Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Swiss Water Decaffeinated Coffee Inc. Conference Call. Before the Swiss Water Decaffeinated Coffee Inc. conference call starts, they require 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 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 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 Inc.'s Management Discussion & Analysis posted on SEDAR and Swiss Water's website for a full discussion regarding forward-looking statements and the risks therein.

[Operator Instructions]

It is now my pleasure to turn the floor over to your host, Frank Dennis, President and CEO of Swiss Water Inc. Sir, the floor is yours.

[Frank Dennis, executive]

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, 2022.

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 outlined in yesterday's press release and in our quarterly MD&A, Iain and I are very pleased to report that the strong performance improvement Swiss Water achieved during Q4 of 2021 and the first 3 months of 2022 continued and, in fact, strengthened further during the second quarter.

Our Q2 volumes and warehouse utilization, revenues and profitability, all exceeded our expectations, leading to a stronger-than-anticipated first half of the year. As always, volumes were the key driver of our performance with total volumes growing by 40% in the second quarter and by 32% in the first half of the year.

The volume growth, coupled with a higher coffee futures price drove a 68% increase in our quarterly revenue, which at $48.4 million was up by $19.6 million over Q2 last year. This brought our first half revenue to $86.8 million, up 59% from last year.

In addition to our strong volume growth and the resulting high level of plant capacity utilization and increased green coffee differential margin and disciplined management of inflationary pressure enabled us to achieve a significant improvement in profitability.

Our second quarter net income of $1.5 million was up by $1.2 million from Q2 of last year. And for the full 6 months to June 30, net income of $2.8 million was up by $2.7 million from the first half of 2021. While adjusted EBITDA of $5.3 million for the quarter and $9.2 million for the 6 months was more than double last year's results in both periods, our current LTM EBITDA now stands at $15.3 million.

These strong results were achieved despite the inflationary pressures and the lingering impacts of the pandemic that all businesses face today because of a number of positive factors that are benefiting Swiss Water. The first and most important of these is the recovery of demand from the vital out-of-home coffee market as the North American and international foodservice economies returned to pre-pandemic levels of activity.

The second is that as cafes, restaurants and retail grocery outlets in our key markets adapt to increasing environmental responsibility and food safety requirements, coffee roasters and coffee consumers are increasingly choosing chemical-free water-processed decaf over coffee decaffeinated with methylene chloride or ethyl acetate.

While the volume growth was notable across all our geographic markets, it's particularly encouraging that in North America, we continue to achieve strong double-digit growth with year-over-year volume up by 34% in Q2 and 27% in the first half.

This strong improvement came from a combination of new customer acquisition and organic growth with existing customers, most of whom are now ordering ahead of pre-pandemic levels. As I've noted previously, we began shipping to some new high-profile out-of-home North American customers during the second half of last year. This new business is helping boost our results this year and provides an encouraging indication of future growth potential.

A prime example is Peet's Coffee, a San Francisco-based specialty coffee roaster and retailer with commercial distribution across the United States. Another interesting development is that our international markets have now overtaken Canada as our second largest geographic segment, with business outside of North America growing by 68% in the quarter and 51% during the first 6 months of this year.

So a big driver here were volumes delivered to the Asia Pacific region, which were up by 107% in Q2 and 84% in the first half, mainly due to organic growth. In Europe, volumes were also up nicely growing up -- growing by 17% in both periods.

Importantly, we also see the positive changes in our customer mix as another clear sign of the strong recovery of the out-of-home coffee market, while at the same time, at-home consumption has remained buoyant. The removal of restrictions on food service outlets in the U.S. and elsewhere and the return of more people to their offices and other workplaces helped us increase volume shift to our higher-margin specialty customers by 56% in the second quarter and by 42% in the first half.

This, coupled with the 29% volume growth from our commercial customers in Q2 and 25% in the first half is indicative of a growing demand for decaf generally post-pandemic as well as the increasing number of industry participants converting to our chemical-free process.

As I've noted before, it's unusual that we've achieved this exceptional volume growth across the business despite a stubbornly high New York futures contract coffee price or NY'C'. The NY'C' rose steadily through the second half of last year and has remained unusually high. During the second quarter, the NY'C' averaged USD 2.25 a pound, down somewhat from the peak of USD 2.58 in the first quarter.

However, this compares to the average of USD 1.46 we saw in the second quarter of last year. Normally, when the NY'C' rises and remains at such high levels, our customers tend to consume their own inventories as they wait for the price to all back rather than buying more coffee from us. Given that the NY'C' has remained high for over 12 months now, customer inventories would have been depleted in any event.

However, during 2021, an unusual double frost in Brazil, coupled with the disruption of global supply chains, leading to significant delivery risk have created a persistent fear of a coffee shortage among industry participants at all levels.

This was leading to growing inventories in coffee-consuming nations. These concerns have helped support our volume growth and very well may have caused some customers to move their orders forward to ensure that they have sufficient inventory on hand to meet demand.

