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Edited Transcript of PL.TO earnings conference call or presentation 13-Aug-19 3:00pm GMT

Q2 2019 Pinnacle Renewable Energy Inc Earnings Call

Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Pinnacle Renewable Energy Inc earnings conference call or presentation Tuesday, August 13, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrea Louise Johnston

Pinnacle Renewable Energy Inc. - CFO

* Robert McCurdy

Pinnacle Renewable Energy Inc. - CEO & Director

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Conference Call Participants

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* Jonathan Lamers

BMO Capital Markets Equity Research - Analyst

* Mark Thomas Jarvi

CIBC Capital Markets, Research Division - Director of Institutional Equity Research

* Nelson Ng

RBC Capital Markets, LLC, Research Division - Analyst

* Rupert M. Merer

National Bank Financial, Inc., Research Division - MD and Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Sylvy, and I will be your conference operator. At this time, I would like to welcome everyone to Pinnacle Renewable Energy's Second Quarter Results Conference Call and Webcast hosted by Robert McCurdy. (Operator Instructions) Today's call is also being webcast and recorded. An archived webcast will be available after the call.

And I would like to turn the call over to Mr. Robert McCurdy. Please go ahead, sir.

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [2]

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Thank you, Sylvy. Good morning, and thank you for joining us. With me on the line today is Andrea Johnston, our CFO. We have also posted a supplementary slide deck for this call this morning, which will be available for download on our website and through the webcast link.

I'll start the call today with a few key highlights and an operational update from the second quarter, then Andrea will follow with a review of the financial results. And we'd welcome questions after that.

The second quarter of 2019 marked a strong period of production and revenue growth, demonstrating the successful execution of our growth strategy with revenue up over 22% from a year ago.

During and shortly after the end of the quarter, we moved 2 more new long-term take-or-pay contracts across the finish line. The first with GS Global in South Korea for 100,000 metric tons per year beginning in 2022. The second with Mitsubishi in Japan for up to 120,000 metric tons per year beginning in 2021. These new contracts demonstrate the strengthening of our relationship with our Japanese contracts and expansion of our business into the Asian markets with GS contract marking our third contract in South Korea.

With the growth of our contracted backlog and diversification of our counterparties, we are continuing to evaluate and develop further opportunities to add incremental production capacity, hence the announcement early in the third quarter of our new facility to be constructed in High Level, Alberta with a partnership with Tolko. The new facility will diversify our fiber supply by using high-quality wood fiber sourced primarily from Tolko's existing sawmill in High Level. And we expect to see a run rate production capacity at this facility between 170,000 and 200,000 metric tons per year.

At the quarter end, our backlog had grown by $500 million over the end of the first quarter to $6.9 billion. We did face some operational challenges in the quarter that impacted our financial results, including the ongoing effects of the fire event at Entwistle and the transition to processing a broader range of fiber sources at some of our BC facilities that was required due to the sawmill curtailments.

The curtailments impacted our fiber sourcing at Burns Lake, Meadowbank, Williams Lake, Houston and Smithers. Due to the fiber supply constraints, each of these facilities received a wider range of low-quality fiber, which caused more wear on the production equipment than typical and resulted in more downtime as well as higher repair and maintenance costs.

Over the upcoming quarters, we expect to mitigate the impact of the curtailments as we continue to optimize the production flows in our plants and some of the curtailed mills restart. We are now confident that we have enough fiber in front of our mills, and we are focused on the processing and cost optimization.

Despite these challenges, we sold approximately 478,000 metric tons of pellets in the quarter, an increase of 24.2% compared to Q4 -- sorry, Q2 of last year. Our revenue was up 22.6% year-over-year.

Improvements at Aliceville continued to progress. Production volumes have improved consistently through the execution of best practices by the team and planned capital improvement program. The facility is well positioned to contribute to adjusted EBITDA in 2019. Additionally, Smithers is expected to reach full production run rate of 125,000 metric tons per year in Q3 of this year and make positive contribution to adjusted EBITDA.

