Ten Peaks Coffee Company's (SWSSF) CEO Frank Dennis on Q2 2018 Results - Earnings Call Transcript

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About: Swiss Wtr Decaffinated Coffee Inc. (SWSSF)
by: SA Transcripts

Ten Peaks Coffee Company, Inc. (OTC:SWSSF) Q2 2018 Earnings Conference Call August 9, 2018 12:00 PM ET

Executives

Frank Dennis – President and Chief Executive Officer

Analysts

Operator

Greetings and welcome to Ten Peaks Coffee Company’s Second Quarter 2018 Earning Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder this conference is being recorded.

Before we start, I am 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 we consider as reasonable at the time they were 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.

Ten Peaks Coffee Company does not assume responsibility for the accuracy and the completeness of the forward-looking information. Similarly, the company does 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 the company's management discussion and analysis posted on SEDAR and Ten Peaks' website for a full discussion regarding forward-looking statements and the risks therein. At this time, I would like to turn the conference over to your host, Frank Dennis. Thank you. You may begin.

Frank Dennis

Thank you. Good morning, and thanks for taking the time to join me. I'm Frank Dennis, Ten Peaks President and CEO. If you've dialed in before, you know I usually co-host these quarterly calls with Sherry Tryssenaar, our CFO for the past nine years. Sherry recently retired. And we are now in the process of hiring her replacement. So I'll be conducting this conference call on my own.

As a standard, I'll be providing a brief overview of the financial results for the three and six months ended June 30, 2018, that we released yesterday before taking your questions. Looking at our results for the second quarter and first half of this year. During the second quarter, our SWISS WATER Process decaffeinated coffees continue to gain market share with processing volumes growing 8% over Q2 a year ago, and for the first half, volumes were up by a strong 13% year-over-year.

Looking at volume growth by customer type. Shipments to roasters, those customers whose – customers who roast and package coffee to sell to consumers in their own coffee shops or for home or office use, increased by 12% in Q2 and by 19% for the year-to-date. Shipments to importers, who resell our coffees to roasters where and when they need it, were virtually the same as in 2017 for both periods.

Strong growth in sales to roasters came in two ways. First, we sold more decaf to existing roaster accounts as they grew their own business either by increasing their distribution venues or by adding to their product offerings; and second, we increased our customer base by adding roasters, who used to source their decaffeinated coffees from a CO2 plant in Europe that closed last year.

We also saw additional North American volumes due to CO2 plant closure in Houston, Texas that shutdown in June this year. Looking now on our financial performance. This year's growth in processing volumes had a positive effect on our revenues, with sales for Q2 growing by 3% to $22.7 million and sales for the first half rising by 7% to $43.9 million.

In both periods, the impact of our higher processing volumes were partially offset by a lower New York 'C'. During the second quarter of this year, the New York 'C' averaged US $1.17 per pound compared to US $1.31 per pound in Q2 2107. In the first half, the NY'C' averaged US $1.19 per pound compared to US $1.38 per pound during the same period last year.

As a substantial portion of our revenue comprises the amount we charge our customers for green coffee, and as we charge market rates for this coffee, our revenue drops when green coffee costs fall. Our revenues for both Q2 and the first half were also affected by a lower average U.S. dollar when compared to prior year as a large portion of our sales is built on that currency.

Cost of sales rose slightly by 1% to $18.7 million in the second quarter and by 7% to $37 million for the first half compared to the same periods last year. The increase during the first half of the year was due to several factors, including higher freight charges, and variable production costs associated with our increased volumes, as well as higher green coffee costs.

Gross profit for Q2 was $4.0 million or a margin of 17.4%. This is an increase over the same period last year when we recorded a gross profit of $3.4 million or margin of 15.4%. There is also an increase over the first quarter of this year when we recorded gross profit of $2.8 million and 13.4% margin. The improvements in profit margins were helped by focused efforts of our management team to review and reduce operating cost following the margin compression that we saw in Q1.

