Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good day. Before Swiss Water Decaffeinated Coffee Inc. conference call starts, they are required to remind you that 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 and uncertainties and other 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 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. I would now like to turn the floor over to your host, Frank Dennis. Sir, you may begin.

[Frank Dennis, executive]

Thank you, Holly. Good afternoon, 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 is Iain Carswell, our CFO. Iain and I are here today to discuss Swiss Waters' financial results for the 3 and 9 months ended September 30, 2024. As usual, I'll begin with a brief review of our performance, then Iain will provide more details about our financial results before I return to tell you about our longer-term plans and expectations.

We continued this growing demand for our chemical free and decaffeinated coffee offerings during the third quarter and first 9 months of this year. We are pleased to report volume growth and improved profitability for both periods. Compared to Q3 of last year, total volume grew by 27% and adjusted EBITDA increased by 40%.

However, when comparing our quarterly results for 2024 with the same period last year, it's important to note that the distribution of quarterly sales volumes in 2023 did not follow normal seasonality patterns. Volumes during the third quarter of last year were lower than normal due to the temporary production constraints we experienced during our scheduled exit from our legacy Burnaby site.

This year, except for a short planned maintenance period, both our decaffeination lines and Delta has run generally well on a 24/7 basis since January, and we have returned to more normal order patterns. This is borne out by our year-to-date performance with volumes growing by 4% and adjusted EBITDA increasing by 13% year-over-year.

Consolidation of all our operations in one location has resulted in significant efficiencies and cost savings. Along with the higher processing volumes, these savings helped boost our gross profit by 80% in the quarter and 62% for the year-to-date. Gross margin percentage also showed strong improvement, growing from 10% in the first 9 months of last year to 16% this year.

We achieved these strong results despite the significant challenges posed by a stubbornly high NYC coffee futures price and renewed destructions to the coffee supply chain. I'll tell you more about these issues and our outlook for the balance of the year. But first, let me turn the call over to Iain to take you through our financial results in more detail. Iain?

[Iain Carswell, executive]

Thanks, Frank, and good afternoon, everyone. As always, I'll begin my review with volume shift to customers as this is the key metric that drives our financial performance.

Taken together, volumes in all categories are up by 27% in the quarter. And for the year-to-date, total volumes were up by 4% from the 2023 level. As Frank noted, the year-over-year differences were expected as the volumes reported in Q3 last year were lower than normal. This was due to a temporary capacity constraints experienced during the period as we exited our legacy production facility in Burnaby and consolidated all operations here in Delta.

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 40% in the third quarter and by 3% for the 9 months, while shipments to importers those customers who resell our coffees to roasters where and when they need it, were up by 13% in the quarter and by 5% for the year-to-date.

Looking at the roaster segment another way, specialty roaster account volumes were up by 7% in the quarter and by 1% in the 9 months to September 30. These accounts serve the out-of-home consumer primarily in cafes and restaurants in our key geographic markets.

Shipments to large commercial roasters were also up significantly in Q3, increasing by 47% when compared to the third quarter of last year. For the 9 months shipment to these accounts were up by 6% from last year's level.

Turning now to revenues. Third quarter revenue of $41.8 million was up by $9.2 million from Q3 of last year. However, at $123.9 million, 9 months revenue was down by $1.2 million from the 2023 level. The Q3 result was driven by the significant increase in volumes when compared to Q3 last year when our capacity was constrained.

The drop in 9 months revenues is primarily the result of changes in our mix of business. During the first 3 quarters of this year, we had higher proportion of toll sales, which do not generate green coffee revenue but only a processing fee.

Looking at the cost side, our third quarter cost of sales was $35.3 million, an increase of $6.3 million or 22% compared to Q3 last year. The increase was primarily driven by higher volumes and an elevated NYC, partially offset by cost savings associated with consolidation of operations at one location and lower utility rates.

For the year-to-date, cost of sales was $104.7 million, down by $8.5 million or 8% from the 2023 level. The 9-month decrease was driven by cost savings and efficiencies resulting from the consolidation of operations at a single location as well as by higher portion of toll volumes in our sales mix and a $2.5 million decrease in onetime depreciation expense.

