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Data Communications Management Corp
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Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the DCM Q3 Earnings Conference Call. [Operator Instructions] James Lorimer, Chief Financial Officer, you may begin your conference.
Thank you, Lisa. Welcome to our call. Cautionary note in terms of comments that may be made on this call will include forward-looking information. For a full description of our financial results for the third quarter and the year-to-date, please refer to our unaudited consolidated financial statements for the 3 and 9 months ended September 30, 2018, and related management's discussion and analysis, copies of which are available on SEDAR.I'll now turn the call over to Greg Cochrane, President and CEO.
Thanks, James. Good morning, shareholders. I want to provide an overview of the following: our third quarter 2018 results and the results from our first 9 months of this year; our third quarter initiatives and drivers for our business; and lastly, the management outlook, our outlook for the balance of 2018.Third quarter 2018 financial results. Revenue for the quarter was $74.9 million compared to $70.2 million in the third quarter of 2017, an increase of $4.7 million or 6.7%. Now excluding the effects of adopting IFRS 15, for the quarter ended September 30, 2018, revenues were $3.1 million or 4.5% higher than the same period last year. The quarter reflected a continued improvement in our core DCM business, that's excluding all the acquisitions we made since February 2017, with $61.8 million of revenue recognized compared to $59.4 million in the prior year's period. Adjusted EBITDA was $5.2 million versus $3.3 million in the third quarter of 2017, an increase of $1.9 million or a 59.1% improvement. Excluding the effects of adopting IFRS 9 and 15, adjusted EBITDA was $4.8 million or 6.5% of revenues for the quarter ended September 30, 2018.Nine months 2018 financial results. Revenues for the first 9 months of 2018 were $241.6 million compared to $213.4 million, an increase of $28.2 million or 13.2%. Excluding the effects of adopting IFRS 15 for the 9 months ended September 30, 2018, revenues were $21.6 million or 10.1% higher than the same period last year. Our core DCM business generated revenues of $203.5 million compared to $187.1 million last year, which is an increase of $16.4 million or 8.8%. Now adjusted EBITDA was $15.7 million compared to $10.5 million in 2017, an increase of $5.2 million or 49.9%. Excluding the effects of adopting IFRS 9 and 15, adjusted EBITDA was $14.7 million or 6.2% of revenues for the 9 months ended September 30, 2018.Now I'd like to look at and share with you our third quarter initiatives and drivers. Let's talk first on sales performance. Our core DCM business continued to improve through expanded wallet share from existing clients and successful wins from first-time clients. The third quarter also saw a very specific focus on standing up our cannabis clients and preparing them for market. To date, more than 10 of the leading licensed cannabis producers are relying on your company to deliver their packaging labels. October 17, 2018, was truly a historic date for this emerging market, and your company was and is still proud to be involved in our clients' success. While cannabis packaging label revenue was minimal in the third quarter, we expect the full realization of our efforts starting in the fourth quarter of 2018, and we are seeing that.I also want to talk about our joint venture with Aphria. I'm very pleased to report our joint venture agreement has been signed with Aphria and executed by both parties. Perennial is working with the senior leadership team at Aphria, finalizing the brand architecture road map for branded cannabis products and segmenting the areas and customer profiles we want to enter with products and services. We will provide a more fulsome description of our plans as we roll out that branding strategy in 2019.Let's now turn to operations. I'm pleased to say that our new Gallus/Heidelberg hybrid digital label press is in advanced stages of production testing. This press will easily handle our current demand for cannabis labels and will provide us with a new opportunity in the wine and spirits markets, offering a completely new value proposition for these producers and distributors compared to the current offerings.We also have recently secured a new Heidelberg 6-color press, which will be installed in our Thistle operation in the first quarter of 2019. This new piece of equipment will provide us with enhanced capabilities, allowing us to migrate more of our sheet fed volumes from Tier 2 suppliers and will also help improve operating efficiencies and gross margins as it will replace our older 5-color press.Lastly, we've advanced our ERP project implementation and testing. While we were highly confident we can execute on the initiative in the fourth quarter, I decided to defer the launch until the first quarter of 2019 to ensure we kept our focus on executing a very busy fourth quarter of revenue for our clients. Margin and cost discipline. As many of you know, I indicated in my second quarter note, we expected to see our gross margins improved. Well, our gross margins for the