Supremex Inc.

Good morning, ladies and gentlemen, and welcome to the Supremex first quarter 2022 earnings conference call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star followed by zero for operator assistance. This call is being recorded on Thursday, May 12, 2022. I would now like to turn the conference over to Martin Goulet. Please go ahead.

Thank you, operator. Good morning, ladies and gentlemen, and thank you for joining us for Supremex's first quarter conference call. My name is Martin Goulet from MDC Capital Markets Advisors, the investor relations consulting firm supporting Supremex with IR activities. With me today is Stuart Emerson, President and CEO, and Mary Chronopoulos, Chief Financial Officer and Corporate Secretary. Following their comments, we will open the call for questions. For a more detailed analysis of our results, please refer to financial statements MD&A, and press release published earlier this morning and available on the company's website at www.supremex.com and on CEDAR. In addition, we posted a presentation supporting this conference call, which is available through the webcast and on the company's website. I'd like to remind listeners that this conference call contains forward-looking information within the meaning of applicable gain securities laws. Please refer to the forward-looking statement as detailed in the presentation supporting this conference call. Furthermore, risks and uncertainties are discussed in the Annual Information Forum dated March 30, 2022, under the heading Risk Factors and updated in the company's latest MD&A. During this call and in the presentation, we may refer to various non-IFRS measures, including, but not limited to, EBITDA, adjusted EBITDA, adjusted debt earnings, adjusted earnings per share, free cash flow, and ratio of total debt to adjusted EBITDA. These terms are defined in the company's MD&A. And unless stated otherwise, all figures are expressed in Canadian dollars. With that, let me turn the call over to Stuart.

Hey, thank you, Martin, and welcome, everyone. Let's turn to slide 43 for an overview of the first quarter. I am very pleased with our results. We delivered solid 18% top-line growth and increased our margins in a period of steep inflation. Q1 was the ninth consecutive quarter of year-over-year improvement in adjusted EBITDA. That earnings rose more than 50% to $6.3 million, or 24 cents per share. This solid performance was driven by selling price and mix improvement, impressive increased revenue across all lines of business, which more than offset inflationary pressures and a tight paper market, and by the continued improvements in efficiency across the operating platform. Envelope revenue was up by 16.7% to $44.7 million, mainly driven by average selling price increases required to offset material cost increases. And packaging and specialty products revenue rose 21.5% to $18.6 million, reflecting revenue growth in both Canada and the U.S. and across each of our lines of business. Packaging revenue was also supported by a full quarter of last year's small acquisition of Vistagraphics, communication. CFO Mary Karnopoulos will provide additional details in a moment. I would like to share a couple of important specific insights with you. The first is around the envelope segment. You may notice that we now refer to the envelope segment as one geographic entity where we used to segregate Canada and the U.S. in prior period. Per the strategy laid out in 2014-2015, we had ambitious plans to broaden our geographic reach, and we and the market now see ourselves as a bona fide North American player. And with that, the secular decline in Canada becomes much less relevant as penetrated access to a 20 times larger U.S. market has delivered and provides significant ongoing growth opportunities for Supremex from our existing envelope facilities. The second is around supply chains. In both envelope and packaging, we are operating in a period of a significantly constrained paper market. Although we have solid relationships with suppliers for a multitude of reasons, supply is tight and it's a real challenge to meet existing obligations, much less capitalize on new opportunities. Backlogs are very strong, there are a lot of opportunities, and all of our facilities have available capacity, but paper continues to be an inhibitor to growth and will be for the next few quarters. To address this tightness, we have sought out alternative sources of supply, and while it won't solve all of our problems, I'm pleased to report that we have secured additional shipments of high-quality paper, which is expected to start to arrive in early Q3. These alternative sources come at a premium price, but taking care of committed customers and meeting obligations is paramount to us, and we believe going this route in the long term is in the best interest of all Supremex stakeholders. To summarize, there is demand for our products, To date, we've been able to pass through inflation as witnessed over the past several quarters, and with this new supply, we have a great opportunity to better service customers. And finally, a quick update on our plan to move the folding carton plant in the town of Mount Royal. The move has been delayed to 2023 as we renegotiated a one-year lease extension for the facility. Pushing out the move provides the team with more time to plan and can be supported by Stéphane Gabois, our new Director of Operations on the packaging side. With that, I'd like to turn the call over to Mary for a review of our Q1 financial results. Mary?

