Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Greetings, and welcome to Ten Peaks Coffee Company First Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.I would now like to turn the conference over to your host, Sherry Tryssenaar, CFO. You may begin.

[Sherry D. Tryssenaar, CFO & Secretary]

Thank you. Good morning, and thanks for taking the time to join us. I'm Sherry Tryssenaar, CFO of Ten Peaks Coffee Company, and with me is Frank Dennis, Ten Peaks President and CEO.Frank and I are here to discuss Ten Peaks' financial results for the 3 months ended March 31, 2018, which represents the first quarter of our 2018 fiscal year. Frank will begin today with a brief review of our quarterly results and some of the factors that are driving the steady growth of our processing volumes. Then I'll provide more detail around our financial performance before Frank returns to talk about our plans and expectations going forward. After that, we'll be happy to take your questions.But before we start, I'll remind you that certain information in today's presentation is forward-looking in nature. Any such forward-looking information or statements are based on assumptions that we considered reasonable at the time they were prepared. Such information involves known and unknown risks, uncertainties and other factors outside our control that could cause actual results to differ materially from those expressed in the forward-looking information.Ten Peaks Coffee Company does not assume responsibility for the accuracy and completeness of the forward-looking information. Similarly, the company does not undertake any obligation to publicly revise this forward-looking information to reflect subsequent events or circumstances, except as required by law.Please refer to our Management's Discussion and Analysis posted on SEDAR and on our website for a full discussion regarding forward-looking statements and the risks therein.With that, I'll turn the call over to Frank. Frank?

[Frank A. Dennis, President, CEO & Director]

Thank you, Sherry, and thank you, everyone, for joining us today. During the first quarter, our SWISS WATER Process decaffeinated coffees continued to gain market share against our competitors. As a result, our processing volumes rose by 17% over Q1 2017 and our revenues were up by 10%. However, our gross profit, net income and EBITDA for the quarter were down due to higher green coffee cost, stronger Canadian dollar and expenses incurred to support a series of strategic growth initiatives we're currently implementing. Sherry will provide more detail around these numbers in a few minutes.Looking at our volumes. The 17% increase in our first quarter shipments was driven by a number of factors: first, the overall market for decaffeinated coffee continues to expand. According to the National Coffee Association, total decaffeinated coffee sales were up last year with decaf now being the fastest-growing segment of the U.S. coffee market. Sales of specialty decaf coffee, like our SWISS WATER Process coffees, were particularly strong, especially in out-of-home markets. Notably, the largest consumers of premium decaf coffee these days are 18- to 24-year olds. This is a group that's grown up surrounded by excellent coffee. They love drinking it and they enjoy spending time at the comfortable, well-designed coffee shops that provide it. Our premium decaffeinated coffees let them enjoy both experiences all day without worrying about the side effects of caffeine. This helps enable improved later daypart volumes and profitability for coffee shops owners.A second factor that's driving up demand for our SWISS WATER Process coffees is the trend toward healthier eating. Today's consumers are highly conscious of artificial ingredients and chemicals in their food and drink and choose avoid them when possible. As a result, some recent media stories about the health and environmental hazards associated with methylene chloride, the main chemical used by our competitors to decaffeinate coffee, got a lot of attention. These stories help more people understand why our 100% chemical-free SWISS WATER Process coffees are worth seeking out, a nice development our marketing team is working to build on. Food companies, too, know that their customers are looking at the providence of their food and drink. In response, many of them are electing to add our branded coffees to their offerings.While consumer trends have definitely helped boost demand for our coffees, our volume growth is also related to the work we've done to extend our market penetration. We opened a sales office in Seattle, Washington in the fall of 2013. Since then, we've worked steadily to establish a solid foothold across the U.S., strengthening business relationships, launching high-profile promotional campaigns, and very recently, augmenting our sales and marketing team.During the first 3 months of this year, for the first time in SWDCC's history, sales to the U.S. comprised more than half of our quarterly revenue. In Q1, 53% of our revenue came from the U.S., 35% came from Canada and 12% came from international markets. The United States was also SWDCC's largest geographic market by volume. Looking at our volumes by customer type. Shipments to roasters, those customers who roast and package coffee to sell to consumers in their own coffee shops or for home or office use, increased by 27% in Q1. While shipments to importers, those who resell our coffees to roasters where and when they need it, were comparable to a year ago. The strong growth in sales to roasters came in 2 ways: first, we increased our customer base by adding roasters who used to source their decaffeinated coffees from a CO2 plant in Europe that closed last year; second, we sold more decaf coffee to existing roaster accounts as they grew their own business either by increasing their distribution venues or by adding to their product offerings.Looking ahead, we believe demand for our SWISS WATER Process coffees will continue to grow. Consumers love their coffee and love being able to enjoy it at any time of the day. To take advantage of many of the opportunities we now see emerging, we are currently investing in our future by implementing a multifaceted growth plan. This includes setting up a European subsidiary and sales offices. But before I talk about our expectations, I'm going to pass the call over to Sherry who will provide some more detail around our financial results. Sherry?

