Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Thank you all for your participation as well as your patience. Ladies and gentlemen, before today's Swiss Water Decaffeinated Coffee Inc. conference call starts, we are required to 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 they considered reasonable at the time of the information was 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.Swiss Water Decaffeinated Coffee Inc. does not assume responsibility for the accuracy or the completeness of the forward-looking information. Similarly, they do not undertake any obligation to publicly revise the forward-looking information to reflect subsequent events or circumstances, except as required by law. Please refer to Swiss Water Decaffeinated Coffee Inc.'s Management Discussion and Analysis posted on SEDAR and Swiss Water's website for a full discussion regarding forward-looking statements and the risks therein. As a reminder, today's session is being recorded. And now to get us started with opening remarks and introductions, I am pleased to turn the floor over to Frank Dennis. Frank?

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

Thank you, Jim. Good morning, everyone, and thanks for taking the time to join us. These are challenging times, and we really appreciate your attendance. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. With me virtually today is Iain Carswell, our CFO. Before we begin, let me once again express our hope that you and your families are all staying safe and healthy as we continue to work our way through the COVID-19 pandemic and its impact on all of our lives. Iain and I are here today to discuss Swiss Water's financial results for the 3 months ended March 31, 2020. I'll begin with a brief review of our results, and I'll also talk about the pandemic's impact on our operations. Then Iain will provide more detail about our financial performance before I return to tell you more about our longer-term plans and expectations. After that, we'll be happy to take your questions. Looking now at our results. During the first quarter, our gross profit, operating income, net income and EBITDA were all up over Q1 2019. This, despite the fact that we saw lower volumes, compared to an exceptionally strong Q1 of last year. We've consistently grown and increased volumes each and every one of the prior 12 quarters as coffee industry participants migrated away from chemical decaffeination in favor of the clean SWISS WATER Process. So the 16% reduction we saw in Q1 volumes was our first quarterly decline in 3 years. This occurred primarily because of a series of spikes in the New York Arabica Coffee Futures Price that began in the last weeks of 2019 and persisted through the first quarter of this year. For context, by the end of December 2019, the New York 'C' Futures Contract or NY'C' had moved to a peak of USD 1.41 a pound, almost 45% above the 2019 year-to-date average of approximately USD 0.98 a pound in a matter of a few weeks. While our volumes remained strong through the fourth quarter, they began to weaken markedly in the first quarter as the higher NY'C' impacted the overall coffee market. As has been the case with previous spikes in the NY'C' rather than placing new orders, many of our customers curtailed coffee purchases and drew down their existing inventories, while waiting for the market to soften. The scene has now declined back down to levels that are close to 2019 and is now trading at approximately USD 1.10 a pound. Under normal circumstances, we can now expect customers to begin rebuilding inventories, but these are unusual times. Following the run-up in the sea, the onset of COVID-19 began to affect our business towards the very end of the first quarter. When the pandemic was declared early in March, we saw an immediate increase in demand from customers that supply the retail grocery trade, as consumers loaded their pantries in anticipation of quarantines and supply disruptions and began to consume their coffee at home. And following that, demand from customers who serve the out-of-home market began to significantly weaken as coffee shops, restaurants around the world were shuttered or restricted to take-out and drive-through sales only. As this situation persists, it's having an increasingly negative effect on demand from all customer channels. Depending on how long it takes for the vital out-of-home channel to resume normal operations, we will almost assuredly experience a decline in our full year volume compared to 2019. We remain in contact with customers in all of our markets and are well positioned with significant green coffee inventory and production capacity to respond dynamically as the situation unfolds through the year. We continue to operate both production lines at our plant in Burnaby on the normal 24/7 basis as well as our Seaforth coffee-handling subsidiary, while taking all necessary measures to protect the health and safety of our employees, customers and other stakeholders. The commissioning of the new production line in our Delta, BC facility is continuing very well, however, with the U.S. Canada border closed to the vendors of some key final systems and with short-term volume demand reduced, we no longer expect nor intend to fully complete the start-up process during the first half of this year. In the short term, this will save on completion costs and variable cost of key inputs. Finally, as we announced on March 19, we are proceeding with engineering on a potential second new production line at our Delta, BC facility. This is intended to ensure that we are prepared to have the production capacity required to meet our longer-term demand for our coffees. Timing of this initiative was driven by the recent sale of our Burnaby, BC site to a new owner. This has created an unacceptable risk that an extension of the current lease on this facility may not be granted and that we may not be able to continue operations in Burnaby beyond 2023. Accordingly, we are moving with the planning process to expand our new Delta, BC plant sooner than we had originally thought. Based on current engineering, the targeted endpoint capacity at the Delta facility would be at least 40% greater than the current existing capacity of the 2 lines in our legacy Burnaby site. This plan gives us a runway for continued growth in the next 5 to 6 years. Of course, we are still in the midst of an extraordinary social and financial crisis, the plans of the landlord may change. However, we must take preliminary preparatory engineering steps to ensure we are capable of meeting current customer demand. With that, I will turn the call over to Iain to take you through the results in more detail. Iain?

