Directors’ Report

The Directors of Timberlands West Coast Limited (Timberlands) present the tenth Annual Report together with the financial statements of the company for the year ended 31 March 2000. The following comments are in accordance with the requirements of Section 15 of the State Owned Enterprises Act 1986 (SOE Act), and other relevant legislation, and are designed to enable an informed assessment to be undertaken of the affairs and results of Timberlands.

Statutory Obligations
The principal objective of a State Owned Enterprise (SOE) is to be a successful business. This is a clearly prescribed requirement of the SOE Act. Incidental to this over-arching obligation is the need to be as profitable and efficient as comparable businesses, to be a good employer, and to exhibit a sense of social responsibility to those communities in which the company is carrying on business. Throughout its ten year history, Timberlands has consistently endeavoured to balance these statutory demands in an environment which frequently has had its own competing pressures.

Principal Activities
Timberlands’ primary function is to grow high quality plantation forests from which it can sell logs at a profit. It must achieve this in an environmentally sensitive manner, and be responsive to the needs of the communities in which it operates. Of critical importance in more recent years has been the company’s role in developing ecologically sustainable management systems for harvesting New Zealand’s indigenous forests on the West Coast of the South Island. The plantation logs are supplied to both the domestic and export markets, whilst the indigenous logs are processed domestically. The company’s most significant capital obligation is the growing of the plantation forests until they reach sustained yield volumes in 2003/04. Timberlands is also establishing Special Purpose Species (SPS) plantations in South Westland as part of the development programme agreed with the Crown.

Financial Performance
The financial performance of Timberlands can be summarised as follows:

Net Taxation Before Profit
Net Taxation After Profit
The company concluded the year with an after tax net profit of $4.23 million (1999 $4.87 million), generated from sales of $24.85 million (1999 $24.12 million). In a year of quite considerable change, and a large measure of operational uncertainty, the Directors regard the latest result as most acceptable. In all significant respects, the financial targets contained in the 1999/00 Statement of Corporate Intent (SCI) were exceeded.

Shareholders’ funds currently stand at $75.97 million (1999 $86.73 million), a decrease of $10.76 million. This drop in net equity is substantially attributable to the write down in the book value of the exotic forest estate, which in turn reflects the Directors’ re-assessment of the future returns capable of being generated from the harvesting of the forests concerned. The calculation of value is extremely sensitive to market related variations in price per cubic metre.

The Directors have also updated the value of the rights to harvest the podocarp forests but, in view of the uncertainty in connection with Timberlands’ ability to access these forests for commercial purposes, the Board has determined that the balance sheet value should not be amended this year. It is also of note that, whilst the SPS estate has been assessed to have a present worth of approximately $15 million, no value beyond cost has been ascribed to this asset in the accounts. The harvesting of these species is still some fifteen years away.

Trading Results
Gross revenues from the sale of exotic logs were 2.2% down on those anticipated in the SCI. This was comprised of a favourable volume variance of 5.5%, which was partially offset by an adverse price variance of 3.3%. The aggregate sales value of rimu logs was up by 18.1% on the SCI projections. Actual average prices exceeded targets by 20.2%, and these benefits were reduced by volume shortfalls of 2.1%. The beech results were basically in line with management’s volume and pricing expectations.

The overall cost of producing logs is up in comparison with both last year and the SCI forecasts. In the case of exotic sales, production costs are very much consistent with budget, notwithstanding the increased volumes of wood extracted. However, the logging costs of rimu have risen quite sharply with the longer helicopter flights undertaken to minimise the ecological impacts of field operations generally, but particularly those conducted in the Buller region. Overheads are consistent with the SCI projections.

West Coast Community
The Board of Timberlands continues to be aware of the importance of the timber industry to the people of the West Coast. The company is therefore concerned to ensue that the local industry remains viable over time. This is in the interests of both Timberlands and its customers.

In recent years, the proportion of Timberlands’ plantation sourced logs processed on the West Coast has ranged from between 65% and 85% of total production. At 31 March 2000 this factor was 72%. These high levels of supply to the West Coast mills acknowledge the company’s desire to satisfy local demand before looking for sales opportunities elsewhere. Clearly, the application of this policy must be accompanied by a prudent approach to credit and commercial risk.