[Sherry D. Tryssenaar, CFO & Secretary]

Thanks, Frank. I'll start with a review of our revenue. During the first quarter of this year, our sales totaled $21.2 million. This is an increase of 10% over Q1 2017 due largely to our higher processing volumes. All 3 of our revenue categories were up year-over-year. Process revenue is the amount we charge our customers to decaffeinate green coffee, and during Q1, process revenue increased by 12%, reflecting our higher processing volumes offset by a lower U.S. dollar. During the first quarter, the U.S. dollar averaged CAD 1.26, which was 5% lower than in Q1 2017. Green revenue is the amount we charge our customers for the raw coffee we buy for decaffeination. In Q1, our green revenue increased by 10%, reflecting our higher volumes partially offset by lower green coffee prices. In the first 3 months of this year, the NY'C' averaged USD 1.21 per pound compared to USD 1.45 per pound during the same period last year. Distribution revenue is comprised of the shipping, handling and warehousing charges we bill our customers. Distribution revenue rose by 14% in Q1, driven by our higher volumes and by growth of Seaforth, our green coffee warehousing and handling business. Cost of sales for the first quarter was $18.4 million, up by 14% over Q1 2017. The increase was due to a number of factors, including higher freight charges and variable production costs associated with our higher volumes as well as increased green coffee costs. Cost of sales also rose with the lease of a new warehouse for Seaforth in November of 2017. We added this space to accommodate growth in Seaforth's business and to ease significant backlogs in unloading inbound coffee. However, setting up the warehouse and relocating some coffee inventory increased Seaforth's operating costs significantly and ultimately reduced Ten Peaks' overall financial results.Accordingly, we will be undertaking a detailed review of Seaforth's business over the next few months to ensure it once again provides a net contribution to Ten Peaks' financial performance by the end of this year.Gross profit for the first quarter decreased by 6% as the increase in our cost of sales exceeded the increase in our revenues. Sales and marketing expenses grew by 28% to $800,000 in Q1. The higher expenses related to our expansion in Europe, increased sales and marketing activities and related travel costs to support SWDCC's strategic growth initiatives, which Frank will discuss shortly.Administration expenses also increased, growing by 33% to $1.5 million in Q1. This change was also related to our strategic growth initiatives, including higher staffing and staff-related expenses and recruitment expenses for a number of positions. Higher stock-based compensation contributed $100,000 to the increase. Operating income fell by 56% to $600,000 for Q1, primarily due to our increased operating expenses. You may recall that in October of 2016, Ten Peaks entered into a convertible debenture. Under IFRS, this instrument is deemed to contain an embedded option, which must be revalued at each balance sheet date. Revaluation of the option resulted in a gain of $500,000 in Q1 compared to a gain of $900,000 in the same period last year. The revaluation of the option is included in income in each of the relevant periods, but it's excluded from operating income or EBITDA.Overall, Ten Peaks recorded net income of $500,000 in the first quarter compared to net income of $1.4 million in Q1 2017. The change was due to the decline in our gross profit, the reduced gain on the embedded option and our higher operating costs. On a per-share basis, we recorded earnings of $0.05 per share in the first quarter compared to earnings of $0.16 per share in the same quarter last year. On a fully diluted basis, our earnings per share were $0.03 in Q1 2018 compared to $0.08 for the first quarter of last year.Another measure of financial results is earnings before interest, taxes, depreciation and amortization or EBITDA. During Q1, EBITDA declined by 34% to $1.1 million, reflecting our increased operating costs and reduced gains on risk management activities.Finally, turning to our dividends. On April 16, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on March 29. I'll now turn the call back to Frank who will talk a bit more about our expeditions for the months ahead. Frank?

