Supremex Inc.

Danielle Ste-Marie - IR Stewart Emerson - President and CEO Guy Prenevost - CFO and Corporate Secretary Lyne Begin - Interim VP of Finance and Corporate Controller

Neil Linsdell - Industrial Alliance Sam Fergus - Beacon Securities

Thank you, Dan. Good morning, ladies and gentlemen.

My name is Danielle Ste-Marie and I am an independent adviser and act as an Investor Relations capacity for Supremex. With us today is Stewart Emerson, President and CEO; Guy Prenevost, who joined the company on April 16 as Chief Financial Officer and Corporate Secretary; and Lyne Begin, who acted as Interim Vice President of Finance and who has returned to her previous role as Corporate Controller.

I would like to welcome you to today's conference call to discuss our financial and operational results for the quarter ended March 31, 2018, which were released earlier today. This call will be held in English.

[Operator Instructions] For a more detailed analysis of our result, please see our financial statements, our management discussion and analysis and our press release disclosed earlier this morning and available on the company's website and on SEDAR. In addition, we posted a presentation supporting this conference call which is available through the webcast and on our website.

I would like to remind listeners that this conference call contains forward-looking information within the meaning of applicable Canadian securities laws and I refer the audience to the forward-looking statements as detailed in the presentation supporting this conference call. Furthermore, risks and uncertainties are discussed throughout the 2017 December 31 MD&A, under the heading Risk Factors.

Unless stated otherwise, all figures are expressed in Canadian dollars. During this call and on the accompanying presentation, we use various non-IFRS measures, including EBITDA, adjusted EBITDA, adjusted net earnings and net debt to adjusted EBITDA ratio.

These terms are also defined in our MD&A. With these formalities out of the way, I would like to turn the call over to Stewart Emerson, President and CEO at Supremex, to review the quarter's key operational highlights and recent events.

Stewart?

Thank you, Danielle, and welcome, everyone. And I apologize for the short delay in getting the call started.

I'm pleased to be here today to discuss our first quarter results and our recent acquisition of G2 Printing and Pharmaflex. I'd also like to take this opportunity to formally introduce our new CFO, Guy Prenevost, who joined us just 3 weeks ago.

Guy has over 20 years experience of and diversified in finance, sales and operations. He was most recently Chief Financial Officer of Rolland Enterprises, a privately held industrial paper supplier and a supplier of Supremex.

He also held various finance positions at Cascades Group, was a member of the Board of Directors of Cascades U.S.A. and Best Diamond Packaging.

He has a great understanding of the paper and packaging industries and I'm confident that his experience will serve him well in his new role. He just came - he came on board at just the right time to help us push our most recent acquisition over the line.

On May 1, we announced the conclusion of the acquisition of G2 Printing and its related company, Pharmaflex. This represents our third acquisition in the packaging space in less than 1.5 years.

Based in Laval, Quebec, G2 printing is a leading manufacturer of premium quality folding carton packaging and its related company, Pharmaflex, manufactures labels primarily for the pharmaceutical industry. We believe this is a tremendous opportunity for Supremex, G2 and Pharmaflex.

This acquisition perfectly complements our existing folding carton offering within Stuart Packaging as well as our existing industrial label business in LaSalle. We see tremendous growth opportunities at G2 Printing and Pharmaflex and important synergistic opportunities with our existing businesses.

And just like Stuart Packaging, G2 has an impressive book of business and a reputation for high-quality products and customer service. Just a little more background on G2.

G2 printing was a family-owned business that was founded over 40 years ago. The company manufactures premium quality folding carton packaging and Pharmaflex, a related company, manufactures flexo label that it sells through its packaging customers via G2.

They primarily serve a very demanding and complex pharmaceutical industry which generally results in sticky sales. They are well equipped and operate out of 2 pristine facilities.

In the last 12 months, they had $12 million in revenue and have grown in each of the last 5 years. G2 and Pharmaflex perfectly ties in our existing - with our other acquisitions and legacy operations.

To better understand our growing operations and structure, we have created 3 distinct product groups: Supremex envelopes, which manufactures and distributes envelopes in Canada and the U.S.; Supremex packaging which is structured in three different components of the packaging market; the folding carton division, essentially Stuart Packaging and G2 Printing which manufactures premium quality folding carton packaging out of 2 state-of-the-art facilities located in Canada. It is dedicated to the international pharmaceutical, cosmetic, nutraceutical and fragrance markets.

