Magnera Corp (MAGN) Q3 2018 Earnings Report, Transcript and Summary

Good day. My name is Lori, and I will be your conference operator today. At this time, I would like to welcome everyone to the Glatfelter's Third Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to John Jacunski. You may begin your conference.

Thank you, Lori. Good morning and welcome to Glatfelter's 2018 Third Quarter Earnings Conference Call. This is John Jacunski. I'm the company's CFO. Before we begin our presentation, I have a few standard reminders. During our call this morning, we will use the term adjusted earnings as well as other non-GAAP financial measures. A reconciliation of these financial measures to our GAAP-based results is included in today's earnings release and in the investor slides. We will also make forward-looking statements today that are subject to risks and uncertainties. Our 2017 Form 10-K filed with the SEC and today's release, both of which are available on our website, disclose factors that could cause our actual results to differ materially from these forward-looking statements. These statements speak only as of today and we undertake no obligation to update them. I will now turn the call over to Dante Parrini, Glatfelter's Chairman and Chief Executive Officer.

Thank you, John. Good morning and thank you for joining us today to discuss our 2018 third quarter results. We have a lot to cover. As this quarter is underscored by the significant progress we are making with the strategic transformation of our business. Following our announcement earlier this year to explore strategic alternatives for our Specialty Papers business, we successfully delivered on that initiative by closing on the sale of the business to Lindsay Goldberg on October 31, for $360 million. I'd like to thank our Specialty Papers colleagues for their hard work and dedication over the years and during this entire process. We wish them much success under new ownership. In October, we also completed the acquisition of Georgia-Pacific's European nonwovens business, further bolstering our Airlaid platform. The successful execution of these strategic transactions, in addition to the opening of our new state-of-the-art facility in Fort Smith, Arkansas earlier this year, are pivotal steps as we build the new Glatfelter. I'll provide more perspectives on our path forward during my concluding remarks. From an earnings perspective, the third quarter was challenging. In particular, Composite Fibers is being handicapped by the sharp escalation in raw material prices. We've made progress with our efforts to reduce costs and improve efficiency, although it hasn't been enough. As a result, we recently announced the 7% price increase on all products to help recover some of the raw material inflation. For the Advanced Airlaid Materials business, volume growth in North America has been slower to develop this year, due to the timing of certain customer qualifications, and that has affected the profitability of the business. However, I am pleased to say that we made significant progress during the third quarter with these qualifications. We expect growth to begin accelerating in the fourth quarter, driven by the ongoing ramp-up of the Fort Smith facility and the backfilling of open capacity at the Gatineau facility, which will build positive momentum, heading into 2019. Before I turn things over to John, I'd like to point out that the preparation and presentation of financial results reflect a very complex quarter, given the reporting of discontinued operations due to the sale of Specialty Papers. John will take you through the changes and give you a full appreciation for all the moving parts and then I'll offer some closing comments. John?

