Supremex Inc

TSX:SXP

Earnings Call Transcript

[Operator]

Good morning. My name is Steve, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Supremex Inc. Fourth Quarter and Year-End Results Conference Call. [Operator Instructions] Thank you. Danielle Ste-Marie, Investor Relations, please go ahead.

[Danielle Ste-Marie]

Thank you, Steve. Good morning, ladies and gentlemen. My name is Danielle Ste-Marie. I'm an independent adviser and act in an investor relations capacity for Supremex. With us today is Stewart Emerson, President and CEO; and Guy Prenevost, Chief Financial Officer and Corporate Secretary.I would like to welcome you to today's conference call to discuss our financial and operational results for the fourth quarter and year ended December 31, 2018, which were released earlier today. This call will be held in English. [Foreign Language]For a more detailed analysis of our results, please see our financial statements, our MD&A and our press release disclosed earlier this morning and available on the company's website and on SEDAR. In addition, we posted a presentation supporting this conference call, which is available through the webcast and on our website.I'd like to remind listeners that this conference call contains forward-looking information within the meaning of applicable securities laws, and I refer the audience to the forward-looking statements as detailed in the presentation supporting this conference call. Furthermore, risks and uncertainties as discussed throughout the December 31, 2018 MD&A under the heading Risk Factors.Unless stated otherwise, all figures are expressed in Canadian dollars. During this call and on the accompanying presentation, we will use non-IFRS measures, including adjusted EBITDA and adjusted net earnings. These terms are also defined in our MD&A.With these formalities out of the way, I would like to turn the call over to Stewart Emerson, President and CEO at Supremex, to review this quarter's key operational highlights and recent events.

[Stewart Emerson, President, CEO & Director]

Thank you, Danielle, and welcome, everyone. Thank you to all of you for joining us today and for our fourth quarter and year-end results. I'm happy to report fourth quarter revenue and adjusted EBITDA improved both sequentially and year-over-year, reversing the trend experienced over the last few quarters. This improvement comes from our growing packaging business combined with the effects of playing price catch-up and passing through cost increases across all of our lines of business. Regarding revenue, once again, this quarter and year-over-year revenue from our packaging platform grew significantly and was the largest contributor to revenue growth. Packaging revenue improvement came from a combination of our 2017 and 2018 folding carton acquisitions and from organic growth across each and every one of our packaging lines of business.Our health, beauty and cosmetics folding carton business, the former Stuart Packaging, increased its share of wallet with most of its major customers. In fact, revenue from the top 10 customers grew by over 30% from the previous 12-month period. We also made significant inroads with the integration of our pharmaceutical folding carton business, the former G2 Printing, which we acquired in Q2 of 2018. We have renewed an important contract and experienced some nice gains within existing customers. We are also making good progress in our objective to expand our reach with both large international and local pharmaceutical accounts. We continue to gain penetration in our e-commerce business. Despite sizable displaced revenue from a -- from the distributed portion of the shipping solution we have with a major U.S. e-commerce customer, as we explained during the previous call, we were able to remain flat on the revenue side. U.S. envelope sales also performed very well. Our U.S. team has worked hard to raise prices, and we saw the effects in the fourth quarter. This allowed us to catch up with a lot of our paper price increases that occurred over the previous few quarters. Over the past 6 months, we've rebranded as -- we rebranded Bowers, Classic and Buffalo Envelope under the Supremex USA banner, and I'm very proud and appreciative of the work that our team has done to strengthen our operations and improve our recognition of our brand in the U.S.There are also encouraging signs of industry consolidation of production capacity from some of our larger competitors in the U.S. We are seeing increased sales activity and have actually secured some business in Canada as a result of U.S. market movement and are hopeful that these changes could bode well for our businesses south of the border. As a result, even though our strategic production contract with a commercial printer ran its course and ended in the second quarter of 2018, we still managed to grow our book of business and improve our customer mix, which helped margins improve.On the Canadian envelope side, our revenues were also up in the fourth quarter of 2018. Volumes were down by approximately 7% from the effects of ongoing secular decline and from the uncertainty caused by the Canada Post labor disruptions in the fall. But despite the volume decline, revenues increased in Q4. This was primarily the result of increased selling prices. But we are not all the way there yet. Like the packaging and U.S. envelope businesses, we have made good headway in playing price catch-up on the unprecedented increase in paper cost over the previous 4 quarters.Q4 2018 envelope average selling prices were 9% higher than Q4 2017 and was 2% higher than Q3 of 2018. As you know, many of our contracts and agreements did not allow us to raise prices in lockstep with multiple raw material cost increases, but as predicted, we have been able to play catch-up.With respect to profitability and the Durabox project, we are slightly behind in this division with a greater drag on Q4 earnings than expected. As discussed in the past, the success of this business and the impetus for the project in the first place is our ability to corrugate in-house, and we experienced delays through November and December. We faced modest cost overruns, a slower-than-expected commissioning of the new facility and, as a result, greater-than-anticipated duplicated expenses. I was actually in the new facility yesterday, and the corrugator was running at OEM-recommended speeds, and they are on their way to the anticipated levels. Durabox has been a solid contributor since acquired in 2015, and we believe it is poised to add both revenue and EBITDA growth in the coming quarters as we exit the commissioning phase.Despite Durabox and other challenges discussed today and previously, I am pleased that we delivered an increase in adjusted EBITDA against both Q4 2017 and the third quarter of 2018. Q4 marked the highest adjusted EBITDA delivered since we started feeling the effects of rising input costs towards the end of 2017, and we are pleased that we have reversed the trend over the last few quarters. As discussed, this improvement was accomplished through a combination of pricing catch-up, improved mix and pure growth in our packaging businesses. We also started to see some of the modest -- started to see some of modest benefits of our cost-rationalization plan in the fourth quarter and expect its full benefits to take effect as we progress through 2019.With strong growth from packaging, price increases across all of our offerings and improving customer mix in the U.S., we are entering 2019 in a good position for continued success.With this, I'll turn the call over to Guy for a quick review of our financial results for the fourth quarter and year ended December 31, 2018. Guy?

