Supremex Inc. (OTCPK:SUMXF) Q2 2022 Earnings Conference Call August 11, 2022 11:00 AM ET

Stewart Emerson - President and Chief Executive Officer

Mary Chronopoulos - Chief Financial Officer

Neil Linsdell - iA Capital Markets

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Supremex Q2 2022 Earnings Conference Call. [Operator Instructions]

Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, August 11, 2022.

I will now turn the conference over to Stewart Emerson, President and CEO. Please go ahead.

Good morning, ladies and gentlemen. I am here with Mary Chronopoulos, Chief Financial Officer at Supremex. Thank you for joining us for this discussion of the financial and operating results of our second quarter ended June 30, 2022. Our press release reporting Q2 results was published earlier this morning. It can also be found on our website at www.supremex.com, along with our MD&A. These documents are all available on SEDAR as well. In addition, we posted a presentation supporting this conference call, which is available through the webcast and on the company’s website.

Let me remind you that all figures expressed on today’s call are in Canadian dollars unless otherwise stated. And so with all of the formalities and fine print out of the way, allow me to get on to the President and CEO’s comments.

Let’s turn to Slide 43 for an overview of the second quarter. I am very pleased with our strong results with top line growth in excess of 20% in the quarter and significantly higher margins in both segments. Q2 was the 10th consecutive quarter of year-over-year improvement and record quarter in adjusted EBITDA. Net earnings more than doubled to $7.4 million or $0.28 per share. These results were driven by improved pricing mix and increased volume in the envelope segment and both a better product mix and improved margins and operations in packaging this year versus last. Mary will provide additional details on our performance in a few moments, but I’d like to take a few minutes to discuss our performance and market dynamics.

In envelope, I assure you we’re not in the bottom of the ninth inning with 2 men out. In fact, there is still a lot of ball to be played and the count is in our favor. First, we have an extremely strong team, and we have been setting ourselves up for this success since we made the decision to both consolidate the Canadian envelope space and aggressively pursue growth in the U.S. a few years ago.

We have the scale associated with being in the top five largest envelope manufacturers in North America. We have coast-to-coast reach and a dominant position in Canada. We have strategically grown our footprint in the U.S. market, methodically built the brand and developed an excellent reputation in the vast U.S. Envelope market, while still only enjoying approximately 5% market share. Second, on the procurement side, we have spent several years purposefully cultivating and nurturing relationships with Tier 1 suppliers and have built a supply chain that is as good or better than anyone in the business, and we’ve been rewarded. Additionally, we have been creative and used an outstanding balance sheet to successfully secure new sources of supply to augment and complement core suppliers. In doing so, we’ve had the necessary raw materials to capitalize on constrained Envelope supply.

Third, and I am really proud of this, across our organization, at the height of the pandemic, we made prudent and fortuitous decisions on our most important resource, our people. We have first rate teams on the floor. While overall market demand dropped significantly and times were tough at the height of the pandemic, Supremex continued to grow and maintained our workforce where the broader industry made the tough decision to furlough. As a result, as the market bounced back, we didn’t have to scramble to bring back or find new staff. As we all know, labor in general is scarce, skilled labor is even more scarce, but we made a conscious decision to support our workers, and we have not been affected as much as many of our competitors.

Make no mistake, there are two forces at play in the Envelope space today and they are going to be with us for some time. Paper is going to remain tight for the foreseeable future. Those with strong supply chains and good balance sheets have a distinct advantage. The North American Envelope – and two, the North American envelope industry cannot make nearly as many envelopes today as it could pre-pandemic. And let’s face it workers that were furloughed from Envelope plants and found new jobs, many in emerging industries are not going to return to former employers anytime soon. The market is significantly constrained, and we are extremely well positioned, and this is why year-to-date Envelope units are appreciably up and sales are up significantly. The runway in envelope has been considerably extended, some of it by things we have done, some of it by decisions of our competitors made in a time of crisis.

In keeping with the baseball analogy, not only are we not behind with two outs in the bottom of the ninth, we actually have the lead. There is nobody out and we are ahead in the count. In packaging, we continue to progress nicely. Year-to-date sales are up double-digit. We are passing through inflationary costs and adding margin. Our core packaging businesses are both enjoying year-to-date revenue growth with folding carton and e-commerce up by very high single-digits. Our improved product mix which, along with continued improved operations, has seen segmented EBITDA in the packaging, increased significantly, both in the quarter and year-to-date. Our packaging businesses are performing very well.

In addition to what I just discussed, we have two key developments on the packaging side to share with you. First, last week, we announced the appointment of Simon Provencher as President of our Packaging operations. With over 20 years in the industry, Simon brings extensive experience and great leadership qualities to the team. We are confident he can take this segment to the next level and provide additional bandwidth as we continue to pursue M&A in packaging.

