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

Good afternoon, ladies and gentlemen. Welcome to Conifex Timber, Inc. Q2 2023 Results Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, Patrick, and good afternoon, everyone, and welcome to this call covering our second quarter 2023 results. I'm joined today by Conifex's Chief Financial Officer, Trevor Pruden and by our President; and Chief Operating Officer, Andrew McLellan. We'll be hearing from both of them after some brief opening remarks from me, but 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 statement set out on Pages 1 and 2 of the MD&A report dated August 9, that we released earlier. Turning to our results. In the second quarter, we reported negative EBITDA of $8.7 million, which worked out to a net loss of $9.2 million or $0.23 per Conifex share. This loss lowered our book value per share to $3.25. After depositing nearly $1 million in duties in the quarter, our potentially refundable duties now exceed $1.10 per Conifex share before, of course, any allowances for potential holdbacks and income taxes. Our Q2 results trailed our Q1 results for 2 main reasons. Number one, Canadian dollar denominated benchmark SPF prices were $32 per thousand, square feet lower in Q2 than in Q1. And secondly, our annual and another special maintenance project that we completed at our power plant meant that we lost 3 weeks of power production. Other than our financial results, we're very pleased with our Q2 achievements in terms of safety, environmental compliance, and harvest sustainability. I will now turn the meeting over to the CFO, Trevor Pruden.

Thank you, Ken. And good afternoon, everybody. As we continue to navigate the volatile lumber markets, we are focused on keeping a strong balance sheet. Our net debt to capitalization is 32%, with our power loan and 9% excluding the power loan, which is non-recourse to our timber assets, which is an entirely manageable position. Current ratio, which is current assets divided by current liabilities, is 2.2. This indicates that we can manage our obligations over the next 12 months. Over the last 2 months, since I've been in this role, without being too specific, I've been approached by lenders who have expressed interest in expanding or building a relationship with Conifex. They are attracted to the fact that our sawmill, tenure, and duty deposits are all unencumbered. So, I'm encouraged that there are additional funding sources out there should we need them. I will now turn it over to Andrew to speak about the operations.

Thank you, very much, Trevor, and welcome to those present on our call today. Throughout the second quarter, our focus and commitment to enhancing operational excellence and dependability at our sawmill and power plant remained at the forefront of our strategic efforts. During the quarter, we witnessed one of BC's worst fire seasons on record, which added a layer of challenge to our operations. I'm extremely pleased by the remarkable performance and commitment exhibited by our forester team, Ministry staff, and forest firefighting crews during this period. As a result, we were able to effectively navigate through potential disruptions to our fibre supply. I'm equally pleased to report a positive shift in fire conditions, leading us to anticipate a respite from any further fire-related fibre supply challenges in Q3. As a result, we are well positioned to utilize the latter half of 2023, to operate at full capacity and achieve an 85% operating rate for the entire year. Although stumpage rates in BC exhibited a general decline in Q2, it's important to note that our second quarter deliveries typically remain modest, due to our customary transition of logging contractors from the southern truck haul operations to the northern water deliveries. As we look ahead, we anticipate more favorable stumpage rates will continue to be available in the latter half of the year. I should note, however, that our strategic approach involves a conscious shift from our practice -- harvesting practices towards a greener log diet. This shift may moderate some of the cost advantage linked with reduced stumpage rates. Nevertheless, we expect to benefit from heightened hourly production rates, lower conversion costs, enhanced grade outturns, elevated lumber recovery, and improved sales realizations for the remainder of the year. In the latter part of Q2, we also encountered a series of nuisance power disruptions at our power plant, stemming from heightened lightning activity across the region. Much like the fire conditions, the weather has now transitioned to more typical patterns. As a result, we can confidently anticipate full capacity operation of the power plant in the latter half of the year, with the advantage of seasonally elevated electricity prices. In the upcoming weeks, we anticipate the Ministry of Forests will provide additional clarity on the TSA, or the Timber Supply Area apportionment process in relation to the most recent timber supply review. In this regard, our efforts will be focused on ensuring licensees continue to have access to operating areas within the timber supply area, which provide opportunities to sustainably harvest the timber profile, in line with the very clear expectations set out by the Chief Forester in his most recent AAC determination. So, with that I'd like to turn the meeting back to our CEO, Ken Shields.

