Conifex Timber Inc.

The Conifex Timber Incorporated conference call hosted by Mr. Ken Shields at 5 p.m. Eastern time on Tuesday, 9th of May, 2023. You may dial 2 at any time during this call for a detailed help menu.

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Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Incorporated Q1 2023 results. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, Michael, and good afternoon, everyone, and welcome to our call covering our Q1 2023 results. 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 1 and 2 of the MD&A dated May 9th that we distributed. Turning to our results, in the first quarter, we reported negative EBITDA of $6.9 million and a net loss of $8.1 million, which was equivalent to 20 cents per Conifax share. This loss lowered our book values per share to $3.51. After depositing $1.25 million in duties, our potentially refundable duties now exceed $1 per Conifex share before any allowances for holdbacks or income taxes on any return of duties. Our Q1 results were below the guidance we provided you on our previous call. Lower than expected lumber prices in the closing weeks of Q1 coupled with a $200,000 inventory write-down were two main reasons for the shortfall. The third main reason was the $500,000 shortfall in our power revenues while we worked through the numerous challenges associated with restarting a biomass power plant in the middle of winter after it had been down for eight months. We are pleased with our Q1 achievements in terms of safety, environmental compliance, and have the same ability. Given current lumber prices, it is not surprising that rumors have been circulating over the past week or so that further lumber production curtailment in the interior of BC are likely to be announced shortly. We are assessing the need to consider a similar curtailment at our sawmill complex possibly coincident with our annual two-week maintenance shutdown at our power plant. BC Hydro has recently advised us that water levels in the Williston Reservoir are likely to remain at well below normal levels through to July. Consequently, our log dewatering operations are adversely impacted which is going to make it more challenging for us to secure the thaw log supplies that we need to sustain sawmill operations. And although we're monitoring water levels daily, we've not yet been able to establish a firm date for when we can resume log deliveries to our sawmill complex. The most significant development impacting our future prospects was the May 4th release by British Columbia's Chief Forester of a new harvest level determination for the McKenzie Timber Supply Area, or TSA. The new determination will remain in effect for up to 10 years. In recent calls, we advised you that our lumber EBITDA has been held back by a decision the former Chief Forester made in 2014 that mandated us to source 55% of our saw log supply from dead and dying beetle killed stands. We also advised you that the ministry's figures indicate that by 2020, 70% of the beetle-tilled stands were reclassified as uneconomic pulpwood or bioenergy fiber stands, which meant that only 30% of the available fiber from the salvage stands was commercially viable solid material. We are pleased to report that the requirement to focus on salvage stands was removed on May 4th. Future harvests are now going to be sourced from green, commercially viable stands. Our summer logging plans were developed under the old rule, which means that our transition to green stands will fully take effect in Q4 when our winter logging season kicks in. Transitioning to a green log diet, of course, it reduces our sawmill conversion costs, it improves our lumber recovery factors, and it provides us richer grade out turns, and it also boosts our average lumber selling price realization. Having discussed log quality, let's talk about log availability. The chief forester set the new annual allowable cut, or AAC, at 2.39 million cubic meters. This annual green harvest entitlement is almost equal to the average harvest level of 2.5 million cubic meters recorded in McKenzie historically. We operate the only sawmill complex in the McKenzie TSA, and our annual fiber requirements amount to something like 800,000 cubic meters. The new AAC, as you can see, is roughly three times our present requirements, and this confirms our belief that the McKenzie timber supply area has a higher degree of saw log self-sufficiency than any other TSA in the interior region of British Columbia. We are also pleased that the Chief Forester took steps to provide greater certainty and predictability about future log availability and cost. He achieved this desirable outcome by requiring future harvest to be roughly equally balanced between the lower cost southern portion of the TSA and the higher-cost northern portion. In summary, the chief forester's decision enables our McKenzie site to migrate to and remain at a lower and more enviable ranking on the lumber industry cost curve. Our workforce and members of the ultra-forest-dependent community of McKenzie will be pleased to know that we are now better positioned to sustain capacity-throwing operations over an even wider range of commodity lumber prices. While the recent AAC and harvest mix determination enhance our future competitiveness, the ministry still has more work to do to meet its obligations to encourage a globally competitive timber processing sector in our home province. BC Timber Sales is responsible for managing the harvesting and reforestation of approximately 20% of the timber available for harvest