quarter were 24.4% versus 23.7% a year ago. We still continue to experience paper and other raw material increases and are working closely with our customers to manage pricing. We're also highly focused on our procurement approach with our strategic suppliers as well as refining our order entry and manufacturing processes.We also made the decision to close our corporate engineering group in Drummondville, Québec, which was completed in October. This is expected to reduce our operating overhead by approximately $1.5 million on an annualized basis, and we expect to take a restructuring charge of approximately $600,000 in the fourth quarter related to this initiative. As a testament to the team's talent, we understand almost all of these dedicated professionals have found alternative employment. Québec is booming. Our SG&A expenses have also shown an improvement over last year and accounted for 20.8% of revenue for the quarter versus 21.9% a year ago. While we've only began tackling our sourcing and production efficiencies as well as our SG&A expenses, I'm pleased to see we're making gains with a more disciplined approach to cost control.Lastly, I want to turn to our outlook for the balance of 2018. We expect our revenue for fiscal 2018 will come in at the high end of our previously announced guidance of between $295 million to $310 million and expect to achieve the low end of our adjusted EBITDA guidance of $22 million to $25 million, both of which we set out at the start of this fiscal year. Our fourth quarter is expected to benefit from an incremental revenues as we onboard our cannabis clients as well as continued wins with new clients and expanded opportunities with existing clients. The reduction in the expected adjusted EBITDA is primarily due to increases in input costs that we have experienced.I'm going to turn things now back to James and we'll open -- he'll go through some details on our finances, and then we'll go open it up on questions.
Thank you, Greg. For the 3 months ended September 30, we generated $2.6 million of cash flow from operations compared to negative $800,000 last year. For the 9 months ended September 30, we generated $14.5 million from cash flow compared to $1.5 million. Our focus remains on paying down debt, reducing the -- and paying down the vendor take-back notes that we incurred with relation to the acquisitions we've made over the past 1.5 years, and investment in our ERP system and our related infrastructure to support that. Over the next 12 months, we have $5.6 million of scheduled principal repayments and $4.5 million of repayments scheduled on our promissory notes for a total of $10.1 million. Our revolver will fluctuate with our working capital needs.In the quarter, our -- we did a revaluation of our pension plan effective January 1. This confirmed that our funding obligation has decreased from approximately $1.4 million a year ago to approximately $500,000 a year presently, and that payment is expected for 2019 and 2020. We're pleased to make progress on aligning our pension plan.With that, I'm going to turn the call back to the operator.
[Operator Instructions] Our first question comes from the line of Scott Nirenberski from Muskoka Capital. We'll move on to our next question. We'll move on to the next question from Ed Sollbach from Spartan.
First question was just about taxes. I noticed you're paying some taxes. What is your outlook for taxes, given all the tax losses incurred?
Yes, Ed. We -- when we did our IFRS 15 adjustments in the beginning of the year, effective the first quarter in January 1, those adjustments used up all of our tax losses that we previously had. So we're taxable currently and expect to be going forward. Our current tax rate's approximately 26.5%.
Well, I don't understand because you had the tax losses. Aren't those still there in terms of revenue Canada? Like what did you do with those tax losses?
Well, when -- with IFRS 15, the adjustments that were made at the beginning of the year. We had quite an amount of revenue and net income that got pulled forward at the beginning of the period, and so that adjusted -- that adjustment flowed through our retained earnings. As you look in our balance sheet, you'll see we have now a positive shareholders' equity in the amount of approximately -- sorry, let me just get that. Yes, sorry. We moved to a positive shareholders' equity of approximately $8.6 million as of September 30. And at the end of the year, December 31, we had a deficit of $5.4 million. So essentially, over the period, we pulled forward and recognized income, which offset those tax losses that were previously there.
Okay. But are you actually paying taxes to -- or is that just an accounting?
Yes. Yes, we are paying cash taxes now.
Okay. I don't get that. But I mean, because you had massive tax losses.
Yes. There were about $6 million or $7 million, I think, at the end of December.
I thought they were quite a bit larger, given all the restructuring. Anyways, don't want to get hung up on that. Yes, I'm just wondering about -- last quarter, you talked about the cost increases in paper and et cetera, and since then, we've really seen a collapse in oil prices and lumber prices, for sure. And I'm wondering if you're starting to see some of your cost inputs come down in terms of paper.
