Magnera Corp (MAGN) Q2 2019 Earnings Report, Transcript and Summary

Good morning. My name is Misty, and I will be your conference operator today. At this time, I would like to welcome everyone to the Glatfelter's second quarter earnings conference call. [Operator Instructions]. Thank you. Mr. Ramesh Shettigar, you may begin your conference, sir.

Thank you, Misty. Good morning, and welcome to Glatfelter's 2019 Second Quarter Earnings Conference Call. This is Ramesh Shettigar, and I'm the company's Vice President and Treasurer. On the call today to present our second quarter results are Dante Parrini, Glatfelter's Chairman and Chief Executive Officer; and Sam Hillard, Senior Vice President and Chief Financial Officer. 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 2018 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.

Thank you, Ramesh. Good morning, and thank you for joining us today. Following a strong start to the year as a new Glatfelter, the momentum continues as we achieved solid overall results in the second quarter that were in line with expectations. We reported total revenues of $235 million, adjusted EBITDA of $28 million and adjusted earnings per share of $0.19. All three metrics posted an improvement on sequential quarter basis and demonstrated a meaningful step change when compared to prior year. Advanced Airlaid Materials delivered $10.4 million of operating profit in the second quarter, setting another record by slightly outpacing the all-time high results achieved in the first quarter. When compared to last year, revenues grew 44% on a constant currency basis, including Steinfurt, while the legacy business delivered 12% sales growth. We remain firmly on track to achieve our previously communicated legacy volume growth of 10% and Steinfurt's operating profit target of $7 million to $9 million in 2019. In Composite Fibers, we delivered sequential quarter improvement in shipments and profitability. However, the year-over-year comparison was challenged by competitive market pressures, higher input costs and weak demand in the wallcover and metallized segments. While the $2 million in benefits from our previously enacted cost reduction actions nearly neutralized impacts from lower volume and market downtime, we were not able to fully offset input cost headwinds, particularly abaca fibers through our price increase initiatives. Corporate costs this quarter were $3.7 million lower when compared to last year through diligent rightsizing efforts following the sale of Specialty Papers business. And we're on target to deliver our previously communicated $14 million to $16 million of cost reduction by the end of 2020. At this point, I'll turn the call over to Sam to provide a more in-depth review of our second quarter results. I will then offer some additional color on the announced functional operating model leadership as part of my closing remarks before opening the call for your questions. Sam?

