Conifex Timber Inc. (CFF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Conifex Timber Q1 2020 Results Call. At this time, I'd like to turn the meeting over to Mr. Ken Shields, CEO. Please go ahead.

Well, thank you very much, and good morning, everyone, and welcome to our call covering our Q1 results. Newly appointed CFO, Jordan Neeser, is with me and we're both available to respond to any questions you may have at the end of this call. Before reviewing Q1 performance, we'd like to emphasize that our #1 priority over the past several weeks has been to protect the health and safety of both employees and visitors to the sites that we operate. In mid-March, we implemented a variety of measures to protect the health and safety of these people, and we're very pleased with how well our employees mitigated the risks of the pandemic, and we're very proud of the fact that no Conifex employee has been infected. We also thank our employees for maintaining productivity and for improving overall safety performance during a unique and difficult Q1. The actions governments and businesses have taken to contain the virus have resulted in a sharp decline in softwood lumber demand and pricing. In Conifex, literally in the blink of an eye, our focus shifted from early in the quarter when we were anticipating strong cash flow generation, and we were reflecting on the options to return capital to shareholders, we immediately had to shift over to safeguarding liquidity and managing our balance sheet. This rapid deterioration in market conditions led to unaffordable cash operating losses for BC lumber producers and triggered numerous sawmill curtailment announcements. Our Mackenzie sawmill is presently scheduled to restart early in June. We understand and deeply regret the impact curtailments have on our employees, contractors, customers, the regional district of Mackenzie and our First Nations partners. But we also greatly appreciate the support of our federal government, in particular, in the sense that they provided forest industry stakeholders an important safety net during these unprecedented and challenging circumstances. COVID-19 has challenged many aspects of our business. And one of the key purposes of our call today is to update all of you on our financial and operational status and outline the resources we have available to successfully contend with the challenges created by the pandemic. Let's quickly recap a couple of key points about the financial information we'll be referring to shortly. First, we will be making forward-looking statements and references to non-IFRS measures and therefore, call your attention to the disclaimer on the second slide and on Pages 1 and 2 of our MD&A dated May 14, 2020, that was distributed to you this morning. Secondly, our Q1 results and results for the comparative quarter last year have been reclassified to exclude the contribution from the logistics and marketing businesses we sold or wound down last year as well as the 3 U.S. mills we contracted to sell last December. And third, we're going to be making references to adjusted EBITDA. And adjusted EBITDA excludes onetime reorganization costs incurred or provided for as a consequence of the aforementioned transaction. And it also excludes the noncash impact of the foreign exchange translation gains and losses on the U.S. dollar-denominated debt that we repaid early in February. I'm sure all of you agree that adjusted EBITDA is a better indicator of comparative operating performance between the public lumber companies. At Mackenzie, the business plans we develop and execute for our harvesting, our lumber manufacturing and power generation businesses are interlinked and codependent. The 3 component plans are developed to maximize cash generation from the entire site when lumber prices are at or above normal levels or they're developed to minimize cash usage at the entire site when lumber prices are below normal. Accordingly, we no longer meet the requirements for segmented reporting and we, therefore, present our results as a single segment. We reported an operating loss of $6.8 million in Q1, an improvement from 8.5% in Q1 of last year, and last year included our Fort St. James operation. Despite absorbing the higher per unit cash conversion costs we incurred by operating our mill on a 4 day per week basis so far this year, our adjusted EBITDA was positive $500,000 in the quarter. And that's a significant improvement over the $4 million or so in negative EBITDA we reported for each quarter in 2019. This year, we would have reported $1.2 million as lumber prices had remained stable through the end of the quarter because we would have avoided taking a $700,000 write-down in our finished product inventories. Compared to Q4 of 2019, our lumber business benefited from moderately higher sales realizations, reflecting strong residential construction activity in the U.S. early in the quarter. On our last call with you, we alerted you to the fact that our lumber production in Mackenzie in the first half of 2020 would be adversely impacted as a consequence of the tight liquidity position we experienced in the second half of 2019. Our financial resources back then were too limited to fund the seasonal buildup and log inventories that would support full operating rates on a 5 day per week basis through the first half of 2020. We guided that it was likely we'd operate our Mackenzie sawmill at something like 2/3 of capacity in the first half of this year. And in Q1, we were in line with that lower guidance. Adjusted EBITDA was also reported after expensing roughly $2 million in duties at the 20.23% cash deposit rate presently in effect on Canadian lumber exports to the U.S. Many of you will recall last year that we sold a considerable portion of our rights to potential duty refunds. But these potentials for refunds are being rebuilt. We're now eligible for USD 3.8 million, and that's equivalent to roughly 25% of our present equity market capitalization. Looking ahead to Q4 of this year, we expect duty deposit rates to decrease from around 20% to around 8%. And this is why it makes sense for us to schedule our curtailments now and do everything possible to maintain capacity or near-capacity operations through the end of the year when we benefit from the lower cash deposit rates. Our power plant produced solid results in Q1, generally consistent with prior Q1 results. And then the second quarter, even though our sawmill has been curtailed, we do not expect that will have any adverse impact on our power business and it will report EBITDA in line as what it has typically done in Q2. Our gross debt totaled approximately $66 million, and it's virtually entirely represented by the long-term power loan we had which, of course, is limited recourse to our lumber operations. It's at a fixed interest rate and it's got a 10-plus year