We began upgrades to our Williams Lake and Meadowbank facilities during the quarter. This included the installation of new fiber drawing and air filtration equipment, improvements to access infrastructure. The upgrades with an expected capital cost of $34 million will allow the 2 facilities to process a broader array of available fiber sources in the Cariboo region and to achieve safety and environmental advances.

Upon completion, these facilities will have a combined production capacity increase of about 80,000 metric tons per year. The investment will enhance our operational flexibility at these facilities and position us better to adapt to the cyclical changes of the wood fiber supply in that region of British Columbia. We expect to have the upgraded facilities completed and commence commissioning by Q1 of 2020.

In early May, we signed an agreement with CN for rail rates for a 5-year term for our operations in Western Canada. This provides rate and service stability for our rail transportation for a significant proportion of our business, and it reinforces the collaboration between Pinnacle and CN to develop the wood pellet industry in Western Canada.

We restarted Entwistle in late March using dry fiber only. The plant is currently operating at approximately 20% to 30% of its production capability. The plans to restart the dryer are still on schedule for the fourth quarter of this year. The capital costs to replace the dryer area at Entwistle are in the range of $13 million to $15 million, and we expect substantially all the capital and operating costs associated with the incident to be recovered under our insurance policies.

Additionally, we are installing a destoner system at Entwistle, which will enable us to improve the fiber quality and reduce the downtime of the facility. We spent $1 million on this capital project in Q2, which is partly subsidized by fiber suppliers and will complete -- be completed concurrently with the dryer rebuild.

Andrea will provide further details at Entwistle in a moment. But before I hand it over to her, I'd like to highlight and congratulate Scott Bax on assuming the role of Chief Operating Officer at Pinnacle. Scott has been a strong member of the team since 2013 and has the background to support our operations and strategic growth. We are also pleased that Leroy Reitsma, with Pinnacle since 2007, has transitioned from a COO role to focus on U.S. development projects and support of the team.

Additionally, we recently appointed [Adnan Khan] as the Vice President of Strategic Capital. This is a newly created position that will continue to support Pinnacle's strategy through the development of greenfield, brownfield projects, acquisitions, joint ventures with the overarching goal of strategically deploying capital to support the growth of our business. Our best wishes to all.

Now I'll turn it over to Andrea.

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [3]

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Thanks, Rob, and good morning, everyone. Before I begin with the financial summary of the quarter, I would like to remind participants that this call contains forward-looking statements and non-IFRS financial measures, both of which are more fully described in our published MD&A for the quarter. Additionally, you may have noted that we have removed 2 commentary sections of our MD&A this quarter, namely the sections titled Summary of Factors Impacting Performance and IFRS Measures. These sections remain included in our annual information form, and to the extent any changes occur prior to publishing the next DIF, we will be sure to provide an update and highlight any changes in our MD&A.

Moving on to the results. Revenue for the second quarter of 2019 totaled $104.2 million, an increase of 22.4% compared to Q2 a year ago, reflecting our higher sales volume as we produced and sold higher volumes of pellets from our Smithers and Aliceville facilities, where there was no production from them in Q2 last year.

Production costs were $69.9 million in the quarter compared to $53.9 million in Q2 last year. The increase was primarily due to an increase in sales volume, higher fiber costs, higher cash conversion costs and increased costs incurred for third-party wood pellet purchases. An initial amount for business interruption insurance proceeds of $4.5 million for lost net profit from the Entwistle incident was recorded in production costs, partially offsetting the fixed overhead and incident response costs incurred from the Entwistle incident of $2.7 million in the second quarter.

We expect over the coming months that we will see the conversion costs per metric ton return closer to historical levels as we realize the benefits of increased same facility production volumes with optimized production flows. Our $0.1 million decrease in distribution costs compared to Q2 last year reflects the lower proportion of CIF versus FOB sales, offset by negative variances resulting from rate increases at the ports and demurrage costs as a result of production volume delay.

Our $0.8 million increase in SG&A expenses in the quarter was primarily attributable to a $0.4 million increase in personnel costs primarily due to the expansion of operations, we have 3 new facilities compared to the same period last year; a $0.3 million increase in stock-based compensation; and $0.1 million increase in legal and insurance costs. The increase was partially offset by a decrease in costs relating to the IPO that we recorded in the second quarter of last year.

