Appendix-A

Financial State of the Forest Industry and Delivered Wood Cost Drivers

Appendix A
Terms Of Reference

Background

The forest industry has historically been subject to market cycles. There is a growing concern at this point in the current cycle, however, that the longer term competitive position and financial viability of the industry may have been permanently impaired by increases in wood costs resulting from both higher timber prices (stumpage and royalties) and increased logging costs.

At the December 5, 1996 meeting of the Forest Sector Strategy Committee, and at a December 18, 1996 meeting with a number of deputy ministers, senior industry representatives presented a paper entitled "Industry on the Brink" which, among other things, presented estimates of the profitability of the Industry by sector through the first nine months of 1996.

The presentation argued that the Industry is not making an adequate return on capital and that its financial viability is being crippled by:

High stumpage;
Lack of recognition of cost impacts on Industry from the Forest Practices Code and other factors.

Reflecting this concern about the information presented, the government representatives indicated their intent to undertake a project that would provide objective, independent information upon which efforts to resolve the problems facing the Industry could be based. Industry representatives indicated their willingness to co-operate in this project and that their books would be open to those undertaking it.

Project Objective

The objective of the project is to provide Industry and government with mutually acceptable background information that will underlie and support both in efforts to resolve the issues facing Industry. That includes information about the financial state of the Industry and information about delivered wood cost drivers. The study will not include recommendations about how to address the issues.

Project Description

Using detailed financial and cost information made available by Industry, the project will be comprised of two tasks:

1. Review of Financial Performance
The purpose of this task will be to assess the seriousness of the current situation by reviewing the financial information through the first nine months of 1996 contained in the presentation, "Industry on the Brink," evaluating the methodology employed to generate the aggregate results, analyzing the underlying data in detail to determine, for example, the extent of regional and sectoral variations, and putting the overall results in context. The examination will include all of the sectors in the Industry: Lumber - Coast/Interior, Plywood/Veneer and Pulp & Paper.
2. Analysis of Delivered Wood Costs
The purpose of this task will be to assess the delivered wood cost structure of the forest industry by examining the cost drivers associated with forest industry activities related to supplying wood fibre to processing facilities. This will be done by reviewing and analyzing data collected by Price Waterhouse as well as additional data collected directly from participating companies. Where possible, the analysis will build on previous work in the area such as Price Waterhouse's January 1996 report, "British Columbia Forest Industry Forestry and Logging Costs 1992 - 1996."
The data will be collected on a company-specific basis, recognizing that different companies will have different quantities and types of data available. Within companies, data will be collected based on geographical units, where possible. The objective is to identify the factors contributing to the current level of costs and to cost increases in recent years, to quantify the impacts of those cost drivers to the extent possible and to determine the extent to which there are geographical variations. At a minimum, that will involve a separate examination for the coast and interior regions of the province.
The methodology for identifying the delivered wood cost drivers will be developed with input from the industry and appropriate officials in the Ministry of Forests. The identification and quantification of cost drivers, including but not limited to elements of the Forest Practices Code, is the primary objective of this part of the project. The analysis will depend critically on the financial accounts maintained by the companies and will be key to those companies with the most detailed accounts for, or recent studies of, wood costs.

Project Reports

Project results will be documented in a preliminary report to be delivered by February 24, 1997 (four weeks from the project start-date of January 27, 1997) and in a final report by the end of March, 1997.

Confidentiality

Maintenance of strict confidentiality of detailed company-specific cost data in a competitive industry such as the Forest Industry is of upmost important to ensure the full co-operation of industry participants. KPMG will collect and manage all such data and will accord it with the same standard of care accorded data collected during auditing and company-specific consulting work. The preliminary and final reports will not directly or indirectly disclose any company-specific data.

Ministry of Forests access, if any, to company-specific data will be under the following condition:

To be determined, if any, through mutual agreement of Ministry and CEOs concerned.

The project will be undertaken jointly by Dan Perrin of Perrin, Thorau & Associates Ltd., Tom Simons of H.A. Simons & Associates Ltd. and a team of accounting professionals and management consultants with KPMG. Contract costs for Perrin, Thorau & Associates Ltd. and KPMG will be borne by the Ministry of Forests. Costs for the services of Tom Simons and any charges from Price Waterhouse will be paid by the industry.