As you may recall, in 2023, we incurred a significant onetime noncash depreciation expense resulting from the write-down of unsalvageable assets at our old Burnaby facility. There was no such charge this year. As to green coffee costs at an average of $2.46 per pound in the third quarter, the NYC was up by $0.90 from $1.56 per pound in Q3 last year. For the year-to-date, the NYC averaged $2.18 per pound, up by $0.47 from $1.71 last year.

With the coffee futures prices at these near record levels, some of our customers are consuming their own inventories and waiting for the market to come back down again before replenishing their stocks. This is a normal market dynamic that is likely to negatively impact our volumes temporarily. Evidence to high coffee prices beginning to impact consumer demand is also starting to emerge. This is a growing concern that Frank will tell you more about in a minute.

Foreign exchange rates can also have a material impact on our profitability and cash from operations. This is because most 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 has this year.

In Q3, the U.S. dollar averaged CAD 1.36 up, CAD 0.02 from CAD 1.34 in the same period last year. During the 9 months to the end of September, U.S. dollar averaged CAD 1.36 compared to an average of CAD 1.35 in 2023. This appreciation had a positive impact on our revenues when they were converted to Canadian dollars.

Third quarter gross profit was $6.4 million, an increase of $2.9 million or 80% when compared to Q3 of last year. For the year-to-date, gross profit was $19.2 million, up by $7.3 million or 62% from last year's results. Gross profit percentage increased 15% for the quarter compared to 11% in Q3 last year.

For the 9 months, gross profit percentage was 16%, up from 10% last year. The profitability improvements this year were driven by higher processing volumes cost savings associated with the consolidation of our operations at one location, lower utility rates and a decrease in onetime depreciation expenses. These positive factors were partially offset by increased operating expenses. Third quarter operating expenses were $3.6 million, up by $900,000 when compared to Q3 of 2023.

For the year-to-date, operating expenses were $11.3 million, up by $1.7 million from last year. The administrative portion of our operating expenses was up by 47% in Q3 by 26% for the 9 months. The primary driver of the increase in both periods was planned headcount, wage increases, higher professional fees and increased stock-based compensation due to a higher share price. These negative impacts were partially offset by the cost savings associated with the consolidation of all operations at one location.

The sales and marketing component of operating expenses was unchanged in the quarter and down by $100,000 for the year-to-date, primarily due to changes in the scheduling of our marketing activities. Q3 operating income of $2.8 million was up significantly from $758,000 in the third quarter of 2023. The 9 month operating income of $7.9 million was also up nicely from $2.3 million last year.

Turning to net income. We recorded a net loss of $791,000 for the quarter compared to a net loss of $417,000 in Q3 last year. For the year-to-date, a net loss -- the net loss was $744,000 compared to a net loss of $1.5 million in 2023. Last year, the reported losses were largely due to onetime costs related to our exit from the Burnaby facility and consolidation of operations in Delta.

This year, despite an improved gross margin, higher interest expenses on our construction loans and increased mark-to-market losses on our risk management activities offset much of the benefit. Noncash losses on the revaluation of Swiss Water's embedded option and mark-to-market adjustments on stock-based compensation also impacted our profitability.

The third quarter net finance costs of $1.8 million were unchanged from Q3 of 2023. For the year-to-date, finance costs were $5.5 million, up by $700,000 or 14% from last year's level. The increase was primarily because following the commissioning of our second decaffeination line in Delta, the interest rate and construction loans for the project could no longer be capitalized.

Third quarter adjusted EBITDA of $2.2 million was up by $600,000 from Q3 2023. And for the first 9 months of this year, we reported adjusted EBITDA of $9.4 million, an increase of $1.1 million compared to the same period last year.

As with gross profit, the improvement in adjusted EBITDA in both periods was driven by higher processing volumes, cost savings resulting from the consolidation of our operations at a single location, lower utility rates and reduced depreciation. These positive impacts were partially offset by the higher operating expenses and by increased losses on our risk management activities because of the near record high coffee futures prices we've had to contend with this year.