Okay. Well, thank you, Andrew. And building on Andrew's comments, we expect significantly improved results in the third quarter but we're still not quite sure whether lumber prices will be strong enough to enable interior BC sawmill operators like us to generate positive EBITDA. I'd like to now bring you up to speed on a revenue diversification opportunity that we talked about at our last meeting. At that meeting I explained how we were examining the feasibility of leveraging our power sector expertise by developing power infrastructure designed to support next-generation data centers. On that call, I also mentioned how the $100 million we invested in our power business materially enhances and stabilizes our cash flow generation, and furthers our objective to operate the most economically viable and environmentally sustainable softwood processing site in the interior region of B.C. We believe we have a similar value-enhancing opportunity available to us through the development of high-performance computing data centers. The preliminary numbers were working with indicate, number one, that a fully built-out HPC data center site can be constructed for approximately one-half of the amount we expended on our power plant. But 2, and more importantly, the EBITDA contributions from a data center would be substantially equivalent to the contribution from our power plant, which means that the returns on investment are materially higher and the payback periods are materially shorter in the data center side of things. Based on these metrics, you can understand why we are challenging the legal validity of the 18-month deferral imposed on the project, as described in our April press release. The Ministry of Energy, Mines and Low-Carbon Innovation here in B.C. has requested feedback by August 18, on the process it has underway to develop a crypto currency mining policy in B.C. We are well advanced preparing a white paper outlining how Conifex assesses the economic and social consequences of the moratorium imposed by B.C., and we plan to publicly release our findings before the August 18, deadline. A white paper is likely to conclude that any moratorium imposes heavy costs on the residents of BC, including things such as number one, unnecessary limitations on value-added development opportunities in rural and hard-hit forest communities, forgone indigenous reconciliation opportunities, a chill on investment in BC reflecting the risk of future arbitrary government policy actions. Another one's a general loss of economic efficiency and a stifling of innovation and employment. And probably the last one I'll mention is just an undermining of regulatory integrity and independence. So, summing up, the Conifex white paper outlines several ways and reasons why the actions of the provincial Cabinet contravene the law, interfere with the regulatory system, and in fact works directly against the government's own stated economic and reconciliation goals. All of you on the line are most welcome to contact us if you have any questions or comments on the paper when it's released next week. Summing up our discussion today, we believe we're well-positioned with a strong safety culture and unparalleled degree of softwood sawlog fibre self-sufficiency, near-term opportunities to improve log quality and boost lumber revenues. We have industry-leading power generation assets, as Trevor mentioned, conservative financial leverage coupled with appropriate liquidity. And lastly, exciting future potential to capitalize on our ability and make good use of B.C. Hydro's available green power in our region. Thank you for taking your time today to learn more about Conifex. Andrew and Trevor are here with me today, and we each look forward to responding to any questions analysts and shareholders may have. So, I'll now turn the meeting back to our operator, Patrick.

[Operator Instructions]. The question is coming up. One moment, please. We'll take the question. The participant did not leave their information. Please state your name. Your line is open.

Yes. Hopefully this is me. It's Paul Quinn, RBC. Just passing it to you guys. Slightly disappointing quarter, but I understand the reasons around it. Now, the question I've got is, Ken, on the HPC opportunity diversification, it sounds like it's a $50 million tag on kind of $14 million EBITDA, so kind of 3.5-year payback. Is that the way you're characterizing?

Yes, it's the way that we'd characterize it. Paul, with the -- those were numbers that we did months ago. And what's happening in this space, the demand for data center locations that have robust power supply continues to increase. And in this sector of the data center industry, the margins have been expanding a little bit. So, if we refreshed our numbers for today's industry conditions, it looks like the financial returns might be a little more robust than you've just mentioned.

Okay. And then, what are the next steps to actually going forward with that? Do you have to wait for the outcome of the lawsuit? Can you start raising some capital and going through with it? Like how should we think about the opportunity?

