Supremex Inc.

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Supreme Access Q1 2023 earnings conference call. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. 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 Wednesday, May 10, 2023. I will now turn the conference over to Stuart Emerson, President and CEO. Please go ahead.

Thank you, operator. Good morning, ladies and gentlemen. I'm here with Stephen Perot, Interim Chief Financial Officer of Supremex. Thank you for joining us for this discussion on the financial and operating results for our first quarter ended March 31st, 2023. Our press release reporting these results was published last evening. It can also be found on the investor section of our website at www.supremex.com, along with our MD&A. These documents will be available on CDAR as well. We also posted a presentation supporting this conference call. Let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. Supremex had another strong quarter with revenue growth of nearly 40%, a 13th consecutive year-over-year improvement in adjusted EBITDA, and a 50% rise in net earnings. The revenue growth was both organic and by recent acquisitions, namely Royal Envelope and Paragraph, in the packaging segment. Stephen will provide additional details in a few minutes, but let me take a moment to discuss with you the business dynamics. Our envelope business had another exceptional quarter as we delivered on the solid bookings we had at the beginning of the period. Execution on a clear strategy also continues to bear fruit as we benefit from a better sales and customer mix in our U.S. activities. We continue to drive a greater proportion of our business from program-oriented and end-user customers, which tend to be stickier and have a higher margin profile. In doing so, we have moved up the distribution channel with less reliance on wholesalers and brokers. Q1 also marked the first full period with Royal Envelope, which contributed approximately $12 million in revenue. The operational integration has progressed well, and as I said in the last quarter, We see attractive growth opportunities, both in direct mail and conventional channels, and we are only beginning to tap this potential. As you are aware, the US market is of significant size, and with our scale, know-how, and expanded offering, we have been ambitious in looking for revenue synergy from cross-selling our respective product offerings to satisfy a wider range of needs for both existing and new customers. Excuse me. Turning to packaging, we have made considerable progress and continue to build impressive scale, but candidly, we expected more in the quarter. The shortfall was primarily due to residual inefficiencies following the relocation of the town of Mount Royal folding carton plant to the Lachine facility. This move, while a remarkable feat by our operations team, was a significant distraction and impacted productivity and efficiencies. Not surprisingly, the inefficiencies had a negative impact on packaging sales, absorption, and margins in Q1. We continue to make progress on the commissioning at a steady pace. The relocation constitutes an essential step in our packaging strategy, as this larger and more efficient facility will easily accommodate more equipment and volume to assist in reducing costs while building the business. Q1 was also our first quarter with ParaGraph, and it generated just less than $8 million in revenue. The integration has more moving pieces than a traditional single product acquired company, but we've made good progress and we believe these operations will yield important synergies within our expanded network. And on the topic of expansion, on Monday we announced the acquisition of GrafPak, a manufacturer of folding carton packaging solutions to several commercial markets, including food and cosmetics. Located on Montreal's West Island, GrappPak is a relatively small business with sales of approximately $6.7 million. It is a perfect synergy tuck-in with our existing operations in the greater Montreal area. In announcing the transaction, we informed employees that within 90 days, we intend to move their activities to the new Lachine facility, which is less than 15 kilometers away. We expect this tuck-in operation to rapidly yield synergies within our folding cart and group. With that, I turn the call over to Stephen for a review of the Q1 financial results.

