Supremex Inc. (SXP) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Supremex Third Quarter 2021 Earnings Conference Call. [Operator Instructions] This call is being recorded on Friday, November 12, 2021. I would now like to turn the conference over to Jennifer McCaughey. Please go ahead.

Thank you, operator. Good morning, ladies and gentlemen, and thank you for joining us for Supremex Third Quarter Conference call. My name is Jennifer McCaughey from MaisonBrison Communications, an Investor Relations consulting firm supporting Supremex with IR activities. With me today is Stewart Emerson, President and CEO; and Mary Chronopoulos, Chief Financial Officer and Corporate Secretary. Following their comments, we will open the call for questions. For a more detailed analysis of our results, please see our financial statements, MD&A and press release published 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. Please refer to the forward-looking statements as detailed in the presentation supporting this conference call. Furthermore, risks and uncertainties are discussed in the annual information form dated March 31, 2021, under the heading Risk Factors and updated in our latest MD&A. During this call and in the presentation, we use various non-IFRS measures, including adjusted EBITDA and adjusted net earnings. These terms are defined in our MD&A. Unless stated otherwise, all figures are expressed in Canadian dollars. With that, let me turn the call over to Stewart.

Thank you, Jennifer, and welcome, everyone. Let's turn to Slide 43 of the investor presentation for an overview of the third quarter. I'm extremely pleased with our third quarter performance, which included strong sales growth in both segments and the second consecutive quarter of year-over-year improvement in adjusted EBITDA. We maintained our growth momentum with revenues up 9.9% and adjusted EBITDA up 8% over the same period last year. We achieved these results despite a negative currency conversion, an extremely tight supply chain for all paper grades and rapidly escalating costs across the board. These results are a testament to our product and geographic diversification, the resilience of our business model, strong relationships with suppliers and the dedication of all our staff. Our team did an excellent job gaining market share, passing through price increases, implementing cost efficiencies and managing through the challenges linked to supply chain and labor issues. Turning to operations. The integration of Vista is on track and the new equipment has arrived and is in the process of commissioning. More specifically, gluer is running live jobs and the die cutter is currently being installed. Not unlike a lot of companies, staffing has been the biggest challenge we faced in Indianapolis. But the local team has stepped up and are working over time to ensure we service customers while the HR team put a full court press on recruiting head onboarding. Once complete, this investment will provide our e-commerce team with much needed capacity, new capabilities and improved efficiencies in the local U.S. markets. In terms of footprint, after closing the Edmonton facility and downsizing the Moncton facility, we have begun the planning of the move of our folding carton plant in the town of Mount Royal to an alternative location in the Greater Montreal region. This move to be completed in the second quarter of 2022 is required as a result of the expropriation of our current facility for the Royal Mount project. The team is working diligently on the project, so we can transition with minimal disruptions to operations. We are well down the path of site selection, and between the 3 folding carton locations and external partners, there's good redundancy built into the network. There is ample time with the support of our external and internal Supremex resources to make this transition smooth, efficiently and with minimal disruption to the customers. We will incur onetime costs for the project, which will be largely recorded in the first half of 2022, and we expect our annual rent expenses to be higher than what we are currently paying. Organizationally, we have made some important strides in our structure to support future growth. Anybody that's followed the company for any period of time appreciates that we've been a lean management team. To set ourselves up for future growth, we have made a decision to move to a more traditional large company structure with full-fledged envelope and packaging divisions and to build our executive team. In line with this objective, I'm excited to highlight that we have created 2 new executive positions, which will improve our bench strength and better position the company for future growth. First position is President, Envelope. As U.S. Envelope becomes a more material portion of the envelope segment, this new position will allow us to look at operations, pricing and go-to-market strategies more holistically. Joe Baglione has been with Supremex for over 30 years and has been promoted to this newly created position. Joe and I have worked side-by-side for 25 years. Joe took on sales, marketing and management roles and successfully progressed through the organization, becoming Vice President and General Manager of U.S. Envelope in 2018. Most recently, he has held the position of Vice President and General Manager of Eastern Canada Envelope and Label, which represents approximately 85% of Canadian Envelope's revenue, and his plants produced the envelopes for over 50% of the U.S. Envelope's revenue. Joe is extremely talented, a subject matter expert and Supremex is part of this DNA. Joe is a known entity, a proven leader, and I look forward to continue working closely with him in his new capacity. We also created the position of Vice President, People and Culture. This is an important next step for Supremex to add a senior HR executive. We consciously selected the title of People and Culture to reflect the growing challenges in labor markets, and I'm pleased to welcome Leslie Sutherland to this new position. Leslie is a highly accomplished strategic human resource leader with over 25 years of large private and public companies as well as governmental organizations. Before joining Supremex, she was Vice President, Human Resources and Business Operations at Toronto Global, an arm's length organization representing municipalities in the Toronto region. I'm convinced that Leslie's experience and skill will make an immediate contribution to the team. Welcome aboard, Leslie. Over the next few quarters, we are hoping to announce other key additions to the team. In summary, we had another very good quarter and are positioning the company for future growth. With that, I'd like to turn the call over to Mary for a review of our Q3 financial results. Mary?

