Supremex Inc.

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

My name is Danielle Ste-Marie, I am an independent advisor and act as an Investor Relations capacity for Supremex. With us today is Stewart Emerson, President and CEO; Guy Prenevost, Chief Financial Officer and Corporate Secretary.

I would like to welcome you to today's conference call to discuss our financial and operational results for the third quarter ended September 30, 2018, which were released earlier today. This call will be held in English.

For a more detailed analysis of our results, 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 December 31, 2018 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 adjusted EBITDA.

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 this quarter's key operational highlights and recent events.

Stewart?

Thank you, Danielle and welcome everybody. Third quarter revenues were $45.2 million, which is in line with last year.

Our diversification strategy, specifically into the U.S. envelope market helped compensate for lower Canadian envelope revenues and flat packaging and specialty sales.

Profitability in the third quarter was a challenge. The residual overhang from the concluding Phase 1 investments we made in our packaging platform continued to cause inefficiencies in the quarter which mitigated the important gains we made on the price to cost relationship in envelope.

On the Canadian envelope front there is no surprise that we continue to feel the effects of secular decline. The quarter saw higher year-over-year volume reduction than what we averaged in the last few quarters.

This is primarily the results of secular decline and the effects of our decision to maintain a price leadership strategy in the industry. We intend to continue to be good stewards of our industry and will maintain prices at a level that reflect the quality of our work, our service platform and the ongoing cost environment.

While this surely contributed to some customer movement, we are confident that it remains important to keep a healthy and balanced supply environment. Through strategy laid out three or four years ago, we have been able to utilize our U.S.

footprint and reach to keep Canadian facilities running at a good high utilization rates, which leads to maintaining efficiencies. By layering on a higher average selling prices to offset last year's cost inflation, we turned in the quarter in line with forecast despite the larger than anticipated drop in Canadian volumes.

We are comfortable with our price to costs relationship on this side of our business. In general, our envelope platform continues to generate significant cash flows and we intend to do what is needed to maintain our competitive advantage and extend our runway.

I’m pleased with the performance of our U.S. envelope activities which delivered organic growth despite having lost one of our larger customers in the third quarter last year.

We not only replaced the volume and revenue but we have improved our customer and product mix which contributed to higher average selling prices. Perhaps more importantly, the U.S facilities are fulfilling their mandate to drive units to the larger, more efficient envelope plants with units produced in Canada for U.S.

affiliates up almost 60% year-over-year. There is a symbiotic relationship between Canadian and U.S.

envelope and the hard work by the various divisions continues to pay off. On packaging, during the last two years, which I refer to as Phase 1 years, we invested significantly to grow our packaging capabilities and capacity to aid our diversification initiatives.

While this was and is an important investment in our future, it resulted in significant inefficiencies operationally and has had a sizable impact on our bottom-line over the last four quarters. I'm referring specifically to Durabox and folding carton.

With respect to Durabox I have said on this call previously that we believe the distractions of the corrugate expansion were behind us and while I continue to believe this is the case, the anticipated EBITDA has been slower materializing than expected. That said, Durabox has grown top-line and has demonstrated a slow, steady climb to expected contribution and has the ability to deliver impressive growth.

This operation is performing at a phenomenal rate and we're now producing all of our corrugate requirements, but we've been unable to turn the dial on sales as quickly as I expected. We invested significant R&D time and money in August and can now produce E and F flute in addition to the standard B flute and this opens the door to new customers and applications in a plethora of markets.

E and F flute make a finer corrugate sheet that score and fold more cleanly making crisper boxes and allows for better printing quality and precision. To demonstrate anecdotally, by combining these new micro food capabilities of Durabox and the new press at folding carton, we have developed and commenced selling new food packaging solutions that are an alternative to single use plastic containers.

