Supremex Inc.

Thank you, Juliann [ph]. 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 fourth quarter ended December 31, 2019, which were released earlier today as well as the recent acquisition of Royal Envelope. This call will be held in English.

[Foreign Language] 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, 2019 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 everyone. During 2018 and 2019 and we invested significantly in our packaging operations in order to raise capacity and capabilities.

These were good investments in our future, but they were short-term material drains. Durabox has been a real challenge, if you recall we were pretty ambitious with our expansion plans we moved from 37,000 square feet to 144,000 square feet over the past year.

We actually increased both our capabilities and our capacity significantly. Unfortunately the ramp up has been much slower and costlier than expected.

After more than six months of a very steep learning curve we’ve been self-sufficient on a corrugator [ph] since June 2019 and have capacity available. Unfortunately as soon as we got through the issues on the front end of the operation and started to stress the backend, we started having material issues on two off the three lines.

We limp along through the balance of 2019 and into early 2020. These challenges caused serious inefficiencies outsourcing in R&M cost and force management to temporarily essentially abandoned the sales growth process.

We’ve rebuilt one line and the second line has been repaired to a reliable state. We’re not completely out of the woods yet, but the new management team has done an excellent job.

We’re producing well and think will have cleared our backlog by mid-March, at which time we can focus on selling the available capacity and executing on the original business case. Folding Carton was also an unexpected drag on earnings in 2019 and primary culprit was the decommissioning of an old and the commissioning of a new press at our Montreal facility.

Combining efficiencies, increased space and R&M along with significant outsourcing cost were a sizable drag. Add to that some turmoil associated with integration and ERP implementation.

These issues at Durabox and folding carton in addition to the loss of the above mentioned e-commerce customer explains the $4.5 million shortfall and adjusted EBITDA versus 2018 in our packaging and specialty product segment. The fundamentals of both of these businesses remain good.

Folding carton business was without its money maker for essentially 25% of the year and struggled staying focused with distractions. The corrugated business simply took much, much longer to ramp up then we could have reasonably expected.

We changed the management independently and are ready to move forward. We’re disappointed by the outcome but I’m encouraged by what I see and what I’m living.

We have put considerable effort in direct flying [ph] the challenges. I don’t foresee additional material CapEx required in either of these businesses and I believe the personnel changes we’ve made and are making are the right ones.

On the e-commerce side, we’re making steady progress and have had three good wins in the last couple of months. With subscription based e-commerce customers in the oral hygiene, shaving and eye care space and have several other really interesting projects on the go.

After the letdown of the large customer that we’ve talked for few quarters now. It finally fees like we have some wind at our back.

US Envelope is doing exactly what we needed to do. It is driving volume, activity and efficiencies to the Canadian plants as a Canadian secular decline continues at a rate in excess of the US declined.

Units produced in Canadian plants for US affiliates were up 27% year-over-year which is an increase in excess of what we managed from 2017 to 2018. The role will take on even more importance as a result of the Royal Envelope acquisition.

By conservative estimates by combining the entities producing in local markets and taking advantage of the efficiencies associated with gaining runs. We believe we can increase the available capacity by up to 10% to 15% with the existing manpower.

As a result we have a full cork [ph] press on US volume. On the Canadian Envelope front there is no surprise that we continue to feel the effects of secular decline.

Volumes were down 12.6% in 2019 which is roughly in line with the 11.3% transaction mail volumes declines experienced at Canada Post during the last quarter. That said, we posted above expected revenue and earnings by improving mix passing through delayed raw material increases tightly managing cost and through the effects of Project Canada restructuring from Q4, 2018 and Q1 of 2019.

Although the Canada Envelope market continues its secular decline these operations remain a key and steadfast contributor to our profitability and cash flow generation. As an important part of our strategy, earlier this week we announced the acquisition of Royal Envelope which we’re confident can be quickly integrated and will immediately generate top and bottom line synergies.

About Royal Envelope the company had $30 million in revenue in the last 12 months primarily in Eastern Canada. It employs 135 people and operates primarily out of the 56,000 square foot facility in Concord, Ontario with a small operation in Lachine, Quebec.

Royal Envelope is a tier-1 supplier known for quality products in goods service. They have a modern fleet of equipment and some capabilities and competitive advantages that Supremex had not invested in.

We paid $27.4 million and their profitability margins are roughly in line with ours. The rationale is fairly straightforward.

The North American Envelope market remains challenging and continues to face secular decline. We require additional scale to help us deliver cost effective product to both the Canadian and US markets.

