Don Demens - President and Chief Executive Officer Steve Williams - Senior Vice President and Chief Financial Officer

Sean Steuart - TD Securities Hamir Patel - CIBC Capital Markets Paul Quinn - RBC Capital Markets

Thank you, operator, and good morning, everyone. I'd like to welcome you to Western Forest Products 2017 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.

I'll provide you with some introductory comments, and then ask Steve to take you through a summary of our financial results. I will then share our outlook for the second half of 2017 and provide an update on our margin improvement and capital initiatives.

We'll then open the call up for your questions. As we discussed on our first quarter call, a tragic accident in our Englewood timberlands' operation occurred on April 20, 2017, in which five western employees were injured, three fatally.

We continue to care for the families, employees and communities impacted by this tragedy and work through the ongoing investigation. The safety and security of our staff has always been and will continue to be our highest priority.

Now looking to our results from the most recently completed quarter, Western achieved a company record second adjusted EBITDA of $47.1 million, and capitalize on improved lumber pricing to overcome log supply challenges and U.S. lumber duties.

The imposition of U.S. softwood lumber duties on Canadian lumber products in April has created both lumber market uncertainty and volatility.

It's also begun to influence global softwood lumber flows. In the past few months, we've seen an increase in European lumber on the U.S.

east coast, reduced shipments from the U.S. Pacific Northwest, lumber producers into Japan and increasing Pacific Northwest export log prices into Asia.

By maintaining a diverse geographic sales mix supported by our flexible operating platform, we position Western to take advantage of any opportunities that changes in global softwood flows will present. In the second quarter of 2017, we leveraged our flexible operating platform to direct shipments to the strong China market, and focused our sales into the U.S.

market on targeted products where pricing leadership largely offset softwood lumber duties. This strategy limited ourselves to do the expense to $9.2 million in the quarter and reduced the impact of duties on our results.

Operationally, we minimize the financial impact of challenging coastal harvest conditions and we continue to optimize our operating platform by consolidating our secondary processing and our recently modernized Duke Point planer. Increased production and efficiency at the Duke Point planer enable us to close our Saltair planer during the quarter.

After the quarter end on July 27, we announced the indefinite curtailment of our Somass Sawmill due to long-term log supply constraints for this facility, as well as the uncertainty in rising costs caused by the U.S. softwood lumber dispute.

Somass was temporarily curtailed in February 2017, part of which had operated on a single-shift basis. In order to view operating sawmills on a single shift basis over an extended period of time is not economically viable, as this operating strategy does not deliver the returns necessary to support sustaining capital.

I'll turn it over to Steve to review our financial results.

Thanks, Don. My comments this morning will focus primarily on our financial results for the second quarter of 2017 by a comparison to the second quarter of last year.

As previously mentioned, our adjusted EBITDA increased by 10% to $47.1 million, primarily as a result of having directed lumber shipments to markets providing the highest net returns. Adjusted EBITDA include softwood lumber duties of $9.2 million expense in the period.

As supported by the outcomes of past rounds of the U.S. softwood lumber dispute, we believe these duties are unwarranted and will be ultimately be descended and returned.

However, as that is not a certainty, we are expensing these duties as incurred consistent with past treatment. In addition to duties expense, we have disclosed a contingent liability of USD 11.7 million arising from the 90-day retroactive duty applications.

The U.S. Department of Commerce preliminary determination of critical circumstances been reversed in all past instances of this dispute and our decision not to express the retro duties is consistent with past treatment and consistent with the accounting treatment applied by most of our peers.

Our lumber revenue declined by 4% as a 15% reduction in lumber shipments was largely offset by a 13% increase in our average realized lumber pricing. Log revenue declined by 11% as lower harvest production limited log sales volumes.

Second quarter operating income was $34.5 million in 2017, as compared to $32.7 million from the same period last year. Included in operating income in 2017 was $3.1 million of WorkSafe Certificate of Recognition rebates received in the period.

