Supremex Inc

TSX:SXP

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Supremex' Q3 2022 Earnings Conference Call. [Operator Instructions]

Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Friday, November 11, 2022.

I will now turn the conference over to Stewart Emerson, President and CEO. Please go ahead.

[Stewart Emerson, executive]

Thank you very much, operator. Good morning, ladies and gentlemen. I'm here with Mary Chronopoulos, Chief Financial Officer at Supremex. Thank you for joining us for this discussion of the financial and operating results for our third quarter ended September 30, 2022.

Our press release reporting Q3 results was published last evening. It can also be found in the Investors section of our website at www.supremax.com, along with our MD&A. These documents will be available on SEDAR as well. We also posted a presentation supporting this conference call on our website. Let me remind you that all figures expressed on today's call are in Canadian dollars, unless otherwise stated.

Let's turn to Slide 40 for an overview of the third quarter. Driven by revenue growth of nearly 24%, Supremex generated a fourth consecutive quarter of record adjusted EBITDA margin at 22.8% of revenue and a record adjusted net earnings per share that reached $0.32. Q3 was also the 11th straight quarter of year-over-year improvement in adjusted EBITDA. Mary will provide additional details on our performance in a few minutes, but let me take a moment to discuss our market dynamics.

Our Envelope business continues to deliver solid gains and exceptional revenue and EBITDA growth. We have cultivated our platform such that we can maintain and grow revenues well into the future. As one of North America's largest envelope manufacturers, we have know-how, fire power, scale, brand power, and both product and geographic diversification that allows us to entry into some of the industry's largest and most desired markets and customers. The combination of significant market share in Canada and a unique gateway into the expansive U.S. market provides a blend of margin, volume and runway that drive strong sustainable profitability.

Last week's acquisition of Royal Envelope adds another compelling layer to not only the product and geographic diversification, it adds a layer to our Envelope value proposition. Based in Chicago, Royal positions us as a bonafide manufacturer in a very large Midwest envelope market that puts us dab in the middle of the high value-added direct mail space, an area we have not materially participated in until now. Royal is profitable. It's well run, a second-generation envelope manufacturer that utilizes a modern refreshed equipment base and provides additional available turnkey capacity and present some very attractive synergies.

In the 12-month period ended June 30, 2022, Royal generated sales of approximately USD 38.8 -- USD 38.8 million.

Turning to Packaging. It is performing at very high levels and experiencing nice growth. Adjusted for the Durabox wind down, revenues are up double digits for the year and margins well above 20%. We continue to make excellent progress on all of our 2022 strategic priorities. We're experiencing growth in our core verticals. We continue to penetrate the U.S. e-commerce space and operations in Indianapolis have progressed appreciably in the last 2 quarters.

Backlogs remain strong and pricing buoyant while supply chain start to ease. In Montreal, the team has done an excellent job planning and preparing for the relocation of our Town of Mount Royal folding carton plant to the former Durabox location in Lachine, which we expect to be completed by mid-December. While there's no doubt the move consumed bandwidth in the quarter, the team did a remarkable job communicating with and servicing customers, preproducing orders and prepping for the decommissioning and recommissioning of the main press at the new location.

While nobody likes to move a business, once complete, this facility will be a showcase that we anticipate will feature improved workflow and will provide for material growth opportunities in terms of capacity expansion and tuck-in possibilities.

With that, I turn the call over to Mary for a review of the Q3 financial results. Mary?

[Mary Chronopoulos, executive]

Thank you, Stewart. Good morning, everyone.

Please turn to Slide 41 for our Q3 top line review. Total revenue was up 23.9% to $67.9 million from $54.8 million last year. Revenue from the Envelope segment rose 32.6% to $49.1 million. This strong growth reflects an average selling price increase of nearly 30% from last year's comparable period.

The higher average selling price was driven by pricing adjustments to mitigate input cost inflation, a more favorable customer and product mix from our U.S. operation, and a favorable currency conversion effect on U.S. revenue. Unit volume rose by 2.1%, also reflecting higher sales in the U.S. market.

Packaging & Specialty Products segment revenue grew 5.8% to $18.8 million. The increase is attributable to higher sales of folding carton products due to a favorable product mix and a positive currency translation effect. These were offset by a decrease in corrugate sales resulting from the anticipated shutdown of Durabox.

