Noranda Income Fund

Welcome to Naranda Income Fund 3rd Quarter 2022 Financial Results Conference Call-In Webcast. At this time, all participants are in a list only mode. Following management's presentation, there will be a question and answer session open to financial analysts and investors only. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star followed by the zero for operator assistance at any time. I would like to remind everyone that the conference call is being recorded today, November 15, 2022, at 8.30 a.m. Eastern Time. I would now like to turn the conference over to Paul Anderson, CEO of Canadian Electrolytic Zinc Limited, Noranda Income Funds Manager. Please go ahead.

Thank you, Operator, and good morning, everyone. Thank you for joining us. Also on the call this morning is our CFO, Sylvain Lorette. Before we start, I would like to draw your attention to slide three of the presentation regarding forward-looking information. During the course of today's presentation, we will be making a number of forward-looking statements that are based on certain assumptions and subject to a number of risk factors outlined on this slide. As a result, Miranda Income Fund cannot guarantee that any forward-looking statement will materialize, and you are cautioned not to place undue reliance on these forward-looking statements. Please note that all dollar amounts in this presentation are in U.S. dollars unless otherwise indicated. Turning to slide four. Excuse me. The third quarter of 2022 was challenging for us both from a financial and operational perspective. While market conditions were favorable with strong zinc prices and treatment charges, our financial results continued to be hampered by lower zinc production and sales as a result of production issues. For the third quarter, we incurred a loss before taxes of $16.9 million, including an unrealized derivative financial instrument loss of $33.4 million and an impairment of non-financial assets of $30 million, which was a result of lower production and increased cell house capital expenditures. We also continue to deal with previously discussed labor shortages and our efforts to recruit and fill vacancies, while more challenging than the past, have continued. Hiring has improved, and we have less and less open positions. Once hired, recruits will receive the necessary training and coaching as we look to build operator experience. Finally, as you know, we commenced the major cell repair and cell house maintenance shutdown in late October, which is currently underway. Let's take a moment on this major development related to our cell house operations, turning to slide five. Our top priority is improving operating conditions of our cell house. As announced on October the 19th, 2022, given the accelerated deterioration of the cell house operating conditions, we made the difficult decision to temporarily shut down operations to proceed with a proactive cell repair program. This decision was not made lightly. We have been trying to repair the new cells without having to shut down the facility, but the cadence of repairs was not sufficient. As such, we determined that a shutdown was necessary to properly repair the previously identified damaged cells. In addition, during the shutdown, we are undertaking a cell-by-cell integrity assessment to determine if further repairs are warranted. It is also important that we undertake these repairs before the cold winter month, complicate the maintenance even further. We are entering the third week of the shutdown, expended the last four to six weeks. However, additional time may be required if additional cells need to be repaired or other issues are discovered during the cell inspection process. At this time, the team is making progress and we can report that in total, 65 cells have been cleaned and closed. Of those, 37 have been repaired. We have about 26 cells left to repair. However, this number may increase as more cells are cleaned and inspected. We have 204 cells in the cell house in total, and we had initially estimated to repair between 60 and 80 cells. While this shutdown is being undertaken to stabilize near-term cell house operating conditions, the repairs will still not fully address the underlying issues impacting operating conditions. We expect that a replacement of all cells in the cell house will be necessary to stabilize and improve operating conditions for the long term, as well as the previously planned crane replacements. As previously disclosed, a full cell and crane replacement is currently estimated to cost approximately 100 million U.S. dollars, and would not be started before 2024, depending on supply chain constraints and successfully obtaining financing. We will provide an update to investors as the plan for long-term cell house revitalization and financing advances. Because of the cell house maintenance shutdown and uncertainty regarding its duration as previously disclosed, we do not expect to meet our most recent annual production and sales guidance for 2022. of between 225,000 and 240,000 tons of zinc. In addition, we do not intend to provide annual production and sales guidance for the foreseeable future. In the past, production and sales were stable and much more predictable, but with the processing facilities production capacity remaining constrained and due to continued risks in terms of operating stability, aging infrastructure, and other such factors, production is now much more difficult to predict and will remain so until the underlying production issues are fully addressed. While we will not be providing detailed production guidance for 2023, and although we are optimistic as we look forward, we remain cautious about predicting a return to production volumes as seen in 2020 and 2021. Production volumes will be subject to the impact of the tight labor market, repairs and maintenance strategies, and the uncertainty of operating aging infrastructure, among other factors. I'll now turn it over to Sylvain to review our financial and operating results in more detail.

