Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good day, ladies and gentlemen, and welcome to the Swiss Water Decaffeinated Coffee Fourth Quarter 2018 Earnings Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host for today, Mr. Frank Dennis. Sir, please go ahead.

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

Thank you, Jess. Good morning, and thank you for taking the time to join us today. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. And with me today is Iain Carswell, Swiss Water's CFO. Iain joined us last October. And as I mentioned [ while ] I introduced him on our last call, he brings more than 15 years of extensive international financial experience to his new role. This experience leaves him ideally positioned to help lead Swiss Water in our quest to become a global leader in coffee decaffeination. I am happy to report that Iain is already having a noticeable impact on our results and the execution of our business strategies. Iain and I are here this morning to discuss Swiss Water's financial results for the 3 and 12 months ended December 31, 2018. Our 2018 fourth quarter and fiscal year, respectively. 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. Looking now at our results. During the fourth quarter, our SWISS WATER Process decaffeinated coffees continued to gain market share against our competitors. As a result, our processing volumes were up for both the fourth quarter and full year, growing 8% in the quarter and 11% on an annual basis. The increases came 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 coffee or office use were up by 11% for both Q4 and the full year. As reported the last time we spoke, the increase in business with the roaster segment came in 2 ways: first, we sold more coffee to existing roaster accounts as they grew their own businesses 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 gained new business when a CO2 plant in Houston, Texas shut down last summer. These plant closures have tightened the supply side in the chemical-free decaffeination market at a time when demand is growing. This should enable us to more rapidly utilize the additional production capacity we have coming online when we commission our new plant near the end of this year. Shipments to importers who resell our coffees to roasters where and when they need it were flat for the quarter but also grew by 11% for the full year. Our steady volume growth is also related to some significant changes impacting the market we serve. As we reported before, the overall market for decaffeinated coffee is expanding and continues to outpace the growth of the U.S. coffee market as a whole, particularly in the specialty out-of-home segment. We believe that this is the result of the overall premiumization of the coffee market. Consumers simply want to drink and are prepared to pay for better coffee. Changing demographics are also paying -- playing a role. Our data shows that the largest consumers of premium decaf over the last 5 years are 18 to 24 years old. This is a group that's grown up with excellent coffee. They love drinking it, and they love spending time with a cool and comfortable coffee shops that serve it. Premium decafs like ours let them enjoy both experiences all day and all evening without worrying about the possible side effects of caffeine. That's good for us and great for coffee shop owners who can extend their profitable selling cycle well past the morning rush by pouring high-margin decaf coffee drinks for as long as their doors are open. Our second factor that's driving up demand for our SWISS WATER Process coffees at the overall trend toward healthier eating. Today consumers, particularly younger ones, are highly conscious of artificial ingredients and chemicals in their food and drink and choose to avoid them when possible. A particular impact on the coffee trade is a growing awareness and concern about the health and environmental hazards associated with methylene chloride, the main chemical used by our competitors to decaffeinate coffee. The fact that a number of major retailers in the U.S. have recently banned the sale of paint strippers containing methylene chloride certainly give the informed coffee drinker pause. After all, who wants to risk drinking traces of a chemical used in a paint stripper? Consumers are also increasingly attracted to products that are certified as organic. In recent research, 39% of consumers say they're more likely to buy coffee that is certified organic, and 49% say they're more likely to buy coffee if it's grown in an environmentally sustainable way. One can assume that these numbers are even higher among the younger demographic. By including our branded 100% chemical-free SWISS WATER Process coffees in their product offerings, coffee roasters and importers are responding to these trends and positioning themselves as market leaders. Going forward, we believe that actively promoting the many benefits associated with our premium decaffeinated coffees will enable us to continue growing our processing volumes. Before I talk about our future plans and expectations, I'm going to pass the call over to Iain, who'll provide more detail around our 2018 financial results. Iain?

[Iain Carswell, Chief Financial Officer]