Thank you, Stuart. Good morning, everyone. Q1 2023 was another record quarter for SPREMAX. Turning to our top line review, total revenue was up 39.8% to $88.4 million from $63.3 million last year. Revenue from the envelope segment rose 44.4% to $64.5 million. This solid growth includes a $12 million revenue contribution from the acquisition of Royal Envelope completed last November. Revenue was also favorably impacted by an average selling price increase of 40.1%, which mainly reflects more favorable customer and product mix in U.S. operations, as well as pricing adjustments to mitigate input cost inflation. Packaging and specialty product segment revenue amounted to $24 million, up 28.7 percent from $18.6 million last year. This increase reflects a $7.8 million contribution from Paragraph and higher e-commerce related sales, partially offset by the wind down of DuraBox operations and residual impact on sales of relocating the folding carton facility. Looking at EBITDA, consolidated EBITDA was $18.5 million in the first quarter of 2023 versus $12.1 million in Q1 2022, while adjusted EBITDA reached $18.8 million, up from $12.1 million last year. As a percentage of revenue, the adjusted EBITDA margin was 21.3%, up from 19.1% a year ago. Envelope segment adjusted EBITDA totaled $17.3 million compared to $10 million last year. The sharp increase primarily reflects the Royal Envelope acquisition, as well as higher margins related to a more favorable customer and product mix in the U.S. The adjusted EBITDA margin was 26.8%, up from 22.4% last year. In the packaging and specialty product segment, Adjusted EBITDA was $3.8 million compared to $4.2 million last year. This decrease reflects the residual effect on profitability from relocating the folding carton facility, partially offset by the contribution from paragraph. Adjusted EBITDA margin was 16.1% compared to 22.5% for the same period in 2022. Corporate and unallocated costs were $2.3 million in the first quarter of 2023, compared to $2.1 million last year. The slight increase is mainly due to higher compensation-related expenses. Now looking at net earnings, net earnings reached $9.5 million, or 37 cents per share, up from $6.3 million, or 24 cents per share, last year. Adjusted net earnings amounted to $9.8 million or $0.38 per share in the first quarter of 2023 versus $6.3 million or $0.24 per share a year ago. Turning to cash flow, net cash flows from operating activities were $7.5 million in the first quarter of 2023 versus $0.2 million in Q1 2022. The year-over-year variation is due to higher profitability and a reduction in working capital requirements. Pre-cash flow was $3.4 million in Q1 2023 compared to minus $0.1 million as the aforementioned factors were partially offset by higher capex this year compared to last. Looking at our financial position, our total debt amounted to $81.4 million as at March 31, 2023. versus $54.7 million as at December 31, 2022. This increase is essentially related to the acquisition of paragraph for consideration of $27.1 million. Net debt, which excludes deferred financing costs and cash, stood at $79 million. As a result, our net debt to trailing 12 months adjusted EBITDA ratio was 1.2 times as at March 31, 2023, versus 0.9 times as at December 31, 2022. At the end of the quarter, we had $39.9 million in available liquidity under our senior secured revolving credit facility of $120 million, leaving us sufficient flexibility to finance our investments and operations. Finally, the Board of Directors declared a quarterly dividend of 3.5 cents per common share payable on June 23, 2023, to shareholders of record at the close of business on June 8. I turn the call back to Stuart for the outlook. Stuart?