I think we should think about the opportunity this way, Paul. Number one, there will probably be some court hearings after the end of our September quarter, so say early in October, if historical precedents are of some value, there could be an outcome released right towards the end of the calendar year. And if we have everything that goes as planned, we will be liaising with high-performance computer, computing operators, and coming up with some collaborative arrangements, and the opportunity we have is to build these facilities on a step basis, where you do an initial phase and then the cash flow from the initial phase helps fund some follow-on phases. The other characteristic of this industry is that the operators in this sector, in order to access green power, typically pay significant deposits up front, and they are an important source of the capital requirements. So, we did our power plant project on a stand-alone basis, and we have early indications that this business could be could be financed on a non-recourse basis to our sawmill sector, just as our power plant was.

Okay, that's helpful. Just in terms of outside, besides this diversification opportunity, what else are you guys thinking in terms of strategic direction for Conifex? Are they going to remain at one sawmill, one power plant with potential diversification in HPC, or are you going to look to sell the business or look to increase any assets?

Well, in terms of the opportunities we have, and I'll talk about some of the strategic federations, because that's my direct area of responsibility. But, Paul, at McKenzie BC, going back to day one, we were subject to a harvest partition that caused us to focus on salvaged timber. So, we didn't think it made sense to modernize and upgrade our sawmill at that time. And that's why we got into the power business. And we're glad we did because the 40-some people that we have in that business are enabling us to look at some other opportunities in the power sector. So, on March 4, we had the new harvest level determination. As Andrew mentioned, by the end of this year, we believe that what's called the apportionment process, but it's really just a process by which the pie is divided up appropriately amongst all the operators. So, everyone has access to similar fiber. When that's done, we believe that just changing certain machine centers at our site, there would be an opportunity to take that sawmill up to approximately 300 million board feet of capacity. And we like that project a lot, Paul, because so much of the return on the investment is a function of cost savings, both in people. It's also a function of better lumber recovery. So, we'd be getting more lumber out of our existing log consumption, and it's a function of some cost savings, Kiln, drying when you have new modern kiln capacity. Because the return on that project is driven by cost reductions and it's not really dependent on future lumber prices and exchange rates and duty and positions, that's looking attractive to us. And once there's further clarity and certainty about our fibre supply, we'll have to give that serious consideration. So, we're prioritizing that internal project overlooking externally at all.

All right, that's great. Thanks for the update, best of luck.

Thank you.

[Operator Instructions]. We'll take the next question. Please go ahead.

It's Hugh. Just 2 quick questions. Firstly, I think you have $11.8 million that you said you've taken as you classified as income, but does that sit on your balance sheet as receivables currently?

I have to let Trevor ask that. Are you referring to the refunded duties?

Yes. No, I'm referring to, yes, no. The $2.2 million and the $9.6 million you took in '22 on the business interruption insurance is that -- where is that money right now?

There is currently about $2.2 million sitting in restricted cash.

Okay.

And then that's it. The rest is sitting in the P&L. It's moved across.

Sorry, but where is it on the balance sheet?

Just $2.3 million sitting in the restricted cash.

Okay. And the $9.6 million in '22. Is that already come in then?

That's correct.

So you've got the money.

Yes.

Okay. The other question I had was just on the duties. If I'm not mistaken, you're somewhere around a dollar share of duties, is that what kind of the number is in the U.S.?

Yes. That's we're at $32.5 million U.S. And I think I used it CAD 0.745 and it works out to $1.10 per Conifex share.

And there's no movement on that? That could be one year, 2 years, you never know when that's going to come.

Yes. The impression we have and there's some meetings being held in B.C. On this topic before the end of this month, which I'll be participating in, but the most recent impression I had is that with the election cycle in the U.S. that it's unlikely there'd be any movement towards this settlement until the election is over. So, a 2-year time frame is probably realistic and possibly even longer.

Okay. That's it for me. Thank you.

Okay. Thank you.

[Operator Instructions]. There are no further questions at this time. I would like to turn the meeting back over to Mr. Shields.

Okay. Well, Patrick, thank you very much for handling us today, and thank you, to all the listeners who participated in the call. We look forward to reporting the improved results to you in November. Enjoy the rest of your day.

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