Not surprisingly given our size and geographical proximity there are some attractive cost synergies available to us. The unique capabilities and capacity from the Royal assets are necessary to support the growing needs of our US organization.

Supremex had allocated the majority of its CapEx over the last couple of years to be aforementioned packaging projects and was getting to a point where we needed to do several machine updates or upgrades over the next few years and when we did the analysis buying the equipment from Royal versus new or from a broker up justified a good portion of the acquisition cost. In the current tight labor market, this transaction provides access to high quality skilled labor and strong envelope human resources throughout the business.

Adding the equipment, employees had knowhow from Royal to the Supremex platform helps us remain relevant to envelope employees, customers and suppliers over the longer term. We have an impressive track record in integrating envelope operations.

We have a deep talent base from which to draw and the business itself is well run. Our intention and expectation is to do exactly what we achieved when we concluded the 2015 acquisition of Premier Envelope in Western Canada.

We increased operating rates. Improved our Western Envelope divisions margins and freed up capacity setting the stage for our growth and diversification strategy into the US market and then subsequently into packaging.

We expect the Royal acquisition will do just that. Yes, the acquisition of Royal Envelope is an offensive play in a declining market.

But it will help protect our market share and bottom line, providing the means and resources to improve our cash flow generation capabilities and provide additional cash flow to continue executing our diversification strategy. With this I’ll turn the call over to Guy for a quick review of our financial results for the fourth quarter and fiscal year ended December 31.

Thank you, Stewart. Good morning, everyone.

Fourth quarter total revenue was $49.2 million down 9.2% versus Q4, 2018. Revenue from the envelope segment stood at $35.8 million down 6.8% or $2.6 million compared to the fourth quarter of 2018.

Canadian Envelope revenue was $23.9 million down 7.3% from $25.8 million in the fourth quarter of 2018. Canadian Envelope volume declined 14.2% primarily resulting from the combined effect of industry wide secular decline.

Customer movement and the company strategy to maintain a disciplined market approach through a price leadership and differentiation. Average selling prices increased by 8.1% to mitigate the effect of significant cost inflation that occurred throughout 2018 and in the first half of 2019.

Revenue from the US Envelope market was $11.9 million a decrease of 5.7% versus Q4, 2018. The volume of unit sold decreased by 7.1% while average end prices increased by 1.5%.

Packaging and specialty product segment revenue stood at $13.4 million a decrease of 15% compared to the equivalent quarter of 2018. The majority of the declined results from the loss of business within e-commerce customer and from weaker revenue in the folding carton division.

Packaging and specialty products represented 27.3% of the company’s revenue and the quarter down from 29.2% in Q4, 2018. Fiscal 2019 total revenue was $191.7 million a decrease of 1.8% versus 2018.

Revenue from the envelope segment was $137 million down 0.8% versus prior year. Canadian Envelope revenue was down 3.3% to $91.7 million from a volume reduction of 12.6%.

During the year we managed to increase average selling prices a 10.6% to mitigate cost inflation. US Envelope revenue increased by 4.8% or reaching $45.5 million compared to $43.4 million in 2018.

The volume of unit sold decreased by 2.7% while average selling prices increased by 7.7% to offset rising cost. Average selling prices were impacted by positive foreign exchange translation effect of approximately 2.4% from a weaker gained dollar when compared to the equivalent period of last year.

Packaging and specialty product segment revenue decreased by 4.1% to $54.5 million. The loss of volume from a single e-commerce packaging customer was partly mitigated by higher folding carton sales from the acquisition of G2 Printing.

Moving onto earnings, fourth quarter adjusted EBITDA was $5.4 million compared with $8.1 million in the equivalent quarter of 2018. The decrease of $2.7 million was down primarily from the lower contribution from the packaging and specialty product segment.

Fourth quarter 2019 adjusted EBITDA margins were 11% of revenue compared with 15.1% in the equivalent quarter of 2018. Envelope segment adjusted EBITDA was $5.8 million in the fourth quarter down from $6.1 million in 2018.

Lower contribution of the US operation was mitigated by slight improvement of operating profitability of the Canadian Envelope operations. Envelope segment adjusted EBITDA margins stood at 16.2% up from 16% in the fourth quarter of 2018.

Packaging and specialty product segment adjusted EBITDA was $0.3 million down to $1.7 million versus Q4, 2018. Operational inefficiencies and folding carton was the largest contributor to the reduction operating profitability followed by inefficiencies from the slower than anticipated ramp up of the Durabox facility.