Using our new capacity and capabilities we have won some nice pieces of business both in pizza boxes and non-food boxes and we have started producing packaging for the Canadian Supremex Envelope division, but we are still in the ramp up phase. Lastly, during the third quarter we also acquired the pizza box and related food packaging sales of Lovepac, a Lachine-based packaging manufacturer, printer and reseller of products in our target markets.

In the transaction, we also acquired a small press that print smaller quantities more efficiently. This non-material acquisition was concluded for cash considerations of approximately $400,000.

It brings equipment and customer relationships and helps accelerate our growth as a supplier of food packaging solutions. We believe that significant opportunity is abound in this market.

The key for us in corrugate will be to remain competitive and grow selectively on the pizza box side and to address new value-added markets, whether it be in-sourcing for envelope operations, cross-selling and e-commerce or in brand new customers in a multitude of applications. We are on the right path, but we must be slow and patient.

Folding carton also went through a significant project in Q3 this year that affected results. While sales were flat, the high cost of outsourcing and unusual R&M had a significant drag on earnings.

We'd discussed in the Q2 call that we had experienced significant press issues and had gone ahead and acquired a brand new press that was both lower cost and gave us new capabilities. That project is complete and was a roaring success, but the combination of increased pre-project R&M and decommissioning and commissioning activities had a drag of approximately $0.5 million on the quarter's earnings.

The new press is installed and running at OEM rated setups and speeds, but we spent half of Q3 without our money maker. We have established ourselves as the largest independent folding carton organization in the Quebec marketplace and have earned a growing reputation for our premium quality print and folding capabilities.

We have capability, capacity and reputation working for us. On the e-commerce front, in the third quarter we were awarded new orders with a large subscription based e-tailer that we have discussed in the past.

However, unfortunately, this win was short lived as we couldn't come to terms on ownership of IP. We would have liked to keep the business, but not at all costs.

We are actively working to replace this business. We have developed significant in-house e-commerce packaging expertise which we intend to leverage in our pursuit of new customers.

To summarize, our packaging position and outlook, as I said earlier, we are at ground zero on the packaging side. Our CapEx is complete.

As a whole, despite these short-term challenges, our packaging platform is stronger than ever with deeper capabilities and an improved offering. Now it is time for the rubber to hit the road and the entire organization is committed to leveraging the sizable investments made.

Obviously, this was a challenging quarter for Supremex. We experienced EBITDA shortfall across several of our divisions.

As a whole, envelope is performing in line with expectations and we're pleased by that in this environment. The quarter was frustrating from a standpoint that we experienced setbacks in two of our growth areas, namely, corrugate and folding carton.

Looking forward, the corrugating business has been stabilized; and in the case of folding carton, the operational issues have been resolved. We believe, we are clear of the Phase 1 downside, but it now falls squarely upon us to make it happen.

We remain a relatively small team with limited bandwidth, integrating 5 acquisitions in a little over 2 years and completing significant CapEx programs, all while navigating the decline of our core business has been quite a challenge. But we have come out the other side and to reuse the term we are at ground zero.

Now it's time to ratchet up the sales effort and execution. With this, I turn the call over to Guy for a quick review of our financial results, the third quarter ended September 30, 2019.

Thank you, Stewart. Good morning, everyone.

Revenue in Q3 reached $45.2 million, which was in line with last year. Revenue from Canadian envelope market decreased by 4.5% to $20.3 million.

As Stewart previously explained, volume declined by 14% primarily as a result of the combined effect of industry-wide secular decline, customer movement and our pricing strategy. Average selling prices increased by 11.1% to mitigate the effect of significant input cost inflation that occurred throughout 2018 and in the first half of 2019.

For reference, Canada Post Transactional Mail volumes were down 5.7% during the second quarter ended June 29, 2019. Revenue from the U.S.

envelope market increased 6.1% to reach $11.6 million. The volume of units sold increased by 1.5%, while average selling prices increased by 4.5%.

Average selling prices were positively impacted by a foreign exchange translation effect of approximately 1% from a weaker Canadian dollar. For reference, the U.S.

