Swiss Water Decaffeinated Coffee Inc. (OTCPK:SWSSF) Q4 2021 Earnings Conference Call March 31, 2022 1:00 PM ET
Company Participants
Frank Dennis – President and Chief Executive Officer
Iain Carswell – Chief Financial Officer
Conference Call Participants
Lyle Parkin – Analyst
Patrick McNeil – Analyst
Bill Woo – Analyst
Operator
Before Swiss Water Decaffeinated Coffee Incorporated, conference call starts, there 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 are considered reasonable at the time of 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 Incorporated 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 Incorporated Management’s Discussion and Analysis posted on SEDAR and Swiss Water’s website for a full discussion regarding forward-looking statements and the risks therein. I would now like to turn the floor over to your host, Frank Dennis. Sir, the floor yours.
Frank Dennis
Thank you [Indiscernible]. Good morning, everyone. And thank you again for taking the time to join us. I’m Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee. With me today is Iain Carswell, our CFO. Iain and I are here today to discuss Swiss Water’s financial results for the three and 12 months ended December 31st 2021. As always, I’ll begin with a brief overview of our performance, then Iain will provide more detail about our financial results before I returned to tell you more about our longer term plans and expectations. After that, we’ll be happy to take your questions. If you’ve read yesterday’s press release and reviewed our quarterly and annual MD&A and a you will already know that Swiss Water achieved strong processing volumes as well as record financial results for the fourth quarter end 2021 fiscal year.
At 125.1 million, our annual revenue set a new all-time record exceeding 100 million for the first time. And our adjusted EBITDA of $10.5 million for the year was another record exceeding $10 million for the first time in our history. This strong performance built on the positive momentum we reported in November with our third quarter results. As then, this strong performance resulted from the combination of a number of positive factors. First, we are seeing very positive market consumption figures from the decaffeinated or reduced caffeine segment. The work-from-home shift has been very favorable for greater afternoon at home consumption of decaf coffee, which has driven market growth.
Second is that, as cafes, restaurants, and retail grocery outlets in our key markets adapt to increasing environmental responsibility and food safety requirements, coffee roasters and coffee consumers, are increasingly choosing chemical free water process decaf over coffee decaffeinated with methylene chloride or ethyl acetate. The results are clearly visible in our total processing volumes, which were up by 23% in the fourth quarter, and by 17% for the full year. Meeting this demand enable us to achieve a high level of capacity utilization from all three of our current production lines. Over 80% during the second half of 2021.
This in turn enabled us to achieve very strong profitability, with gross profit growing by 53% in the fourth quarter, and by 13% for the full year. While the volume growth was notable in all of our geographic markets, with many of our customers ordering in line or even ahead of pre -pandemic levels. Europe stood at once again posting an increase of 72% in Q4, an annual growth of 70% over 2020. Business in the Asia Pacific region was also very strong, with volumes up 56% in Q4 and up 30% for the year, mainly due to organic growth. And in our largest market, North America, volumes were up by 7% in the quarter, and by 5% for the full year.
Of note, is that during the second half of the year will began shipping to some new high profile out-of-home customers in the U.S and Canada, helping boost our results and providing an encouraging indication of future growth potential. Since 43% of our current business is in the U.S. and 31% in Canada, this is where we expect to see the bigger overall growth per ton. Importantly, we see the positive changes in our customer mix as a clear sign of a strong recovery in the vitally important out-of-home coffee market while at the same time at home consumption has remained pointed.
The relaxing of restrictions on food service outlets in the U.S. and elsewhere has helped us increase volumes shipped to our higher margin specialty accounts by 34% in the fourth quarter and 26% for the full year. What’s unusual is that we’ve achieved this exceptional volume growth across the business despite an ever increasing New York futures contracts, coffee commodity price were NYC. For comparison after peaking at U.S. $2.50 a pound, the NYC average U.S. $2.20 in Q4 nearly double the U.S. $1.14 we saw in the fourth quarter — comparable fourth quarter of 2020.
