Western Forest Products : Q1 2021 Quarterly Report

Western Forest Products Inc.

2021 First Quarter Report

Management's Discussion & Analysis

The following MD&A reports and comments on the financial condition and results of operations of Western Forest Products Inc. (the "Company", "Western", "us", "we", or "our"), on a consolidated basis, for the three months ended March 31, 2021, to help security holders and other readers understand our Company and the key factors underlying our financial results. This discussion and analysis should be read in conjunction with our unaudited condensed consolidated interim financial statements and the notes thereto for the three months ended March 31, 2021, and our audited annual consolidated financial statements and the notes thereto and Management's Discussion and Analysis for the year ended December 31, 2020 (the "2020 Annual Report"), which can be found on SEDAR at www.sedar.com.

The Company has prepared the consolidated financial statements for the three months ended March 31, 2021, in accordance with International Financial Reporting Standards ("IFRS"), as issued by the International Accounting Standards Board. Amounts discussed herein are based on our unaudited condensed consolidated interim financial statements and are presented in millions of Canadian dollars unless otherwise noted. Certain prior period comparative figures have been reclassified to conform to the current period's presentation.

Reference is made in this MD&A to adjusted EBITDA1. Adjusted EBITDA is defined as operating income prior to operating restructuring items and other income (expenses), plus amortization of property, plant, and equipment and intangible assets, impairment adjustments, and changes in fair value of biological assets. Adjusted EBITDA margin is adjusted EBITDA as a proportion of revenue. Western uses adjusted EBITDA and adjusted EBITDA margin as benchmark measurements of our own operating results and as benchmarks relative to our competitors. We consider adjusted EBITDA to be a meaningful supplement to operating income as a performance measure primarily because amortization expense, impairment adjustments and changes in the fair value of biological assets are non-cash costs, and vary widely from company to company in a manner that we consider largely independent of the underlying cost efficiency of their operating facilities. Further, the inclusion of operating restructuring items which are unpredictable in nature and timing may make comparisons of our operating results between periods more difficult. We also believe adjusted EBITDA and adjusted EBITDA margin are commonly used by securities analysts, investors and other interested parties to evaluate our financial performance.

Adjusted EBITDA does not represent cash generated from operations as defined by IFRS and it is not necessarily indicative of cash available to fund cash needs. Furthermore, adjusted EBITDA does not reflect the impact of certain items that affect our net income. Adjusted EBITDA and adjusted EBITDA margin are not measures of financial performance under IFRS, and should not be considered as alternatives to measures of performance under IFRS. Moreover, because all companies do not calculate adjusted EBITDA in the same manner, adjusted EBITDA and adjusted EBITDA margin calculated by Western may differ from similar measures calculated by other companies. A reconciliation between the Company's net income as reported in accordance with IFRS and adjusted EBITDA is included under the "Non-GAAPMeasures" section herein.

Also in this MD&A, management uses key performance indicators such as net debt, net debt to capitalization and current assets to current liabilities. Net debt is defined as long-term debt less cash and cash equivalents. Net debt to capitalization is a ratio defined as net debt divided by capitalization, with capitalization being the sum of net debt and equity. Current assets to current liabilities ratio is defined as total current assets divided by total current liabilities. These key performance indicators are non-GAAP financial measures that do not have a standardized meaning and may not be comparable to similar measures used by other issuers. They are not recognized by IFRS; however, they are meaningful in that they indicate the Company's ability to meet its obligations on an ongoing basis and indicate whether the Company is more or less leveraged than in prior periods.