Thank you, Dante. Second quarter income from continuing operations was $6.3 million or $0.14 per share. Adjusted earnings of $8.5 million or $0.19 per share more than doubled when compared to the prior year second quarter, boosted by the Steinfurt acquisition, strong organic growth in Airlaid materials and benefits from cost-reduction actions. Slide 4 shows a bridge of adjusted earnings per share of $0.09 from the second quarter last year to this year's second quarter of $0.19. Composite Fibers' results were net neutral to earnings as lower shipments and higher raw material prices were offset by higher selling prices, benefits from cost-reduction actions and favorable currency hedging. Advanced Airlaid Materials' results increased earnings per share by $0.04, driven by strong legacy volume growth and the addition of the Steinfurt acquisition to the portfolio. Corporate costs improved results by $0.06 as we continued to right size our corporate structure following the divestiture of the Specialty Papers business. Net interest expense improved earnings by $0.03 from lower borrowing costs driven by our recent financing and taxes reduced results by $0.03. Slide 5 shows a summary of second quarter results for the Composite Fibers business. Total revenues were 3% lower on a constant-currency basis compared to last year due to volume declines in most product lines. The exceptions were composite laminates, which posted 14% volume growth, while food and beverage shipments were marginally ahead of the prior year. Metallized product shipments for the quarter declined 17% as overcapacity in the market continued. However, we are finalizing commercial qualifications with a large wet-glue label customer that we secured in the first quarter of this year and expect shipments to commence, with volume ramp-up anticipated during the fourth quarter. Wallcover shipments were 11% lower with continued impact from Russia-Ukraine trade restrictions, local market competition and weak customer demand. However, we did experience 24% volume improvement on a sequential quarter basis from the first quarter of this year. Although this may indicate that the commercial environment is normalizing, we continue to be cautious about further volume recovery for the remainder of the year given the high volatility in this market. On the food and beverage side, continued strong growth in coffee was largely offset by declines in tea shipments. With regard to energy and raw materials, we were negatively impacted by $1.5 million as higher abaca costs more than offset declining wood pulp prices in the second quarter. For the third quarter, shipments are expected to be slightly higher compared to the second quarter while full year volumes are projected to be flat to slightly down versus 2018, largely dependent on the wallcover and metallized markets. And selling prices are expected to be in line. While pulp prices are projected to continue a downward trend, we expect the benefit to be largely offset by abaca price increases. Finally, we expect machine downtime in the third quarter to be in line with second quarter as we continue to manage inventory levels. Slide 6 shows a summary of the second quarter results for the Advanced Airlaid Materials business. Including Steinfurt, total revenues of $102 million were up 44% on a constant-currency basis with shipments up 39%. The legacy business excluding Steinfurt also recorded solid volume growth of 10% while revenues were up 12%. The strong quarter on the legacy side was attributed to growth across most product lines with wipes volumes up 41% and tabletop up 92%. We are pleased to see that the new capacity in Fort Smith and Steinfurt is contributing to the overall success of this business. Raw material and energy price increases were more than offset by selling price increases through the contractual pass-through arrangements with customers. Operating profit grew by $2.8 million and was largely driven by the addition of Steinfurt to the portfolio and growth in legacy volumes. Higher operating costs were partially offset by favorable currency. For the third quarter, we anticipate total shipments to increase slightly compared to the second quarter. Selling prices and raw material prices are expected to decline slightly. We are reaffirming our guidance on annual shipment growth in the legacy business to be at the high end of the 8% to 10% range as stated last quarter and operating profit guidance for Steinfurt remains in the $7 million to $9 million range for the full year. Slide 7 shows corporate costs and other financial items. As a reminder, following the divestiture of Specialty Papers and its results being recognized as discontinued operations in our consolidated financials, corporate costs have been adjusted accordingly for all periods shown to include corporate shared service costs that were previously allocated to Specialty Papers. For the first half of the year, corporate costs declined by $8.5 million when compared to the prior year same period and was driven by headcount rightsizing and reduction in spending including professional services. We expect third quarter corporate costs to increase in the range of $1 million to $2 million, driven by the timing of certain corporate expenses and the ramp-down of transition services related to the Specialty Papers business. We expect full year corporate costs to be in the range of $33 million to $35 million. We remain on target to take out $14 million to $16 million of total costs by the end of 2020 as compared to 2018 levels. We also terminated our qualified pension plan as of June 30 with a view toward eliminating our long-term risks of managing such plan. At the same time, we transitioned to an enhanced defined contribution plan to provide our employees with greater control over their retirement assets. We expect no material change to our pension and other postretirement benefit costs for 2019. Slide 8 shows our free cash flow. During the second quarter, adjusted free cash flow was slightly positive and $21.4 million higher when compared to the second quarter last year driven by increased earnings, lower working capital usage, lower interest payments and lower capital spending. We expect total capital expenditures to be in the range of $23 million to $28 million for 2019 while depreciation and amortization expense is projected to be $52 million for the year. We continue to expect significant improvement in our cash flow profile going forward as earnings grow and all major capital projects are now behind us. And we are projecting our full year tax rate for 2019 to be approximately 38%. Slide 9 shows some balance sheet and liquidity metrics. Net debt on June 30 was $326 million. Net leverage at quarter end was 3.5x and we had available liquidity of $99 million. We expect our liquidity and leverage to improve by the end of 2019 as earnings and cash flow increase. This concludes my comments. And I will now turn the call back to Dante

Thanks, Sam. As we enter the second half of 2019, we're encouraged by the momentum of two solid quarters that were in line with expectations. The successful execution of the Airlaid growth strategy, disciplined actions taken around corporate and Composite Fibers cost reductions and ongoing operational excellence across mill operations illustrates our ability to become a leaner, agile and more profitable engineered materials company committed to delivering meaningful value to our shareholders. The Airlaid business is on track to deliver record volumes and earnings this year with Fort Smith and Steinfurt capacity being the catalyst for such strong performance. Additionally, we continue to work on realizing the full potential of synergies from the Steinfurt acquisition and optimizing our production capabilities across the entire Airlaid platform. Composite Fibers is deeply focused on cost optimization of operational excellence in response to the commercial headwinds facing the business. This business remains committed to delivering innovative solutions and building upon our leading positions in the markets we serve. At an enterprise level, we've taken additional steps in transitioning to a functional operating model by announcing leadership changes that will further enable our transformation. Under the new structure, business unit president roles are being replaced by senior executives responsible for the company's global commercial and integrated supply chain functions both reporting to me. Chris Astley, currently Advanced Airlaid Materials Business Unit President, has been promoted to Senior Vice President and Chief Commercial Officer and will have responsibility for global sales, marketing, customer service and innovation. We're also undergoing an external search for a global supply chain leader and we'll provide an update once an executive has been named. These elements of our strategic transformation are intended to make Glatfelter a flatter, more agile and integrated engineered materials company as we execute our growth and profitability strategies. We expect to begin running the business under this new operating model in the fourth quarter. I'll now open the call for your questions.

