Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good day, ladies and gentlemen, and welcome to your Swiss Water Decaffeinated Coffee Inc. Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. [Operator Instructions]Before Swiss Water Decaffeinated Coffee Inc. Conference Call starts, they 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 are considered reasonable at the time and the -- at the time the information was prepared. Such information involves unknown -- 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 does not assume responsibility for the accuracy and completeness of the forward-looking information. Similarly, they do 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 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. Thank you.At this time, it is my pleasure to turn the floor over to your host, Frank Dennis. Sir, the floor is yours.

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

Thank you very much. Good morning, everyone, and thanks for taking the time to join us. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. And with me today is Iain Carswell, our CFO.Iain and I are here today to discuss Swiss Water's financial results for the 3 and 6 months ended June 30, 2020. I'll begin with a brief review of our results. I will also update you on the COVID-19 pandemic's impact on our operations. Then Iain and I 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. We are pleased to report that our volumes rebounded better than we had anticipated in the second quarter and that all of our financial metrics during the quarter were very positive. In fact, for both the second quarter and first half, Swiss Water recorded strong year-over-year increases in gross profit, operating income, net income and EBITDA. Revenues were up for the quarter and on par with a year ago on a 6-month basis.These strong financial results were achieved despite only slightly lower volumes, which were down 2% in the quarter and 9% in the first 6 months of the year when compared to an extraordinarily strong first half in 2019. Viewed sequentially, Q2 volumes recovered well and were up by 24% compared to the first quarter of this year. It's important to remember that, in each of the 12 quarters prior to the onset of the pandemic, we consistently developed new business and increased volumes as clients migrated away from halogenated, solvent-based decaffeination in favor of our chemical-free Swiss Water Process.This year's decline in volumes was primarily due to the COVID-19 pandemic as well as Q1 effect of the temporary spike in coffee futures. Under normal circumstances, we can expect customers to rebuild inventories after a spike in the New York 'C', but given the nature of the COVID-19 pandemic and its effects on our business and the economy at large, we saw a major shift in distribution channels for coffee.When the pandemic initially hit toward the end of the first quarter, we experienced exceptional demand from customers that serve the retail grocery channel as coffee consumers loaded their pantries in anticipation of an extended lockdown. In the out-of-home market, demand dropped immediately as coffee shops and restaurants were shuttered or forced to rely solely on takeout orders. As restrictions began to ease during the second quarter, the in-home market slowed and the out-of-home market slowly began to pick up, again, as outlets reopened, albeit with significantly reduced seating capacity.Now many jurisdictions around the world are experiencing a resurgence of COVID cases and shutdowns in some regions are being reintroduced, for example, in Australia. The situation, as you know, is exceedingly dynamic, and we are unable to reliably predict the future for customer volume accurately during the ongoing pandemic environment. Accordingly, there is an ongoing risk that we may experience a decline in volumes this year despite the positive trend we saw in Q2.We continue to operate both production lines at our plants in Burnaby, BC on a normal 24/7 basis, as well as operating normally at our Seaforth coffee handling subsidiary, while taking all necessary measures to protect the health and safety of our employees. Before I update you on the start-up of the new production line at our Delta, BC facility, I'll turn the call over to Iain to take you through our results in more detail.Iain?

[Iain Carswell, Chief Financial Officer]