We recorded a net profit of $2.4 million in Q2 2019 compared to a net profit of $6.5 million in Q2 last year. The change in net profit reflects higher SG&A expenses, higher production costs, higher amortization costs as a result of our new production facilities and increased finance costs. These factors were partially offset by lower income tax expense.

Excluding the impact of the implementation of IFRS 16 and the Entwistle incident, net loss in Q2 2019 was $3.6 million. Adjusted gross margin in the quarter was $21.2 million or 20.4% of revenue compared to $18.1 million or 21.3% of revenue in Q2 last year. The decline in adjusted gross margin percentage was primarily attributable to higher production costs resulting from the Entwistle incident and as a result of fiber mix constraints occurring at other facilities. These factors were partially offset by increased revenue from higher sales volumes.

Adjusted gross margin for Q2 2019 also reflects our adoption of IFRS 16, which is described in detail in our MD&A. Excluding the impact of the implementation of IFRS 16 and the Entwistle incident, adjusted gross margin was $17.6 million or 16.9% of revenue in the quarter.

Free cash flow for Q2 2019 was $7.2 million compared with $10 million from Q2 last year. The decline is primarily due to an increase of $3.5 million in maintenance CapEx and an increase of $2.6 million in interest and finance costs, offset by an increase of $1.3 million in adjusted EBITDA and a decrease of $2 million in mandatory amortization of term debt. The Entwistle incident resulted in a $0.4 million impact on free cash flow.

Our maintenance CapEx for Q2 was $4.8 million, up from $1.3 million in Q2 a year ago. As mentioned previously, maintenance capital expenditures can vary from quarter-to-quarter. We expect that we'll have a range of $10 million to $12 million in maintenance CapEx for 2019, which encompasses all of our facilities.

At quarter end, we had cash and cash equivalents of $9.8 million and $250 million available under our credit facilities to fund our growth activities. I will note that in June, we amended the senior secured debt facility to provide up to $280 million term loan, a $185 million delayed draw term loan and a $65 million revolving operating line maturing in June 2024, placing Pinnacle in a strong position to evaluate and pursue acquisition opportunities and other strategic initiatives.

Our headline leverage ratio will remain high while we bring Entwistle back to operation on its commissioning curve. Our amended credit facility gives us the flexibility to manage our ongoing growth strategy while completing commissioning of Entwistle. We are still safely within our covenant's ranges.

Adjusted EBITDA totaled $16.1 million for the quarter compared to $14.9 million in Q2 a year ago. The increase of $2.2 million reflects increased revenue, offset by higher fiber and conversion costs resulting from fiber mix constraints, which increased repairs and maintenance costs in the quarter and costs associated with the Entwistle incident, partially offset by the impact of IFRS 16. Excluding the impact from the Entwistle incident and the adoption of IFRS 16, adjusted EBITDA was $13.6 million in the quarter.

Before providing information concerning our financial outlook for the remainder of 2019, I'd like to provide a summary of the Entwistle Facility. We continue to rebuild at the dryer, which remains on schedule to restart in the fourth quarter, and we are actively working with customers and partners to mitigate the impacts of the anticipated production shortfall this year as a result of the incident. We are also working closely with our insurance providers to determine the insurance recoveries available for the Entwistle incident and expect substantially all of the costs incurred to be recoverable through insurance.

Capital costs and other expenses required to replace the dryer and restore the Entwistle Facility are estimated to be a total of $21 million to $25 million with capital costs to replace the dryer area estimated to be in the range of $13 million to $15 million. The remaining costs are estimated to be in the range of $8 million to $10 million, of which $5 million has been incurred year-to-date. $1.9 million was reflected in production costs in Q2 2019, $2.1 million in Q1 2019 and $1 million was incurred in other expenses in Q2 2019. The remaining amount will be incurred through the end -- to the end of the year as we return the facility to its pre-incident commissioning curve.

