Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good afternoon. 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 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, circumstances, except as required by law. Please refer to Swiss Water Decaffeinated Coffee Inc.'s management's 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 Inc. Sir, the floor is yours.

[Frank Dennis, executive]

Thank you, Matthew. Good afternoon, everyone, and thank you for joining us today. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. And with me 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, 2025. As usual, I will begin with a brief review of our performance and operating environment, then Iain will provide more details about our financial results. After that, I will share some closing thoughts before we take your questions.

We delivered another quarter of stable performance, supported by strong execution and continued demand for our chemical-free decaffeinated coffee. Our customer base remains broad and diversified across North America and international markets. Strategic inventory positioning continues to be a key enabler, allowing us to respond quickly to customer needs and develop new customer relationships. Market conditions remain complex with volatility continuing to affect industry behavior. Coffee futures have moderated from earlier highs, but continue to trade well above historical averages, and the market remains inverted. This results in short hedges losing money upon expiration of the contract period.

Normally, in a carry market, short hedges make a slight gain on expiry. The inverted condition is persisting in the futures market because of net overall production shortfalls and will likely persist into 2026. At the same time, uncertainty around U.S. tariffs on imports from key producing countries continue to influence nearby trading behavior. These dynamics are continuing to drive leaner inventory positions and more cautious purchasing across the supply chain. Against this backdrop, our strategic approach to inventory has been essential, allowing us to support customer demand and avoid what would have otherwise been a material volume decline. We are beginning to see early signs of price sensitivity in certain consumer segments, particularly the U.S. grocery, but overall demand for decaffeinated coffee is generally steady.

Our focus remains on execution. The Delta facility continues to operate well with the flexibility needed to respond to shifts in demand. We were able to meet customer needs throughout the quarter, supported by our inventory positioning and production planning. From a risk management standpoint, we continue to actively manage input cost volatility through our commodity and ForEx hedging programs. While the current inverted structure of the NY'C' futures market created a short-term EBITDA impact, as we move our futures positions through consecutive periods, our approach remains structured and consistent with the rest of the industry. We are pricing for the inversion costs as is the balance of the coffee trading industry, and we expect these costs to be recovered over the remainder of the year and into 2026.

Overall, we're encouraged by how the business is performing. While we expect some variability as the year progresses, we remain well positioned to navigate it. Our team continues to execute with focus. Our customer relationships remain strong, and our brand is well aligned with long-term consumer trends. We're operating in a complex environment, but we are confident in our ability to manage through it with discipline and consistency. We're pleased with the progress we made this quarter, both in how we supported customer demand and importantly, in the steps we took to strengthen the business financially. While the environment remains dynamic, our strategy continues to work. We've taken deliberate steps to manage risk, preserve flexibility and position the company to meet demand with confidence.

With that, I'll turn the call over to Iain to walk through the financials. Iain?

[Iain Carswell, executive]

Thanks, Frank. Firstly, from a balance sheet and capital structure perspective, in the quarter, we successfully renewed and expanded our credit facility, repurchased and canceled the Mill Road Capital warrants, removing a large overhang in shares and continued repayments on our long-term construction borrowings. These actions strengthen our balance sheet and will provide improved financial flexibility going forward.

Working capital increased significantly during the quarter, primarily related to the reclassification of the renewed credit facility. Outside of that reclassification, inventory costs remain high. We expect that to somewhat unwind over the next few quarters as higher volumes flow [indiscernible]. Our financial results also reflect the effect of rolling hedge positions forward in a sustained inverted market, something I will speak to in more detail shortly.

Total shipped volumes increased by 2% in the first half of the year. The increase in volumes was driven by robust underlying sales with our established customers. In a market where importers are holding leaner inventory positions to manage cost exposure due to NY'C' volatility and inversion, our strategic approach to spot inventory availability has allowed us to reliably meet roaster demand and ensure supply continuity in most geographies.

Looking at volumes by customer type, shipments to importers, those customers who resell our coffees to roasters where and when they need it, were down 6% in the quarter, while 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 5% in the second quarter.

Looking at the roaster segment another way, specialty roaster volumes were down 9% in Q2, but up 6% year-to-date. These accounts serve the out-of-home consumer primarily in cafes and restaurants in our key geographic markets. Commercial roaster volumes were up 5% in the quarter and down by 1% year-to-date. Q2 revenue was up 56% to $67.7 million compared to $43.4 million in Q2 2024. Primary driver of the increase in revenue for the second quarter is the NY'C', the effects of which flow through our green coffee revenue. However, this was amplified by inversion and tariff cost recovery, customer mix and improved revenue in our logistics subsidiary, Seaforth.

Looking at our costs. Q2 cost of sales was $62.4 million, up 75% year-over-year. The increase in the second quarter was driven by elevated NY'C' With more modest contributions coming from the front-loading of maintenance costs in the first half of this year, U.S. dollar depreciation, labor costs and tariff costs associated with sales to our U.S. customers.