Second, we have positive news in regards to the move of our Town of Mount Royal folding carton plant. Although we renegotiated that lease extension earlier this year, we have since received an early termination notice from the lessor. Given the dynamics of the packaging markets we operate in and the assessment of core, non-core in our offering, we have elected to transfer the Town of Mount Royal folding carton business to the DuraBox facility in Lachine and to gradually wind down DuraBox’s corrugated packaging activities. This strategic repositioning will result in better utilization of our manufacturing footprint and capacity, provide some cost avoidance and will significantly focus on value-added products.

With that, I turn the call over to Mary to review the Q2 financial results. Mary?

Thank you, Stewart. Good morning, everyone. Please turn to Slide 44 for our Q2 top line review. Total revenue was up 20.7% to $62.5 million from $51.8 million last year. Revenue from the Envelope segment rose 30.2% to $45.9 million. The growth reflects an average selling price increase of more than 20% from last year’s comparable period, primarily implemented to mitigate input cost inflation. Unit volumes increased by 7.9%, reflecting higher sales in the U.S. and sustained demand recovery from channels more affected by the pandemic. Packaging and Specialty Products segment revenue remained relatively stable at $16.6 million, as growing sales of folding carton products stemming from a favorable product mix were offset by a decrease in corrugated sales.

Moving on to Slide 45, consolidated EBITDA and adjusted EBITDA both reached $13.9 million in the second quarter of 2022, up from $8.6 million in the second quarter of 2021. This increase resulted from higher sales volume and selling prices, partially offset by the higher cost of materials and the absence of government subsidies this year versus last. As a percentage of revenue, the EBITDA – the adjusted EBITDA margin recorded a robust increase to 22.3% compared to 16.5% a year ago. Envelope segment adjusted EBITDA was up 83.1% to $11.6 million compared to the same period last year. The significant increase essentially reflects higher revenue driven by an increase in the average selling price and a more favorable product mix in the U.S. Adjusted EBITDA margin was 25.3% up from 18% in the equivalent period of 2021.

In the Packaging and Specialty Products segment, adjusted EBITDA was $3.3 million, up 35.7% over the same period last year. This increase is mostly due to our higher average selling price, leading to higher profitability for folding carton and e-commerce. Adjusted EBITDA margin was 19.6% compared to 14.5% in the corresponding period of 2021. Corporate and unallocated costs were $900,000 in the second quarter of 2022 compared to $200,000 for the same period last year. The variation reflects the phasing out of government subsidies and severances partially offset by a foreign exchange gain and a favorable adjustment of the deferred share units.

Turning now to Slide 46, net earnings and adjusted net earnings stood at $7.4 million or $0.28 per share for Q2 2022 compared to $3.4 million or $0.12 per share for the equivalent period last year.

Turning to cash flow and capital deployment on Slide 47, net cash flows from operating activities reached $10.4 million in the second quarter of 2022, up from $4.9 million in Q2 2021. The year-over-year variation is mainly attributable to higher profitability. Similarly, free cash flow amounted to $10.2 million in the second quarter of 2022 compared to $4.5 million for the same period last year.

In the quarter, we used our cash primarily to reduce the balance of our revolving credit facility by a net amount of $8.2 million. As shown on Slide 48, we also returned funds to shareholders through $1.3 million in dividends and $700,000 in share repurchase. More specifically, during the second quarter, the company purchased over 215,000 common shares for cancellation under its normal course issuer bid program. Subsequent to the end of the period, nearly 74,000 shares were also purchased for cancellation. The current program is set to expire on August 30, and we intend to renew it. With the debt reduction, our financial position continues to improve.

Slide 49 shows that on June 30, 2022, total debt stood at $36.7 million, down from $44.9 million 3 months earlier. Similarly, we concluded the second quarter with a leverage ratio of 0.8x, down from 1.1x 3 months ago. During the quarter, we entered into a 3-year senior secured revolving credit facility of $120 million, which replaced the previous revolving and term facilities. It matures in May 2025 and can be extended by subsequent 1-year period subject to lender’s approval.

At the end of the second quarter, we had approximately $83 million in available liquidity under this facility to pursue our growth objectives. Given our solid financial position, the Board declared yesterday a 20% increase in the quarterly dividend to $0.03 per common share. This increased only 7 months after reinstating payment shows the confidence the Board has in our ability to continue to generate solid cash flow while ensuring we maintain sufficient resources to further grow the business. In keeping with the new amount, the next dividend of $0.03 per common share will be payable on September 23, 2022, to shareholders of record at the close of business on September 8, 2022.

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

Thank you, Mary. So halfway through 2022, we are very proud of our team’s accomplishments. Let me reiterate. Our objective from the beginning was to build this business for the long term and the spoils we are enjoying today are the result of the seeds we planted over time. There is no denying that changing market conditions have put wind in our sails, but we had the skip pointed in the right direction and the sails were up, allowing us to benefit from the strong tailwinds. We are confident that we are on the right track, but we continue to push and position ourselves. Resting on our laurels is not in our DNA. We are both product and geographically diversified.