As of the end of the second quarter, we have recognized a total of $8 million of insurance proceeds for capital expenditures net of the deductible in accounts receivable on our balance sheet. Of this amount, $5 million recognized in the second quarter is expected to positively impact cash flow in Q3 2019. Additionally, an initial amount of $4.5 million for business interruption was recognized in the second quarter, which we expect to receive in Q3 2019 as well and that will also have a positive impact on our cash flow.

I'll now turn to our outlook for 2019. The lumber market sawmill curtailment programs in BC have resulted in fiber and production cost increases as we optimized our fiber movement and production flow for different residual compositions, including fiber from salvaged round logs and harvest residuals. In the coming quarters, we expect the mix of fiber to stabilize and our expanded team remains focused on ensuring efficient fiber for our facilities.

We have included a map of the permanent curtailments in our MD&A and slide deck for the call this morning. As you will see, the permanent curtailments have a minimal impact on Pinnacle, and we expect to see some of the temporarily curtailed sawmills to restart in coming quarters, further decreasing the impact on sawmill fiber flow. As we achieve improved production volumes and costs in BC and ramp up our Alberta and Aliceville facilities, we expect to return to our historical margin levels.

During 2019, we continue to realize full run rate public company costs and full year costs for our investments in late fiscal 2018 in building our team for growth in the U.S. and Alberta and our fiber and capital and development teams.

As previously mentioned, we continue to proceed on repairs at the Entwistle Facility and to return the plant to its commissioning curve. We will continue to provide updated information on the progress as well as further amounts of insurance recoveries expected. We remain on schedule to recommence operation of the dryer in Q4 2019. However, we don't expect the facility to provide a meaningful contribution during the quarter. We remain confident that Entwistle will generate $19 million to $21 million of EBITDA when it reaches full run rate production.

I'll now turn the call back over to Rob for closing comments.

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [4]

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Thanks, Andrea. We continue to execute on our strategic growth plan in 2019 as reflected by the completion of 3 new customer contracts in Asia since the beginning of the year, the commencement of the Williams Lake, Meadowbank expansions, the announcement of the development of the High Level facility.

We continue to evaluate and develop additional potential growth opportunities to meet customer demand, including capacity expansions of our existing facilities, new greenfield and brownfield projects and potential acquisitions. The production and revenue growth are expected to continue throughout 2019 as will some of the margin compression experienced in Q2 of '19 as we adopt our operations to manage the impact of the fiber transition at our BC facilities.

In the upcoming quarters, we anticipate the mix of fiber to stabilize. We'll continue to work with our suppliers and use our operational experience with our teams to optimize the production flow and reduce the costs. As Andrea said, the map includes -- the map that was included in the slide deck includes the disclosures today shows permanent curtailments announced by the sawmill residual companies. The 2 plants at Canfor, Vavenby and West Fraser had an impact on our plants. Our residual -- our fiber procurement team has successfully replaced the sawmill residuals and have consistent and sufficient fiber in front of those mills. The other permanent curtailment such as MacKenzie is well outside of our 100-kilometer supply radius for our facilities, so no impact.

We are closely monitoring the change in BC fiber basket and anticipate and responding to the changes as they impact us. We are very focused on improving our fiber processing, haulage and cash conversion costs at this time.

At this point, I'd like to open up the mic for questions, and thanks very much for listening.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question will be from Mark Jarvi at CIBC Capital Markets.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [2]

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You talked about stabilizing fiber supply and replacing lost fiber from permanent curtailments. Maybe you can talk a bit about how you see margin evolving through Q3 and Q4 through the balance of this year?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [3]

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So I think -- the short answer is I see the margins improving. And really, it's because of the work that the team has done and it's really a combined effort of the fiber team. As I said, I'm confident we have sufficient fiber in front of our plants and we have backup plans in place and have ramped up facilities such as bush grind facilities and other facilities in the province.