Thank you, Dante. As Dante stated in his opening remarks, we completed the sale of the Specialty Papers business last week. Because of this, Specialty Papers results are classified as discontinued operations for all periods presented in the earnings release and accompanying investors' presentation. We also filed an 8-K this morning with historical results for 2015 to 2017, restated for the same presentation. Slide 4 shows the third quarter's consolidated income statement on a GAAP basis, with comparison against last year, recognizing Specialty Papers results as discontinued operations. Revenues shown for the quarter is related to our Composite Fibers and Advanced Airlaid Materials businesses and was up 1% on a constant currency basis. Operating profit was down in Q3 this year versus last year, primarily driven by lower profitability from our business units, which I will speak to in a minute. In addition, costs related to corporate shared services that were historically allocated to Specialty Papers remain in continuing operations as required by the accounting standards. I will provide further context around corporate costs later in the call. Continuing operations now exclusively represent our engineering materials business, and corporate shared services and overhead. For the third quarter of 2018, after excluding non-core and non-recurring business items, we reported an adjusted loss of $200,000 or a breakeven on an EPS basis, compared with adjusted earnings of $7.6 million or $0.17 per share in the third quarter of 2017. During the quarter, we also had a loss on discontinued operations after-tax of $95 million, including a pre-tax impairment charge of $126 million to write down the carrying value of the Specialty Papers' business to reflect the price at which the business was sold. Slide 5 shows a bridge of adjusted earnings per share for continuing operations from the third quarter of last year to this year. Composite Fibers results reduced earnings per share by $0.08, driven primarily by a significant escalation in raw material prices. Advanced Airlaid Material results reduced earnings per share by $0.05, driven by increased fixed cost with the start-up of the Fort Smith facility earlier this year and limited overall volume growth. And taxes reduced earnings per share by $0.04, driven by a higher effective tax rate. Slide 6 shows a summary of third quarter results for the Composite Fibers business. Total revenues were slightly behind last year on a constant currency basis, the shipments down 6%. Shipments in metalized products were down 13%. And as we discussed in prior quarters, this market has been impacted by industry overcapacity and product substitution, and we don't expect any near-term improvement. Shipments of wallcover products were down 8%, with demand being somewhat affected by the euro/ruble exchange rate. We expect demand for wallcover to remain weak in the fourth quarter as well. Food and beverage volumes were up a modest 1%, with weak volumes in tea, driven by unseasonably warm weather across most of Europe that has affected consumption. Single-serve coffee shipments continue to perform well, with year-to-date growth of 6% and third quarter volume growth improvement of 15%. Operating income for the quarter declined $4.5 million compared to last year. Similar to last quarter, selling prices increased $2.2 million, but this was not sufficient to offset the negative impact of increased wood pulp prices and other raw material inputs that reduced earnings by $4.7 million. Effective cost control actions mitigated other inflationary pressures and the impact from market-related downtime. Finally, currency translation negatively impacted results by $1.8 million. For the fourth quarter, shipments are expected to be down about 7%, driven by normal seasonality and weakness in the wallcover market. Selling prices and raw material prices are expected to be in line with the third quarter. During October, a key supplier of specialty fibers had a significant fire, which will take most of their production down for an extended time frame. We are working to qualify additional suppliers to ensure there is no impact in our ability to satisfy customer orders. While we do not expect any significant impact to the fourth quarter, we do not yet have sufficient supplies to meet expected demand in the first quarter of 2019. Our current supplier is expected to have its facility operational early in the second quarter of next year. For 2019, we expect overall shipments to grow year-over-year in line with the market at 3% to 4%. And while we recently announced the 7% price increase across all product lines of Composite Fibers, it is too early to estimate the expected realization for next year. Slide 7 shows a summary of third quarter results for the Advanced Airlaid Materials business. Total revenue for the quarter was $71 million, a 5% increase on a constant currency basis. Overall, shipments were up 1%, with wipes continuing to grow at a healthy pace, up 7% for the quarter. Operating income declined $2.7 million, mainly due to $1.2 million of additional depreciation, associated with our Fort Smith facility and higher fixed cost associated with this new facility, with limited overall volume growth. Unfavorable currency translation also impacted earnings by $800,000. Slide 8 shows our outlook for this business in the fourth quarter and 2019. I will start with the right side of this slide that outlines our expectations for the Steinfurt acquisition, which closed October 1. This business has less contractual cost pass-throughs than in our Airlaid business, so it's been more meaningfully impacted by the recent rise of raw material prices. We expect this to continue in the near-term, but we are evaluating further cost reduction opportunities and price increases to help mitigate the impact of the higher raw material prices. For the fourth quarter, we expect a breakeven operating profit, including the impact to depreciation from the acquisition step-up to fixed and intangible assets and EBITDA of $1.7 million. For 2019, we expect operating profit of $7 million to $9 million and EBITDA of $14 million to $16 million. During the third quarter, we made significant progress with a new customer and product qualifications that will help to accelerate growth in the fourth quarter and into 2019. Excluding Steinfurt, we expect shipments to be 4% higher in the fourth quarter compared to the third quarter, which represents 8% growth versus the fourth quarter of last year. For 2019, excluding Steinfurt, we expect volume growth to be in the range of 8% to 10% compared to 2018. With the new facility in Fort Smith, the progress we have made with product qualifications and the addition of Steinfurt, we are well positioned to drive significant growth in 2019. Slide 9 shows corporate costs and other financial items. Following the divestiture of Specialty Papers and its results being recognized as discontinued operations in our consolidated financials, corporate cost have been adjusted accordingly for all periods shown to include corporate shared services costs that were previously allocated to Specialty Papers. Corporate costs for the third quarter were slightly lower compared to the same period last year. For the fourth quarter, corporate costs are expected to be between $10 million and $11 million. Because Specialty Papers is not operated as a stand-alone business, Glatfelter will be providing transition services to the new company until the business is fully separated from GLT. In addition to this considerable work, we need to adjust a variety of programs to fit the new GLT and right-size our corporate shared services. As a result, 2019 will be a transition year, during which we expect to reduce corporate cost by $14 million to $16 million by the end of the year. This will result in estimated corporate cost of $35 million to $37 million in 2019 and $28 million to $30 million in 2020 compared to 2018 corporate cost of $43 million to $44 million. Slide 10 provides a summary of the effective tax rate dynamics on our adjusted earnings. As we discussed earlier this year, our circumstances are such that we continue to have an elevated tax rate. Our tax rate is generally driven by three factors: a blended foreign rate of 26%, with all of GLT's earnings generated in foreign jurisdictions; a new U.S. tax on foreign earnings, which was enacted with the U.S. tax reform in late 2017; and losses being generated in the U.S. on which we cannot recognize the tax benefit. With the expectation that we will improve profitability in the U.S. through the Fort Smith facility and the plan to reduce corporate cost, we expect to fully utilize existing NOLs over the next two years. This will drive an improvement in the overall effective tax rate from the 40% we expect in 2019 to 30% in 2021. Slide 11 shows our free cash flow. During the third quarter, cash flow from continuing operations was lower than last year due to reduced earnings and higher usage of working capital. Capital expenditures continue to decline as we have now completed our major capital programs. We expect solid cash flow in the fourth quarter, driven by a working capital improvement of approximately $30 million. We also expect solid cash flows in 2019, driven by improved earnings, lower cash use for working capital and reduced capital intensity of our business now that Specialty Papers has been divested. Slide 12 provides details on capital expenditures. Following the completion of our Airlaid capacity expansion project in Fort Smith earlier this year and the divestiture of the Specialty Papers business, our capital expenditures levels are set to reduce significantly going forward. We expect maintenance CapEx going forward to be in the range of $20 million to $25 million per year, with total capital spending $5 million to $10 million higher after including normal improvement projects. Slide 13 showed some balance sheet and liquidity metrics. Our net debt on September 30 was $412 million, reflecting incremental revolver borrowings and cash on hand in preparation to fund the Steinfurt acquisition. On a pro forma basis, including the sale of Specialty Papers and the acquisition of Steinfurt, net debt was $290 million and leverage was 3.0 times, with ample liquidity of $139 million. This is based on pro forma EBITDA of $95 million, which as we discussed today, includes corporate shared services cost previously charged to Specialty Papers. Our financial flexibility is expected to improve in 2019, with higher EBITDA from our businesses, lower corporate shared services costs and improved cash flow. This concludes my comments. I will turn the call back to Dante.