[Iain Carswell, Chief Financial Officer]

Thanks, Frank, and good morning, everyone. And I'll begin with my review of the volumes shipped to customers. As Frank indicated, while our gross profit, income and EBITDA were all up in Q1, Swiss Water recorded lower volumes when compared to the very strong first quarter of last year. As he explained, 16% year-over-year decline in Q1 volumes was primarily driven by market response to a series of spikes and the NY'C' coffee commodity price began in the last peaks of 2019 and continued through the first quarter of this year. With several moves up and down done during the quarter, the NY'C' averaged USD 1.11 per pound compared to USD 0.99 per pound in Q1 2019. Looking at volumes by customer type, shipments to roasters, those customers who roast and package coffee to sell to consumers in their own coffee shops or from home or office consumption were down 16%. Shipments to importers, those customers who resell our coffees to roasters where and when they need it, were down 15%. Looking at the roaster segment another way, specialty roaster account volumes were down 11%, and shipments to large commercial roaster accounts were down 19%. The decline in the first quarter processing volumes had a negative impact on our revenues, which at $21.8 million were down 10% compared to Q1 of last year. In percentage terms, the revenues held up better than volumes due to the offsetting impact of the higher NY'C' coffee price on the per pound dollar value of the coffee we sold. As a substantial proportion of our revenue comprises the amount we charge our customers for green coffee, as we charge market rates for this coffee, our revenue is directly impacted by changes in the cost of green coffee. Our revenues are also impacted by the U.S. to Canadian dollar exchange rate, as a large portion of our sales are billed in U.S. currency. In Q1 of this year, foreign exchange had a slightly positive impact on our revenues as the U.S. averaged -- as the U.S. dollar averaged CAD 1.34, an increase of 1.2% over the same period in 2019. Looking at the cost side. Our first quarter cost of sales was $17.6 million, a decrease of $3 million or 15% from Q1 of last year. The decrease in cost of sales was consistent with the year-over-year reduction in business activities during the period. Impacting factors included lower variable production costs due to the lower processing volumes and lower natural gas price, partially offset by an increase in annual labor cost inflation. Q1 gross profit was $4.2 million, up 20% from the $3.5 million recorded in Q1 of last year. The improved profitability resulted from a number of factors, including lower natural gas costs, a higher proportion of regular volumes in our sales mix, improved supply chain efficiencies and our ongoing efforts to control operating costs. These positive impacts were partially offset by higher labor costs and a decrease in the volumes we shipped during the quarter. First quarter operating expenses were $2.2 million, a decrease of 15% when compared to Q1 of 2019. The year-over-year improvement was due to stock-based compensation recovery, lower travel expenses and reduced recruitment fees. Operating income for the first quarter was $2 million, an increase of $1.1 million or 109% when compared to the same period last year. First quarter net income was $1.4 million compared to a net loss of $0.01 million in 2019. This year's improved quarterly operating income was enhanced by net gains in nonoperating expenses, including a significant gain on the revaluation of an embedded derivative, net of a smaller loss on risk management activities. These factors had a positive impact on net income. EBITDA of $2.6 million was up $300,000 or 14% when compared to the first quarter of 2019. Q1 EBITDA, excluding the impact of IFRS 16 was $2 million, a year-over-year increase of $400,000 or 26%. Operationally, the improvement was driven by the normalization of natural gas costs when compared to the unusually high costs we had to absorb in Q1 of 2019, ongoing efforts to enhance cost recovery and an increased financial contribution from our Seaforth supply chain subsidiary also had a positive impact. Finally, as a result of the decision our Board took on March 19 to suspend dividend payments in order to help fund the construction of a second new production line at our Delta, BC facility, no dividends were paid in the quarter. With that, I thank you for your attention, and I'll now turn things back to Frank, who will tell you more about our expectations for the balance of the year. Frank?