[Operator Instructions]. The first question comes from the line of Steven Sheeckutz with Deutsche Bank.

I was wondering if you could discuss sort of the price realization you saw in Composite Fibers this quarter relative to expectations? And then I believe last call, you were talking about a $7 million price realization benefit for '19. I was wondering if that's still the case and if there's any update on timing for that?

So I'll talk about the price increase that we announced last November of '18 of 7%. We do expect to realize year-over-year price appreciation in 2019 primarily for products containing abaca fiber. The weakness in wallcover and metallized combined with abating wood pulp prices will most likely result in overall selling price appreciation for Composite Fibers to come in below the previous expectations. And as you might be able to appreciate, price realization levels will vary by segment, geography and customer group. Now as it pertains to Q2, Sam, you have any comments on...

Yes, I will just say we didn't experience the price increase that we expected to going into the quarter.

Smaller amount.

Right.

Got it. And then I guess, in terms of the market downtime you called out in that segment. I was wondering if that's focused on any specific end market?

It's broad-based. Similar to last quarter.

And your next question is from Steve Chercover from Davidson.

So my first one is on a couple around Composite Fibers. And I know you indicated that the inflation in abaca fiber is going to persist for the short term. But is there a longer-term change? I mean it's a crop. So was there a crop failure? Or do you expect the higher pricing to persist in the next year and beyond?

Yes, you're right. It is a crop, and so there is some variability from year to year, and that can be influenced by things that range from disease and weather to the mix of fibers that we get. So I would say that the pricing for abaca is at a higher level. We're not expecting it as much to increase going forward, but it's going to stay at this high level for some period of time. We have invested over the years in developing abaca crops in other regions of the world as well, and we're going to continue to work to accelerate the development of those alternative sources of fiber supply for a couple of reasons. One, it gives us business continuity. Second, it will give us the ability to maintain quality. And third, that it will help us better manage some of the input cost volatility that we do experience from time to time with this particular niche fiber.

Okay. And with respect to the new metallized volume. Once that's ramped up, would that be sufficient to offset the business that was lost last year?

Yes.

More than offset or...

It's about a push.

Okay, and any start-up expenses associated with qualification of the ramp?

No. It's just a bit of a delay. There's some internal distractions at the customer that have just caused the qualification process to become a little bit more protracted than the time line that they originally laid out for us. But in terms of the products themselves, the high level of confidence we know how to make them and we expect this qualification process to finalize this quarter and get to our full run rate in Q4.

Okay. One more on Composite. So not to beat a dead horse but obviously, the wallcover has just been an ongoing source of frustration. I mean is there any -- it seems like it's political issues that are way beyond our Western sphere of influence. Do you think that's ever going to change or is this what we should expect forever in Russia and Ukraine?

Yes. So the macro issues are outside of our span of control. You're correct. So it has to do more with the geopolitical backdrop, trade tensions, commodity pricing and how that affects currencies and the economic environment in Russia-Ukraine. Forever is a long time and these things can change. However, I don't have a crystal ball. So we're focused on really strong blocking and tackling, aggressive management of our costs and operational excellence then also working to develop another product line for us to manufacture at our Dresden, Germany facility which makes wallcover. And I think the combination of those activities are the best recipe to manage on the near term. And then we will see how things play out over the intermediate to longer term and base our decisions, as we do with all parts of our portfolio, on the outlook and the fit.

Okay. One then on Airlaid. Can you just give us or quantify your operating rates both in North America and in Europe?

Sure. I would say that in North America, our operating rates are in the mid to high 80s for Q2. And in Europe, our operating rates were in the low 90s. So if you just look at a bit of a blended average for the entire Airlaid business, we were around 90-ish.

So is that what you'd call a sweet spot or in the next three to five years, are you going to need capacity on either side of the Atlantic?

Yes. Basically, our current assessment of market demand and support for this particular technology and the plans we have for continuous improvement and establishing centers of excellence, we believe that we have 2 to 3 years of capacity with our existing platform before we would need to contemplate adding a capacity. And that's always subject to changes in market performance. But I would say that we've got another good two to three years of optimizing the portfolio of assets and make the assets sweat a little harder and increase the overall profit profile for that particular part of the business.

Yes, Steven, including the opportunity to improve the mix over time as the mills become more full, which can drive growth in the bottom line.

Got it. Okay. And I did have one for you, Sam, as well, which is with respect to the interest expense, is the Q2 number something that we should be annualizing? Because I think that would -- if that was a new run rate, that would bring our interest expense down more than the $6 million that you guided to this year.