These high prices have continued into Q1 of this year with the NYC currently at U.S. 225. Normally, when the NYC is rising like this, our customers tend to consume from their own inventories rather than buy more coffee from us as they wait for the price to fall back. However, during 2021 an unusual double frost in Brazil together with the widespread disruption of global supply chains created a growing fear of a looming coffee shortage among industry participants at all levels.
This concern has helped support our volume growth and may even have caused some customers to move their orders forward to ensure that they have sufficient inventory on hand to meet demand. Over the coming weeks and months, we will see how this plays out. So before I tell you more about our outlook for this year and our preparation for the future, let me turn the call over to Iain to take you through our financial results.
Iain Carswell
Thanks, Frank. Good morning, everyone. As always I’ll begin my review with volume shipped to customers, as this is the key metric that drives our financial performance. As Frank indicated, Swiss Water’s processing volumes set new records in the year to December 31st, primarily as a result of the ongoing recovery food service economy. Total volumes were up by 23% in the fourth quarter, and by 17% for the full year, compared to the same period in 2020. Looking at volumes by customer type.
Shipments to roasters, those customers who roast and packaged coffee to sell to consumers in their own coffee shops for home or office consumption, were down by 6% in the quarter, but increased slightly for the full year, growing by 1%. Shipment to importers, those customers who resell our coffees to roasters, where and when they need it, were up substantially, growing by 69% in Q4, by 50% in the full 12 months of the year. Looking at volumes another way, as Frank noted, specialty account volumes continue to trend upward, growing by a healthy 34% in the quarter, and by 26% for the full year.
These accounts serve the out-of-home consumer, primarily. Strong growth here reflects the yielding of cafes and restaurants in a number of our key geographic markets. Shipments to large commercial accounts who serve the grocery market principally, were also well up, growing by 14% in the quarter and by 12% in the 12 months of the year. Turning now to revenues; fourth quarter revenue of $35.1 million was up by $10.6 million or 43% from Q4 of 2020. Full year revenue of $125.1 million, set a new record for Swiss Water, increasing by $27.5 million or 28% over the 2020 level.
The revenue increase in both periods was due to the growth in our volumes, as well as significantly higher prices for Green Coffee in 2021. Looking at the cost side; our fourth quarter cost of sales was $30.7 million, an increase of $9.1 million or 42% compared to Q4 of last year. For the full year, cost of sales was $107.5 million, up $25.5 million or 31% from the 2020 level. The increase in both periods was mainly driven by higher Green Coffee cost, and our significantly increased production volumes, as well as by increased depreciation due to the inclusion of our new Delta manufacturing facility, incremental labor, and production expenses.
As Frank noted, the NYC coffee commodity price has been trending sharply upward in recent months, hitting an average of $2 [Indiscernible] per pound in Q4, versus an average of $1.14 in the fourth quarter of 2020. Over the full 2021 fiscal year, the NYC averaged $1.68 per pound, up over 50% from $1.11 in 2020. As you would expect, such a significant rise in coffee prices triggers a major increase in our working capital needs, and the increased value of inventory in our balance sheet is reflective of this. We’re monitoring our working capital needs very closely and evaluating options to increase credit availability.
Finally, the additional depreciation and amortization expenses from the Delta facility finance lease totaled $900,000 for the quarter, and 3.4 million for the full year. Fourth-quarter gross profit was $4.4 million, an increase of $1.5 million or 52%, compared to Q4 of 2020. For the 12 months to December 31st, gross profit was $17.6 million, up by $2 million or 13% from 2020. The improvement in Gross profit was primarily driven by the record processing volumes we put to our facilities, particularly during the fourth and third quarters.
By utilizing all 3 of our production lines, at an average of 80% of capacity, we were able to realize significant production efficiencies in January, to a higher differential margin. These 2 factors comfortably offset the increase in depreciation charges and incremental labor and production expenses following the commissioning of Line 1 at our new Delta facility. Fourth quarter operating expenses were $2.9 million, up by 5% from Q4 of 2020. For the full year, the operating expenses were $10.9 million, an increase of 4% compared to 2020.
