Earnings Transcript for CFXTF - Q4 Fiscal Year 2022

Operator: Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. 2022 Annual Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Ken Shields: Well, thank you very much, Patrick, and good afternoon, everyone, and welcome to the Conifex call covering our fourth quarter and full year 2022 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 statement on Pages 1 and 2 of the MD&A we distributed earlier today. Our fourth quarter results were exactly in line with the guidance we provided on our November 8th call. Back then, we stated that we anticipated recording business interruption insurance proceeds in our Q4 income statement in an amount that would slightly more than offset potential losses at our sawmill complex, and we expected that our full year EBITDA and net income would be within 10% of the record levels we achieved in 2021. Q4 2022 EBITDA of $2.3 million brought our full year EBITDA to $46.7 million, which is 10% lower than the $51.8 million we reported last year. 2022 net income of $24.5 million was also 10% lower than we achieved in 2021. With fewer shares outstanding, earnings per share of $0.61 in 2022 were about $0.01 higher than we achieved in 2021. Because we paid a special dividend of $0.20 earlier in 2022, our year-end book value per share increased by just over $0.40 to $3.68 per share. We ended the year with US$31.3 million in potentially refundable duties on lumber -- duty imposition that were on deposit. And of course, in Canadian dollars, that translates into just over $1.00 per Conifex share before any allowances for potential holdbacks and income taxes. We're very proud of what we achieved in 2022 in terms of our safety and sustainability rankings. We're also proud of the fact that our earnings per share increased slightly when six other lumber-oriented public companies reported declines of 19% to 67% in their per share results for 2022. You will note that we recognized $9.6 million as other income in our income statement to reflect the proceeds received from a business interruption insurance claim. A manufacturer's defect in the power plant turbine caused power generation to be curtailed for the closing six months of 2022. The proceeds we received are a testament to the fact that no shortfall in our maintenance procedures nor in our maintenance practices were identified by the engineering and accounting experts that the insurers engaged to examine the cause of the power plant curtailment. It's also a testament to the high uptime reliability our power generation team achieved when they're not held back by factors completely outside of their control. All of us at Conifex, including our entire Board of Directors, are extremely proud of the performance from our experienced highly-competent power plant team. The results we reported for the closing six months of 2022 provide investors additional insight into the economic sustainability of our integrated and co-dependent harvesting, sawmilling and power generation businesses at Mackenzie, BC. My key point here is that the $100 million we have invested in our power generation business materially enhances and stabilizes our cash flow generation. It also furthers our objective to operate the most economically viable and environmentally sustainable softwood processing site in the interior region of BC. Since our last call, several of you have contacted us and asked what's happening in BC with respect to sawlog availability, cost competitiveness, regulatory developments, et cetera. Permit us to share our views on these topics. We believe Conifex is well positioned in terms of sawlog supply. As many of you know, our tenures are located in the Mackenzie Timber Supply Area, or TSA. The land base in the TSA is about equal to the combined land base in the states of Vermont and New Hampshire. We operate the only sawmill on this large land base. We believe that the standing timber inventory in the Mackenzie TSA is capable of supplying sawlogs in perpetuity that are at least double and perhaps as much as triple are present and foreseeable requirements. We believe our company enjoys a degree of regional fibre self-sufficiency that is not available in any other TSA in the interior region of BC. Furthermore, if you examine our financial reports, you will note that we ended 2022 with record high log inventories of $33 million at a time when others were taking downtime due to fibre shortages. You will also note that our inventory write-downs were just over $2 million when others were taking write-downs of phase, something like 20 or 50 times the amount we took. These figures suggest that our delivered log costs are competitive compared to other mills operating in the interior region of BC. Over the past few years, the ministry has imposed several new policy on forest sector operators in the interior of BC. Since many important regulations have yet to be drafted and/or implemented, it's difficult to precisely determine how future sawlog supplies and delivered log costs may be impacted. We expect that fibre supply will remain tight in the interior region of BC through the remainder of 2023. The main reason is that BC timber sales is finding it difficult to develop an auction [stand] (ph) to achieve its mandate to provide 20% of the sawlog harvest in the interior of BC. BC timber sales' excuse is that it's being held back by the province's old growth retention, First Nations' reconciliation and other emerging land based management objectives. Looking at BCTS activity, in the Mackenzie and our neighboring Prince George Timber Supply Area, over the 2017 to 2019 period, BCTS auctioned something like 4 million cubic meters annually and met at 20% of harvest objective. In its fiscal year ended March 31, 2022, BCTS auctioned just over 1 million cubic meters and accounted for considerably less than 10% of the harvest. Over the nine-month period ending December 31, 2022, BCTS auctioned just over 300,000 cubic meters and accounted for a nominal portion of the harvest in Prince George and Mackenzie. Converting the cubic meters into lumber, BCTS went from supplying the fibre requirements for four large interior BC sawmills to supplying the requirements at one small sawmill. These low auction volumes exacerbate fibre shortages. They directly increased the competition for and the cost of auction wood and contribute to artificially high stumpage rate [indiscernible] on tenured wood supply. Turning to lumber prices, we get the sense that prices have climbed down the side of the mountain and now crossing the valley bottom and will soon begin to climb up the other side of the valley. We believe sawlog supply constraints coupled with BC's cost structure will trigger further curtailment announcements and produce a better balance between [SPF] (ph) supply and the lower demand currently being experienced. In our company, we expect our Q1 earnings may lag the results reported by some other public lumber companies for three main reasons. The first is that our sawmill was offline in the first week of the year and we were forced to take an additional seven operating days downtime because railcar shortages prevented us from shipping our lumber. Fortunately, the railcar supply has improved a great deal. The second reason is that our power generation results in February were held back as we progressed through the startup curve associated with a winter restart following eight months of downtime at the power plant. And the third reason is that our log costs in Q1 of 2023 will be at normal level, not at the written-down levels available for certain other companies. Given these three factors, we expect we will report negative EBITDA in the opening quarter of 2023. It looks like we're probably going to get back something like 10% of the EBITDA we earned in 2022. However, we expect our quarterly results to improve as we progress through the balance of 2023. That concludes my prepared remarks. Andrew McLellan, who heads our Operations; Trevor Pruden, who heads our Corporate Services and Business Planning; and CFO, Winny Tang, are here with me today, and we look forward to responding to questions analysts and shareholders may have. I'll now turn the meeting back to Patrick, our operator.