[Guy Prenevost, CFO & Corporate Secretary]

Thank you, Stewart. Good morning, everyone. The revenue for the fourth quarter of 2018 increased by 9.7% or $4.8 million, reaching $54.2 million. Canadian envelope revenue grew 1.1% to $25.8 million from price increases of 9.2%, more than offsetting the volume decline of 7.4%. U.S. envelope sales increased 15.1% to $12.6 million as a result of price increases averaging 11.2% and volume growth of 3.5%. Revenue from packaging and specialty products increased by 22.2% to $15.8 million. Revenue for the 12-month period increased by 8.9% or $16 million, reaching $195.1 million. Canadian envelope revenue decreased by 7.2% to $94.8 million as a result of reduction in volume of 10.9%, partially mitigated by price increases of 4.2%. U.S. envelope sales increased by 2.5%, reaching $43.4 million. Price increases of 6.8% more than offset the volume decline of 4%. Revenue from packaging and specialty products increased by 64.4%, reaching $56.9 million.Adjusted EBITDA increased 2.3%, reaching $8.1 million in the fourth quarter of 2018. Adjusted EBITDA margin stood at 15.1% of revenue compared with 16.1% in the equivalent quarter of 2017. Solid growth in the U.S. envelope business and selling price increases across all major product lines mitigated some of the effects of the inflationary pressures on input cost, mainly paper and transportation.For the 12-month period, adjusted EBITDA increased 1.1% to $26.8 million. Adjusted EBITDA margin stood at 13.8% of sales compared with 14.8% in 2017. The reduction in -- of envelope volume in Canada, combined with inflationary pressures on input costs, more than offset this by the strong contribution of the company's packaging operations.Net loss for the fourth quarter stood at $0.44 per share compared with net earnings of $0.08 per share in Q4 2017, primarily resulting from a noncash goodwill impairment charge of $16.1 million related to our envelope CGU. On an adjusted basis, net earnings increased to $0.17 per share compared with $0.16 per share in Q4 2017.Net loss for the 12-month period reached $0.17 per share compared with net earnings of $0.43 per share last year, again, primarily as a result of goodwill impairment to the envelope CGU. Cumulative adjusted net earnings stood at $0.50 per share compared with $0.52 per share in 2017.On a full year basis, operating activities generated cash of $11.9 million compared with $15.9 million in 2017. This results mainly from lower net earnings, the necessary inventory build-up associated with the company's decision to invest in increasing Durabox's production capacity and increase in input cost.On February 20, 2019, the Board of Directors declared a quarterly dividend of $0.065 per common share, equivalent to the third quarter of 2018 and fourth quarter of last year. In 2018, the company declared a total of $0.26 per share in dividend, an increase of 6.1% over the prior year. During the year, Supremex purchased 125,000 common shares for cancellations under NCIB program, for total considerations of $431,840. As of December 31, 2018, we have over $21 million available of borrowing capacity on our $75 million credit facility. This additional availability will support us in the execution of our growth and diversification strategy.Our net debt to adjusted EBITDA ratio remains conservative at 1.98x.I would now like to turn the call over to analysts for questions. Operator?

