Supremex Inc

TSX:SXP

Earnings Call Transcript

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Supremex Inc. Fourth Quarter 2020 Results Conference Call. [Operator Instructions]I would now like to hand the conference over to Danielle Ste-Marie, Investor Relations for Supremex. Thank you. Please go ahead, madam.

[Danielle Ste-Marie]

Thank you, operator. 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 fiscal year ended December 31, 2020, 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 management discussion and analysis 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 would like to remind listeners that this conference call contains forward-looking information within the meaning of applicable Canadian 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 are discussed throughout the December 31, 2020 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 use various 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 of Supremex, to review this period's key operational highlights. Stewart?I think Stewart is on mute. We don't hear you, Stewart.

[Stewart Emerson, President, CEO & Director]

Sorry. Thank you, Danielle, and welcome, everyone.I think it's fair to say that 2020 was quite an eventful year. I think at this point last year none of us knew exactly what laid ahead or how radically our world would change. I certainly know I didn't. Supremex went from being a wind at our backs, quick out of the gate start across all of our lines of businesses in January and February with the prospects of closing on an acquisition of our largest Canadian envelope competitor to market chaos almost overnight.I vividly remember those days. A couple of weeks that were very active in terms of activating our business continuity plans, the daily huddle up calls, building new activity-based KPIs, implementing aggressive health and safety measures and actioning strong expense and capital containment measures, all while closing and integrating our largest acquisition in more than 30 years. Through the pandemic, I think our entire team rose to the challenge. And I'd like to take this opportunity to thank each and every one of them and our partners for their contribution, their dedication and their focus and hard work.As a leader of a fairly large and diversified business, you wonder and worry about whether you've done the right things. Is the business stable? Is it diversified enough? Do we have the right people? Do we have the right culture? Is the business built to sustain the unknown? It can always be better, but we take some satisfaction in the way 2020 turned out.We are organized into 5.5 lines of business, have 16 locations in Canada and the U.S. and roughly 850 employees, and I'm proud of what they were able to accomplish. We continue to diversify. We're quick to implement cost mitigation and capital preservation strategies and focused on reimbursing debt, which allowed us to finish 2020 in a stronger position.Consolidated revenues are up 6.7% to more than $200 million for the first time in our history. Adjusted EBITDA is up almost 28%. And our balance sheet has been significantly delevered, and we have already reimbursed a significant portion of the monies borrowed to acquire Royal Envelope in February 2020.Speaking of Royal, as I said, this acquisition represents our largest in the last 30 years, and it has proven to be highly accretive despite the integration challenges of working remotely, avoiding cross-contamination in a pandemic environment. Employees have embraced the change. We implemented the Supremex ERP on July 1. The Canadian envelope market has been supportive with attrition rates below anticipated levels. We've extracted synergies at or above what our hypothesis called for. And we are utilizing the additional capacity to support U.S. envelope growth. Together with the recent cost optimization plan announced in early December, we believe we have significantly extended the runway of the envelope platform, thereby protecting its earning power and cash flow generation capacity.On the packaging side, 2020 was an impressive year for our e-commerce business and marked the significant