It must also be recognised that the volume of low-end logs produced by the company is unlikely to warrant new capacity being constructed to have this material processed on the West Coast. In addition, approximately 2% of the company’s production is in high quality veneer logs that are necessarily processed outside the region with the lack of appropriate capacity on the West Coast. These circumstances alone, which are obviously beyond the control of Timberlands, have resulted in up to 20% of the company’s plantation logs being processed elsewhere.

The Estate
With the inclusion of the SPS estate in South Westland, it will not be until after 2020 that the company’s forest development programme will be complete. Although the Pinus radiata forests in the north are in their final stages of development, considerable expenditure is still required to bring these forest holdings to their sustainable yields of production. This should be achieved in 2003/04. These volumes will again increase significantly in about twenty-five years time when the plantings in the 1990’s come on stream.

The average cost of producing the current exotic volumes is therefore greater than that which will ultimately apply when the total estate is in full production, and the full economies of scale are finally achieved. In recent years between 80% and 150% of reported profits have been reinvested in growing the exotic and SPS estates. In the latest financial year about 94% of the pre-tax profit was capitalised and added to the balance sheet values of the assets concerned.

This programme of intensive silviculture over many years has drawn heavily on the company’s free cash flow, and has denied Timberlands the ability to pay a regular dividend.

Market Conditions
Whilst Timberlands itself sells mostly into the domestic market, its customers are predominantly engaged in export activities. The hangover from the Asian economic downturn still adversely affected the company’s sales in the first quarter of the reporting period. However, demand subsequently has improved and remains strong.

Timberlands has developed a reputation for high quality and distinctive plantation wood, and this should secure ongoing demand at competitive prices. Even the lower grade material which was difficult to move at the beginning of the fiscal year is now back in demand. Rimu is being uplifted at the contracted levels, and prices are anticipated to progressively improve. Demand for beech logs was steady throughout the year, but harvesting came to an immediate halt in December when the Government issued a directive requiring Timberlands to stop the felling of beech on Crown owned land.

Curtailment of Beech
After years of intensive planning by Timberlands for the development of beech on a commercial and fully sustainable basis, and some millions of dollars of associated cost incurred by the company, the new Government determined in December 1999 that the harvesting of beech was not an appropriate business for Timberlands to undertake. Accordingly, the company’s SCI for the 1999/00 year was required to be amended to remove all reference to beech.

However, Timberlands had earlier in the year, and in all good faith, entered into contracts with customers for the supply of 48,000 cubic metres of beech per annum for periods of up to eight years. On receipt of the directive from the Government, Timberlands formally suspended these contracts and the related resource consent applications before the Buller and Tasman District Councils. This action was taken pending the outcome of litigation brought by the aggrieved beech customers against the Crown which questioned the authority of Shareholding Ministers to issue the directive in the manner and circumstances involved. In the event, the claims by the plaintiffs were dismissed, and Timberlands then proceeded to cancel the beech contracts in reliance on a force majeure clause contained in them.

Whilst Timberlands is clearly obligated to conform with Government policy, and will continue to do so, it was with genuine regret that the Directors received the revised policy direction regarding beech. The company’s confidence in the commercial prospects for this species had been reaffirmed by the level of customer interest displayed in the product, there was good reason to believe that the Resource Management Act requirements would be deemed satisfied during the course of hearings before the District Councils, and the company believed it would receive international recognition for developing an ecologically sustainable basis for the harvesting of indigenous wood. In the event, with the directive from the Crown, none of this was to be.

Status of Rimu
It is now widely known that the term of the so-called Buller over-cut was reduced by six years, and will now terminate at the end of this calendar year. From that point forward, only sustainably managed volumes of extraction will be permitted. The volume of cut will fall from the current year’s level of 30,400 cubic metres to 23,800 cubic metres next year and 11,300 cubic metres per year thereafter. This reduction in podocarp volumes has a significant effect on Timberlands’ earning potential in the medium term, and will continue to do so until the increased exotic production comes on stream in 2003/04.

