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Edited Transcript of SWP.TO earnings conference call or presentation 9-May-19 4:00pm GMT

Q1 2019 Swiss Water Decaffeinated Coffee Inc Earnings Call

May 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Swiss Water Decaffeinated Coffee Inc earnings conference call or presentation Thursday, May 9, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Frank A. Dennis

Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director

* Iain Carswell

Swiss Water Decaffeinated Coffee Inc. - CFO

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Conference Call Participants

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* Ian Cassel

MicroCapClub LLC - Founder

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Swiss Water Decaffeinated Coffee First Quarter 2019 Earnings Call. (Operator Instructions)

At this time, it's my pleasure to turn the floor over to Mr. Frank Dennis. Sir, the floor is yours.

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [2]

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Thank you, John. Good morning, and thank you all for taking the time to join us today. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. And with me today is Iain Carswell, our CFO. Iain and I are here this morning to discuss Swiss Water's financial results for the 3 months ended March 31, 2019, which comprise the first quarter of our fiscal year.

I'll begin today with a brief overview of our results and some of the factors that are driving strong growth of our processing volumes. And then, Iain will provide more detail about our financial performance before I return to talk about our plans and expectations going forward. After that, we'll be happy to take your questions.

Looking now at our results. 2019 is off to a great start for Swiss Water. During the first quarter, we continued to gain market share against our competitors. Our total processing volumes were up by 23% in the quarter, while specialty decaf category growth was approximately 4%.

This along with our ongoing efforts to reduce costs and enhance our production efficiency had a very positive effect on our financial performance.

Volume increases came from across our customer base and from every geographic region. 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 use, were up by 20%. The growth in the roaster segment came both from organic growth within existing roaster accounts either by increasing their distribution venues or by adding to their product offerings. And we added new roaster customers, some of whom had previously sourced their decaffeinated coffees from competitive CO2 manufacturers that have shut down over the past 18 months.

The CO2 plant closures have tightened the supply side of the chemical-free decaffeination market at a time when demand is growing. This fact should also help us to more rapidly utilize the additional production capacity we have coming online when we commission our new plant near the end of this year.

Shipments to importers who resell our coffee to roasters where and when they need it were also up nicely growing by 28% when compared to Q1 last year.

Our steady volume growth is also related to some significant trends affecting the markets we serve.

As I've outlined over the past few quarters, the overall market for decaffeinated coffee is expanding and continues to outpace the growth of the U.S. coffee market as a whole.

Sales of our specialty decaf coffee like our SWISS WATER Process coffees had been particularly strong, especially in out-of-home markets. In part, this is the result of the overall premiumization of the coffee market. Consumers simply want to drink and are prepared to pay for better coffee.

Changing demographics are also playing a role. Research is showing that the largest consumers of premium decaf over the past 5 years are 18- to 24-year-old. This is a consumer cohort that has grown up with excellent coffee. They love drinking it, and they love spending time at the cool and comfortable coffee shops that serve it.

Premium decafs like ours let them enjoy both experiences all day and all evening without worrying about the possible side effects of caffeine. And that's good for us and great for coffee shop owners who can extend their profitable selling cycle well past the morning rush by pouring high-margin decaffeinated coffee drinks for as long as their doors are open.

An overall trend toward healthier eating is also helping drive up demand for SWISS WATER Process coffees. Today's consumers, particularly the younger generation, are highly conscious of artificial ingredients and chemicals in their food and drink and choose to avoid them when possible.

A particular impact on the coffee trade is the growing awareness and concern about the health and environmental hazards associated with methylene chloride, the main chemical used by our competitors to decaffeinate coffee. Methylene chloride is an industrial solvent that's also used to degrease auto parts, in bathtub refinishing and in paint strippers. The EPA in the United States has now banned its use in all consumer paint removers, effective November 24 of this year.

Methylene chloride is not something consumers want to contemplate while they sip their coffee even in trace amounts. Consumers are also increasingly attracted to products that are certified as organic.

In recent studies by the National Coffee Association, 39% of consumers say they are more likely to buy coffee that is certified organic and 49% say they are more likely to buy coffee that is grown in an environmentally sustainable way. One can assume that these numbers are even higher among the younger demographic.

By including our branded 100% chemical-free SWISS WATER Process coffees in their offerings, coffee roasters and importers are responding to these trends and positioning themselves as market leaders. To grow brand awareness and promote many benefits associated with our premium decaffeinated coffees, we are employing a range of focused marketing initiatives at both the trade and consumer level. These include digital and print advertising, social media communications, participation in trade shows and sponsorship at key coffee industry events.

We are also expanding our geographic reach and strengthening our sales teams. During the first quarter, we opened our new European sales office to help drive our growing penetration in the European Union, which is the world's largest market for decaf coffee. We also continue to add bench strength to our sales and marketing team in the U.S., which at nearly 50% of the sales remains our largest single market.

All of these efforts are designed with 1 goal in mind to enable us to continue growing our processing volumes and thus, our profitability.