Operator: Thank you. [Operator Instructions] We'll take the first question. We have a question from -- please go ahead.

Gabe Nicholson: Gabe Nicholson. Hi. Hey, sorry about that. This is Gabe with CIBC. Good afternoon. Hope everyone's doing well.

Ken Shields: Yes, we are Dave. Thank you.

Gabe Nicholson: Okay. So, first question. I was just wondering what kind of change do you see in BC stumpage as we move from December into January? And then, where do you think that's going to go in April here?

Ken Shields: Okay. Well, Andrew McLellan is closer to that than I am. So, he'll answer your question, Dave. Thank you.

Andrew McLellan: Hi, Dave. Andrew McLellan here. As we kind of look forward into the remainder of Q1 here and into Q2, we're seeing very competitive bidding in the BCTS auctions within the province that are outside of our Timber Supply Area, but influence the estimated winning bids with the pricing model in BC. So, we expect, obviously, with lumber prices declining that we'll see some relief in stumpage, but hard to tell how much relief we're actually going to see with the competitiveness in the bidding within BC. So, we'll see as the adjustments are made here, but not expecting any material decreases in stumpage.

Gabe Nicholson: Okay. Yes, great. Thank you. Thanks for the color on that. And then, second, in terms of the letter or statement by the provincial government dated December 21, do you have any idea if your existing customer or that you started the trial run with back in September, will they be grandfathered in? Or is there any kind of details you could provide around that? And then, just in terms of the three potential customers you guys mentioned, how do you think they will be impacted?

Ken Shields: Okay. Well, Trevor Pruden will respond to your -- that question, Gabe.

