Conifex Timber Inc.

Good afternoon, ladies and gentlemen, and welcome to the Conifers Timber Inc. Q3 2022 results conference call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you very much, Paul, and good afternoon, everyone, and welcome to our call covering our Q3 results for 2022. CFO Winnie Tang is next to me here today and available to respond to questions that analysts and shareholders may have following some prepared remarks. Let's quickly deal with the housekeeping item. We will be making forward-looking statements and references to non-IFRS measures, and therefore call your attention to the complete warning statement set out on pages one and two of the NDA that we released earlier today. In Q3, we are pleased to report net income of two cents per share and EBITDA of 4.2 million was achieved. Our results for the most recent quarter were aided by a $5.7 million reversal of excess duty deposits paid in prior period And, of course, the reversal resulted from subsequent imposition of lower deposit rates. On the other hand, results were held back by losses incurred at a power plant, which was idled in Q3, while repairs were made to manufacturer defects in a turbine. A bottom line was also held back by shift reductions and curtailments at a thermal complex. At our sawmill, normal two-shift operations resumed on October 24th. You know, as I look at our Q3 results, as I see it, the non-recurring items, namely the duties offset by the other two factors, they had an approximate equal and offsetting effect. So our normal results would have indicated a slight profit based on the numbers that I've been looking at. So turning to the outlook for Q4, of course, we expect benchmark SPF lumber prices to be weaker than they were in Q3. And I've observed that most public lumber companies are guiding analysts to expect a sequential decline in EBITDA and net income in the closing quarter of the current calendar year. In our case, if benchmark SPF prices remain at or near their recent levels, we expect our Q4 results will be very similar to our Q3 results. And this is because recent discussions with our insurance adjusters have been highly encouraging. And based on these discussions, we expect to record business interruption insurance proceeds in Q4 in an amount that is expected to more than offset any potential income losses that may be incurred at our sawmill complex. So I think this backdrop, our full year EBITDA net income should come in within 10% of the record levels we achieved in 2021. As of September 30th, our potential refundable duties on deposit amounted to $30.6 million U.S., which translates into a dollar Canadian per con effect share based on the 40 million shares we have outstanding at quarter end. And while we appreciate that the legitimate timing of a full or partial refund is highly uncertain, our network will improve greatly when the trade dispute is eventually settled and cash refunds show up in our bank account. We are not aware of any other publicly traded lumber producers with potential duty refunds representing over 60% of their present equity market capitalization. I'd now like to talk about cyber in D.C., and as many of you will have heard on our last call, in July, the Chief Forester in British Columbia issued a public discussion paper and at the same time requested feedback from us and other licensees regarding the merits and demerits associated with future harvest levels he may establish for the McKenzie Timber Supply Area, which is the part of the province where we source all our fiber requirements. To this end, we met with the Chief Forester in October and came away feeling confident that solid supply in our operating region can be sustained at more than double our present annual requirements. And all this is illustrated in slide nine in the deck we distributed an hour or so ago. We also feel confident that when the Chief Forestry's final report is released, likely before the end of the year, we will transition to a green timber supply and no longer be mandated to source an important portion of our harvest from stands dominated by uneconomic pulpwood and bioenergy fiber components. We trust that the Chief Forest's final report will also include recommendations to ensure a solid supply is available to sustain lumber production for decades to come in the ultra forestry dependent community of McKenzie. A topic we tabled at the meeting was for the ministry to incorporate employment and community sustainability considerations in decisions impacting fiber sourcing locations, saw log quality, and log cost affordability in the McKenzie timber supply area. We were pleased to have had an opportunity to present our views to ministry officials, which, if accepted and implemented, will help restore trust and confidence in the ministry's oversight of the forest sector in McKenzie. I know many of you on this call analyzed future supply-demand balances in lumber when compiling your forecasts for future SPS lumber pricing. I've seen many thoughtful analyses about how timber supply will contract as the annual harvest in BC decreases due to beetle damage, government policy decisions such as restricting the harvest in all those stands, emerging species at risk protection initiatives, First Nations Reconciliation Activity and wildfires. However, the important role BC timber sales plays supplying fiber to the BC forest sector is infrequently mentioned. Many of you would be aware that BC Timber Sales is responsible for managing the harvesting of approximately 20% of the timber available from British Columbia's timberlands. In the MD&A we released exactly four quarters ago, we disclosed that there was an 80% shortfall in BC timber sales auction volume in the Prince George and McKenzie TSAs. Since then, there have been no new auctions in the Prince George timber supply area, which as many of you know, is the largest timber supply area in the province. nor have there been any auctions at all in the two timber supply areas to the north