Swiss Water Decaffeinated Coffee Inc. (SWP) Earnings Call Transcript & Summary

Good day. Welcome to the Swiss Water Decaffeinated Coffee Inc. Second Quarter 2026 Conference Call. [Operator Instructions] Please note, this conference is being recorded. Before Swiss Water Decaffeinated Coffee Inc. conference call starts, they are required to remind you that certain information in today's presentation is 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 of 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 assume responsibility for the accuracy and completeness of the forward-looking information. Similarly, they do not undertake any obligation to publicly revise this forward-looking information to reflect subsequent events or circumstances, except as required by law. Please refer to Swiss Water Decaffeinated Coffee Inc.'s management's discussions and analysis posted on SEDAR and Swiss Water's website for a full discussion regarding forward-looking statements and the risks therein. I will now turn the conference over to your host, Frank Dennis, President and CEO at Swiss Water Decaffeinated Coffee Inc. You may begin.

Thank you, Paul. Good afternoon, everyone, and thank you for joining us today. I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Inc. Joining me on the call is Iain Carswell, our CFO. We're here today to discuss our results for the 3 and 6 months ended June 30, 2026. And as usual, I'll give a brief overview of our performance and the operating environment. Iain will walk through the financials in more detail, and I'll come back with a few closing thoughts before we open the line for questions. This was a very strong quarter for Swiss Water. And with the momentum in the business, including a solid order book, a growing brand and a rapidly improving balance sheet, we believe we're well positioned heading into 2027. Given that improving outlook, we intend to seek TSX approval for a share repurchase program under a normal course issuer bid or NCIB. We believe our share price could be undervalued over the coming year based on our financial performance and future prospects and that repurchasing shares alongside continued debt reduction is an appropriate use of funds to increase shareholder value. The NCIB is subject to TSX acceptance, and we will provide an update on that once it is available. For the last several quarters, we've said that when coffee prices came off their highs and the inversion eased, our customers would return to the market. That's exactly what happened in the second quarter. Processing volumes were up 17% over the second quarter of last year and now 8% year-to-date. That growth was supported by strong demand from our established customers, solid spot order flow and incremental volume from new customers. Our production lines operated at very high levels of capacity utilization throughout the quarter. And our forward order book is as strong as we've seen it with customers booking well into the first quarter of 2027. That's a very different picture from a year ago. Last year, the NY'C' was running up sharply. The futures curve was deeply inverted and customers stayed lean because they didn't want to carry the cost of that inversion. Those who kept their forward coverage short and purchased largely for immediate needs. This year, with a strong Brazilian crop and the market well off its highs, that inversion has corrected substantially. When that happens, customers refill pipelines and extend their order horizons to a degree, and that's what we're seeing in our order book. The market is still volatile and the trade is still cautious, but the direction is becoming clearer. The NY'C' averaged USD 2.78 per pound in the quarter against USD 3.59 in the same period last year. That flows straight through our green coffee revenue, so headline revenue was down 3%, even with volumes up significantly. As we've been very consistent about saying, we don't overinterpret revenue in either direction. What matters to us is volume, gross profit, adjusted EBITDA, cash generation and whether we're recovering the cost of carrying coffee for our customers. On every one of those, this was a very strong quarter. We're particularly encouraged by our trailing 12-month performance. LTM adjusted EBITDA passed $17 million for the first time in our history. That isn't the result of a single quarter. We've now improved sequentially for 4 quarters running, and that progress is visible in our cash flow in a debt levels. It reflects volume strengthening, our operations maturing and market conditions moving somewhat back towards normal at the same time. Our Delta facility continues to perform very well. Both production lines have been running for over 2 years now, and that continuity keeps showing up in quality, consistency and throughput. We operated at record capacity utilization this quarter. And given the strength of our order book and the demand we're seeing, we're assessing targeted investments to increase capacity, which we would expect to fund from internally generated cash flow and little debt. We'll evaluate the timing and scope of that work carefully in the near term. Interest in chemical-free decaffeination continues to build. Consumers are more label conscious than they've ever been and regulatory scrutiny of solvent-based processes keeps increasing in both the U.S. and Europe. But those developments are encouraging more roasters to evaluate chemical-free alternatives, and they support a conversion we have said for years that the consumer wants. It isn't the only factor driving our growth, but it reinforces the value of the process our brand is built on. We are realistic about the market. Coffee futures are still volatile, inversion is still being priced into both Arabica and Robusta, and we're watching the U.S. grocery channel closely where retail prices are still elevated and could create some changes to buying behavior in the back half of this year. Experience tells us it takes time for lower futures to reach the shelf. Our focus doesn't change. We keep coffee available for our customers, price appropriately for the cost of carrying it, operate reliably and remain disciplined in our use of capital. We go into the second half of the year with strong demand, real forward visibility, high capacity utilization and meaningfully less debt on the balance sheet than we carried a year ago. With that, I'll turn the call over to Iain to walk through the financial results in more detail. Iain?

