Swiss Water Decaffeinated Coffee Inc

TSX:SWP

Earnings Call Transcript

[Operator]

Good afternoon. Before the Swiss Water Decaffeinated Coffee Incorporated 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 of our control that could cause actual results to differ materially than those expressed in the forward-looking information. Swiss Water Decaffeinated Coffee Inc. does not assume responsibility for accuracy and completeness of the forward-looking information. Similarly, they do not undertake any obligation to publicly revise the forward-looking information to reflect subsequent events or circumstances, except as required by law. Please refer to the Swiss Water Decaffeinated Coffee Inc. 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. I would now like to turn the floor over to your host, Frank Dennis. Sir, the floor is yours.

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

Thank you, Catherine. Good morning, 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 today is Iain Carswell, our CFO. Iain and I are here today to discuss Swiss Water's financial results for the 3 and 12 months ended January 31, 2020. I'll begin with a brief review of our results, then Iain will provide more detail about our financial performance before I return to tell you more about our longer-term plans and expectations. After that, we'll be happy to take your questions. Looking now at our results. As we reported at the end of the third quarter, our overall volumes have proven to be much more resilient than we had anticipated when the COVID-19 pandemic first hit us, and everyone else in March 2020. In fact, when compared to a very strong 2019, our fourth quarter volumes were down by only 4%. For the full year, volumes were down by just 6%. And despite the decline in volumes and the exceptional challenges we all faced in 2020, Swiss Water's financial metrics generally track in line with 2019. While it's disappointing to experience an interruption in the strong growth trajectory we established in each of the 12 quarters prior to the onset of the pandemic, like most businesses, we are not immune to the pandemic's negative impact. When you consider your total setdown to the world economy last spring and early summer, our businesses model performed well in 2020. In addition to the consistently high-quality of our products and services, this resilience is largely due to the high degree of customer and geographic diversification that we've built into the business. We've proven our ability to consistently win new business as coffee consumers as industry participants continue to migrate away from solvent-based decaffeination in favor of our chemical-free Swiss Water process. We now serve a broad spectrum of the coffee traded in over 60 countries around the world. This diversification has certainly served as well as we look back over the past year. I'd like to say that we sell the coffee wherever it goes. Last year, during the early stages of the pandemic, we experienced strong demand from those customers that serve the retail grocery trade. This was driven by consumers eluding the pantries in anticipation of quarantines and supply disruptions or simply consuming their coffee at home. As things unfolded, this at-home coffee market remains strong, but leveled off than the initial spike of demand. Meanwhile, our customers who serve the out-of-home coffee market in cafes and restaurants proved much more susceptible to serious disruption as health facilities or and other world declared widespread or targeted food service shutdowns to combat upsurges in COVID cases. Despite this turbulence, some coffee outlets have stayed open throughout the pandemic for takeaway and drive through customers. However, traffic to these locations dropped significantly. Competencies increasing work from home revenue stopping by the morning office coffee bag. Beginning in the spring and summer of last year, many jurisdictions lifted the lockdowns and the out-of-home channel began to recover as food service outlets reopened, albeit with significantly reduced . This has continued to be an on-again, off-again situation as closures are listed and then reimposed when cases eased and then spike again. While coffee, the reopening of Cafés and restaurants help bring volumes shift to our specialty customers back out, driving an 8% increases by all segment in the third quarter and a 12% increase in the final 3 months of the year. The aggressive vaccination program, now underway in the U.S.A. and around the world gives us hope that return to a more normal market conditions is on the horizon. The strong volume growth we experienced in the Asia Pacific region, where volumes were up 6% for the year and 14% in the fourth quarter is also encouraging, and hopefully, a harder of good things to come. Japan, South Korea and other countries in Asia are widely acknowledged to have managed the pandemic better than North America and Europe and hence have covered sooner. We see the recovery in Asia as the leading indicator of what will happen in other markets once the COVID-19 pandemic is under under control. Hopefully, as large spread vaccination recently scaled outbreaks that lowers the risk of future lockdowns or volumes strictly out-of-home coffee market, in particular, when we cover in a more sustainable manner. Despite our optimism, the negative impacts of the pandemic on our business and economy in general continue. Shortness of vaccines in many countries and the emergence of new variants with the disease reduces the short-term outlook, so that's impossible to predict for certain. Accordingly, the risk remains this site may well reflect overall volume are lower than pre-pandemic leverage for some months to come. We are in continuous contact with customers in all of our markets, and we are well-positioned with sufficient green coffee inventory and production capacity to respond to the situation we're in. Operationally, we continue to run both decaffeination lines on our legacy production facility in Burnaby, BC on 24/7 basis to 2020. Swiss Water having been deemed an essential service provider. And last September, we completed the first production run of commercial-grade coffee for our new delta BC facility. Product quality and efficiency from the initial decaffeination line in delta has been excellent, and it's now running slot on a 24/7 schedule as well. As we move through the balance of 2021, we plan to migrate more of our production to delta to reduce some of the pressure on our older assets in Burnaby. As those of you who follow our story know, we must relocate all the main production from Burnaby by June 2023 due to the coming expiry of our lease. Before I update you on some recent developments of the customer front and our plans to prepare the company for the future. I'll now turn the call over to Iain to take you through our financial results in more detail. Iain?