Supremex corrugate, essentially Durabox Paper which manufactures corrugate sheets for internal procurement and corrugated boxes. And finally, Supremex fulfillment packaging solutions, our innovative e-commerce fulfillment division, including conformer and other legacy packaging products.

And then lastly, Supremex labels, manufactures and distributes flexo and digital labels mainly to our packaging and envelope customers. As we stand today on a pro forma basis, including the G2 and Pharmaflex acquisition, our trailing 12 months revenue from the packaging and specialty products market, along with our US envelope marketing, accounts for almost 50% of our revenues at the end of the first quarter of 2018 compared with just 18% back in 2014.

This is good news considering that we continue to feel the secular decline of the envelope market. On the strength of our diversification strategy in the packaging and our legacy e-commerce fulfillment offering, our total revenues grew over 8% in the quarter.

And with this, I'll turn the call over to Guy for a review of our financial results for the first quarter ended March 31, 2018.

Thank you, Stewart. Good morning, everyone, I'm happy to be here today for the first time addressing the financial community in the capacity as the Chief Financial Officer of Supremex.

Moving on to Q1 results. Revenue for the three month period ended March 31, 2018, increased by 8.4%, reaching $48.9 million, primarily from the contribution of Stuart Packaging acquired in July 2017.

Revenue from the Canadian envelope market stood at $25.9 million, a decrease of 7.8% from a reduction in volume of 9.6%, which was partially compensated by an increase in average selling prices of 2.1%. In addition from the industry-wide secular decline, the remainder of the volume decrease comes from the effects of timing and ebbs and flows of customer movement.

For comparison, Canada Post transactional mail or proxy for envelope market was down 5.5% in 2017. Revenue from the US envelope market stood at $10.1 million, a decrease of 7.5% from a volume decline of 7.8%, combined with an increase in average selling prices of less than 1% stemming from the strength of the Canadian dollar during the period.

The reduction in volume of sales results from a combination of timing of sales and loss of volume with an existing customer. Revenue from the packaging product reached $12.9 million, an increase 111.5% or $6.8 million compared to the prior year.

This resulted primarily from the contribution of the acquisition of Stuart Packaging and continued growth in our legacy e-commerce packaging offering. Adjusted EBITDA stood at $6.6 million, a decrease of $0.3 million or 3.9%.

Our folding carton packaging operations from the acquisition of Stuart Packaging and the continued growth over e-commerce fulfillment packaging business were strong contributors to EBITDA in the quarter. However, they did not fully compensate for the effects of the secular decline in the envelope market and inflationary pressures on the price of paper, window film, adhesives and corrugated boxes.

The adjusted EBITDA of $6.6 million also includes a loss of $0.1 million, which is attributable to a noncore operations of Printer Gateway compared to a $0.3 million loss in the comparable period of 2017. I'll remind you that we shut down this operation on January 22, 2018.

For the first quarter of 2018, adjusted EBITDA margin stood at 13.6% of revenues compared with 15.3% in the equivalent quarter of 2017. Adjusted net earnings stood at $3.6 million or $0.13 per share in the first quarter of 2018 compared with $4.1 million or $0.14 per share in the equivalent period of 2017.

Operating activities generate cash of $3.2 million compared with $0.8 million during the same period in 2017. The Board of Directors declared a quarterly dividend of $0.065 per common share payable on July 17, 2018, to the shareholders of record at the close of business on June 29, 2018.

During the first quarter of 2018, we did not purchase shares under Supremex outstanding NCIB, instead deciding to allocate capital to our ongoing growth and acquisition projects underway in the quarter. At the end of the quarter, our $60 million credit facility was drawn by $43.7 million, higher by $0.7 million compared to the end of 2017.

Our net debt to adjusted EBITDA ratio increased to 1.5x after the acquisition of Stuart Packaging in the third quarter of 2017. Considering our most recent acquisition, our leverage ratio remains at a conservative level at approximately 1.77x times last 12 months adjusted EBITDA.

I'll pass it back over to Stewart.