Packaging adjusted EBITDA margins were 2.4% compared with 12.9% in the equivalent quarter of 2018. Fiscal 2019 adjusted EBITDA was $20.2 million down from $26 million during the equivalent period of 2018 primarily from lower contribution from the packaging and specialty product segment.

Adjusted EBITDA margins stood at 10.6% compared to 13.4% last year. Envelope segment adjusted EBITDA was $20 million in line with 2018.

Envelope adjusted EBITDA margins stood at 14.6% slightly up from 14.5% in 2018. Packaging and specialty product segment adjusted EBITDA was $2.7 million down from $7 million in 2018.

Operational inefficiencies at the folding carton division was the largest contributor again to the reduction of operating profitability followed by inefficiencies related ramp up of the new Durabox facility and the loss of volume with an e-commerce customer. Packaging adjusted EBITDA margins were 5% compared with 4.4% in 2018.

Fiscal 2019 net earnings were $7.1 million or $0.25 per share for the 12-month period ended December 31, 2019 compared with the net loss of $4.8 million or $0.17 per share in the equivalent period of 2018. Net cash flows from operating activities were $20.2 million as fiscal 2019 compared with $11.9 million last year.

The improvement was mainly attributable to the impact of IFRS 16 and to a $2.5 million reduction in inventory. On February 20, 2020 the Board of Directors declared a quarterly dividend of $0.065 per common share payable on April 15, 2020 to the shareholders of record at the close of business on March 31, 2020.

This dividend is designated as eligible dividend for the purpose of the Income Tax Act in any similar provincial legislation. I would now like to turn the call over to analyst for questions.

Operator?

Obviously, you’ve had a lot of challenges with some of the growths, some of the ramp up with the new facilities and such. Can you just rehash the headwinds that you’re having both on the envelope and the packaging side?

I’m trying to figure out what the customer losses on the packaging side and the customer movement that you talk about on the envelope side. When can expect to be past these headwinds and what kind of normalized growth or declines on the envelope should we be thinking about going forward?

There’s no customer movement on the envelope side. It’s all secular that we’re facing.

There’s nothing on that side that material then you’ve got the addition of the Royal Envelope side, it kind of changes market share. On the e-commerce side that we’re through customer number one if you will be declined.

We’ve gone through our full four quarters after Q4, so we’re past it. We had a lot of frankly we had too much customer concentration in the e-commerce side.

I mean our first win was a big win and ultimately it helped a lot on the upside, but it hurts a lot on the downside as well. We’d like to have that customer concentration we’re in line with what we on the envelope side, where no one customer is more than 5% of our total sales.

But just the way it, wait out [ph].

Okay, well just sorry going back on the Canadian Envelope. So I’m just reading through the press release here.

And you do talk about the volume decline being from the secular decline and customer movement was that customer’s that maybe moved over to Royal Envelope and now you’ve gotten back with the acquisition?

Well there’s certainly some of that with the acquisition, but most of that played out in 2017 and 2018. I think what we’re talking in the press release it’s sort of normal ebbs and flows of customers moving around.

There wasn’t anything material or any major customer that ousted. We’re all kind of sitting here and looking at what did other say, what was the customer in Canadian Envelope but it’s more the ebbs and flows.

Okay, fair enough. Thanks for the clarification.

And now with the acquisition, obviously you’ve got your new credit facility. You’ve taken some increased debt due to the acquisition of Royal.

So how do you feel now with your leverage ratios, your debt level the way it is now, is there going to be a focus on paying down the debt or are you going to be investing more in growth more on the packaging side?

So we actually addressed that in my closing comments.

You were speaking very quickly, I missed some of it.

No, my closing comments after your questions.

Okay.

I mean we can jump ahead there, no problem whatsoever. I mean our capital projects are mostly completed and we really don’t see any other significant investments in equipment or being required and until their profitability margins demonstrate consistent improvements.

We don’t include to or don’t intend to conclude any major acquisitions until such time as get the other two businesses turned.

Okay.

Sorry?

No go ahead, finish.

Maintenance CapEx will sort of be in consistent with previous year to $2.5 million.

Okay. Anything specific on the pharmaceutical side on that packaging after you bought G2 and the Pharmaflex Labels.

We’ve seen any like really positive opportunities come in or anything on the horizon.

No and frankly the challenges are primarily around the original business. The cosmetic business and there’s a few things there one was the press and there’s been a switch in customer preferences from one raw material to another which squeezes margins a little bit for the manufactures.

But there’s been no big wins, couple of losses on the cosmetic side nothing like e-commerce.

