Supremex Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 10, 2023

There are 5 speakers on the call.

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Supremix Second Quarter 2023 Earnings Conference Call. At this time, all participants are in listen only mode. Following the presentation, we will conduct a question and answer session.

Operator

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 Thursday, August 10, 2023. I would now like to turn the conference call over to Stuart Emerson, President and CEO. Please go ahead.

Speaker 1

Thank you, operator. Good morning, ladies and gentlemen. Thank you for joining us for this discussion of the financial and operating results for for the Q2 ended June 30, 2023. Our press release reporting these results was published earlier this morning. It can also be found in the Investors section of our website at www.premax.com, along with our MD and A and financial statements.

Speaker 1

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. I'm joined today by Francis Baluca, Supremix's new Chief Financial Officer. Francois joined us In early July, he brings more than 25 years of experience as a financial executive with large private and public companies.

Speaker 1

We are very pleased to have him on board as the company will benefit from his leadership skills and expertise in all matters related to business strategy, M and A and Capital Management. Thank you, Francois. Let's turn to Slide 39 for an overview of the 2nd quarter. For our usual format, Francois will provide additional details in a few minutes, but let me take a moment to discuss our market dynamics. To be candid and direct, our results are primarily reflective of the temporary effects of 3 external forces and internal inefficiencies in 1 of the folding carton From a revenue standpoint, the most material impact we experienced in Q2 as we predicted and commented on after both Q4 and Q1 were the effects of certain customers working through substantial inventories accumulated through panic or over buying in 2022 when supply was very tight.

Speaker 1

This was felt primarily in the envelope segment where seven Long term resale customers accounted for 40% of the U. S. Unit decline in the legacy envelope business. This was purely a destocking exercise moderately exacerbated by a soft economic environment. 2nd, high interest rates and high inflation have impacted our markets in 2 ways.

Speaker 1

1st, In Packaging, and I think you'll understand this, reduced availability of discretionary income for items like Fragrances, Cosmetics and other Health and Beauty items adversely affects a core and high value added segment in our folding carton division. Additionally, and this isn't obvious to most casual Observers, high interest and inflation affects smaller charitable donations many charities like the Humane Society, the Cancer Society, Wounded Warriors and others rely on, particularly in the U. S. Market. That is if home budgets are being squeezed by the high cost of groceries and increased mortgage and car payments as a result of higher interest rates, they are less likely To make the small donations, this prompted major fundraisers to abandon or seriously curtail their mailing plans in Q2.

Speaker 1

Finally, on the revenue front, high and fluctuating interest rates materially dampened credit card solicitation mailers as issuers tried to ascertain What incentives made sense? Imagine being a credit card issuer trying to determine whether 0 interest or 1% interest or 3% interest or No interest for 6 months or whatever was viable if it's unclear rate hikes are over or not. The cumulative effects of working through loaded inventories and reduced discretionary income took a toll on Supreme X and our markets in Q2. From an internal efficiency standpoint, obviously a reduction of volume has a negative absorption effect in all of the facilities, But the issues were compounded in Q1 and Q2 by the underperformance of operations in the relatively newly commissioned Lachine facility. It's the same people operating essentially the same equipment, albeit in a new facility that underperformed.

Speaker 1

It was a confluence of issues including the rush nature of the exiting the TMR location and commissioning the Lachine facility at the end of 20 22 and the quote unquote distraction associated with the Paragraph acquisition in January and the Graf Pak acquisition in May and subsequent 90 day consolidation, which is now completed, spread local management a little too thin and a general malaise due to soft backlogs. The combination of temporarily reduced volumes across most business units And a primary facility that underperformed led to the tepid results. The promising news is that we see volumes trending back Some level of normalcy in the second half, resellers have started to replenish inventories, credit card issuers and fundraisers can't And are not staying on the sidelines indefinitely, they need new clients and they need donations. Forecast and booking from the Health and Beauty segments are encouraging. In Outlook, we've been diligently reengaging with customers we couldn't serve during the tight supply period 2022 and engaging with new customers by leveraging our strong brand to continue to gain market share.

