Swiss Water Decaffeinated Coffee Q2 2023 Earnings Call Transcript

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August 10, 2023

There are 5 speakers on the call.

Operator

Welcome to the Swiss Water Decaffeinated Coffee Inc. Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

Before we begin today's call, we would like to remind you that certain information in today's presentation It's forward looking in nature. Any such forward looking information or statements are based on assumptions that they considered reasonable at the time The information was prepared. Such information involves known and unknown risks, uncertainties and other factors outside our control that could cause actual results to differ materially from those expressed in the forward looking information. Swiss Water Decaffeinated Coffee, Inc. Does not Please refer to Swiss Water Decaffeinated Coffee Inc.

Operator

Management discussion and analysis posted on SEDAR I will now turn the conference over to your host, Ian Carswell, CFO at Swiss Water. Ian, you may begin.

Speaker 1

Thank you, Paul. Good day, everyone, and thanks for taking time to join us. I'm Ian Carswell, CFO of Swiss Water Decaffeinated Coffee Inc. Frank Dennis, our President and CEO is away and unable to attend today's So I will carry the ball this time. I'm here to discuss Swiss Water's financial results for the 3 6 months ended June 30, 2023, which were released yesterday.

Speaker 1

I'll begin by taking you through our financial results, and then I will tell you more about our longer term plans and expectations. After that, I'll be happy to take your questions. As outlined in yesterday's press release, in our MD and A and on our Q1 earnings call in May, The Q2 of this year fell within a transitional period for Swiss Water. As such, our financial performance during the quarter was not typical of what we have delivered Recent periods nor of what you can expect going forward. In April, we decaffeinated the last bag of coffee at our legacy production facility in Burnaby, B.

Speaker 1

As we prepared to permanently shut down our 2 decaffeination lines there and vacate the site on the exploration of our lease in June. As the Burnaby asset ceased production before our new second decaffeination line at our Delta facility was fully operational, we began bridging a short period of capacity constraints during the Q2. This transitional period stretching from April through August of this year was Several months ago, we began working proactively with all our customers and suppliers to ensure that we were aware of what Expect from Swiss Water regarding the production of coffee leading up to the Burnaby exit. During the period of lower production capacity And before the new decaffeination line in Delta begins producing a commercially viable product. Knowing that our capacity would be temporarily During the second and third quarters, many of our customers moved the timing of their orders forward into the Q1 to ensure that they had Fish and coffee on hand to bridge the transition.

Speaker 1

We also built up our own inventory to enable us to meet customer demand. This had a very positive impact on our volumes and as a result, our financial performance during Q1. Predictably, the capacity constraints we experienced during the Q2 had an offsetting negative impact on our volumes. The temporary reduction in volumes combined with a number of Significant one time costs related to the shuttering of our old Burnaby facility negatively impacted our financial performance for the 3 6 months ended June 30. When we look at the first half, the strong results we achieved during Q1 helped offset some of the impact of the 2nd quarter transition.

Speaker 1

It's important to emphasize that this was a temporary disruption of the upward trend in the growth of our business and in this Strong performance in Swiss Water has demonstrated over the past several quarters. That said, the curtailment in volume we absorbed in Q2 of this year And the one time costs related to vacating Burnaby will likely lead to lower earnings year over year when we report results for the full 2023 fiscal year. In July, subsequent to the end of Q2, construction of the second line in Delta was completed and the first bag of trial coffee was decaffeinated on the new line. We expect to begin producing commercial grades product from Delta Line 2 before the end of Q3 this year. Now that we have put the burn of the exit behind us and consolidated all production in Delta, we expect to regain our volume trajectory as we ramp up production on our 2nd new line.

Speaker 1

With that context, let me now take you through our financial results. As always, I'll begin my review with volume shipped to customers, This is the key metric that drives our financial performance. As a result of the temporary capacity constraints resulting from the shutdown of the two lines at our legacy Burnaby Swiss Water's processing volumes were down as expected during the Q2. Taken together, volume shipped to customers in all categories were down by 25% in the quarter. For the first half, volumes were down by just 5%, largely due to the front loading of orders into the Q1.

Speaker 1

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 While shipments to importers, those customers who resell our coffees to roasters where and when they need it were down by 46% in the quarter and by 26% for the first half. Looking at the roaster segment another way, specialty roaster account volumes were down by 35% in the quarter and by 13% in the 6 months to June 30. These accounts serve the out of home consumer primarily in cafes and restaurants in our key geographic markets. Shipments to large commercial roasters were also down in Q2, shrinking by 17% compared to the Q2 of last year. However, first half shipments were comparable to 2022, growing by 1% this year.