Thank you, Stuart. Good morning, everyone. Turning to slide 44 for our Q1 top-line review. Total revenue was up 18% to $63.3 million from $53.6 million last year. Revenue from the envelope segment was up 16.7% to $44.7 million. The improvement reflects an average selling price increase of 14.2% from last year's comparable period, primarily resulting from price increases swiftly implemented to reflect rising input cost inflation. The volume of units sold increased by 2.2%, driven by initiatives to increase penetration of the U.S. envelope market, and from the rebound in demand from certain channels more affected by the pandemic and lockdown measures. In our packaging and specialty product segment, revenue grew by 21.5%, to 18.6 million, primarily from the acquisition of VISTA, coupled with organic growth across our lines of business. Moving on to slide 45, consolidated EBITDA increased 28.6% to 12.1 million in the first quarter of 2022. Likewise, consolidated adjusted EBITDA increased by 26.6% to 12.1 million from 9.5 million in the first quarter of 2021. This increase resulted from higher revenue in both segments, driven by increased volume in sales prices. It was partially offset by the higher cost of materials. The adjusted EBITDA margin increased by 19.1% compared to 17.8% in the equivalent quarter of 2021. Envelope segment adjusted EBITDA was up 36.9% to $10 million versus the same period last year. This increase was primarily due to higher revenue, driven by an increase in average selling price, partially offset by a less favorable product mix. Adjusted EBITDA margin was 22.4%, up from 19.1% in the equivalent period of 2021. In the packaging and specialty product segment, adjusted EBITDA was $4.2 million, up 69.9% over the same period last year. The significant increase is mainly explained by greater revenue, driven by higher volume and average selling price. Adjusted EBITDA margin was 22.5% compared to 16.1% in the corresponding period of 2021. The corporate and unallocated costs stood at $2.1 million in the first quarter of 2022, compared to $0.2 million for the same period last year. The variation reflects severances, unfavorable adjustments to the DSUs, due to share price appreciation and the phasing out of the Canadian government subsidies. Now turning to slide 46. Net earnings were $6.3 million or $0.24 per share for Q1 of 2022 compared to $4.1 million or $0.15 per share for the equivalent period last year. Adjusted net earnings also amounted to $0.24 per share versus $0.15 per share for the equivalent period of 2021. Turning to cash flow and capital deployment on slide 47, cash flows related to operating activities decreased to $0.2 million in the first quarter from $4.5 million in Q1 of 2021, mainly attributable to investments in working capital partially offset by higher profitability. Similarly, free cash flow decreased to a use of funds of $0.1 million in the first quarter compared to free cash flows of $4.2 million for the same period last year mainly attributable to investments in working capital partially offset by higher profitability. In the quarter, we used our cash primarily to make a small acquisition for $0.9 million, invest in CapEx for $0.4 million, and repurchase shares for $0.3 million, as you can observe on slide 48. More specifically, during the first quarter, the company purchased 106,000 common shares for cancellation under its normal course issuer bid program. Subsequent to the end of the period, an additional 105,100 shares were purchased for cancellation. Now, a brief update on dividends. In January, we announced the reinstatement of the company's quarterly dividend after having suspended them in the early months of the pandemic. After dividend declarations in January and February, the Board is now expected to follow a declaration schedule that mirrors our quarterly results. In keeping with this new schedule, The Board yesterday declared a dividend of 2.5 cents per common share payable on June 27, 2022 to shareholders of record at the close of business on June 9, 2022. Turning to the balance sheet on slide 49. We ended the period in a solid financial position. Total debt stood at $44.9 million in the first quarter of 2022, slightly above the $44.5 million at the end of Q4 2021. Similarly, we ended the first quarter with a leverage ratio of 1.1 times, in line with the previous quarter. Moreover, we had approximately $64 million in available liquidity under our revolving facility to pursue our growth objectives. I turn the call back to Stuart for the outlook. Stuart?

