Conifex Timber Inc.

Good afternoon, ladies and gentlemen. Welcome to the Conefax Timber Inc. Q3 2021 results conference call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, Omar, and good afternoon, everyone, and welcome to our call covering Q3 results. CFO Winnie Tang is here with me in Vancouver, and Operations VP Andrew McClellan joins us from our McKenzie site. And both of them are available to help you respond to questions that you may have later. Before moving on, we wish to reemphasize that our number one priority continues to be protecting the health and safety of employees and their families. And the men and women at our harvesting locations, sawmill site, and power plant deserve tremendous credit for ensuring a safe work environment and mitigating the risks arising from the recent upsurge in COVID infection rates in northern D.C. Let's deal with the housekeeping items. We will be making forward-looking statements and references to non-IFRS measures, and therefore call your attention to the warning statements that are on pages one and two of our MD&A dated today that we just released. For the third quarter, we incurred a net loss of $900,000, or two cents per share. EBITDA was $3.3 million. Lumber production was held back by a two-week market curtailment in late August. Lumber shipments were 15% lower than production because we purposefully built up lumber inventories by around $5 million. in anticipation of being able to attract higher sales realizations by liquidating the inventories in Q4, which is exactly what we're doing and is well underway. Our power generation business performed well in the third quarter and we expect another solid performance in Q4. Benchmark SPF prices were around $480 U.S. in Q3. And I agree with the analysts who may be on this call who have the opinion that prices at this level trigger operating losses of around $100 per thousand board feet of lumber produced at interior VC sawdust. But our consolidated results indicate that we shipped 34.1 million board feet in the quarter and achieved $3.3 million in EBITDA, which on a lumber equivalent basis translates into EBITDA of around $100 per thousand foot feet. And this vividly demonstrates the mission-critical role that our green power generation plan plays in moving our McKenzie site to a much lower ranking on the global software lumber industry cost curve. Stumpage rate increases took effect at the beginning of Q4 for this reason and also reflecting seasonal factors. We built up our log inventories by $14.7 million in Q3, and this is the main reason that our cash balances in the quarter declined by $12.5 million to $23.4 million. Looking ahead, we expect our financial results in the closing quarter of 2021 will be similar to our third quarter results. Although benchmark SPF prices will be higher in Q4, we expect our mill mint selling price realizations to be largely unchanged. Our shipments to the high-priced Japanese markets We'll be a lower portion of our shipments in Q4 than in Q3. Well, as we all know, we have higher duty deposit rates kicking in in December. And for those two main reasons, we expect our no-ment sales receipts will not track the change in benchmark prices in Q4. Turning to industry development, one week ago, the government in B.C. announced its intention to defer 2.6 million hectares of B.C.' 's old growth forest. With respect to next steps, the ministry has indicated details of the old growth locations have been shared with First Nations rights and title holders. And the province is requesting that First Nations indicate within the next 30 days whether they or not support the deferral. As you would all expect, our forestry team is hard at work evaluating how harvest levels in the McKenzie TSA could be impacted by this development. More importantly, however, our forestry team is working on a priority basis with local First Nations and the McKenzie TSA to ensure that we fully understand their perspective and to offer our support in the analysis and review underway. In the region where we operate, we truly believe it's entirely possible to adhere to best-in-class forest sustainability and conservation regimes while concurrently maintaining good-paying, family-supporting jobs for residents of Indigenous communities. As we go into in some detail on pages 14 to 16 of the MD&A we released earlier today, we explained how an error in a key ministry assumption underpinning a harvest mix determination led to unnecessary hardship for forest sector stakeholders, as well as the local community of McKenzie and nearby First Nations communities. We also outlined how recent ministry disclosures provide us a strong indication that the upcoming harvest determination will enable us and other licensees to access higher quality saw logs and provide good potential for sawmill complexes operating in McKenzie to migrate to a lower ranking on the global softwood lumber industry cost curve. We trust you understand and agree with us that we have no choice but to put our sawmill modernization and upgrade plans on hold until we have solid evidence that the ministry's taken concrete steps to restore competitiveness in the McKenzie timber supply area. And the ministry is doing a better job meeting the competitiveness obligations legislated in the Ministry of Forest and Rain Jack. While we await the harvest level redetermination we are taking advantage of an opportunity to explore how we can further enhance cash flow generation at a McKenzie power plant site. You know, I think the background of having a location and a relatively cool climate, the availability of a lot of affordable and renewable power from BC Hydro as the modes to its traditional resource sector is waning. Adding to that, that we've got a large site relative to the portion of the site occupied by a power plant. And we have a highly flexible and technical workforce at the power plant. For all those reasons, we concluded that our power plant site is ideally suited to host, and I emphasize the word host, data center for other high-performance computing operations, such as cryptocurrency mining. The expertise of our power engineers and technicians operating on a 7x24 basis are applied completely to this new business opportunity. Later this year, in partnership with the CKDMA First Nations, We intend to host approximately three megawatts of Bitcoin mining activity on a trial basis. Should we as hosts and the experienced Bitcoin mining operator conclude that the trial has been successful, we plan to build and host a larger data center operation. We expect the initial capital outweighs will be modest because we're going to redeploy the legacy power transformer and other infrastructure components that presently sit idle at the site. The potential exists to build out a hosting business in phases and utilize a portion of the cash flow from the initial phase to fund the development of additional hosting capacity. Although there's no assurance that we'll establish a material data center hosting operations, We're extremely excited about the potential and look forward to sharing more details with you on our next call early in 2022. As you've no doubt observed yesterday, our board approved the commencement of a substantial issuer bid for 4 million shares or just over 9% of our capitalization. at a purchase price of $2.25 per share. All the analysis we've undertaken includes that we can afford to fund a substantial issue or bid at this quantum and concurrently maintain a strong lumber business balance sheet and also fund projects that are necessary to remain compliant with enhanced safety and environmental regulations as well as smaller, quick payback projects that improve the operating reliability in our cell mineral complex. Obviously, we launched a substantial issuer bid because we believe our shares trade at a material discount to our underlying fundamental value. Coming up, we believe that Conifx remains well-positioned We enjoy a strong safety culture, a very high degree of solid fiber self-sufficiency compared to any other timber supply area in the interior region of BC. We've got near-term opportunities to benefit from improvements in fiber quality, availability, and delivered costs. We own and operate industry-leading power generation assets. We've got exciting opportunities to diversify and strengthen cash flow generation. And at the same time, we have entirely manageable debt service obligations. So thank you all for taking the time today to learn more about our company. And Winnie, Andrew, and I would be very pleased to respond to any questions that you may have, so we'll carry the meeting back to Omar, our operator.

