Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Swiss Water Decaffeinated Coffee Conference Event [Operator Instructions]Before Swiss Water Decaffeinated Coffee 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 considered reasonable at the time 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 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 the Swiss Water Decaffeinated Coffee management discussion and analysis posted on SEDAR and Swiss Water's website for a full discussion regarding forward-looking statements and the risks therein.It is now my pleasure to turn the floor over to your host, Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee. Sir, the floor is yours.

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

Thank you, Matthew. Good morning, everyone, and thanks for taking the time to join us. Again, 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, 2021, our second quarter and first half.As usual, I'll begin with a brief review of our performance, then Iain will provide more detail about our financial results before I return to tell you more about our longer-term plans and expectations. After that, we'll be happy to take your questions.As we've reported to you during our last 3 conference calls, Swiss Water's overall volumes have proven to be much more resilient than we'd anticipated when the COVID-19 pandemic first emerged in Q1 of last year. In fact, since the beginning of this year, our business has continued to grow as we attract new customers to our products and services and as existing customers experience the benefits of growing their chemical-free decaf coffee offerings. As cafes, restaurants and other businesses in our key markets emerge from lockdowns and capacity restrictions, we are seeing good evidence that coffee industry participants and coffee consumers are increasingly choosing chemical-free decaf over coffee decaffeinated with methylene chloride. This ongoing trend is evidenced by the growth in our volumes, which were up 4% in the second quarter and 8% in the first half. While the volume growth was notable in all of our geographic markets, Europe stood out posting a 74% increase over the first half of last year. While this is in the Asia Pacific region, it was also very strong with volumes up 10% in the first 6 months of this year, mainly due to organic growth. As I've noted before, we see the strong recovery of demand in our international markets as a positive leading indicator of what is now happening in North America as the food service economy reopens and business returns to more normal trading patterns. Since 43% of our business in the U.S. and 35% is in Canada, this is where we expect to see the bigger overall growth to come. Importantly, we see the positive changes in our customer mix during the first half as an encouraging sign of recovery in the vitally important out-of-home coffee market. The relaxing of restrictions on food service outlets in the U.S. and elsewhere helped us increase volumes to our higher-margin specialty accounts by 29% in the second quarter and 24% in the first half of this year.Over the coming weeks and months, as vaccination programs hopefully reach maturity in several developed countries, we hope to see a continued normalization of trading conditions in our key markets.Before I tell you more about our outlook for the balance of the year and our preparations for the future, let me now turn the call over to Iain to take you through our financial results. Iain?

[Iain T. Carswell, Chief Financial Officer]

Thanks very much, Frank. Good day, everybody. As always, I'll begin my review with volume shipped to customers. This is the key metric that drives all our other results. As Frank indicated, Swiss Water's processing volumes have continued to prove remarkably resilient despite the ongoing disruption of the pandemic. Total volumes were up by 4% in the second quarter and by 8% for the year-to-date when compared to the same periods last year. Looking at volumes by customer type, shipments to roasters, or those customers who roast and package coffee to sell to consumers in their own coffee shops or for home or office consumption, were down by 8% in the quarter and 4% in the first half. Shipments to importers, those customers who resale our coffees to roasters where and when they need it, were up by 31% in Q2 and by 34% in the first 6 months of the year.Looking at the roaster segment another way, as Frank noted, specialty roaster account volumes continued to trend upwards, growing by a healthy 29% in the quarter and by 24% for the first half. These accounts are out-of-home consumer primarily, and the strong growth here reflects the ongoing reopening of cafes and restaurants in a number of our key geographic regions. Shipments to large commercial roasters were down by 8% in the quarter, but level with the first half of last year.Turning now to revenues. Second quarter revenue of $28.8 million was up by $2.4 million or 9% from Q2 of 2020. First half revenue of $54.4 million showed even stronger growth, increasing by $6.3 million or 13% over last year's level. The revenue increase was due to the growth in our volumes as well as higher green coffee price during the first half of this year.Looking at the cost side, our second quarter cost of sales was $25.1 million, an increase of $3.8 million or 18% compared to Q2 of last year. For the first half, cost of sales was $47.2 million, up $8.4 million or 22% from the 2020 level. The increase in both periods was mainly driven by higher green coffee costs as well as an increased depreciation due to the inclusion of our Delta manufacturing facility on incremental labor and production expenses. For comparison, the NY'C' coffee commodity price averaged USD 1.46 in Q2 versus USD 1.5 in the second quarter last year. While the additional depreciation and amortization expenses from the Delta facility and finance lease totaled $800,000 for the quarter and $1.7 million for the first half of this year.Second quarter gross profit was $3.7 million, a decrease of $1.5 million compared to Q2 of 2020. For the 6 months to June 30 of this year, gross profit was $7.2 million, a decrease of $2.2 million from the first half of last year. The reduction in gross profit was driven by a number of factors. These included the increase in depreciation charges and incremental labor and production expenses following the commissioning of Line 1 at the Delta facility as well as lower coffee quality differential margin due to foreign exchange variability. These movements were not unexpected and were partially offset by improvements in Swiss Water's customer sales mix as well as supply chain efficiencies in our Seaforth property handling and storage subsidiary.Second quarter operating expenses were $2.6 million, [ down ] by 9% from Q2 last year. The quarterly improvement was largely due to reduced salary expenses resulting from the restructuring of some of our departments earlier this year as well as an income tax credit for research and development booked during the quarter.For the first half, operating expenses were $5.4 million, an increase of 8% over 2020. The first half increase was primarily due to the fact that in the first quarter of 2020, there was a significant unplanned recovery of share-based compensation of -- due to a drop in Swiss Water share price. In the first quarter of this year, there was no comparable cost recovery and, in fact, a small expense was recorded. If share-based compensation were excluded from the calculation, this year's first half operating expenses would have been reduced by $200,000.Q2 operating income was $1.1 million, down from the $2.4 million recorded in the second quarter of 2020. First half operating income was $1.8 million compared to $4.4 million in the first half last year. Although operating income declined this year, the fundamentals of our business have remained strong. The change was not unexpected and was primarily driven by the impact of foreign exchange conversion on coffee quality differentials. These dropped back from the high levels reported in 2020. The additional expenses we incurred from running 2 facilities this year also had a negative impact.Net income for the quarter was $216,000 compared to income of $1.7 million in Q2 2020. For the first half, net income was $120,000 compared to $3.2 million last year. The year-over-year difference in quarterly and first half income reflects the combination of changes in gross profit and in both operating and nonoperating expenses. Nonoperating expenses were higher in the quarter and first half of this year due to an increase in finance costs in both our construction loan and credit facility. In 2020, during the construction of Delta Line 1, borrowing costs related to this project were capitalized. Following its commissioning in Q3 last year, the related borrowing costs started to be recognized as an expense. Another factor contributing to this year's increased nonoperating expenses is that last year, our first half nonoperating expenses were reduced by the revaluation of an embedded derivative as a result of a lower share price, offset by a slight loss on our risk management activities. During the same period this year, there was a much smaller revaluation effect and an increase in finance expense.Second quarter EBITDA of $3.2 million was the same as in Q2 last year. For the first half, EBITDA was up slightly to $5.9 million. Operationally, our EBITDA this year was driven by revenue growth, successful efforts across the company to enhance cost recovery and the increased financial contribution from Seaforth. These positive impacts were offset by the lower foreign exchange conversion, coffee quality differentials as well as the additional expenses we incurred for running 2 production facilities.With that, I thank you for your attention, and I'll turn things back over to Frank. Frank?