and east of McKenzie. The ministry's lack of performance accountability at BC Timber Sales, in our opinion, is the single biggest reason the saw log harvest in the northern interior region of BC declined 20% in the first nine months of 2022. and why numerous shift curtailments and other shift reductions were announced at several interior BC sawmills and pulp mills. As we see it, BCPS auction performance is showing little, if any, sign of improvement. We therefore believe that saw log supply in BC may be even more restricted and most knowledgeable industry observers have been incorporating in their supply-demand models for lumber. And against this backdrop, we suspect that fiber constraints may be underestimated and that consensus SPF price forecast for 2023 may prove to be conservative. So having reviewed these key industry developments, I wish to take a few minutes now to explain four initiatives that we are actively pursuing to position Pranafex for success in 2023. First of all, we built up log inventories to ensure that we are not forced to curtail operations due to saw log supply shortages. You may note that we had $25 million invested in saw log inventories at the end of Q3 And this represents what we would view as an industry-leading three-month saw-lock supply. We plan to maintain inventories at this robust level at least through to the March 2023 spring breakup period. This log inventory buildup is, first of all, a testament to the mutually beneficial relationships we've established with local First Nations partners. But it's also an indication of how collaboratively and effectively local forest ministry officials and the Conifers fiber procurement team work together to ensure that harvest permits are approved on a timely basis and that both employment and local government tax receipts are sustained in McKenzie. The second initiative we have underway is that we are well advanced transitioning to green saw log stands, and accordingly have spent considerable sums developing roads, bridges, camps, and other support infrastructure so we can access green stands in the new operating areas. The third initiative, we've completed some key improvements to our saw line and finishing lines at our sawmill complex both designed to improve uptime performance and lumber recovery. And against this background, we expect our cash costs of producing lumber will be lower in 2023 than in 2022. Fourth and finally, we're lining up customers for the richer grade out turns we expect to have available from processing the green log dyes. We've got people in Japan today, actually, that are hard at work rebuilding our Japanese customer base to allow us to boost shipments of duty-free premium priced J-grade lumber in 2023 and beyond. In summary, successful execution of our transition to a green log diet reduces sawmill conversion costs, improves lumber recovery, provides richer grade out turns and boosts average lumber selling price realizations. These benefits will enable us to migrate to a lower and more enviable ranking on the lumber industry cost curve, thereby positioning us to sustain capacity operations over an even wider range of commodity lumber prices. I would now like to update you on another step in our journey in furtherance of our objective to develop the most economically viable and environmentally sustainable integrated software processing operation in the interior region of D.C. As described on page three of the MD&A we just released, we're examining the feasibility of developing data center hosting activities in northern D.C. that would consume the surplus power that D.C. Hydro expects to have available through the year 2030 and beyond. In furtherance of this objective, we are pleased to announce that we will be hosting a new customer at our trial site in McKinsey. The customer is Greenwich Generation Holdings which is a NASDAQ-listed public company, and it plans to locate its servers at our site in McKenzie later this month. It's a company that currently operates over 25,000 servers at sites in New York State and South Carolina. Turning to our balance sheet, you'll see that our overall debt was $57.8 million at the end of Q3, pardon me. mainly represented by our power loan. And no amounts were drawn against our revolving credit facility. And when we deduct cash balances, we ended Q3 with net debt of approximately $29 million and a net debt to cap ratio of approximately 17%. Our solid financial position, $36 million in liquidity and power flag cash flow give us confidence in our ability to endure a lengthy period of wage lumber prices should this happen to occur. Turning to capital allocation, at our August board meeting, our board of directors approved reinstatement of a normal course issuer bid, entitling us to repurchase and cancel approximately 10% of our public float, which works out to 2.46 million shares. We purchased 194,000 shares in September prior to entering our blackout period, and we'll be back in the market in a few days once the blackout period has lapsed. We note that our shares presently trade at an approximate 55% discount to book value per share, which is a much steeper discount than presently recorded certain other public lumber companies. The reinstatement of our normal course issuer bid is underpinned by our belief that the trading price of our shares continues to reflect zero value for our harvest tenures and our sawmills. Summing up our notes, we believe that Conifex is well-positioned with its strong safety culture, an unparalleled degree of fiber self-sufficiency, near-term opportunities to improve product mix and revenue, industry-leading power generation assets, a strong balance sheet, and exciting future potential, hosting customers wishing to access DC Hydro's abundant, affordable surplus student power. We thank you for taking the time today to learn more about Pontifex Winnie and I would be very pleased to respond to any questions you may have. And so I'll turn the meeting back to Paul, our operator.