Thanks, John. Before we conclude today's call, I'd like to recap the progress we've made over time on our path to transform Glatfelter into a leading global engineered materials company. As you can see on Slide 14, we've taken meaningful steps since 2010 to evolve Glatfelter from a U.S. focused paper business to now a global leading player in engineered materials. This was achieved through the successful completion and integration of critical acquisitions and several organic growth investments. The expanding scale and product portfolio built by the strategy has allowed us to become the supplier of choice to customers we serve and better position us for long-term success. Slide 15 summarizes the recent steps taken to exit the paper business and reshape our portfolio. The new Glatfelter is about $1 billion revenue business with two global operating units, serving high-valued, niche non-woven markets that are growing at rates from 2% to 6% per year. Our portfolio that includes leading positions in feminine hygiene, adult incontinence, table top, teabags, single-serve coffee, non-woven wallcover and a rapidly growing position in wipes has now more focused in growth-oriented platform of engineered materials. This reshaping of our portfolio will enable Glatfelter to operate as a more integrated and synergistic enterprise going forward. And Slide 16 covers investment highlights, which outlines how we intend to create value for our shareholders. Our growth strategy will focus our energy and resources along four critical dimensions. Driving innovation and growth by leveraging our leading market positions, longstanding customer relationships; and deep technical expertise to develop meaningful new products that will enhance and refresh our product portfolio. Investing in organic growth and strategic acquisitions to expand our capabilities add scale and broaden our global footprint. Achieving more consistent operational excellence across the company to the application of a robust continuous improvement program and reducing our cost structure to better align with the smaller and more focused engineered materials business, and generating improved and more stable cash flows as we build a more profitable and less capital intensive business. In closing, we're clear-eyed about the work that lies ahead. We're here to build a new company and enthusiastic about the upside for the business as we continue to execute our transformation and growth strategy. I'll now open the call for your questions.