Speaker 1

As you may infer from my earlier comments on direct mail, Royal Envelope had a weaker quarter with revenue of $9,100,000 However, we are buoyed by renewed activity in July August and more robust mailing plans we have seen for the balance of 2023. The operational integration at Royal has gone well. We've extracted important synergies and we rely and we are actively seeking opportunities to leverage our scale, capabilities and expanded offerings of both existing and new customer relationships acquired in the acquisition. In Canada, year to date units in Envelope are basically flat for a couple of key reasons. Due to our market share and geographic proximity, We were able to manage the inventories of our resale customers effectively.

Speaker 1

And as a result, those customers have not had to work through over inventory situations. And given the small direct mail market in Canada, the downturn related to available discretionary spending and fluctuating interest rates that I passed earlier were much less dramatic. In the Packaging and Specialty Products segment, revenue from our core pharma and food segments were strong. Sales in the e commerce business were also strong and exceeded the prior year. Activity in the retail sector was off at a level consistent with overall market data.

Speaker 1

And as previously mentioned, the Health and Beauty segment has been a challenge, but their forecast for the second half looks Encouraging. Operationally, we completed the Graf Pak operation we completed the integration of the Graf Pak operations into the machine facility within the 90 days as planned. As we referenced when we concluded This is a perfect example of a pure synergistic tuck in that can provide benefits both on the revenue generation and cost reduction side. As I mentioned in my earlier comments, with the Paragraph acquisition in January and the GrafPac acquisition and integration Largely completed May June, coming immediately on the heels of the consolidation of the former Town of Mount Royal facility, We experienced some inefficiencies which disrupted normal flow of activities. As a result, in packaging, the combination of lower demand from Certain markets and operational inefficiency, we had a sales and profitability shortfall.

Speaker 1

Having said that, the consolidation of holding carton activities at Lachine is an essential component of our packaging strategy. This facility should and will be the jewel of our packaging operation. It houses great equipment, has an optimal workflow, has a group of employees that have proven they can deliver results. With Paragraph Operations now under our wing for 2 quarters, the Graf Pak closure and consolidation complete and a growing backlog, We are confident that our experienced management team and committed employees will work through their elements quickly. With that, I'll turn the call over to Francois for a review of the Q2 results.

Speaker 2

Thank you, Stuart. Good morning, everyone. I'm very pleased to join Supremix, a dynamic, well managed and financially strong company. Please turn to Slide 40. Total revenue was up 14.6 percent to $71,700,000 from $2,500,000 last year.

Speaker 2

Revenue from the Envelopes segment rose 7.3 percent to $49,300,000 The increase reflects a $9,100,000 revenue contribution from the acquisition of Royal Envelope completed last November. Revenue was favorably impacted by an average selling price increase of 33.6%, which mainly reflects More favorable customer and product mix in our U. S. Operation as well as the year over year effect of pricing adjustments made in 2022 to mitigate input cost inflation. Conversely, volume decreased almost 20% as a result of lower industry demand, as Stuart mentioned.

Speaker 2

Packaging and Specialty Products segment revenue amounted to 22,400,000 up 34.7 percent from $16,600,000 last year. This increase reflects a $7,800,000 contribution from Paragraph, higher e commerce related sales and the integration of the grass pack operations in our Lashim facility. These were partially offset by the wind down of the Durabox operations in 2022, reduced demand from certain markets more closely correlated to the economic conditions and the residual effect of on sales and inefficiencies from consolidating the folding carton operations in Neshim while integrating Paragraph and Graf Pak. Moving on to Slide 41. Consolidated EBITDA was $9,400,000 in the Q2 of 2023 versus $13,900,000 last year, while adjusted EBITDA amounted to $9,600,000 compared to $13,900,000 a year ago.

Speaker 2

As a percentage of revenue, the adjusted EBITDA margin was 13.3%, down from 22.3% last year. Envelope segment adjusted EBITDA totaled $9,700,000 compared to $11,600,000 last year. This decrease is mainly due to the effect of lower volume on the absorption of fixed costs. As a percentage of revenue, The adjusted EBITDA margin was 19.6 percent compared to 25.3% last year. Now in the Packaging and Specialty Products segment, Adjusted EBITDA was $1,700,000 versus $3,300,000 last year.