Thank you, Paul, and good morning, everyone. We will begin our key performance drivers in Q3 on slide 7. Zinc concentrate and secondary feed process was lower than in the same period in 2021 as a result of lower production levels. Commodity prices have mostly remained high in the first nine months of the year, as reflected in higher average LME zinc price. However, the zinc price was volatile and trending lower in the third quarter. The concentrated inventory is protected against zinc price decreases through the inventory management program. Byproduct revenues increased as a result of higher sulfuric acid netbacks offset by lower volumes. Finally, the average exchange rate was lower at 77 cents. Turning now to slide 8, as Paul mentioned, we continued to experience operational challenges in Q3, resulting in a significant decrease in zinc metal production in cells. Lower sulfuric acid cell volumes is also mainly related to lower volumes of the concentrate process. Turning now to slide 9, Loss before income taxes were $16.9 million for the third quarter of 2022, including an unrealized derivative financial instrument loss of $33.4 million and an impairment of non-financial assets of $30 million. This is compared to earning before income taxes of $5.9 million, including an unrealized derivative financial instrument loss of $0.1 million in the same period in 2021. The unrealized financial instrument loss was driven by a large edge book and fluctuations in zinc prices in the quarter. On the impairment charge, we conclude that an impairment existed relating to our generating unit. As Paul mentioned, this is due to sell-out operating conditions. First, the extensive repair program needed to stabilize near-term operations Second, lower production. And third, increased sell-out capital expenditure. Turning now to slide 10, after removing the unrealized derivative financial instrument impacts, the impairment charge, and the other adjustments, adjusted EBITDA in Q3 was $40.4 million compared to $7.8 million in Q3 of 2021. Higher adjusted EBITDA compared to the same period last year mainly reflects the support provided by positive market conditions, despite our lower production levels and resulting higher costs. In Q3, CAPEX was $8.5 million. This includes strategic expansion projects of $1.7 million aimed at increasing production capacity and profitability. The balance is sustaining capex necessary for maintaining our operations. Turning now to cash flow on slide 12, excluding changes in working capital, interest, and tax payments, cash flow from operation was $41 million in Q3 compared to cash flow of $8 million for the same period last year. Realized derivative financial instrument gains were a strong cash flow driver in the quarter as zinc prices decreased. Cash flow in Q3 of 2022 was also impacted by higher commodity prices and treatment charges, partly upset by lower volumes. Looking now to our ABL, as at September 30th, 2022, it was at $175.2 million, including letters of credit, leaving an excess availability of $4.8 million. Our senior secured metal liabilities stood at $32.9 million. Working capital increased to $234.2 million, up from $155.5 million as of December 31st, 2021. Paul, back to you.

Thank you, Celine. Current market conditions continue to fluctuate with changes in the European, Asian, and North American markets being impacted by lingering pandemic issues, global economic recession, and continued conflict in the Ukraine. Indicative spot treatment charges have increased from $85 per ton at the end of 2021 to the current level of $260 per ton in October, as reported by the industry firm CRU. However, it's important to keep in mind that for the fund, the positive impact of higher treatment charges is limited by our lower volumes and operational issues as we continue to consume inventory acquired in the first half of the year. The prices of zinc, copper, and sulfuric acid have been strong through 2022. During the quarter, however, zinc prices have been volatile, ultimately recovering to $3,000 per ton by the end of the quarter. The key factors impacting industry production Our price and pricing are China's zero COVID policy and its impact on Asian markets, along with the war in Ukraine and its impact on the European recession. And finally, the pressure on demand due to global economic recession. CRU previously reported that zinc premiums may have peaked in the second quarter of 2022. However, low zinc inventories in North America and continued zinc production shortfalls have continued to a continued increase in the North American premium which has averaged 37 cents per pound over the last six months. Fast market sites economic uncertainty and recession as factors that will flatten premiums in the near term. CRU is predicting that the concentrate market to reach a surplus of 379,000 tons in 2022, but declining to a surplus of 121,000 tons in 2023, and forecast a benchmark treatment charge of $260 per ton in 2023, with an average benchmark treatment charge of $250 per ton for the years from 2024 to 2027. I will conclude by saying that as we look to the fourth quarter, we are clearly most focused on the repairs to our cell house operating facility, but we are also investing in improvements in other areas of our operation, including addressing our labor shortages and other required maintenance work. Although all these factors are causing low production levels and having a negative impact on our overall profitability, as I've noted before, the current positive market conditions are providing an important level of financial support during this period. Ultimately, our objective is to finalize plans to permanently address the underlying salehouse operating issues, and that work continues in earnest. That concludes our formal remarks. Operator, back to you for the Q&A.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys.