[Operator Instructions] We have a question from the line of Mark Wilde from Bank of Montreal. Your line is open.

Good morning, Dante. Good morning, John.

Good morning, Mark.

Good morning, Mark.

Dante, can you just walk us through where you're at in the process of certifying the Fort Smith customers? I think you mentioned that you had qualified another customer within the quarter?

Yes. So we've made very good progress over the last few months, qualifying new customers and new products. So it's not just one new piece of business, but it's several pieces of business that are both with existing and new customers. So similar to what we said during our last call, we were expecting to see volumes accelerate in Q4 and further into 2019. Some of the qualification and the order arrangements are fixed. Others are in the final stages. So, again, as John stated earlier, we expect to see the volume uptick this quarter and continue into 2019.

Okay. And then, just stepping over to Composite Fibers, are there contracts in that business, which will create lags or other issues as you try to roll through this 7% price hike?

I mean, we have a few contracts in place with some of our larger customers that as you might expect are a little bit more complex other than straight transactional types of agreements of volume for particular price and delivery through the course of a given fiscal year. So we're actively engaged in having these discussions with our customers, especially, given the fact that we just announced the 7% price increase. And with an effective date of November 19, it's difficult for us at this early stage to predict much, other than we think that the increase is justified and necessary to obtain appropriate margin for the business, and that these input cost inflation issues are not just affecting Glatfelter, but as you witnessed, they are affecting the broad industry and a number of industry players.

Okay. And then related to that, you mentioned, that supplier prior, I wondered if you could put a little more color around that. I'm wondering if that's one of the abaca suppliers, because I'm conscious of the fact that there aren't too many abaca suppliers out there.

Right. So it is not an abaca supplier. It's actually a Continental European producer of a specialty fiber that we procure from them. They have declared a force majeure. And as John stated, we have adequate fiber supply for Q4 and we're actively working on securing alternative source of supply for Q1 so that this is transparent to our customers. And the supplier has indicated that they expected to have their operation up and running, again, sometime in Q1. So we just want it into early Q2. So we want to err on the side of caution and make sure that we leverage our scale and our relationship with a variety of suppliers to ensure our customers continued source of supply.

Okay. And then, finally, John, I wondered if you can just kind of walk us through the synergy timeline on GP? And then put a little more color on what you're doing to give yourself more ability to pass through raw material costs?

So on the synergies, Mark, we have estimated synergies of $6 million. We expect to generate about $2 million of that next year. It's, as you might expect, we will sort of increase the synergy realization as we go through the year. We'd expect we'd get the full $6 million in year two, so in 2020. And so, that's kind of where we stand on the synergy realization.

