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Edited Transcript of CFF.TO earnings conference call or presentation 27-Mar-19 3:00pm GMT

Q4 2018 Conifex Timber Inc Earnings Call

Apr 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Conifex Timber Inc earnings conference call or presentation Wednesday, March 27, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kenneth A. Shields

Conifex Timber Inc. - Chairman, CEO & President

* Yuri Lewis

Conifex Timber Inc. - CFO & Corporate Secretary

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Conference Call Participants

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* Bryan Fast

Raymond James Ltd., Research Division - Senior Associate

* Kasia Trzaski Kopytek

TD Securities Equity Research - Associate

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Roshni Luthra

CIBC Capital Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the Fourth Quarter 2018 Conifex Timber Results Conference Call.

I would now like to turn the meeting over to Mr. Ken Shields, CEO. Please go ahead, Mr. Shields.

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [2]

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Well, thank you, Simon, and good morning, everyone, and welcome to our call covering Q4 and our full year 2018 results. CFO, Yuri Lewis; and EVP, Hans Thur, are with me, and all 3 of us are available to respond to your questions at the end of this call.

We will be making forward-looking statements and references to non-IFRS measures. And therefore, I call your attention to the disclaimer on the second slide.

Furthermore, we'll be making references to adjusted EBITDA. And that's our EBITDA adjusted for the noncash impact of foreign exchange translation gains or losses on U.S. dollar denominated long-term debt. Most of our long-term debt is in U.S. dollars because most of our borrowings were incurred to fund the development of our lumber business in the U.S. South.

We believe adjusted EBITDA is a far better indicator of our operating performance in any reporting period. This morning, as most of you will have seen, we reported 2018 revenues increasing by 40% to $670 million and adjusted EBITDA falling by 12% to $40 million. The revenue gain largely reflects the build-out of our U.S. South lumber business, and the EBITDA slippage largely reflects challenges the interior B.C. lumber industry faced in the back half of 2018. In common with others, our Q4 results were weak and adjusted EBITDA was $6 million negative. A decline in lumber prices, punitive duty impositions on U.S. shipments and rapidly escalating log costs at our 2 B.C. mills combined to produce negative EBITDA in the close quarter of the year.

But while Q4 was challenging, we remain committed to optimizing the performance of our B.C. mills under current lumber price and fiber cost conditions, and we remain excited about the potential returns from the investments we've made in the U.S.

Before reviewing our lumber segment, let's quickly review 2 highlights from power. First, Q4 bioenergy segment EBITDA of $4.7 million and full year EBITDA of $14.2 million were both at record high levels. Second, we secured new long-term funding for the plant on a fixed rate nonrecourse basis that better matches future principal repayments with the cash flow generation we expect over the remaining term of the contract we have with BC Hydro. In 2019, we expect a further modest improvement in bioenergy segment EBITDA.

Turning to lumber. Our lumber segment has generated adjusted EBITDA of $36.5 million in 2018 versus $43.3 million in 2017. Higher duties, rapidly inflating log costs in B.C. and above-normal unit cash conversion costs, while we were training and ramping up our second shift production at the 2 Arkansas mills, those were the main factors that held back EBITDA last year.

At our B.C. mills, we paid $24.7 million in duty deposits in 2018 versus $9.9 million in 2017. Our aggregate duties on deposit now represents -- or now totals $34.6 million, which as many of you would be aware, it represents the approximately 40% of our present equity market capitalization.

Also at our B.C. mills, log costs increased 20% in 2018 on top of the 15% increase that was recorded in 2017. Besides pushing interior B.C. mills higher up the industry cost curve, a 2-year log cost increase of approximately $20 per cubic meter raises cash costs by approximately $70 for every thousand board feet of lumber we and our industry produces. This explains why interior B.C. lumber industry EBITDA turned negative when lumber prices collapsed in Q4 of last year.

On our last call, we reported that we were working to identify and implement a more cost-effective operating format at our Fort St. James sawmill complex. In January, we ceased operating the site with the 2-sawline configuration and commenced operating with a single sawline configuration for a trial period. Doing so furthers our objective of lowering the average cash cost of producing lumber at the site and it also positions us to achieve positive EBITDA in the lumber price recovery sector. It also helps us achieve a better balance between fiber consumption at the site and the economically available sawlog supply in the Fort St. James region.