Thank you, Mary. From the beginning, the objective is to build the business for the long term at a measured and steady pace, focused on our core competencies. No new and improved slogans, no rebranding. It's all been about blocking and tackling. It's been about ensuring the envelope business is built with a long runway to support diversification into a growing and environmentally sustainable paper-based packaging segment that fits with our manufacturing know-how. We believe our last nine quarters demonstrate that we are not only on the right track, but that we are well down the line. To summarize, there is strong demand for our products across all lines of business. We have solid backlogs and we're operating at high utilization rates given the available raw material and labor. Although certain issues remain, especially with respect to paper procurement, our position in the market continues to yield significant growth opportunities. We believe our teams have done a tremendous job executing the strategy and getting us to this enviable position and that they've been exceptional over the last few quarters in navigating us through what has been choppy waters on the supply side. In the envelope segment, as I said earlier, our strategy was to increase the runway, and I like where we are. We sold 7% more envelopes in 2021 than we did 2020. We sold 14% more envelopes in Q4 last year than we did the year before. We sold 2% more envelopes in paper-constrained Q1 than we did in Q1 2020. While I hesitate to say we've slayed the dragon, it's clear the runway has been extended. In packaging, we continue to build out our capabilities with a goal to attain an equal revenue split between our two business segments by 2025. In closing, as we look ahead to the remainder of 2022, we still expect revenues and profitability to be ahead of 2021 in aggregate. However, quarterly distribution of the results will be contingent on paper availability with an outlook that tightness in most paper grades should ebb in late Q3. With that, I want to thank the entire Supremex team for the passion and dedication and commitment to the organization and its success. Thank you. Operator.

Thank you. If you'd like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw your question, please press star one again. We'll pause for just a moment to compile the Q&A roster. And our first question comes from Neil Lindsdell from IA Capital Markets. Please go ahead. Your line is open.

Yeah, thanks. Well, congratulations, guys, on really good performance in a very difficult market. Obviously, the big thing we want to delve a little bit deeper into is the paper supply. So can you talk about the, you mentioned alternative sources, you're getting some supply in, you mentioned in Q3, you're looking at tight supply in Q2 and Q3, and then you think that's going to ease by the end of Q3. Should we expect with these alternative sources, which I guess are just suppliers you've not been dealing with previously, is there going to be some margin compression or can you pass any kind of extra costs on to your customers?

I'll take that, Neil. Thank you. Yeah, so you're 100% correct, new suppliers. We think that domestic supply should ebb in late Q3. So we went out and sourced some paper from new suppliers. It takes a little bit of time to get in the queue and get it to North America, but... On the margin compression, that's the $64,000 question. Some of that new supply will go to ensuring that existing customers and existing commitments are fulfilled. We think we can recoup some of the increased costs. And then some of that supply will go to new opportunities that we'll be able to pass through in full. So the split I was just not completely sure of at this point. Okay, but overall? Overall, there will be a modest, there's a risk of a modest compression. Okay. Sorry, Neil, but supported by more revenue and units, right, than we would have gotten.

Yes.

Okay.

Yes, all good. In the MD&A, you mentioned that the Niagara acquisition has helped mitigate the paper supply. Is that true? Is this alternative source a source through that acquisition, or was there something else that I'm missing?

No. They had their same paper suppliers as our traditional paper suppliers, so no new suppliers introduced through that channel. But really what we've done with Niagara is we've taken some of their – paper allocation and capacity and applied it to existing business that we had in Western New York, which means we don't have to produce it in Toronto or Montreal and freeze up that paper for other customers. That's the mitigation.

Okay, got it. And then when you talk about paper supply, if we look at the different products that you have between the envelopes, the folded carton and the corrugate, Are you seeing the same type of constraints across all those different, I guess, types of paper? Yeah, we are.

Yes, we are. The corrugated paper hit first, the thickness of supply, but that's already started to happen. It's quite available now, so that's not a concern. The issues in folding carton, e-commerce, and envelope are essentially the same. Different suppliers between envelope and folding carton. But same issue. And running about the same timeline.

And when we're looking at the packaging specifically, but I guess across all the product lines, I'm just wondering, you talked about the backlog. So when you talk about your backlog, is it stuff that you've already, you know, you have the orders in hand, you're committed to deliver on a certain date, three months or six months in the future? Is it open purchase orders that you just have to deliver against, or how much visibility do you really have, and how much of that backlog is secure versus just intended? It's all secure, 100%. So how far out is that? It's like you're committed to deliver 12 months from now?