amortization period. The principal, we can -- after deducting cash balances, we ended Q1 with a net debt of approximately $48 million, which is -- which produces a below industry average net debt to capitalization ratio of 29%, and we had liquidity of $12 million. In 2018, we extended our borrowings just as the lumber market cycle was ending its upswing. And to reduce leverage, we did a variety of things such as eliminating all nonessential controllable expenses, actively managing working capital levels to optimize liquidity, scaling back capital expenditures, we sold our Fort St. James mill and tenures and we monetized and liquidated some other noncore investments. In February of this year, we sold our 3 U.S. mills and used the cash proceeds to repay the entire debt that had been secured by our lumber assets. So we ended the first quarter of 2020 with $12 million of unrestricted cash, a debt-free lumber business with no requirements to utilize sawmills' EBITDA to pay interest or repay principal. We ended the quarter with $23 million of net working capital. And I can't help but mention that one indicator of our unusually low trading price is that our equity market capitalization is less than our net working capital. But I believe the other public SPF produces trade at prices equivalent to several times their net working capital. In Q1, our SG&A expenses were 1/2 the year earlier level. We, of course, have no material unfunded capital expenditure commitments or obligations, so there's no cash burn from that source. And lastly, we have no pension deficits in need of funding since we only provide the Conifex team with defined contribution plans. So simply put, we believe the actions that we took over the past 12 months position us to successfully manage our way through the adverse impacts of the pandemic. We have additional confidence in our ability to weather the COVID storm for these 3 reasons. The first is that a majority of our investment in fixed assets is in power generation. And it has stable and predictable revenues and cash flow streams tied to a fixed price take-or-pay contract with the remaining term of 15 years. The second source of additional confidence is that we have inventories, receivables and forest tenures with an aggregate value of something like $100 million. These are all unpledged assets and available to support new credit facilities. Like today, we're probably the only public lumber producer in North America that does not have lumber credit facilities in place. We view the release of our Q1 results is providing us the up-to-date financial information. We intend to use, to liaise with the lenders with the objective of arranging credit facilities capable of providing us an additional cash cushion. The third factor leading to our confidence in weathering the storm is that over the past several weeks, various levels of government have implemented a number of temporary payment deferral and cost reimbursement mechanisms that will lessen cash usage as we proceed through Q2 and Q3 of this year. So for all those reasons, we believe that we've got the same power necessary to withstand a period of negative or nominal cash flow generation in the interior BC lumber industry. But besides surviving the COVID storm, our other key objective is to emerge as the stronger company when lumber market conditions normalize. At Mackenzie, over 200 hard-working men and women wonder why they are sitting at home at a time when mills in competing North American supply regions are running flat out. These BC curtailments reflect cost increases that took place over the past 3 or 4 years, which was the period when costs were flat or declining in other lumber supply regions. Clearly, costs need to be reduced in BC in order to restore competitiveness and avoid further declines in market share servicing the North American softwood lumber market. Every one of us at Conifex is hard at work identifying and implementing cost reduction initiatives at our Mackenzie site. We promptly responded to the request Premier Horgan made last year when he reminded forest industry CEOs of their social license responsibilities and asked CEOs to arrange group meetings with all local forest sector stakeholders. He asked CEOs to stimulate collaborative and constructive discussions and for that group to come up with recommendations designed to enhance economic and environmental sustainability for the supply -- for the timber supply area being reviewed. With the support of the province and the support of the regional district of Mackenzie, we helped form a Mackenzie Timber Supply Area stakeholder coalition group. Our group has met several times over the past 6 months. And later this month, we plan to present recommendations to the Ministry of Forests. By the time we host our next quarterly analyst call, we hope that we're in a position to share additional information with you about the cost reduction initiatives that have been implemented or have underway in furtherance of the objective of moving operators from the Mackenzie TSA to a lower ranking on the forest industry cost trade. Turning to our AGM. Our Annual Shareholders Meeting is scheduled for June 22. Our management information circular will be available in the next few days. We plan to reduce our number of Directors from 8 and take it down to 5 as a reflection of our smaller footprint and BC focus. We also recalibrated director and executive compensation. And aggregate director compensation will be set at our AGM at a level that's approximately 50% of the 2019 run rate, while our executive team salaries effective June 1 will be set at a rate equivalent to approximately 70% of the 2019 actuals. This way, we've aligned Our Director and executive compensation with the lower level of employee compensation likely to emerge due to the curtailments. I would like to personally thank the 3 Board members whose terms will expire at the upcoming AGM. All of us at Conifex have admired your professionalism and your high ethical standards. And we thank you for your guidance and support. In closing, I wish to remind listeners that the interior BC lumber sector has lived through other severe economic contractions. Although this one is unique in its speed and magnitude, but unlike other severe recessions, the exact cause of the current contraction is well known. Mitigation efforts are underway and bearing fruit. And economic activity in North America, in our opinion, is poised to resume an upward trajectory in the very near future. Our goal is to operate our Mackenzie site at their near capacity and generate positive EBITDA throughout the second half of 2020. In closing, thank you for taking the time today to learn more about Conifex. And as I mentioned earlier, Jordan and I would be pleased to respond to any questions you may have. So we'll turn the meeting back to the operator.