[Iain Carswell, Chief Financial Officer]

Thanks, Frank. Good morning, everybody. As always, I'll begin my review with volume shipped to customers as this is the key metric that drives our other results. As Frank indicated, Swiss Water's processing volumes have remained remarkably resilient despite the significant challenges brought by the pandemic. Fourth quarter 2020 volumes were down just 4% when compared to a very strong Q4 in 2019. And as we have cautioned since the pandemic began, full year volumes also declined, coming in 6% below the 2019 level. That said, the drop was much less than we had feared during the first quarter of 2020 when our volumes dropped by 16%. And with lockdowns being imposed around the world, the outlook for the balance of the year looked very uncertain. 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 down by 5% in the fourth quarter and by 4% for the year. Shipments to importers, those customers who resell our coffees to roasters where and when needed, were down 3% in Q4 and by 8% for the full 2020 fiscal year. Looking at the roaster segment another way, specialty roaster account volumes were up by 12% in the quarter and down by just 1% for the 12 months to December 31, reflecting a nice recovery by this customer segment in the final months of the year. Shipments to large commercial roasters were down by 13% in Q4 and by 8% for the full year. Looking now at revenues. Fourth quarter revenue of $24.5 million was down by 2% for Q4 -- from Q4 of 2019. However, at $97.6 million, full year revenue was up slightly, reflecting an increase of $300,000 over the 2019 level. Revenues in both periods were negatively impacted by the year-over-year decrease in volumes and a softening of coffee quality differentials. On the plus side, higher freight revenue and favorable changes in customer mix, which resulted in higher process revenue, made a positive contribution. Looking at the cost side, our fourth quarter cost of sales was $21.7 million, an increase of $700,000 or 4% from Q4 of 2019. The quarterly increase was driven by higher green coffee costs as well as by increased depreciation charges following the commissioning of our new manufacturing facility in Delta BC in September. The additional depreciation expense from Delta was $0.5 million for the quarter and $1 million for the full year. For the full 12 months of the year, our cost of sales increased by $1.2 million or 1% to $81.9 million. The slight increase in our annual cost of sales reflects the increased depreciation as well as higher production costs associated with operating from 2 locations and annual labor cost inflation. These figures were partially offset by a year-over-year decrease in green coffee costs. Fourth quarter gross profit was $2.8 million, a decrease of 30% compared to Q4 2019. The change was primarily due to the softening of coffee quality differentials, lower sales volumes during the period and higher depreciation charges. For the full year, gross profit was $15.7 million, a drop of $800,000 or 5% from the 2019 level. The decrease in annual gross profit was driven by our lower sales volumes short-term coffee differential losses and the higher depreciation expense. These factors were partially offset by improved supply chain efficiencies and lower natural gas costs. Fourth quarter operating expenses were $2.7 million, a decrease of $900,000 when compared to Q4 2019. 12-month operating expenses of $10.5 million were down by $800,000 from the 2019 level. The decrease in operating expenses was driven by lower-than-expected travel expenses due to the pandemic, reduced recruitment costs and lower stock-based compensation costs as a result of lower share price -- of a lower share price in 2020. Q4 operating income was $126,000, down from $539,000 recorded for the fourth quarter of 2019. The however, for the full year, operating income was virtually flat at $5.1 million, down marginally from $5.2 million in 2019. Net income for the fourth quarter was a loss of $320,000 compared to income of $716,000 in Q4 2019. On an annual basis, net income was $2.9 million in both 2020 and 2019. The year-over-year differences in gross profit and both operating and nonoperating expenses offset each other, resulting in the same level of net income in both years. In 2020, nonoperating expense was reduced by the revaluation of an embedded derivative as a result of our lower share price. This was offset by a slight loss on risk management activities. Fourth quarter EBITDA was $1.9 million, an increase of $400,000 or 30% from the 2019 level. For the full year, we recorded EBITDA of $9.8 million, a decrease of $600,000 or 6% compared to 2019. Q4 EBITDA, excluding the impact of IFRS 16, was $1.2 million, up 49% from the $800,000 we reported in the fourth quarter of 2019. Annual EBITDA, excluding the impact of IFRS 16 decreased by $300,000 or 4% to $7 million in 2020. The drop in our 2020 annual EBITDA was expected and was primarily due to the softening of coffee quality differentials during the second half of the year. With that, I thank you for your attention, and I'd like to turn things back to Frank. Over to you, Frank.