Of greater importance is the recently announced Government proposal to cease all indigenous production on Crown owned land by 31 March 2002. Whilst Shareholding Ministers have indicated a desire to consult with the Board in this regard, no time has yet been indicated for this purpose. The foregoing change is accompanied by the intention of Government to end the 1986 West Coast Forest Accord (the Accord) in accordance with the provisions contained in the Forests (West Coast Accord) Bill 2000 (the Bill), which is currently before the House of Representatives. The intent of the Bill is to set the West Coast Accord aside with effect from 10 May 2000.

Regardless of any merit from an environmental standpoint, adjustments of this magnitude are not easily accommodated by either the sawmillers on the West Coast or the furniture industry at large. It creates uncertainty in relation to ongoing supplies, renders business planning difficult, and undermines investment decisions based on the status quo.

Year 2000 Compliance
There were no Y2K problems experienced with the advent of the new millennium. This is particularly pleasing as the company had taken the opportunity during the planning phase to extensively test and upgrade the hardware and software systems.

Quality Initiatives
Timberlands remains committed to high quality standards, a fact well recognised in the achievement of ISO 14001 certification for all of its operational activities. Worthwhile efficiency gains have already been extracted in key areas and, with the changing shape of the company’s business, further cost economies will be rigorously pursued by the Board.

Ngai Tahu
Timberlands has recently entered into a long term Forestry Right with Ngai Tahu. This follows the transfer from the Crown to Ngai Tahu, by way of settlement under the Treaty of Waitangi, of much of the land on which the company’s plantation forests are growing. The Directors welcome the opportunity to work collaboratively with Ngai Tahu to maximize the productive capacity of the land concerned.

The Directors are appointed under the Constitution for varying terms. Mr J B Falconer was appointed on 29 September 1999 for a period of up to three years, and Mr J F S Baldwin retired on 31 March 2000.

Directors’ Interest
There were no interests registered by Directors during the year which require statutory disclosure.

Insurance of Directors
During the year the company paid premiums insuring all Directors in respect of liability and costs to the extent permitted under Section 162 of the Companies Act 1993.

Use of Company Information
No notices were received from Directors requesting use of company information received in their capacity as Directors, which was not otherwise available to them.

Share Dealing
The company is a State Owned Enterprise and Ministers of the Crown hold all of the shares.

Committees of the Board
The board has formed an audit sub-committee. The function of the committee is to assist the Board in carrying out its responsibilities under the Companies Act 1993 and the Financial Reporting Act 1993.

The Auditor, being the Office of the Controller and Auditor General, continues in office pursuant to Section 19 of the State Owned Enterprises Act 1986, and has appointed Ernst & Young under Section 29 of the Public Finance Act 1977 to undertake the audit on its behalf.

The domestic market is rather subdued, with a softening of prices. This is particularly true with building grade material. Climbing interest rates and a weakening dollar do not in the short term augur well for domestic investment or capital outlay. In the housing market, new starts have fallen since the beginning of the 2000 calendar year, and permits for renovation work are well down.

The export market, of most relevance for the customers of Timberlands, is reasonably buoyant. Offshore prices are very competitive, but the fall in the New Zealand dollar is producing better returns for exporters. Volume exports to the Asian markets are increasing, and there is no reason to believe that this improving trend will falter. Demand from Australia for processed product is strong, with prices currently firm, but greater competition from North American suppliers could see this position change quite quickly. Timberlands’ volume projections for next year currently stand at 190,000 cubic metres of exotics and over 23,000 cubic metres of rimu. These targets should be comfortably achieved.

The company has concluded a year of notable change, both current and prospective. Its business has been significantly curtailed, the financial outlook has been rendered more uncertain, and the customer base is restive. Having said that, Timberlands has adjusted well to challenge and change in the past, and will continue to do so in the future. That this is possible is a credit to those that work so ardently for the well-being and improved performance of the company. The Board wishes to acknowledge that commitment, and accordingly extends its appreciation to all staff.