Ta Ann dossier

This is a background note on the financial aspects of  Forestry Tasmania’s (FT’s) major customer Ta Ann Tasmania, as the new FT Board contemplates its future.

With a lack of continuity on the Board and uncertainty whether FT management will relapse back to the unfortunates ways of the Kloeden/Gordon era, this is a quick summary for new Directors of tawdry Ta Ann, its profit shifting activities and how it operates as part of a group which dwarfs FT in size and profitability yet is funded by the Australian taxpayer and partly underwritten by an insolvent FT.

·       The initial deal and subsequent changes

Ta Ann Tasmania (TAT), a wholly owned subsidiary of Ta Ann Holdings Berhad, domiciled in Malaysia, signed a wood supply agreement with Forestry Tasmania (FT) in January 2006. FT’s CEO at the time was Evan Rolley.

A rotary peeler veneer mill, constructed in the Huon to process contracted timber, commenced production in the 2007 year. (NB TAT reports on a calendar year basis).

The wood supply agreement contained an option to build a second veneer mill in Smithton. The option was exercised in 2007. The agreement meant additional timber of 115,000 tonnes (the Smithton wood supply) would be supplied taking the contracted annual amount to 265,000 tonnes. Smithton veneer production commenced in 2009.

Three tonnes of green timber makes approx 1m3 of veneer. The veneer was shipped back to the parent company to make industrial plywood. The veneer mills also source timber from private growers including plantations.

During the 2013 year as part of the so called forest peace deal negotiations, Ta Ann surrendered 108,000 tonnes of contacted timber.

·       The plywood mill

TAT current quota of 157,000 tonnes is enough for 50,000 m3 of veneer. The capacity of the Smithton ply mill is 48,000 m3.

We are yet to see any figures from the ply mill.

One thing we can be sure about is the location of the plymill in Smithton will mean that nearby coupes will have lower transportation costs than more distant ones. With contracts based on mill door delivered prices FT will favour nearby coupes.

Like Lapoinya for instance.

·       Government assistance

FT contributed $2.4 million to TAT by way of redeemable preference shares in TAT in 2006. The shares have since been redeemed.

TAT paid $100,000 to FT for the Smithton wood supply option (exercised in 2008). TAT received a grant of $7 million conditional on constructing the Smithton veneer plant as part of the Tasmanian Forest Industry Development Grant process.

Such was the level of outrage from other recipients that grants were taxable; all recipients received another 30% in compensation. The strength of the forest industry lobby was glaringly apparent. As was their shameless opportunism.

TAT received $10.3 in grants over the year 2007 to 2009 to assist with the construction of the Smithton veneer mill.

Compensation totalling $26 million was received in 2013 and 2014 for the surrender of 108,000 tonnes of quota. The amount was taxable.

A further amount of $7.3 million was received in 2015 (a further $200,000 is expected in 2015.....financials not yet available) to assist with the construction on the Smithton ply mill completed in 2015. This amount was also taxable.

Government assistance to TAT to date has totalled $44 million.

·       TAT’s balance sheet

Property plant and equipment on TAT’s balance sheet at cost is $93 million. This includes the new Smithton ply mill, almost complete at last balance date.

There are no borrowings save for loans from the parent entity.

Working capital is not an issue as TAT only has one client, its parent company.

Accounting losses to date have been $19 million. These have resulted from profit shifting to the parent entity (see below).

TAT’s equity represented by contributed capital and loans from associates after netting off receivables totals $60 million.

Given government assistance has totalled $44 million, a cynic may argue the difference of $16 million is the parent company’s net contributions, mostly represented by second hand machinery transferred from Malaysia.

TAT is essentially an operation conducted for the parent’s benefit largely funded by the Australian taxpayer.

·       TAT profitability

In five of the eight years of operation for which financials are available revenue was insufficient to cover the factory costs (ie before overheads) of producing veneer. Factory costs include logs supplied as peeler billets, factory wages, other direct factory costs and depreciation).

Losses to date have been $19 million. This is after government grants being included as income

According to FT’s figures the mill door value of logs is $62 per tonne. For 1x m3 of dry veneer that implies $186 worth of timber inputs. Together with other factory inputs, total factory costs are around $350 per m3 of veneer.

Overheads run at around $5 million, which depending on throughput, is currently adding between $60 and $90 to the cost of each m3 of veneer.

TAT has three ways to easily shift profits to its parent:

·       Interest on loans.

·       Foreign exchange losses on intra-group hedging and dealing in $AUD and Malaysian Ringgit.

·       Adjusting the selling price.

The best year was the 2011 year where production was 130,000 tonnes of veneer and sales were 135,000 tonnes (the difference was from inventory). The selling price was $365 per m3. Factory costs were $325 per m3 in that year, the best to date. However profit was only $1 million.

In every other year there have been losses before grant income. Over the period 2012 to 2014 trading losses were of such magnitude they were almost enough to absorb  $33 million of grant and compensation income received in those years. At a tax rate of 30 c in the $, that’s a tax savings of $10 million which together with the plywood mill grant of $7.5 million was enough to build the $15 million ply mill.

A bit of profit shifting was all that was needed to ensure the Australian taxpayers fully funded the new mill.