Okay and then just finally with the Royal Envelope acquisition. I don’t think there is much expected from cost associated with any of the integration or in restructuring that’s going to happen as you integrate those two business I believe.

And I think can you talk about when or how you’re going to start seeing synergies between the business and a little bit of detail.

Well interestingly enough, we actually moved a major order from Toronto to Montreal yesterday. I’ve talked to all of major raw material suppliers, so those synergies are buying out immediately.

And we’re actually producing, Royal Envelope also - sorry I missed that spot. But Royal Envelope also purchased $2 million outside of the Royal family last year from other envelope companies a little bit including Supremex.

That $2 million can be immediately in sourced as opposed to outsourced. So I mean we’re on it right away, we’ve got an integration team embedded in the Royal facility as we speak and they’re pushing order around, taking advantage of the purchasing opportunities and you’re correct.

I mean we’re - there’s no sort of major cost associated with integration. I mean the operation here in Montreal is very, very small and the Toronto operation is quite large and very efficient.

There’s no sort of consolidation parts there or anything along those lines.

Okay, just actually one more. Royal Envelope, did they have much business out in Western Canada that you’ve now going to be able to serve much more efficiently or was it mainly in East?

Low double-digit from a percentage.

Okay, thanks. That’s it from me.

Sorry, operator. Do we have one more question?

We have another question.

I just had a few follow-up questions on the Royal acquisitions. When you said margins are in line with what you guys do, is that with respect to the company overall or for the envelope division specifically?

Envelope division.

Okay perfect. And then if you look at the cost synergies to revenue synergies.

In two to three years’ time, do you expect - what’s going to be the bigger number? The revenue side of it or the cost side?

I’m not sure how to answer that one, Jason. I mean we’re going to get - we have significant cost synergies that we can take advantage.

In the sale side, I mean the market is not growing. Market is declining fairly rapidly but we’re going to take that excess capacity and we’re going to blow it into the US which is at a lower margin than the Canadian business.

So I mean there’s so many plusses and minuses there I just don’t know how to answer the question.

Yes, no. The revenue ones, definitely the harder one to guess.

Onto US comment, did Royal sell anything into the US currently?

$137,000.

Okay, so not much. Yes, okay.

Perfect and then just last one of the Royal. Just on the price paid, with a touch higher than sort of price to sales or EV [ph] EBITDA basis, base in some of the deals you guys did in 2015, 2016 so maybe just [indiscernible] about how you got to the price paid?

All right. Well in our case, of course we ran scenarios as far as building this business, the synergies that we would get from the acquisition.

But we feel and actually I wasn’t here when we did the other acquisitions you’re referring to and in this case the multiple is, we have a more reasonable multiple because it’s a business in secular decline of course so we’re looking at a more reasonable multiple if you’re factoring the synergies that we’re planning for in the models that’s actually a very, very reasonable multiple for us.

The other thing on that when we talk about. I mean you’re drawing some inferences on sort of Canadian Envelope is more profitable than our overall envelope segment.

All right. Yes that’s helpful.

Yes and I just compared to your price of sales to some of the ones, you did in the - classic or premier some of those ones with a little lower. But maybe that margin difference could explain it.

So yes and that’s all I had. Thank you very much.

[Indiscernible] explained it very much. Yes.

Okay, so thanks guys for your questions. Just in conclusion.

We intend on the packaging side is to really leverage our capital investments to raise the margins. We entered the year with close to 28% of our revenues from packaging and specialty product sales and then we remain committed to our long-term goal of achieving 50-50 revenue split between envelope and packaging obviously that stretch is a little further now with the addition of Royal Envelope’s $30 million.

We intend to ensure we successfully integrate Royal. This is what we do well.

On the capital allocation front, we remain committed to bringing down our leverage by consistently and continuously reimbursing debt. Our capital projects as we talked about earlier are mostly complete.

We don’t expect any other significant equipment to be required in 2020. The maintenance CapEx should be in line with previous years in $2.5 million range.

Our profitability margins demonstrate consistent improvements, we do not intend to - until demonstrate consistent improvements. We don’t intend to conclude any additional acquisitions.

We strongly believe in the businesses, but are disappointed that our packaging divisions have taken so long to capitalize on the investments of time and capital. That said, we’re positioned to operationally to grow across all three lines and as I said in last quarter remarks.

We have great assets. The infrastructure is in place and it’s now time to leverage so - investments by getting out in front of customers and selling.

This completes my closing remarks. I look forward to meeting you on again on this call to discuss our first quarter results and at the AGM in May.

Thank you very much and have a great weekend.