Ed, we are. We've had 3 of the paper suppliers in during September and October, part of our top 20 vendor review, and each one has the same message. And where it's coming from is the mills that produce what we use as materials, basically, many of them have shut down or have gone off-line. So these decisions were probably made 4 or 5 years ago by many of these paper manufacturers who are looking at, perhaps, a pretty steep decline in paper usage. It hasn't really been the case. And so all of us, including our competitors, are struggling. The other side of it, Ed, is increase in raw pulp for the needs of China. They are increasing their demand as well as the change to a brown box or brown paper for a lot of the online shipping needs. So it's kind of the perfect storm. We're seeing price increases. I think they're -- in one, there was 4 price increases to date, and they're warning 2 price increases for next year. So we're trying -- all of us, and I can -- I know from the industry, we're trying to get ahead. And our customers are aware of this, and we're meeting with our customers. One of the issues, challenges we have is that 60% to 70% of our business is contracted, and these contracts, some of them were done in '16, '17 when paper price increases and inflation weren't part of it. We're wearing off some of those contracts or price increases are allowed. Most recently, we had one where a price increase after 2 years was allowed on October, and we took it. As for non-contracted business, we have provided price increases. And orders that come in that are non-contracted are priced in the moment. So we're very current on those. I hope that answers that.
Yes. No, I guess that's just -- so I guess it not only ties with lumber per se, because I know that's come down a lot, but it's...
Yes. It's just pure facilities.
Yes. And finally, just about the joint venture with Aphria. So I get how Aphria benefits, because obviously Perennial is getting -- is providing their expertise. Like how does DCM benefit? Or is that -- are you sharing revenue or profits with Aphria? Or how is that structured?
The joint venture is structured as follows. It's a 50-50 equal partnership. There's 4 of us on the board, and we share 50-50 in the cost as well as the revenue and, hopefully, the profit. And we're building out literally brands, products and services that are cannabis-infused. So if you think about the beer business as an example, the beer business, let's just pick one, Steam Whistle. Steam Whistle has a pilsner. Okay, that's fine, that's great. But I'll just use the term Molson. Molson or some of the larger have a number of brands. And where we see an opportunity is in beer, light beer, non-alcohol beer, cannabis-infused beer. We see that. We see that opportunity. And so for us, we want to own product. I want to own some revenue, and Perennial has had a history of this. They've owned brands. They've had brands which they have sold. When we bought Perennial, I probably just didn't do a good job with the story. Everyone thought we were buying the marketing expertise and branding, which they have. But they have had a long history in building their own brands out in bottled water, cosmetics, actually, restaurants, and they sold them. And most of them have been a success, some were failures, but they have a team ready to do that.
Okay. So they would actually own the products. But if Aphria would put in the -- they would -- Aphria would get margin from the inputs.
Aphria gets margin from putting in the raw material, the cannabis or the cannabis oil or if it's a powder or whatever it is, and we'll contract the price for that. DCM, as an example, if there's packaging, if there's any type of merchandising, would obviously benefit from that. But at the end of the day, that product is going to be manufactured by a third party. We will share equally in the profit, from the manufacturing cost to the sell cost, whether to customer or to retailer.
Okay. And I guess the launch of those products would be middle of next year?
No. Cannabis, there's -- the regulations are still unclear. As many of you can appreciate, it's pretty much the Wild West at this point in time. And Health Canada has not really legislated that. So we're looking 18 months out.
[Operator Instructions] Our next question comes from Scott Nirenberski from Muskoka Capital.
A couple of quick questions. The margins, actually, kind of came in better than I thought they would've despite, obviously, the paper price increases that you described. I'm just curious if you were able to get -- it sounded like you're starting to get a little bit of pass-through on the input cost, but there's the improvement that you got. Is that just really a function of better fixed cost absorption on the revenue increase? Or did mix factor in as well on the gross margin line?
Scott, really, a lot of that has to do with our mix of product. In the second quarter, we produced some of the lower-margin work that we've contracted for. And our third quarter, we had a feeling and we kind of forecasted that we would have a mix that had a higher gross margin level. So for us, that was kind of -- you're seeing that in that full plus point of gross margin improvement. Our actual price increases really hadn't come through in the third quarter. You'll see the effect of some of those in the fourth quarter.