Thank you, Stewart. Good morning, everyone. Turning to Slide 44 of the presentation for our top line review. Total revenue was up 9.9% to $54.8 million from $49.9 million last year, Revenue from the envelope segment was up 8.5% to $37 million. Canadian envelope revenue grew by 2.7% to $22.3 million. Average selling prices increased by 8.5% from last year's comparable period primarily resulting from price increases swiftly implemented to reflect rising input cost inflation and from changes in the product mix. This was partially offset by a volume decrease of 5.3% stemming from the secular decline affecting the envelope market. Revenue from our U.S. envelope activities increased by 18.7% to $14.7 million. The volume of units sold increased by 18.9% from efforts dedicated to increase penetration to the U.S. envelope market and from the rebound in demand in recent quarters from certain channels that were more affected by the pandemic lockdown measures. Although price increases were implemented in the U.S. market, our average selling price, when translated in Canadian dollars, were immaterial given the negative foreign exchange translation during the period. Packaging and specialty products segment revenue grew by 12.8% to $17.8 million primarily from the acquisition of Vista Graphic Communications concluded on March 8, 2021, coupled with organic growth. EBITDA and adjusted EBITDA increased by 8% to $8.7 million from $8.1 million in the third quarter of 2020. This increase resulted from higher sales volumes in both segments and operational efficiencies derived from the cost optimization plan. It was partially offset by higher cost of materials and lower recorded subsidies. Adjusted EBITDA margin decreased to 15.9% compared to 16.2% in the equivalent quarter of 2020. In our envelope segment adjusted EBITDA was up 19.5% to $6.9 million, driven by higher sales volumes and operational efficiencies derived from the cost optimization plan. Adjusted EBITDA margin was 18.6%, up from 16.9% in the equivalent period of 2020. In our packaging and specialty products segment, adjusted EBITDA decreased 12.2% to $2.6 million. These results reflect an unfavorable product mix partially offset by increases sales volumes and the contributions of the Vista acquisition. Adjusted EBITDA margin was 14.4% compared to 18.5% in the equivalent period of 2020. Driven by higher adjusted EBITDA, net earnings and adjusted net earnings increased to $3.4 million or $0.12 per share compared to $2.7 million or $0.10 per share for the equivalent period in 2020. Turning to cash flows and capital deployment on Slide 47. Cash flows related to operating activities decreased slightly to $6.7 million from $7.2 million in Q3 2020 mainly due to a negative net change in working capital adjustments partially offset by higher profitability. Similarly, free cash flow decreased to $4.8 million in the third quarter compared to $5.1 million for the same period last year. We used our cash primarily to invest in CapEx for $1.5 million and repurchased shares for $700,000, as you can observe on Slide 48. On August 27, 2021, we received approval from the TSX to renew our NCIB and purchase for cancellation up to 1.3 million of our common shares representing approximately 5% of our $26.9 million issued in outstanding common shares as of August 18, 2021. Purchases under the NCIB will be made over a maximum period of 12 months beginning on August 31, 2021, and ending on August 30, 2022. During the third quarter, the company purchased 292,400 common shares for cancellation under its current and prior NCIB program for a total consideration of $700,000. Year-to-date, the company purchased a little over 1 million common shares for a total consideration of $2.3 million. Subsequent to the end of the period, an additional 150,300 shares were purchased for cancellation for a total consideration of $347,855. Turning to the balance sheet on Slide 49. During the quarter, we entered a series of annuity buyout transactions in order to reduce the risk profile associated with our defined benefit pension plan. We ended the quarter in a solid financial position. Total debt stood at $52.1 million down from $56.8 million at the end of Q4 2020 despite an amount of $2.7 million used to acquire Vista Graphic Communications in Q1 2021. We ended Q3 2021 with a leverage ratio of 1.6x, a marked improver over the 2x at the end of Q4 2020. We also have over $50 million in available liquidity to pursue our growth objectives. I will now turn the call back to Stewart for the outlook. Stewart?