The difference was primarily due to an increase in the administrative portion of operating expenses due to the absence of cost recovery of share-based compensation of 2021 compared to 2020. Q4 operating income was $1.5 million up significantly from the $126,000 recorded in the fourth quarter of 2020. Full-year operating income was $6.7 million compared to $5.1 million in 2020. Net income for the quarter was $241,000 compared to a loss of $320,000 in Q4 of 2020, representing a year-over-year improvement of 175%.
For the full year net income was $496,000 compared to $2.9 million in 2020. The decline in net income was driven by a number of factors, including increased depreciation and amortization and non-cash loss on extinguishment of the convertible debenture and an increase in finance expense. Also included with a negative impact of mark-to-market changes and foreign currency exchange rates in futures market activities. Hiring on operating expenses also had an effect.
Non-operating expenses were higher for the quarter and for the year due to an increase in finance costs in both our construction loan and credit facility. Fourth-quarter net finance expenses of $1.1 million are up by 200 thousand over Q4 of last year for the year net finance costs was $3.9 million, an increase of $1.3 million compared. Increase in net finance costs resulted from higher interest expense due to higher borrowings from our credit facility and constructions. Importantly, in 2020 during the construction of Delta Line One, borrowing costs related to this project were capitalized. following its commissioning in Q3 last year, the related borrowing cost start to be recognized as an expense.
Another factor contributing to 2021 increased non-operating expenses has been in 2020, our non-operating expenses were reduced by the revaluation of an embedded derivative as a result of a lower share price offset by a slight loss on our risk management activities. During 2021, there was a much smaller revaluation effect. Another factor contributing to our higher 2021 donor proceeds expenses resulting from the restructuring of our debt.
By amending our convertible debenture with Millwood Capital into a debenture with warrants, we incurred a one-time non-cash loss on the extinguishment of the convertible debenture [Indiscernible] Despite the additional cost burdens on the company during the year, we achieved a significant improvement in adjusted EBITDA, fourth-quarter adjusted EBITDA of 2.1 million was up by $900,000 or 78% in Q4 in 2020. And as Frank noted, for the full year adjusted EBITDA of 10.5 million was up by $3.5 million or 50% over the 2020 results.
Operationally, our adjusted EBITDA improvement this year was driven by volume growth, efficiency gains resulting from our higher capacity utilization and an increased financial contribution from our Seaforth coffee-handling substitute. As I’ve noted, these positive impacts were partially offset by the higher Green Coffee costs and incremental labor and production expenses associated with operating in two standalone facilities experienced in 2021. Once we consolidate all production at our Delta location, exit the Legacy Burnaby facility in mid-2023, the resulting efficiencies will bring down our operating costs significantly. With that, I thank you for your attention and I’ll hand back over to Frank.
Frank Dennis
Thank you very much, Iain. Well, as we have indicated we are both very encouraged by the results we’ve achieved in fourth quarter and for the full year — last year in 2021. Demand for the decaf category particularly at home and an increase in desire for roasters and brand roaster improved the sustainability of their food supply chains have helped drive existing customer growth. And these trends have helped develop new customer earnings. However, we are in an environment of a very elevated coffee futures price and these input prices will start to be seen in Q2 at the retail store level. And the effect could be demand destruction.
Both of these factors have an effect on our 2022 volumes. Although as 2022 begins, we have a very strong order book, and our production facilities are running very smoothly despite ongoing delays in coffee arrivals. The high capacity utilization we achieved on all three decaffeination lines and at our Seaforth subsidiary during the second half of 2021 drove solid profitability and gave us a clear view of what could be achieved in the future. That said, caution continues to be called for the Russian invasion of Ukraine is creating a lot of uncertainty in Europe and around the world.
And at this point, no one knows how this will be resolved, nor how it will ultimately impact the European and global economies. At the same time, the COVID-19 pandemic is not over. And although we may be learning to live with it, at least in the developed world further disruptions may well occur. Notwithstanding the Ukrainian situation, one unfortunate side effect of the post COVID-19 economic recovery that grinds on, is the disruption of global supply chains.