Thank you, Frank, and good afternoon, everyone. Just a reminder that all the figures I'm going to discuss are in Canadian dollars unless otherwise stated. As Frank mentioned, the second quarter reflected a significant acceleration in volumes, stronger profitability and continued improvement in cash generation and the balance sheet. Total processing volumes increased by 17% in the quarter and by 8% for the 6 months of 2026 when compared to the same period last year. Capacity utilization was very high during the quarter, supported by strong demand from established customers, solid spot order flow and incremental sales to new customers. Looking at volumes by customer type, shipments to importers, those customers who resell our coffees to roasters where and when they need them, were up 26% in the quarter. Shipments to roasters, those customers who roast and package coffee to sell to consumers in their own coffee shops or for home and office consumption, were up 5% in the quarter. Looking at customer channels another way, specialty volumes were up 17% in the quarter. These accounts serve the out-of-home consumer primarily in cafes and restaurants in our key geographic markets. Commercial volumes were also up 17% in the quarter. Q2 revenue was $66 million, down 3% from $67.7 million in Q2 2025. Revenue for the first 6 months was $123.4 million, down 5% from $129.9 million in the same period last year. The primary drivers of the decrease were the lower NY'C' coffee futures price and reduced tariff costs passed through to customers, partially offset by the increase in volumes. As we said consistently, we're careful not to overinterpret movements in revenue because the value of green coffee flows through both revenue and cost of sales. In this quarter, the material increase in volumes largely offset the impact of significantly lower NY'C'. Moving on to our costs. Q2 cost of sales was $55.8 million, down 11% year-over-year. The decrease was primarily driven by lower NY'C' coffee futures prices, the elimination of U.S. tariff expense, direct labor efficiencies and lower utility usage and rates. These factors were partially offset by the increase in volumes and higher activity in green coffee logistics and storage services at our subsidiary, Seaforth.

Apologies, Frank, we seem to have lost the Iain's line. We'll get reconnected as soon as possible. Yes, Frank, if you want to go ahead, and we will reconnect Iain as soon as we can.

