Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Greetings, and welcome to Swiss Water Decaffeinated Coffee Inc.'s Third Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Before Swiss Water Decaffeinated Coffee Inc.'s conference call starts, they are required to remind you that certain information in today's presentation is forward-looking in nature. Any such looking information or statements are based on assumptions that they consider reasonable at the time the information was prepared. Such information involves known and unknown risks, uncertainties and other factors outside our control that can cause actual results to differ materially from those expressed in the forward-looking information. Swiss Water Decaffeinated Coffee Inc. does not assume any responsibility for the accuracy and completeness of forward-looking statement 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. It is now my pleasure to introduce your host, Frank Dennis, CEO of Swiss Water Decaffeinated Coffee Inc. Thank you, Mr. Dennis. You may begin.

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

Thank you very much. Good morning, and thank you all for taking the time to join us today. I'm Frank Dennis, President and CEO of the Swiss Water Decaffeinated Coffee Inc., which was formerly known as the Ten Peaks Coffee Company Inc. As we announced last month, we have amalgamated our company and changed its name in order to better leverage the considerable equity associated with the SWISS WATER brand. Now it's much easier to make the connection between our premium decaffeinated coffees and our publicly-traded shares. The name change also simplifies some aspects of our corporate structure, which saves administrative costs. Our corporate rebrand was completed on October 22, when our ticker on the Toronto Stock Exchange changed from TPK to SWP. The other good news announcement we made last month was the appointment of Iain Carswell as Swiss Water's CFO. Iain, who is here with me today, brings more than 15 years of extensive international financial experience to his new role. Much of that time was spent with Mars Inc., a multibillion-dollar food, beverage and confectionery company that's known as a world leader in both food manufacturing and sustainability initiatives. We think that experience has Iain ideally positioned to help lead Swiss Water in its quest toward to becoming a global coffee company, and we are very happy to have him on board. Iain and I are here this morning to discuss Swiss Water's financial results for the 3 and 9 months ended September 30, 2018. The 3-month period represents the third quarter of our 2018 fiscal year. I'll begin today with a brief review of our results and some of the factors that are driving the steady growth of our processing volumes. Then Iain will provide more detail about our financial performance before I return to talk about our plans and expectations going forward. After that, we'll be happy to take your questions. So looking now at our results. During the third quarter, our SWISS WATER Process decaffeinated coffees continued to gain market share. As a result, our processing volumes for Q3 and the year-to-date both increased by 12% over the same periods in 2017, with the increases coming from across our customer base. 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 use, were flat in Q3 but up by 11% for the year-to-date. The 11% increase in our 9-month volumes to the roasters segment came in 2 ways: First, we sold more decaf coffee to existing grocery accounts as they grew their own business, either by increasing their distribution venues or by adding to their product offerings. We also gained new roaster customers, some of whom had previously sourced their decaffeinated coffees from a CO2 plant in Europe, which closed last year. We also picked up some new business when a CO2 plant in Houston, Texas shut down this past summer. These plant closures have tightened the supply side of the chemical-free decaffeinated coffee market. And this should enable us to more rapidly utilize the additional production capacity we have coming online next year. Shipments to importers who resell our coffees to roasters where and when they need it were also up significantly, growing by 43% in Q3 and by 14% for the year-to-date. Here, the volume gains are due to several factors including recent customer wins and lower NY'C' feature to market. When coffee prices are relatively low as they are now, importers tend to build up their inventories. Our steady volume growth is also related to some significant changes in the market we serve. As we reported before, the overall market for decaffeinated coffee is expanding. According to the National Coffee Association, total decaffeinated coffee sales were up last year, with decaf now being the fastest growing segment of the specialty -- of the U.S. coffee market. Sales of specialty decaf coffee, like our SWISS WATER Process coffees, were particularly strong, especially in out-of-home markets. Notably, the largest consumers of premium decaf now are 18 to 24-year olds. This is a group that's grown up with excellent coffee. They love drinking it and they love spending time with it at the comfortable, attractive coffee shops that provide it. Our premium SWISS WATER Process coffees lets them enjoy both experiences all day and all evening without worrying about the possible side effects of caffeine. That's good for us and good for coffee shops owners who are just as happy to sell high-quality, high-margin decaffeinated drinks along with their regular caffeinated counterparts. The second factor that's driving up demand for our SWISS WATER Process coffees is the consumer trend toward cleaner or more transparent food products. Today's consumers are highly conscious of artificial ingredients and chemicals in their food and drink, and seek to avoid them when possible. As a result, some recent media stories about the health and environmental hazards associated with methylene chloride, the main chemical used by our competitors to decaffeinate coffee, got a lot of attention. These stories helped more people understand why our 100% chemical-free SWISS WATER Process coffees are worth seeking out, a nice development our marketing team is working to build on. Food companies, too, know that their customers are looking more closely at the providence of their food and drink. In response, many of them are electing to add our branded coffees to their offerings. Going forward, we intend to continue actively and positively promoting the many benefits associated with our premium decaffeinated coffees in order to continue growing our volumes. But before I talk about our future plans and expectations, I'm going to pass the call over to Iain, who will provide some more detail around our recent financial results. Iain?