Thank you very much. We will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please lift your hands up before making your selection. If you have a question, please press star one on your device keypad. When prompted by the system, please clearly state your name to register your question. Please press star one at this time if you have a question. Once again, please press star one on your device keypad if you have any question. Thank you very much. And our first question is from, please go ahead.

Yeah, thanks. Good afternoon, Ken and Winnie. Just maybe a question. It's been busier, so I haven't read through the whole MD&A, but are you expecting the AAC review on McKenzie TSA?

We are expecting a public data package. The province said that it would have been delivered a few months ago. It still hasn't showed up, but that will include their base case. We expect the revised AAC determination to be available in Q1 of 2022, and then the apportionment decision later in 2022. And that apportionment decision is, of course, when they determine what AAC is allocated to First Nations, BC Timber Sales, and the licensees. Paul, the current AAC is 4.5 million cubic meters. We expect the revised AAC will be about cut in half because we're at the end of the Pine Beetle salvage program. So if it's cut in half, we are still very confident about our saw log self-sufficiency because... The Ministry of Forests documents indicate that at capacity, Canfor has a saw log requirement of approximately 1.2 million cubic meters. And the Ministry documents put our annual saw log requirements at 875,000 cubic meters or something like that. So we're just over 2 million cubic of requirements, and even with a 50% reduction in the AAC, we still have a SOLOG availability that exceeds the full capacity requirements of the domino capacity that's in place in the TSA.