And just in terms of improving the economic performance of Steinfurt, now that we're on the other side of the successful regulatory reprocess and have owned the business now for a month, we will dig in and better understand some of the contracts and the arrangements that they have with their customers, as John stated. And they have less pass-through provisions for raw material price increases than our legacy Airlaid business. And so, we're looking at ways to optimize our overall cost structure, leverage centers of excellence across the broader Airlaid platform because Steinfurt does some things better than legacy Glatfelter's Airlaid business and vice versa. And in the same regard, we're taking a look at their input cost inflation and looking at opportunities for us to increase prices for that part of the business as well.

Okay, great. I'll turn it over.

Yeah. Lori?

Your next question comes from the line of Deborah Jones from Deutsche Bank. Your line is open.

Hi, good morning.

Good morning, Debbie.

Hi, Debbie.

The first question I wanted to ask is on your volume target for 2019 for Airlaid, the 8% to 10%. And I know you called for more meaningful improvements in that range in the past. But I feel like some of the delta might have changed a little bit. Can you just give us a sense of how much of this improvement next year is coming from the qualification process actually completing? How much from underlying market growth, and then how much from the Fort Smith ramp and the improvement that you're getting there?

Sure. So I think a fair number to use for market growth is around 4%, year-over-year. And a good part of the year-over-year growth is coming from the qualification of some of these new pieces of business. I would say, what's different now versus a year plus ago was we had a lot less clarity and certainty around the overall timing of building and starting up a facility, qualifying customers for Fort Smith, sequencing the timing of commercial negotiations with customers for Gatineau, moving product from Gatineau to Fort Smith. So I think you get the picture. It was a complex set of activities that required pretty precise synchronization. And we don't completely control our customers' thought process, and how ultimately they choose to invest time and energy to these qualifications. Now, everything is up and running. We are fine-tuning the operation. It continues to run quite well, this is Fort Smith. We've been able to focus more of our time and attention on the short list of commercial opportunities that we had been working on. And as I said earlier in my prepared remarks, some of those are already confirmed, so qualification complete. Everything approved, PO in hand and looking forward to starting up shipments in Q4 or in early 2019 and a couple of the others were in the final stages of refining the overall parameters of the new supply agreement. So I would say that we have a much better line of sight and greater overall confidence in the guidance we're providing.

Okay. I'm sorry if you said this earlier, but how much of the growth is coming from the acquisition? It wasn't quite clear to me how you're accounting for that in the 8% to 10%.

So Debbie, the 8% to 10% is on sort of our legacy AMBU business, so it's separate, excludes Steinfurt. And so, the way we provide our guidance was Steinfurt and then separately the Airlaid business as it existed.

Okay. And that's what is in the slide deck, but I thought I missed it on the call. So thank you for clarifying. I wanted to ask about the CapEx, why you're pointing to 2019, $20 million to $25 million - excuse me - in total CapEx, but then there's another part here where you talk about expecting $25 million to $30 million for project improvements. And I'm just curious, did you say that it's actually $25 million to $30 million for 2019 or are you waiting to see if there are some other things that may come to fruition? And then, how should we think about the allocation of that kind of base $20 million to $25 million between the two legacy segments?

Sure. So the guides we're trying to provide was generally speaking, what to expand - what to expect going forward year in and year out. So year in and year out, we should be in around the $20 million to $25 million for maintenance CapEx and additional $5 million to $10 million of improvement projects. So you get to a total CapEx in that $25 million to $30 million. Specifically for 2019, our guidance is that we will have capital spend of $20 million to $25 million. So as you know, maintenance CapEx can ebb and flow, sometimes it might be a little below $20 million and sometimes it might be a little bit above $25 million, but generally speaking in that range. So for next year, our expectation is total capital expenditures of $20 million to $25 million.