Thank you, Guy. I'm pleased that we continue to make great strides in our diversification strategy, both through acquisitions and our legacy e-commerce fulfillment packaging business and by our ability to nurture and grow these businesses.

Since 2017, we've used our strong cash flow to return shareholder value while making several investments to A, diversify the business in the face of rapid secular decline in the envelope business; B, to add and upgrade equipment to improve our manufacturing efficiencies and capacity to help nurture and grow in growth areas; and C, our investment in people and talent to execute on the strategy and leverage the entire Supremex platform. I'm proud of the team and all that they've accomplished.

During the remainder of the year, our focus will be on integrating our recent acquisition, driving organic growth both in Canada and the U.S., cross-selling opportunities and leveraging our expanded reaching capabilities. I should also note that we are well-advanced in our plans to move the Durabox operations to their new location.

The majority of the preplanned move related expenses will start occurring through Qs 2 and Q3. Durabox continues to serve its customers well and is staying focused.

We actually received much of the anticipated equipment - or the acquired equipment, sorry, into the new building at the end of last week and into the beginning of this week. We expect the move to be completed in paying dividends toward the end of the third quarter of 2018, at which point, we'll decommission the current facility.

At a ratio of less than 1.8x debt to adjusted EBITDA post G2 acquisition, we remain very comfortable at this level of leverage. I'd now like to turn the call over for questions.

I'd like to start talking about G2 a little bit more. Can you give us a little bit more color on the profitability, the revenue growth ramp historically and recently and if there's any kind of synergies, cost savings that can happen?

And third part, when you purchased Stuart Packaging, there was constraints to that - how that business was operating the you've alleviated. Is there any kind of similar opportunities here?

So G2. So the profitability on a normalized basis is in the 15% to 17% area.

Sales growth, I should be doing math in my head here but - work in absolute dollars instead of percentages but just 3 years ago, it was a $10-million business. Today, it's a $12-million business in the trailing 12 months, so it seems to be the growth on a percentage basis.

I think it's all - and sort of caution on some of the other acquisitions we've done, the mindset of an owner-operator is very different than the mindset of a publicly traded company. Oftentimes, those companies, they position themselves for 1 shift, 2 shifts at max.

I know it's maybe more of a lifestyle business as opposed to maximizing the opportunity. It's more optimization as opposed to maximizing.

And I think the same is there with G2 and it was there with Stuart Packaging as well. I mean Stuart's growth has been quite remarkable since Supremex took over.

We're very pleased with it. And they had the mindset of an owner-operator.

Now they have a mindset of a corporation, and I think the same will hold true for G2. Contrary to the Stuart Packaging acquisition, G2 doesn't have a constraint.

It's a good memory, Neil, that we had to invest roughly a $1 million very quickly in Stuart Packaging to increase the capacity. It's completely the opposite with G2 to the point where we think it's going to create some additional capacity in other areas of the Supremex business.

So as always, that's a long answer to - well, that was a long question, too.

No, it was a long question, I'll admit that one, yes. It has multiple parts but I'm trying to just count it as one.

So just to - on that comment on the owner-operator versus a public company, does that mean there will be some kind of cost saving synergies, profitability improvements when you fully integrate it into your systems?

I should have written those questions down. I wasn't trying to omit that last portion of your question.

Yes, there's always, to what degree is synergies. There's obviously raw material purchasing, shared services, costs that are synergies available to Supremex, there's no question about that.

I'm not sure that we're not at a point where we're looking at facility rationalization or things like that at this point.

No, but you can't put a $1 value on say, $0.5 million of savings over the next couple years kind of thing?

No.

And I'll ask a second question then I'll pass it over. The decline that we saw in Canada on the envelope side.

We talked last quarter as well about ebbs and flows in clients. How much of that could you specify is the secular decline that we're seeing?

And how much was it maybe for specific customer contracts? So I'm trying to figure out like what's a more normalized level of decline going forward?

It's a good question and I'll admit, we've been - for competitive reasons, we've been a little bit evasive to that answer over the last couple of quarters. But again, I talk in general numbers.

I think you had some numbers in this piece but of the volume decline in Canada, a little over 50% of it could be attributed to pure secular decline. Though round numbers, you could say 45%, 40% of it was movement.