Our underlying operating cost structure remains stable and in line with expectations, with the consolidation into the Delta facility continuing to enhance variable cost control and optimize utility usage. As for green coffee costs, at an average of $3.59 per pound in the second quarter, the NY'C' was up 64% from $2.20 per pound in Q2 last year. While still elevated, this reflects a modest decline from the Q1 2025 average of $3.73.

Customers remain cautious with inventory management in response to sustained high coffee futures and ongoing tariff uncertainty. As noted earlier, we're seeing a shift in customer mix with some customers maintaining normal supply during the quarter, while others take a more conservative approach. These dynamics continue to drive variability in historical ordering patterns during the quarter.

Exchange rates between the U.S. and Canadian dollar continue to influence our reported results and cash flow. While our revenue is primarily earned in U.S. dollars and a meaningful portion of our costs are incurred in Canadian dollars, we also carry U.S. dollar receivables and payables on our balance sheet. This quarter, fluctuations in exchange rate led to a foreign exchange loss, largely reflecting the revaluation of those U.S. dollar balances at period end. We continue to monitor this exposure and use hedging tools where appropriate to manage our underlying risk.

In Q2, the U.S. dollar averaged $1.38, up from $1.37 in the same period last year, down from $1.44 in Q1. This decrease has a negative impact on our revenues when they were converted to Canadian dollars. Q2 gross profit was $5.2 million, down 22% year-over-year. Gross margin percentage decreased to 8% in Q2 from 18% in the prior year. In addition to the factors we just discussed, our sales mix this quarter also contributed to a lower percentage margin in the quarter.

Turning now to operating expenses. Q2 operating expenses remained flat at $2.9 million, down 1% year-over-year. Sales and marketing expenses were down 7% in the quarter, broadly reflecting changes in the timing of marketing activities. Q2 net loss was $374,000 compared to income of $947,000 in Q2 2024. Aside from the factors we discussed previously, Q2's increase in nonoperating or other income and expense was driven by a $1.1 million loss on risk management activities, largely due to the timing difference between recognizing the cost of rolling hedge contracts forward in a still inverted NY'C' market and the recovery of those costs through customer invoicing.

This resulted in an incremental realized loss -- resulted in incremental realized losses as contracts were rolled forward into the next futures period upon contract expiry. As Frank mentioned, we are pricing for the cost of the market inversion common to the balance of the industry. The inversion losses booked year-to-date are expected to be recovered through these pricing actions over the coming months and into 2026. Furthermore, we also recorded mark-to-market adjustments reflecting commodity price movements and the U.S. dollar strength. These outcomes are consistent with our approach to managing pricing volatility, risk exposure and aligning with our supply commitments.

Importantly, during the quarter, we reached an agreement with Mill Road Capital to repurchase and cancel their outstanding warrants for $675,000, with the transaction being completed just after the quarter on July 3, 2025. As a result of this agreement, the fair value of the embedded option was valued at the actual consideration being paid to extinguished option. We saw a $460,000 increase over Q2 2024 related to the noncash revaluation of the fair value of the embedded option related to the Mill Road warrants. There was a $590,000 decrease in finance expense, largely attributable to a decrease in the interest on the Mill Road debenture, which was fully repaid in Q4 2024.

In addition, a decrease in interest on long-term borrowings after repayments and decreasing interest rates compared to Q2 2024. Q2 adjusted EBITDA was $1.8 million, down $2.7 million or 59% year-over-year. In addition to the factors affecting gross profit, fluctuations in adjusted EBITDA were driven by the previously mentioned loss on our risk management activities, which we expect to be fully recovered through customer collections and disciplined management of operating expenses over the balance of this year.

Turning now to inventories. Our inventory balance decreased slightly to $43.3 million in the second quarter, primarily reflecting a significant reduction in the hedge accounting component of inventory. However, this was largely offset by higher green coffee costs due to elevated NY'C'. Inventory management remains a key component of our strategy. We continue to take a deliberate forward-looking approach to holding stock in order to support anticipated customer demand and ensure delivery continuity.

Notably, we continue to see renewed order activity from smaller roasters with commitments to cover previously deferred purchases due to pricing volatility. At quarter end, Swiss Water held $4.8 million in cash compared to $8.5 million at the end of 2024, and net working capital of $49.1 million. The change in net working capital is driven primarily by the reclassification of our operating credit facility to noncurrent borrowings as a result of the renewal during the quarter.

We continued making principal repayments on our long-term borrowings in Q2, primarily related to construction of our Delta facility. This marks a step towards lowering interest expense and improving our leverage position over time.

With that, I will turn the call back to Frank.

[Frank Dennis, executive]

Thank you, Iain. Turning to questions, I'd like to leave you with a few closing thoughts. While the coffee market remains volatile and challenging, we are encouraged by the way our business is performing. Our ability to meet customer demand despite persistent volatility in the market and uncertainty around tariffs speaks to the strength of our execution and the value of our strategic inventory approach.