Over the coming weeks and months, we will see how this plays out and whether we will see any form of demand destruction from elevated consumer coffee prices. But before I tell you more about our outlook for the balance of this year and our preparation for the future, let me now turn the call over to Iain to take you through our financial results.

[Iain Carswell, executive]

Thanks, Frank. As always, I'll begin my review with volume shipped to customers as this is the key metric that drives our financial performance. As Frank indicated, Swiss Water's processing volumes continued to grow in the 3 and 6 months to June 30, primarily due to the ongoing recovery of the foodservice companies.

Total volumes were up by 40% in the second quarter and by 32% for the year-to-date when compared to the same periods last year. 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 for home or office consumption, were up by 15% in the quarter and 8% in the first half.

While shipments to importers, those customers who resell our coffees to roasters where and when they need it, were up by 80% in Q2 and by 68% for 6 months of the year. Looking at the roaster segment another way, as Frank noted, specialty roaster account volumes continued to trend upward, growing by a healthy 56% in the quarter and by 42% for the first half.

These accounts serve the out-of-home consumer primarily, and the strong growth here reflects the ongoing return of cafes and restaurants to pre-pandemic operations in our key geographic markets. Shipments to large commercial roasters were up by 29% in the quarter and by 25% in the first half of the year.

Turning now to revenues. Second quarter revenue of $48.4 million was up by $19.6 million or 68% from Q2 of 2021, setting a new quarterly record for Swiss Water. First half revenue of $86.8 million also showed very strong growth, increasing by $32.3 million or 59% 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.

Record levels of activity and increased financial contribution from Seaforth coffee handling and logistics subsidiary also had a positive impact. Looking at the cost side, our second quarter cost of sales was $40.4 million, an increase of $15.3 million or 61% compared to Q2 of last year.

For the first half, cost of sales was $73.1 million, up by $25.8 million or 55% from the 2021 level. The increase in both periods was mainly driven by our significantly increased production volumes, the higher cost of green coffee and increased freight expenses.

As Frank noted, while down slightly from its first quarter peak, the NY'C' coffee commodity price has been trending sharply upward since early in the third quarter of last year. In Q2 of this year, the NY'C' averaged $2.25 per pound compared to an average of $1.46 per pound in the second quarter of 2021.

As you would expect, such a significant rise in coffee prices triggers a major increase in our working capital needs and increased value of inventory in our balance sheet is reflective of this. We are monitoring our working capital needs very closely and evaluating options to increase credit availability.

Foreign exchange rates can also have a meaningful impact on our profitability and cash from operations. This is because the majority of our revenues are generated in U.S. dollars, while a significant portion of our costs are incurred and paid in Canadian funds.

Our exposure to changes in the exchange rate is managed in part through derivative financial instruments. However, all other factors being equal, we benefit when the U.S. dollar appreciates as it did during the second quarter of this year. In Q2, the U.S. dollar averaged $1.28, up $0.05 from $1.23 in the second quarter of last year.

Second quarter gross profit was $8 million, an increase of $4.3 million or 118% compared to Q2 of 2021. For the 6 months to June 30, the gross profit was $13.7 million, an increase of $6.5 million or 90% from the first half of last year.

Importantly, gross profit percentage for both periods increased to 16% compared to 13% last year. The improvement in gross profit dollars and percent was primarily driven by our increased processing volumes and resulting high utilization rates on all 3 of our current decaffeination lines, which operated at approximately 80% of capacity throughout the first half.

This high capacity utilization as well as record business at our Seaforth subsidiary enabled us to realize production efficiencies. In addition, the comparatively low availability of green coffee due to inefficiency in the coffee supply chain, as referenced by Frank earlier, enabled us to make very good green coffee differential margin.

These positive factors were partially offset by inflationary pressure on our variable production costs. Second quarter operating expenses were $3.5 million, up by 39% from $2.5 million in Q2 last year. For the first half, operating expenses were $6.4 million, an increase of 20% over $5.4 million reported in 2021.

The administrative portion of operating expenses is up by $1.3 million or 37% during the first half of this year due to general inflationary pressure as well as higher professional fees and salaries and the incremental cost of operating from 2 locations.

The sales and marketing component of operating expenses were less impacted, increasing by just $100,000 or 7% in the quarter and decreasing by $200,000 or 10% for the 6 months to June 30. I should point out that there is an element of timing at play here and the first half decrease will reverse as our marketing activities increase over the balance of the year.

Q2 operating income was $4.4 million, an increase of $3.3 million or nearly 300% from the second quarter of 2021. Operating income for the year-to-date was also up very significantly, growing at $7.3 million, an increase of $5.5 million over the $1.8 million recorded in the first half of last year.

After accounting for increases in finance expense and income taxes as well as losses on our risk management activities, this strong performance flows down to net income. For the second quarter, net income was $1.5 million compared to $216,000 in Q2 2021, representing a year-over-year improvement of 576%.