Turning now to inventories. The second half of 2023, the commissioning of our second production line and Delta led to an acceleration in raw materials usage and increased shipments of finished goods. As a result, we closed 2023 with inventories at their lowest level since Q1 of 2021. As planned, we continue to manage our inventory position down during the second quarter and first half of this year. This was in part because we consumed the last remaining coffee inventories we've built up to bridge last year's move out of Burnaby.

Meanwhile, logistics delays affecting freight passing through the Panama Canal, slowed the arrival of coffee into Vancouver during the first 9 months of this year. This became a matter of increasing concern to offset the risk of delayed deliveries impacting our ability to meet our customer commitments started to increase our key -- our coffee inventories from some origins during the third quarter.

As a result, when combined with the effect of a rising NYC, our closing third quarter inventory value rose to $38 million from $28.8 million at the end of the second quarter. At this level, we are confident we have sufficient inventory on hand to support our operations and near-term growth.

As always, we remain focused on optimizing inventory levels and proactively managing our working capital commitments. With the construction of our new production assets now complete and fully paid for, that reduction is a key priority for Swiss Water going forward.

We've made significant progress in this regard. Of particular note is that subsequent to the end of Q3, on October 31, and in accordance with our agreement, we fully repaid the debenture with warrants, which was due to Mill Road Capital. The total repayment of $15.9 million consisted of $50 million of principal and $900,000 of accrued interest.

Following this payment, all obligations to duties and responsibilities of the parties to the event were terminated. That said, the maturity of the debenture did not affect our obligations or the rights of no route under their existing warrant agreement. This repayment -- with this repayment, we have succeeded in paying down a total of $16 million of our debt obligations since the third quarter 2023. Reduction in our leverage will help reduce our net finance costs going forward. And with that, I will turn the call back to Frank.

[Frank Dennis, executive]

Thanks, Iain. Looking forward, interest in chemical-free decaffeinated coffee remains high, and we are optimistic about the future. We are moving diversified global customer base, new state-of-the-art production facilities quality products, growing demand, a strong brand and a proven team. We are working to reduce our debt levels and are once again sharply focused on growing the business.

All our operating consolidated in a single location with 2 modern processing lines. These assets enable us to optimize our operational processes and produce premium decaffeinated coffee of consistent and high quality. We have sufficient production capacity to meet our current needs and with ongoing optimization along with some modest targeted investments enough capacity to meet our medium-term growth needs.

The performance of all our Delta production assets has been excellent, and we are optimistic that we can unlock further efficiency gains. We continue to see growing demand as ever more industry participants move away from chemical free or chemical decaffeination in favor of chemical-free and organic processes like ours.

However, the New York 'C' coffee futures price remained close to an historic peak during the third quarter, and evidence is starting to emerge that this is negatively affecting consumer fee consumption, roaster demand and especially importer inventory.

Futures prices remain at elevated levels and the Coffee Futures market structure continues to be inverted. This may have a negative effect on our ending volume growth in 2024. Adding to the challenges are persistent disruptions of the coffee supply chain. As Iain noted, like all in quarters, we have had difficulty clearing treatments through the Panama Canal for several months.

In addition, we have had back-to-back labor disputes at Fort Vancouver, the latest of which just began on Monday this week with a foreman strike. When combined with the elevated NYC futures price, the result has been very limited spot availability of coffees to backfill supply chain issues leading to some shortages. This situation has compelled us to add inventory from some origins during Q3 to ensure our ability to meet our commitments to customers.

Finally, like businesses everywhere, Swiss Water is not immune to wider macroeconomic risks. Inflation is not fully abated, and economies around the world are struggling to get a grip on by maintaining high interest rates. The ongoing war in Ukraine and the crisis in the Middle East have opted to global order and continue to create a lot of uncertainty in Europe and around the world and are certainly the driver of many of the logistical challenges we are facing.

Despite these challenges, we are optimistic that we will be able to deliver modest volume growth, profitability in 2024. Whatever the future holds, Swiss Water is now much better positioned for the years ahead. That wraps up our comments for today. Iain and I would now be happy to answer any questions that you might have today.