Trevor Pruden: Hi, it's Trevor here. Yes, we continue to still like this business. We have a new customer for our 3-megawatt deployment that we anticipate will be energizing the miners in the coming weeks. We're still exploring how we can best scale up this segment. And we continue to evaluate the potential impact from the BC government's order and counsel to BC Hydro on our hosting services business.

Gabe Nicholson: Okay, great. Thanks. I'll leave it there.

Trevor Pruden: Great. Thanks.

Operator: Thank you. [Operator Instructions] The next question is from Paul Quinn. Please go ahead.

Paul Quinn: Yes, thanks very much. Good afternoon, guys. Just maybe start with the BCTS, Ken, because you brought it up. What's the fix here?

Ken Shields: I beg your pardon, what's the fix here?

Paul Quinn: Yeah. How do they fix this system? I mean, this has been going downhill. [indiscernible] 20% to make the competitive stumpage system representative and competitive and the undercut, it's getting worse by a year. How do you fix this situation?

Ken Shields: Okay. Well, first of all, I can tell you, Paul, that a vendor's forest routines chalked up statistics like that. That would never happen, because we have a much more robust system of management accountability and delivering against business plans and targets. But, Paul, I don't think there is a quick fix to it. I know that there are representations given by BCTS that they will do better. The BC provincial budget indicated that there would be 6 million cubic meters of volume from BCTS in the year ended March 31. The best figures I have is that they'll be lucky to be at 5 million cubic meters. And I just think that the difficulty they're having to get approval to go into old growth stands or to go into areas that have some control and direction exerted by local First Nations make it very difficult for them to ramp up their volumes anywhere close to the 20% of the provincial harvest. And my guess is that they might be at 10%. But as I'm sure, Paul, you've seen some of the work that's been done on the interior BC industry when people have attempted to assess what the impact. In BC, we've got a province-wide reduction in the interior BC harvest level. And although old growth set aside, and wildlife set aside, and First Nations' reconciliation objectives are having some impact on overall harvest levels, the single biggest cause of the harvest shortfall in BC is BCTS. As an industry we've been encouraging the province and the ministry to ensure that BCTS does a better job, but there's not a lot of evidence that much progress is being made to date.

Paul Quinn: Okay. And then, just looking at -- you've experienced a couple of shuts in 2022 due to lack of railcar availability, but you also mentioned that this is better. What are the alternative transportation arrangements that you can make? And is that a longer-term solution to move away from rail at least to the next reload, because there's a problem in Mackenzie?

Andrew McLellan: Hi, Paul. It's Andrew here. So, in terms of our ability to shift to trucking, for example, certainly not something that we want to do. There's, obviously, some additional costs associated with the trucking lumber into a reload and rehandling. So, our intention is to continue to work with our rail partners and ensure that we have adequate service to support our business. We do occasionally rely on trucking when we get behind on railcars, but it's not a long-term solution for us.

Paul Quinn: And just so I understand that component, if you went to truck [and reload] (ph), what's the additional cost of the rail -- reloading? Where is that reload? Is that a Prince George's reload for you guys?

Ken Shields: Okay. Well, what -- Paul, given the nature of our core customer base, the trucking option that works best for us is to take the wood from Mackenzie down to the lower mainland and ship it on the Burlington Northern into our key markets in Arizona and Texas. And so that's the trucking option and it's probably something like $35 or $40 per thousand board feet of additional cost to do that. As you're probably aware, a truckload of lumber contains about as much as one-third of a boxcar. So, if you're trying to replace boxcar shortages with trucks, you need a lot of trucks. And what happens is that most of us in the interior BC, we're all looking for trucks at the same time. So, it's -- the trucking -- the higher cost trucking option can be a bit of an [necess] (ph), but it's -- as Andrew mentioned, it's not a permanent solution.

Paul Quinn: Okay. So, in a typical year, are you like 10% truck and 90% rail...

Ken Shields: Probably 95%-5% would be my guess.

Paul Quinn: Okay. That's helpful. And then, Ken, any update on the Mackenzie TSA AAC apportionment?