As we stated in our MD&A, the combination of this change in format, coupled with the production curtailments we've taken at Fort St. James so far this year, are expected to combine to reduce lumber production from our B.C. mills in the first 6 months of 2019 by 28%. Consequently, we expect that a majority of our lumber production will be sourced from the more competitive U.S. South lumber supply region in 2019.

Looking into our U.S. South lumber business. The 2 highlights in 2018 were the commencement of production at our restarted El Dorado Mill and our July purchase of the Cross City, Florida and Glenwood, Arkansas sawmill complexes. Our Cross City, Florida mill, with its stable 2-shift production history and the ability to manufacture premium decking products, it continues to compile solid financial results.

Our recently acquired Glenwood mill and our El Dorado, Arkansas mill are similar in many respects. Both of the sites have been modernized and upgraded, both are strategically positioned near our Florida bulk locally sourced sawtimber supplies, and both are well positioned to serve the high-demand commodity lumber markets in Texas at lower freight costs than most of our competitors. The mills were on similar trajectories in the second half of 2018.

Following the commissioning of a second dry kiln at Glenwood, we commenced training our second shift employees in August. We commenced training our second shift workforce at El Dorado a week or so later.

Let's recap our progress in the U.S. South. In Q1 of 2018, we had 0 reportable Southern Yellow Pine production. In Q2, annualized production was 100 million board feet, reflecting the initial production from our El Dorado, Arkansas mill. In Q3, annualized production was 330 million board feet, reflecting the addition of the 2 acquired mills. And in Q4, annualized production was 380 million board feet, reflecting productivity gains slowing from a more seasoned workforce at our 2 Arkansas mills.

Our focus at the 2 Arkansas mills today is on capturing more value out of every log we process and more value out of every board we produce. We are also ranking and prioritizing a suite of low cost, rapid payback capital expenditure opportunities that are available to us to expand margins.

When you analyze the factors that drive the return on investment on U.S. South mills, you will find that something like 1/2 of the return on investment is driven by mill uptime and reliability, and the other half is driven by a combination of lumber recovery, grade outturns and product mix. We have initiatives underway to improve each and every one of the aforementioned performance indicators.

With the momentum we presently enjoy in our U.S. South lumber business, our target is to lower our ranking on the industry cost curve by $25 per thousand board feet of lumber produced between Q1 of this year and Q3 of this year.

For the year-to-date period in 2019, our 3 U.S. South mills are achieving annualized production rate approaching 420 million board feet. EBITDA has turned positive, and we continue to believe that the run rate EBITDA we are capable of achieving from these mills over a full lumber cycle will infer that our ultimate total investment in the U.S. South is equivalent to a multiple of something like 4.5 to 5.5x sustainable EBITDA from the 3 mills.

In summary, we know we have more work to do in the U.S. South, but we're confident that we have the people, the fiber supply and the converting facilities to realize on the ambitious return on investment targets that I shared with you a moment ago.

So far on this call, we've reviewed the initiatives we have underway to reduce cash outflows at our B.C. mills and to increase cash inflows at our U.S. mills.

Turning to our finances. Our MD&A also discloses that we intend to actively manage controllable expenses and working capital levels through optimized liquidity.

The transaction we announced this morning, whereby we agreed to sell our Lignum lumber distribution business to CanWel furthers the aforementioned objectives. Successful completion of the transaction will enable us to reduce our short-term borrowings by over USD 10 million.

Our MD&A also indicates that we are prepared to consider monetizing certain assets that are not core or strategic to our mid- and long-term development as a North American lumber producer. Times are changing in today's intensely competitive interior B.C. forest sector. What hasn't changed is our belief that nothing is more important to us than the safety and health of our employees and our unyielding commitment to environmental stewardship and sustainability. What has changed is the fact that, and just putting it very simply, there's too little sawlog supply available to support and maintain the present manufacturing base. We're starting to detect a greater willingness among existing forest industry stakeholders to explore whether opportunities exist for collaboration to develop more competitive and sustainable forest industry hubs or clusters in the northern interior region of B.C.