Speaker 1

Turning now to revenues. 2nd quarter revenue of $43,400,000 was down by $5,000,000 or 10% from Q2 of last year. Our first half revenue of $92,400,000 was up by $5,600,000 or 6% from last year's result. As with volumes, the drop in quarterly revenue was largely due to the temporary reduction in production capacity during the transition from Burnaby. For the first half, this negative impact was offset by the strong volumes we put through in Q1.

Speaker 1

Looking at the cost side, Our Q2 cost of sales was $40,000,000 down by $500,000 or 1% compared to Q2 last year. The quarterly decrease was due to the capacity constraint and resulting reduction in volumes during transition from Burnaby. For the first Half cost of sales was CAD84.1 million, an increase of CAD11 million or 15% from the 2022 level. The first half increase was mainly driven by our increased production volumes during Q1, the significant one time increase in depreciation expense associated with the write down As to green coffee costs are remaining at historically high levels. The NYC was down from $2.25 per pound In Q3 2022 to $1.85 per pound in the Q2 of this year.

Speaker 1

With coffee prices now on a downward trend, We can expect some of our customers to sit on the sidelines and wait for the market to bottom out. Foreign exchange rates can also have a material on our profitability and cash from operations. This is because the majority of our revenues are generated in U. S. Dollars, while a significant portion of our costs are Our exposure to changes in the exchange rate is managed in part through derivative financial instruments.

Speaker 1

However, all other factors being ECO, we benefit when the U. S. Dollar appreciates as it did during the Q2 of this year. In Q2, U. S.

Speaker 1

Dollar averaged CAD1.34, up CAD0.06 from CAD1.28 in the Q2 last year. As I noted, this appreciation had a positive impact on our revenues when they were converted to Canadian dollars. 2nd quarter gross profit was $3,400,000 a decrease of $4,500,000 or 57 percent when compared to Q2 of 2022. For the first half, gross profit was CAD 8,300,000 down CAD 5,400,000 or 39% from last year's results. The gross profit percentage decreased from 16% last year to 9% in the 2nd quarter.

Speaker 1

The drop in gross profit was primarily driven by lower sales volumes, reduced green coffee differential margins and one time incremental depreciation expenses $400,000 in the 2nd quarter and $2,500,000 for the first half. As with the $2,500,000 impairment charge we took in the Q4 of 2022, this one time non cash expense resulted from an assessment of the salvageable assets at our legacy Burnaby facility in advance of the lease expiry there in June. To a much lesser extent, inflationary pressure on our variable production and freight costs also had a negative impact. As we've explained previously, in preparing to shut down the facility and vacate the site, we undertook a detailed analysis of our Burnaby With the help of an outside engineering consulting firm, this process carefully considered the potential future use, costs and benefits And related cash flow impacts involved in removing and repurposing equipment and determined that only a portion should be salvaged and the rest written off. 2nd quarter operating expenses were $3,400,000 up by $200,000 when compared to Q2 of 2022.

Speaker 1

For the first half, operating expenses were $6,800,000 up by $400,000 from last year. The administrative portion of operating expenses Higher professional fees related to the refinancing of our debt structure. For the first half, administrative expenses were up by 5% Due to general inflationary pressure and higher insurance fees as well as the depreciation and rental expenses associated with operating 2 facilities The sales and marketing component of operating expenses was up by CAD200,000 for both the quarter and the first half. As we move through the balance of 2023, we expect our sales and marketing costs to increase over last year's level due to slightly higher headcount and salaries well as return to normal travel and trade show activity. Q2 operating income Of $100,000 was down by $4,300,000 from the Q2 of 2022.

Speaker 1

First half operating income of CAD1.5 million, a decrease of CAD5.8 million from last year's result. Again, the big drivers of the drop in operating income were the reduction in production capacity during the 2nd quarter transition materially lower green coffee differential margins, the increase in depreciation expense and to a lesser extent Inflationary pressure on our variable production and freight costs. Turning now to net income, we reported a net loss of $400,000 for Quarter compared to net income of $1,500,000 in Q2 last year. For the first half, we recorded a loss of $1,100,000 Down by $3,900,000 from net income of $2,800,000 in the 1st 6 months of 2022. As with gross profit and operating income, the drop in quarterly net income was largely a result of the same factors as well as a material increase in finance associated with increased borrowings under our debt facilities.

Speaker 1

These negative factors were partially offset by gains on risk management activities, A revaluation of Swiss Water's embedded option within our debentures with warrants, higher finance income, reduced loss on foreign exchange And lower income tax expense. 2nd quarter net finance costs of $1,600,000 were up by $300,000 or 25 percent over Q2 of 2022. For the first half, finance costs were $3,000,000 up by $500,000 or 24% from last year's level. The increase was primarily due to higher outstanding balances on our construction loans and credit facility as well as higher variable interest rates. 2nd quarter adjusted EBITDA of $1,800,000 was down by $3,500,000 from Q2 2022.