In our case, we are experiencing logistical challenges in moving coffee from growing regions to our production facilities and then, onto markets both in North America and internationally.
The simple availability of equipment and drivers is causing isolated but severe issues. This is being felt most acutely at the Port of Vancouver, as the 2 major steamship lines have eliminated service to the port, leaving only 1 remaining at this time. The tight supply of exportable coffee due to crop shortages and logistics challenges, is also keeping pressure on the coffee futures market, and we have seen spot availability of coffees fall substantially as a result.
This, in turn, further supports a high future market in the near term. While, on the other hand, the war in the Ukraine will eliminate demand, potentially causing supply and demand to come back more in balance. Likely we will need to get through the important June, July, Brazil frost season to have a better view of the future in terms of the [Indiscernible].
While high coffee prices can have a destabilizing impact on the efficient movement of coffee inventories, they also put additional pressure on our working capital resources. On top of this, like most businesses, we are experiencing inflationary pressure on many of our other cost inputs, from natural gas to packaging to freight and labor. This required us to implement a processing price increase during the fourth quarter in order to sustain our margins. So far our customers have understood and accepted this change. More action on pricing may well be required if inflationary pressures persist.
Operationally, we continue to run both decaffeination lines at our legacy production facility in Burnaby BC on a 24/7 basis, as we did throughout 2021. The initial line at our new Delta facility in Delta BC operated smoothly and efficiently, also on a 24/7 basis throughout the year. We are continuing to migrate more of our production here. Since it’s startup, we have been gradually increasing the processing speed of Delta line one as we work to optimize and maximize its production. If you’ve been following our story, you’ll know that we must relocate all remaining production from Burnaby by June 2023 due to the upcoming expiry of our lease there.
Accordingly, in order to ensure that our ability to deliver on customer orders is uninterrupted and to meet the growth and demand, we see ahead, we are in the process of building a second new production line in Delta. Financing for this project was a range in Q2 of last year and the necessary permits were secured over the summer. Foundation was completed [Indiscernible] during the third quarter last year and ground construction began in Q4. The project is currently proceeding on time and on budget toward a targeted completion date before the 2023 lease expiring in Burnaby.
As I’ve noted before, based on engineering reports from a third party engineering firm, when both are completed, we expect the two new lines in Delta together will have a targeted end capacity, at least 40% greater than the current Burnaby facility The Preliminary cost estimate for design and construction of the line two production project in Delta is approximately $45 million, plus commissioning costs of around $2 million. These estimates are preliminary and like all major design expecting projects are dependent on local and global economic factors. That wraps up our comments for today, and Iain and I would now be happy to answer any questions that you might have.
Question-and-Answer Session
Operator
Ladies and gentlemen, the floor is now open for questions. [Operator Instructions]. Your first question for today is coming from Lyle Parkin. Lyle, your line is live.
Lyle Parkin
Hi. Just trying to look forward here. Do you have any idea or thoughts on when you might start to paying a dividend again?
Frank Dennis
Thank you. I’ll take your question. At the moment obviously we’re in the middle of fairly significant Capex projects. And at the moment that’s our priority in terms of funding and use of excess cash. We have communicated fairly consistently that we’re going to fund that project from combination of free cash flow, from operations, and a new capital. That remains our focus in the short term. We will continue to evaluate with the board the most appropriate timing for potential introduction of the dividend but at the moment our priority remains using our free cash flow to fund the Capex project that we have in hand at the moment [Indiscernible] priority.
Operator
[Operator Instructions]. Your next question for today is coming from Patrick McNeil. Patrick, your line is live.
Patrick McNeil
Oh, hi. Yeah, I was just wondering what this fiscal 2022 year looks like for gross margin based on the growth in revenue of Europe and Asia. And do you have an expectation that the gross margin will be higher this year based on changing growth rates in different regions and product mix or how you’re thinking about that impact?