This MD&A contains statements that may constitute forward-looking statements under the applicable securities laws. Readers are cautioned against placing undue reliance on forward-looking statements. All statements herein, other than statements of historical fact, may be forward-looking statements and can be identified by the use of words such as "will", "estimate", "expect", "anticipate", "plan", "forecast", "intend", "believe", "seek", "could", "should", "may", "likely", "continue" and similar references to future periods. Forward-looking statements in this MD&A include, but are not limited to, statements relating to our current intent, belief or expectations with respect to: domestic and international market conditions, demands and growth; economic conditions; our growth, marketing, product, wholesale, operational and capital allocation plans and strategies, including but not limited to payment of a dividend; fibre availability and regulatory developments; the impact of COVID-19; and the selling of additional incremental ownership interest in TFL 44 LP and APD LP in the future. Although such statements reflect management's current reasonable beliefs, expectations and assumptions as to, amongst other things, the future supply and demand of forest products, global and regional economic activity and the consistency of the regulatory framework within which the Company currently operates, there can be no assurance that forward-looking statements are accurate, and actual results and performance may materially vary. Many factors could cause our actual results or performance to be materially different, including: economic and financial conditions, international demand for forest products, competition and selling prices, international trade disputes, changes in foreign currency exchange rates, labour disputes and disruptions, natural disasters, relations with First Nations groups, the availability of fibre and allowable annual cut, the ability to obtain operational permits, development and changes in laws and regulations affecting the forest industry including as related to old growth timber management and the Manufactured Forest Products Regulation, changes in the price of key materials for our products, changes in opportunities, future developments in COVID-19 and other factors referenced under the "Risks and Uncertainties" section herein. The foregoing list is not exhaustive, as other factors could adversely affect our actual results and performance. Forward-looking statements are based only on information currently available to us and refer only as of the date hereof. Except as required by law, we undertake no obligation to update forward-looking statements. Unless otherwise noted, the information in this discussion and analysis is updated to May 5, 2021.

1 Earnings Before Interest, Tax, Depreciation and Amortization

Summary of Selected Quarterly Results (1)

						Q1			Q1			Q4
(millions of Canadian dollars except per share amounts and where otherwise noted)		2021			2020			2020
Summary Information
Revenue
Lumber					$	276.6	$	83.2	$	256.6
Logs						33.1			12.9			53.4
By-products						12.8			3.0			8.9
Total revenue					$	322.5	$	99.1	$	318.9
Freight					$	22.8	$	6.3	$	24.9
Export tax expense						8.2			4.0			12.1
Export tax recovery						-			-			31.6
Stumpage						9.2			1.0			8.1
Adjusted EBITDA					$	62.9	$	(17.4)	$	71.1
Adjusted EBITDA margin						20%			(18%)			22%
Operating income (loss) prior to restructuring and other items	$	48.8	$	(28.4)	$	56.0
Net income (loss)						53.8			(21.0)			34.4
Basic and diluted earnings (loss) per share (in dollars)		0.14			(0.06)			0.09
Operating Information
Lumber(2)
Lumber Shipments - millions of board feet
Cedar(3)						52			22			54
Japan Specialty						19			15			19
Niche						22			10			24
Commodity						111			17			107
Total						204			64			204
Lumber Production - millions of board feet						199			61			180
Lumber Price - per thousand board feet					$	1,356	$	1,300	$	1,258
Wholesale Lumber Shipments - millions of board feet		10			10			6
Logs(4)
Log Shipments - thousands of cubic metres
Export						35			1			73
Domestic						159			100			225
Pulp						90			40			173
Total						284			141			471
Net production - thousands of cubic metres(5)						688			167			901
Saw log purchases - thousands of cubic metres						195			141			222
Log Price - per cubic metre(6)					$	117	$	91	$	113
Illustrative Lumber Average Price Data(7)	Price Basis
Grn WRC #2 Clear & Btr 4x6W RL ($C)	c.i.f. dest. N Euro				$	5,583	$	4,500	$	4,867
Grn WRC Deck Knotty 2x6 RL S4S	Net f.o.b. Mill	$	2,042	$	1,362	$	1,757
Grn WRC #2 & Btr AG 6x6 RL	Net f.o.b. Mill	$	2,566	$	2,346	$	2,540
Coast Grn WRC Std&Btr NH 3/4x4 RL S1S2E	Net f.o.b. Mill	$	1,602	$	1,095	$	1,402
Grn Hem Baby Squares Merch 4-1/8x4-1/8 13' S4S	c.&f. dest. Japan	$	1,098	$	809	$	790
Grn Dfir Baby Squares Merch 4-1/8x4-1/8 RL S4S	c.&f. dest. Japan	$	1,216	$	1,005	$	952
Grn Dfir (Portland) #1&Btr 100% FOHC 6x6 Rough	Net f.o.b. Mill	$	1,543	$	1,268	$	1,470
Hemlock Lumber 2x4 (40x90) Metric RG Utility	c.i.f. dest. Shanghai	$	605	$	425	$	476
Coast KD Hem-Fir #2 & Btr 2x4	Net f.o.b. Mill	$	1,031	$	456	$	764
Average Exchange Rate - CAD to USD						0.790			0.744			0.767
Average Exchange Rate - CAD to JPY						83.62			81.09			80.01