It varies. The backlog, so new requests, customers showing up today. We're taking no new requests at this point from new customers and haven't for several months. Someone trying to get in the queue right now without sort of a current position would be looking at October, November at earliest. But we have left some space for committed customers that have sort of unforeseen demand. So we're pushed out quite a ways.

And the other thing, obviously, everybody's looking at inflation. So I guess for the most part, other than the paper supply that we've talked about, the biggest concern would be on labor costs. Are you seeing pressure to raise wages to either retain or get the people that you need? And is that different in different jurisdictions?

I think it's Fairly broad-based. If we're talking about direct labor, it's the same everywhere. I think we took really good care of our employees through COVID. We were rewarded for that. Our profit share program was good last year based on the good results. The employees appreciate that. We didn't furlough or lay off a number of employees, so we didn't have to bring them back. We took a fairly aggressive step at the beginning of this year to try and get wage increases through, not in line with current inflation, but sort of higher double than what we would normally do in past practices. And then on the indirect side or the salaried side, yeah, we're seeing pressure there. But I like our position. We have a good position to pass those increased costs through. And the difference in the market is just so tight that you are able to sort of get the increases that you require to cover those inflationary costs. We can get them through, and I think you see that in our margins.

Yeah. Yeah, I want to get to the margins in a bit. On the cost price increases, the shortage of paper and everything like that, I got to think based on your size and dominance in the market, you're in a much better position. So what do you hear from your competitors or what are you seeing as far as the competitors? Are they just suffering so much that that's why you're getting so many inbound calls? I think it's a combination.

I think it's a combination of both. I said in prior two quarters that I think we will come out of the tightness sooner than our competitors will, just because the mills are rejockeying their position. They're aligning themselves with future winners or those that are clustered around their mills, and we're in good shape in all of those areas. Yeah, let's face it, some of the opportunity that we are getting today, I think the opportunities that we got in Q4 and sort of continued to materialize is because we did have available supply, whether it's available supply of paper or we kept our labor. But, you know, some of the things that we're turning away today are a direct result of our competitors' inability to get paper or have labor to supply, so customers are looking for a new safe harbor. We took a really good approach, I think, over the last couple of quarters as we saw this unfold. We completely moved away from, and that's why I talk about improvement and mix, we moved away from sort of the opportunistic buyer that we were sort of had to, cater to when supply outstripped demand, and we went to program-type customers. We were looking for customers, not orders, and the team's done an exceptional job locking those customers up for 6, 8, 10, 12 months, and that's why those backlogs are committed well into the fall. And we get calls from resellers, customers of ours, saying, oh, I'm turning down so much volume because you can't give me more volume. Well, the reason you're turning down that volume is because other suppliers can't get there. So it's a little bit of both. But I think the team's done a really good job migrating us from opportunistic work to more program-committed type work, which gives us better visibility. You can plan your supply chain X, Y, and Z. Okay.

And for all those factors, as we see how things are hitting the competitors and how much better you're positioned, is there anything you can tell us as far as acquisitions? Is it creating an environment where people need or want to be part of a larger organization?

I think there's two things, three things maybe. It's tough right now. So those that were thinking about sort of exiting the business – It's tough. I can't overstate how tough it is on the operational folks trying to get paper and drive it through and dealing with missed deliveries just because you can't get labor or you can't get paper. It's tough. So I think that's accelerated some of the thinking for owner-operators. I also think, you know, we're not the only one that's done better in the last couple of quarters and, you know, vendors trying to capitalize on, you know, an improved EBITDA or trailing 12-month EBITDA to maximize the purchase price. And, you know, we've got your traditional sort of succession issues that are sort of continuing as we sort of age. So that's all there. But So there is a fair amount of activity and interest in both segments, envelope and packaging. We're not interested on the envelope side, but we're getting lots of calls.

Yeah, I guess you don't need to acquire on the envelope side. You can just get the paper and supply the customer. One of the things you don't really break out, I don't think, is on the packaging side. On the envelope, you have the volume difference and the pricing difference. On the packaging side, are you seeing the same type of inflationary impact, which is boosting your revenue numbers, or is that all too difficult to say because the products might be so mixed?