Net income of $25.6 million or $0.06 per diluted share as the increased operating income was partially offset by impairment charges related to the recently announced indefinite curtailment of our Somass Sawmill. This compares to net income of $23.8 million or $0.06 per diluted share in the second quarter of 2016.

Of note for the third quarter, we intend to offer voluntary severance to the employees of our indefinitely curtailed Somass Sawmill, and we estimate that the total severance liability to be approximately $8 million. This will be recognized in third quarter restructuring items.

Now moving on to cash flow for the second quarter, cash provided by operating activities, excluding noncash working capital was $40.7 million, compared to $38.9 million in the second quarter of 2016. Our capital expenditures totaled $8.2 million in the current quarter made up of discretionary maintenance capital and strategic capital.

Uncertainty arising from the U.S. softwood lumber dispute has caused us to slower the first certain projects.

Also during the second quarter, we distributed $7.9 million of dividends to shareholders. At June 30, 2017, we had total liquidity of $285 million, including $51 million of cash on hand and no drawings on our debt facilities.

As a result of strong ongoing cash flows from operations and the strength of our balance sheet, we continue to be well positioned to execute on our balanced approach to capital allocation. Yesterday, we announced that Western has received approval to make a normal course issuer bid beginning on August 8.

This initiative will permit us to purchase and cancel up to 5% of our issued and outstanding common shares. We need to purchase shares from time to time or we believe that the market pricing for our shares is attractive that the purchase would be in the best interest of our shareholders.

Don that concludes my comments.

Well, thanks, Steve. So let me start off our outlook section by touching on third quarter seasonality.

Typical third quarters can be challenging operationally as hot dry weather can force us to curtail harvest activity, losing large volumes and increasing costs. We thankfully not experienced fire activity like that impacting other areas of the province, but the recent hot dry weather is currently resulting in curtailments and reduced harvesting efficiencies in our operating area.

Looking to our markets, I'll begin by talking about the U.S. softwood lumber disputes with Canada.

During the quarter, the United States announced preliminary countervailing and antidumping duties on Canadian lumber shipments into the United States. Western's combined duty rate is 26.5%, and as Steve indicated, we are subject to 90-day retroactive application for both duties.

The preliminary countervailing duty will be in effect until late August, at which point, the countervailing duties expire in accordance with U.S. law.

We believe the countervailing duty gap period will add to the market uncertainty and volatility. Countervailing duties may be reintroduced in the fourth quarter when the U.S.

Department of Commerce is expected to make its final duty determination. Antidumping duties are expected to remain in effect through December.

Through the quarter, we continued our efforts to seek exclusions for high-value products including Cedar, which are disproportionately impacted by these duties, by working through the Departments of Commerce and International Trade Commission processes. We believe that Western has a financial stability and market diversity to withstand near term uncertainty caused by these U.S.

trade actions. Looking to our markets, we believe global log and lumber markets will remain strong supported by increased demand from the recovering new home construction segment in the United States, increased growth in China and the ongoing application of U.S.

duties. These markets drivers should deliver firm pricing for our commodity products in the third quarter despite the usual China market seasonal slowdown.

Demand for our Western Red Cedar products remains strong supported by limited supply and low inventories throughout the supply chain. Pricing is somewhat uneven as certain product categories are exhibiting more resilience in the face of the disproportional impact of the lumber duties than others.

We continue to direct production to the highest margin alternatives. And finally demand from Japan continues to support our product offerings in that market.

I should note the price realizations for all our U.S. dollar sales could be impacted by the recent strength in the Canadian dollar.

Now let me update you on our margin improvement initiative. After significant evaluation and planning, on July 1, we implemented simplified log served procedures that are intended to reduce timberland's operating costs through reduced handling and improved operating efficiencies.

We expect this initiative along with the streamlining and standardization of other operating processes will drive an incremental $25 million of EBITDA on an annualized basis. Early benefits of our margin improvement program should be evident in our results in the second half of 2017.

In respect of our capital program, we continue to reinvest in and consolidate our operating base to position our mills as the most cost competitive facilities in the coast of BC. We expect to complete the $17 million Duke Point planer project in the fourth quarter.