Our response to these developments is straightforward. We intend to keep an open mind whenever we are apprised of potential opportunities for collaboration that has the effect of moving interior B.C. operators to a lower ranking on the forest industry cost curve.

Summing up, we look forward to our next discussion with you in May after we report our Q1 results. Our best read of Q1 that we see at present is that the momentum we're enjoying in the U.S. South will enable us to materially reduce the EBITDA loss we incurred in Q4 of 2018, but we're not sure if it'll be adequate to enable us to report a materially positive EBITDA in the opening quarter of 2019.

Thank you for your time today and your interest in our company. We'd be pleased to respond to any questions that analysts or shareholders may have. And on that regard, we'll turn the program back to Simon.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll now take our first question from Paul Quinn from RBC Capital.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [2]

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Just noticed midweek price for Western SPF 2x4 is down $12 down at $356, I suspect most of the industry is underwater at this price. Why do you think the industry continues to run? And why are you guys running here?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [3]

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Well, first of all, Paul, Hans Thur, who is with me here, was out of the office, visiting some sites in the U.S. yesterday. And I was very surprised when I saw the lumber price that Random Lengths reported because I can assure you that there's no lumber that is being transacted from our sales desk at the Random Lengths price. And my theory is that there's a possibility that some independent operators are under some financial strain because you'll recall that the winter logging program is just coming to a halt now, and most operators would have a significant payment for logs that will be made in the past few days or in the next few days. So I have the impression that there were some distressed sales in order to fund future log purchases. Looking at B.C. in total, Paul, I share your concerns, and I've heard it from many of your investing clients that they -- when they look at the economic factors, and given immediately foreseeable lumber prices and you take duties off that, it's clear that the cash operating losses exceed the shutdown costs at many mill locations in B.C. But I do get the sense that industry participants are now less willing to incur operating losses that exceed shutdown costs for extended periods. And that causes us to think that there will be some more responsible industry behavior taking effect in B.C. And that when we tally up B.C.'s total production and shipments for 2019, I think we're going to end up quite a bit lower than most of the forecasts that I see. So that's why -- that's part of the reason that we have an opinion that lumber prices are more likely going to be going up as we go through the remaining months of this year than going down because we think the industry observers have potentially underestimated the supply contraction in B.C. that would flow from more responsible industry behavior.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [4]

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Okay. So therefore, I guess, it follows that you expect, following break-up, you're less logging over the course of the summer unless we see material change in lumber prices, right?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [5]

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That's exactly my view. And remember that when you make 1,000 board feet of lumber on, say, April 1, that your log costs are some costs. So if you need to generate cash from your log pile, it's possible to do that by selling lumber at a low price.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [6]

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Okay. And then just on the targets that you set for U.S. South production, I understand you had that 420 million if you annualized Q1, that sort of represents a 76% operating rate. What is the goal for the end of the year?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [7]

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Well, Paul, the goal for the end of the year is to certainly be at a production rate of 472 million board feet, which was our original target. We're a little light this month, partly because one of the consequences of this wet weather, we know that it impacts deliveries of lumber to construction sites and it slows up the whole distribution chain. But the other thing it does in certain areas is that it curtails logging activity. So this month, we probably lost 10 or 11 shifts in the U.S. due to log supply shortages that are weather related. The other thing that's happening in the U.S., and I'm sure you see these numbers, but if you look at the price payables, you will see that 2x4 trades at $125 or $130 per thousand board feet higher than by 2x10. And so it our mill in South Arkansas, we have in that part of the U.S. South, the average log diameter is about 11 inches. So if mills were just operating naturally, they produce a lot of 2x10 lumber. And what we're doing is we're trying to make a lot more 2x4 out of those mills. So we are -- we're not all that fussed really, Paul, if we're a bit light on our 472 million board foot production targets because we changed the product mix much more to 2x4, and we believe that our margins will be better with slightly lower production, including more 2x4 than they would be if we reached our old target with a product mix that was less profitable.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [8]

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Okay. That's helpful. And then just lastly, you mentioned monetizing certain assets. What do you guys consider noncore? Maybe you could give us some more color on that.

