Conifex Timber Inc.

Good afternoon ladies and gentlemen. Welcome to the Conifex Timber Incorporated 2021 Q1 results conference call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well thank you and good afternoon everyone and welcome to this call covering our Q1 2021 results. With me today we have Chief Financial Officer Winnie Tang and Operations VP Andrew McClellan. So I'm going to make some opening remarks and then I'll hand the call over to the two of them and then I'll have some closing comments at which time all three of us will be pleased to respond to your questions. Before moving ahead, first we wish to re-emphasize that our number one priority continues to be protecting the health and safety of our employees and their families. And the men and women at our harvesting locations, our sawmill site, our power plant, they all deserve the credit for ensuring a safe work environment during this unprecedented global pandemic. Second, let's quickly deal with a housekeeping item. We will be making forward-looking statements and references to non-IFRS measures and therefore call your attention to the warning statements set out on pages one and two of the MD&A document that we released earlier today. Turning to our first quarter, net earnings were $4.5 million or 10 cents per share and EBITDA was $9.7 million. And I know many of you skilled and knowledgeable forest products analysts on this call were expecting stronger results from us in the first quarter. One reason our Q1 results came in below consensus was that we expensed 13 weeks of power plant costs but produced electricity for only six weeks. On our last call, we alerted you that the proceeds from our business interruption insurance claim will likely be booked in Q2 or Q3 of this year. Had we booked what we estimate the insurance proceeds to be, Q1 EBITDA would have been right in line with consensus. The other reason that our Q1 results came in below consensus was that we only shipped 10 weeks of the lumber we produced in the 13-week reporting period. Although Q1 lumber production climbed to 51 million board feet, shipments of 37.8 million board feet were much lower. Our ratio of SPF shipments to production was 74%. Far below the 90% shipment to production ratio, BC's two largest SPF producers averaged in Q1 of 2021. Clearly, CN railcar delivery shortfalls were more pronounced in the Mackenzie region than in other parts of the province. To mitigate the buildup in finished lumber inventories, our sales and logistics team stepped up truck deliveries, and by doing so we incurred extra delivery costs in the quarter. Subsequent to the quarter end, we shipped the lumber that was built up. The mill net selling prices we realized on these shipments were $200 per thousand board feet higher than we achieved on our Q1 shipments. The key point here is that besides lowering revenues, railcar shortages added to our costs and lowered the mill net selling price realizations we recorded in Q1. Had we achieved a ratio of shipments to production in line with the two majors, we would have exceeded consensus Q1 EBITDA forecasts. We are encouraged that to date in the current quarter, railcar deliveries have improved and weekly shipments have consistently exceeded production. Should this continue for the next few weeks, our lumber production and shipments are expected to be in balance by the time we report results for Q2 in this year. I now have the pleasure of turning the meeting over to Andrew McClellan, our Vice President and General Manager, Northern BC Operations for Connex.

Thank you very much, Ken, and good afternoon, everyone. Let's start with lumber. Our Q1 lumber production was 5% higher than Q4 of 2020. However, our shipments were approximately 23% lower. On my last call with you, I explained how we and certain other sawmillers in the Northern Interior region of BC experienced challenging weather conditions last winter, which led to log harvest and delivery shortfalls and retarded lumber production in the first half of 2021. We plan to boost lumber production as soon as we have the benefit of summer log deliveries starting next month. We continue to anticipate our full operating rate will exceed 90% of our two shift rated capacity of 240 million more feet in 2021. Any number of pandemic related or unanticipated production and or shipment disruptions could hold us back and prevent us from achieving the production target. However, on a full year basis, 2021 lumber production is anticipated to be 70% higher than our 2020 results. The BC Ministry of Forests has a timber supply review underway for the Mackenzie Timber Supply Area. The Chief Forester expects to release a new harvest level determination sometime around the end of the year. We have two major studies underway at present that are related to this coming announcement. One focusing on the characteristics of the saw log supply we expect to process over the next decade and beyond at our sawmill facility. And a second study focusing on the potential to boost our lumber production capacity at Mackenzie by approximately 25%, lower our cash conversion costs, as well as improve our lumber recovery and great outturns at our Mackenzie facility. We expect to settle our plans for expanding and modernizing our Mackenzie sawmill site shortly after the release of the new harvest level determination. I'll turn now to the power generation business. Our power plant continues to achieve its daily power production targets since the plant restarted in late February. And at this time, I'll turn the discussion over to my colleague, CFO Winnie Feng. Thank you.

Thank you, Andrew. And good afternoon, everyone. And just so we're turning to finance, overall debt at our core end totals approximately $62 million. This is mainly represented by a long-term power loan with limited recourse to our lumber operations, a fixed interest rate, and a lengthy amortization period. After deducting cash balances, we ended quarter four with net debt of $49.9 million, a net debt to capitalization and realize ratio of 29%, and available liquidity of $16.4 million. The $10 million revolving credit facility we had arranged late last year remains undrawn. In December 2020, we had commenced our normal course issuers bid, which allowed us to repurchase and cancel up to 2.9 million shares. To date, we have repurchased and canceled 922,800 shares at an average price of around $1.60 per share. We view share buybacks as an appropriate use of the excess cash we anticipate generating in Q2 through to the balance of the year. We continue to believe our share price trades well below our estimate of fundamental value. I will now turn the meeting back to Ken.

