Pinnacle’s Q1 2020 results impacted by CN Rail disruptions

Pinnacle Renewable Energy today announced its financial results for the 13-week period ended March 27, 2020.

Q1 2020 financial and operational highlights

• Revenue of $109.7 million in Q1 2020, compared to $89.6 million of revenue in the 13-week period ended March 29, 2019;
• Adjusted EBITDA totaled $4.0 million in Q1 2020, compared to $7.1 million in Q1 2019; and
• Sold 510,000 metric tonnes (MT) of industrial wood pellets in Q1 2020 compared to 402,000 MT sold in Q1 2019.
• Entwistle production exceeded expectations in the first full quarter of facility operations since recommissioning the dryer system. The facility achieved positive EBITDA1 contribution in March 2020 and achieved increasing production levels during the quarter;
• Broke ground at the new industrial wood pellet production facility in the U.S southeast (the Demopolis Facility) in Q1 2020. Commissioning the Demopolis Facility with initial industrial wood pellet production is expected in the second quarter of 2021, and it is expected to produce 360,000 MTPA;
• Resumed construction of the High Level Facility as planned in March 2020 with the arrival of warmer weather conditions. The High Level Facility is expected to be completed as planned in Q4 2020, and to produce 200,000 MTPA; and
• In January 2020, Pinnacle entered into a long-term lease with NYK Bulk & Projects Carriers Ltd., to charter a vessel to be used to carry wood pellets from Canada to Japan. The vessel is scheduled to be available for use by Pinnacle commencing in Q1 2021, for a period of 15 years;

Q1 2020 challenges

• Sales in Q1 2020 included a significant volume of high cost finished pellet inventory from year end and third party purchased pellets with no margin which were used to fulfill customer obligations due to production shortfall as a result of the Entwistle incident;
• Operational challenges arising from CN Rail disruptions:
• A January 2020 derailment in B.C. damaged Pinnacle leased railcars and resulted in some lost pellets and ten straight days of cold weather in January caused CN rail disruptions resulting in some facility downtime;
• In February, CN Rail lines and B.C. ports were disrupted by blockades resulting in downtime at the Company’s northern facilities;
• CN Rail disruptions resulted in approximately 20,000 MT of production lost, with a $2.1 million EBITDA impact;
• With challenges resolved, operational progress was realized in March with solid production volumes and cost performance as the facilities were able to operate continuously;

The Aliceville facility was down for five days during a flooding at the facility dock. Adjusted Gross Margin was negatively impacted due to the prolonged pellet storage on barges during this high-water event. This matter has now been resolved;
With the emergence of COVID-19 in Q1 2020 and the resulting supply chain disruptions and international travel restrictions affecting the onsite presence of our external experts, smaller projects have been proactively delayed in order to preserve capital and enforce federal safety standards in light of the pandemic.

Q1 2020 financial results

Revenue for Q1 2020 totaled $109.7 million, an increase of 22.4 per cent compared to $89.6 million for Q1 2019. The increase is primarily attributable to higher sales volumes. Cost, insurance, and freight (CIF) sales in Q1 2020 were 1.2 per cent lower than Q1 2019 and accounted for 48 per cent of total sales in Q1 2020, which also contributed to a shift of revenue in Q1 2020 compared to Q1 2019. The company also experienced shipping delays due to the CN Rail strike in Q4 2019 that resulted in a shift of revenue into Q1 2020.

Production costs were $86.1 million for Q1 2020, an increase of $19.0 million, or 28.3 per cent compared to $67.1 million for Q1 2019. The increase in production costs can be attributed to an increase in sales volume, higher fibre costs and higher rail costs. Production costs were also affected by the high cost of Q4 2019 inventory sold in Q1 2020. This inventory included high fibre costs consumed in Q4 as well as the costs associated with the CN Rail disruptions in Q4 2019. The higher costs were partially offset by lower cash conversion costs. During Q1 2020, Pinnacle sold third-party pellets for a net loss of $0.4 million. Additional production costs were also incurred to manage the impact of the disruption from the CN Rail blockades.

Adjusted Gross Margin was $9.0 million, or 8.2 per cent of revenue in Q1 2020, compared to $10.4 million, or 11.6 per cent of revenue in Q1 2019. The decrease in Adjusted Gross Margin percentage was primarily due to an increase in operating loss, partially offset by increases in selling, general and administrative (SG&A) expenses and amortization expenses in Q1 2020. Production costs in Q1 2020 include $0.03 million of costs associated with fixed overhead and incident response costs for the Entwistle Incident. These costs are offset by $1.0 million of business interruption insurance receivable recorded in Q1 2020. Excluding the impact of the Entwistle Incident, Q1 2020 Adjusted Gross Margin was $8.0 million, or 7.3 per cent of revenue.

The company reported a net loss of $4.1 million in Q1 2020, compared to a net loss of $7.0 million in Q1 2019. The change in net loss reflects higher SG&A expenses, production and distribution costs and amortization costs reflecting the company’s new production facilities, partially offset by reduced finance costs. Excluding the impact of the Entwistle Incident, net loss in Q1 2020 was $5.9 million.

Adjusted EBITDA totaled $4.0 million in Q1 2020, compared to $7.1 million in Q1 2019. The decrease is attributable to higher production costs due to increased sales volume, the sale of external finished pellet inventory and costs incurred to manage the impact of the CN Rail disruptions and higher port charges due to blockades. This was partially offset by the impact of business interruption amounts recoverable.