Speaker 2

The decrease reflects lower demand from Consolidating folding carton activities in Pulachian while integrating acquisitions. As a result, Adjusted EBITDA was 7.4% compared to 19.6% for the same period in 2022. Corporate and unallocated costs were $1,800,000 in the Q2 of 2023 compared to $900,000 in 2022. The increase is mainly due to foreign exchange loss and an unfavorable adjustment to stock based remuneration expenses. Turning to Slide 42.

Speaker 2

Net earnings reached $2,100,000 or 0 point $7,400,000 or $0.22 per share last year. Adjusted net earnings amounted to $2,200,000 or $0.09 per share in the Q2 of 2023 versus $7,400,000 or $0.28 per share a year ago. Moving on to cash flow on Slide 43. Despite lower profitability, Net cash flows from operating activities remained solid amounting to $10,000,000 in Q2 2023 compared to $10,400,000 last year, mainly due to positive cash stream from working capital. For the same reason, free cash flow We use our cash flow to finance the acquisition of Graf Pak and proceed with net repayments of $3,100,000 on our revolving credit facility.

Speaker 2

We also returned an aggregate of $2,100,000 to shareholders through dividend payments and the repurchase of 56 1700 common shares. Looking at our financial position on Slide 44, total debt was reduced to $78,200,000 as of June 30, 2023 from $81,400,000 as of March 31, reflecting the aforementioned debt repayment. Net debt, which excludes deferred financing costs And cash stood at $76,900,000 As a result, our net debt to trailing 12 month adjusted EBITDA ratio was 1.3x x as of June 30, 2023 versus 1.2x 3 months earlier. At the end of the quarter, We had $43,000,000 in available liquidity under our senior secured revolving credit facility of $120,000,000 leaving us sufficient flexibility to finance our investments and operations. Finally, the Board of Directors declared a dividend a quarterly dividend of $0.035 per common share payable on September 22, 2023 to shareholders of record at the close of business on September 7.

Speaker 2

I turn the call back to Stuart for the outlook. Stuart?

Speaker 1

Thank you, Francois. Although disappointed with the Q2 results, We remain bullish with what the future holds for Supremax as we methodically build the business for the long term. Our strategy is simple, Leverage our capacity, know how and cash flow in Envelope to fund the Pivot Ins packaging. We are both product and geographically diversified, And we operate in 2 segments that we have positioned for sustainable success. In Envelope, we are the 2nd largest manufacturer in North America, Yet our market share is only about 7% to 8% in the U.

Speaker 1

S. Market. After developing our brand in stock and both in statement envelopes, We positioned ourselves as a leader in the vast U. S. Direct mail market with the Royal Envelope acquisition.

Speaker 1

We now stand firmly in all 3 of the major segments in the envelope market offering a broader than ever product portfolio to meet market demand. In Packaging, paper based solutions have market favor as CPG companies are increasingly turning to sustainable eco friendly packaging. In this segment, we are solidly rooted in the high value added verticals of Pharma, Health and Beauty, Food and E Commerce. We are very pleased with the integration progress of our 3 most recent acquisitions. The softness in Q2 was definitely not related to With the seamless transition of Graf Pak's operations, our short term priority is to leverage the now even greater As the adage goes, potential is a great thing to have, but a bad thing to keep.

Speaker 1

And be assured, we have added resources and refocused management's attention to Glasheen with a mandate and a sense of urgency quickly evaluate and execute on optimization initiatives and capture all available benefits. In parallel, our continued Solid financial position despite the soft quarter allows us to consider further expanding our scope in packaging. Having reached an optimal size in Quebec, our eyes are set on new territories either in Ontario or in the U. S. Regions where we already have a presence to continue and grow and benefit from natural synergies.