We are seeing signs of more cautious purchasing behavior in some parts of the supply chain, but our outlook remains steady. Taking deliberate steps to manage risk, maintain flexibility and support our customers consistently across markets. While we're expecting the coffee futures market to remain inverted into 2026, we also continue to expect significant futures market variability through the second half, but we believe we're in a strong position to navigate it with disciplined focus and a clear strategy that is working.

With that, we'd be happy to take any of your questions.

[Operator]

[Operator Instructions] Your first question is coming from M. Marin from Zacks.

[Marla Marin, analyst]

So against the backdrop of a very uncertain economic environment and the tariff impact, your business continues to move ahead. And the initiatives you've taken, I'm a little curious to just get a little bit more color, if you can. You made a few balance sheet initiatives, eliminating the warrant, eliminating that debt and also taking on, I think, a new revolving credit facility with a new traditional lender. Are you thinking in the past, you have said that one of your goals was to build inventory so that you could be well positioned to address customer demand given that there's a little bit of uncertainty as to timing of orders coming in. Is this still one of the goals?

[Frank Dennis, executive]

Thanks for the question. Staying current with spot inventory is critical in this market for sure. Overall, we have reduced the total pounds of inventory that we are carrying versus the end of 2024 significantly, about 15%, maybe 18%. But what we've done is we've moved more of that coffee from green or raw goods into finished goods, so decaffeinated coffee, and putting that in position primarily in warehouses in the states, where, yes, there's a lot of questions around tariffs and what countries will be dealing with what particular tariff rate at any given moment.

But what that has enabled and will continue to enable is roasters, both large and small, to be able to get our coffee where we've seen a lot of importers walk away from holding coffee and in fact, walk away from sending tolls to us that are -- that stay in their inventory position. So we have -- by being in inventory, yes, that has -- that carries the inversion cost, which we're pricing for, but we will continue to stay in inventory with good inventories on both coasts and in the middle of the U.S. so that we are able to service the upcoming heavier fall roasting period.

So we will continue that. I mean, I think we're starting to see importers come back to the market. People are realizing, well, either we're in the coffee business or we're not in the coffee business. And so it's good to see people now just dealing with and maybe accepting that the current market levels aren't so bad after all in terms of just under $3 is what we're trading at right now. And that they're dealing with the additional costs of inversion and accepting that as being part of a business just like tariffs now have become part of business, at least in the U.S. Other international markets, that's not an issue and nor is it in Canada. But we are in other jurisdictions, also seeing importers finally start to take on some inventory. But being in inventory is important. We have a 24/7 production facility that we want to keep running. And so it makes a lot of sense for us to stay current and up to date with spot inventory.

[Marla Marin, analyst]

Okay. That makes sense. Now you just mentioned that in the U.S., the tariffs are obviously a top-of-mind issue, not so much so in other markets. Last quarter, you were very strong in terms of the performance you saw in some other international markets. I think you mentioned that part of the reason for that was that you were in discussions or you had benefited from ongoing discussions leading up to new orders from opening up new markets. Can you give us a little bit of color on how that initiative is progressing?

[Frank Dennis, executive]

More broadly, we continue to see strength in many Asian markets, and that is -- that jurisdiction or that whole geographic area is a very important development area for us, although we have other opportunities, Middle East and Eastern Europe. Asia is providing a lot of opportunities for us, and we'll continue to do that. It's the same story as it was previous quarter.

[Marla Marin, analyst]

Okay. Great. And then the last question I have is you called out the grocery store channel. Would it be -- how should we think about that? Is it -- is that channel geared towards a more price-sensitive consumer than the consumer who would be buying specialty coffee at an on-site cafe or from roaster, let's say. And so there's no correlation? Or should we think about what goes on in the grocery channel as potentially a leading indicator for other channels that you deal with?

[Frank Dennis, executive]

The grocery channel just volumetrically takes up so much more importance. If you think about bringing home a 2-pound tin or a 1-pound bag at home versus -- and brewing or making up several cups/pots of coffee versus going into a specialty store, the volume difference is pretty significant. And so we focus on grocery, number one, because it's something that is measurable and that we can get good data on and because of the overall volumetric size of that.

What I would see is that what U.S. grocery, which is the only place that we buy kind of scanner data would have a leading indicator or be associated with would be other, for example, European grocery would kind of, I would imagine, work in lockstep when you have significantly increasing prices, primarily because of the New York 'C' in the future, probably because of tariffs, consumers will either reduce the quality of the coffee they purchase and they can also reduce the quantity of coffee they purchase. They won't maybe load up on coffee as much as they might at lower price points. And in fact, maybe they'll even, who knows, miss a day or two as opposed to being fully stocked. And even that little amount of a couple of households missing a couple of days of coffee because they ran out because they aren't loaded up, that has an overall impact on consumption. So that's why we track grocery.

[Operator]

[Operator Instructions] Thank you. That completes our Q&A session. Everyone, this concludes today's event. You may disconnect at this time, and have a great day.