But before I talk about our future plans and expectations, I'm going to pass the call over to Iain, who will provide a little more detail around our financial results. Iain?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [3]

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Thanks, Frank. Hello, everybody. It's good to be here with you today. I'll begin with our revenues. The significant growth in our first quarter processing volumes had a positive impact on our revenues, which at $24.2 million were up 14% compared to Q1 last year.

The positive impact of the volume growth was partially offset by lower coffee futures price or NY'C'. During the first quarter, the NY'C' averaged USD 0.99 per pound compared with USD 1.25 per pound in Q1 2018. The substantial portion of our revenue comprises the amount we charge our customers for green coffee. And as we charge market rates for this coffee, our revenue falls when green coffee costs falls.

Our revenues are also impacted by the U.S. to Canadian dollar exchange rate as a large proportion of our sales are billed in U.S. currency. In Q1 of this year, the U.S. dollar averaged CAD 1.33, an increase of 5% over the same period in 2018.

Looking at the cost side, our first cost -- first quarter cost of sales was $20.6 million, an increase of 12% over Q1 of last year. The increase in cost of sales was consistent with the growth of our business during the period. Impacting factors included higher variable production costs due to the significant increase in our processing volumes and annual labor cost increases due to inflation. These were partially offset by a decrease in green coffee costs due to the lower NY'C'.

As in Q4, we also had to absorb a much higher cost for the natural gas used in our production process. This was due to significant supply constraints resulting from a pipeline explosion in Northern British Columbia in October 2018 and an unusual polar vortex called weather pattern in March of this year. These are onetime factors that are not expected to impact gas prices going forward.

Q1 gross profit was up by 25% to $3.5 million as a result of higher revenues, more than offset the increase in our cost of sales. This resulted in a margin of 15%, which is 1.2% improvement over the Q1 2018 results.

Our improved gross profit and margin were primarily result of our higher processing volumes. However, a sharp focus on reviewing and reducing the operating costs of both SWISS WATER and Seaforth Supply Chain Solutions, our green coffee and logistics business, also had a positive impact.

During the quarter, we increased the prices of Seaforth's customers and continue to implement efficiency improvements in the business. This enabled Seaforth to once again make a positive contribution to our financial results.

Across all of our operations and in all of our activities, we continue to see cost recovery opportunities and to implement cost reductions, provided, of course, that they don't compromise the quality of our coffees.

Operating expenses for Q1 were up 12% over the 2018 level. The increase was primarily due to higher staffing and staff-related expenses as well as increased spending on advertising and marketing. For the past several quarters, we have been investing and enhancing our operational capabilities on sales activities to prepare the [growing] for the additional production capacity we have coming online in the fourth quarter of this year.

Q1 operating income was $1 million, an increase of 76% or $400,000 from what we reported in the first quarter of last year. This year, we recorded a net loss of $10,000 compared to net income of $500,000 in Q1 2018. This is because of our -- because our improved quarterly operating income was offset by higher noncash expenses and by the adoption of IFRS 16. This small net loss we recorded in Q1 was primarily due to the revaluation of embedded derivative on our convertible debenture, higher finance expenses related to an interest on leases as a result of the adoption of IFRS 16 and interest on a construction loan also played a role.

Another measure of financial performance is earnings before interest, taxes, depreciation and amortization, or EBITDA. For the first quarter, EBITDA was $2.3 million, an increase of $1.2 million or 109% over Q1 last year. The significant improvement in EBITDA was in part due to new accounting standards related to our leases as well as our strong growth in processing volumes, ongoing efforts across the company to enhance cost recovery and the increased financial contribution from our Seaforth subsidiary.

Finally, turning to dividends. Subsequent to the end of the quarter, on April 15, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on March 31, 2019.

With that, I thank you for your attention, and I'll now turn things back to Frank, who will tell you more about our expectations for the balance of the year. Frank?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [4]

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Thank you very much, Iain. Looking ahead into the balance of this year, we expect to once again record strong year-over-year growth in our annual processing volumes.

As I mentioned in the past and again at the start of the call, we are benefiting from several consumer trends that are helping us grow our business. These include a strong desire to drink excellent coffee throughout the day without worrying about caffeine consumption coupled with an increased awareness and concern about methylene chloride. These 2 factors, in particular, are helping drive and accelerating movement away from acceptance of chemical decaffeination processes and a growing demand for chemical-free premium decaf coffees like ours.

This is happening at a time when the industry's ability to meet this demand is constrained. As the world's only branded 100% chemical-free decaffeination process and the only supplier with new capacity coming on-stream in the next 12 months, we believe we are well positioned to capitalize on this growing awareness and demand.

Our focus remains on positioning the company for growth in both the immediate and long term. And to do that, we're continuing to invest in the resources we need to generate increased sales volumes as we respond to the heightened demand.

Our new European sales office now puts us front and center in the world's largest market for decaffeinated coffee. As we continue to expand our business in Europe, we expect revenues from our international markets, which now comprise 56 different countries, will continue to increase in both dollar and percentage terms.

At the same time, we are expanding our ability to target specific customer groups by selectively adding to our sales and marketing team in the U.S., which at 50% of sales remains our largest market by far.

While these initiatives are increasing our expenses somewhat, we expect them to generate the increased volume we need to begin filling the additional production capacity we have coming on-stream later this year.