One moment please for your first question.

The first question comes from Daniel McConvey of Rossport Investments. Please go ahead.

Hi, good morning. Thanks for the presentation. A bit of a different question. It's been a struggle for the last few years trying to create free cash flow, et cetera, and now you have the cell replacement issues, et cetera. The concentrate that you're dealing with is not the original concentrate that the The refinery was built for decades ago. I'm just wondering, is there an alternative? Is it possible to sell it? And is it possible to close it and sell it because there's a lot of value there for the assets and for the location, et cetera? And if the answer is yes, I know the relationship with your off-take partners, et cetera, that might preclude you from doing it. It maybe makes no sense. No sense, but I just like to ask, is there an alternative for continuing?

Thanks, Daniel. It's not the first time this question has come through to us on the investor call. We're looking at a number of different options going forward, but the issue on closure is the remediation. Although there is value to the land here, it does cost a lot of money to remediate the site. So it's not as easy as adding up the columns in the balance sheet and having it spit out a result to you. So we are looking at all of the options, but we are focused on the continued operation of the facility.

What are you accruing for reclamation liabilities, roughly? What is that number?

We haven't updated the number recently here, Daniel. We have one number in the balance sheet that reflects the cost to remediate the ponds themselves, but there's a larger number that exists to take care of the entire site itself. So we've got about $20 million in the balance sheet right now for the ponds themselves, but the dismantling of the site and the reclamation of the entire site would obviously be a larger number.

Okay. And if you were, if a decision was made to sell it or to close it, What would the implications be just in terms of your offtake arrangements? What would be the earliest you would be able to do it, or is that – how problematic is that?

Yeah, there's no real – the documents, although there's some redaction in those documents, they're all available on CDAR. But there's not really anything in there that says we absolutely have to take concentrate. There are certain quantities of concentrate on an annual basis. It does talk to certain volumes that we take. anticipated to take every year. And similarly, on the zinc and the acid side, there's no guarantee there that we need to fulfill necessarily on a production point of view, but there are some indications in those contracts of the level of production that we're expected to have. So there's no real guarantees in those contracts. Obviously, Glencore does own 25% of the facility, so they would obviously have a very strong say in whether we continue or not as an operation.

Okay, and I think the last question, if you go forward, going forward, you're going to replace the cells, you're going to build a new crane in 2024, et cetera. Once you do that, just with some of your statements in the preamble, it sounds like there might be other things too, but if you get those two major things done, is that the vast majority of what you think would need to be done in the next five years in terms of CAPEX improvements?

Yeah, you can see that with an aging infrastructure, the CAPEX envelope over the last couple of years has been increasing, and we do expect that to continue to float upwards somewhat, not certainly in the scale of what we're seeing with these two particular projects, but we do need to replace certain elements. We have had an extensive repair and replacement program, and that's largely what our annual CAPEX is taking care of over the past. with the exception of the two projects that we undertook on the filtration and the cooling towers. So generally speaking, we are monitoring the condition of the assets and replacing them when they're worn out and when they need to be upgraded, if you will. So those numbers will continue to move forward. And yeah, there are other elements that we're pointing to on the production capacity point of view. We have been hit, as everybody, with labour issues. shortage of staff and high turnovers, and that really impacts our productivity as well. So we're working hard to put in place coaching and supervising activities to make sure that we get through the learning curve for the new people as quickly as possible, but also that we strengthen our repairs and maintenance functions so that not only the cell house, but the entire plant can operate to its full capacity.

In 2024, assuming you have the crane up and running and you replace the cells, and I guess there's the labor situation, but one would hope that you'd be able to bring back guidance once those things are aired.

Yes, we're optimistic that not only we'll be able to get back up to our previously identified targets, but also that we'll be able to do that with providing stable production. It's something that's always been one cornerstone, regardless of regardless of our cost structure, having inflationary impacts, regardless of the market terms fluctuating, we've always been able to produce relatively stable amounts of zinc every year and basically hit our targets within a very close range. So we are operating now in sort of uncharted territories, but we are optimistic that we'll be able to get back to stable production and higher production.

Thank you very much for full answers.

Thank you, Daniel.

thank you once again ladies and gentlemen if you do have a question please press star 1 at this time there are no further questions at this time this does conclude our conference call for today we thank you for your participation and ask that you please disconnect your lines