[Operator]

[Operator Instructions] And your first question comes from Neil Linsdell with Industrial Alliance.

[Neil Linsdell]

So first off, obviously, pricing increases gave you a big boost. Could you talk about -- you mentioned catching up to the pricing. Could you kind of detail that between Canada and the U.S.? If you've completely caught up? If you're expecting more significant price increases coming through 2019? Or are we just going to, kind of, float along with input cost increases?

[Stewart Emerson, President, CEO & Director]

Good question. So we're most of the way there. Just anecdotally, I would say we still have some customers that are a little bit behind. We have inventories in place for customers that are still priced at sort of older prices. I guess, they were 80% of the way there, something along those lines, got a little bit more room. And all new orders are being priced at the going rate. We have some legacy stuff that still needs to be pushed through. Canada and the U.S., they both face the same amount of cost increase, but the U.S. market is typically a little tougher pushing increases through. And I'd say we're sort of 70% of the way there. But looking forward to 2019, we expect that there will continue to be inflation on raw materials, particularly paper, but we anticipate it would be nowhere near the level it was in 2018 -- 2017, 2018. And we've always said we're pretty good at getting 1 or 2 increases through. The challenge we had where we had to play catch-up was on the third and fourth increase in 4 quarters. So I think we'll see prices continue to go up as cost goes up in 2019.

[Neil Linsdell]

Okay. Fair enough. And you mentioned you're seeing some rationalization, I guess, or acquisition activity in the U.S. with your competitors. Has there been any kind of irrational pricing because some guys are struggling there, that there would be easing because of this?

[Stewart Emerson, President, CEO & Director]

We've seen -- we know of or we've seen a fair bit of equipment being retired or removed from the industry. And I know we haven't seen anything on the pricing side that would lead us to believe that there's more rational pricing, but we have seen a lot of activity. And as I mentioned, we won a nice contract here in Canada as a result of that movement in the U.S. So I think it's too early to say whether there's going to be an improvement in the pricing conditions in the U.S., but there's definitely a fair bit of angst and available orders in the U.S. from the movement of equipment out of the industry.

[Neil Linsdell]

Well, you also said that -- just to go back to the U.S., we had talked on last quarter, previous quarters on -- you'd lost some customers there, but they were lower-margin customers, you expected profitability to improve. But you're increasing your volumes at the same time. So is there more -- because of your position in the market, it's obviously much easier to do in the U.S. than in Canada. But is there still a lot of business that you can take from these competitors?

[Stewart Emerson, President, CEO & Director]

Yes, we still have less than 3% market share, we say, well, less than 5% market share. Yes, so there is lots of room to grow in the U.S., I mean, I'd temper that with. We still have to have the capacity internally to make the envelopes, and we're still ramping up the staffing in both Canada and the U.S. to support U.S. envelope growth. But there is lots of room.