The advancements at Duke Point have supported the consolidation of both our South Island and Saltair planers. We'll also complete the $4.2 million Chemainus sawmill timberland project in the fourth quarter.

In addition, we are laying the foundation necessary for future investments by upgrading our management information systems. We've installed a new production and sales system and are progressing with the implementation of a new accounting system.

Our 2017 capital forecast, a combination of maintenance and strategic capital, has been revised to $15 million and it includes the projects I've highlighted this morning. We've scaled back capital as a result of the uncertainty caused by the softwood dispute.

We will, however, continue to invest in quick return, lower cost capital projects that reduce production cost. We'll be funding our investments from cash generated from the business and the ongoing monetization of non-core assets.

Turning to our non-core assets, on May 17, we announced the sale of three non-core properties to the Huu-ay-aht First Nation for the proceeds of $3 million. This transaction included the sale of a dry land sort and associated agreement for a harvest of 200,000 cubic meters of timber from Huu-ay-aht land.

These agreements all form the foundation for a long-term mutually beneficial relationship with the Huu-ay-aht. Later this month, we expect to announce the completion of the sale of our South Island Remanufacturing facility for $3 million.

These sales form part of the $5 million to $10 million of non-core asset sales we committed to executing in 2017. Additionally, we continue to explore market opportunities for our northern private timberlands.

And with that, operator, we can open the call up for questions.

Thanks good morning guys. Few questions.

Don, with your reference to lower CapEx this year, $50 million and we were at $70 million previously, which might have been a bit high, but can you give us a sense of what projects are being deferred as you look ahead to the CapEx spend?

Sure, Sean. Good morning.

Yes, the capital I would say we are deferring a large capital projects that would require access to the U.S. market to support the returns and provide the market diversity necessary to ensure, we get the returns from the projects.

So it's those types of projects that we are deferring.

Okay. And would your sense be that these are projects you would move ahead with in 2018, I suppose depending on the outcome of softwood lumber?

But should we expect to that just get the push to the 2018 right now?

Yes. So I think yes, we would look to execute on those opportunities if we had the proper access to the market.

For your modeling, I think we should go back to the $70 million for next year, but we will provide a better more fulsome update on the next call for our 2018 forecast and projections, but for modeling I think you can go back to the guidance we provided earlier.

Got it. And Don, with respect to softwood lumber trade, if we're headed towards a potential quota deal, do you have any thoughts on how the coast should be treated for allocation of that quota?

Well, for sure I've got thoughts. Whether they're implemented or not, through the negotiation, we'll see.

Yes, the coast is in a unique position, I think, across Canada for two reasons. One, we produce predominantly high-value products, which aren’t at the root of the dispute, and therefore, it's our view, it shouldn't be penalized and we should have access to the market.

The second thing is there are log volumes that are currently being exported that could be redirected in the sawmills here and put into the market. So we're not constrained by reduced AAC or reduced availability of logs.

So from both those point, the fact that we produce high-value products, which I think - we think Canada, which would be promoting because the value to the economy and because we have access to additional fiber, which can be produced here. I think the coast should be viewed favorably in any type of core allocation coming from the federal government.

Got it. I will get back in the queue.

Thanks guys.

Hi, good morning. Don, just kind of following up on Sean's question there.

Do you think the quota will be allocated by the federal government or by the provincial governments?

Good morning Hamir. The agreement will have to be struck between the Canadian government and the United States government.

From then on quota allocation - any discussion of quota allocation is pretty speculative on my part. So, we'll have to see, how the federal governments and the provincial governments determine, how the quota would be allocated, and we have not been provided direction on that as of yet.

Fair enough. And Don, you mentioned the $25 million of EBITDA improvement you expect from the noncapital margin improvement initiative.

When do you expect the full $25 million to be realized?

Yes, so the $25 million margin improvement program would be an annualized number. We'd expect to see some of that realized in the fourth - in the second half of this year, and we'd expect to see the full amount being realized in 2018.

And then Don, on the M&A front. Just curious if you could comment on what that pipeline is looking for opportunities in the U.S.