Well, thanks, Winnie and Andrew. Just as a reminder, we differ from the major public SPF producers in the sense that we pay duty deposits on nearly all our lumber shipments. The other public SPF producers do not. Accordingly, duty deposit expenses impact our pre-tax earnings to a much greater extent than the other public companies. For example, we achieved pre-tax income of $6.3 million in Q1 of this year after expensing $2.5 million in duty deposits. For us, duty deposit expenses represented just under 40% of our pre-tax income, while it ranged between .5% to .2% of pre-tax income for the larger, more diversified SPF producers. It follows that if there is a resolution of the trade dispute, and furthermore, duties are eliminated, it's clear that the impact on cash flow generation in our company will be considerably greater than for the other public companies. As a corollary to this point, we are building an off-balance sheet asset in the form of potential duty refunds, and these duty refunds will likely represent a greater proportion of our equity market capitalization than is true for the larger, more diversified companies. We now have $12.3 million US on deposit that is potentially refundable to us. Given our expectations for lumber prices and shipments for the balance of 2021, this number will likely exceed US $20 million by the end of the year. This will represent a materially higher percentage of our present equity market capitalization than is true for the other companies. While we appreciate that the timing of a settlement and the likelihood of a full or partial refund of duties is highly uncertain, history suggests it's highly likely that our balance sheet will be further strengthened at some future date. Before turning the meeting over to your questions, we are pleased that we had the ability to release our inaugural ESG report this afternoon. All of us at ConFX are very proud of the track record we've compiled in terms of each of the metrics covered in the report. In closing, lumber markets are strong, and we expect to report record Q2 and full year earnings for the reasons set out on slide 11 of the presentation we released an hour ago. So thank you for taking the time today to learn more about ConFX. We're pleased to answer any questions you may have, so we'll turn the meeting back over to Roxanne, our offer.

Thank you. Please press star 1 at this time if you have a question. When prompted by the system, please clearly state your name to register your question. There will be a brief pause while participants register for questions. Thank you for your patience. We will take the first question. Please go ahead. Hi,

Ken. You brought up a point about your duty burden being higher than some of your peers. I guess I'm just curious, in this very strong market, what is even compelling you to sell into the U.S.? I'm assuming there's no Canadian discounts, so why wouldn't you try to place all the products domestically?

Well, first of all, when we reviewed that this morning at our board meeting, we found that the MillNet sales price realizations, depending on the product, were pretty similar between the two markets. We're selling roughly 80% in the U.S. The customers that we have in the U.S. have been loyal to us for a long period of time, effectively, Lumber's on allocation. The people that have been supporting us through good and bad lumber markets are being served now. We have about 8% of our lumber going to Japan. There's a definite lower realization on Japanese lumber prices because those prices are set up in advance. As you well know, cash lumber prices have increased $500 per thousand board feet in the last five weeks, and they'll be up again when they're reported tonight. Japan has low realizations, but it typically has fully competitive realizations. That's how we're looking at the business here.

Okay, thanks Ken, that's helpful. Andrew, I wanted to follow up on the capital project that you mentioned, or potential capital project at McKenzie, which could potentially drive a 25% capacity increase. If you were to go down that road, what would be the capex and timing of how quickly that production growth would come on?

At this point, Hamir, we're engaged with an engineering firm and preliminary design and general arrangements are available. We're currently working on identifying lead time for equipment. It would be a bit early for me to give an indication in terms of timing or capital at this point, but we have committed the funding to do the front-end engineering work and come up with those answers likely in Q2 or Q3.

Last one for me, Ken, the Premier made a lot of comments about how he wants things to evolve in BC with forestry policy and tenure. I'm just curious to get your thoughts as to how that potential changes could impact con effects and your fiber baskets specifically.

Okay, well, that's a very meaty question that you've posed, Hamir. Here's our take on the situation. There are two important announcements expected later this month. One is the release of the intentions paper, which I think will provide more detail on some of the comments that the Premier made at the COFI convention in early April. And the second is the allotment of the harvest in the Prince George Timber Supply Area, which is the largest TSA in the interior region of BC. And about three and a half years ago, the Chief Forester concluded that the harvest level needed to be established at a considerably lower level than it was previously when there was still some pine beetle salvage harvest activity underway. But the Ministry has never disclosed how they intend to divide up the harvest between BC timber sales, between First Nations, and what portion would be remaining for licensees. So it seems clear to me that certainly con effects' expectation is that in order to remain at your present level of fiber sales efficiency, you're going to have to have some log purchase agreements or arrangements with First Nations. So the effect on BC, in BC one thing we know for sure is that the harvest levels are going down over the next few years because the salvage programs are close to being exhausted. And the second conclusion is that for many companies, their degree of fiber self-sufficiency is measured by the tenures under their control and direction as a percentage of their total log requirements. That degree of self-sufficiency is going lower and there will be a heavier reliance on purchases from other tenure holders, mainly BC timber sales and First Nations. So that's what we see happening here and that's why we have, as Andrew explained, we're commissioning these reports so we can come up with an ideal optimization plan for McKinsey's site. But it's important to us that we know more about the volume and characteristics of the fiber available to us in McKinsey before we can finish our engineering work. So that's why it'll be late this year, like following the release of the TSR review, before we can precisely set the specifications for a modernization and upgrade and before we can estimate what the costs are. But we see no reason why we would be out of line with the industry in terms of modernizations and upgrades typically have a three to five year payback in terms of EBITDA. And we should be in that range based on everything I see today.