Thanks. I'll begin my review with volume shipped to customers. As Frank indicated, while our gross profit, income and EBITDA were all well up in Q2 and the first 6 months of the year, Swiss Water recorded lower volumes when compared to a very strong 2019. As he explained, the minus 9% drop in our first half volumes was primarily driven by the market's response to a series of spikes in the NY'C' coffee commodity price that began last December and continued through the first quarter as well as the impacts of the COVID-19 pandemic. The year-over-year decline of only 2% in the second quarter was less than we anticipated given the pandemic's growing impact, particularly on the out-of-home coffee market. Viewed sequentially, volumes recovered nicely in the quarter, coming in at 24% better than Q1.Looking at volumes by customer type. Shipments to roasters, which are those customers who roast then package coffee to sell to consumers in their own coffee shops or for home or office consumption, were up by 3% in the second quarter and down by 8% in the first half. Shipments to importers, those customers who resell our coffees to roasters where and when they need it, were down 12% in Q2 and by 10% in the year-to-date. Looking at the roasters segment another way: Speciality roaster account volumes were down 17% in the quarter and 12% for the first half of the year, and shipments to large commercial roasters were up by 7% in Q2 and down by 7% in the first half of the year.Looking now at revenues. Second quarter revenue was $26.4 million, an increase of 8% over Q2 2019. 6 months revenue was relatively constant at $48.2 million, a decrease of 1% from the first half of last year. Revenues remained strong despite the decrease in processing volumes because of the positive effects of customer mix, higher coffee quality differentials and a higher average U.S. dollar exchange rate.Looking at the cost side of our business. Our second quarter cost of sales was $21.2 million, an increase of $900,000 or 5% from Q1 of last year. This was driven by an increase in the costs of green coffee. For the first half, our cost of sales decreased by $2.1 million or 5% to $38.8 million. The decrease in the 6-month period reflects the drop in business activity as well as lower variable production costs due to the lower volumes and reduction in natural gas prices. These factors were partially offset by an increase in annual labor cost inflation.Quarterly gross profit was $5.2 million, an increase of $1 million over Q2 2019. First half gross profit was $9.4 million, was up by $1.7 million or 22% from the 2019 level. This year's improvement in gross profit was due to a number of factors. These included positive changes in our sales mix; margin gains due to higher coffee quality differentials; enhanced supply chain efficiencies, including consolidation of our Seaforth subsidiary's warehouses; and the lower natural gas prices. These positive effects were partially offset by the decrease in volumes shipped during the first half and by higher annual inflationary labor costs.Second quarter operating expenses were $2.8 million, the same as last year. For the first 6 months of 2020, however, operating expenses were down by 7% year-over-year to $5 million. The first half reduction resulted from lower-than-budgeted travel and recruitment expenses due to the pandemic as well as recovery of stock-based compensation costs as a result of lower stock price this year.Q2 operating income was $2.4 million, an increase of 75% from the same period last year. For the first half, operating income was up even more, growing by 89% to $4.4 million.For the second quarter, we reported net income of $1.7 million, up by $300,000 from the $1.4 million last year. Year-to-date net income was $3.2 million, an increase of $1.9 million from the $1.3 million we reported in the first half of 2019. This year's increase in gross profit, combined with decreases in both operating and nonoperating expenses, were the key drivers in the improvement in net income. Nonoperating expenses were down significantly due to the revaluation of an embedded derivative linked to the company's share price, offset by a small loss on risk management activities.EBITDA for the second quarter was $3.2 million, up by $100,000 or 3% to Q2 -- over Q2 2019. First half EBITDA was $5.8 million, up by $400,000 or 7% over last year. EBITDA excluding the impact of IFRS 16 increased by $300,000 or 11% to $2.5 million for the quarter and by $700,000 or 17% to $4.5 million for the first half. The improvement in EBITDA was the result of the higher revenues, improved short-term green coffee differential margins, lower natural gas costs and tight control of operating expenses as well as an increased financial contribution from our Seaforth subsidiary.With that, I thank you for your attention, and I'll now turn things back to Frank.Frank?

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

Thank you, Iain. While our Q2 financial performance is encouraging and the company is well diversified geographically and by its customer base, the ongoing impact of the worldwide pandemic has created an uncertain outlook for the balance of the year.Commissioning of the additional production line at our new facility in Delta, BC was completed in mid-July after some temporary delays in getting equipment and technical personnel across the U.S.-Canada border during the early stages of the pandemic. We are currently creating green coffee extract, the initial step of production, and coffee is now coming off the new line and is approaching specifications. We expect to be at specification on the new line sometime later this month.Additionally, we have begun third-party engineering work to enable the exit of production from our legacy facility in Burnaby, BC by June 2023 due to the coming expiry of our lease there. To ensure that our ability to deliver on customer orders is uninterrupted and to meet the growth in demand we see ahead, we need to build additional new production capacity before we depart from the Burnaby site. Accordingly, planning for the financing, design and construction of a second line in Delta is now underway, with a targeted completion date before the 2023 deadline in Burnaby.Based on engineering reports from a third-party engineering firm, when both are completed, we expect the 2 new lines in Delta together will have a targeted end capacity at least 40% greater than the current Burnaby facility. The preliminary cost estimate for the design and construction of the line in the new -- second production facility in Delta is approximately $45 million, plus commissioning costs of around $2 million. These estimates are preliminary and, like all major design and construction projects, are highly dependent on local and global economic factors. We are now in the process of formulating the financing strategy and expect to have the plan finalized by the end of this year.That wraps up our comments for today, and Iain and I would now be happy to answer any questions you might have.

[Operator]

[Operator Instructions] And we take our first question from Grover Wickersham with Glenbrook.

[Grover Wickersham;Glenbrook;Analyst]

Congratulations on the quarter. I had -- actually I had 2 questions, but I noticed your reference to P&L impact of equity derivatives and I wasn't familiar with that. I'm wondering if you can elaborate that -- on that. And then secondly, if you let me, I was just curious where you stand on possibly resuming the dividend.

[Iain Carswell, Chief Financial Officer]

Okay, thank you for your questions. In terms of the first part, we have a convertible debenture in our business. The value of the option attached to that varies and dependent on the equity price at any given time, and every quarter end, there is a calculation that's -- that values that option. And there are -- there is a gain or a loss that's generated, depending on where our share price sits relative to the share price that closed the previous quarter. I'd refer you to our MD&A, where there's a lot more detail as to how that calculation is made. I'd be happy to answer any questions, further questions, that you have following review of that section of the MD&A or [indiscernible] regards the dividend question, we've made our position clear. We announced earlier this year that we were suspending our dividend. As and when that position alters, we'll communicate to the market.

[Operator]

Mr. Dennis, at this time, there are no further signals.

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

Thank you very much. If there are no further questions, I'll conclude today's call. Iain and I wish you all good health, and thank you very much for joining us.

[Operator]

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. Have a great day.