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

Thank you, Iain. As with businesses in every sector of the economy, the COVID-19 pandemic has created an uncertain outlook for Swiss Water over the balance of this year. As I noted earlier, depending on when the out-of-home food and beverage sector returns to normal or even opens, we are likely to experience a decline in our annual volumes in 2020. That said, there are positive indications that the health crisis is abating, and things are beginning to open up in a number of jurisdictions in North America and around the world. Looking beyond the immediate challenges presented by the pandemic, we are confident that demand for our proprietary SWISS WATER Process decaffeinated coffees will continue to grow well into the future. We are positioned for today and preparing for the brighter days ahead. Our customers are well diversified, both geographically and by channel. Coffee is a nearly essential product to a very large proportion of the world's population. If people can't drink in a cafe or restaurant at the moment, they will stock up at the grocery store and enjoy their coffee at home. And at a time when consumers in the coffee trade are growing ever more concerned about the potential health effects of the chemicals used by our competitors to decaffeinate coffee, and chemical-free production capacity is constrained, Swiss Water Decaffeinated Coffee has the right product and is taking the right steps to prepare for the future. That wraps up our comments for today, and Iain and I would now be happy to answer any questions that you might have.

[Operator]

[Operator Instructions] First, we'll hear from Warren Goldblum, investor.

[Warren Goldblum]

Thanks. Firstly, thanks for the extra, sorry, clarity, just in terms of the capacity add of the second line at Delta. Just in terms of your statement, you said the targeted endpoint capacity was at least 40% greater than the current 2 lines at Burnaby. Are you talking just about the additional expansion? You're not talking about the first line at Delta or are you're inclusive of the first line of Delta and the spend when you're talking about that over 40%?

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

Thanks, Warren. Yes, the intent would be that I'm referring to inclusive of the second line.

[Warren Goldblum]

So, you mean inclusive of the first line?

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

First and second...

[Warren Goldblum]

Sorry, the total -- post the spend, the total capacity at Delta would be 40%, at least 40% greater than the current capacity at Burnaby?

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

That's right. Yes, on both lines, yes.

[Operator]

[Operator Instructions] We'll hear next from Viking Capital and the line of John Sartz.

[John Sartz]

I was -- actually, I was also wanting to know about the second Delta line specifically. Could you give me a time line of the completion, could you give me the cost? And also how you expect to finance it?

[Iain Carswell, Chief Financial Officer]

So maybe I can start off with this, and then, Frank, you can add. So we expect -- we haven't completed final engineering. However, we expect that the cost will be somewhere in the region of $45 million. In terms of the time line, obviously, our lease expires in June of 2023. So we don't anticipate having the new volume in place in advance of that. The specific dates and deliverables are still being worked out. And so obviously, we haven't completed the final engineering plan. I don't know, Frank, if you have anything that you want to add?