Figures in the table above may not equal or sum to figures presented elsewhere due to rounding.

1. Included in Appendix A is a table of selected results from the last eight quarters.
2. Includes wholesale lumber shipments.
3. Comparative figures have been reclassified to conform to the current year presentation. Cedar includes Western Red Cedar, and shipments of Yellow Cedar and Japanese Cedar to North American markets.
4. British Columbia business only.
5. Net production is sorted log production, net of residuals and waste.
6. The average realized log price per cubic metre has been presented on a gross basis, which may include fee-in-lieu and shipping charges incurred on behalf of customers to facilitate sales to export markets.
7. Sourced from Random Lengths in USD/Mfbm, except Hemlock Lumber Metric RG Utility that is sourced from the Forest Economic Advisors LLC China Bulletin.

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Summary of First Quarter 2021 Results

Adjusted EBITDA for the first quarter of 2021 was $62.9 million, as compared to negative adjusted EBITDA of $17.4 million in the same period last year. We delivered record first quarter adjusted EBITDA by redirecting production to a strong North American lumber market.

Operating income prior to restructuring and other items was $48.8 million, as compared to an operating loss of $28.4 million in the same period last year. Comparative results were significantly impacted by the United Steelworkers Local 1-1937 ("USW") strike (the "Strike"), which curtailed the majority of our BC based operations through February 2020. In addition, we curtailed our BC manufacturing facilities for up to one- week in March 2020 in response to the impacts of the novel Coronavirus pandemic ("COVID-19").

We continue to strictly enforce enhanced health and safety protocols and regularly re-evaluate market conditions arising from COVID-19. Our near-term focus remains on ensuring the health and safety of our employees, maintaining financial flexibility, and servicing our customers.

Sales

Rising North American lumber demand, driven by increased levels of new home construction and a strong repair and renovation segment, combined with limited supply to deliver record lumber pricing in the first quarter of 2021. Lumber producers have struggled to respond to the strong market due to permanent production curtailments in the BC Interior as a result of the Mountain Pine Beetle and COVID-19 related labour constraints in other producing regions. To capitalize on market conditions and overcome container shipping constraints that reduced export market access, we further levered our flexible operating platform and increased production for the North American market.

Lumber revenue rose 8% from the fourth quarter last year, on the strength of higher prices for our products and increased North American shipments. We grew our total commodity volumes by 4% during the quarter as compared to the fourth quarter of 2020. Our North American commodity shipment volumes represented 64% of total commodity shipment volumes during the first quarter of 2021, well above our historical average. We successfully grew sales to selected customers in the specialty treating sector, increasing volumes by 12% from the fourth quarter of last year.

Our first quarter average realized lumber price was $1,356 per thousand board feet, an increase of 8% from the fourth quarter of 2020, despite a weaker sales mix and a stronger Canadian to US dollar exchange rate. Wholesale shipments were flat due to limited market availability and supply chain challenges.