improvement of our folding carton activities. As I said on the last call, none of our packaging businesses were materially aided by the pandemic. We just don't participate in those segments in any meaningful way. But we are augmenting our offerings to capitalize on changing consumer behaviors, both in e-commerce and the transition away from single-use plastic packaging.The long selling cycle associated with our e-com offering produced a handful of higher volume direct-to-brand e-tail customers that rewarded us with recurring and ongoing volume. As you would expect, we have a fairly robust pipeline in this space, and the team is working feverishly to convert those prospects.Folding carton experienced a dip in demand in the health and beauty business, primarily cosmetics and fragrances, but did a nice job offsetting those declines with new volume and supported e-commerce with cross-selling. The material gains in folding carton came primarily from meaningful improvements in operations, capitalizing on the 2018-2019 CapEx program, and we are now seeing margins in this segment beginning to trend back to historical and expected levels.On the capital allocation front, with the ongoing threat of the pandemic, we elected to pursue a conservative approach and suspended our quarterly dividends starting in the second quarter and focused on returning shareholder value by deleveraging and repurchasing shares through the NCIB. With the pandemic ongoing, we are maintaining this approach and focusing our efforts to further improving operating efficiencies and building a stronger packaging platform to emerge with a stronger balance sheet and significantly improved cash flow generating capabilities.Now for a quick review of the fourth quarter 2020. Fourth quarter results followed previous quarter trends with revenues up 11.1% and adjusted EBITDA up 37.5% over Q4 2019.Envelope revenues were up 13.2% from the contribution of the acquisition of Royal Envelope and from important market share gains in the United States, which compensated for the secular decline and a less favorable envelope mix during the pandemic. For more granularity, in the fourth quarter, we experienced a modest bounce back in envelope sales, primarily from resellers replenishing their inventory from the Canadian census and from residual vote-by-mail volume in the U.S. Looking ahead, I expect the envelope market to remain soft through Q1 and Q2. However, we continue to make good headway in the United States with increased activity and volumes trending higher, similar to what we've seen in the last few quarters.In my opinion, the continued U.S. growth speaks well to Phase 1 of our diversification strategy launched in 2015. Our 3 operations in the U.S. have become increasingly proficient at using their local manufacturing capabilities to serve shorter run custom orders, while leveraging their relationships to secure high-volume orders to take advantage of the expertise, know-how and capacity that we have in Canada.In the recent years, we have been better at working as a group. Our operations north and south of the border are aligned and ready to grow in this sizable market, where, as the third largest envelope manufacturer in North America, Supremex still only enjoys less than 5% market share.On the packaging and specialty products side, revenues were up 5.4%, primarily from e-commerce sales growth and adjusted EBITDA as a percentage of sales almost tripled to 16.4%, primarily due to sales gains and the significant improvements in the folding carton business. With respect to the Durabox corrugate die cut operations, we continue to be adversely affected by changing dining habits related to the pandemic and candidly, continued challenges on the operations side, some of it COVID-related, some of it not.There is modest CapEx embedded in the 2020 numbers that are aimed at improving production efficiency and capacity. With the additional CapEx, we believe we are close to being able to have the confidence necessary in operations to support an aggressive approach in sales.I'd now like to turn the call over to Guy for a review of our financial results. Guy?