And I don't want to say lost contracts. I think that is a little simplistic.

We sell - a little over 60% of our volume is sold through distribution and we win and lose with our partners and our distributors in the market. So if a distributor - if one of our distributors loses a piece of business, we take a little bit more of a hit.

If our - and we work with big players. If our partners win some business, we're the beneficiary.

And so it's not like we're out there losing contracts, it was really - and that's why we say ebbs and flows and that's kind of an oculus term and - but it's not like we bid on a contract and we lost it. We were working through a third party.

And then third party happens to win or lose a piece of business, then we're along for the ride, positively or negatively. Hope that helps.

Yes, so just to sum that up then. So if we look at a more normalized decline level on either volume or revenue basis, are we still looking at that 4% or 5%?

Or has anything accelerated or decelerated recently?

I would say that the empirical evidence is that it's at a full 5%. That's Guy's notes were - and again, I don't have the information in front of me but transactional mail with Canada Post in 2017 is now 5.5%.

Is that a good proxy for the future? Your guess is as good as mine but our model is around is - it works with the 5%, 5.5%, 6%.

Quickly, on the decline in envelope sales in the U.S. Is 7.5% what we can expect moving forward?

Is there a particular number you're modeling? And just what can we expect moving forward in the U.S.

in the envelope side?

Sam, so yes. No, we were completely disappointed with 7.5% decline in volume.

Our models are in the mid-single digits to the low double digits, so minus 7.7% reduction is rather significant for us. There was one piece of business that we literally walked away from.

But the market in the U.S. and I'll address it maybe in my closing comments here, but the market in the U.S.

it's a tough market. We had good growth for - I don't know, go back 12, 14, 16 quarters, experienced very good growth.

We had a really good Q2, 3 and 4 last year. We had some good wins with some of the secular change going on.

And then it was confluent and it sounds like excuses and I don't want it to. It's confluence of a number of different things with prebuys, timing but - and we also walked away from the second largest customer we had at - in the Midwest, which was an unprofitable customer and it was addition by subtraction from a bottom line standpoint.

But it did hurt on the volume.

One more question on the cost of paper and the cost of shipping and the potential impact on margins moving forward. Is there anything you're projecting that's changed?

That's a good question, Sam. Part of the - we attribute a bit of the margin decline in Q1 of this year to both the shipping and the raw material cost increases.

Generally, in Canada, we're very good. Primarily, we're experienced at it.

We have good processes in place and we're accustomed to increasing selling price in lockstep with an increase in cost. I don't think we were as good in Q1 as we should have been or ought to have been.

You have to remember that from Q3 and 4, foreign exchange declined. The Canadian dollar became less profit --or less strong.

And our cost went up in absolute U.S. dollars.

So we got a bit of a double whammy. I think what the sales teams did and it's kind of market conditions as well, the sales team got the increase in absolute dollars but they didn't get the effect of foreign exchange as well.

I think we've rectified that. Looking at the U.S.

envelope market, the U.S. envelope market has been oversupplied for a number of years and they're not very experienced and they're not very good at passing through increases.

But with our largest competitors filing a Chapter 11 on February 1, the market did go out and increased selling prices proportionate to the increase in cost. But it didn't happen until April.

So by the time you get it, we absorbed the increase, call it, mid-February and then we didn't get the price increase through until April. So there's a lag there and there's a margin squeeze.

The $64,000 question, just being blunt and this gets - for better or for worse, that's what I am. There's another price increase happening in the middle of May.

Paper market is extremely tight for a number of reasons. Supply and demand are completely imbalanced.

Utilization rates are through the roof. And when supply and demand are imbalanced, paper guys increase the price.

So now, we have to push through a second increase in Q2, that we were a little late on in Q1. And all the indicators say that there will be another price increase - paper price increase in Q3 of this year.

So the teams are going to have to - the teams and the market are going to have to be very disciplined at putting those increases through. We're very good at it internally but we still deal with market forces.

So it sounds like Q2 might be a bit of a struggle and we might see something similar to what we saw in Q1. But moving forward in the long term, you're not expecting significant changes to the margin.

They're more just due to issues experienced in Q1 relating to FX and a few other shortfalls you mentioned.