Thank you, Stephen. As we've said many times, we are methodically building this company for the long term. Our strategy is relatively simple and universally understood by our management teams. Leverage our market position, capacity, know-how, and cash flow in envelope to fund the pivot to packaging. We are pleased with the progress made in its execution, but we are not satisfied. In the immediate term, our priorities are to integrate the recent acquisitions to harvest all synergies. This includes making further inroads in the US direct mail market for our envelope operations, leveraging larger capacity of our revamped Lachine folding carton facility and packaging, and integrate both of the 2023 packaging acquisitions. Our revenue run rate is approximately $350 million and our first quarter sales exceeded its proportional share. This said, we expect some softness in the second and potentially third quarter as customers work through higher inventories built through panic buying during last year's constricted supply. Fast forwarding to this year, those customers must work through their excess inventory during a time of general market softness resulting from the economic uncertainty, and our new order intake has been negatively impacted. I want to be clear here. The market and business fundamentals have not changed. This is simply a reset required after a tumultuous 2022 in both segments we serve, and we expect a return to normalcy in Q2 and into Q3. Fortunately, for Supremex, we can rely on a solid reputation and wide geographic and product reach to help mitigate the adverse effects of a reset, and as always, we will continue to tightly manage our expenses. Supremex's results clearly show that our strategy is sound, and we continue to drive toward our midterm objective of achieving a 50-50 balance between envelopes and packaging by the end of 2025. Currently, our run rate is roughly 70-30. To reach our objective, we need approximately $150 million in new packaging business. While we have identified organic growth opportunities, about 80% of the additional revenue should come from M&A, ideally with a cadence of one per year using a healthy balance sheet to acquire, integrate, and deleverage before moving on to the next target. With the recent additions, we feel our presence in Quebec is now optimized, and we are ready to expand to new territories, either in the Ontario market or in US markets where we already have a presence to benefit from natural synergies. Supremex has a solid balance sheet and generates strong cash flow. This provides us with the flexibility to look for strategic initiatives that create the most value for our shareholders. In conclusion, I thank all Supremex employees for their excellent performance. We are privileged to have solid teams in both Canada and the US, as well as in both envelope and packaging. These achievements would not have been possible without their talent and dedication. We will now be pleased to answer any questions you may have. Operator?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Kyle McPhee with Cormac Securities. Please go ahead.

Hi, everyone. Just to start off with the envelope segment, your pricing seems to be landing higher than I thought and fully sticking at those higher levels. And my question is what we should expect going forward, you know, immediate and midterm with sector supply chains now loosened and your input costs likely deflating. Should we expect envelope pricing to start deflating? And maybe as part of your answer, you can address Canada and the U.S. market dynamics.

Yeah, so that's a $64,000 question, Kyle. Q1 was largely booked in Q3, Q4, so those orders were in-house, in-place, already pre-priced. We are seeing sort of a natural return of questions around pricing and people more interested where in last year they were more concerned about supply and availability. Today they're asking about both availability and price. How far that ebbs remains to be seen. We actually did have a little bit of pullback on ASP ever-selling price in the U.S. in Q1, kind of hidden a little bit by continued growth in Canada. So as supply and demand gets more imbalanced and natural, I don't know what that number is, and nor do I care to predict how far or how much pressure there will be there, but there will definitely be some. Obviously, Canada is less so, given our market share and market position. It really comes down to how quickly customers work through their inventories. And those that have sort of stayed out of the mail for a period of time because of the economic uncertainty, how quickly they get back into it will dictate sort of where competitors go on price. But I do like our position. I mean, where we were a year ago and where we are today with the customer mix is going to give us some insulation on any downside.

Okay, thanks for that, Keller. That's helpful. Again, on the envelope segment, your comments, pointed that you're losing volume relative to the temporarily very strong period in 2022. I'm just looking for a little more detail on exactly what's going on. Are you losing client accounts that no longer need you as sector supply shortages are gone? Or are you just losing volume from clients that you're keeping, but they're just chewing through their inventory? Or is it both?

It's a little bit of both, but it's more the latter than the former. So yeah, there's been a few customers that have gone somewhere else for a better price or something that, you know, really needed us in 2022, but there's not very much of that. Most of it is, you know, wholesalers that have, you know, they were buying as much product as they could possibly get, and, you know, we were supplying and others were supplying. For example, we have a large wholesaler in New England, and their units purchased this year are down 61%, but they haven't moved a single item from us. They're just chewing through the inventory. They say they're two weeks away from being able to put replenishment orders back in the system. And it's more of that type of impact than customers leaving us.

Got it, understood. Okay, and then mid-term beyond all this lapping noise, is the goal with your envelope segment to still have flat-ish organic volume growth? Or in other words, do you still expect you can take enough share in the U.S. market to offset those Canadian secular declines? Has the view on your runway in the U.S. changed at all?

Not at all. In fact, it's actually improved a little bit with the acquisition of Royal. We have some capacity there, and it takes us into a market that we weren't terribly familiar with.