from British Columbia's timberlands. B.C. timber sales failure to deliver even 10% of the total harvest has resulted in restricted log supply for interior B.C. sawmills. Its underperformance has kept stumpage rates at artificially and unjustifiably high levels. If the ministry wishes to regain the trust and confidence of McKenzie residents and forest sector stakeholders, BCPS will have to demonstrate that it can meet its statutory obligations. Thinking back about the board meetings we held over the past two days, we spent much time reviewing the competitiveness of the interior BC lumber sector relative to other North American supply regions. and determining where our McKenzie site ranks relative to other BC sawmill operators. Based on our review over the past three or four years, we believe our McKenzie site is positioned near the 50% in the interior region of BC. We view this as a considerable achievement given the low quality logs we were forced to process because of the salvage harvest requirements remaining in place too long. Putting this another way, the superior EBITDA contribution provided by our power generation business was largely offset by the inferior EBITDA contribution from our sawmill complex. When we transition to a green log diet, we expect to move lower on the BC cost curve. Moving forward, at mid-cycle or normal lumber prices, we expect our site level EBITDA will be higher than estimates that would be derived by simply extending our historical EBITDA margins into the future. I'd now like to update you on the next step in our journey to develop the most economically viable and environmentally sustainable integrated software processing site in the interior region of BC. As described on page three of the MD&A that we released today, we're examining the feasibility of developing a data center hosting business in northern BC that will consume surplus electrical supply that BC Hydro has available in our region through the next decade and beyond. We note the customer that we are presently hosting at our three megawatt trial site in McKenzie is achieving excellent performance, and our hosting services have been well received. On our last call with you, we mentioned how the $100 million we invested in our power generation business enhances and stabilizes cash flow generation. We believe we have a similar value-enhancing opportunity hosting high-performance computing data centers in regions where BC Hydro has surplus hydroelectricity available once its massive site seed project comes on screen within the next 12 months or so. The preliminary numbers we are using indicate that a fully built-out HBC hosting site can be constructed for approximately one-half the money we spent on our power plant. Furthermore, our preliminary numbers indicate that the EBITDA contribution from hosting is substantially equivalent to the contribution from our power plant. And against that backdrop, clearly the returns on investment in hosting are higher than in power generation, and the payback periods are shorter. The revenue streams for hosting are typically sourced from multi-year contracts with institutional quality customers, and this helps us ensure that we achieve payback on any capital we may commit to this business. One major difference between HPC hosting and a power plant is that the hosting business can be built out in phases, with the cash flow from the initial phases redeployed to fund follow-on phases. Based on these financial characteristics, we believe all ConEffect stakeholders and all British Columbians, in fact, benefit if we promptly move forward on this opportunity. This explains why we are challenging the legal validity of the 18-month deferral imposed on the project that we described in our April press release. Since the matter is before the court, you understand that it's not possible for us to discuss legal developments with you. However, we would be most pleased to respond to any other questions you may have about our intentions to develop this complementary revenue stream. In summary, we believe ConFx is well positioned with a strong safety culture, an unparalleled degree of fiber self-sufficiency, near-term opportunities to improve log quality and boost lumber revenues. We have an industry-leading power generation asset. We have a solid balance sheet with appropriate liquidity. And lastly, we have exciting future potential hosting companies or customers wishing to access BC Hydro's affordable surplus green power in our region. Thank you for taking time this afternoon to learn more about Conifex In closing, I want to draw your attention to the fact that this call is different from what we planned for our upcoming call in August. One major difference is that incoming Chief Financial Officer Trevor Pruden will be presenting our financial results during our call in August. Before signing off, I'd like to sincerely thank retiring CFO Winnie Tang for the huge contribution she made to Conifex during her tenure as CFO. Second, on her upcoming call, newly appointed President and Chief Operating Officer Andrew McClellan will be presenting her operating results. Andrew and his team, in the meantime, will be focusing on developing and implementing some potential expansion and modernization plans that are available to us at our sawmill complex in McKenzie now that the Chief Forester has clarified our future saw log availability. Winnie, Andrew, and Trevor are all here with me today. We each look forward to responding to any questions that analysts and shareholders may have. I'll now turn the meeting back over to Michael.