Yes. I'll just -- I'll pick up on our cost structure right now. So moving on to our costs. Q2 cost of sales was $55.8 million, down 11% year-over-year. The decrease was primarily driven by lower NY'C' coffee futures prices, the elimination of U.S. tariff expense, direct labor efficiencies and lower utility usage and rates. These factors were partially offset by the increase in volumes and higher activity in green coffee and logistics and storage services at Seaforth. As for green coffee costs, the NY'C' averaged USD 2.78 per pound during the quarter compared with USD 3.59 per pound in Q2 2025, a decrease of 23%. For the first 6 months, the NY'C' averaged USD 2.97 per pound compared with USD 3.66 per pound in the same period last year, a decrease of 19%. Customer purchasing behavior continued to improve during the quarter as coffee futures prices declined from their late 2025 highs and inversion substantially corrected. Customers accelerated the replenishment of inventories and extended their purchasing horizons to a degree. We continue to see caution because the futures market remains volatile, but the ordering environment is much stronger than it was throughout 2025. Exchange rates between the U.S. and Canadian dollar continue to influence our reported results and cash flows. As a reminder, most of our revenues are earned in U.S. dollars, while a meaningful portion of our costs are incurred in Canadian dollars. We also carry U.S. dollar receivables and payables on our balance sheet and use hedging tools to manage our underlying currency exposure. In Q2, the U.S. dollar averaged CAD 1.38, in line with Q2 2025. For the first 6 months, it averaged CAD 1.38 compared with CAD 1.41 in the prior period. Q2 gross profit was $10.2 million, up $4.9 million or 94% year-over-year. Gross profit for the first 6 months was $18.1 million, up $5.6 million or 44%. The improvement was driven by higher volumes, improved recovery of conversion expenses, direct labor efficiencies, lower utility usage and rates and a reduction in foreign exchange losses compared with Q2 2025. Turning now to operating expenses. Q2 operating expenses were $5.9 million, up 53% over last year, led by administrative expenses at $4.4 million, up 47% year-over-year. The increase was primarily driven by a higher noncash share-based compensation associated with a higher share price as well as higher professional fees due to timing of the activities. Sales and marketing expenses were $1.5 million, up 70%, primarily reflected the early timing of sales and marketing activities in 2026. Q2 net income was $1.9 million compared with a net loss of $400,000 in Q2 2025. Net income for the first 6 months was $2.3 million compared with $100,000 in the same period last year. Aside from the items we discussed, the improvement in net income reflects lower financing costs. It also reflects the elimination of the embedded option revaluation following the repurchase and cancellation of Mill Road warrants in 2025. The prior year quarter included a gain on that revaluation, which was not present in 2026. On risk management activities, we recorded a loss of $1.1 million in the quarter, in line with Q2 2025. For the first 6 months, the loss was $1.7 million compared with $3.9 million in the prior year period. These losses reflect the realized cost of operating in an inverted coffee futures market, along with mark-to-market movements in commodity and foreign exchange instruments. The market was substantially less inverted in 2026, particularly compared with the first quarter of 2025. As we've consistently said, we price to recover the costs of inversion as the associated coffee is shipped and invoiced, although there can be a timing difference between when those costs are recognized and when they are recovered from customers. Net finance expense was $1 million for the quarter and $2 million year-to-date, representing decreases of 28% and 25%, respectively. The improvement primarily reflects lower average loan balances and more favorable variable interest rates. Q2 adjusted EBITDA was $5.3 million, up $3.5 million or 191% compared with $1.8 million in Q2 2025. Adjusted EBITDA for the first 6 months was $9.6 million, up $5.8 million or 151%. The improvement was primarily driven by the increase in gross profit and materially lower year-to-date losses on risk management activities, partially offset by higher operating expenses. On a trailing 12-month basis, adjusted EBITDA was $17.1 million, the highest in the company's history. Turning now to inventories. Our inventory balance decreased by $10.5 million or 23% from December 31, 2025. The decrease primarily reflects the decline in the value of the NY'C' together with the reduction in pounds held. We remain committing -- committed to carrying sufficient spot inventory to ensure that coffee is available for immediate customer needs, and we expect inventory volumes to remain at or close to current levels in the near term to support continued spot demand. We will also continue to charge for the carry costs we incur in holding and hedging those inventories. At quarter end, Swiss Water held $5.9 million in cash compared with $6.6 million at year-end and net working capital was $34.1 million compared with $42.3 million. Net cash generated from operating activities was $10.7 million in the quarter and $16.2 million for the first 6 months compared with $2 million generated in Q2 2025 and $9.4 million used in the first half of 2025. The improvement was driven by higher net income and favorable changes in working capital. During the first half of the year, we repaid $12 million on our operating credit facility, $2.8 million of construction debt and $500,000 on the EDC credit facility. The outstanding balance on our operating credit facility was $27.5 million at June 30, down from $38.4 million at December 31. We also extended the maturity of the operating credit facility to June 23, 2028. We were in compliance with all financial covenants at year-end. Our focus remains on using the cash generated by the business to reduce debt, lower interest expense and improve financial flexibility, while retaining the ability to support future growth initiatives. And so with that, before we open the line, I'll share a few closing thoughts. Like I said, this was a very strong quarter. It reflects the work that has been building for some time. Volumes are growing. Our facility is running at high utilization. Our order book extends into 2027, and we have now improved sequentially for 4 consecutive quarters. That consistency more than any single quarter is the better measure of the progress we've made. Some of that reflects a market that has moved in our favor, but a great deal of it reflects the decisions we made through 2025. We kept coffee available when others stepped back from holding it. We priced for the cost of the inversion, and we remain disciplined on capital while we did it. The steps we're taking on capital, including the NCIB I mentioned earlier, speaks to our confidence in where the business is heading. Our focus from here remains on what we can control. We'll support our customers, operate Delta reliably, evaluate the capacity investments this business needs and continue reducing debt. We believe Swiss Water is well positioned in the back half of '26 and heading into 2027. And with that, Paul, can we please open the line for questions?