Pacific Northwest? And if you could speak to maybe what sort of valuation multiples vendors are seeking for specialty wood product assets?

So I - yes, I think we've discussed before that we will continue to look at opportunities to expand our business in like product lines, specialty product lines, where we can apply our margin focused strategy to advantage. Multiples, too early to say about multiples, but we understand the multiples are part of our business and we'd make sure that any acquisitions we'd keep in line with those multiples.

Great. Thanks Don that’s all I had.

Thanks.

Yes, good morning. Thanks guys.

Just a couple of questions, I’m trying to understand the disconnect between sort of the record-setting H1 2017 and pretty decent outlook for most of your stuff and then the pause or deferment of some of the capital projects, especially given your squeaky claim balance sheet. So that suggested you're quite nervous about what’s going to happen on the softwood lumber file or market conditions going forward?

Is that fair?

Well, sure, Paul. So, I think you have to look at capital.

We look at capital and we look at our business in this way. One of the advantages we have is we have lots of flexibility to make different products from the same types of logs and - but - and that affords us an opportunity to invest in our business and provide us the backstab to deliver the returns necessary to justify the capital.

In the case of what we are faced with today is an uncertainty in the volumes we're able to ship into the United States going forward. Because we don't have an agreement.

And so all we're suggesting is we’re going to defer large capital investments that might reposition businesses until we have some more certainty around access to the U.S. market, because it's a core fundamental of our business that flexibility in moving volumes back and forth to the highest margin alternatives.

Okay. So your uncertainty forum, we reduced our CapEx and now we've reduced our CapEx even further in 2017 even though we've had really strong results?

Well, what we're saying is we increased our CapEx right after the $80 million mark. That was the guidance we're providing.

We're taking a pause here until we find some more certainty in the market. We think that's the prudent thing to do.

Okay. Maybe you can - it looks like you're making pretty good progress on the noncore asset sales, where are you at with your northern timberland sales process?

We are carrying on in the process right now, Paul. So in early days, as we’ve said all along, we'll look for opportunities where we think we can realize the multiple valuation.

Differential of it makes sense will carry on down that path. So to say, it's early right now.

But you've got a process going on, you've got multiple interest and is that not correct?

We do have interest, Paul, that is correct, but to say it's early in the process right now.

Okay, and then just on the log harvest in Q3, you mentioned some constraints. Are we expecting harvest in Q3 or what you're seeing sort of quarter to date and then looking into the future a little bit similar last year?

Or is it going to be below like we've have been seeing for the most of 2017 here?

Sure. So just to provide some background harvest, I know you know this well, but harvest volumes from second quarter to third quarter typically see about a 20% to 25% reduction in volumes just based on the weather.

Hard to tell, what's actually going to happen because I can't tell you when the weather is going to change. I can tell you, currently, we are experiencing reductions in harvest activity and some closures of operations, because recently we had really hard dry weather and to answer the question directly, volume last year and this year should be - we forecast about the same, but it's really weather dependent.

Okay. And then we're hearing that - just lastly, we are hearing all sorts of rumors on potential softwood lumber agreement based of the quota, somewhere around 30%.

Have you been given any indication that there is an exemption for high-value products?

No, we haven't received any indication that high-value products are going to be treated any differently. We've heard the same rumors you have and once you can't substantiate them anymore than what we see in the process.

Alright, great results. Thanks guys.

Thank you, Paul.

Thanks. Just one follow-up for Steve, can you give us a sense of where your [indiscernible] carry-forwards are, Steve?

And when we should expect the transition to paying cash tax?

Yes, I think it, again it depends on [indiscernible] forecast is for us for the back half of the year. But we started with the year of about $100 million in noncapital loss carry forwards.

I think, so if you're looking at from the beginning of the year, I'd say approximately a year to 1.5 years depending on your view of profitability.

Okay, that’s all I had. Thanks guys.

Thank you, operator. Well to close, I would like to thank everyone for your attention and support of Western.

We continue to be encouraged by our most recent results and look forward to sharing our third quarter results with you in November. With that, have a great day.

Thanks.