And so what I see is what -- exactly what Andrea said, I see that trending back to our traditional levels. In the month of July, there were 2 major Canfor mills that were down and that will affect our margin, but they have restarted and the fiber is flowing. Those impacted particularly Houston and Burns Lake. When I look at the fiber in front of Burns Lake right now, it's well fibered up plant and with a cost position, but we did incur some costs during July.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [4]

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But do you have enough visibility to say now that you think at least you're flat in Q3 if not marginally up from Q2 and then continue to get better through Q4? Is that a fair assessment?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [5]

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So I would say that July will hurt us, so that's why we said that we'll have some continue on squeeze in Q3. Q4, we'll certainly get better. And each -- month by month we'll get better.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [6]

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Okay. As you think about adapting and you think about how you put together contract for things like High Level and new production and even the expansion at Meadowbank and Williams Lake, have you changed your approach on how you structure your fiber contracts and protection provided if there is sawmill curtailments? Is there anything that you guys can do around those contracts?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [7]

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Of the existing contracts, no. What I like with the joint ventures that we have is that the partner is fully aligned to get us fiber. And when I go and look at where some of our joint ventures are and when we've had curtailments, those partners -- Tolko has stepped up and been very cooperative with us for our Lavington facility, and our Lavington plant has been running very well and Tolko has been very good at cooperating with that. And we expect the same thing at High Level, where we get a lot of work with them. They're a 50-50 partner on this one. And a lot of work on securing the fiber, the -- where can ultimate fiber comes from as well as the heat supply for drying.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [8]

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I get that alignment with those partners. What about third-party providers or people that aren't actually putting capital in the plant? If you think about having to bring in some extra fiber at Meadowbank and Burns Lake, I know you guys will bring in maybe some sawmill or some forest residuals. But anything else when you think about at High Level, any other sawmill contracts you guys have on how to make sure you're a bit more protected?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [9]

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So on the -- most of the -- on those contracts, we can't change them. So I think it's important that if we go back and say future ones that we will, we'll certainly incorporate that in, also the importance of having good partners. But also the whole idea of what the fiber team has talked about. We looked at -- if you look at where we were last year, we had 2 bush grinding facilities running. Yesterday, we've got 9 bush grinding facilities running throughout the province. So our capability and who we're dealing with and long-term supply contracts for that equipment is how we're backing up our plants and allowing us to make sure we have enough fiber in front of the plant, but also drilling down on the costs.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [10]

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Okay. And then as you bring High Level in the alignment with Tolko, is that the -- sort of the optimal model going forward, where you would share the capital obligations and have them as -- as a partner or as a vested equity owner in a project? Is that what you'd see as the ideal path forward? Or are you totally comfortable doing 100% self-owned project either in Western Canada or down in the U.S?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [11]

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No. I'm quite comfortable to do 100% own -- 100% owned. Both have -- like anything, they all have pluses and minuses. And so I'm quite comfortable with doing 100%, but also quite comfortable doing a joint venture with somebody.

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Mark Thomas Jarvi, CIBC Capital Markets, Research Division - Director of Institutional Equity Research [12]

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Okay. And then maybe last question before I get -- jump back in the queue. Just with the news on Canfor, do you anticipate that changes the relationship or any potential opportunities down the road to partner with them in the U.S.?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [13]

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I don't see a change in -- we know the Canfor people. I don't see it changing, and I look forward to working with Canfor in the future.

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Operator [14]

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Next question will be from Rupert Merer at National Bank.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [15]

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How much of the fiber that you used in the quarter was from alternative sources and may be impacted by curtailments?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [16]

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I'm looking at Andrea because I'm not sure we released that exactly. I think the point I'd like to reassure everybody is that a big portion of it, like 80% of our fiber, still comes from sawmills, okay? And that has not changed. And so what we have been working very hard is this 5% to 10% that has impacted various sawmills at some time. Some of them are temporary curtailments such as some of the Canfor mills and other ones are permanent. But on the temporary ones, the sawmills are back up again, and so we've filled those gaps with bush grind and pieces like that.

But I think it's really important that people understand that still, 80% of the residuals from sawmills continued to flow throughout all this historical curtailment that was going on in the sawmill industry. So with that in mind, we have been working in this 5% to 10% range. And in that range, some of it is bush grind, some of it is logs and we -- and it's small diameter logs. And so that's been a combination. The other one is some trading as well, so there has been a whole -- various pieces there.