These efforts are continuing and ongoing, and we continue to seek margin maintenance and improvements, following a period of bearing inflationary cost increases, and to implement cost reductions for variable and fixed expenses, provided, of course, that they don't compromise the quality of our coffees.

Gross profit for the first half grew slightly from $6.4 million last year to $6.8 million of this year, with the margin for both years being about the same as 15%.

Operating expenses for Q2 and the first half grew by 28% and 29%, respectively over 2017, with increases mainly due to higher staffing and staff related expenses. Our personnel costs are rising as our business rapidly grows and as we lay the strategic foundation to quickly fill the new production capacity we have coming online in 2019.

Operating income for Q2 was $1.5 million, an increase of 4% over the same period last year, while six-month operating income fell by 24% to $2.1 million, due primarily to our increased operating expenses. Overall, Ten Peaks recorded net income of $1.3 million in the second quarter of this year compared to $1.7 million in Q2 2017, and net income of $1.8 million for the first half compared to $3.2 million in the same period last year.

In both periods, the change in net income was mainly due to our increased operating costs together with foreign exchange losses compared to foreign exchange gains in 2017, and unrealized loss on risk management activities compared to a gain in 2017.

On a per-share basis, we recorded basic earnings of $0.14 per share in Q2 compared to $0.19 per share in the same period last year, and first half earnings per share of $0.20 compared to $0.35 per share in 2017. On a fully diluted basis, our earnings per share were $0.10 in Q2 compared to $0.17 in the second quarter of last year, and $0.13 per share for the first half compared to $0.25 per share for the same period last year.

In terms of EBITDA. For the quarter, EBITDA fell by 16% to $1.9 million and for the first half, EBITDA decreased by 24% to $3.0 million. In both periods, the change reflects our increased operating costs and reduced gains on realized risk management activities, coupled with the investments we're making in our infrastructure to prepare for future growth.

And finally, turning to dividends. On July 16, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on June 29. Looking ahead, we expect to record double-digit year-over-year growth in our annual volumes. Our focus for the next two years will be on positioning SWISS WATER for steady future growth. To do that, we're investing in the resources we need: first, to continue generating increased sales volume; and second, to respond to heightened consumer demand.

Currently, we're in the process of opening a European sales office to better serve customers in the EU, which is largest decaffeinated coffee market in the world. At the same time, we're expanding our ability to target specific customer groups in North America by selectively adding to our sales team. While these initiatives are increasing our expenses, we need to establish people in roles significantly advanced of developing volume, but expect them to begin generating over the back part of this year, and importantly, when our new Delta facility opens.

We're making good progress in the building of our new state-of-the-art production facility in Delta, BC. That new plant will initially help one new production line, which is expected to be commissioned in the third quarter of 2019. I remind you, the building, of starting up a new plant and eventually moving production from our current facility are complex and expensive projects that will impact the results over the coming several quarters.

In short, then, our outlook is positive, particularly from a volume point of view. Demand for specialty decaf coffee is growing, and we have the best products with specialized knowledge and experience, and the operational infrastructure to effectively respond. We also have a well-established brand, we're working to leverage more effectively. For that reason, we asked shareholders at our recent, annual special meeting for approval to change the name of Ten Peaks to Swiss Water Decaffeinated Coffee Inc. This change was adopted, and will take effect at the end of this calendar year.

We believe this simplified structure will help shareholders and potential investors more readily associate the investment opportunity with its proprietary SWISS WATER Process. It will also modestly decrease the company's compliance costs. That wraps up my comments for today. I'd be happy now to answer any questions that anyone might have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from [indiscernible]. Please proceed with your question.

Unidentified Analyst

Yes, hi my name is [indiscernible] out of Montreal. We are a money manager and shareholder of the company for a while. You say that, just to follow up, what you said adding a European sales office, more staff in North America to target specific customers and market, this – this product of decaffeinated coffee. So the question is what you guys have to do to get these big, like, Green Mountain coffee customer or Nespresso or some affiliation of Starbucks? What does it take to get them on board? And to adapt your process of decaffeinated coffee?