I would say - Sam, one thing and I would say, we have the sales teams have their challenges in front of them. But I think Supremex is extremely good at learning from its mistakes and its shortcomings.

We learned that it doesn't take long and it doesn't - to be able to show to the sales team that they didn't capture the price increases, I don't think we're going to repeat in Q2 what we did in Q1. We're aggressively - all eyes are on it and we're being aggressive out there.

And I think with the paper - the tightness in the paper market also works for Supremex. We are the second - call it, the second or third largest envelope manufacturer in North America.

We've always worked with a very dedicated and committed supply chain. We've not been a bid and buyer or an opportunistic buyer in the market.

We work with the four big mills. We commit to them, they commit to us that the person - the customer that's getting squeezed right now is the opportunistic buyer that was buying through third parties and brokers and offshore and whatever.

They're not only having trouble on the price side, they're having trouble getting paper. We have people knocking on our door today that we haven't heard from in years asking us to work - bid on their work not because of the secular change in the U.S.

but because other suppliers don't have access to paper, or as much access to paper. So that tightness in supply and our procurement strategy over the years is kind of paying dividends right now.

I just want to go back and make sure I understand this - the U.S. market here.

So with the troubles at Cenveo, we were expecting you to be able to claim more business, more inbound calls, people worried about their supply. Is that still the case not withstanding these short-term disruptions and the raw material pricing that you've referred to?

So when all these kind of price increases go through, are we looking at some good growth from improvements in market share? Are we seeing any kind of irrational pricing because of the disruption in the market?

And anything on employees becoming available because obviously employees have been plenty of bottlenecks previously.

Yes. So that was three question or four questions but I'll try and remember what they were...

That's just one.

That was one? So as I said, I don't know if it was to you or to Sam.

No, we were completely disappointed with that - with the decline in volume. We knew some of it in advance as with the customer and the EBITDA at - in the Midwest operations actually improved by having - not having that customer.

So those are fairly easy decisions to make, although you have to answer these questions. We did have a - and again, I don't want to get too granular but we had a big customer where we have an ongoing contract that had a double mailing in January of last year.

But the broader question is the market has become, I was going to say stable, but let's call it less irrational in the U.S. For 2 reasons, one is the structural change going on within any uncertainty in the supply market on the supply side.

And then, also with this paper increase. Paper increased and slash paper tightness.

The mills have really - they don't use the word allocation anymore but they've been very forthright, very strong in saying, you take new business at your own peril. We're - we'll commit to - you committed x number times to us, we agreed to take x number of times, we will live up to that commitment.

But anything outside of that is kind of a - it's a crapshoot. And as a result, everybody in the market is being a lot more cautious about how aggressive they are in the market.

And he who has some paper has a little bit more control on the pricing and they're not giving away a scarce commodity at the same level they were when it was a buyer's market. On the people front, Cenveo, I don't usually use that term, there's been no closures in our sort of immediate geographic area.

We anticipated that there might be more but there's not been. So we've not been able to add experienced envelope people at this time.

On the capacity expansion, the Durabox, the money that we've talked about you investing on CapEx. I think you said previously, there was $500,000, $750,000 in cost savings just because of the corrugate capacity that you're going to be bringing online.

Any kind of update on - you mentioned the - most of the expenditures are going to be through Q2 and Q3 on the expansion. That's pretty much all the CapEx spending and then we're going to see...

So we're there's going to be - I'm sorry, go ahead. Finish.

No, and then I want to talk about the timeline for seeing some of these savings and if those numbers are still accurate.

So regarding the - when the timing of the cost, there's 2 elements. There's the CapEx elements and there's the expense element.

So - and both are happening. The majority of the CapEx has been committed and will, from a cash standpoint, will be Q1, Q2.

From an expense standpoint, we, on our lease, we were able to get a fixturing period so we're not sort of paying double expense on lease for a period of time. But by sort of mid-Q2, Q3, we'll be carrying double facilities, and that's on - that's primarily going to hit us on the expense side as opposed to the CapEx side.

On the savings piece, I think the $0.5 million - and I don't have those numbers right in front of me and I could scramble but I think the $0.5 million was - that's ambitious. There may have been $0.5 million in sort of throughput productivity savings partially offset by increased rent, additional costs and such.