Speaker 1

With a current run rate of 70% to 30%, we are still aiming to That said, and in keeping with our conservative nature, While the acquired companies are performing well and in line with expectations in the current market conditions, in acquiring 5 locations in less 7 months, we've bid off a substantial amount and our first priority is to have all operations performing to our standards. In a nutshell, and I want to be clear on this point, the fundamentals of our 2 segments have not changed, We expect the current market reset and conditions to ebb later in the quarter. Our solid reputation should allow us to merge from this demand reset ahead of the market in general and our strong management team will have the Lachine facility had stronger operating efficiency levels in Q3. Meanwhile, on the cost side, we have repeatedly proven that we can tightly manage our expenses. In closing, despite the results, I want to thank the entire Supremex team for providing superior service no matter what the market conditions are.

Speaker 1

Their talent and dedication will bring us success as we carry out the strategy. This concludes our prepared remarks. We'd now be pleased to answer any questions you may have. Operator?

Operator

Thank you. We will now begin the question and answer session. Our first question is from Matthew Lee from Canaccord Genuity. Please go ahead.

Speaker 3

Hi, good morning guys. So just on the envelope side here, it looks like volumes are down about 35% on an organic basis. Can you maybe just help us break down Between the inflation impact on mailing and the impact of destocking, how that kind of splits and then how Much of

Speaker 4

that you've touched on 1 in Q3.

Speaker 1

Yes, sure, Matt. We appreciate it. I think one thing with the envelope business, We look at the 6 months, we had an incredible the year to date numbers, we had an incredible Q1 on the envelope side that surprised a lot of people. We signaled that the market had started to turn in late Q4 And into Q1. And on that basis, I mean, we are ahead of the market decline.

Speaker 1

I think it's really a temporary ebb. The fundamentals of the market haven't changed. And For all of 2022 and the beginning of 2023, the envelope market had a voracious appetite as the industry and we just couldn't make enough envelopes. And To our point earlier, the overstocking and as a result of panic buying, paper supply was tight, so people bought more to ensure They had enough. This made supply even tighter and so on and so forth.

Speaker 1

Small businesses that buy their envelopes through printers Worth mailing more, and USPS didn't see a spike, yet demand was through the roof from the envelope for the envelope manufacturers. And I often say nobody cares about envelopes until they don't have any. And it was the fear of not having any that really drove the market. I guess the most succinct, which is not my strong point way of saying it is, Our situation on resale envelopes was exactly what happened in toilet paper in COVID. At some point, people realized they weren't using more and The supply was way more consistent than they thought it was going to be.

Speaker 1

So they just stopped buying until their living closets were empty. And then they just they restock stuff. So that's exactly what happened and about as distinct as I can be on this Destocking, but then the interest in inflation, like a lot of companies, a lot of industries, We are impacted by it. We're susceptible to macroeconomic conditions and while most people are the casual observer wouldn't Naturally equate elasticity between envelopes and interest rates and inflation, but I hope I did a decent job explaining sort of The nuances of charitable giving and that in my comments, but I tried to provide some real life examples and The not for profit solicitation business is massive in the U. S.

Speaker 1

And really drives a lot of that What we classify as direct mail and when they sneeze, the industry catches a cold and they sneezed in Q1 As the inflation sort of took hold and the residual effects through Q2 and the envelopes used in not for profit solicitations Are made on the exact same equipment that those statements are made on. So if that market dries up, The manufacturers naturally turn their attention to other markets and you've got more capacity chasing the same or less volume. So That's kind of the dynamics of it and the 3 of them, the confluence of the 3 of them and coming off a super hot To 2022, it makes the comp a bugger and then you got the 3 things. If we didn't have destocking and we just had the economic conditions, nobody would have noticed, nobody would have known. But the combination of the macroeconomics inflation and interest rates sort of squeeze in direct mail and others Along with the destocking, it was just something that we couldn't overcome from a volume standpoint.

Speaker 1

Great. That's great color. And then maybe

Speaker 3

when I think about 3. If I think Q1 volumes are up 3%, Q2 volumes are down 20% in terms of reported. Is Q3 double digit decline or is that going to improve from the Q2 number?