Frank Dennis

That was exactly to the heart of the issue that we are dealing with, and that we are – why we are putting in place sales resources. Because it typically takes anywhere from 12 to 15 months, generally, to develop new customers, especially larger ones, who go through a long process of trials and understanding logistics and comparisons, et cetera. And so, with my experience, several years ago, in opening up a second operating line here in 2005, when we had significant amount of additional capacity come online, we hadn't taken the opportunity in advance to place significantly more sales resources to help sell that additional capacity, and we were at a very low capacity for a long period of time. And that was a much bigger issue than putting in place what you're seeing now, which is selling resources that take time to understand our product, and understand the marketplace, and then, build into that additional volume.

So we are preparing for that additional volume. So we are preparing for that additional volume because it is a much – more intense problem when you aren't getting new business coming in when you've just added 40% or 50% additional capacity. So yes, you're seeing EBITDA issues now, for sure. But this is based on our experience that it is important to prepare for our opening, so that we are much – so we much more quickly go up the capacity utilization of that new facility.

Unidentified Analyst

Is that also – are you guys getting a little bit more aggressive on marketing and on social media to make the awareness higher? The awareness of a healthy coffee versus chemical decaffeinated processed coffee? I mean, all these big companies, they seems to – not to – how can I say that, of course, they are aware of the chemical decaffeinated coffee, but they don't seem to protect their customer. So

Frank Dennis

They don’t care – not all of them care as much as we would like. And the first answer to your question is, yes, we also have additional marketing expenses in place, particularly, in the U.S. consumer market. We're doing a lot of work in social media. Yes. In – but also directly to the consumer via electronic New York Times access, which targets exactly the customer that we want in the U.S. and so we're – also have increased expenses around that space. We go at this marketplace from a positive point of view, we talk to the consumer about the positive benefits of wonderful tasting chemical-free coffee.

We don't come at the market from a negative point of view. So plastic straw thing is a perfect example of something that can over time very, very quickly change your marketplace. And we believe that there is that potential over the next couple of years for that – something like that to happen, particularly, with – in the U.S., for example, places like Home Depot and Lowe's are taking methylene chloride out of paint strippers, I know it's a totally different industry, but because of consumer concern about around methylene chloride, that product has – is being taken off the shelves right now, as we speak.

At some point, if consumers knew that methylene chloride is also in their decaffeinated coffee, which – that's what we try to market to, but we – again, we do it in a positive way as opposed to negative. If they knew though, we could be in a situation, like plastic straws, where in nine months, 12 months, consumers have no desire at all for anything, but chemical-free decaffeinated coffee. That would be difficult right now.

Unidentified Analyst

So you – what you're saying is that – with positive awareness, health conscious awareness, it could just acting naturally?

Frank Dennis

That is right. And we have to do this positively. We – I do not like to market from – again, like I said, from a negative point of view. It's – that's how we have to work in our industry, but you never know what can happen. All of – there are – part of the reason that we're focused in the U.S. in this particular segment that we're focusing on, that I'm not really going to say because our competitors listen to this call. But this particular segment that we're focusing on, we are trying to drive that exact type of conversion through that marketplace to see if we can seriously get this ball to start rolling.

Unidentified Analyst

Is that correct, Frank, that in Japan and some European countries, chemical decaffeinated coffee is – cannot be

Frank Dennis

In Japan. Yes, in Japan it is illegal, and in Korea it is illegal. Those are the only two jurisdictions that it's actually illegal. In Canada, which has always been beneficial for us, you need to specify on your product, on your package, whether you're using a chemical solvent or not. So that's why our market share is very good in Canada. But yes, there are jurisdictions that have already recognized, that the methylene chloride is a problem.

Unidentified Analyst

What about market like California? No.