Thanks, Frank, and hello, everyone. It's good to be here today, and I'll begin with our revenues. Last year's growth and processing volumes has a -- had a positive effect on our revenues, with sales for Q4 growing by 11% to $23 million, and sales for the full 2018 fiscal year rising by 7% to $89.9 million. In both periods, the positive impact of our higher processing volumes was partially offset by a lower coffee commodity price or NY'C'. During the fourth quarter, the NY'C' averaged $1.09 per pound compared to $1.25 per pound in Q4 2017. Over the full year, the NY'C' averaged $1.12 per pound compared to $1.37 per pound in 2017. As a substantial proportion 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 the green coffee costs falls. Our revenues are also impacted by the U.S. to Canadian dollar exchange rate. A large portion of our sales are billed in U.S. currency. In Q4 last year, U.S. dollar averaged CAD 1.32, an increase of 3.9% over the same period in 2017. For the full 2018 fiscal year, the average exchange rate was CAD 1.30, a decrease of 0.2% from the 2017 level. Looking at the cost side. Our cost of sales increased by 10% to $19.3 million in the fourth quarter and by 5% to $75 million for the full year. The increases in cost of sales in both periods were consistent with the growth of our business, impacting factors included: higher freight charges and variable production costs as well as higher green coffee costs [ per ] the increase and processing volumes. In Q4, we also had to absorb a much higher cost of the natural gas we use in our production process. This was due to significant supply constraints resulting from a pipeline explosion in Northern British Columbia in October 2018. The result was a tripling of our gas cost in Q4 when compared to the first 3 quarters of 2018. I'm happy to say that gas cost have now started to normalize, however. Q4 gross profit was up 16% to $3.7 million, resulting in a margin of 16%. This represents a gain of $0.4 million, and a 1% increase in margin over Q4 of 2017. Full year gross profit grew to $14.9 million or a margin of 17% from $12.6 million or a margin of 15% in 2017. Our improved gross profit and margins for both periods last year were tied to our higher processing volumes. Our sharp focus on reviewing the operating costs of both SWISS WATER and Seaforth Supply Chain Solutions, our green coffee and logistics business, also had a positive impact. These efforts are ongoing, and we continue to see cost recovery opportunities and to implement cost reductions, provided, of course, that we don't compromise the quality of our coffees. Operating expenses for Q4 decreased by 7% and for the full year, increased by 19% over the 2017 level. There were increases in both periods, primarily due to higher staffing and staff-related expenses. However, in Q4, the increase was offset by an income tax credit related to research and development. As to be expected, our personal costs are rising as we grow the business and work to quickly fill the new production capacity we have coming online at the end of this year. 2018 operating income was up sharply, increasing by 69% or $0.7 million to $1.6 million in the fourth quarter and by 17% or $0.8 million to $5.6 million for the year. Overall, SWISS WATER recorded net income of $0.9 million in the fourth quarter compared to a loss of $0.4 million in Q4 2017. The improvement in quarterly net income resulted from our increased gross profit and improved nonoperating expenses related to the revaluation of an embedded derivative as well as effective risk management activities. This was partially offset by higher income tax expenses. For the full year, we recorded net income of $4.5 million, up from $4.2 million in 2017. The increase in annual net income resulted from $2.3 million increase in our annual gross profit, offset by increased operating expenses of $1.5 million, a loss on foreign exchange of $0.3 million and an increase in income tax expense of $0.1 million. On a per-share basis, we recorded basic earnings of $0.10 per share in Q4 compared to negative earnings of -- negative $0.04 per share in the same period in 2017. Our full year earnings per share of $0.50 compared to $0.46 in 2017. On a fully diluted basis, our earnings per share were $0.03 in Q4 compared to negative earnings of $0.04 in the fourth quarter of 2017, a $0.35 per share for the full year compared to $0.42 in 2017. Another measure of our financial performance is earnings before interest, tax, depreciation and amortization or EBITDA. During Q4 2018, EBITDA grew by 53% or $0.7 million to $2 million. Full year EBITDA increased by $0.8 million to $7.7 million from $6.9 million in 2017. As with the other improvements in our 2018 results, the increases in EBITDA resulted from higher processing volumes in addition to existing efforts we made across the company to enhance cost recovery. Finally, turning to dividends. Subsequent to the year-end, on January 15, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on December 31, 2018. And 2 days ago, on March 11, the company declared an eligible dividend of $0.0625 per share to be paid on April 15 to shareholders of record on March 29, 2019. With that, I thank you for your attention, and I'll turn things back to Frank, who'll talk a bit about our expectations for this year.