Speaker 1

For the 6 months of this year, we recorded adjusted EBITDA of $6,800,000 down by $2,400,000 from the first half last year. The decrease in both periods is mainly driven by our lower sales volumes and reduced green coffee differential margin. As we look ahead into the balance of 20 20 We are continuing to see a strong order book, particularly for late Q3 and early Q4. Encouragingly, first half Sales volume to our North American customers, our largest market remained level with 2022 despite the 2nd quarter capacity constraints And general economic headwinds. Although international sales volume decreased, this was not unexpected, And we are cautiously optimistic this can be partially offset by higher sales volume during the second half of this year.

Speaker 1

In general, trading conditions remain favorable in our key markets as ever more industry participants move away from chemical decaffeination in favor of chemical free processes like ours. However, caution continues to be called for. Like businesses everywhere, Swiss Water is not immune to current and emerging macroeconomic risks. Inflation is becoming increasingly entrenched and economies around the world are struggling to get a grip of it by raising interest rates. The ongoing war in Ukraine has disrupted the global order and continues to create a lot of uncertainty in Europe and around the world.

Speaker 1

Here at Swiss Water, while the supply chain disruptions of the last few years have eased, we continue to experience some Delays in coffee deliveries from certain origins. The recent labor dispute and temporary shutdown of the Port of Vancouver was another illustration Of the brittleness of the international supply chain. And as we've noted, Swiss Water has experienced very significant inflationary pressure on virtually all of our input costs From natural gas to freight to labor. These risks and increasing costs demand our close attention and may require further mitigation measures. Looking at operations during the first half of this year, until the shutdown in late April, we ran both decaffeination lines in Burnaby on a 20 fourseven And here in Delta, the initial decaffeination line, which we designate Delta Line 1, operated smoothly and efficiently Also on a 20 fourseven basis throughout the 1st 6 months of this year.

Speaker 1

Having fully optimized the production from Line 1, we are now sharply focused On ramping up production on Delta Line 2, our 2nd new decaffeination line. As I noted earlier, we decaffeinated the first Trial bag of coffee on Line 2 in July and expect to be producing commercial grade coffee from this new line before the end of the current quarter. We have now completed the exit from Burnaby and are moving forward in our new state of the art production facilities. This transition marks the culmination of a multiyear project to relocate, modernize and expand the capacity of Swiss Water's production assets. The consolidation of all production in Delta Will provide us with a number of operational efficiencies as well as capacity for future term growth.

Speaker 1

As we've noted before, Based on analysis from a 3rd party engineering firm, we expect the 2 new lines in Delta together will have a targeted end capacity at least 40% greater than the old Burnaby facility. As to the Delta Line 2 project budget, The preliminary cost estimate for design and construction was approximately $45,000,000 plus commissioning costs of around $2,000,000 During the second half of twenty twenty two, the impact of global macroeconomic pressures, including inflation, building trades disruptions and Supply chain issues became more acute in terms of the impact on our budget and schedule. Given the impact of these factors, as previously disclosed, We revised the Line 2 construction budget to a total of $53,000,000 The original $2,000,000 commissioning budget remains unchanged. There were also material costs involved in shutting down our legacy Burnaby facility, salvaging whatever equipment was deemed economical I'm vacating and preparing the site for return to the landlord. As I noticed, we developed this exit plan with the help of a third party engineering consultant.

Speaker 1

The budget to complete our exit from Burnaby was $1,500,000 and we are not anticipating any costs beyond this. With last year's incremental $12,000,000 expansion of our senior term credit facility, along with our existing available credit and projected internally generated cash We have sufficient funds to cover both the Delta Line 2 project and the Burnaby exit plan. That wraps up my comments for today. I would now be happy to answer any questions you might have.

Operator

Thank you. Answer session. We request that in the interest of time today, participants limit themselves to one question before getting back in queue. We do have one question in queue. And The question today is coming from Richard Rodri from Glenbrook Capital.

Operator

Richard, your line is live.

Speaker 2

Thank you. Yes. So concerning Delta 2, I just wondered when you envisage the logistically full Has that be available? And also, when do you perceive demand for running that 120 fourseven as well? Thank you.

Speaker 1

Thanks for your question. As I talked about earlier, we are anticipating that We will be running that line commercially before the end of Q3. So within the next few weeks, we are expecting to get commercial product off that line. It is a new line. With all new lines, it does take time To kind of get them up to full operational capacity.