First half net income was up even more, growing from just $120,000 in 2021 to $2.8 million this year. The change reflects the company's improvements in gross margin and operating income. Second quarter net finance costs of $1.3 million were up by $445,000 over Q2 of last year. For the first half, net finance expenses were $2.5 million compared to $1.8 million last year.

The increase in both periods was due primarily to higher interest rate on our debentures with warrants as well as higher outstanding balance on construction loans and credit facility. Despite inflationary pressure on the company during the quarter and first half, we achieved a significant improvement in adjusted EBITDA.

Second quarter adjusted EBITDA of $5.3 million was up by $2.9 million or 117% compared to Q2 in 2021. For the 6 months, adjusted EBITDA was $9.2 million, more than doubling the $4.4 million we reported in the first half last year. Operationally, our adjusted EBITDA improvement this year was driven by [Technical Difficulty]. As I've noted, these positive impacts were partially offset by the higher green coffee costs and incremental labor and production expenses associated with operating as 2 stand-alone facilities.

Once we consolidate all production in our Delta location and exit the legacy Burnaby facility in mid-2023, the resulting efficiencies will bring down our operating costs significantly. Together, the strong performance achieved under all our financial metrics enabled us to bring net income per share back up to levels we haven't seen since late 2018 and early 2019.

On a final note, regarding financing during the second quarter, we reached agreement with Mill Road Capital to increase our senior debt covenant from $65 million to $68 million. We remain in discussion with Mill Road to increase this further should this become necessary to manage ongoing pressure on our working capital and liquidity needs due to the growth of our business and the very high green coffee futures price.

In addition to proactively managing our long-term debt facilities on our hedging program, we also continue to evaluate opportunity to raise new capital to support our long-term strategic objectives. With that, thank you for your attention, and I'd like to hand back to Frank.

[Frank Dennis, executive]

Thank you very much, Iain. As Iain and I have indicated, we're very encouraged by the fact that the positive momentum we saw building across the business in 2021, continued to gain strength through the first half of this year.

While 2022 is off to a good start and remain optimistic about the balance of the year with a strong order book, a high capacity utilization rate and the return of generally favorable trading conditions in our key markets, caution continues to be called for.

Like businesses everywhere, Swiss Water is not immune to current and emerging macroeconomic risks. Inflation is increasingly becoming entrenched and economies around the world are struggling to get a grip on it by raising interest rates.

Supply chains remain problematic globally, and in particular, the Port of Vancouver continues to deal with a significant reduction in steamship service, particularly out of coffee origins like Brazil and Colombia, key origins for our business.

The Russian invasion of Ukraine is disrupting the global order and creating a lot of uncertainty in Europe and around the world. Furthermore, the continuation of a very high coffee futures price is resulting in a significant increase in our working capital requirements.

At same time, we are experiencing very significant inflationary pressure on virtually all of our input costs from natural gas to freight and to labor. These risks are -- and increasing cost demand our close attention and will likely require further pricing actions and mitigation measures. They could also have a negative impact on our margins and our future volumes. Operationally, we continue to run both decaffeination lines in our legacy production facility in Burnaby, BC on a 24/7 basis.

Aside from a scheduled maintenance shutdown in January, the initial line at our new facility in Delta, BC operated smoothly and efficiently, also on a 24/7 basis throughout the first half, and we are continuing to migrate more of our production here. Since the startup, we have been gradually increasing the processing speed of Delta Line 1 as we can work to optimize and maximize its production.

As I expect you all know by now, we must relocate all remaining production from Burnaby by June of next year 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 are now building a second new production line in Delta.

Financing for this project was arranged in Q2 of last year and the necessary permits were secured last summer. Foundation was completed during the third quarter of last year and ground construction began in Q4. We now have about 50% of the structural build completed while all equipment for installation is already in Vancouver or on site.

The preliminary cost estimate for design and construction of the Line 2 project in Delta was approximately $45 million, commissioning costs of around $2 million. During the second quarter, the impact of global macroeconomic pressures, including inflation, trade disruptions and supply chain issues became of increasingly acute concern in terms of their potential impact on our project budget and schedule.

Accordingly, we now consider that there is a risk that we may exceed the preliminary budget by as much as 10%. We continue to work diligently with all concerned to mitigate cost impacts and to keep the project on schedule. At the same time, we are working to quantify the exit costs associated with permanently shutting down the Burnaby facility.

This process involves evaluating the costs associated with removing and relocating some production assets into storage for possible future use as compared to immediate disposal on a piece-by-piece basis.

We will report the results of this analysis to you once we've determined the best options likely in the third or fourth quarter. That wraps up our comments for today. And Iain and I would now like to -- be happy to answer any of your questions that you might have.

[Operator]

[Operator Instructions]

There are no questions in the queue at this time.

[Frank Dennis, executive]

Okay. Well, if there are no questions today, we will conclude today's call. And Iain and I wish you all a great summer. And thank you very much for joining.

[Operator]

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