Okay. Any indication that CAMPOR is looking to start up that McKinsey mill?

Well, you know, Well, it's hard to speculate, and they're a company that has disclosure obligations. There's some material developments. But the local people indicate to me that there are new occupants at that site and that a portion of the site might be dismantled. But that's just hearsay from people in McKenzie. You'd have to ask them what the status is.

Okay, and then over to the new development on Bitcoin mining. Is the trial successful? How do you suspect we model that in for 2022?

Well, boy, that's a tough question. You know, we're at such an early stage, but... You know, I can share with you this is a personal target. This is not a board-approved management opined and we haven't scrubbed all the numbers. But, you know, we spent something like $100-plus million to develop a power plant. And we regularly commented that it had $14 million of EVF-8 potential. And my personal objective or target here is assuming the tests work out and our partner wants to move forward. But we think we've got a shot at maybe spending one-third of the money we spent on the power plant and maybe getting EPIC-DA that's potentially very close to what we had at the power plant. Those are some of the personal objectives that I've established for this initiative.

So just so I understand that right, that's incremental to the current power agreement that you've got with BC Hydro? Completely incremental. Okay, and then we've seen lumber prices in your area move up sharply off the lows in August. Now they seem to be rolling over here. What's your expectation for the balance of the year, Ken?

Well, for the balance of this year, I don't expect much change from where we're at. But, Paul, next year I am probably a bit more bullish than the consensus forecast. And my positive view is a reflection of two factors. I don't think people that study the supply-demand balance for SPF lumber fully appreciate how the higher duty rate impositions are going to shift the cost curve for SPF producers in Canada. So we probably have a... steeper supply curve than was in effect at the lower duty rates. And secondly, you know, we have the impact of harvest reductions, certainly in the very short term while we sort through this old growth development. And, you know, with the suspension of BCPS auction offerings, I think there's I think the saw log availability and lumber production from BC will be lower in 2022 than most forecasters expect.

Okay, and then maybe a bonus question. Now that you brought up softwood lumber, any movement on that file, or do you expect any movement on that file going forward?

Well, you know, first of all, I'm not aware of any communication from the government people and so on. But I think that a base might be building for some meaningful discussions on this file, but we saw much of now because when we're in the next period of review, there's every indication that both the countervailing duty rate and the anti-dumping rate will be materially lower than they're going to be. when the new rates kick in, and then December 1. And so they're, you know, with modest duty-related positions, there's less benefit to the U.S. coalition, and there's a chance they could conclude that the duties aren't helping us very much, and there's a bunch of trash trapped in... U.S. Treasury, and they may want to get a piece of that cash and support a settlement. So I think a year from now, I'd be pretty optimistic that something could happen. But in the immediate future, I think we're pretty much locked into the current arrangement. All right. That's all I have. That's all I

Thank you. Thank you.

The next question is from Lisa.

Please go ahead.

Hi, good afternoon. Just wondering from the work your team has been doing, do you have any early indications of what the impact might be of the logging restrictions in your operating region?

Well, we have what I would call a guest And earlier I talked about the expectation that we have essentially that there would be a likely 50% reduction in the AAC that will be released as determined early in 2022. And if our local First Nation two of whom had significant investments in logging equipment and want some revenues to fund some programs to benefit their community. If on the other side check that the local First Nations decided that they didn't want any deferrals, there'd be no change from my area estimate, 50% reduction in the AAC. If the First Nations decide that they want to cease harvesting in all of the old growth areas, that ministry mapping has identified. And everyone's got a lot of questions about the accuracy of the ministry maps. But if the maps, if we make the heroic assumption that they're accurate, There might be, say, a 53% reduction in the harvest level. It would be that order of magnitude. So, you know, we think it might impact the harvest center area by a lot less than 10%, but maybe if there was a complete deferral, it would probably be a sniggle of 5%. But those are very preliminary numbers. and they apply only to the McKenzie campus supply area, and they make no comment on other campus supply areas in the interior region of BC.