Speaker 1

And in the short term, we are expecting to have Excess capacity on that line. So speaking to my operations director, he doesn't have any concerns about our ability to satisfy demand between now and the end of this year. So we'll be running that line As fast as we feel comfortable between now and the end of this year. In terms of how quickly we'll be running that line on a 20 fourseven basis. I would expect to be running that line at somewhere between 70% to 80% capacity Fairly quickly.

Speaker 1

And then depending on how demand plays out over the next Couple of years will determine how quickly we're going to fill the line up. Obviously, we will also be looking at efficiency, small efficiency tweaks that we can make to squeeze additional capacity out of that line as we move forward. But it's kind of an unknown right now how strong demand is going to be Going forward, we certainly expect Strong growth to come back into the business now that we have excess capacity.

Speaker 2

Okay. Understood. And did I Was I correct when you said that delta-one plus delta-two is 40% more capacity Then the old Burnaby facility?

Speaker 1

Yes. It would be at least 40% of our capacity.

Speaker 2

Because if you're going to be running hopefully 70% to 80% fairly quickly, if the business, It's been very good for many years. I mean, is it possible you'll be at full capacity and perhaps not have enough capacity to meet Demand in the next few years?

Speaker 1

I mean, The rationale for building the second line was to build in enough excess capacity to service our growth In the intermediate term, the reality is that if our business continues to grow at Strong double digit rates as it has done for the last few years. Yes, there will be another Capacity discussion that we'll need to have at some point further down the line. That's something that Management and the Board are acutely aware of and we talk about whenever we meet.

Speaker 2

And is there enough space on-site for that because I haven't had the chance to visit? We've been shareholders for over 20 years, I think so. And I haven't seen the new facility. So I was just wondering if there is room on-site for Delta 3 down the line.

Speaker 1

Yes, we have room for up to Two additional production lines on-site here. So yes, we're not constrained by space as we were in our former

Speaker 2

Okay. And can I just shift the question, correct me if I'm wrong, but I think roughly your debt is just over 1,000,000 in total and that will be paid off in 10 or 11 years? Do you think there's a chance because we've been shareholders, as I say, for a long time, so we remember the days of the dividends. And I just wondered if you envisage and if at what juncture the dividends returning to shareholders?

Speaker 1

I mean, it's something that, again, It's something that is discussed internally. And certainly speaking as CFO, it's Something that I would like to target and I think the Board and management will make an assessment of the most appropriate

Speaker 2

Okay. Thanks, Ian.

Speaker 1

Thank you.

Operator

Thank you. The next question is coming from Graeme Starco and Graeme is a Private Investor. Graeme, your line is live. Yes.

Speaker 3

Hi, there. Now that you've reached substantial completion at the Delta facility, can you give us an idea of what you think the maintenance CapEx And is going to look like going forward maybe into 2024?

Speaker 1

Yes. I mean, generally maintenance CapEx It runs at about $300,000 per line. So I would expect we're running 2 lines. I would expect that to The path forward, meaning obviously these are brand new both brand new asset. Well, 1 is 3 years old, but the other one is brand new.

Speaker 1

You'd expect maintenance Spend to be not be excessive in the 1st few years of life. So yes, I'm not expecting any material increase in maintenance spend.

Speaker 3

Okay, great. So That's $300,000 per line per quarter or per annum?

Speaker 1

Per annum, that's generally what we're running at. Okay, great. Thank you. Historically.

Operator

Thank you. The next question is coming from Richard Whiting. Richard is a private investor. Richard, your line is live.

Speaker 4

Yes. Hello. Could you comment on your business from importers? It seems to be quite a bit weaker than the business from other customer types. And could you Comment, is there something going on there competitively?

Speaker 4

Are you losing market share? Or does competitive conditions change there? It looks like the decline is bigger than would be accounted for just a shift in business temporarily.

Speaker 1

I think there's I think it's across the entire market, the coffee market. We're in a period where the coffee price is coming down. We're also coming out of a period of significant supply chain disruption for the coffee market. And as a result of that, some customers will have held higher stocks The normal through last year over the last kind of 12 to 18 months. I think what we're seeing is that as prices fall, Companies are looking to kind of rebalance their stocks in their warehouses.

Speaker 1

So I think that's contributing to it. And I don't think I think that is just a natural consequence of the cycle that the industry has been moving through, Probably starting in the pandemic and then moving through beyond that and dealing with some quite significant supply chain disruptions for coffee out of origin.

Speaker 4

So you don't see any change in competitive conditions or you don't feel you're losing market Share there in any way?

Speaker 1

I don't feel we're losing market share there. No.

Speaker 4

Okay. Thank you.

Operator

Thank you. And there were no other questions from the lines at this time. Ian, I will hand it back to you for closing remarks.

Speaker 1

Okay. Well, thank you, everybody. If there are no further questions, I'll conclude today's call.

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Swiss Water Decaffeinated Coffee Q2 2023
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