Okay. I'll leave it there. Thanks for the answers.

Thanks, Kyle.

Ladies and gentlemen, as a reminder, should you have a question, please press star followed by one. Your next question comes from Najee Beidou with IA Capital Markets. Please go ahead.

Hi, good morning. Just to pick up the line of questions on envelopes. Can you just give us a bit more details about the sales mix, because volumes are also up in the quarter. How is that looking, and what are some of your expectations on sales mix and volumes for the rest of the year?

So as we said in the statement, I mean, we think volumes are going to be softer in Q2. We've already seen sort of a softening as customers work through that inventory, how it you know, how it looks and how quickly people come out of it is, you know, sort of remains to be seen. And then we get the other dynamic is, you know, on the direct mail side, you know, the not-for-profits or fundraisers have significantly diminished their direct mail in the quarter just as, you know, inflation has affected people's ability to – inflation and concern, I guess, have been impacted people's ability to donate or will to donate to not-for-profits. And then on the banking side, the credit card solicitation acquisition business, interest rates have sort of made it a bit complex for mailers to put their offers together to get people to switch balances and so on and so forth. It's really hard to tell, Nagy. I mean, we're involved in so many segments with so many moving parts. The degree in each segment is really hard to put our finger on, but we do expect volumes to be down in the second quarter, but it's a temporary thing as we work through sort of just some resetting.

Understood. I appreciate it. It's a dynamic sort of issue with a lot of moving pieces. Maybe just... and switching to the packaging side, can you help us just a bit more with the sort of the impacts of the quarter from the relocation? And I guess, big picture, what is sort of your expected sort of growth rate for the business now that DuraBox, like that noise is out of picture and you have the two acquisitions that you just announced?

Yeah, so, I mean, we had a lot of... call it unabsorbed labor in the quarter, in Q4 and in Q1, commissioning the press that we bought at the end of January. The press was there, but getting it commissioned and up and running, you had a lot of sort of direct labor and hanging around, helping with the commissioning. And we just didn't get the absorption, the revenue, the sales revenue didn't drive the absorption that it normally does. You know, same labor, lower sales, I guess is the easiest way to put it, and, you know, flows right through to the bottom. You know, it's largely behind us, just a little bit of residual stuff there and just getting organized and being efficient and getting workflows sort of ironed out in the new facility. You know, tucking in the graph pack piece will add a fair bit of contribution to the to the facility, and we'll take a lot of cost out associated with the rents and overheads and indirect labor in the graph pack business. We're still, of that $150 million, we think 80% of it has to come from M&A, so the balance would be organic growth over the next three years.

It sounds like maybe there's still some impact in Q2 then from the relocation, but to a lesser extent. And any updates on the integration of Paragraph? I mean, I think the business was a bit of a lower margin when you acquired it, but how is that integration going? When do you expect to maybe be more advanced on that process?

Yeah, as I said in my remarks, I mean, this is really the first acquisition we've done that's not been sort of a single product that's either an envelope or a pure package. There are some There's some ancillary businesses around it, and we're just trying to untangle those. It takes a little bit longer than the pure tuck-in. We've grabbed synergies from paper, headcount. I would say we're on track with the synergy side, but just getting our arms around it has taken us a little bit longer.

Okay. I appreciate that. Maybe just one last question. Any updates on the CFO search process?

Yes, we've made good progress. We hope to have something announced here in the next couple of weeks. I've been through a robust interview process and had a candidate meet with the board and we're full steam ahead and hopefully have something to announce here shortly.

Okay, thank you very much and congrats on the good quarter.

Okay, thanks, Najee. If there are no further questions at this time, please proceed.

Okay, thank you very much, Operator. So thank you all for joining us this morning. I hope to see a few of you at the AGM this morning. And for those of you that we don't see, thank you for joining, and we look forward to speaking to you again with our next quarterly call. Thank you, Operator.

You're welcome, ladies and gentlemen. This concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.