[Operator Instructions] And the first question today is coming from Luke Hannan from Canaccord Genuity.

Congratulations on the results. I wanted to dig in. I mean, you touched on several times talking about how capacity utilization is high, and it seems like there's more appetite from your customers to take on inventory. So clearly, it seems like there's a channel fill opportunity here. So my question is twofold. First, you talked about incremental investments in order to support that volume growth going forward. When might you expect to be able to deploy dollars related to that? What can we expect as far as incremental volume growth? And then secondly, just in your estimation, and I realize it's probably different by channel and by customer, but how long is the runway for this channel fill opportunity?

All right. A couple of questions there. I'll try to unpack it as best I can. So we saw some additional fill in Q2. And I think overall, what's happening is that roasters at the very back end of 2025 started to figure out that, gee, importers, decaffeinators are going to price for this inversion and build that into their 2026 plan. And so they became overall more comfortable with the elevated NY'C'. They built that into their plan, and they had built in kind of these additional inversion costs. So that helped them walk into 2026, feeling more comfortable -- somewhat more comfortable to build out their inventories. They aren't at full inventory. I would not say that they're there at all. I think that there is still room to go. I think that they waded into the market more aggressively when the sea dropped basically through Q2, and we saw that. But I think overall, the super hyper cautiousness of 2025 is kind of relaxing in 2026 as roasters have gotten their price that they need to maintain margin on a macro basis into the marketplace, and they are surviving and if not almost thriving now as opposed to being in a world hurt in 2025. So that's that. And so the entire coffee market industry, the trade is still expecting significant -- somewhat significant decline in the [ C ] in the back half of this year, maybe after we get past frost, maybe we have to get past first notice date, which is coming up shortly. There's no absolute crystal ball on this, of course, but there's a lot of coffee in Brazil, and there's a lot of coffee that's being held there. At some point, there should be a decline, but we don't know. And that would, again, help roasters fill in their needs going into 2027. But like I said, I think that roasters have figured the environment out into 2026 and are more comfortable with slightly more coverage. A big drop in the NY'C' would probably change that. As far as additional capacity, yes, we're evaluating that basically over the back half of this year. When we're operating at kind of peak instantaneous capacity like we've been operating for the past 4 months, that isn't your kind of full annual capacity, but we're certainly operating at kind of peak instantaneous capacity. And that has you review alternatives to add additional capacity so that you're prepared to find additional volume. And that's what happens with heavy capital industries is, first, you got to put the capacity in place to be able to go get the volume. It doesn't -- and going and getting that volume isn't just, well, gee, I've got capacity. Therefore, I have volumes like no, it's one before the other. But we're at that point now where we're evaluating that, and we'd probably be looking at something into -- if we're to execute into Q2 of next year. And that would probably bring 5% to 10% approximately additional available capacity on an instantaneous basis if we were to execute. So that enables us to service markets that we are aggressively trying to develop. And also volume will come in chunky, and we can be surprised with volume upside. So we want to be prepared to have that additional kind of instantaneous capacity when we become successful. And sometimes we don't know exactly when we're going to become successful because we're operating on so many fronts all at once. So hopefully, that answers your question, Luke.