But yes, on the pure throughput side, it might have been around a $0.5 million but that wasn't our model in terms of net-net.

You do have some savings from bringing the corrugate capacity in-house, right? You're not going out and purchasing and passing that through little or no margin?

Correct. So part of the $0.5 million was in-sourcing as opposed to outsourcing, and the other was the corrugate that we are producing will now be produced at a faster rate, so therefore, lower cost.

But there are some incremental - there's some increased costs in rent and some of the overheads associated with it that would trim that $0.5 million.

And then maybe just lastly on - you talked about your target for the packaging side of the business growing to around 50%. Hopefully, that's just not as envelope revenues are declining but that's because packaging is going to be growing.

Do you - is that still - do you have a good pipeline on the M&A side to be able to deliver that and over what kind of timeframe do you think you'd be able to hit 50-50?

Yes, I'm not going to commit to that. I will say to you that one of the comments I made that I'm - that we've invested in people, we've invested in a couple of people on the packaging side that are very knowledgeable, very well connected, and are supporting the stated strategy of growing the packaging business through both organic and M&A growth both in Quebec and in Ontario.

And so suffice it to say, those people come with good knowledge and have helped us create a fairly robust pipeline.

Okay, great. Thank you.

Thanks, everybody, for your interest and the questions. Well, it was not crystal clear in our numbers, I'm really pleased with how we continue to build out the organization.

The Canadian envelope operations continue to chug along in the face of difficult market conditions and conditions that we don't hide from. Our dominant market position works both for us and against us.

And this team is completely committed to delivering a value proposition that allows us to pass through increased costs in a declining market in a timely fashion. The U.S.

envelope team is still in its infancy as part of Supremex. They're still finding their way and continue to assert themselves into a challenging market on a daily basis.

They're smaller operations and can still be affected by changing market conditions, lost customers or the pricing action of some larger players. They're working diligently to leverage the Supremex scale and perhaps, more importantly, the Supremex culture to somewhat insulate themselves from the external forces.

Our New England operations got off to a rocky start in the plant and in passing through the increase raw material costs but look like they are now back to their familiar firm footing. I'm pleased that our continued attention and dedication to Bowers in the Midwest is starting to pay off.

The business is on much more solid footing and is profitable. A rebranding process is under way in the U.S.

to leverage the Supremex name and reputation and to improve the cohesiveness and cooperation across the U.S. platform.

While it won't happen overnight, I believe we are well positioned to take on new business both in the Midwest and the Northeast U.S. of the United States.

Our packaging businesses are also performing very well and with our small investment program and equipment transfers, we are positioning ourself very nicely for future growth. I mentioned that we're very pleased with Durabox and are anxious to get the project behind us and leverage the newfound capacity and capabilities.

The e-commerce fulfillment business has experienced a couple of significant wins and continues to leverage them in this dynamic and growing market. The folding carton businesses has surpassed our expectations and with the addition of G2 and the complementary label business, we believe we are on the precipice of significant future growth.

It is clear to us that we're on the right path and we must continue to diversify and lessen our exposure to the Canadian envelope market. Are all of the pieces coming together as quickly as we'd like?

Of course not. And for those of you that know me, it would never be quick enough.

At the same time, we're moving quickly and in parallel on a number of initiatives that are setting us up for long-term success. We're not the rabbit but we're not the turtle either.

Well, as corny as it may sound and to stay with the fable analogy, as I preached to our team, we're the third little pig that is building a home to last. Like 2017 and 2016 and 2015 before it, 2018 has already been a very busy year for Supremex.

We just don't and won't rest. The year has already been marked with an acquisition, ongoing business integrations, growth initiatives designed to give our organization the structure and resources it needs to better execute, to create legitimate staying power and a vehicle for ongoing growth.

On a go-forward basis, our priorities remain the same: nurture the envelope business; build the packaging and specialty platform, mainly with organic growth initiatives and potential opportunistic acquisitions; and to provide strong returns to our shareholders. I look forward to our next conference call.

I'm seeing some you later today at the Annual Meeting of Shareholders at the Fairmont Queen Elizabeth in Montreal. And with that, we'll close the call, and thank you very much.