[Operator]

[Operator Instructions]. Your first question for today is from John Sartz with Viking Capital.

[John Sartz, analyst]

Good afternoon. I was wondering what was -- if you could tell me what the administrative expenses, excluding stock-based compensation for the third quarter?

[Iain Carswell, executive]

Yes. So stock-based compensation impact in the quarter was about $500,000.

[John Sartz, analyst]

No, I actually ran through some math just for fun. So I just annualized your third quarter and I get revenue of $168 million. I get gross margin of $26 million. I get the SG&A of $13 million and interest of $7 million. So basically, near as I can see you're talking earnings before interest and tax of $6 million and CapEx, I just used $1 million for annualized and then $7 million for depreciation. And you're talking you're talking free cash flow of about, I don't know, $13 million. I'm curious how that sort of enables you to be focused on reducing debt. I mean you have $70 million worth of debt, excluding leases and stuff. So I mean that's the $10 million is going to make an awful lot of impact, I don't think.

[Iain Carswell, executive]

Well, we have over $50 million of long-term construction debt, which is low price debt and the balance of our debt is working capital, working capital facility. And we just paid down $60 million in a repayment from free cash flow work from cash on hand to more capital. So $6 million reduction in the last quarter or in the current quarter on our debt facilities. I would like to have a lower debt balance, and we will focus on reducing that as quickly as we can.

[Operator]

Your next question is from Richard Rudgley with Glenbrook Capital.

[Richard Rudgley, analyst]

Good to hear the results. I just had 2 questions today. Firstly, I wondered if you could give us an update on the status of the California legislation regarding methylchloride. And also, what's the level of board interest in developing a U.S. trading market for the stock?

[Frank Dennis, executive]

The Calgary proposition essentially has been removed. It was tabled in, I think, April or May -- late April basically. And there was a vote and California has decided to remove that from their docket for this year. I think that they will review it for next year. The EPA has still bans methylene chloride. However, for general use in the United States. So that's methylchloride.

And then the development -- board interest in the development of a U.S. trading market. I think that there is some good interest. As you may know, we've just started research coverage with [ tax ] in the U.S. to get to develop the market there. In terms of creating a separate offering. I don't necessarily think that that's on the table at this point. I think the view is that through broker accounts, people in the United States can access the marketplace. I think that, that should answer your question.

[Richard Rudgley, analyst]

Just to follow up. I wondered are you saying that you're not really anticipating a proper OTC listing in the foreseeable future?

[Frank Dennis, executive]

Well, I mean, we've looked at it in terms of an OTC listing. We have looked at it. I think that there's -- I guess there's just different points of view on it right now, basically. I think from a management point of view, I can definitely see some of the value. I think -- there's other points of view that there's significant additional costs to manage that and to report in the United States against that, that may or may not be true, but there is a view that there is a significantly increased cost in that as well. So anyways, I mean, we can still certainly continue to debate that.

[Operator]

Your next question for today is from [ Irwin Kleiman ] a private investor.

[Unknown Attendee]

Look, I have 2 questions. The first is a follow-up of the first question. Is there -- do you actually have $13 million of free cash flow? And the second question relates to you have enough capacity for the medium term. Can you define medium term? Is that 2 years? Is that 5 years?

[Iain Carswell, executive]

Well, on the first -- I mean, on the first question, I mean, our cash flow statement is very clear. So you can see what our cash generation is from operations. Obviously, we have -- we were -- at the end of the quarter, we were holding a significant amount of cash in our balance sheet that has subsequently been repaid. We are expecting to continue to grow to generate cash flow from operations going forward. And I would expect to see continuing trend of cash accumulation in the business.

[Frank Dennis, executive]

And yes, in terms of the -- when we say medium term, I think we're thinking 3 to 5 years in that range.

[Operator]

We have reached the end of the question-and-answer session, and I will now turn the call over to Frank for closing remarks.

[Frank Dennis, executive]

Okay. Well, if there are no further questions for today, we will conclude today's call and wish everyone good health, and thank you for joining us.

[Operator]

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