[Iain Carswell, Chief Financial Officer]

Thanks, Frank. I'll begin with our revenues. This year's growth in processing volumes had a positive effect on our revenues, with sales for Q3 growing by 5% to $23.1 million and sales for the year-to-date rising by 6% to $67 million. In both periods, the impact of our higher processing volumes was partially offset by a lower coffee commodity price or NY'C'. During the third quarter of this year, the NY'C' averaged USD 1.04 per pound compared to USD 1.33 per pound in Q3 2017. For the first 9 months of this year, the NY'C' averaged USD 1.14 per pound compared to USD 1.36 per pound during the same period last year. As a substantial portion of our revenue comprises the amount we charge our customers for green coffee, as we charge market rates for this coffee, our revenue falls when green coffee costs fall. Our revenues for the year-to-date were also affected by a lower average U.S. dollar as a large portion of our sales is billed in that currency. Cost of sales decreased by 2% to $18.6 million in the third quarter and increased by 4% to $55.7 million for the year-to-date. The increase in our 9-month cost of sales was due to several factors, including higher freight charges and variable production costs associated with our increased volumes as well as higher green coffee costs, which is a significant portion of our cost of sales. Gross profit for Q3 was $4.4 million or a margin of 19.2%. Looked at sequentially, this is a marked improvement over Q1 when we recorded gross profit of $2.8 million or a margin of 13.4%, and over Q2, when we recorded gross profit of $4 million or a margin of 17.4%. 9-month gross profit grew from $9.4 million or a margin of 14.9% in 2017 to $11.2 million or a margin of 16.8% this year. Our improved gross profit and margins for the 3- and 9-month periods were tied to our higher processing volumes. The gains also came from a focus by management on reviewing and reducing the operating costs of both SWISS WATER and Seaforth supply chain solutions, our green coffee logistics business. These efforts are ongoing and we continue to see cost recovery opportunities meant to implement cost reductions, provided of course, that they don't compromise the quality of our coffees. Operating expenses for Q3 and the year-to-date grew by 32% and 30%, respectively, over 2017, with the increases mainly due to higher staffing and staff-related expenses. As is to be expected, our personnel costs are rising as we prepare to quickly build the new production capacity we have coming online next year. Operating income for Q3 was $1.9 million, an increase of 73% over the same period last year while the 9-month operating income grew by 4% to $4 million. Overall, Swiss Water recorded net income of $1.8 million in the third quarter of this year compared to $1.4 million in Q3 2017. A net income of $3.6 million for the year-to-date compared to $4.5 million in the same period last year. The decline in our 9-month net income was mainly due to our increased operating costs together with foreign exchange losses compared to foreign exchange gains in the same period 2017. On a per-share basis, we recorded basic earnings per share of $0.20 per share in Q3 compared to earnings of $0.15 per share the same period last year. And year-to-date earnings per share of $0.40 compared to $0.50 last year. On a fully diluted basis, our earnings per share were $0.18 in Q3 compared to $0.15 in the third quarter of last year, and $0.31 per share for the year-to-date compared to $0.41 for the first 3 quarters of last year.Another measure of our financial results is earnings before interest, taxes, depreciation and amortization or EBITDA. During Q3, EBITDA grew by 62% to $2.7 million, with the increase due to significant efforts by management to control costs as well as our higher volumes.From the year-to-date perspective, EBITDA increased marginally from $5.6 million in 2017 to $5.7 million this year, as higher cost led to significant decline in Swiss Water's EBITDA in the first and second quarter of this year. Finally, turning to dividends. On October 15, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on September 28. And on that note, I'll turn things back to Frank who will talk a little bit about expectations for the balance of the year. Frank?