Okay. That's helpful. And then last question, I just wanted to confirm on or better understand on the corporate tax, because there's some moving parts here. Now that you sold Specialty Papers - is the $40 million that you're highlighting is that all - sorry, $35 million to $37 million that you're highlighting for 2019, is that inclusive for all corporate cost? Or are you still allocating some of these items to the two legacy businesses? And how does that show up in EBIT?

So we are allocating some of the corporate costs to Composite Fibers and Advanced Airlaid Materials. Those are not reflected in the - in our estimate for next year of $35 million to $37 million. So the $35 million to $37 million is what we would expect to be unallocated. So if you think about sort of how our total P&L works, we have the Airlaid business operating profit, we have a Composite Fibers operating profit and then we have these corporate costs that don't get allocated. And that's our estimate on the unallocated portion, which is $35 million to $37 million.

Okay. Is there going to be a meaningful impact to EBIT as you allocate the corporate cost to other segments for next year?

It will be very close to what we are already allocating now. It's not - we wouldn't expect it to change to any great degree.

Okay. That's helpful. Thank you. And I'll turn it over.

[Operator Instructions] We have a question from the line of Kurt Yinger from D.A. Davidson.

Yeah. Good morning, everyone.

Good morning, Kurt.

My first question was, can you just talk about the actual sources of cost that will come out of the unallocated/corporate segment that you guys talked about?

Sure. It's a variety of cost. So it ranges from things like professional services, office costs and then, of course, personnel. So it's in those typical types of categories.

Okay. Thanks. And does the acquired Airlaid business having seasonality? Or is it the breakeven fourth quarter just a function of the cost pressures you've talked about? And then how much sort of price cost improvement is embedded in the 2019 outlook for Steinfurt?

Yeah, so there is a little bit of seasonality. Like many - our own Airlaid business, we typically see a little bit of shipment drop-off in - particularly in December of the fourth quarter, just as customers shut down plants over holidays. So there is a little bit of volumes that we guided to are a little bit low because of that. We're not breaking out sort of the cost improvement and pricing assumptions that we've made at this point. We do expect we will recover some raw material cost for price increases, and of course, we have the $2 million of synergies that are reflected there as cost out. So we feel good about the estimate that we've provided, the $7 million to $9 million of operating profit that we think is very achievable target.

Okay. Thank you, John. And then my last question is just sort of higher level, if we look at the pro forma trailing EBITDA of $95 million, you guys sort of referenced that you expect that to grow. On the positive side of the ledger, some synergies, lower corporate shipment growth, I mean, how do you think about the price cost for the overall business going into next year? And are there any other sort of big moving pieces in there that we maybe haven't talked about?

Yeah, so I think, on the price cost situation with our Airlaid business, overall, including Steinfurt, about 70% of our revenue has a cost pass-through. So that business is still pretty well situated to pass-through any cost. And as we said, we're evaluating whether we ought to increase some prices, particularly related to some of the Steinfurt products. On the Composite Fibers side, we've seen some pretty sharp increases. And as Dante described, we've seen that in our P&L. We know that that's happened more broadly in the market. And so we think price increases are appropriate in this case. And we're just not in a position to estimate what that impact will be just yet. As Dante mentioned, we just announced this. It's not quite effective yet. We're working with our customers, but we would expect an improved situation next year, certainly, compared to where we are this year.

Historically, I mean, how much of, I don't know these price increases have you sort of captured?

Well, I think, it does range pretty broadly, and it's been certainly more difficult more recently to pass on these price increases, but this is a little bit of a different environment where the price - the raw material prices have risen very rapidly and to a significant extent. And our raw material prices for wood pulp are up 25% year-over-year. And much of that just happened in the last two quarters. So it's been fast and it's been steep. And so it's a little harder to gauge the - like the success and we're just not prepared to provide that type of estimate right now.

Okay. Thanks, John. And good luck for the fourth quarter.

Thank you.

Thank you.

Okay. Well, thank you for joining…

There are no further questions at this time. I'll turn the call over to Dante. Please continue.

Okay. Well, thank you again for joining our call today and we look forward to speaking with you next quarter. Have a good day.