Frank Dennis

That’s always an opportunity, and we do a lot of work in not just California, but through choosing, for example, vehicles like The New York Times, which have – in the U.S., a bit of a, kind of, a left-leaning readership, who are much – tend to be much more concerned about managing health, managing the environment. These types of issues can get picked up, and they can – and so as we're targeting New York Times, that's – absolutely that has national readership, that's not – we absolutely target California through that.

Unidentified Analyst

If in Japan, the chemical decaffeinated coffee is illegal, is – you guys have any lead to bring your solution to that market?

Frank Dennis

We are growing very rapidly in Japan right now. That is one of our core international markets, absolutely. And has been for many years, actually. And so we are seeing some nice growth, particularly, with the two CO2 plant closures that we’re seeing, one in Europe that closed last year, and one in the U.S. that's closed this year. They were selling into the Japanese marketplace, and we are seeing additional inquiries and more rapid conversion because of the lack of capacity in the marketplace right now.

Unidentified Analyst

Is that correct also that in Canada, McDonald's and Tim Hortons are customers of Ten Peaks of SWISS Coffee Decaffeinated?

Frank Dennis

Yes, they are. That is right. Tim Hortons has been with – long-term customer, as is McDonald's Canada. We've had various runs at McDonald's U.S., which is the obvious other question. And they – right now, our weighing that decision, and so we got very deep into conversations with them, but right now, they aren't moving forward, but we continue to press. And fact that comes back to your very, very first question about how long does it take. It can take several years sometimes with major customers as they contemplate where the consumer is, and how important this particular proposition would be to their consumer base. That simply takes time.

So I've been in this industry for a very, very long time, and I know conversion. Typically, it's not an easy thing because we cost more than methylene chloride, and that's the fundamental issue. We're not a cost savings relative to methylene chloride.

Unidentified Analyst

Yes, maybe it's a little but more expensive, but it could add up sales for McDonald's, because, have the customer. And then, it's healthy coffee, green coffee, decaffeinated. So I don't know how they think, but it could be a very positive reinforcement for their brand.

Frank Dennis

You have hit it exactly. Exactly what our selling proposition into those organizations is. We know that with even just a little bit of marketing to the consumer behind a conversion to SWISS WATER, you absolutely will increase volumes to more than make up – more than make up for any sort of cost increase, absolutely.

Generally, our process performs better, and we also help customers choose better coffees and that changes the marketplace. Consumers like good coffee, whether with caffeine or not. And so we do see nice volume growth with our customers when they convert. So that's the story. Do you have any other questions?

Unidentified Analyst

No, just how to grow the company to $200 million revenue – annual revenue company.

Frank Dennis

That is exactly what I am focused on.

Unidentified Analyst

Yeah, the market it there.

Frank Dennis

Yes, the market is there. Yes, yes, yes. And part of it, it is building capacity. It truly is. I mean, that – it's very, very critical that we get more capacity on

Unidentified Analyst

I am still very surprised that these Nespresso and Green Mountain coffee are in Vermont with the many affiliates, and whatever other big companies, Tim Hortons, like McDonald's. How stubborn they are not to adapt such a healthy beverage.

Frank Dennis

Well, Green Mountain does use our product, just not across their entire portfolio.

Unidentified Analyst

I know that Van Houtte, they use your product.

Frank Dennis

Yeah, exactly.

Unidentified Analyst

I know, I go to the grocery store, and I take – I pick many package, and I see you guys, SWISS – Kicking Horse, SWISS coffee decaffeinated. I see a Van Houtte. And also we do see that, but I guess, we had – you have to have more.

Frank Dennis

It is the ends up being consumer preference – the wave of consumer preference. That's what we're focusing on. That's what we're desiring.

Unidentified Analyst

Thank you.

Operator

It appears there are no further questions. At this time, I'd like to turn the call back to Frank Dennis for closing comments.

Frank Dennis

Thank you.

Operator

Thank you. And so if there are no further questions, that will conclude today's call. And thank you very much for joining me.