Postal Service first class mail volumes were down 2.7% during the third quarter ended June 30, 2019. Revenue from packaging products increased 2.4% to $13.3 million.

This variance comes from growth in specialty products which offsets weaker revenue in folding carton. EBITDA stood at $5.4 million compared with $4.1 million in the third quarter of 2018, representing an increase of $1.3 million.

The third quarter 2018 EBITDA included a $1.1 million earn-out provision related to Stuart Packaging acquisition. The adoption of IFRS 16 in 2019 had a material impact on the company’s statement of financial position and statement of earnings as nearly all operating leases were capitalized with a corresponding liability, while operating expenses were reduced by $1.3 million in third quarter of 2019.

Including the effect of IFRS 16 adjusted EBITDA for the third quarter of 2019 stood at $4.1 million compared with $5.1 million in the equivalent quarter of 2018. The decrease of $1 million in adjusted EBITDA stems from lower contribution from the envelope business and underperformance of the packaging acquisition.

Third quarter 2019 adjusted EBITDA margin stood at 9.1% of revenues compared with 11.4% in the equivalent quarter of 2018. Net earnings were $1.2 million or $0.04 per share for three months period ended September 30, 2019, in line with equivalent period of 2018.

Net cash flows from operating activities stood at $4 million during the third quarter 2019 compared with $1.7 million in the equivalent period of 2018. The variance is mainly attributable to the impact of IFRS 16.

On November 13, 2019, the Board of Directors declared a quarterly dividend of $0.065 per common share payable on January 16, 2020 to the shareholders of record at the close of business on December 31, 2019. Our net-debt-to-adjusted EBITDA ratio remains at a conservative 2.06 times in line with the second quarter of 2019.

I would now like to turn the call over to analysts for questions. Operator?

So, can we start off on the Canadian envelope, the volume aspect of it? Obviously you've been getting some pretty good pricing increases, but the volumes have still been pretty significant as far as the decrease and you talked about the transactional mail volumes down 5.7% which would be I assume the proxy for the secular decline.

And we've talked about clients, you had shifting clients. Are we lapped a lot of those types of more volatile things and can look at more regular secular declines in the 5% or 6% going forward?

Yes. So, hi, Neil, it’s Steward.

Yes, there is a few things in there when we look at the declines. So we have the direct mail declines, we have the transactional mail declines.

A sizable or material piece of the additional decline was what we think is the final chapter of ATM envelopes specifically with Quebec-based financial institutions. We have a 100% of that customer’s business and the customer is down 25% in sales, so in volume.

So there's a big piece of that. And there was another bit of an anomaly in the whole thing, we call them Canadian -- the RIN Canadian sales, but we have a large customer in Southwestern Ontario that -- their sales to a U.S customer have dried up, so they actually show up in our Canadian sales, but they were never in the Canadian mail stream.

So there's kind of three things. I think the ATM piece we’ve lapped.

I think the additional U.S. volume that's in Canada has been lapped.

And then if you think about -- we're going to -- based on our strategy in the market, we're probably going to absorb a little bit more of a secular decline than the rest of our competitors. And that's a decision we grapple with on a regular basis, but we still think it's the right one going forward.

Okay, so going forward, slightly higher than the normal secular decline rate due to some competition in there. But overall, a lot of the higher volatility items we seem to have put behind us, right?

Or is there another quarter maybe or two?

We think -- going through you just never know. But generally speaking, we think we've lapped it, and it should be slightly higher than the Canada Post secular decline.

Okay, good. So the other side of the equation, the price increases, you seem to have done a good job in the last year making up on the raw material costs, the price increases you need to push through.

Is that all done now or should we expect more of these types of things going forward?

I think the raw material market is stable. And we don't expect sort of the inflation that we've seen over the -- we saw over last year and the end of 2017.

So, I think we are all caught up. I mean it varies from account-to-account, but generally speaking, we're caught up.