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [9]

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Well, we are just taking a look at what's going on in the industry. And we are -- we've been trying to gain a better understanding of the options that our industry has for rationalization as the post mountain pine beetle harvest productions kicked in. And so we've got some ideas as to how it might shape out, but we're not at a stage now where we've got any definitive ideas that we're pursuing. We want to gain a better understanding over the next few months about how a few things play out in B.C. because there is some wildlife protection set-asides, being established for the forest land base. There's negotiations going on in connection with First Nations tenure allocations. There's more work being done on the spruce beetle salvage initiative. So there's a whole bunch of industry drivers that are -- that I'm certain of. So we're just assessing all the potential outcomes and assessing the -- those other variables that I mentioned, and we'll be ready to respond to any ideas for collaboration that result in a stronger, better industry in the interior region of B.C. That's all I can really say about that.

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Operator [10]

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Our next question comes from Roshni Luthra from CIBC Capital Markets.

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Roshni Luthra, CIBC Capital Markets, Research Division - Analyst [11]

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I just have one question for you, Ken. It's regarding the Lignum sale. Can you tell us what was the revenue and EBITDA contribution in 2018?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [12]

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The short answer is no. I can tell you, that was a business that Hans Thur had control and direction over, and that was consistently profitable. And I want to take a moment and tell you what drove our thinking to conclude a transaction with Lignum. We think lumber prices are going higher. And if you want a wholesale lumber business in a higher lumber price environment, you need to put more capital into it to support the inventories and receivables that increase in value even if your volume stays constant. And in fairness with the Lignum people, it was important that they have additional capital to support higher pricing and to support higher volume. And we have a suite of investment opportunities in the U.S. South that are just very, very tantalizing and appealing to us. So we thought that our company would be doing a better job for shareholders if we released some of the capital in Lignum and redeployed it in the U.S. So there will be a modest EBITDA slippage with Lignum not with us but it's something that can be easily recaptured as soon as we get our spending plans prioritized for the U.S. South. And in the meantime, we'll have a slightly lower interest spillage, the cash is deployed to reduce our operating lines.

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Operator [13]

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We'll now take our next question from Bryan Fast from Raymond James.

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Bryan Fast, Raymond James Ltd., Research Division - Senior Associate [14]

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Now that you've had some time at the assets in the U.S. South, maybe just speak to some of the bottlenecks that you've identified and is there potential for added capacity with minimal capital spend down there?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [15]

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Bryan, that's a very good question, and I think we have the most attractive prospects for production gains from our existing facilities. And they fall into 2 general camps. At Glenwood, Arkansas, Brett Bray and Adam Lites and the teams down there have really got the sawmill running at a very good clip. And we're finding that it's really the back end, the planning end, that is having a challenge keeping up. So that is a site that does not have a great expert or an automated scanning and grading in place. So that's a machine center that virtually every modern mill has, and it's the one remaining part of the capital program at the Glenwood site that we haven't completed. So that's a potential for us. At El Dorado, the bottlenecks are pretty much what we anticipated. And so if you go back to our transcripts when we first talked about the El Dorado Mill, we said that our concept was to put sort of a Ferrari engine right in the middle of the mill. And once we got it up and running that we take some initiatives that would enable us to get more logs in the front end of the mill and more boards out of the back end of the mill. So right now, we are in the process of upgrading our board edger and our trimmer and our stacker to improve the number of boards coming out of the back end of the mill. Those projects total less than USD 0.5 million. And we're also looking at an initiative for later in the year, probably Q3, to get more logs in the front end of the mill because our log processing equipment is a carryover -- well, important components of it are carryover from the old mill, and they're not able to keep up with the primary and secondary breakdown units. So we're not 100% sure about the front end of the mills. We're looking at some used equipment. But originally, we thought it might cost us $1 million to get more logs in front of the mill. But with some of the rationalization that's taken place in other areas of the U.S., we might be able to do it with used equipment for half that amount. So the El Dorado Mill is currently running at probably 80% of the rate that we think it will be running at once we have spent the next $0.5 million at the site.