[Frank A. Dennis, President, CEO & Director]

Thank you, Sherry. Looking ahead, we expect to see strong volume growth in 2018. As I mentioned at the start of this call, several consumer trends, such as increased awareness of methylene chloride and a desire to drink excellent coffee throughout the day are helping to drive demand for chemical-free premium decaf coffees. We see those trends gaining traction, and as the world's only branded 100% chemical-free decaffeination process, we believe that we're ideally positioned to capitalize on that growing awareness and demand.We also expect to benefit from changes on the supply side of the decaf market. As noted earlier, SWDCC recently gained new business following the 2017 closure of an older CO2 plant in Europe. More recently, it was announced that a similar CO2 plant in Houston, Texas will be closing this summer. The Houston facility has mainly been supplying decaffeinated coffee to more mainstream coffee brands in the grocery channel, which have been losing market share to premium coffees and the at-home segment in recent years. So while we don't expect to pick up a lot of new accounts as a direct result of this closure, we expect it will serve to ease competitor pressure generally. This is because it will further reduce the global availability of third-party chemical-free decaffeination capacity and thus help to increase overall demand for our services.Looking ahead, our focus for the next 2 years will be on positioning SWDCC for steady future growth. To do that, we're investing in the resources we need, first, to continue generating increased sales volume; and then, second, to respond to the heightened demand. As I mentioned at the outset, we're in the process of opening a European sales office to better serve customers in the largest decaffeinated coffee market in the world. At the same time, in the U.S., we're expanding our ability to target specific customer groups by selectively adding to our sales and marketing team. While these initiatives will increase our expenses somewhat, we expect them to generate increased sales orders in the latter half of this year. Additionally, we believe these investments will result in major account conversions over the longer term, which will aid us in ramping up production when we open our second decaffeination facility. We are still in the process of building a new state-of-the-art production facility in Delta, BC. The new plant will initially house 1 new production line, which is expected to be commissioned in the third quarter of 2019. In short then, our outlook is very positive. Demand for specialty decaf coffee is growing and we have the best product, the specialized knowledge and experience and the operational infrastructure to effectively respond. We also have a well-established brand name we're working to leverage more effectively.For that reason, we'll be asking shareholders to change the name of Ten Peaks to Swiss Water Decaffeinated Coffee Inc. at the upcoming annual and special meeting of shareholders. If approved, the change will take effect at the end of this calendar year. Concurrently, SWDCC will be merged into Ten Peaks and the resulting entity will bear the new name. This simplified structure will help shareholders and potential investors more readily associate the investment opportunity with our proprietary SWISS WATER Process and also modestly decrease the company's compliance costs.We'll report on their decision following the AGM on June 19. That wraps up our comments for today. Sherry and I would now be happy to answer any questions you might have.

[Operator]

[Operator Instructions] There are no questions at this time. At this point, I'd like to turn the call back to Frank Dennis for closing comments.

[Frank A. Dennis, President, CEO & Director]

Well, thank you very much all. And if there are no further or any questions, I'll conclude today's call. Thank you very much for joining us.

[Operator]

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.