Great. Thanks, Ken. That's all I had. I'll turn it over.

Thank you. Once again, please press star one at this time. If you have a question, we will take the next question. Please go ahead.

Marcus Campo at Herbie C Capital Markets. Hey, good afternoon. Thanks for taking my questions. Hi, Marcus. Just with the mid-year stumpage revision coming up, do you expect that to impact your production costs at all? And if so, is there anything that you can do to help offset that?

We were again, scrubbing those numbers this morning. We have estimated that our delivered log costs in the calendar year 2021 will be about just somewhere between 20 and 25 percent higher than in the previous year. And two or three percent of the increase is due to a greener, better log mix. So we've got a slightly better quality log coming into the mill this year. And a bit of the increase is due to some general inflation in costs. But, you know, something in the high teens to the perhaps as much as 20 percent is due to escalating stumpage costs. That's how the numbers play out for us. And it's consistent with the possibility of a $30 per cubic meter increase in provincewide stumpage rates taking effect on July 1.

That's helpful. And then just on lumber futures, they took a bit of a dip today and caused some concern. What are you seeing in the market today? And do you think we've hit a turning point yet?

We had a discussion about that as well at our board meeting today. And what we found is that at various points in time, the futures market pulls up cash prices or pulls them down. And our sales desk reports that the cash market is stronger on Tuesday of this week than it was on Thursday of last week when random links reported the last cash prices, even though the futures had sold off the last two days. So there's a bit of a divergence there. You know, we don't know exactly how everything's going to shake out through the balance of the year. But what we've experienced, of course, has been incredibly beneficial to Connex. You know, on January 1 of this year, we had an equity market capitalization of $66 million and an enterprise value of about $115 million. And, you know, looking at where prices are at, you know, I suspect that our EBITDA this year will be greater than the 66. And I don't know if we'll make it into triple digits or not, but it's a whopping number relative to the value that our equity base was accorded at the beginning of the year. So we're feeling very good about how things are shaping up and what the increase in tangible net worth will be in our company. And that's the reason why we'll be back in the market on our buyback program as soon as the blackout period is.

Okay, sounds good. And then just on that share repurchase program, could you just remind us how you think about it? Do you have a target valuation that you're looking at or just taking the current market price as a spare value?

Well, one number that is often discussed is looking at book value because, you know, we find that a lot of the forecasts have these companies, including us, probably coming in at three times earnings, perhaps even lower. And not a terribly different enterprise value relative to 2021 EBITDA. So we look at book value and our book value is going to be certainly by the end of the year, it's going to be above the current market trading price. The other lumber producers are at 60 to 80 percent premiums over book value. And so we don't have any trouble tracking or having a repurchase program that tracks our book value increase over time.

Okay, thanks. I appreciate the details. Good luck with the current quarter. Thank you.

Thank you. We will take the next question. Please go ahead.

Brian Poticker. Hi, Ken. Congratulations on a great quarter.

Thank

you. So I'm curious as to and if you answered this previously, I got on the call late, but curious as to whether with these high lumber prices, you're hedging in any of those prices. And if so, could you give us a description of your hedging program?

Okay, well, it's a matter of public record that I think we're sort of in the middle of the pack in terms of hedging. We lost approximately 900,000 on our futures positions in Q1 of this year and we disclosed that. I'm aware of one other company that lost a little over a million dollars per sawmill on hedging and another company that did far worse than that. And I'm also aware of some companies that don't hedge. We think that we will prop. We currently are hedged on a portion of our production. It's way less than 10 percent of our production. But I think that we are going to use hedges to achieve a better balance between log costs and lumber prices. So earlier you heard that that log that stumpage rates in B.C. were going up a material amount per cubic meter of logs effective July 1. So we don't want to find ourselves paying stumpage rates based on say, $1,300 lumber and only be getting seven or $800 for that lumber. So we think there is a business argument to be made to work to try and achieve a balance between your anticipated stumpage costs and the prices that are available in the market to be sure you can cover those higher log costs.

Great. Thank you.

Thank you. There are no further questions registered at this time. I'd like to turn the meeting over back to Mr. Shields.

Okay. Well, thank you, Roxanne, for your service today. And Winnie Andrew and I all thank you for your interest in ConEffects and look forward to speaking to you when we release our Q2 results. Enjoy the rest of your day. Bye now.