So we're confident now that we have got enough fiber and we have got enough backup fiber readily available. And now really is -- some of the sawmills have come back up, other ones are down, but some impact us, some don't. And the other thing that's really important is the capability that our fiber team has developed on bush grind, logs, whole log chipping, a whole range of other things to back up. And now it's really to optimize that, not only bringing it in but how we optimize that 5%, 10% change in feed diet as it goes through the mills.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [17]

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As a follow-up, you mentioned you have now 9 bush grind facilities. Are those sized to have enough capacity to give you 5% to 10% of your fiber diet? Is that how we should think of it? Or could it do more than that?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [18]

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More.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [19]

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Okay. Great. And then secondly, looking at Q3. In Q2, we had some incremental costs at Entwistle, but they were covered by insurance. How is this going to play out in Q3? Will there be insurance proceeds offsetting costs in Q3 as well? Or could we see those coming in, in another quarter and maybe see a rise in production costs in Q3?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [20]

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So will -- the facility won't be operating in Q3, so we're going to -- for the dryer side. The dry shaving side, of course, has been regularly producing since the end of March, but we will still be incurring some incident response costs as well as the fixed overhead related to the dryer area that doesn't go away such as property taxes, et cetera. So we'll have the costs without the correspondent margin.

In terms of business interruption proceeds in Q3 that we can recognize, we'll work very hard to get confirmation from our insurers of some proceeds, but we'll also be working hard to make sure that over the entire term of the incident and its impact on us that we're able to recover the full impact. So if we need to manage timing of when we book those recoveries to be able to increase the amount that we're able to receive, we'll do that.

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [21]

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The other one, Rupert, is we want to reassure everybody that, that facility as far as the start-up, it's on schedule. The deliveries are holding. The major components are arriving on site. The construction crews are starting to ramp up. So that's all on schedule.

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Operator [22]

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Next question will be from Nelson Ng at RBC Capital Markets.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [23]

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The first question relates to the High Level pellet development. Could you just confirm that all of the fiber would be provided by Tolko's adjacent mill? And like how much availability is there outside of the mill in that region to source third-party fiber?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [24]

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So Tolko, as you can imagine, being 50-50 is very intimately involved in this, so most of the fiber is coming from the mill. There's other fiber sources that Tolko can -- has had access to or controls that will supplement or can act as a backup and there's other third-party providers that also we will be tapping.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [25]

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Okay. And has this facility been curtailed lately or not?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [26]

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No. This is a very good facility. It's run very well. Tolko continues to put CapEx into it. Remember, it's in a different jurisdiction than British Columbia, so it has different regulatory features too.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [27]

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Okay. Got it. And then you mentioned in the commentary that in Aliceville you face higher fiber costs. Could you just flag the magnitude of the cost increase? And I believe Westervelt supplies, it's like 25% to 30% of the fiber. So is the fiber increase strictly to third-party providers?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [28]

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So at the Aliceville facility, we have a variety of different fiber suppliers. Indeed, Westervelt is one of them. I think the percentage you gave is probably a bit on the high side and it can vary from month to month, depending on what their sawmill is doing. But I think where we have seen the cost increases is a couple of things. Throughout early Q2, there was certainly heavier rains in that part of the world, and we're working with our suppliers in terms of delivering residuals that we can process and dry as effectively as possible. So we're getting experienced in working with those vendors and leveraging the close relationship with Westervelt to manage the average costs closer to what our target is.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [29]

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Okay. Got it. But the supply from Westervelt is on a fixed cost basis, right? It's the other suppliers where you're seeing cost increase or fiber cost increases?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [30]

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We have contracts in place for almost all of our fiber for that mill as we typically do to manage costs. In the mill though, the contracts are for a green ton, so we end up -- depending on the moisture content, it can have an impact on our cost per metric ton produced.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [31]

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Okay. Got it. And then just moving over to the Houston facility, I think you mentioned that there was a new agreement in place with Canfor. Can you just provide some details in terms of like roughly how much more would Pinnacle buy the pellets from the mill at? And I guess what are you getting in return? Are you getting an extension of the contract or is there better kind of fiber arrangements? Or can you just tell me the puts and takes of that agreement?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [32]

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So you've got some of the puts and takes. So Canfor got a higher -- or the mill got a higher return also. But on the flip side, there's a suite of agreements that went in there and some of them relates to moving the fiber -- moving the pellets through our Westview port. The other one is the term -- the extension of the term. There's also supplying fiber to the mill. So there's puts and takes on there that on balance, I think, was very good for us, and I think good for the mill. And so it ends up with term, Westview, fiber, pellets, all being extended for longer term and those rates adjusted.