Thank you, Mr. Shields. We will now take questions from the telephone lines. If you have a question, please press star 1 on the device's keypad. When prompted by the system, please clearly state your name to register your question. There will be a brief pause while the participants register for questions. We thank you for your patience.

Thank you.

The first question is from Hamir Patel. Please go ahead. Your line is open.

Hi. Good afternoon. Ken, given some of the issues with BC timber sales that you were highlighting, just how much capacity do you think might come out of BC next year, just given the pine beetle and old growth plans of the government? Well, Hamir, we have our hands full keeping track of what's going on in the McKenzie timber supply area, which I think Many of you are aware how much the landmass is as big as the states of Vermont and New Hampshire combined. But I can tell you that the Prince George timber supply area is located just to the south of us. It's the largest timber supply area in the province. And the latest information that I have on the TSA is that licensees early in Q3 began working on the basis that their harvest was being reduced by something like 19%. In October of this year, last month, the harvest level in the TSA was further reduced by 14%. And then, as I mentioned earlier, in that PSA, we're not aware of, there's always a chance I missed the odd sale, but we're not aware that there's been any increased timber sales. So, I mean, there's an example of a 33, a 14, and, you know, as much as another 20% reduction, so it's a very significant downtick in the first nine months of this year. I think the interior BC harvest was down 19.7% or something like that, almost 20%, and I don't expect that year-over-year rate of decrease to, I think, any time soon. Yeah, fair enough. Thanks, Ken. That's helpful. And just a final question I have for Winnie. Could you speak to how we should think about CapEx in 2023?

So we're still in the process of finalizing our 2023 capital and business plan. I will say, though, we will likely be guided by our amortization charge, and we expect it should be in line with our annual amortization charge.

Okay, fair enough. That's all I had. I'll get back in the queue.

All right, thank you.

Thank you. Once again, please press star 1 on the device's keypad if you have a question. The next question is from... Please go ahead. Your line is open.

Yeah, thanks very much. Good afternoon.