[Guy Prenevost, CFO & Corporate Secretary]

Thank you, Stewart. Good morning, everyone.Total revenue for the fourth quarter was up 11.1% to $54.6 million. Revenue from the envelope segment was up 13.2% or $4.8 million to $40.5 million. Canadian envelope revenue increased 15% or $3.6 million to $27.5 million from the contribution of the Royal Envelope acquisition. The COVID-19 pandemic had negative effect on nonessential envelope demand, resulting in an average selling price decrease of 4.6%.Revenue from the U.S. envelope market grew by 9.7% or $1.1 million to $13 million from market share gains and the vote-by-mail initiative ahead of the U.S. elections. Average selling prices decreased by 2.9% from changes in the product mix, which includes a positive FX translation effect of 1.3%.Packaging and specialty products segment revenue grew by 5.4% to $14.1 million, primarily from new e-commerce customers onboarded in 2020. Fourth quarter EBITDA was $4.6 million, down from $6.8 million. A $2.8 million noncash asset impairment charge was taken in the fourth quarter to account for lagging results in the corrugated die cut box CGU as explained earlier by Stewart. And a $1.8 million nonrecurring restructuring expense was also taken as part of the December 2020 cost optimization plan.Adjusted EBITDA grew by 37.5% or $6.7 million to $9.2 million, resulting primarily from the Royal Envelope acquisition, higher e-commerce sales, growth in the U.S. envelope business and a $1 million subsidy from the Canadian Emergency Wage Subsidy program. Adjusted EBITDA margins increased to 16.9% of revenue compared with 13.6% in the fourth quarter of 2019.Envelope segment adjusted EBITDA was up 7.3% to $7.1 million from the acquisition of Royal Envelope, which provided higher sales volume and synergies in production and procurement. Adjusted EBITDA margins from the envelope segment stood at 17.5%, down from 18.4%.Packaging and specialty products segment adjusted EBITDA almost tripled to $2.3 million from $0.8 million in the fourth quarter of 2019, primarily from higher e-commerce sales and efficiency gains in the folding carton division. Adjusted EBITDA margins from the packaging and specialty products operations increased to 16.4% compared with 6% in the equivalent quarter of 2019.Q4 2020 net earnings were $0.3 million or $0.01 per share compared with $2.3 million or $0.08 per share for the equivalent period of 2019. Adjusted net earnings were $3.7 million or $0.13 per share, an increase of 69.8% or $1.5 million compared with $2.2 million or $0.08 per share during the fourth quarter of 2019.Moving on to fiscal 2020 results. Total revenue was up 6.7% to $204.6 million. Revenue from envelope segment was up 6.8% or $9.4 million to $146.5 million. Canadian envelope revenue was up 6.5% to $97.6 million from higher volume resulting from the acquisition of Royal Envelope, which compensated for the secular decline and the effect of the COVID-19 pandemic on nonessential envelope demand. Average selling prices decreased by 5.1%, primarily from the resulting changes in envelope mix.U.S. envelope revenue increased by 7.5% or $3.4 million to $48.9 million from sustained market share gains and the vote-by-mail initiative ahead of the U.S. elections. Average selling prices decreased by 2.3% from changes in the product mix, including a negative FX translation effect of 1%.Packaging and specialty products segment revenue increased 6.5% or $3.6 million to $58.1 million, primarily from the onboarding of new e-commerce customers since Q2 2020. EBITDA for fiscal 2020 increased by 7.7% to $27.2 million. Excluding nonrecurring charges taken in the fourth quarter of 2020, adjusted EBITDA grew by 27.9% or $7.1 million to $32.4 million from the acquisition of Royal Envelope, higher e-commerce sales, growth in the U.S. envelope business and a total of $1.9 million from the Canadian Emergency Wage Subsidy. Adjusted EBITDA margins increased to 15.8%, which is up from 13.2% in 2019.Envelope segment adjusted EBITDA was up 10% or $2.3 million to $25.5 million, primarily from the acquisition of Royal Envelope. The envelope adjusted EBITDA margin stood at 17.4%, up from 16.9%.Packaging and specialty products segment adjusted EBITDA increased by 83.9% or $4 million to $8.6 million from higher e-commerce sales and efficiency gain in folding carton. Packaging adjusted EBITDA margins increased to 14.7% compared with 8.5% last year.Fiscal 2020 net earnings stood at $7.5 million or $0.27 per share, up from net earnings of $7.1 million or $0.25 per share in fiscal 2019. Adjusted net earnings were $11.3 million or $0.40 per share, up from $7.1 million or $0.25 per share last year. Net cash flows from operating activities, before working capital adjustment, increased by $5 million to $24.5 million from higher adjusted net earnings.In August, the TSX approved the renewal of our NCIB. In 2020, we repurchased a total of 305,700 common shares for cancellation for a total of $424,000. An additional 81,800 shares were purchased since the beginning of 2021 for a total consideration of $158,000.Total net debt stands at $56.8 million, a slight increase over our outstanding amount of $53.8 million entering fiscal 2020. As mentioned earlier by Stewart, the majority of the monies borrowed to conclude the Royal acquisition have been reimbursed.I would now like to turn the call over to analysts for questions. Operator?

[Operator]

[Operator Instructions] Your first question comes from the line of Neil Linsdell of IA Capital Markets.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Congratulations on doing quite well in a tough environment, you beat my numbers. If I look at, we talk about product mix a lot as far as impacting whether revenue was up or down or profitability. And I'm just looking, as we get in the Canadian envelope side, as we now lap the Royal Envelope acquisition, are we going to be looking at -- we've got the same kind of secular decline environment that we had before, but does the product mix that you have on the envelope side really allow you to do better or are you really at the mercy of the kind of Post Transactional volumes?