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

Thank you very much, Iain. As Iain and I have indicated, we are encouraged by the return to year-over-year growth in our volumes that we saw in the first half. We continue to attract new customers and to grow our business organically with existing customers as more industry participants and coffee consumers move away from methylene chloride decaffeination in favor of chemical-free processes like ours. While the COVID-19 pandemic is not over, we believe that the increases in business we have seen recently in the Asia Pacific region and in Europe as well as the growth in volumes shipped to our specialty accounts are all leading indicators of an emerging, if early, recovery in the broader coffee market in the U.S. and elsewhere. That said, despite signs of recovery and a strong order book for delivery in the second half, caution continues to be called for, while vaccination programs move toward maturity in many of our key markets, new variants and new outbreaks are likely to occur as vaccination levels plateau. This may result in more disruptions for some time to come. One disruptive side effect of the economic recovery now underway is the congestion in global coffee supply chains. In our case, we are experiencing logistical challenges and moving coffee from growing regions to our production facilities and then on to market. This is being felt most acutely on the West Coast and at the Port of Vancouver. At the same time, a Brazilian frost during July has driven a sharp rise in the coffee future's price. High coffee prices can also have a destabilizing impact on the efficient movement of coffee inventories. We are paying close attention to these emerging risks and are introducing mitigation steps as required to ensure that our production and delivery schedules are not compromised. Operationally, we continue to run both decaffeination lines at our legacy production facility in Burnaby, BC on a 24/7 basis. The initial line at our new facility in Delta, BC is operating smoothly and efficiently, also on a 24/7 basis through [ TAF, ] and we are continuing to migrate more of our production here. As we move through the balance of the year, we expect to gradually increase the processing speed of Delta Line 1 as we work to optimize and maximize its production. If you've been following our story, you'll know that we must relocate all remaining production from our legacy facility in Burnaby, BC by June 2023 due to the upcoming expiry of our lease there. Accordingly, in order 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 in Delta before we depart for the Burnaby site.Planning for the financing, design and construction of a second line in Delta has been underway for some time with a targeted completion date before the 2023 lease expiry 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. Preliminary cost estimate for the design and construction of the line project 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 dependent on local and global economic back. And as with all plans these days, subject to the potential negative effect of the COVID-19 pandemic on cost in time.During the second quarter, we concluded a new financing agreement that will contribute $25 million towards this project. These incremental funds, together with existing available credit, projected internally generated cash flow could be sufficient to fund the completion of the new production line. The exciting news is that last month, we were formally issued the necessary building permits, and we've now broken ground on the construction of line -- Delta Line 2.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] There are no questions in the queue at this time.

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

Thank you, Matthew. And so if there are no further questions, I'll conclude today's call. Iain and I wish you all good health, and thank you for joining us.

[Operator]

Thank you, ladies and gentlemen. This does conclude today's event. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.