[Neil Linsdell]

All right. And then just switching over to the packaging side. You mentioned the Durabox movement has been -- you've had delays, some duplicate costs. Where do we stand on that now as far as getting rid of the duplicate costs and moving forward getting up to full efficiencies as far as timelines are concerned?

[Stewart Emerson, President, CEO & Director]

So I think we're done with the duplicate costs. The...

[Neil Linsdell]

As of today or as of the end of Q4?

[Stewart Emerson, President, CEO & Director]

At mid-January, I'd say, or end of January. So we're done with the duplicate costs and the overheads. Where we're still working through is -- we thought extensively about -- it's a zero-sum game if you have 2x. If you have to buy from the outside, buy sheets from the outside, and we're still buying a few sheets from the outside through January, less in -- less each and every week as we ramp up our production. We expect by the end of Q1 that we'll be fully self-sufficient. So we have a portion of our business that is at 0 EBITDA and -- but a growing portion that is at nice, nice margins. Expect that to be done by Q1.

[Neil Linsdell]

I don't suppose you can quantify, say, the EBITDA margin improvement that we should see once everything is completely up and running?

[Stewart Emerson, President, CEO & Director]

I can quantify it but I can't share it.

[Neil Linsdell]

And then, just, I don't know if you can detail with your packaging business now that you have G2 on board. I know that's a run rate of about $10 million a year. In your packaging side, do you break out the mix among your different segments, say, pharma, say, cosmetics and different types of groups?

[Stewart Emerson, President, CEO & Director]

We do internally. And we expect to be able to give you more color on sort of the segmentation in the next quarter.

[Neil Linsdell]

Okay. All right. I'll leave it till then, then. Just last question. You talked about long term. We've talked about your target of going to 50-50 between packaging and the envelope side. What's the -- what's your definition today of long term?

[Stewart Emerson, President, CEO & Director]

5 years.

[Neil Linsdell]

5 years? Okay.

[Stewart Emerson, President, CEO & Director]

2022, yes.

[Operator]

[Operator Instructions] And there are no further questions at this time. I'll return the call to Stewart Emerson, CEO.

[Stewart Emerson, President, CEO & Director]

All right. Thank you, Neil, for those insightful questions. As our priority is in 2019 is to continue to organically grow our expanding packaging business. We know that all 3 legs, folding carton, e-commerce, and especially Durabox have momentum and are well positioned for both revenue and EBITDA growth. We will continue to nurture our envelope platform and seek means to further improve margins and reduce costs. They're additional levers we plan to pull. I also believe that our U.S. operations are in a good position to benefit from an improving competitive environment, our growing brand recognition and the staffing changes we've made. We remain focused on our objective of prudently achieving our goal of 50-50 envelope-packaging revenue split. Envelope remains a very profitable part of our business, and we intend to protect its contribution to profitability by paying special attention to our costs and better aligning our prices with input cost inflation affecting the overall industry. We have completed our 2017 and 2018 CapEx program and have built significant available production capacity in all of our packaging businesses. We're in our best position ever to meet growing demand for high-quality folding carton and e-commerce fulfillment packaging solutions. Looking ahead, I'm confident in our ability to: one, further execute our M&A road map on the folding carton side; two, generate organic growth across our 3 packaging categories and in the U.S. envelope space; and three, to manage the effects of the decline of the Canadian envelope business on our operating profitability. We remain committed to our short-term goal of returning value to our shareholders by way of dividends and share buybacks. We kept our dividend stable in 2018 while executing our diversification strategy and bought back shares with the share buyback program. Most importantly, cash flows remain strong and allows us to maintain a conservative level of debt while we continue to invest in our long-term growth and diversification strategy.As always, none of our success happens without the support and dedication of our over 800 employees across Canada and the U.S., and I'd like to thank them for their commitment.This completes my closing remarks, and I look forward to meeting you again on this call to discuss first quarter results in May. Thank you very much, and have a great day.

[Operator]

This concludes today's conference call. You may now disconnect.