Speaker 1

Yes. So I mean I tried to provide a little bit color with my comments, but the short answer is yes, and we have tangible evidence that it's improving. Going back to my paper analogy, as long as you continue to use it, eventually you'll have to start to rebuy. And that's something unless something has fundamentally changed, you'll start buying at the same rate with the same cadence. And We have no evidence that the small business that buys 5,000 envelopes from their local printers have changed their mailing patterns.

Speaker 1

And as a result, the We expect the resellers to reorder as they work through their inventories. And in fact, backlogs for stock envelopes have improved considerably. And Anecdotally, just last night, the Senior VP responsible for envelopes at our largest U. S. Customer sent an email to myself and Joe Maglione, who's President of the Envelope Division, and the subject line simply said replenishment orders are coming tomorrow.

Speaker 1

He knows we've been anxious and it's really hurt us. I was with him 3 weeks ago and said, we dedicate a sizable portion of our capacity to you. You were clamoring for more all of 2022. We delivered more to you in all of 2022 and into 2020 the beginning of 2023. You want us there for you when the industry bounces back.

Speaker 1

What are we supposed to do When you bought less than 50% in the first half of the year, well, you destocked. And it was a rhetorical question because I knew we couldn't really do anything about it. But anyway, we were buoyed just last night, literally last night, Refundishment orders are coming today or tomorrow, sorry, meaning today. And on the direct mail side, as I said in my comments, Not for profits and credit card solicitations, they just can't stay out of the mail forever. Mail is a proven effective mode to Attract new customers and attract donations, it's the heartbeat of the revenue streams and they have overheads.

Speaker 1

I mean, There is evidence that they're sort of awakening from a 3 to 4 month slumber. And again anecdotally on the Direct Mail side, our largest customer went from 20,000,000 units a month roughly About 3 years, dollars 20,000,000 a month, dollars 20,000,000 a month, dollars 20,000,000 a month, to just over half of that in Q2. In July, we produced $27,000,000 for them and mailing plan for August is 25,000,000 So it doesn't mean we're out of it, but the signs are all there. It's positive. The market Just can't say, Martin didn't drop 25% fundamentally for overnight.

Speaker 1

And As I said, it really hurts when you get destocking and the macroeconomic conditions in the same quarter. I hope that helps. Yes, that's great color.

Speaker 4

All right.

Speaker 3

I'll pass the line.

Speaker 1

Thanks, Matt.

Operator

The next question is from Ahmed Shath with Beacon Securities. Please go ahead.

Speaker 4

Good morning, Stuart and team. I guess maybe switching gears On the packaging side, maybe give us a little bit of a color of how the demand environment is looking there and What can you attribute relative weakness in the quarter? Had there not been any deterioration issues or challenges in machine?

Speaker 1

Yes. Hi, Ahmad. I don't want to jump ahead on the question, but I do think it's important and maybe I'm splitting hairs a little bit here, but I would like to distinguish between integration and commissioning. There are 2 different things. Royal paragraph, graph back to a lesser extent.

Speaker 1

They were affected by the macroeconomic conditions, but becoming part of Supremeax wasn't Any of the challenges that they faced. So the acquisition, I mean, the synergies we pulled out of Royal in just 3 or 4 months, It's been incredible. It's hard to see on the EBITDA line because of all of the other things that are going on, but that integration has gone fantastic. And then paragraph, it's we've moved some orders around. We've taken advantage of more efficient equipment.

Speaker 1

People have been good. There's a lot that goes into buying a $30,000,000 to facility operation and That created some distraction for the management team on the packaging side. So the integrations themselves are going well. What's Bumpy is way bumpier than sort of I expected and think that it should have been is the just this commissioning of the new facility. So and then on the demand side in packaging, everything I talked about on the envelope side is virtually the same in packaging.

Speaker 1

The destocking to a lower degree, but we do have customers that are overstock, Either they bought too much or their sales have slowed, so they're taking it less. We do a lot of So make and ship and we have no visibility on what the customers how their inventory is depleting and they just replenish later a month later, 2 months later or at a lower quantity. And the order intake slowed in that regard. But we do a lot of vendor management for customers as well and this will maybe talk about What happened in the quarter, but more importantly, what the future looks like. We have forecasts.