Ken Shields: Well, Paul, that's a good question. And we've been promised it by the end of October. We've been promised it before the Board meeting that we had earlier this morning. And who knows, Paul. If you go back to February of 2019 when the green and salvage harvest partition was modified, the Chief Forester at that time said that they were going to move quickly for an in-timber supply review. The data package for the review was issued in October of 2020 and the public discussion paper was issued a few months ago. So, it's an unusually long time and we're still waiting for it. But while we're waiting for it, the trees are continuing to grow and there's probably more inventory in the timber supply area today than when they promised to have the report delivered to us. So, we're not worried about what the AAC determination is. We think we'll have plenty of what to [indiscernible].

Paul Quinn: Okay. And just last question. Any -- you guys are the only operational sawmill in that TSA. Any movement on the other assets in the region as well?

Ken Shields: Well, Paul, we have the same information that you have, which is that 55 weeks ago Canfor announced that they had arranged to sell their tenure to two local First Nations and when Canfor released their results on February 28, they essentially repeated the same statement that they made a year earlier. So, reading that statement, it strikes me that, that transaction is still on, but there's no forecast date for when they might have a banking agreement or expect to apply for the approvals for the tenure transfer. And we understand that the mill in Mackenzie that -- the machine [indiscernible] often taken apart and they're sitting in a place, ready to be shipped out when the tenure transaction closes. So, people in Mackenzie do not believe that there will be any sawmill production coming from that vacated site.

Paul Quinn: Okay. That's all I had. Thanks very much guys. Best of luck.

Operator: Thank you. We'll take the next question. Please go ahead.

Unidentified Analyst: [Hugh Cooper] (ph). Good morning, Ken. I had the same question as Paul, but maybe I've got a couple other questions too. Firstly, any -- is there any update on the -- I think you have somewhere near $1.00 share of duties that are on hold with the U.S. government. Is there any update at all industry-wide on that? And secondly, your tax loss carry forward, if I recall, it's something like about a -- might have been a $180 million, about $4.50 a share. Is that predominantly all in the U.S.? Is there any left in Canada?

Ken Shields: Okay. Well, I'll talk about the duties and Winny Tang will refresh us on tax loss carry forward. So, on the duties, at year-end, we were at US$31.3 million. And that [US$0.725-$1.00] (ph), which I think we're roughly at today, it's the equivalent of $1.08 per share before any possible holdbacks and before any possible taxes on the amount of the rebate. So, that answers the duty question. And Winny Tang will talk about our tax loss situation.

Winny Tang: Yes, of course. Thank you, Ken. So, Winny here. So, thank you for that question about the taxes. I'm always excited to speak about taxes. So, just in answer to your question, the majority of those tax loss carry forward do relate to our U.S. operations. We do have above 5% or so of our balance does relate to our Canadian operations. And that, of course, is after deducting losses that we utilized for the 2022 tax year. So, I think we're in a good position heading into 2023 in terms of Canadian operations and just the ability to shelter our earnings there.

Unidentified Analyst: Okay. Just following up, Ken, the second part of the question on duty. So, is there any update industry-wide on that?

Ken Shields: Okay. Good question. Yes. My understanding is that Federal Government Minister of Trade is liaising with key executives in various provincial forest association and that they're having a call in the next couple of days. And of course, there's been some speculation that President Biden may be visiting Canada before too long. And of course, the forest industry is working hard to have the resolution of the trade dispute on the short list of topics that the two country heads would discuss, if indeed there is a [indiscernible]. So, I might have a feel for it when I'm updated by our industry association in the next couple of days, but that's my understanding as to where we're at today.

Unidentified Analyst: Okay. Thank you, Ken.

Operator: Thank you. There are no further questions at this time. I would like to turn the meeting back over to Mr. Shields.

Ken Shields: Okay. Well, thank you everyone for your interest in our company, and we're going to get back to work, to do everything we possibly can to get rid of the red-pencils in terms of our EBITDA and be in black-ink in the closing half of 2023. So, thank you. Enjoy the rest of your day.

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