[Stewart Emerson, President, CEO & Director]

Yes. Neil, I'm not 100%. There were a couple of questions sort of wrapped up in there. But I think the majority of the mix issue or the mix piece was essential mail was essentially the statement mail. And statement mail, generally speaking, is high volume, longer run and smaller formats and consequently come with a lower average selling price. Call it, discretionary mail are sort of the direct mail, higher or smaller volumes and larger formats. And as a result, that's the business that sort of dried up, hopefully, short term. So that was the driver of the average selling price decline or mix.In general terms, Royal's volume and average selling price is or was and is lower than what Supremex's were because they tend to be a little bit more focused on direct end user relationships in sort of higher volumes. So it's a little bit of both. I think what we saw in 2020 was primarily driven by the essential mail versus discretionary mail. But on a go-forward basis, Royal's average selling price was lower than Supremex's coming into the transaction.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. Yes, that gives me a good context. And I'm also thinking about, you went through a restructuring and cost-saving initiatives at the end of last year. So are you pretty much done with everything that you're going to have to do to align your business cost to the environment or is this going to be like a continual process every quarter or is it more, we'll adjust every year, a couple of years?

[Stewart Emerson, President, CEO & Director]

Yes. It's more every couple of years, hopefully, not every year. The whole objective of the U.S. strategy and that prong of the strategy is so that we don't have to adjust every year and we continue to backfill Canadian secular decline with U.S. growth so that we're not going through it every year.The Western Canada market got pretty small fairly quickly as volume moved east primarily of the major mailers. But the whole objective of the U.S. strategy is oversell the U.S. footprint and produce it in Canada to keep utilization rates high.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Yes. And then the U.S., you seem to be...

[Stewart Emerson, President, CEO & Director]

Sorry, on the project. I mean, on the project, we're moving along extremely well. We've done some good things in a small operation in Moncton. We're basically done in Central Canada, and we will be out of the Edmonton facility by the end of the third quarter this year. So we're moving along. We're right on target.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Right. So for additional restructuring expenses, should we continue to see those through Q1, Q2, in addition to -- so I'm trying to figure out onetime expenses and charges. And so you've got perhaps more restructuring expenses which will be recognized and what about government assistance payments?

[Stewart Emerson, President, CEO & Director]

Guy, do you want to take that?

[Guy Prenevost, CFO & Corporate Secretary]

Sure. As far as the government assistance program, of course, we will keep monitoring this. It depends on the performance that we achieve as far as sales. As you know, Neil, our revenue is maintained or growing, we're not eligible to it, but we keep monitoring it. It will be less. There's no doubt that the amount will be less substantial than what we've had in Q3 and Q4. And the first question was what again, Neil?

[Neil Linsdell, Head of Research & Equity Research Analyst]

Restructuring expenses or anything that we should expect in Q1, Q2?

[Guy Prenevost, CFO & Corporate Secretary]

So the expense that we took and the adjustment you saw is basically a provision for the cost that will come in Q1, Q2, so that will go against the provision. The benefit of the restructuring, the cost reduction, most of it will be achieved by the end of Q2, the run rate. So we'll see the benefit next year gradually, but most of it will be achieved, Q1, Q2 will achieve the bulk of it.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Right. Okay. And just in the packaging, we talk about this, I think, every quarter. As far as, it seems very lumpy sometimes as there's a longer lead time, I guess, on building up some of these customers and some of these projects. So what is that packaging side of the business look like as far as pipeline opportunities? And are there kind of one-off projects in there that run a certain number of months or is pretty much everything on a kind of continuous recurring revenue expectation?

[Stewart Emerson, President, CEO & Director]

The short answer is all of the above. But a lot of the lumpiness really stemmed from the attrition of a couple of customers that we've talked about, one in particular, sort of through 2019, hockey stick up, hockey stick down. And the customer concentration piece, we've done a better job and a nice job of sort of reducing the customer concentration. But these are ongoing sort of weekly, monthly programs that are sort of positioned to run on an ongoing basis as opposed to sort of one-off 2, 3 orders and then out the door.And the pipeline is, we're very focused on very specific sort of target market e-tailers that do monthly subscription. A lot of that commerce revenue is sort of monthly subscription-based. So you just have recurring, they have a recurring need and you have recurring revenue, assuming you can hang on to the account. The lumpiness was, and maybe exacerbated a little bit by the pandemic on the folding carton side with, as you can imagine, not a lot of perfume and makeup and mascara being used in 2020.