Production facility construction and upgrades

In Q4 2019, Pinnacle announced a plan to begin construction of a new industrial wood pellet production facility in the U.S southeast near the Aliceville Facility. The new facility (the Demopolis Facility) will be located adjacent to an existing large sawmill in Demopolis, Ala. The Demopolis Facility is expected to have annual production volume of 360,000 MTPA that will be sold through Pinnacle’s contracted backlog of long-term, take-or-pay off-take contracts. As mentioned above, with added health and safety precautions in place, construction teams broke ground at this facility in Q1 2020 and construction has progressed as planned and within budget during the quarter. With the addition of the Demopolis facility, Pinnacle will have over 44 per cent of its run-rate production capacity outside of the B.C. fibre basket. Commissioning the Demopolis Facility with initial industrial wood pellet production is expected in the second quarter of 2021.

Construction at the High Level Facility resumed with added health and safety precautions, as planned, in March 2020 along with the arrival of warmer weather conditions. The High Level Facility is expected to be completed as planned in Q4 2020. Review of budget and schedule and advancement of scope for the CN rail infrastructure has resulted in additional capital required of $2.0 million, bringing the total to $60.5 million before the project’s share of capital required for rail infrastructure, with Pinnacle’s 50 per cent share being $30.25 million plus 50 per cent of the project’s share of capital for rail infrastructure. The budget overruns are the result of concerns with the design and fabrication of structural elements of the facility. Tolko has indicated that additional fibre will be available for upcoming years due to forest fire log processing, providing a strong supply of fibre. Pinnacle is confident that this will enable the High Level Facility to produce 200,000 MTPA.

The installation of a chipper and additional pelleter at the Smithers facility for a total capital cost of approximately $6.0 million (Pinnacle’s portion: $4.2 million funded from existing credit facilities) is expected to decrease costs and increase production run-rate output by approximately 15,000 MTPA. A substantial portion of this project was expected to begin in Q1 2020, but for the reasons stated above relating to COVID-19, management has decided to extend the project schedule by approximately six months.

Operations at the Williams Lake facility continue with the current dryer in place and the dryer upgrade project has been temporarily suspended as equipment vendors were not able to travel onsite for commissioning purposes due to travel restrictions resulting from the COVID-19 pandemic. As this project is near completion, management is investigating various options to engage remote support in order to safely commission the remainder of the project in Q2 2020.

Upgrades at the Meadowbank Facility have been put on an extended schedule in order to preserve capital due to COVID-19 as previously stated. The expansion of the Meadowbank Facility is expected to be completed in 2021.

Outlook

Pinnacle expects growth in revenue and profitability over the next several years as a result of contracted price increases in most of its off-take agreements. In addition, as the potential demand for industrial wood pellets continues to grow globally, the company is well positioned to meet this demand growth through a combination of expansion projects at existing production facilities and new greenfield and brownfield growth projects. Moreover, Pinnacle will continue to evaluate potential acquisitions and joint ventures to grow its production platform and continue to capture opportunities in the growing Asian marketplace as a result of its longstanding relationships with customers in the region.

The Entwistle Facility achieved increasing production levels during Q1 2020, exceeding the commissioning curve for the facility. The facility is expected to continue to improve and add production volume throughout the year making a positive contribution to Adjusted EBITDA in Fiscal 2020. As the company’s insurer monitors production ramp post restart, further business interruption insurance in Fiscal 2020 will be sought. Final insurance recoveries of capital costs incurred for the rebuild are expected in Fiscal 2020 as well.

Production at the Aliceville facility has returned as water levels have receded and silo storage is back to normal as regular barge transportation has resumed. As both the Aliceville and Smithers facilities are both operating at full production run-rate, incremental production volume and Adjusted EBITDA contribution is expected for 2020.

CN Rail blockades and port delays experienced in February have not impacted service since that time. Progress was realized in March with solid production volume and cost performance as the facilities were able to operate continuously without the earlier impacts of operational disruptions.

Sawmills and key fibre suppliers have started to curtail output as a result of the impacts from COVID-19 on their businesses. As a result, the company will be dependent on harvest residuals in 2020 more than in the last quarter. Fibre breakdown capital and operating requirements to meet production needs will continue to be addressed. As the proportion of wet, coarse fibre to dry fibre increases, drying capacity constraints at some mills are expected, resulting in production volume reductions in some of Pinnacle’s B.C. mills impacting Adjusted Gross Margin. In response to the announced and anticipated sawmill curtailments, inventory of fibre at B.C. mills has increased by 103 per cent compared to the end of Q1 2019. As Q2 2020 continues Pinnacle sees B.C. sawmill residual supplies stabilizing as lumber demand is relatively constant, government incentives are enacted, and the industry looks toward reduction in stumpage rates in Q3 2020. Although there are some sawmill curtailments in Alabama, Pinnacle does not expect production volume or costs to be significantly impacted. The company continues to have strong availability of wood fibre in Alberta.

Over the last two quarters the incremental procurement cost of harvest residuals has been reduced. When the large curtailments were announced in Q3 2019, fibre was purchased at a higher cost to ensure consistency of supply and build inventories. In Q4 2019, and even more so in Q1 2020, a more selective approach to fibre quality and cost was utilized given the current strong inventory levels. The benefit of the cost reduction activities is not yet reflected in Q1 2020 results as older, higher cost fibre and shipping pellets made in prior months are being consumed.