Iain Carswell
Yeah. Thank you for your question. Obviously, as we’ve noted, as our volumes increase and our capacity utilization increases, that helps us to expand our margins somewhat. Also noted that were under quite significant inflationary pressure. Nonetheless, as all businesses are. I would certainly hope that as long as we can maintain current growth levels, that we should see at least a maintenance of current margin levels. And I would hope that if volumes continue to grow, that we’ll again see a benefit from some high capacity utilization. Effectively spreading our fixed costs over a bigger base and that should flow through to the bottom line and shoot to generate margin expansion.
We have also put through some price increases at the back end of last year, but generally, the geographical growth doesn’t have a significant impact on margin expansion. It’s overall volume growth through our production assets that drives that, not necessarily where the output of those production assets is. I don’t know Frank, if you have anything you want to add on that point?
Frank Dennis
Yeah. I think that with our pricing that we took in the fall, that was essentially gross margin percentage maintenance strategy. And to me, the number one wildcard for 2022 is going to be natural gas. Obviously with this war in Ukraine, natural gases in the news daily and that would have an impact on gross margin for sure. We buy forward quite a bit of gas, but I think that is kind of the one potential risk, Patrick. But generally, we’re forecasting a margin maintenance for 2022.
Patrick Mcneil
Okay. Thanks. So just to clarify, so there’s no like the increased inventory it’s not as a result of changing geographic mix. It’s just the increase in commodity. So there’s no real other way to manage the total inventory. You have to carry by adjusting or focusing on, say, just the United States market versus Europe or Asia.
Frank Dennis
The inventory carrying costs and the value of inventory when you’re dealing with the commodity that is as volatile as coffee has both its upsides and downsides. But surely as we sit at a 225 NYC, we’ve got a higher inventory carrying cost. I think that in Europe, as that grows, it’s actually growing kind of nicely balanced between big, large commercial customers as well as higher margin specialty, which is very attractive to us. Asia tend to kind of be more in the commercial space so a different margin structure, while the U.S. where we’re having some good success with new high-profile names, those are some good names and they are at decent pricing levels, and so I think that there are some opportunities for a margin increases, but on a gross margin basis, but like I say, this wildcard of natural gas through the back part of this year certainly is a concern, Patrick. So hopefully that answers your question, inventory carrying costs are a little different than gross margin as you can imagine, but hopefully that gives you some guidance.
Patrick Mcneil
Yes, that’s great. Thank you.
Frank Dennis
Sure.
Operator
[Operator Instructions] There are no further questions in queue. I would like to turn the floor back over to Frank for any closing comments. Oh, I —
Frank Dennis
Okay. Well, if there are no further — sorry?
Operator
You do have a question. You do you do have a question.
Frank Dennis
Okay.
Operator
I apologize. It’s coming from Bill Woo. Bill, your line is live.
Bill Woo
Thank you. Sorry for the last minute question. I just want to know, what’s the price in case we want to buy out all the land in Delta?
Frank Dennis
That’s a good question. We don’t stay on top of that number that closely, but we’re on just over a five acre site or so — 5.2 acres I think. And we’ve recently seen numbers in the acreage in the Delta area in the $6 million range, $5 million to $6 million. So that’s where we’re sitting at and we do have an opportunity to purchase here that is contracted at a previously specified price, which is lower than that current market number, which is terrific and the first opportunity for us to potentially execute a purchase, turn that into a — for example, turn that into mortgage instead of more expensive leasing would be 2028.
Bill Woo
Okay. So the pricing is not locked in the contract, right?
Frank Dennis
The price of the land?
Bill Woo
Yes.
Frank Dennis
There will be an assessment at fair market value with some limits attached to that.
Bill Woo
Okay. Thank you for taking my question.
Frank Dennis
Okay. Thanks, Bill.
Operator
There are no further questions in queue.
Frank Dennis
Okay. Thanks very much, Ali. So if there are no further questions, [Indiscernible] and I will conclude today’s call, and we wish you all good health and thank you very much for joining us. Have a good day.
Operator
Thank you, ladies and gentlemen. This does conclude today’s event. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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