We operate in two segments, both of which generate adjusted EBITDA at rates of greater than 20% of sales. One of those segments, Packaging, operates in a high value-added markets that are growing and are poised to grow at an even greater rate as e-commerce continues to expand and shift to environmentally friendly and sustainable packaging intensifies. The second segment, Envelope, is in a period of significantly constrained capacity that we believe is going to continue well into the future and we have positioned ourselves as the dominant Canadian market leader, the top five in North American capacity where we have developed a brand that will allow us ongoing growth in a large market where we currently have less than 5% market share.

Demand for our products remains strong. We have reconfigured our U.S. customer base, gone up the channels of distribution and are working with accounts where we can add more value, which leads to improved margins and more predictable and sticky revenue. Backlogs are healthy, and while we’re operating at full capacity given current labor availability, we continue to find ways to unlock capacity. We continue to add capacity through efficiencies and added manpower, and we are the destination customer for many of our suppliers.

As we look ahead to the remainder of 2022, we believe revenues and profitability will be ahead of 2021. That said, we expect the rate of improvement to moderate in the back half of the year as we begin to lap the recovery of the markets that were more severely affected by the pandemic. Our balance sheet is in solid shape, which allows us to reinvest in operations and to be a leading contender for any acquisition opportunity that fits the filter whether it be strategically in Packaging or opportunistic in Envelope.

In closing, I’d like to thank the entire Supremex team for a great quarter. We are privileged to have passionate people, and it shows in our performance. This concludes our prepared remarks, and we’d now be pleased to answer any questions you may have. Operator?

Thank you. [Operator Instructions] And your first question comes from Neil Linsdell from iA Capital Markets. Please go ahead.

I have to start off presenting congratulations, quite impressive on the profitability, especially. If we get down into a couple of industry-specific areas, the Envelope business, obviously, you’ve – there is a lot of price increases that have been passed through, which is in that revenue gain, but you’ve still got 8% volume growth year-over-year. Is – and I appreciate all the explanation about what the competitors have been doing, how you’ve been positioning yourselves? And it almost seems like is this a reversal of fortune, have you taken what was a secular declining business and turned it into growth by going after that U.S. market share or is that too optimistic?

Well, thank you for that. Yes and no. We have taken advantage of constrained supply. But it’s also the outcome of a lot of good blocking and tackling, we’ve been setting ourselves up for. And just changing of the customer base, we have almost completely reconfigured the customer base over the last three quarters or so in the U.S., and we’re now – we’re now getting into sort of longer runs, more predictable opportunities, stickier sales that have more margin in them. So yes, I mean, the runway has been extended considerably both by market forces, but also by our penetration of the market over the last few years.

We think it’s not – we don’t think we’re going to experience these declines, this overhang that we’ve had while we are predominantly a Canadian Envelope company with big market share where we are absorbing 100% of the decline. We’re now so diversified that we can not only offset any secular decline in Canada, but we can actually grow incrementally from year to year.

Right. So that’s what I was getting at. So this is actually going to be at least modest growth in the Envelope segment because of the U.S., well, I assume. Are volumes in Canada still declining while you’re picking up all so much extra volume in the U.S.?

Yes. So I mean, from a market share standpoint in Canada, we don’t think anything has changed over the last few quarters, but there is still a secular decline in Canada. We now have the vehicle to do the – to outlet the capacity. And as long as we can outlet the resulting capacity from the secular decline, we can now outlet that in the U.S. for the foreseeable future, and we can actually grow as we unlock capacity and create more opportunity on the equipment side.

Okay. And you were talking about capacity constraints, which seem to be more labor related. So, if you continue to grow the U.S. Envelope business using the capacity in Canada, obviously, but are you going to have to grow by adding equipment in the U.S., labor in the U.S. or can you acquire probably good discounts right now, any of that extra capacity to continue the expansion in the U.S.?

I mean we did that sort of – go ahead.

Yes. No, let’s continue.

I was just going to just add a little bit more color. I mean there are – we did the small tuck-in in Niagara Falls, New York at the beginning of the year, it didn’t cost a lot out of pocket. It was – and added a couple of machines to our repertoire. We have machines that aren’t fully manned in both of our U.S. locations. And some of our – some of the equipment in Canada is not manned around the clock. So all of the above, and let’s face it, as competitors get constrained from a capacity standpoint and don’t know how to come out of it, the business is a challenge right now. And so there are some opportunistic acquisition opportunities that are out there?

Okay. On the profitability of the Envelope, that was really surprisingly strong. And with the fact that you had to go out and get new sources of paper, I thought there was going to be more margin pressure. Is that to come or have you managed to mitigate that with all the efficiencies and you’re buying power and your relationships?