Moving on to Slide 42. Consolidated EBITDA stood at $15.1 million in the third quarter of 2022 and adjusted EBITDA amounted to $15.5 million, up from $8.7 million in the third quarter of 2021. This increase resulted from higher sales volume and selling prices, partially offset by the higher cost of materials and the absence of government subsidies this year versus last.

As a percentage of revenue, the adjusted EBITDA margin was 22.8%, up significantly from 15.9% a year ago. Envelope segment's adjusted EBITDA almost doubled, reaching $13.5 million compared to $6.9 million last year. This significant increase was driven by greater revenue stemming from higher average selling prices as well as a more favorable customer and product mix in the U.S.

Adjusted EBITDA margin was 27.4% up from 18.6% in the equivalent period of 2021.

In the Packaging & Specialty Products segment, adjusted EBITDA was $3.8 million, up 50% over the same period last year. This increase is mostly due to a more favorable customer and product mix, partially offset by reduced profitability from the wind down of Durabox. Adjusted EBITDA margin was 20.4% compared to 14.4% in the corresponding period of 2021.

Corporate and unallocated costs were $1.8 million in the third quarter of 2022 compared to $700,000 last year. The variation reflects the phasing out of government subsidies, severances and an unfavorable adjustment for deferred and performance share units due to share price appreciation. In Q3 2022, we incurred restructuring expenses of $400,000 related to the relocation of our folding carton plant and the winding down of Durabox. These expenses mainly consist of inventory write-down and severances.

Turning to Slide 43. Net earnings reached $8.1 million or $0.31 per share, while adjusted net earnings stood at $8.5 million or $0.32 per share in the third quarter of 2022, versus $3.4 million or $0.13 per share for the equivalent period last year.

Turning to cash flow on Slide 44. Net cash flow from operating activities totaled $4.5 million in the third quarter of 2022 versus $6.7 million in Q3 of 2021. The year-over-year variation is mainly attributable to higher working capital requirements primarily due to an increase in inventories to meet the demands of customers in the coming quarters, partially offset by higher profitability.

Reflecting the same factors, free cash flow was $4 million in the third quarter of 2022 compared to $5.2 million for the same period last year. In the quarter, we used our cash flow primarily to reduce the balances of our revolving facility by $3.6 million.

As shown on Slide 45, we also returned funds to shareholders through dividends and share repurchase for an aggregate amount of $1.1 million. During the third quarter, the company purchased 96,600 common shares for cancellation under our normal course issuer bid program. In late August, we renewed our program, which allows us to repurchase more than 1.3 million shares in the 12-month period ending August 30, 2023. Under this previous program, Supremex bought back approximately 920,000 shares. Subsequent to the end of the third quarter, 20,000 additional shares were also purchased for cancellation.

Looking at our financial position, slide 46 shows that at September 30, 2022, total debt stood at $33.1 million, down from $36.7 million 3 months earlier. Net debt, which excludes deferred financing costs and cash, stood at $32.5 million. As a result, we concluded the third quarter with net debt to trailing 12-month adjusted EBITDA ratio of 0.6x, down from 0.7x 3 months ago.

At the end of the third quarter, we had over $87 million in available liquidity under our senior secured revolving credit facility of $120 million, which provides us with the flexibility to finance the Royal transaction.

Yesterday, our Board of Directors declared a quarterly dividend of $0.03 per common share payable on December 23, 2022, to shareholders of record at the close of business on December 8.

I now turn the call back to Stewart for the outlook. Stewart?

Stewart Emerson

Chief Executive Officer

Thank you, Mary. With the end of 2022 in sight, we are confident we will finish with record results in terms of annual revenue, adjusted EBITDA and net earnings. Despite the majority of the folding carton move happening in November and December, we anticipate a strong fourth quarter in the legacy business, although the rate of growth, excluding acquisitions, should moderate as we start to lap our recent string of strong quarters.

Our priorities remain crystal clear. The integration of Royal Envelope and starting to unlock the synergies and the opportunities available to us. Two, the successful transition of the Montreal Packaging business and coming out of that, a narrow focus on the high value-added verticals in pharma, health and beauty, food and e-commerce. And third, continue to work with our M&A pipeline toward the successful conclusion of a packaging transaction.

As I said many times before, we are building this business for the long haul. We're diversified geographically. We're diversified from a product standpoint, and we are strategically and opportunistically adding strong EBITDA and cash flow. We continue to demonstrate our 2 business segments have been well positioned to succeed with strong demand, healthy backlogs and high capacity utilization.