Is there room to improve margins further? Maybe in some small areas.

But generally speaking, we're comfortable with where we are now and we're at margin levels that are consistent with what we would expect.

Okay. And then switching over to the packaging side.

Obviously you've mentioned how you had a lot of the build in Phase 1. So just to be clear, so the Phase 1 is completely done now, you've got the machines running at full efficiency.

Are we going to see any kind of lingering impact into the Q4 numbers or is it basically now we've got the machines, now we have to sell the material?

You got it. And we don't expect anything material on the cost side for the foreseeable future.

There is no CapEx projects. The machines are running great.

Now it’s -- the pressure goes to sales.

You talked about the flutes, the E and F flutes that you're doing. Is this making -- is this going to make the sales job easier?

It broadens out your potential customer base? And is there a higher margin potential on this stuff, which I guess is more technically difficult to produce?

Yes to all of that. I mean broadening the product offering is important.

It also opens up the opportunity -- more opportunity from a cross-sales standpoint with e-commerce. If we just stayed with B flutes and pizza boxes, it's going to be a long haul.

That wasn't the plan. Obviously there's not -- pizza boxes are essentially a commodity.

And we didn't do this project just to continue to sell a whole bunch of pizza boxes.

So on the sales side, so how are you equipped to be able to increase the sales now? Are you doing more through distributors?

You need more relationships or your in-house sales people or how is that going to develop now that you have to get this out to the market?

It varies depending on the line of business. I mean the e-commerce side is using both direct and indirect sales.

The corrugate business is almost exclusively distribution. So you need fewer people to execute on the growth pattern or growth plans.

And then in the folding carton business, it's really an end user direct relationship, which is a little bit slower and you need more resources to get out and meet all of the cosmetics fragrances, nutraceutical, pharmaceutical companies and that's a direct one-to-one relationship.

So how do you feel you’re equipped on all these different channels that you need to add people? Or is it a ramp up phase?

We think we need to -- we know we need to add both on the folding carton side and on the e-commerce side and we're in the process of doing that. We've added in Q -- end of Q2, middle Q2, end of Q2 a couple of resources on the corrugate side and we think we're pretty good in that space for what we want to do.

And then maybe just lastly, on the Lovepac acquisition, and are there any additional kind of tuck-in acquisitions you are looking at to help you develop and I would assume on more of the product offering to increase net sales and leverage up the manufacturing improvements that you've made?

Yes. That's always been sort of in the pipeline is to accelerate the growth and just on the -- just for clarity on the Lovepac piece, we bought the pizza box and food packaging business out of Lovepac.

We didn't buy Lovepac. So we just bought the sales essentially, we didn't bring any employees, we didn't bring any -- and we brought a small press, some inventory and the customer relationships.

And based on the map and the payback on those types of things, it's actually easier than going out and starting from ground zero and trying to develop and nurture relationships. If you can pull them in the way we did with Lovepac, we think there's -- we think that's the fastest way to get the growth that we need.

So there -- yes, there are other competitors/customers out there that do that and could potentially be targets, both in Canada and the U.S. by the way.

I was wondering, if you could possibly quantify what's the future potential at Durabox now with the new capacity. When that gets up to whatever you consider full, what kind of impact could it have on the business?

Good question, Jason, and respectfully, for competitive reason, I really don't want to go into that on the call. I mean there was a sizable investment, but I really don't want to go into that on the call projecting on what the potential is.

Okay, no problem. And then on the new printing press and folding carton.

Maybe just talk about qualitatively what kind of impact could the new capabilities have?

They could have significant on two fronts. On the cost side, I mean we’ve replaced 20 year old technology.

Our money maker was a 20 year old press. So we've gone with a brand new KBA.

It's the same original equipment manufacturer that the old press was. So while there's a learning curve, it's not quite as steep.