So the offshore paper has really just started to come in at the end of Q2. So there is – we do have to be very cognizant of it in Q3 and into Q4. But the team has done a really good job of isolating sort of that paper and making customers aware that we’ve paid premiums for it and are passing them along. I think a big part of the profitability as well, the growth and the profitability is this recalibration of our U.S. customer base. And again, it didn’t just happen overnight. But when we entered the U.S. market, I mean we had a lot of capacity in Canada to fill, and we grabbed what volume we could, while sort of systematically trying to build the brand and go up the channels of distribution. And as the market dynamics changed and it got really tight, some of those customers that maybe only had a portion of – a small portion of their business with us, we had available capacity, and we locked in with them. And we took a larger share and sort of shed some of the more opportunistic business that was at lower margins. And as a result, it was kind of a doubling effect. We got more volume, and it was volume at a higher margin than the business that we had been taking in the 3 or 4 years prior.

Okay. That’s great. Switching over to the Packaging side, obviously, you mentioned the scaling down of the DuraBox operations. I assume that that’s going to help margins as we go forward. And in that margin response, is there going to be an impact or what kind of costs and what kind of time frame are we looking at as you move to TMR location?

So I’ll deal with the latter question and then sort of turn sort of cost over to Mary. So we have to be out of the facility, the current folding carton facility in Town of Mount Royal, we have to be out by December 31 of this year, we want to be out well prior to that. So we avoid the Christmas holidays, the teams proactively winding down operations in DuraBox and simultaneous to that getting ready for fixturing to receive the new equipment. Our plan is to be completely moved by the middle of December and do it in a staged approach where we shut down a piece of equipment and move it, get it up and operational before we shut down the other so that we can continue to service customers either through the TMR location or through the redundant capacity in Laval. And our focus right now is just ensuring there is minimal disruption to customers as we possibly can, trying to get ahead and produce as much as we can in the next couple of months. From a cost standpoint, I’ll turn that over to Mary.

So just in terms of the financial impact of that move, we’re looking to incur expenses in the range of $2.8 million to $3.5 million, and that’s a combination of CapEx, primarily leasehold improvements and one-time OpEx expenses.

Okay. And that will be spread between Q3 and Q4, mostly in Q4?

Okay. And then as you – I assume that the DuraBox business that you’ve had it running at is not quite as profitable. So after we get through this process, should we expect a bump in profitability from that realigning the business?

Yes, generally speaking – yes, generally speaking, the two other lines business, the core business is significantly more profitable than the corrugate DuraBox business on a percentage, yes.

Right. And we’re still talking about capacity here, is that going to alleviate any of your capacity concerns to be able to continue to grow that as well or is it the same kind of capacity mostly with labor that’s hitting here?

So as part of this process, we’re actually looking at increasing the capacity to help us with the transition and getting some new capacity in place prior to shutting down and moving existing capacity. So coming out of the back side of it, yes, we expect to have more capacity in the folding carton space.

Okay. And then just overall, looking at the balance sheet, obviously, strong cash flow, you’re doing everything as far as the dividends, the share buyback. But your debt ratio is getting down now. You said you’re comfortable with, I think, a 2x debt to EBITDA. You’ve got a lot of capacity. You have got a lot of dry powder here. Are you not being aggressive enough on acquisitions, dividends, buybacks?

So I mean, obviously, the leverage is quite low. We are fairly active. We are active in the – on the M&A side, which with that, we wanted to be – we want to remain prudent on the share buyback and on the dividend increase. So the combination of the three, we just felt this was a really good spot for us to be in, slow and steady increases. And return share – return value to shareholders through the NCIB, but while keeping enough dry powder to do what we want to do on the growth side.

Okay. And is there anything that’s kind of changing as you’re starting to see some of these benefits on the operational side? Is it inspiring people that you may have been talking to either on the Envelope or the Packaging side, I’m assuming both in the U.S. to be more interested in joining up with Supremex or has there been any kind of, I guess, roadblock in any of the negotiations that you’ve had that might be alleviating as you’re showing all these improvements?

I guess not sort of tangibly but inherently, we’ve always been – most of our acquisitions have all been from owner operators generally facing succession issues. But Supremex has a very good reputation in the market, both on the Packaging and the Envelope side and most entrepreneurs or potential vendors, they are comforted by sort of our reputation and that’s how we do things and strong results, I think, just lends more credibility to that we are a very good option in the long-term.

Okay, fair enough. Look forward to next quarter. Thanks and congratulations again.

There are no further questions at this time. Please proceed with your closing remarks.

Great. Thank you very much, operator, and thank you all for joining us on this call. We look forward to speaking with you again at our next quarterly call in the fall. Thank you very much.

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.