I would generally stick to the guidance that we gave in terms of the year-over-year decrease by around $6 million. But you're right, it is down and that's because of the timing of when we took out the bond in Q1. But yes, you're right, it is trending lower.

So it's probably not going to be sub-$2 million per quarter going forward until you actually pay down more debt?

Yes, I mean there's a few factors there, including what happens to interest rates. We have some floating debt there, so it depends on what happens to rates.

[Operator Instructions]. Your next question is from Mark Wilde with Bank of Montréal.

Dante, just come back to abaca for one more time. You used to be largely vertically integrated in the abaca business. I think you had a mill out in the Philippines. What does your sourcing look like today?

So we do have -- we still operate our mill in the Philippines and we remain the largest buyer of raw fiber in the industry. We've grown our business over the years. So we've gone from being vertically integrated to about 85%-or-so integrated. And so the other 15%, we do buy some market abaca pulp.

Okay. And turning to the Composite Fiber business. Once this new piece of label business runs in and if you're able to come up with some other products out of Dresden, are you still pretty comfortable at that point with the existing capacity base? Or do you need to do some more work on the, on rightsizing the business?

Clearly, the wallcover in metallized businesses have been the biggest pinch points for us. And they're also the highest basis weight products. So when they're off, it really has a material impact on the rest of the portfolio. And so if we were able to get the wallcover capacity stabilized and find a second product line for Dresden and we get this annualized piece of business for the wet-glue label at its full run rate, all else being equal, then I would feel much better about our overall Composite Fibers portfolio. Food and beverage is going to continue to grow at 3%-or-so per year on a blended average. Coffee is growing faster as you know. And we still have opportunities in composite laminates, which we intentionally kind of downsized when we rebuilt our last machine in Gernsbach to provide more capacity for technical specialties and our food and beverage business. And then, as you know, the technical specialties portfolio has doubled in terms of its size of the Composite Fibers portfolio over the last three or four years. So those are the two areas that can help us the most. I would say on a margin, the margin profile for the wallcover and metallized business isn't the same as it is for some of the other abaca-containing product lines. But nonetheless, you've got absorption issues that can be addressed by running those businesses full.

Okay. And then just to bat around there in the food and beverage, can you give us some sense of trajectory on the coffee and tea side? I mean, you said in aggregate kind of 3%. How are you seeing both of the two pieces there?

Sure. So I'd say that our expectation for single-serve coffee, the market is growing at about 6% per year. And tea has been growing at the 1% to 2% per year. I would say this year has been affected by the excessive heat waves we're seeing across Europe. I'm sure you've read about this. But we've had almost all of Western Europe hitting above 100 degrees F for extended periods of time. And only 2% of German households have air conditioning. And so even the fruit and herbal teas which are consumed in Germany, when it's that hot, people don't drink tea. And about 70% to 75% of all the Europeans live in either an urban or a suburban environment that is surrounded by concrete and pavement, and they just don't have the AC infrastructure that we have in North America. And so that's really affected short-term demand for tea products. Now we're hoping as we exit summer and get into the fall -- that is more traditionally a busier season as we ramp up for fall and winter, that we'll see some recovery. But in the short term, that's why tea had such a weak second quarter in our opinion. And then you've got the same competitors chasing fewer orders. So that doesn't necessarily help matters in the short term.

Okay. Right. Sam, I wondered if you can talk with us about your preparations exposure to the Brexit issue?

Yes, sure. So we've got two mills in the U.K. who currently ship to the U.S., and that will be not a huge impact, but where we'll be impacted is where the U.K. mills ship product to the EU, whereas today they can do that freely. But we expect, once Brexit actually occurs, looking like October 31, that there would likely be some delays and hiccups within the customs and border agencies. So we've been building a little bit of an inventory in preparation for that to make sure that the mills have what they need to produce in advance and be able to get product out the door in anticipation of delays. So you do see a little bit of inventory build going on this year so far.

Okay. And also, both the euro and the pound have weakened recently. Can you talk about the impact of that as you kind of look into the second half of the year and into 2020?

Yes. So you saw we had some FX gain this year.

Yes, I did see that.

And that relates to hedges we put in place. We generally hedge about 18 months out. Looking into the next quarter, I don't expect there to be a meaningful difference from Q2 to Q3 in terms of the FX impact based on the rates that we locked in looking back 18 months to today. So quarter-to-quarter, I wouldn't expect a big change. Might see a little bit less benefit than when we did previously.

There are no further questions at this time. I will now turn the call back to Mr. Dante Parrini.

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

And this concludes today's conference call. You may now disconnect.