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

Thank you very much, Iain. And so looking ahead, we expect to record double-digit year-over-year growth in our annual volumes. As I mentioned at the start of this call, several consumer trends such as increased awareness of methylene chloride and the desire to drink excellent coffee throughout the day are helping drive demand for chemical-free premium decaffeinated coffees. The reduction in chemical-free decaffeination capacity in the U.S. and Europe is also assisting growth. We see these trends gaining traction. And as the world's only branded 100% chemical-free decaffeination process, we believe that we are ideally positioned to capitalize on this growing awareness and demand. Our focus remains on positioning Swiss Water for future growth. And to do that, we're investing in the resources we need, first, to continue generating increased sales volumes. And then second, to respond to the heightened demand. Currently, we're in the process of setting up a European subsidiary and opening a European sales office to better serve customers in the EU, the largest decaffeinated coffee market in the world. At the same time, we're expanding our ability to target specific customer groups by selectively adding to our sales and marketing team in the U.S. While these initiatives are increasing our expenses somewhat, we expect them to generate increased sales orders for the balance of this year and to the early part of next year and going into the future. Additionally, we believe these investments will result in major account conversions over the longer term, which will aid us in ramping up production when we open our second decaffeination facility. As we've noted previously, we're in the process of building a new state-of-the-art production facility in Delta, BC. Construction is progressing well, and we expect to commission our new production line in the third to fourth quarter of 2019. We also recently completed an efficiency enhancement project at our Burnaby, BC facility in order to maximize production capacity there. This work, together with the capacity we added at the facility in Q1 of 2016, is expected to be sufficient to meet anticipated growth in demand until the new production line is operational. In short then, our outlook is very positive. Demand for special decaf coffee is growing and we have the best product, the specialized knowledge and experience and the operational infrastructure to respond successfully. We are also a very -- we're also have a very-well established brand name we're working to leverage more effectively. That wraps up our comments for today. And Iain and I would now be very happy to answer any questions you might have.

[Operator]

[Operator Instructions] Our first question is from Warren Goldblum with NorthShore Partners.

[Warren Goldblum]

Couple of questions. First, just in terms of the gross margin. So approximately 19% for the quarter, you obviously spoke to kind of pulling out some costs, but potentially continue to pull out costs. But I just wondered how much of that was a cost control issue and how much was a favorable mix in terms of obviously higher process revenue or higher decaffeinated services revenue?

[Iain Carswell, Chief Financial Officer]

Yes. I can take that. I would say that yes, there were some cost efficiencies coming through within the period. They were largely around our Seaforth business and some steps that we've taken in that area to reduce costs in specific areas that we've seen some progress on, or would be demurrage around our freight and also some admin cost efficiencies that we've seen coming through. And however, you're right. I mean there is probably the weight of development in gross margin is more around cost recovery activities and mix so you see that speciality side of our business is growing faster than the commercial side at the moment and not -- that has a premiumization effect in terms of revenue per pound.

[Warren Goldblum]

I mean, is there any way -- so just to give some comment, grain to granularity on how much of -- I mean, was it a combination of the 2 effects, some, if we look at the GP margin increase, would it say half -- mix, half cost recovery?

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

Yes. I would also point out that although we do point to the percentage gross margin, what we do is we manage internally on a rate per pound, and we don't publish pounds for competitive reasons. And so part of that change -- part of it is also the numerator, in other words, the NY'C' declining. And so you've got some margin built in to that from a percentage basis, but that doesn't relate to a per pound basis. So we are doing, yes, cost recovery. We are -- which does mean also, taking some price increases, particularly in the Seaforth business, but also on SWISS WATER and assuring that we are fully pricing for all of the services that we provide, particularly in the freight place, we're seeing good -- where much better pricing execution on freight and recovery on freight, which has been a worldwide issue in the past, I'd say, last 2 years, in any case, significantly increasing freight costs that we are much better pricing for now.

[Warren Goldblum]

Okay, great. So now I'd use one more question and I'll go back in the queue. Just on the new Delta facility which comes on-stream, obviously, in about 12 months' time. What's the thought process in terms of how long it'll be, so once it's up and running, once it's commissioned, to actually build out the capacity use of that new facility?

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

That's a great question. One that we aren't really going to provide complete guidance on. When we built our facility here in 2006, it was over a period of time to fill that. This is a big capital expansion, for sure, and this is a capital-intense business as opposed to labor intensity and variable cost intensity. And so it will take a period of time, but I'm not going to say whether it's 1, 2, 3, 4 years, exactly. I don't really know, but what we look at is focusing on driving our ongoing 10% type growth, that's what we're trying to achieve, and that's what we're going to focus on. As opposed to, gee, are we going to absolutely fill something out super quickly, by maybe pricing more aggressively than we should?

[Operator]

[Operator Instructions] There are no questions at this time.

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

Thank you very much, and that wraps up our presentation for today. If there are no further questions, thank you very much for joining us. Have a good day.

[Operator]

Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.