[Operator Instructions] We will now take the first question.

This is Roshni from CIBC Capital Markets. Can -- I just wanted to know how much will the stumpage release of the next July 1 update reduce your unit costs?

Okay. Well, we don't look at the stumpage as a separate and strict component because we're always balancing harvest sourcing to minimize the combination of stumpage and harvesting and delivery costs. So we look at it as the total package. So in the first quarter of this year, our delivered log costs were down sort of in the mid-single-digit level. And the target we have for the back half of 2020 is at least a further 10% reduction and maybe as much as a further 15% reduction. But we haven't completed all of the work that's underway to design and implement the cost reductions that we're capable of achieving.

Okay. Fair enough. And then just wanted to know, what's the company's ability to run the bioenergy plan if the sawmill needs to take more market-related downtime? And how long can the power plant operate at a time without access decided from the sawmill?

Okay. Well, that's a good question. Our power plant is typically curtailed. And this year, it's scheduled to be curtailed from April 24 to July 31. But as you're probably aware, British Columbia has a -- the principal source of electric power in BC is through the hydroelectric facilities we have. And we've had a very reasonable snowpack this winter, and we're in the run-off season right now. So when the water levels behind the hydro facilities are at maximum levels, we are typically curtailed, we have been in the past and we are again this year. So in that April to the end of July period, our power plant receives the take-or-pay revenues, but we're not actually operating the plant. So we have no need to supply the power plant during that period with our in-forest or sawmill residuals. So that's why we are trying to get comfortable to take downtime in Q2 of the year, and this is why we are focusing on having capacity -- near-capacity operations in our sawmill business in the second half of this year because the residuals from sawmilling and the residuals and bio logs from our log harvesting activities play an important role keeping the feedstock supplies for the power plant. So with lower log costs, lower duty impositions, clearly, we have plans to run both facilities at or near full capacity starting in Q3 and running through Q4.

