime, the benefits of our margin improvement programs and a heavier mix of commodity lumber drove lower manufacturing costs quarter-over-quarter.

First quarter log production was 1,029,000 cubic metres, 13 per cent higher than the same period last year, due to improved winter operating conditions. Rising stumpage rates and increased production from higher cost operations drove a five per cent increase in harvest costs, which more than offset benefits of our simplified log sort optimization and other timberlands cost savings initiatives.

Low market log availability driven by poor operating conditions in 2017 and high coastal log export volumes have distorted coastal log market pricing, which serves as a primary input to coastal stumpage rates. As a result, first quarter 2018 stumpage rates have increased more than expected. The provincial government has raised concerns with export log sales which we anticipate may prompt favourable policy changes in support of supply for domestic sawmill manufacturing.

We supplemented our internal log supply with saw log purchases of 257,000 cubic metres, an 11 per cent increase from the same quarter last year. Constrained domestic log supply led to higher market pricing for purchased logs.

Freight expense decreased by $5.8 million as compared to the first quarter of 2017, due to reduced export log freight expense and lower lumber sales volume. A stronger CAD largely offset rising USD-denominated fuel surcharges.

Western’s results for the first quarter of 2018 include $9.7 million of export duty expense, comprised of countervailing duty (CVD) and anti-dumping duty (AD), whereas no duties were applicable in the first quarter of 2017. We leveraged our margin-focused sales strategy by directing lumber sales to alternative markets to limit the impacts of duty on our business.

Selling and administration expense
First quarter selling and administration expense was $8.6 million in 2018 as compared to $8.4 million in the same period last year. Incremental expense was primarily due to investments in foundational systems and process improvements to support our growth strategy, as well as increased performance related compensation.

Net income
Net income for the first quarter of 2018 was $21.7 million, as compared to $16.2 million for the same period of 2017. Improved revenue and operating margin drove an increased net income that was partly offset by export lumber taxes and higher operating restructuring items.

Operating restructuring items
Included in $2.2 million of operating restructuring items in the first quarter of 2018 were $1.0 million in severance and related expenses attributable to ongoing business optimization initiatives, $0.6 million relating to the indefinite curtailment of our Somass sawmill, and $0.4 million incurred to retrain employees affected by the closure of the Englewood train announced Nov. 7, 2017. We incurred $0.5 million in operating restructuring items in the first quarter of 2017.

Our Somass sawmill remains indefinitely curtailed as a result of rising costs associated with the U.S. softwood lumber dispute and a fibre supply deficit arising from years of tenure takebacks and land use decisions. We are evaluating options to create a sustainable, long-term solution for the site, and we are considering the input of government, First Nations and other stakeholders.

Income taxes
Current income tax expense of $0.1 million and deferred income tax expense of $8.0 million were recognized in net income in the first quarter of 2018, primarily relating to operating earnings. Total income tax expense was $6.3 million in the same quarter last year.

We continue to receive deferred treatment of Canadian income taxes due to outstanding non-capital loss carryforwards, which we expect to fully utilize in 2018.

Strategy and outlook
Western’s long-term business objective is to create superior value for shareholders by building a margin-focused log and lumber business of scale to compete successfully in global softwood markets. We believe this will be achieved by maximizing the sustainable utilization of our forest tenures, operating safe, efficient, low-cost manufacturing facilities and producing and selling high-value specialty products for global markets. We seek to manage our business with a focus on operating cash flow and maximizing the value of our fibre resource through the production cycle, from the planning of our logging operations to the production, marketing, sale and delivery of our log and lumber products. We routinely evaluate our performance using the measure Return on Capital Employed.

Market outlook
The gradual improvement in U.S. new home construction, and the continued strength of the repair and renovation segment, combined with the increased use of lumber in China are expected to continue to drive demand for our log and lumber products. We expect near-term pricing to be positively influenced by the spring building season.

North American demand for our Western Red Cedar (WRC) products continues to be supported by robust repair and renovation spending. Pricing for our targeted specialty products is expected to remain strong. As anticipated, lumber pricing in Japan has improved due to a combination of steady demand and low inventories. Demand and pricing for our Niche products is expected to move higher as markets adjust to the ongoing application of US export lumber duties.

The domestic saw log market remains undersupplied despite a 28 per cent increase in coastal log production over the first quarter of 2017, as reported by the province of B.C.’s harvest billing system. Strong domestic saw log demand is expected to support pricing despite seasonally increased production as we move through the second quarter. Demand for small-diameter saw logs and pulp logs will remain strong as pulp mills seek additional sources of fibre to capitalize on resilient pulp markets.

Softwood lumber dispute and U.S. market update
On Jan. 3, 2018, US Department of Commerce (DoC) published amended final determinations, resulting in reduced, final CVD and AD rates of 14.19 per cent and 6.04 per cent respectively for “all other” Canadian lumber producers including Western.

During the first quarter of 2018, we expensed $6.8 million of CVD and $2.9 million of AD for a total of $9.7 million, as compared to nil in the first quarter of 2017. To March 31, 2018, we have paid total CVD and AD of $26.5 million since the latest imposition of export lumber duties by the United Statesbeginning in April 2017.

Our shipments to the U.S. market are predominantly high-value, appearance grade lumber, representing less than 25 per cent of Western’s total revenue in 2017. Continued strong demand and a lack of supply has supported ongoing improvements in our specialty lumber product pricing, partly offsetting the impact of duties.

The U.S. application of duties continues a long-standing pattern of U.S. protectionist action against Canadian lumber producers. We disagree with the U.S. trade determination and the inclusion of specialty lumber products in this commodity lumber focused dispute.

Our recent acquisition of a distribution and processing centre in Arlington, Wash., is expected to assist in mitigating the damaging effects of duties on our products destined for the U.S. market while increasing U.S. market sales. We intend to preserve our strong balance sheet and leverage our flexible operating platform to continue to overcome any challenges that arise from this trade dispute.

Strategic capital program update
We continue to implement a strategic capital program that is designed to position Western as the only company capable of sustainably consuming the complete profile of the coastal forest and competitively manufacturing a diverse product mix for global markets.

Our strategic capital program is focused on the installation of technology that will deliver top quartile performance and improve our ability to manufacture targeted products that yield the best margin. In addition to investments in our manufacturing assets, we also allocate capital to strategic, high-return projects involving our information systems, timberlands assets, and forest inventories.

In the first quarter of 2018, we acquired a distribution and processing centre in Arlington, Washington and commenced the first phase of planned capital upgrades at that facility. We continued to make advancements with the auto-grading component of our Duke Point planer rebuild. We also made significant progress in the start-up of the timber deck enhancements at our Chemainus sawmill. That timber deck investment will support incremental production of high-value, appearance-grade timbers. In addition, we began a number of small, high-return capital projects at our other operations.