It adds -- there’s some bells and whistles on it that we didn't have, that we either had to outsource or not participate in. But the technology piece of it, I mean the run speed -- the OEM run speeds are about 7% or 8% faster, but the wash-ups that make-readies are a quarter of what they were on the old press and about 70% less than -- less material required for setup in terms of waste.

So we think we can do all that we were doing on two presses in less than one. And we also have the subsequent lower R&M with a brand new press versus a 20 year old press.

The 20 year old press is actually closer to 25 years old.

And then just on the downtime in the quarter, as this transition happened, you mentioned $0.5 million impact. Was that just increased cost or does that also reflect sort of lost revenues from not having the press for 50% of the quarter?

So that’s a great question, which should help others on the call. That's a very conservative number.

Essentially, our sales were flat as we said. So we service the customer.

We had to produce a little bit as much as we could ahead of time before the press went down. But that $0.5 million is just the increased outsourcing that we had to do to other printers in the Quebec marketplace to service our customers.

So we outsourced more than $0.5 million, more this Q3 than last Q3. We keep all of the people, all of the headcount because you can't lay people off for a period of three or four weeks or five weeks and expect to get them all back, coming back.

We needed some of those resources to help decommission the old press and put the new press in. So that $0.5 million doesn't take into account the increased R&M in the quarter and it's purely the additional money we spent outside to have other printers print stock for us.

And then shifting to the e-commerce business. Just to clarify that the customer that was sort of -- you couldn't get the commercial agreement with, was that the customer you talked about last time on the win back that you sort of had in e-commerce, was that the customer you referred to last -- in the 2Q call?

Yes.

Okay, perfect. And then just maybe can you add a little bit more detail about what was the sticking point?

Why you couldn't conclude that win?

Yes, so the product we sell, we're a licensee of a patent holder and we put a tremendous amount of R&D into it, but we don't actually own the patent. And we took the product to the customers, save them multiple millions of dollars in postage, and then the client laid claim to the IP.

Our relationship was with the end client but the IP is actually owned by a third-party. And we just couldn't come to an -- it wasn't our patent to assign.

And the holder wasn’t willing to assign it. We tried to broker a three-way deal and just couldn't come to an agreement.

That makes sense. And then maybe the last one from me, just maybe an update on where we are in the ERP system rollout, I think we had two folding carton facilities online in July.

Just any update there?

Yes, so, like -- so the -- like any ERP, I mean it's bumpy but we have great confidence in the financials. They are rolling out.

They do very, very well. Some of the shop floor data collection and those types of things are not as efficient or as optimized as we would like and maybe not the KPIs aren't as reliable as a result of the shop floor data collection.

But I mean we only implemented it in July, it’s put some stress on the organization more from a frayed nerves standpoint than anything else. But the financial package runs fantastic.

The team has done a really good job in terms of the implementation and training. It's just now learning the system and optimizing.

Okay. So it's fully rolled out.

It's now just about maximizing the -- sort of the impact and usefulness of the system?

Yes.

Alright. Thanks Neil and Jason, I appreciate the questions.

To close our envelope business remains on very solid ground. The investments we made in the U.S.

are paying off exactly according to plan and we continue to look at alternatives to further strengthen our envelope platform, both at the top and bottom-line levels. It's clear to me that we've demonstrated our ability to manage the industry's decline.

On the packaging side despite a small team we've made significant progress and starting our diversification strategy and completing these last two years of investments. We have prepared our packaging platform for growth.

While packaging represented almost 30% of the company's revenue in the quarter, we are positioned operationally to grow across all three lines. Again, in my mind, we're at ground zero.

We have great assets. The infrastructure is in place and now it's time for us to leverage those investments by getting out in front of customers and selling our unique and growing value proposition.

That's precisely what we intend to do. Importantly, our cash flows remain strong and allow us to maintain a conservative level of debt, while we have invested in our growth and diversification strategy.

This completes my closing remarks. I look forward to meeting you again on this call in the fourth quarter results in February.

Thank you very much.