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

Thank you, Iain. As I mentioned earlier, towards the end of 2020, we experienced a strong recovery in volumes shipped to customers in the Asia Pacific region as countries there succeeded in bringing the pandemic under control sooner than North America and Europe. We believe this to be an encouraging sign of what's likely to occur in the U.S. and our other large markets once vaccination programs are further along. We're also encouraged by recent developments on the customer front. During the first weeks of 2021, our sales and marketing team landed a couple of promising new accounts closer to home. The first is a leading brand in the West Coast of the U.S. The other win is a major cobranding initiative with the national growth retail. These are all encouraging signs that support our cautious optimism that our volumes will remain resilient and could well bounce back from growth as 2021 unfolds. As we noted in past calls, in order to ensure that our ability to deliver our customer orders is uninterrupted, and to meet the growth in demand we see ahead, we need to build additional new production capacity before we depart our legacy Burnaby site. Accordingly, planning for the financing, design and construction of a second line in Delta, BC is now well underway, with a targeted completion date for the 2023 lease expiry in Burnaby. Based on interim reports from a third-party engineering firm, when both are completed, we expect the 2 new lines in Delta together will have a targeted end capacity at least 40% greater than the current Burnaby facility. The preliminary cost estimate for the design and construction of the second new production facility in Delta is approximately $45 million, plus commissioning costs of around $2 million. These estimates are preliminary and like all major design and construction projects are dependent on local and global economic factors. And as with all plans these days, subject to the potential negative impact of the COVID-19 pandemic on costs and timing. We are now formulating the financing strategy and expect to have things finalized within the next quarter. Although the pandemic continues to create a good deal of uncertainty in the short term, we are confident in Swiss Water's longer term prospects. There are encouraging signs that vaccination programs in all our major markets will soon bring change to further shutdowns. We have a strong brand and competitive position and benefit from broad and diversified customer base. Whether consumers drink their coffee at home at their office or in a Cafe or restaurant, Swiss Water is well equipped to supply the growing demand for chemical free decaffeination coffee whatever is the customer channel or geography. That wraps up our comments for today, and Iain and I would now be happy to answer any questions that you might have.

[Operator]

[Operator Instructions] Your first question is coming from Blake Pelham.

[Blake Pelham]

First question I have is, is the 40% capacity greater than the Burnaby facility, does that go to each line? Or is that after you get the second line put in?

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

Yes. I understand that. Yes. So it is on the basis of the completed 2 line construction.

[Operator]

Your next question is coming from Stefan Debut.

[Unknown Analyst]

Yes, good day. I just want to visualize, if, let's say, by the end of 2024, the second line is open, and working, and you say that it's 40%. So let's say we made -- the company made $97.5 million. And then how does that translate? Is that -- are we going like at the end of 2024, the company that makes $138 million, $140 million revenues. And what's the increment in the EBITDA? Right now, over the last 2 years, the company made about a 10.5%, 11% margin as far as EBITDA. Do you expect economies of scale, meaning that out of $138 million, $140 million running at the end of 2024, the company could have a 15% EBITDA because of the economies of scale and how the addition of the technology and getting bigger, bigger accounts so -- that's spread out into too many individual smaller accounts. So what's your reflection on that? And what can you -- what color can you give us?