Got it, okay. And then speaking of 4Q, if you look at kind of a seasonally stronger quarter, typically, you got your higher margin lines, you got Perennial and the startup cannabis and things like that. Is that really -- are those going to be the main factors in driving margins hopefully higher or -- and you achieving your EBITDA guidance?
Yes.
Okay, great. And then on the OpEx side of things, there was a pretty meaningful chunk down in absolute dollars on SG&A from 2Q '18 to this to 3Q. And I'm just curious about how we should think about it going forward in both percentages as well as absolute dollar terms. Obviously -- presumably, it might go up because fourth quarter is usually seasonally a stronger quarter for you. But could we sort of expect to see further SG&A leverage, I guess, on higher sales?
Yes. I think the SG&A that you saw in the third quarter is kind of in line with what we'd expect in the fourth quarter. We've been looking for every opportunity to find some savings in the business, and we think we're at a pretty good run rate there.
Okay, great. That's excellent. And then I know -- obviously, you talked about your ERP, and it looks like a lot of the money already got spent on it in the quarter. Did that basically -- can we think about that as maybe -- at least for 2019, there'll be some money that you spent this year that won't have to be spent next year, and then therefore, all else being equal, you'll be able to realize some of that additional cash flow for debt reduction or acquisitions or whatever is the -- obviously, the best opportunity from the savings on not spending for ERP next year?
Yes, absolutely. We did make the decision to postpone it to Q1. You'll see some more spending in the fourth quarter. But as we get into Q1, we're going to be focused on training and implementation. So -- sorry, not implementation. We're focused on the implementation right now, but we'll be really, really focused on training and going live.
Okay, okay. And then on the new Heidelberger (sic) [ Heidelberg ], the 6-color press, if I read it right, it looked like you're going to use that for business that you couldn't serve before. Was that basically stuff that was getting outsourced as part of larger contracts from Thistle and now you will actually be able to just pull that back in-house and, therefore, the margins are better? Or is that...
Scott, it's actually not Thistle's revenue. It's core DCM revenue that we were -- prior to buying Thistle, we were outsourcing several millions of dollars to second-tier suppliers. When we bought Thistle, we could -- we moved, what, about 1 million and a bit of volume over to Thistle, but the problem was it's a 5-color press with no coater, et cetera. People that are primarily in the retail business, et cetera, want a 6-color coater, et cetera. And so we were continually still outsourcing several millions of dollars to second-tier, third-tier suppliers. With this new press, we believe we can pull in at least $2 million to $2.5 million of work that we've been outsourcing. So it's not really Thistle's work. Thistle chunks along, and it's a great little business, so.
Got it. Okay, that's great. So you get the -- you'll recapture the margins on that. Okay. And then I guess the only other question is just -- when I look at your guidance, if you look at the first 9 months on revenue, mathematically, it seems like you should easily make your high end. I'm not asking you to raise your guidance. But I've just -- like -- it seems like even if you have a flat quarter with the seasonally slow third quarter, it'd be pretty hard for you not to be outside the upper end of your range on revenue, unless I'm missing something. Just wanted to know if you'd care to comment on that.
Well, our revenue -- let me just understand the question better. I think you just asked, are you being conservative on this? Is that what you're asking?
Yes. That's what I asked, yes.
Okay. All right. And that's on EBITDA?
That was actually just on the revenue line, looking at it.
Well, yes. You know what? $310 million sounds like a good number. It'd be up, I don't know, almost double digits versus last year. If we could, we could be more. There's only 16 production days in December. So Scott, literally every day, we are -- as we should be, we're on it. So we could be doing a little bit more, don't know.
We have no further questions in queue. I'll turn the call back to presenters for closing remarks.
Thank you, ladies and gentlemen. It's Lisa, I believe, on the line. Thank you for that. We're focused on the fourth quarter. It is our busiest quarter. I think we will -- as Scott has indicated, I think we'll have a very good revenue focus. And then as we're gearing up for 2019, there are some other excitements that we're building into our plans. And I think one of the things you should leave on is how much we are focused on our core customer base. About 150 to 200 customers constitutes most of your business, and we are really focused on them and focused on their needs. We deal with 70 of the 100 largest corporations in Canada, and I think that's a tribute to 60 years of being in business. And we want to get better at that. So with that, I'm going to sign off, make it a good day. We're back to business. Bye.
This concludes today's conference call. You may now disconnect.