Thank you, sir. Ladies and gentlemen, we will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please lift your handset before dialing your selection. If you have a question, you can register by dialing star 1 on your device keypad, and you can cancel the question if you wish by dialing star 2. Please dial star 1 at this time if you have a question, and there will be a brief delay while participants register. Once again, please press star 1 on your device keypad if you have a question at this time. And the first question is from Christopher Dilvacchio. Please go ahead. Your line is now open.

Good afternoon. Thanks for taking my questions. My first question, I guess, is just around the impact of the new AAC, specifically in regard to bioenergy fuel. With that said, Does the impact of the AAC have any constraints or negative impacts on the bioenergy fuel? Specifically, does it result in less sawdust or hog fuel because they are greener logs?

Thank you for the question, Chris. It's Andrew McClellan here. I think, in fact, it will provide additional opportunities for biomass within the McKenzie TSA. We don't foresee any challenges switching to a green log. We have greened up our log diet and had periods of time while we're running the mill on a fairly green log, and the power plant seems to be completely happy with the moisture content of the fuel. And of course, we have a second fuel stream, which is a drier fuel stream, which comes from the cleaner. So we don't expect any interruption or difference in our fuel types there. Okay, great. Thank you.

And then back to the bioplant, have you looked at any potential credit programs, maybe carbon offset credits or BC greenhouse gas reduction credits, anything of that nature to just give you an extra bump in the power plant?

Well, that's another good question. It's Ken Shields once again. Under the power purchase agreement that we negotiated with BC Hydro that runs until 2035, we obtained what we think is a full and fair price for the power we sell. But in exchange for receiving that price, we had to leave those types of potential benefits that you're referencing with BC Hydro. So we don't have access to those benefits from our power plant. but we do have a steady cash flow stream from the power plant.

Okay, great. Thank you. I'll jump back in the queue.

Thank you. Once again, ladies and gentlemen, please press star 1 if you have a question at this time. And the next question is from Paul Quinn. Please go ahead.

Your line is now open. Yeah, thanks very much afternoon, guys. Sorry I got on the call late. I had difficulty accessing. So I missed your comments around the decision. But if I could summarize the way I look at it, maybe you could help me if I've got this right. Essentially, the chief forester came down with 2.39 million meters. That's predominantly green fiber. And do you guys use around 800 to 850,000 meters?

Sorry, Paul. It's Ken and Andrew. We had trouble hearing your last sentence there. Were you inquiring, do we use approximately 800,000 meters annually?

Yeah, I thought, you know, given the production of your mill, you'd use somewhere around 800 to 850,000 cubic meters a year?

That's exactly right.

Okay, so you're well covered by the new AC determination, right?

Yes, we think that... that if you study sustainable harvest and compare it to installed lumber capacity and TSAs across the interior region of BC, we think that we have fiber self-sufficiency or fiber surpluses that are not matched in any other TSAs in the interior. In fact, many TSAs have surplus thermal capacity relative to that. level of production that can be supported by the sustainable harvest.

Okay, that's good news. And then just turning to markets, you know, we're seeing Western Estuary prices, you know, still way below breakeven here for most operators. How do you see the path going forward? Do you see additional shuts required to bring it back into breakeven or better? Or do you see any pickup on the demand side as well?

Yes. Well, Everything that we read in here is that it looks like the single-family residential construction is firming in the U.S., and the demand is more likely to move up over the next several months rather than retreat. In the early part of our call, I mentioned, Paul, that we are hearing rumors of some potential imminent curtailment announcements in the interior region of BC and we are assessing the potential need for curtailment ourselves and one complicating factor that we have is that we source an important portion of our logs from deliveries down the Williston Reservoir and BC Hydro has advised us that the reservoir levels will be way below normal between now and sometime in July. So we may have trouble dewatering logs in the next little while, which will impact our ability to sustain full-out sawmill operations through the balance of the year. So we've got this under review. We're checking the water levels daily. But we haven't made a decision yet, but we're looking at it very closely.

Okay. Thanks for that, Keller. And then just lastly, I mean, this AEC determination, you know, a lot of your longer-term strategic plans were held up on this. So do you start taking a look at what your strategic options are? I mean, obviously the market's not paying up for the quality of your fiber slash, you know, processing capacity. What are those options? And, you know, is that something that you'd look at over the next year or so?

Well, I think, Paul, the answer to that question is that before we can identify our options, in terms of coming up with an estimate of the fundamental value of our company, the overarching variable, of course, is the cost and quality of the fiber. Because, as you know, fiber represents roughly 75% or so of the cost of manufacturing 1,000 board seats. of lumber, so fiber costs drive future EBITDA expectations. So where we sit now is that the chief forester has told us, to use his words, he's told us the size of the pie. And then over the next several months, we suspect that we'll spend a bunch of time, and Andrew and his team will be leading our efforts in discussions about how that pie is divided up. As you know, the policy in BC is for BCPS to have roughly 20% of the harvest and First Nations up to 20% of the harvest. And so once we know what the licensees are going to have on a sustainable basis, and then we'll be able to guesstimate what portion of the BCPS supply and the First Nations supply that we will have to purchase to achieve 100% fiber self-sufficiency. And we don't think it's a big number. We think it's something like maybe 20% of what they have available. But once we've got that additional information, Paul, I think we'll be able to have a better estimate of our future cash flow generating capability and be able to answer the question you pose, which is to what extent is our current market price way below the fundamental value of the company and what are our options to address that gap?