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Operator [33]

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(Operator Instructions) And your next question will be from Jonathan Lamers at BMO Capital Markets.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [34]

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Of the unusual expenses being incurred to procure fiber right now, I'm thinking about things like equipment rentals, extra labor hours, extra repairs, extra downtime, can you -- is there any way to break out the expense related to those in a quarter or quantify the hours of downtime or extra labor?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [35]

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Certainly, Jonathan. Internally, we do a lot of analysis mill by mill to really understand those incremental costs, but the way I would look at it rather than to try to understand it compared to history is we're working hard in looking at Q3 and Q4 and what the fiber diet is expected to be. Because at some of the mills where there have been impacts from permanent curtailments, or shift shots, we won't see the same residual composition as we had in Q1 or Q2. So we really -- we look at each mill, we understand what the residual flow will be. And then we look at things in terms of how can we minimize incremental costs, as you say, of getting loaders on site to move logs or incremental costs of fiber handling and processing. So that's what we're really focused on, on driving that down. And it's -- I think we've stated that over the coming quarters, we expect the margin to get back in line with what we've seen historically. So if you look at the Q2 costs compared to what we had in, say, early 2018 prior to the commencement of Entwistle, that'll give you an idea of the overall aggregate impact in Q2.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [36]

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Okay. And these comments that you've made about margins improving by Q4, does that consider the normal impact of seasonality at the same facilities? I mean, typically, they would generate a lower margin in Q4 versus Q2.

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [37]

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Yes. It impacts -- sorry, yes, we have considered that.

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [38]

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And you're right. When we say margins will return to historical levels, considering the comparable cyclical quarter.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [39]

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Sorry, just to clarify, on an absolute basis, there is no reason to expect that percentage margins will be better in Q4 versus Q2 of 2019?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [40]

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That's correct.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [41]

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Okay. If we can move on a bit, can you kind of update us on your development funnel for new facilities? Has -- are there any projects that are moving a little bit closer to permitting or financing?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [42]

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So the developmental funnel is extraordinarily active right now, and I think you can see that we've announced the High Level operation. We have other ones that are in permitting phase right now. We have other ones that are in engineering phase right now. And it's a very active funnel right now.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [43]

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Just to clarify, there's multiple projects in the permitting phase?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [44]

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Yes.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [45]

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And how would that compare to, say, this time and at the beginning of the year?

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [46]

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I would say 2 things to that is that in anticipation of our growth and what we're doing, we brought on [Adnan Khan], who will be a key feature person with his background in engineering to beef up our capabilities in that area. The other one in our strategic or our major capital program, we brought in other project engineers in anticipation of future builds.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [47]

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Andrea, there seem to be some moving parts with the SG&A this quarter. Can you provide us with sort of any guidance on what you think the run rate SG&A would be going forward either as a percentage of revenue or in dollars?

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Andrea Louise Johnston, Pinnacle Renewable Energy Inc. - CFO [48]

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Yes. I think the SG&A this quarter was a little high on a couple of categories, but the biggest reason for the increase compared to Q2 2018, for example, was the additional roles that we've invited in the capital team, fiber team, and then operations with the expanded number of facilities. So I don't think the Q2 level is unusually high. So if you shave a little bit off, that should be approximately the run rate.

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Operator [49]

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And at this time, Mr. McCurdy, I would like to turn the call back over to you for any closing comments.

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Robert McCurdy, Pinnacle Renewable Energy Inc. - CEO & Director [50]

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I'd just like to thank everybody for dialing in and listening and look forward to a good quarter.

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Operator [51]

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Thank you, sir. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.