Log revenue was $33.1 million in the first quarter of 2021, an increase of 157% from the same period last year and a 38% decline from the fourth quarter last year due to seasonality. We achieved a higher average realized log price as compared to the fourth quarter last year despite lower export market shipments. We directed export log inventory to our sawmills in support of increased commodity lumber production, to capitalize on the strong North American lumber market. Limited export log shipments originated primarily from commitments under First Nation partnership and joint venture arrangements.

By-product revenue was $12.8 million, an increase of $9.8 million as compared to the same period last year, and an increase of $3.9 million from the fourth quarter of 2020. Chip price realizations benefitted from a sharp increase in NBSK pulp price in the period, and increased production led to higher by-product shipments.

Higher first quarter log and lumber pricing reduced inventory provisions by $9.3 million as compared to the same period last year.

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Operations

We have continued to lever our flexible operating platform by redirecting production from export markets into the strong North American market.

First quarter lumber production of 199 million board feet was 226% higher than the Strike-impacted first quarter last year and was 11% higher than the fourth quarter of 2020. We achieved higher production through increased operating hours, improved production efficiency, and a shift to more domestic lumber production. Increased production of North American commodity lumber contributed to improved sawmill recovery but also increased our secondary processing requirements, consistent with the fourth quarter last year. Insufficient BC coastal kiln capacity limited incremental kiln-dried lumber production volumes.

We produced 688,000 cubic metres of logs from our coastal operations in British Columbia ("BC") in the first quarter of 2021, as compared to 167,000 cubic metres in the Strike-curtailed first quarter last year and 901,000 cubic metres in the fourth quarter of 2020. Harvest volumes and costs declined due to typical seasonal operating conditions. We lowered harvest production costs in the first quarter of 2021 through improved alignment of road expenditures and harvest volumes. We increased private timber production by logging the Orca Quarry land prior to its disposition, which did not incur stumpage expense and reduced requirements for higher cost purchased logs.

BC coastal saw log purchases were 195,000 cubic metres, an increase of 38% from the same period last year and a decrease of 12% from the fourth quarter of 2020. BC coastal harvest activity has improved market log supply while strong North American product pricing has increased log market competition.

Freight expense increased by $16.5 million from the same period last year. Freight expense grew as a result of higher shipment volumes and increased container costs. Global container supply disruptions caused a diversion of shipments to other markets and led to slightly higher ending inventory. We partly mitigated the impact of limited container availability and rising container costs by directing more shipments to North American markets and by using other modes of transportation.

Selling and Administration Expense

First quarter selling and administration expense was $14.3 million in 2021 as compared to $6.4 million in the Strike-curtailed first quarter last year. Record financial results and rapid share price appreciation had a net incremental expense impact of $7.0 million. We continue to incur higher health and safety and IT costs associated with COVID-19 protocols and remote work requirements.

Record financial performance and a stronger market outlook drove an incremental $3.9 million in performance-based incentive compensation expense. An incentive compensation expense recovery in the first quarter of 2020 contributed to that period over period result.

The Company's shares appreciated by 41% in the first quarter of 2021, resulting in an incremental $3.1 million of mark-to-market expense on long-term compensation liabilities. First quarter mark-to-market expense was $1.9 million in 2021, as compared to an expense recovery of $1.2 million in 2020.

Other Income

We recognized other income of $16.7 million attributable primarily to gains from the sale of non-core assets. In the same period last year, we realized $1.6 million of other income largely resulting from gains on the sale of obsolete operating equipment.

Finance Costs

Finance costs were $0.9 million as compared to $2.2 million in the first quarter last year, due to a lower average outstanding debt balance. As at March 31, 2021, we had returned to a net cash position.

Income Taxes

Record first quarter operating earnings led to income tax expense of $10.3 million for the first quarter of 2021, as compared to an income tax recovery of $8.4 million in the same period last year.

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