[Neil Linsdell, Head of Research & Equity Research Analyst]

So I know you don't have the same kind of leverage to e-commerce as far as you're not making boxes for Amazon shipments or what have you. But are you seeing any kind of fundamental shifts from the customers that you are dealing with as far as we are looking at more online, we expect this to stay significant even if it drops off a little bit as people get back into the malls. I'm just wondering like what's your sense from your customers as far as are we going to see an acceleration of this growth or have we seen kind of a bump and we're going to get to some kind of more normalized lower growth level?

[Stewart Emerson, President, CEO & Director]

So a couple of, it's a little bit like our U.S. envelope business. I mean, are we really impacted by sort of with our small market share? Are we really materially impacted by sort of day-to-day activity? I mean, there's lots of room for us to grow even within a flat commerce market. There are lots of opportunities out there for us to grow.But with our e-tailers and with our sort of monthly subscription-based customers, they continue to take on new customers almost on a regular basis as their brands become better known and marketing initiatives start to take hold. And so we continue to see the requirements on a monthly basis grow.Just putting it out there, the growth has led to a little bit of capacity constraint on the e-commerce side that we're trying to address. And that's, I wouldn't say hampered us, but it's made the climb a little bit steeper for us.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. And on the M&A side, obviously, with the Royal Envelope behind you, the U.S. envelope is doing well. Would you consider, say, the U.S. envelope on the West Coast type acquisition or anything more on the packaging side that could really complement what you're doing? Are there any active discussions you have?

[Stewart Emerson, President, CEO & Director]

Yes. So categorically, I mean, never say never. But our thrust in the U.S. envelope has really been around offsetting secular decline in the Canadian operations. And the hub of the Canadian operations are Toronto and Montreal. We don't have a ton of excess capacity in Western Canada. So not a lot of synergies or we wouldn't really be a strategic buyer in West Coast U.S. So highly unlikely that we would pursue anything on the West Coast and there's sort of nothing in U.S. envelope even in the east.On the packaging side, I talked a little bit we're constrained in a few areas, particularly on the e-commerce side. We would look at opportunities, both on the capital side and a small tuck-in on the M&A side to support what we think is a great growth opportunity on the e-commerce side. Even if we're in a niche part of the market, we think it's a significant opportunity for us with a little bit of additional capacity.

[Neil Linsdell, Head of Research & Equity Research Analyst]

Okay. And one last question. We always or for years we've been talking about this long-term target of 50-50 envelope to packaging revenue. Any idea what long term means within that context?

[Stewart Emerson, President, CEO & Director]

Yes. So we were well on our way and thought we could be there in another, a couple of years, and then we added $30 million worth of revenue with Royal on the envelope side, which sort of pushed the bar a little bit higher. Our objective is, from a strategic plan standpoint is, it's about 3 or 4 years out without a transformative acquisition on the packaging side, which not in the works today.So just to summarize, I'd say that the team did an outstanding job, and we ended 2020 in a significantly stronger position. We successfully integrated our largest acquisition in recent history. We managed the effects of the pandemic on our balance sheet, and we ended the year with a conservative level of debt. Our teams demonstrated leadership at every level of the organization to see us through a year nobody saw coming. Continuing to safeguard the well-being of our employees and our customers remains our #1 priority. We're highly focused on further improving operational efficiencies and growing sales in both segments of our business. We have capacity and know-how, and we operate many of the businesses in high-growth markets and we dominate others.I believe that the strong results, specifically in the last 3 quarters, in the middle of an unforeseen crisis, demonstrates the resiliency of our business model and benefits of diversification. We are emerging stronger and better from our lessons learned from the last 2 years. We continue to remain cautious with our capital allocation, prioritizing debt reimbursement and when possible, purchasing shares.Our long-term strategy remains the same: manage the effects of secular decline in the envelope operations by steadily growing market share in the U.S. and continuing to grow packaging businesses in Canada and the U.S., with the ultimate goal of remaining at achieving a 50-50 revenue split between envelope and packaging in the foreseeable future.This completes my closing remarks, and I look forward to our AGM and discussing our first quarter results in May. Thank you very much. Take care and be safe, everyone. Thank you.

[Operator]

And this concludes today's conference call. Thank you for participating. You may now disconnect.