However, as I reminded you in the past, converting major accounts to our SWISS WATER Process coffees takes several quarters to complete, so our strategic investments in marketing and in human resources may take some time to bear visible fruit. Of more immediate impact are the many efforts we have taken and continue to take to improve our operational efficiency and enhance our margins.

Under Iain's direction, we have been looking at all aspects of our operations with the goal of reducing our costs without impacting product quality, which is paramount to everything we do.

Of particular note is the success we've had in improving the performance of our Seaforth coffee handling and distribution subsidiary, which is contributing positively to our results.

Finally, construction of our new state-of-the-art production facility in Delta, BC is progressing on time and on budget. And we expect to commission our new production line as planned later this year.

In the meantime, the efficiency enhancement project we completed during last year at our Burnaby, BC facility, together with the capacity we added there in Q1 2016, should enable us to meet anticipated demand until our new production line is running.

In short, we see a lot of opportunity ahead. Demand for specialty decaf continues to grow and Swiss Water has the best product, specialized knowledge and experience and the operational infrastructure to respond successfully. We also have a well-established brand name and we're working to leverage that much more effectively.

That wraps up our comments for today. Iain and I would now be happy to answer any questions that you might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We do have a question coming through from Ian Cassel with MicroCapClub.

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Ian Cassel, MicroCapClub LLC - Founder [2]

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I had really just 1 question and it relates to the volume processing increases that you saw during the quarter year-over-year. You're obviously benefiting a little bit from price of coffee being a decade low. I'm just curious if you could provide some color may be just qualitatively on how much of the growth that we're seeing now is related to sort of the market environment we're in versus strategic execution on your front?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [3]

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It's sort of a good question, I guess. Ian, yes, we are sitting at historic lows on the NY'C'. At least since 2005, we haven't seen these types of numbers. I'd point out that our volumes have been growing double digits for about 4 or 5 years or so. And that's much beyond market-driven conditions or declining NY'C' because that certainly has bounced around.

What is happening is a focus on product quality, a focus on building our brand and a focus on converting roasters away from the concept of methylene chloride. And I would suggest that probably the vast majority of new roasters in most jurisdictions around the world in the past 10 years, no one has chosen methylene chloride. And that's because of the strategic drive that we've had over decades now in terms of pushing the concept of a chemical-free, better-for-you product.

So yes, it sort of helps when the 'C' is going down. And you know what, when the 'C' jumps back up to -- pick the number, 75, do we see some inventory rebalancing? Every time. But we don't see our volumes fall off to nothing. So this is well beyond scenario of just, hey, it's a declining 'C'.

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Ian Cassel, MicroCapClub LLC - Founder [4]

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I didn't mean the question to seem condescending towards the execution you guys are obviously doing. And maybe a follow-up question. When you look at the competitive landscape in the decaffeinated processing market, are you seeing any competitors that are developing, building other water methods across the globe?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [5]

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Yes. And that's important. The answer is yes. And most -- you might kind of think why is that positive because I in fact see that as positive. Back to the point I made about roasters not choosing methylene chloride anymore. I mean it really is a legacy type product.

With a couple of CO2 plant closures, the world of roasters needs additional capacity. And when you're dealing with business-to-business supply chain, single source of volume is always a risk. So larger organizations need to have 2 or 3 sources of supply. Some main, some backup or just have alternatives. And I'm happy to say that we are seeing one of our major German competitors, whose core business is methylene chloride, they've sort of seen the light and are adding capacity in Bremen, Germany. And I see that as positive also because they are the main supplier for Starbucks. Is that -- when that plant comes on and I'm not sure exactly when that's going to happen, it could be a year, 1.5 years, I don't know exactly. It's tough to know. But then at least now, Starbucks potentially has an answer to some of its issues with our inability to supply all of their coffee and not wanting to have a single source of supply.

And so we open up the market now to much bigger customers in making a choice and moving away from methylene chloride would be monumental for this category. In terms of being able to shift towards a chemical-free decaffeination, we need additional capacity. So long answer to say, we actually are pleased to see that some of the world's biggest methylene chloride decaffeinators are seeing potentially a different path forward.

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Ian Cassel, MicroCapClub LLC - Founder [6]

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Okay. Maybe 1 last question and I'll get back in the queue. When you look at your increased capacity ramping up towards the year-end and in the next year, I'm just curious as to are you anyway limited because of your geographic location in the Western side of Canada as it relates to addressing larger customers in other parts of the world mainly due to logistical costs of transportation and things like that? Are you sort of limited at least when it comes to major customers looking primarily in North America because of that?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [7]

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Yes. Ian, we periodically need to do sort of subsidization to a degree in terms of freight costs into different jurisdictions because, you're right, moving coffee by land over a bunch of mountains in North America is sometimes problematic. Long term, and this is kind of 5 to 10 years, but our desire would be to have processing capabilities in Europe that would be basically a better overall strategic positioning of volume both here as well as the other side of the continent/Europe.

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Operator [8]

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(Operator Instructions) And ladies and gentlemen, there appear to be no further questions at this time, so this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.