Good afternoon. Sorry, just Just curious on what happened up in McKenzie with stumpage October 1st. What do you expect January 1st and the balance of 23? Stumpage in McKenzie, Paul, it's very complicated and it's something that if you wish to discuss offline, I'm very willing to do so. But I wanted to point out that we have two distinct logging seasons in McKenzie. In the winter logging season, we harvest wood that is close to our sawmill complex. All the wood is delivered by truck. And so it's a low-cost region, and that triggers pretty high scumbage. In the summer months, in the summer logging season, when the Williston reservoir dies free, we operate from way more remote locations and the higher cost locations. You know, we run camps. We've got long delivery distances to get the work from the north end of the reservoir down to our site. So that... in a year when stumpage did not change, let's assume that the BC government stumpage rate was constant throughout the year, we'd have much higher stumpage on the winter logging season than the summer logging season. So what happened to us this year is that as we got into Q3, our stumpage bill didn't change very much, but we incurred a lot more cash costs in harvesting and delivery. And so when we get into the logging season, we think that there won't be much change because stumpage rates are coming down, but we've got fewer cost allowances, which will trigger a higher stumpage rate. So that background, our stumpage rates have been pretty flat throughout the year, but our log costs They were a bit higher in the summer months, and they were lower in the winter months. So, as I said, it's a complicated topic, but that's what happened to us in McKenzie. Okay. Then, given that overall B.C. stumpage is expected to go down in 23 days, do you expect lumber pressures to track down with it? Well, Paul, I really don't because, as I said earlier, you know, if there was a precipitous decline in residential construction activity both for new and R&R in the U.S., I suppose they could go back. Let me ask you this question. You know, some of the companies have reported whopping write-downs to net realizable value. One company reported $90 million, another couple reported $35 million, and one other reported about $25 million Canadian. So, you know, those inventory write-downs are very high relative to what the alternative is of cutting sawmills down. So we think that some companies in BC would be pretty poised to take down time if lumber prices slide from here because it's doubtful they'll want to continue utilizing the cash flow from their low-cost supply regions to subsidize ongoing production in the high cost region of BC. So we don't see the stumpage rates reduction triggering heightened production from BC. We continue to believe that supply and fiber constraints in BC will not lead to an over-supplied

market on a sustainable basis okay and then just uh flipping over to the power side what's the status of the generation right now what do you expect for 23 yes so we're still actually in the process of working with the original manufacturer on uh repairs to defects uh some latent defects of on the turbine We are expecting the power plant to come back online in around January 2023, and we look forward to that as that's one of our peak times for generating revenues because of the time of delivery factor.

So at the end of the day, do you expect 23 revenues to be up over 23 revenues given the downtown that we experienced this year?

Yes, I would say that we would. see a revenue uptake in revenues as a result of the power plant contribution. We will, however, we are expecting to see some net earnings impact from a business interruption claim on the power plant in 2022.

Okay, I didn't need to forget and I'm getting flanked there. And I just maybe cannot, you mentioned a dollar dollar share in duties. How do we solve this at this point? What's your current thinking? Well, you know, I'd like to tell you that I had a two and a half hour dinner last night with a lumber trade expert and that we identified a cure path forward, but I can't say that. It looks like there continues to be no incentives for the U.S. coalition to want to show up at the bargaining table. So that's an unsettling element in the potential for a trade settlement. But on the other hand, duty rates came down this year, as you well know, And later this year, we expect another announcement about preliminary duty rates, and there's powerful evidence that the duties will further reduce. So when I think about the position of a US lumber coalition member that has seen this massive pot of duty deposits filled up, and if they want a share of it, that pot's unlikely to be increasing very much, you know, 12 months or so from now. So I think that there will be a financial incentive for the U.S. to up its budgeting in the next 12 or 14 months. Okay, and what's your estimation of the size of the massive pot? The last number, Paul, I heard was $9.4 billion. And that's U.S., right? Yeah. All right. Maybe something I'll shake out once we get after an even 10. Thanks very much. Best of luck. Thank you.

Thank you.

Thank you. There are no further questions registered at this time. I will return the call back to Mr. Shields. Okay.

Well, thank you, Paul. Uh, Whitney and I, uh, always enjoy our discussions with all of you on the line. Thank you for your interest in Karnaca. And, uh, we look forward to, uh, speaking to you again early in 2023 with, uh, another, uh, uh, quarter of black ink on, on our bottom line. So all the best. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.