Okay. Well, thanks for that, caller. And then just looking at 2022, can you provide any preliminary CAPEX figures for next year?

We have typically we do have Our budget and business plan pretty well finished at this time of the year, but I'm sure you can appreciate that for the last eight days, we have downed tools on our budget and business planning process and focused exclusively on attempting to gain a better understanding of the new developments on all those logging sites. I'm sorry if I don't have any guesstimates for 2022 that I can share with you at this time. Clearly, we think we're going to have a satisfactory level of cash flow generation because we wouldn't have directed $9 million to repurchase our own shares.

Okay. Marie, thanks for calling. Good luck in the quarter.

Thank you. Thank you. Once again, please press star one on your device keypad if you have any questions.

And the next question is from Mario Nucci.

Please go ahead.

Hey, Ken. Thanks for the clarity and the updates. My question was really around the economics of the Bitcoin or data hosting ad there. My question was answered in the question from the previous analyst there, so I'll get back in queue. Thanks. Take care.

Thanks, Ray. Thank you very much. The next question is from?

Paul Quinn.

Please go ahead, sir. Hey, Ken.

Just a quick question. a follow-up. I mean, you've been around the B.C. forest industry since you've been a teenager, so you've gone through a number of different governments and restrictions. Just wondering if you could give an overall comment of what you think the current government is trying to do with the industry, and are they going to be successful at the end of the day?

Well, you know, Paul, For the reason you mentioned, I have spent a huge portion of my career looking at timberlands and sawmills and chip bins. And accordingly, I haven't spent much time in Victoria. But the concern I have is that there are so many initiatives underway whether it has to do with caribou protection, First Nations reconciliation, old growth preservation, carbon mitigation, responding to climate change. And you know the old adage, if you try and prioritize everything, you end up prioritizing nothing and nothing gets done. So that would be the concern that I would have. And what's your impression, Paul?

I'm just wondering, with all these cuts to the harvest level, whether the industry can ever get to be competitive and return a cost of capital. It's just pushing the cost curve higher and higher in BC, and I'm just kind of nervous for the BC-based companies like yourself.

Yeah, well, you know, in our case, Paul, the feeling I have is that I am very pleased and proud with what our leadership team and employees have done. So, you know, when you do have time to read the MD&A, remember that we fibered up our mill with over 50% beetle damage, dead and dry wood last year. And that really hurt us in our unit log costs. and it created lots of production disruptions, which hurt cash conversion costs, and we had a way above normal amount of low-grade lumber, which trades at a steep discount to construction-grade lumber. So as I look forward, Paul, the way the numbers work, it's something like, you know, there's probably... $60 US of additional duty deposit cost in 2022 is probably $90 Canadian on stumpage relief. And in our case, if we could harvest the profile of the timber inventory rather than this subsequently disproven harvest partition that's been mandated, we could potentially improve our cash margins by as much as $100 per thousand board feet. So I don't want you to view our recent margins as indicative as to what we're capable of producing unless we're harvesting the profile of the remaining timber inventory. But we'll have the ministries estimates of the characteristics of the timber inventory should be available in the next few weeks.

Well, let's hope you get access to the profile. We'll see if that happens. Just on the Bitcoin, can you identify your crypto partner who's got the expertise?

We cannot because we're subject to a non-disclosure agreement, but clearly if we get through the... The trial says that that will be publicly disclosed. But they're an experienced nurse, and they've got solid settings.

All right. That's all I have. Best of luck. Thank you, Bob.

Thank you. Once again, please press star 1 on your device keypad if you have any questions.

Omar, it sounds like we might be at the end of the call.

Yes, sir. We have no further questions. It's fine. Back to you.

Okay. Well, listen, those of you that listened in, thank you so much for your interest in ConEffects, and feel free to reach out if there are other questions that come to mind that you'd like some help on. So enjoy the rest of your day, and so long until our next call.