All right. Thanks very much. That's all I have. Okay. Thank you, Paul.

Michael? Yes, sir. The next question is from Hugh Cooper. Please go ahead. Your line is now open. Good afternoon, Ken.

Just a couple questions here. The first is roughly you have about $1.10 of duty per share that is owed coming back from the U.S. Presumably you get some or all of that back. I'm not sure how much, if it would be taxable or not, but would you pay that out to shareholders or would that... But would you put that towards a build out of the Bitcoin mining? That's the first question. The second question, were somebody to take over Conifex, you have about four and a half dollars a share of tax loss carry forwards, which is kind of, as I see it, a nice hidden asset. Would a cross-border company be able to use those or would there be some measure of difficulty in applying those losses?

Okay, well, thanks for those two questions, Hugh. Winnie will answer the second question about tax after I exhaust my complete knowledge of tax in a sentence or two that I'll share with you in a moment. But in terms of your first question, you know, Hugh, it's difficult to exactly or precisely determine In effect, you're asking what our capital allocation priorities are in the event that we had a windfall receipt. And so we don't know what portion of the duties are likely to be returned. And when we go through markets like this, the only thing I know about tax is that there'll be less tax paid on the duties that we do receive because of some of the results that we're incurring this year. And secondly, you know, one thing I'd ask you to reflect on here is that we financed our power plant using non-recourse debt to the parent company. We think that hosting And I put the emphasis on the word hosting because we're not Bitcoin mining. We are hosting high performance computers, some of which do mine Bitcoin, that it's got cash flow characteristics and an ability to pledge assets that opens up the potential that it could be financed similar to the power project. And additionally, in that business, customers typically prepay the posting fee. we haven't determined what net equity is required, uh, to, uh, build out this hosting business. But, uh, I do not see a situation where we'd ever, uh, require a dollar plus per share of cash to go in it, to be used as equity, to build this, this new, new business. Okay. So, uh, I'll turn it over to Winnie, who will remind us of the breakdown of our tax losses between Canada and the U.S. and what value they may be to other prospective purchasers.

Yes. So I would say that a large portion of our non-capital losses relate to our U.S. operations. with the balance relating to our Canadian operations. And I can't speak too much around the cross-border points, but I will say that the general rule of thumb is if you are operating it the same or similar business as how the losses were generated, you should be able to utilize those losses. Again, you'll have to look at the specific nuances of the loss and the characteristics there.

Okay, thank you.

Thank you. Thank you. And the next question is from Christopher Del Vecchio. Please go ahead. Your line is now open.

Hey, thank you. Yeah, just a quick follow-up related to the power plant. In the event of a full economic downturn where, let's say, sawmill went 100% idle for illustration purposes, let's say, It just completely closed its doors. What alternatives do you guys have to fuel the power plant? What would that cost? And I guess, what would the economic impacts be to the standalone plant? If you could just talk a little bit to that, that'd be very helpful.

Well, Chris, it's Ken Shields. Your question almost describes the situation that we faced in 2019. when we were in an extremely difficult financial position and our sawmill was idle for a considerable period of time. And what we did in that year is that we got a special dispensation to use natural gas as an important source of fuel supply to augment the purchased feedstock that we were able to secure. And we ran the power plant for a considerable period even while the sawmill was idle.

Agreed. And were those natural gas fuels more costly than your regular fiber? And was the plant profitable during that time?

Yes, the plant was profitable. But the natural gas prices, of course, is a big seasonal factor. So there were times when it was above our internal cost. At other times, it was substantially equivalent to our biomass feedstock cost.

Okay, great. This is very helpful. Thank you, Gus. Good luck. Thank you.

Thank you. Once again, please press star 1 if you have a question at this time. There are no further questions, Mr. Shields. I would like to turn the conference back over to you, sir.

Okay. Well, thank you, Michael, and thank you for listening. We feel we're crossing the valley bottom in lumber prices and look forward to climbing up the other side in the back half of this year. So enjoy the rest of your week, everyone. Thank you.

Thank you. Ladies and gentlemen, your conference has now ended. All callers are asked to disconnect their lines at this time. And thank you for joining today's call.

Okay, thank you, Michael.