[Iain Carswell, Chief Financial Officer]

Okay. Stefan, it's Iain here. Thank you for your questions. I think it's important to to remember that our revenue number, so the $97.5 million number that you referenced, is heavily influenced by the value of the underlying coffee commodity. So all things being equal, if the coffee commodity cost was to remain as it is today, yes, you would expect to see a significant increase in the revenue line. However, the coffee commodity cost price is quite volatile, and therefore, I can't commit to a number. But yes, our revenue number, assuming that the -- assuming that the coffee commodity price remained as it is today, we'd, for sure, increase in proportion to our volume increase. From an EBITDA perspective, it's difficult for us to commit to an EBITDA forecast in 2024. What I can share with you is that, yes, when we have consolidated production on one site here, there will be some economies of scale that we will benefit from so I would expect some EBITDA enhancement from that. And as the utilization rate of the assets here in Burnaby increase, we would also expect to see a benefit and an enhancement of EBITDA as a result. Hopefully, that answers your question.

[Operator]

[Operator Instructions] You have a follow-up coming from Stefan.

[Unknown Analyst]

Yes, I think it's -- I guess, we have to -- we have to share the vision on the financial prospective numbers eventually because that's -- this is what is all about, creating share value and how can we have confidence in creating that shareholder value. Being said, the follow-up question is, okay, you want to expand fine, no problem. But do you have any big clients out there or prospective clients that says, if you guys increase your capacity to a certain extent, yes, we're going to move our capacity, the production to you guys because there's hardly any other place in the world where we can do that. So that follow-up, a third comment, meaning what -- who are your competitors? And if you do scale up to that new technology and that facility, how competitive that would be compared to other facilities in the world that may be in Europe or Asia? Can you try to share with us your vision on that and the market -- the worldwide market situation?

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

Sure, Stefan. Where we are at is, prior to March of last year, we've been growing at approximately 8% to 10% per year. And that is based on a series of both small and large customer acquisition. And it's also based on the development of existing customers of which we have many that are in -- particularly in the food service space, that are major, major food service roasting operations who have 30, 40, 50 customers that they do business with. And that's a focus for us, particularly. One of the new accounts that we just picked up, and our first shipments to in Q1 of this of this year, that was based on consumer requests to that account for Swiss Water specifically. And it was because of the concern around methylene chloride. So with methylene chloride still representing 75% to 80% worldwide capacity, there is a very large opportunity for us to grow our business. And I can't be specific about the accounts. I can't name names in terms of our opportunities. Why? Because you point out the fact that, yes, there's competitors out there. And I'd rather not be specific because, of course, every time that we do a conference call or release information, our competitors follow us as we're the only decaffeination operation in the world that's publicly traded. So I can say that I am still very happy with the progress that we're making. As we move into 2021, I'm seeing some very, very positive signs in our business. And the fact that we've had a major West Coast customer move away from methylene chloride based on consumer demand specifically, is really exciting to us. And I think that is a very positive outlook for our future opportunities all the way through 2024 and beyond. I think that, over time, we will have assets that are available from our Burnaby, BC facility that have -- as we retire those that could potentially be applied into markets like Europe. We know that there are many customers in Europe who have been very specific to us in terms of being able to have a facility in that region and wanting to work with us if and when we get to that point. But well in advance of that, we've been demonstrating our ability to grow out of Vancouver at that 8% compound annual growth rate. And that is and will generate very significant EBITDA increases over the horizon. And I think probably it's something that maybe Iain can follow-up with you, Stefan, and we'd be happy to have further conversations about that over the next little while.

[Operator]

Your next question is coming from Blake Pelham.

[Blake Pelham]

Just concerned about if there's any Buy America policy or similar type policy. Do you see that as injuring your ability to compete or infiltrate into that market?

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

Not at all. We -- that hasn't shown up as being an issue. Coffee beans -- like coffee in itself, green coffee comes out of tropical countries, as you can imagine. And the U.S. needs to import all of its coffee. Furthermore, there are no decaffeination assets in the U.S. any longer. And so there really isn't an alternative.

[Operator]

We have no further questions from the lines at this time. Thank you, Catherine.

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

And so if there are no further questions, I will conclude today's call. Iain and I wish you all good health, and thank you very much for joining us. Good day.

[Iain Carswell, Chief Financial Officer]

Thank you.

[Operator]

Thank you, ladies and gentlemen, this does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.