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Bryan Fast, Raymond James Ltd., Research Division - Senior Associate [16]

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Good. I appreciate the color there. And then second, as we look into 2019, I understand there's a lot of moving parts here. But what level of capital spend do you think you'll be targeting?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [17]

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Our budget is for a very modest amount, it's CAD 9 million is our budget for this year. And we probably have about 1/3 of that would be expended in the first half of the year and the balance in the close of the year.

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Operator [18]

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(Operator Instructions) Our next question comes from Kasia Kopytek from TD Securities.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [19]

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It's Kasia. Ken, can you give some insight into maybe the magnitude of your Q1 working capital needs? I know it tends to be a heavy working capital quarter, I'm just trying to get a sense of how much that could be for you.

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [20]

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Okay. You were a little hard to hear, but we understand the question is, could you give us an insight into your -- was it working capital needs?

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [21]

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That's right, yes, for Q1. I mean, I know it's a heavy working cap build quarter, and I'm just trying to get a feel for the magnitude of how much that was this year in Q1 for you.

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [22]

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Kasia, it's Yuri. As Ken mentioned, we temporarily went to a 1-line operating format at Fort. So it was a little bit lighter there. I would say on average, the net noncash working capital, including all of our mills, was around maybe CAD 95 million.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [23]

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Sorry. That's the working cap draw in Q1, CAD 95 million?

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [24]

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In average, yes.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [25]

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Okay. So that's significantly higher, right, than that -- than historically? Because I'm looking last year's financials Q1 was about $10 million draw, Q1 '17 was $13 million. So that would've been a significant...

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [26]

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I'm sorry, that was the average level. Did you mean how much it went up?

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [27]

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That's right, yes. I'm just wondering how much cash was (inaudible) for working capital... yes.

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [28]

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Sorry. Yes, so typically, it goes up. But traditionally with the Canadian mills, it can go up $30 million during the log build. I would say that it was probably half of that this year, $15 million to $20 million.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [29]

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Okay. Okay, great. That helps. And just the previous caller's question about CapEx. I'm not sure I heard it. Can you just repeat what you guys expect for CapEx in 2019?

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [30]

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CAD 9 million, 1/3 of which will be spent in the first half and 2/3 of which will be spent in the second half. That's what our business plan says.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [31]

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Got it. Okay. And one last one for me. Yuri, this one's probably for you. But I'm looking at Note 15 of your financials just where you guys disclosed the contracted cash -- contractual cash outflows for your borrowings. And for 2019, I see $46 million. And then I'm comparing that just to your MD&A on Page 16, where you have a similar schedule, and it breaks it down a bit more. And I see for debt-related pieces, it's for about $55 million. So can you just help me understand the difference between the 2 figures?

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [32]

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Okay. So the one that is in Note 15 is only the -- our loan -- let me take a closer look.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [33]

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Yes, so if I look at Page 16 of your MD&A where you have a similar table and I just look at the first 2 items, which is the long-term debt piece for $43 million and the revolving credit facility for $12 million, the sum of those 2 is about $55 million.

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [34]

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Okay.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [35]

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Do you want me just to follow-up after the call? Would that be easier?

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Yuri Lewis, Conifex Timber Inc. - CFO & Corporate Secretary [36]

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Yes. Let's do that, sure.

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Kasia Trzaski Kopytek, TD Securities Equity Research - Associate [37]

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Okay. I'll follow up with you after the call. That's all the questions I have.

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Operator [38]

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There are no further questions registered at this time, sir. I would like to turn the conference back over to you.

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Kenneth A. Shields, Conifex Timber Inc. - Chairman, CEO & President [39]

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Okay. Well, Simon, thank you very, very much for your service today, and thanks to all of you for your interest in Conifex. We look forward to chatting with you all early in May. Enjoy the rest of your day.

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Operator [40]

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Ladies and gentlemen, the conference has now ended. Please disconnect your lines at this time. Thank you for your participation.