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

Thank you very much, Iain. Looking ahead, we expect to record strong year-over-year growth in our annual volumes, once again, in 2019. As I mentioned at the start of this call, we are benefiting from several consumer trends such as increased awareness and concern about methylene chloride and the desire to drink excellent coffee throughout the day. These are helping drive and accelerating movement away from the acceptance of chemical decaffeination processes and a growing demand for chemical-free premium decaffeinated coffees at a time when the industry's ability to meet it is constrained. The closure of the large legacy CO2 plants in Europe and in Texas last year had significantly reduced the global chemical-free decaffeination capacity and changed the competitive landscape in our favor. As the world's only branded 100% chemical-free decaffeination process and the only supplier with new capacity coming on-stream in the next 12 months, we believe SWISS WATER is ideally positioned to capitalize on this growing awareness and demand. Our focus remains on positioning the company for growth in both immediate and long term. To do that, we're investing in the resources we need, first, to continue generating increased sales volumes and second, to respond to heightened demand. In January, we incorporated a new European subsidiary in France and now open a European sales office. And this will enable us to better serve customers in the EU, which is the center of the world coffee trade and the world's largest market for decaffeinated coffee. As we continue to expand our business in Europe, we expect revenues from our international markets, which now comprise 56 different countries, will continue to increase in both dollar and percentage terms. At the same time, we are expanding our ability to target specific customer groups by selectively adding to our sales and marketing team in the U.S, which, at 51% of sales, remains our largest market by far. While these initiatives are increasing our expenses somewhat, we expect them to generate the increased volume we need to begin filling the additional production capacity we have coming on-stream later this year. However, as I've indicated in the past, converting major accounts to our SWISS WATER Process coffees take several quarters to complete. So our strategic investments in marketing and in human resources may take some time to bear visible fruit. But more immediate impact are the many efforts we have taken and continue to take to improve our operational efficiency and enhance our margins. Under Iain's direction, we've been looking at all aspects of our operations with the goal of bringing every cent we can from our costs without impacting product volume, which is paramount to everything that we do. On a particular note is the success we've had in improving the performance of our Seaforth coffee handling and distribution subsidiary. For much of last year, Seaforth's rising costs have become a bit of drain on our performance, but the business is now turning around quite nicely. In January, we announced a price increase to Seaforth's customers that took effect on March 1, and our Seattle counterpart in the coffee handling business has followed suit and the new pricing has been accepted in both markets. Along with the range of cost control measures we've introduced, this is helping restore Seaforth's albeit small but positive contribution to our overall results. Finally, construction of our new state-of-the-art production facility in Delta, BC is progressing on time and on budget, and we expect to commission our new production line as planned later this year. In the meantime, the efficiency enhancement project we completed during last year at our Burnaby, BC facility, together with the capacity we added there in Q1 of 2016, should enable us to meet anticipated demand until our new production line is up and running. In short, then, our outlook remains positive. Demand for specialty decaf coffee is growing, and we have the best product, the specialized knowledge and experience and the operational infrastructure to respond successfully. We also have a well-established brand name we're working to leverage more effectively. That wraps up our comments for today. Iain and I would now be happy to answer any questions that you might have.

[Operator]

[Operator Instructions] We'll go first to Warren Goldblum at NorthShore.

[Warren Goldblum]

Let me just -- a couple of questions. Firstly, just on expansion plan. So there's a mention of cost to complete of about $23.9 million [ in ] FY 2018 numbers. And it looks like it's been -- today, it's been around about $35 million, and obviously, that incorporates some capitalized interest. But I guess the question is, how much less is in marginal spend kind of post 2018? And then the second question would be, maybe, just if you can quantify -- obviously, there's a lot of investments ahead of the new volume that's going to come, certainly, new volume capability that's going to come on later on. Can you maybe give a -- just a simple comments of the actual impact of FY 2018 number that you kind of preloaded this expenses and then capability?

[Iain Carswell, Chief Financial Officer]

Okay, so to answer your first question, and how much CapEx is still to go? So it's $23.9 million is the number. That's stated in our financial statement. In terms of the level of investment and in terms of sales and marketing, which I think is the question that you're asking, the majority of the 1.5% -- sorry, the $1.5 million increase that you're seeing coming through in the operating expenses is driven by that investment to drive the marketing activities and sales activities within the business, split between North America and Europe.

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

Correct. And those hires as well as the increase in brand development, which has been well recognized by customer and prospect customers that we've had exposure to. We'll [ be running ] over most of that early this year. So in other words, those additional expenses from last year were reasonably early in the year -- in the fiscal year.

[Warren Goldblum]

Maybe to...

[Iain Carswell, Chief Financial Officer]

What I would add to that point is that there are some fixed costs within that inflation, which, obviously, would correspond in the run rate going forward.

[Warren Goldblum]

Understood. So just maybe to follow up on the first question. So just in terms of total costs, so original -- [ from an ] original expansion plan [ in quarter 4 ] recognized in the mid-30s, $35 million. It looks like spend today's been roughly that, and now you're obviously talking about a marginal $23.9 million. So I guess the question would be, is this -- is this been a restructuring of the project, greater capacity, is there been some components of cost [ percentage ] equipment? I mean, what's the reason for the kind of great total cost in terms of expansion?

[Iain Carswell, Chief Financial Officer]

Well, the $35 million that you quote was -- I mean, it was -- it wasn't $35 million. The -- I think the original scope was $35 million, but we increased the scope of the project, which took the figure up to $42 million. So I think to align against the $35 million is the wrong base position to align against.

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

And just for clarity. On the base scope, there were some additional cost related to the fact that, from the original -- the very, very original scoping, there was additional safety cost that needed to be built into the engineering, primarily for earthquake and also because of where the location of that particular plant is, which is in a kind of a low line area near a river in BC here. So there was an additional cost just for the operating plant, and then the additional cost beyond the $42 million that Iain mentioned are essentially for building. So we had the operating plant, and then you had the building costs, the exterior building costs. And so with that building now, we have all of the capabilities to also add additional capacity because we have purchased the inbound and outbound coffee movement components of the operating process, which burdened the first line that you put in place, the next execution would be less expensive, for sure.

[Operator]

[Operator Instructions] And gentlemen, there appear to be no further questions at this time.

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

Okay. Well, if there are no further questions, then we will conclude today's call. And thank you very much for joining us.

[Iain Carswell, Chief Financial Officer]

Thank you.

[Operator]

Thank you. This does conclude today's teleconference. We thank you for your participation, and you may disconnect your phone line at this time. Have a great day.