Thank you, Mary. So looking ahead, we expect demand for our products to remain strong in the fourth quarter and into 2022 driven by increased activity, customers rebuilding inventory, a potential reemergence of direct mail, a robust pipeline in folding carton and e-commerce solutions and our sales initiatives in the U.S. That said, we must still contend with the lingering effects of the pandemic on our activities and on global economic landscape. The 3 main concerns are: persistent supply chain issues primarily with paper procurement forecasted to last into 2023; second, rapidly escalating costs across the board; and third, labor shortages, which are constraining us from additional production hours and improving capacity utilization. That said, we are very well positioned to manage through these challenges given the strength of our team and our diversified product offering. Our backlogs are strong, and we are confident in our supply chain. We believe we'll get enough paper to satisfy the demand created in 2021 and generate some modest growth in 2022, but the tightness in the supply chain might impede our ability to maximize the demand opportunity in front of us. Furthermore, we are currently operating at full capacity, given the labor at our disposal and continue to successfully pass on price increases. In an effort to mitigate all of these effects, we continue to tightly control our operating expenses and use working capital prudently. In short, our near-term focus includes managing challenges related to the pandemic, integrating the Vista acquisition and completing the commissioning of the new equipment, transitioning to more value-added products in packaging, improving our customer mix in the U.S., building our bench strength, continuing to optimize our production capacity and capabilities to support our growth markets and planning the move of our TMR plant. In summary, we expect to continue to build on the momentum and finish 2021 on a strong note. Our long-term strategy remains intact, leverage our Canadian envelope capacity, know-how and cash flow to fund the pivot to packaging. Recall that our target is to generate 50% of our revenue from the Packaging segment by 2025 and our last 12 months revenues in packaging are at 30% of consolidated revenues. To accelerate this shift, we are intensifying our search in strategic acquisitions. Given our scale in the envelope segment and our strong financial position, we are well positioned to execute on our growth strategy. This concludes our prepared remarks. We'll now be pleased to answer any questions you may have. Operator? Thank you.

[Operator Instructions] Your first question comes from Neil Linsdell with IA Capital Markets.

Congratulations on the pretty good results, especially given the environment. Talking about the average selling price increases that we're constantly seeing, are we getting to any kind of point where this is going to become problematic and you're going to get customers that seek alternatives to your products? Or is this more of a changing mix or just everybody is accepting because of the inflationary environment? What do you see for that?

It's a good question, Neil. I mean, I would say it's the latter. Right now, customers are more concerned about supply than they are about pricing. They see it in their day-to-day personal lives and especially with the shortness of supply, a lot more concern about can I get the product versus what is it going to cost to get the product. the long-term effect on sort of decline or secular decline, our products tend to be a relatively small portion of the cost of the end product for their customers, for instance, bank statement costs, the bank's $2.50, $3 to prepare and mail, and our product is $0.02 or $0.03 of that $2.50 or $3. So we don't take our products, but the overall inflation will certainly have people asking questions about whether they should be using the product or not.