The balance sheet remains impressively strong, which provides us with the flexibility to add any strategic initiative that creates value for our shareholders.

In closing, I'd like to thank the entire Supremex team for their passion, drive and commitment in delivering another exceptionally strong quarter.

This concludes our prepared remarks. We will now be pleased to answer any questions you may have. Operator?

[Operator]

[Operator Instructions] The first question comes from Rala Chen of iA Capital Markets.

[J. Rala Chen, analyst]

Congratulations on another excellent quarter. I'd like to touch on a couple of things. Let's start with industry specific. On first Envelope business, can you talk about how you were able to post 30% price increases in your Envelope business, which is kind of mind blowing? What kind of sustainability of the price adjustment that you see in 2023?

[Stewart Emerson, executive]

A, it's Stewart. So -- the -- yes, the average price increase was significant. We are comparing it to Q3 to Q3. If you recall, we've been pushing price increases through since the fourth quarter last year when the inflation really started to hit. So from Q-to-Q, it's not that significant. There are a couple of things that play there. We've talked over the last few quarters about we've reconstituted our customer base where we've gone from being an opportunistic seller in the U.S. market to a modified well-positioned manufacturer, and we've gone up the channels of distribution where we're selling to more end users, and we're taking some of that margin with us.

And we've reconstituted our customer base where it's more program related as opposed to bid and buy. And then the other part is the foreign exchange, the favorable foreign exchange that's given us a bump on average selling price as well.

So sustainability, the market continues to remain tight. The industry cannot produce as many envelopes as it produced in the past. And we've really kind of got U.S. pricing more in line with the Canadian pricing, which as supply continues to struggle to keep up with demand, it should be sustainable.

[J. Rala Chen, analyst]

Will it be fair to say that also the pricing mainly is coming from the U.S. side?

[Stewart Emerson, executive]

Well, we're getting the gains and it's a higher growth rate on average selling price in the U.S., certainly. We continue to pass through increases and get a little margin gain in the Canadian side as well, sort of leveraging our position in the Canadian market. It's a combination of the 2, but it's greater gain from the U.S. side than the Canadian side for sure.

[J. Rala Chen, analyst]

And how about FX, what's the contribution of FX in the pricing increases?

[Stewart Emerson, executive]

Mary?

[Mary Chronopoulos, executive]

The FX impact on pricing is -- represents around $1 million. So it's -- there is an impact, but it isn't what explains the majority of the selling price increase. Like Stewart mentioned, really, it's the types of programs that we've put in place in the United States with our customer base. And like he mentioned, we're just -- we're moving up the channels of distribution, and we're really -- we're focusing on a different type of clients and what the organization was catering to a year or 18 months ago.

So that's really what's underpinning kind of the improved -- the improved margins and profitability and price increases that you're seeing in our results today.

[J. Rala Chen, analyst]

Okay. Great. And next, I would like to a bit more on the acquisition of Royal Envelope. What is your business plan in 2023? Can you walk us through how you think about the growth profile going forward?

[Stewart Emerson, executive]

About the growth profile of the overall business or Royal Envelope?

[J. Rala Chen, analyst]

Royal Envelope.

[Stewart Emerson, executive]

Yes. So Royal Envelope was an opportunity, a company we've known for a while that participates in a market that we don't participate in. If you think about the genesis of how we ended up in the U.S., we had a bunch of bills and statements type equipment that was in secular decline. We went to the U.S. with that bills and statement type equipment. And that's what we went looking for in the U.S. market. We filled ourselves up. We think we've got a sustainable runway on the bills and statements side in the -- being able to pull those units out of the U.S. market and keep the equipment at high operating levels.

But the area we never participated in, in the U.S. market was direct mail just because our equipment profile didn't allow us. This is an area that doesn't really -- it doesn't really suffer from secular decline. The ROIs in direct mail are extremely high, and they're proven true and proven vehicle in which to -- for businesses to grow. So this was an area we thought that we felt that is really strong value-added. It's a business that has good capacity availability.

And we think we can grow the business from a top line standpoint fairly significantly in fairly short order. And from an EBITDA standpoint, there are synergies that were just so attractive to us that, while the strategy talked about getting to 50-50 in Envelope and Packaging and really, our preference is to do acquisitions in the Packaging side. We're not going to walk past an acquisition that is just so attractive just because we said we're going to be 50-50 in Envelope and Packaging. So it's got a good growth profile, both on the top line and on the bottom line.