[Operator Instructions] We will now take the next question.

Paul Quinn, RBC. Ken, so I take it that sawmill is down now and the power risk, energy is down now. The power comes up in August and the sawmill is expected to come up in July 1?

Well, it's -- we've announced that we are definitely curtailed until early in June. And clearly, we're assessing the situation. And we have logs in front of the mills that could certainly support an early June restart. But we need a little more visibility as to whether this recent upward move in lumber prices is likely to be sustainable. So Paul, we're going to be assessing our restart as we get towards the end of this month.

Okay. So with the recent move up in lumber prices, are you close to being breakeven at this point?

We think that lumber prices' fall in 2019 averaged -- benchmark prices averaged roughly $360. And we think that at Mackenzie, that if lumber prices were at that level, we're at an indifference point between whether the cash operating losses are about equal to the shutdown costs. In Q4 of this year, with the progress that we believe we're capable of achieving on log costs and with the lower duty deposit rates, we believe that at $360 that there shouldn't be any EBITDA losses at the Mackenzie site.

Okay. And that's what the -- okay. And maybe you could detail some of the cost reduction initiatives at being between the Mackenzie TSA things? Is this like sharing of harvesting responsibilities and dividing up logs? Or what are the main things to be able to drive down the cost?

Well, when people talk about costs, Paul, it's really an oversimplification in the sense that at Mackenzie, BC, we are subject to a harvest partition where roughly 50% of the harvest is directed into dead and dying mountain pine beetle and spruce beetle stands. And the chief foresters' public releases really questioned whether that timber is still commercially viable. So part of our initiative in Mackenzie is related to moving to harvest sites that are closer to our sawmill facility and incurring less delivery expense. But part of it is the expectation that there will be a possibility of a slight change in mix to a greener log, which improves our grade outturns and improves our average selling price realization.

Okay. And then just on pricing itself. I mean we have a huge disconnect between the lesser SPF markets and Southern Yellow Pine. What do you think is responsible for that? And it's a little bit perplexing to me because the majority -- the vast majority of the downtime has been taken in the last year. So how do you reconcile that?

Well, we had a good discussion about that at our Board meeting yesterday. And our Head of Marketing pointed out that when the pandemic hit in -- and became well-known early in March, that the whole distribution chain ran inventories down. And now in the U.S. South with the do-it-yourselfers having high offtake that they're caught a bit short, and they're operating this in this short-term price moves. I guess our general view follows that people such as yourselves and the FPA and others suggest that there might need to be a 6 billion board foot reduction in total lumber supply this year. The rough numbers I look at indicate that it's probably been 2.5 billion or 3 billion board feet withdrawal of supply. And so we don't think -- there's a good chance that we're only halfway through the curtailments that we need to have for a balanced market. And our instincts are that the lumber markets are more likely to be oversupplied in the immediately foreseeable future than undersupplied. And our hunch is that prices could very well retreat from their recent levels at -- on both sides of the border.

Okay. And just last question on the power side. I think this year's shut, it just seems a little bit over 3 months long. What has been the history in the last 5 years on that curtailment?

Well, it's been extended an average of -- last year, it was 114 days. So I think it was very close to 4 months last year. But it's typically been 3 months and sometimes, depending on snowpacks, it's an extra month. This year, there's always a chance it could be extended a little bit, Paul, because electricity consumption is low in BC and the snowpack's quite high. So our present understanding is that we'll have the plant back up and running in late July. There's always a chance that could be lengthened a bit.

There are no further questions. [Operator Instructions] As there are no further questions, I'll now turn the call back to your host for any additional or closing remarks.

Well, just thank you all for your interest in Conifex, and we look forward to reporting our progress to you about 3 months from now. Thank you.

That will conclude today's call. Thank you for your participation. You may now disconnect.