Well, there's definitely a mix. phenomenon on the packaging side that you don't see as much on the envelope side, so depending on the product, that really does impact both the margins. But we are, like Stuart mentioned, the entire environment is such that there is a high demand for the product that we are producing, and we are able to pass on cost increases to our customers. And with the added value that we can provide, that creates a very favorable environment right now for the packaging segments that we operate in.

Go ahead. I would add as well, you know, I talked about the environmental sustainability piece of it as well. The packaging segment is getting a boost on the environmental side. Our packaging segment is getting a boost on the environmental side. There's more pressure You know, more pressure is applied to have more sustainable products, and all of our products are paper-based, so it tends to be an area where consumers are starting to look. So there is a demand increase as well.

Well, thanks. That's actually a good segue into another question I had, which we don't always talk about, but new product development. Right. There's obviously the sustainability, the paper-based, the ESG-type angle to your products, but how much effort do you have, and this could be across folding carton, envelope, how much product development or new initiatives or technological improvements is there in your business, and is there anything specific that you're trying to do now, or is it just keeping up with volumes?

No, because that will end. That's a great question. You know, that whole tightness of supply is going to work its way through at some point, and we're thinking ahead for the future. We recently announced that Murray Rundle, a 30-year guy, MBA, been with us on the envelope side and then moved over to the packaging side. We brought him back to the envelope side several years ago. And he's been running e-commerce, and he's the man essentially responsible for e-commerce and e-commerce growth, has taken on the position of Vice President Marketing and Innovation. He's leading our fairly deep design team, responsible. He's also responsible for IP and equipment innovation, where we could add sort of certain functionality and attachments to our equipment that allow us to be more value-added and do things that others may or may not be interested in. As a mid-market manufacturer on the packaging side, we really want to be at the forefront of sort of the innovation on design, and especially in e-commerce. On the folding cart side, the consumer packaged goods companies They have their own design teams, and they work really hard at what they're doing. His focus on that side will be with the equipment. But on the e-commerce side, it's evolving so rapidly. We want to be at the forefront of innovative, sustainable packaging because we see what can happen with the margins in that space and the margins we're getting with IT-protected products. So we're doing a fair bit. In fact, Murray's going to be here in 15 minutes to meet me.

You want to wait and we can get them on the call? You're smooth. Okay, you can call me after. And I'll kind of finish this off because obviously we want to talk about it. Profitability. I mean, you're looking at margins that you haven't hit in the recent past. How much of profitability improvements that we're seeing now are just price increases, leverage of overhead costs. I know you've put a lot of cost-cutting measures in place. You do this on a regular basis. But explain to me where this profitability is coming from in your mind for the most part. And are there changes that you've made recently that we should see further profitability improvements?

You save the best for last. Well, the profitability is coming from all of the things you talked about. I mean, we closed a factory in Edmonton last year. We ceased manufacturing in New Brunswick. We've improved operations all the way around. They're all more efficient now, even though we're doing more cutting and chopping of orders to preserve paper for the next guy. All of the plants are more operationally efficient. We're more mature as an organization. I don't want to say that we're finishing up integration, but we're more mature as an organization, particularly on the packaging side. Yes, we have a very good market position. The market as a whole is strong. They're passing through increases and getting a little bit more margin in the process. We do a good job for customers. We've had a good supply chain. We're focused on what we want to do. I think the work we did in terms of building a foundation that maybe took a little bit longer than you know, and didn't give us the run-up that we wanted or that the market wanted as quickly as it happened is actually paying dividends now that it's just a more solid organization sort of from top to bottom. So, your question is, is there going to be a pullback at some point and to what degree? The short answer is we don't know on either of those. But we're continuing to, you know, if we continue to add on the M&A side, continue to do good things there, we think, you know, EBITDA can continue to grow certainly in absolute dollars and margins aren't going to be, you know, it's not going to get cut in half. Long answer to a short question. Maybe it wasn't that short a question.

No, it was a long answer. It was a long question, too. Okay, no, I appreciate it. That's everything for me. Thank you very much.

Thanks, Neil. This concludes our Q&A session. I'd like to turn the call back over to the presenters for closing remarks.

Okay, well, thank you for joining us on this call, and we look forward to speaking with you again at the next quarterly call. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.