[J. Rala Chen, analyst]

That makes sense. Could you provide some color on revenue and cost synergies since you already touched upon that? What kind of cross-selling opportunity you see in Royal Envelope and is there any kind of a saving in back office, IT, infrastructure, et cetera?

[Stewart Emerson, executive]

So on the revenue side, its TTM was USD 39 million. The infrastructure that's built there would have the capability, and now I caution, we have to sell it. But it has the capability to produce products that would generate in USD 47 million, USD 48 million, USD 50 million range. In fact, it's just sort of -- it's just added a -- they just expanded to a second plant and put some equipment in there. So there is a very good growth profile.

From a synergy standpoint, there's not a tremendous amount on the paper side, because they use sort of higher-quality different grades of paper. There are the other normal synergies window film, adhesives, all of those things, back office that you talked about. But the single greatest synergy available to us is more on the pricing side. We feel that the business has been undersold for a number of quarters or years. And we think with some tweaking that we can gain margin predominantly through getting the pricing more to market.

[J. Rala Chen, analyst]

So I guess we all have to prepare for the worst. How would you see the -- any recessional impact would have on direct mail in terms of your customer mix? I know the largest 1 is the financial service and how about the rest of customers?

[Stewart Emerson, executive]

So the -- actually, the majority of the volume, our revenue comes from the financial services industry and direct mail in that space. Historically, it's not been impacted by recession, predominantly because they are a credit card acquisition mailings to generally high net worth customers. So historically, for 2008, they didn't experience declines.

On the other part that's important is the preparation of the mail generally happens in the Chicago area. It's a hub for these direct mail service providers and a lot of the envelopes come from outside of the direct -- outside of the Chicago area. So if the market were to soften a little bit, suppliers really want their other suppliers in the local market, and we think we can draw some volume in from suppliers out of the sort of the West and back east.

So we don't -- I'm not terribly concerned about a recession on the direct mail side, particularly the direct mail market that we're participating in.

[J. Rala Chen, analyst]

This great to hear. Let's switch over to Packaging. We see that taking -- if we're taking out of the Durabox out of the equation on the double-digit growth. How should we look at the organic growth in the U.S. and Canada?

[Stewart Emerson, executive]

Exactly as we sort of positioned it there. It's -- the businesses are -- they're plugging along. They're in the different markets. They're back to visiting customers that we worked with in the past that haven't worked with over the last couple of years. The capacity is -- available capacity is growing as the Indianapolis facility continues to find its legs. The move of the folding carton facility is going to give us new capacity as well.

So again, it's -- you got to sell it, but the team is built. They're blocking and tackling. We have compelling value. There's -- backlogs are extremely strong. So I just think it's more of the same.

[J. Rala Chen, analyst]

Okay. Great. And so in terms of the restructuring expenses related to Durabox, are you still expecting some additional onetime costs in Q4?

[Mary Chronopoulos, executive]

I'll take that. Yes, we are expecting some additional expenses to come through in Q4 as we wind down that business, and migrate our folding carton business into that Durabox location.

[J. Rala Chen, analyst]

It's also like regarding to inventory writing down, severance or any other expenses?

[Mary Chronopoulos, executive]

Well, it's primarily going to be related to relocation expenses and onetime costs that are nonrecurring. So we're looking at a range of $1 million, $1.5 million and there will be some additional investment coming through with regards to the move on the CapEx side, and that will represent around $2 million to $3 million.

[J. Rala Chen, analyst]

For the Packaging business, we see now you have a new president in place to grow this segment. And other key highs you have in mind to bring this business to the next level?

[Stewart Emerson, executive]

So we did press release and I believe we press released, we added a Director of Operations about a year ago now, Stefan [ Debois ] who comes to us from Cascade. He's established himself and insert himself in the business. He's owning the move. We can attribute some of the performance improvement in Indianapolis to his tutelage. He's added a couple of industry insiders to his team from competitors.

And then on the sales side, that's the 1 area that we really need to add to. So we're beefing up the sales team to give us a little more reach and that has a little bit more comfortable -- a little bit more comfortable working with brand owners and going directly to the subscription-based e-tailers. So we're adding on the sales side as well.

[J. Rala Chen, analyst]

Okay. And in terms of the FX impact in Packaging. How much is that?

[Stewart Emerson, executive]

I don't -- so from an FX standpoint, we do have a little bit of a natural hedge, not quite as well as we do in the envelope side. I haven't measured it recently, but we were slightly over 25% of revenue came from the U.S. market. So -- your papers are generally denominated in or tied to the U.S. dollar, and it represents 25% to 30% of the sell price, and then you got 25% of your sales in U.S. dollars. So if the dollar drops, you get more revenue back.