There have been years when sales revenue as per the cash flow statement could not be reconciled with the income statement simply by making the necessary adjustments for accruals. The answer lay in the associate’s loan account where ‘sales adjustments’ were recorded, reducing sales in the income statement by, in effect, saying it was a loan not a sale. Even though the cash flow statement indicated the receipts were sales, a sales adjustment soon converted the sales to loans. Losses were thereby increased.

The selling price bottomed in 2013 at an extraordinary low figure of $203 per m3, well, well below cost. Given that it takes 3xtonnes of green timber to make 1xm3 of veneer this was less than woodchip prices.

Massive profit shifting made it possible to absorb almost all the profits from the $33 million in government handouts. The 2014 financials, the latest available show tax of only $450,000 due. It was an impressive accounting performance.

·       Compensation: How was it calculated?

TAT’s accounts show the Smithton wood supply agreement covering 115,000 tonnes per annum has a cost of $100,000.

Yet in 2013 108,000 tonnes of overall contract was surrendered for a price of $26 million.

How it is possible for a company that sells its product at below factory cost can receive compensation for scaling back its activities and reducing the losses? If it were a loss of profits claim made pursuant to an insurance policy, would an insurance company cough up that much?

So was it compensation payable to the parent company for the loss of profits that were shifted abroad?

It seems TAT has secured the best of both worlds.

It is able to shift profits overseas and create losses yet is still able to claim loss of profits compensation.

The windfall compensation coincided with a payment to Mr Rolley now a local director of TAT and a small vineyard operator, for $150,000 worth of wine (including GST). As he assured The Mercury at the time the matter became public it was an arm’s length arrangement. The wine was needed to entertain TAT’s customers.

This seems an unlikely story.

TAT only has one customer.

·       TAT as a major FT customer

FT has more than one customer but TAT is the largest since the demise of Gunns.

In 2007 the Ta Ann contract of 265,000 tonnes was less than 10% of the amount being removed annually from publicly owned native forests.

 In 2006 native forest harvest from public land was 2.8 million tonnes. In that year high quality sawlogs of 330,000 tonnes , cat 2 and 8 sawlogs of 85,000 tonnes, pulpwood of 2.2 million tonnes and regrowth peelers of 150,000 tonnes were taken from public lands.

FT had equity of $400 million back then. It was larger than Ta Ann’s parent when it negotiated the Wood Supply Agreement.

Now the picture is completely different. FT has zero equity making losses funded by the taxpayer.

Ta Ann Holdings Berhad had net equity of $400 million at December 2014. In the 2014 year it made $63 million before tax. From a pure accounting perspective, from a return on equity, that’s a pretty good result.

The plywood division contributed $7.5 million or 12% of the Group’s bottom line after the oil palm division (49%) and logging (39%).

The plywood division only has borrowings of $29 million. During 2014 as it embarked on significant capital expenditure to build the Smithton ply mill and add another 25% to the manufacturing capacity of the plywood division, the division was reducing debt using the proceeds of Australian government handouts.

The plywood division’s borrowings are now, in effect, completely underwritten by FT, a company with zero equity operating only because of the State government’s letter of comfort.

Given that 40% of TAT’s peeler billet entitlement was surrendered for $26 million, the remaining entitlement must be worth more than current borrowings of $29 million.

We were told at the time of the original wood supply agreement that supply to Ta Ann could easily be achieved by diverting a few logs otherwise destined for the chipper. Ta Ann logs would be sourced from arisings, the residue of sawlogging operations.

We now know public forests were being overcut, FT was starting to wonder how it could continue to supply its mandatory minimum amount of high quality logs of 300,000 tonnes per annum. Native forest woodchipping was levelling off before dramatically falling after 2008/09.

Ta Ann quota is now 157,000 tonnes and the minimum high quality sawlog requirement is 137,000 tonnes. The need to honour the Ta Ann wood supply contract is now the principal stated reason for logging the much publicised Lapoinya coupe. Peeler billets are no longer, if indeed they ever were, arisings from high quality sawlog production.

The tail is now wagging the dog.

It is mind boggling to realise all the work to establish sustainable harvest levels for public forests is now being set aside whilst the search party is out to find a level of logging for a sustainable FT.

Assumptions of 80 to 90 year rotations used to calculate sustainability in native forests are being trashed if logging small 60 year old regrowth coupes like Lapoinya, with only 245 tonnes of immature logs per hectare still occurs.

The coupe is a good example of a poorly managed production forest being logged 20 to 30 years before time.

FT says it’s an above average coupe.

If that the case the end for FT is not far away.

There can be no conclusion other than the Lapoinya coupe is being logged to satisfy Ta Ann Smithton’s contracted amounts. Approximately 4,000 tonnes is destined for Smithton. The mill door delivered price based on FT figures is $250,000. After harvest and cartage FT will be lucky to clear $80,000, which even with revenue from sawlogs and woodchips won’t be enough to cover roading, replanting FT wages and all the other overheads.

No self respecting forester will argue logging Lapoinya reflects sound forestry practices.

It’s just belligerent stupidity, born of contractual necessity and driven by a short-sighted view of profits.