That does. Very comprehensive. My second question here is just on your inventory as well. It was very much a working capital tailwind during the quarter to the extent that your free cash flow conversion was well north of 100%. So I guess similar line of questioning, I'm curious to know how much more there is to come on that front, recognizing, yes, there's a channel fill opportunity, but also with the NY'C' inversion being a little bit less than what it would have been before. I imagine there's just purely, we'll call it, an average cost per pound relief that you're getting there. So I guess the question is how much visibility do you have on there being more working capital tailwinds for the balance of the year?

Yes. I'd be cautious on that one, Luke. And the reason is we're kind of -- we talk specifically in this conference call to a June 30. If we look at what's happened with the [ C ] the past 5 weeks, it has run back up. And so we could see mark-to-market increases in working capital. It's quite possible. We're maintaining inventories. But Q3, I wouldn't be racing to say that that's going to be this kind of same tailwind. But like I said, this entire industry has been talking about the size of this Brazilian coffee crop. And it's not -- it isn't just Brazil as well. I mean every origin is seeing these prices and supply and demand still works. I mean microeconomic still happens and growers are growing more coffee and trying to export it. They're just trying to get the prices that they kind of become used to. So at some point, there can be a decline. But when there's declines, increases kind of follow after that. So it's always a volatile industry when you're talking overall commodities. I think we're going to be maintaining our overall inventory pound levels where we're at right now, we're reasonably comfortable, maybe a small uptick because we are seeing increased demand. And that's -- as I had pointed out, roasters aren't loving the idea of institutions or governments reviewing methods for decaffeination. They aren't -- they don't love the scrutiny on methylene chloride and start to question what their supply chains are. And we've had additional questions, maybe not conversions, but interest from major roasters talking about, gee, where is your overall capacity? Where are you sitting? And over time, those things more often than not, at some point, turn into volume. So we want to be prepared.

Got it. Last one, and then I'll pass the line. Just on that topic then of free cash flow conversion. So recognizing inventory, maybe we shouldn't be as aggressive there as far as how it relates to during the quarter. But maybe just looking at -- I mean, the cash taxes that you guys pay is close to de minimis. You guys have a pretty sizable balance when it comes to tax loss carryforwards. If we're just thinking about this for our models going forward, what would be a realistic time line in your view that you'd be able to use these tax loss carryforwards?

I don't have the exact length of time, but it's like somewhere between 3 and 5 years, if not more. So it's a pretty positive outlook as it relates to forward tax. And I think Iain can probably fill you in more specifically. Unfortunately, [ Iain ] he dropped off here. So he would have a better view, but I'll kind of go with a conservative 3 to 5 years.

The next question is coming from Marla Marin from Zacks.

So one question, which is a follow-up on some of what was just discussed during the Q&A. The volume increase in the quarter was actually very strong. It's consistent with what you've been telegraphing for several quarters in terms of when NY'C' futures prices were more or were lower. So it's consistent, but it was a very strong volume increase number. Based on your conversations with both existing customers and prospective customers, you had said in the past that given the caution that you were seeing in 2025 with many customers drawing down inventories, what is your sense right now in terms of where some of the key customers are in terms of returning to normalized inventory levels and in terms of what that means going forward for the Delta in terms of volume growth that we should expect on a quarterly basis. Obviously, I'm not looking for exact numbers, but are we -- should we be thinking that it will be at the same level? Or this was just a very unusually strong volume growth quarter?