So I think the business overall, what we know that, that the business overall is very, very, very well hedged. And the Packaging business isn't a lot different than the Envelope business.

[Mary Chronopoulos, executive]

Yes, correct. I mean the impact is less than $1 million.

[J. Rala Chen, analyst]

Okay. Looking at both segments, what are the KPIs that you're measuring? The progress towards your target. I know you mentioned a bit about the priority and the outlook. Is there anything that we should pay attention to?

[Stewart Emerson, executive]

Well, it is -- I mean, KPIs, there's a number of KPIs. But it is a bit of a game of operating utilization. So we look at units produced. It's more relevant on the Envelope side than it is -- because the basket of goods is more consistent. But we look at utilization rates in both locations or in both businesses and the sort of units produced. And the other one, and you're seeing it, you see it in the numbers, we really measure selling price and average selling price.

The reality is Supremex doesn't manufacture any materially faster or materially slower than our competition. We're extremely good at managing our expenses and working our way into value-added businesses and products that just generate better margin. So selling price is a key driver of the business. That and just how many -- how effectively we produce what it is we're selling.

[J. Rala Chen, analyst]

And how about the CapEx? How are you -- how you look in both segments in the next few quarters or years?

[Stewart Emerson, executive]

This is a very CapEx light. Go ahead, Mary.

[Mary Chronopoulos, executive]

No, go ahead.

[Stewart Emerson, executive]

It's a relatively light CapEx business. Packaging takes more than Envelope. Obviously, we have the move that Mary alluded to. It's going to require some capital as we build out the Lachine location. But beyond that, there's no -- there's not a tremendous amount of CapEx contemplated and not more than what we traditionally spend.

[J. Rala Chen, analyst]

Well, lastly on the list. Where are you seeing the acquisition pipeline now? Could you bring us up to date on where you are on that target? And maybe talk about what your current view is on the current pipeline?

[Stewart Emerson, executive]

We're not going to get into specifics on the pipeline. But certainly, from a general standpoint, we do have a nice pipeline that is -- we have various things at various stages. We have a couple that are sort of well further developed than others. It's really around the packaging side. As I said in my remarks, we are still committed to packaging M&A, and that's where our focus has been. And as a result, that's where our pipeline is.

I wouldn't read anything into the Royal acquisition other than it was opportunistic that made perfect sense for Supremex that was low risk, relatively low cost with significant upside, but the M&A strategy hasn't changed. We really want sort of our next couple of acquisitions to be in the Packaging space.

[J. Rala Chen, analyst]

Do you have any preference between U.S. or Canada?

[Stewart Emerson, executive]

Well, we've said all along that it's -- we wanted to be Canadian-centric until we got to a lot of diminishing returns in Canada. We've become increasingly more comfortable in the packaging space, especially with the addition of some additional talent and some outside talent. The U.S. market doesn't particularly scare us, but given our druthers, we'd rather get a couple more done in Canada that's a little closer to home, provide a little -- a few more synergies and work it through there. But the U.S. market doesn't scare us anymore.

[J. Rala Chen, analyst]

That makes sense. Well, final question, I promise. So you continue to buy back shares in Q3, also in Q4 and renewed NCIB. So are share repurchase is still a capital allocation priority, like how about it comparing if there is a better opportunity on the M&A front?

[Stewart Emerson, executive]

Go ahead, Mary.

[Mary Chronopoulos, executive]

So we did -- I mean we did renew our NCIB core program, and we do believe that it's still a vehicle to provide value to our shareholders. That being said, given the focus on growth and the focus on acquisitions, we definitely want give ourselves some dry powder in order to achieve those objectives. So the velocity at which we may be purchasing shares may decrease slightly versus what we -- you could have observed last year. But we still believe in the program, and that's why we renewed it. So when there's opportunities to buy back shares at an attractive price, we'll continue to do so.

[J. Rala Chen, analyst]

Congratulation again.

[Operator]

There are no further questions at this time. Please continue with closing remarks.

[Stewart Emerson, executive]

Great. Thank you very much, operator, and thank you, Rala, for your questions. Thank you to all of you for joining us early this morning. We appreciate it, and we look forward to speaking with you again at our year-end call. Thank you very much, and have a terrific weekend.

[Operator]

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.