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

Yes. The early projections are approximately a $45 million spend. The engineering estimates are always plus and minus 10%. I haven't seen very many minuses. And yes, in any case, as we move down this path, what we're planning for is a series of, as our Board calls them off-ramps, opportunities where we can place a hold, for example, on the expansion. If, for example, for whatever reason, our new owner decides that we could stay in our existing facility for an extended period of time with some certainty, and that's -- I think that's an important planning stance for us to take. We have to mitigate risk of losing any customers, especially the large commercial customers at all through an inability to supply, would be in our estimate, very, very negative for the business and in the confidence that we've built up in being able to supply large internationally based branded customers, which rely on consistent supply. So that's why we've needed to take this preparatory planning stance. However, as we look at this project, there are a series of tranches of execution from engineering to an equipment purchase, to construction of, for example, the building itself to the construction of the internals and the installation. So there's a series of elements in the project plan that allow us to either hold or extend our timing if things change in the marketplace. And that's exactly how we're approaching this. And that's, I think, a prudent way for us to deal with the situation that we are in now. I hope that answers your question.

[Operator]

[Operator Instructions] We'll hear next from [ Lyle Parkin ], private investor.

[Unknown Attendee]

You mentioned -- when you're talking about costs, you mentioned the improved supply chain efficiencies. Would it be possible to elaborate on what that entailed?

[Iain Carswell, Chief Financial Officer]

Sure. Well, we consolidated -- last year, we took a step to consolidate our warehousing. So this time last year, we were operating 2 warehouses. We now operate 1 bigger warehouse. And as a result, we have higher utilization rates of our warehousing space. So that's an efficiency that's flown through. We've also seen increased kind of freight traffic to the East Coast of North America from a mix perspective, which generates slightly better performance for us from a freight point of view. I would say it's largely efficiencies, which we have gained from consolidating our warehousing operations.

[Operator]

[Operator Instructions] And we'll take a follow-up at this time from [ Lyle Parkin ] once more.

[Unknown Attendee]

So this question is about dividends. So just assuming best-case scenario, you get your second line built out and everything is working fine, at what point do you think dividends would be restored?

[Iain Carswell, Chief Financial Officer]

Well, I mean, that's -- it will take us until 2023 to construct the second line. I think it's too early for us to indicate any decisions on future dividend policy at this stage.

[Unknown Attendee]

2023. Can you explain why it would take that long? Not like you're building, creating a whole new factory, building and land acquisition and everything, it seems like an awful long time.

[Iain Carswell, Chief Financial Officer]

Have you ever visited the decaffeination factory before, Lyle?

[Unknown Attendee]

No, I haven't.

[Iain Carswell, Chief Financial Officer]

There's a significant amount of engineering involved in completing this. We have just constructed a line. We knew exactly what it takes to construct a line. It's not what many people would imagine a food production facility to be. So that's not a case of having a warehouse and rolling in a fairly standard production line. It's much more complex than that and there's a significant amount of engineering involved in what we do.

[Operator]

Gentlemen, we have a question coming from the phone from the line of John Simmons.

[Unknown Analyst]

One of your earlier questioners asked about the construction and -- engineering and construction plans with respect to the second line and asked about how you're going to finance that. And your answer was quite comprehensive, but didn't deal with the financing issue. So could you talk to that as well as your total financing plan going forward? You have a significant debt coming due in 2023 as well as a $45 million financing -- or capital requirement. That comes close to $60 million. Can you tell me, if you can, what the current plans are for financing that capital requirement?

[Iain Carswell, Chief Financial Officer]

Sure. I think we covered this off in our last call when we summarized the year-end results. Our intention is to finance the project from a combination of the dividend suspension, the internally generated free cash flow, and we will have to top this up with some additional debt. However, we believe that the growth rates that we've been experiencing in recent years, this is the first quarter, I think, in 12 quarters where we haven't reported significant growth. We expect to see -- we expect to be able to fund a significant proportion of this from internally generated free cash flow as our volumes improve.

[Operator]

[Operator Instructions] Frank and Iain, we have no signals from the audience. I will turn it back to you for any additional or closing remarks that you have.

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

Thank you, Jim. So at this point, if there are no further questions, that will conclude today's call. And Iain and I wish you all good health and thank you very much for joining us.

[Operator]

Ladies and gentlemen, this does conclude today's meeting, and we do thank you all for your participation. You may now disconnect your lines, and have a great day.