Speaker 1

We plan around those forecasts. We get approvals to produce Off of their forecast before we go to press, and they started to cut back on the call off quantities in Q1. We shipped just in time. We know in real time what's happening and have some visibility and we could see what was Coming in some of those segments, like envelope, we're seeing the same dynamics. Customers are coming out of slumbers, are becoming more bullish for Q3 and Q4.

Speaker 1

And the relationship between overstocking and in the Health and Beauty segment, our products are Purchased with our customers' products that we serve are purchased with discretionary dollars. Our largest my 2nd largest customer, I guess now, in the health and beauty side and I think you know who it is. Our main product with them is professional hair salon products that go to professional hair salon. So now you got $8 butter and you got $6 milk and you got your mortgage rate is going up. I think people are Waiting longer before they go back to the professional salon instead of monthly, maybe they're going every 6 weeks or instead of every couple of months, they go quarterly.

Speaker 1

And We're just a bit of a victim of that and we didn't have enough time to sort of reconstitute or to develop enough new business to backfill that. And those customers expect us to be there When things swing back. So, and then so we didn't have enough absorption in the plant and Labor is another problem. Again, we all know what tough labor is and customers expect us to be able to turn on the tap when they want us to. Our shareholders expect us to be able to drive revenue and we need labor to make those products.

Speaker 1

And we get a dip in demand and we generally bring orders forward From inventory and produced inventory, but our warehouse assets are full. So we kept People employed and maintain productivity and get absorption, but our warehouse is full and we just did maintenance and we forced vacations, but there was Very little relief for the P and L in the quarter. Yes, we believe it's temporary and we're reengaging and talking to customers. But in Q2, we just Didn't have enough levers to pull to overcome destocking and sort of a general slowing economy for discretionary items. Does that help?

Speaker 1

No, that's

Speaker 4

a great color, Stuart. So is it fair to say from what I was referring to comments Looking into Q3, Q4, the second half of the year, the dynamic in the packaging is similar to what we've heard from you earlier on the envelope side or are customer is still more gun shot in terms of orders for the second half?

Speaker 1

No. So our backlog in Lachine is extremely strong right now for August and into September. A month or 2 doesn't make a quarter or a trend. But yes, we're seeing more activity. We know that Those vendor managed inventories, the forecasts are stronger for Q3 and Q4 than they were in Q1 and Q2.

Speaker 1

So the aggregate effect of that is should be helpful. And just triggering ahead to that, looking at the inefficiencies in the Lachine I mean, as I said, it's not really integration. It's move related and it's no one thing. It's been a bit of a confluence of things. And It's generally the same people running the same equipment and they'll get there.

Speaker 1

We took management Other facilities and to evaluate equipment and spread them pretty thin and Just the combination of weak backlogs, New environment, equipment, not running quite as efficiently as it was. We know from experience whether you move a machine halfway around the globe or you move it 6 kilometers, It's going to take time before it functions like it did in the previous facility, whether it's the same people running it or not. And that's exactly what we're experiencing. We sort of see every day that it's better and we've now hired people at Paragraph that allows the sort of a local management team To spend more time in the Lachine facility and being there to help troubleshoot issues or make decisions or Frankly, push the guys a little bit harder. I mean, it's not hard to imagine that backlogs are weak, Taken a little bit longer to set up every job.

Speaker 1

It's kind of human nature and it requires management to be Johnny on the spot and

Speaker 4

That's very helpful, Stuart. Thanks

Operator

This concludes the question and answer session. I'd like to turn the conference back over to Stuart Emerson for any closing remarks.

Speaker 1

Okay. Thanks very much, operator, and thank you to everybody that's on the call this morning. We really appreciate your interest in Supremex. And while we were disappointed with the quarter, we're still very bullish on where we are, what we are, And we look forward to speaking to you at our next quarterly call. Thank you very much.

Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.

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Supremex Q2 2023
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