Okay. But you're in a relatively good position based on that equation. So when you talk about -- you're at full capacity now given the constraints. So this is, I guess, mostly labor constraints that you're talking about. And is that the same in all the different facilities and regions that you operate?

Yes. We're right up against it from a labor standpoint. The plants are running well. They've got very good backlogs. It's a bit of a tight road block with -- between securing paper and having the machine time or the labor to run the machines. But it's across the entire organization.

Okay. Because I'm just wondering if suddenly you get an influx of labor and that or would you be able to substantially increase your production capacity? I just wondered is that completely the constraint that you're looking at right now?

Well, it's a combination of the 2. I mean, we think there's about 20% capacity, maybe a little bit more in the pipeline. Like in the organization, if you fully staffed all of the primary equipment, there's probably another 20%. The challenge would be getting 20% more paper to operationalize it. For my comments. I mean, we think we -- I mean we're in discussions with our suppliers and our supply chain. Supremex is a customer that suppliers like to have. We give them good forecast. They get good visibility. We treat them fairly and we pay our bills. All of them have said they will try. They expect they'll be able to get us more paper in 2022, which will allow us some additional growth.

Okay. And you've been talking for years, I think, about how -- your relationships with your suppliers. So that's not really a surprise that you're well positioned given the environment that we're in. Is there anything else? I'm thinking of Glue Inc. Anything else that you use that's really making any kind of restrictions? Or is it mainly the labor and the paper then?

It's labor and paper, and there's a little bit on the corrugated side. It's available, just lead times are much longer. It limits flexibility, but by and large, it's paper.

Okay. And then you've made comments specifically about M&A, ramping up your strategy and I guess that would be focused on the packaging side. But you've actually done a lot of acquisitions, if I look at your charts here over the years as well. So how is your -- is your approach changing? Are you just putting more resources into it? Would you be going outside what your normal criteria were for acquisitions going forward?

So I mean, we're -- we referenced the change in the organization structure and a lot of that is designed to bring some people in so that senior management has more time dedicate to M&A. So that's part of it. Adding Joe will take a burden off some of the responsibility I have on that side, Leslie as well on the HR side. So I wouldn't say we're not changing our approach, but we're freeing up more time and resources to work on M&A. Is there a second question in there? Oh, yes. Our strategy remains the same in terms of filter. We said very clearly that when we went to the packaging, that we would focus in a geographic area, acquire until we got to the law of diminishing returns. And then we would change our -- turn our attention to another geographic market. We think we've done that in Montreal. Our attention is turned to the rest of Canada, and we have a pretty robust pipeline.

Okay. And then just one more on the equipment that you're having installed right now. Is there any kind of jump that we can expect at a certain date in.You got a backlog of requirements that you are just waiting to be able to get out the door? Or is this going to be more of a gradual ramp-up as this capacity is added?

A jump concerns me a little bit, I'll admit to that. But it adds a significant amount of capacity in an area in a geographic region where we're having tremendous success. So we've been significantly constrained on that e-commerce side from a capacity standpoint. This adds -- a potential to add 6,000 more hours of production. So I wouldn't commit to jump, but it really is going to help us take advantage of opportunities. The other nice thing there is in the local Indianapolis market, we've partnered with a mill that's given us allocation for 2022 that we think will allow us to meet our growth objectives.

Okay. I didn't mean to put work -- your mouth as far as that. So but the intent of the question is really to look at -- so the capacity that you're putting in and the equipment and all the changes that you're making is really to address demand that is pretty much already there. This is not we're going to put in the capacity and then we're going to go out and try and sell it. Is that...

Correct. Correct.

There are no further questions at this time. Please proceed.

Thank you all for joining the call. We look forward to speaking to you at our next quarterly call, and have a great weekend. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.