Mativ Holdings, Inc. (MATV) Q4 2011 Earnings Report, Transcript and Summary

Welcome to SWM's Fourth Quarter 2011 Earnings Conference Call. Hosting the call today from SWM is Frederic Villoutreix, Chief Executive Officer. He is joined by Mark Spears, Interim Chief Financial Officer; and Scott Humphrey, Corporate Treasury Director. Today's call is being recorded and will be available for replay beginning at noon, Eastern Standard Time. The dial-in numbers are (800) 585-8367 or 404-537-3406. And the PIN number is 43058172. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Humphrey. Sir, you may begin.

Thank you, Jackie. Good morning. I'm Scott Humphrey, Corporate Treasury Director at SWM. Thank you for joining us to discuss SWM's fourth quarter 2011 earnings results. Frederic will provide -- will discuss the key factors impacting our business. He will then provide additional detail related to our fourth quarter results and outlook. We will then take your questions. Before we begin, I would like to remind you that the comments included in today's conference call constitute forward-looking statements. Actual results may differ materially from the results suggested by these comments for a number of reasons, which are discussed in more detail in the company's Securities and Exchange Commission filings, including our annual report on Form 10-K. Certain financial measures discussed during this call exclude restructuring expenses and valuation allowances and are therefore, non-GAAP financial measures. I will now turn the call over to Frederic. Frédéric Villoutreix: Thank you, Scott, and good morning, everyone. On today's call, I will share some high-level comments about our fourth quarter and full-year 2011 performance and cover our initial 2012 outlook and priorities. I will then take you through a more detailed review of our financial results and guidance. Slide 4 summarizes our financial results for the quarter. Improvement in fourth quarter revenue and earnings measurements finally reflect gains in our Paper business, driven by an increase in EU LIP volume and profitability, as well as LIP royalty income, which includes the settlements of past sales from Delfor as a result of the agreements announced in October. Our tier sales volumes increased sequentially during the fourth quarter and brought full-year sales volume to essentially the same level as prior year. Fourth quarter earnings also benefited from several unusual items, including approximately $6.9 million in net favorable tax benefits. Continued inflationary cost increases, higher mill operating costs, including some seasonal machine downtime and increased non-manufacturing expenses, primarily from LIP legal actions partially offset the benefit of increased LIP sales. Adjusted earnings per share from continuing operations improved to $2.66, an all-time quarterly record for SWM, reflecting improved business performance as well as a 16% effective tax rate during the fourth quarter due in part to tax incentives associated with LIP investments in Poland. Cash generation increased compared to the fourth quarter last year, primarily due to the high earnings income generation but remained below 2010 on a full-year basis. The lower cash generation during 2011 was largely due to the planned increase in working capital, primarily reflecting new working capital needs to support operations in Poland. Moving to operational trends on Slide 5. Our fourth quarter results benefited from the further ramp-up of LIP sales in Europe and the recognition of additional LIP royalty income, while RTL demand remained at a high level throughout the quarter. General macroeconomics, in terms of inflationary cost increases and currency volatility had a negative impact on our fourth quarter results but at reduced rates compared to earlier in 2011. Finally, our stock costs have now swung to a net favorable year-over-year comparison. We have also continued to drive improved operational performance from our Lean 6 Sigma initiatives, albeit fourth quarter overall manufacturing cost performance was negatively impacted by the some residual amounts of EU LIP start-up costs and some seasonal machine downtime in December. Non-manufacturing costs remained high during the quarter, primarily due to LIP-related legal actions. In total, we are very pleased with our fourth quarter and full-year performances and are poised to build on the positive momentum in our Paper business to achieve further top line and bottom line growth in 2012. Turning to Slide 6. We have made further significant progress on several of our key growth initiatives. European LIP regulation went into effect in November. We continue to estimate our share of the European market to be approximately 40% and reiterate our expectation of generating more than $50 million in incremental actual pretax earnings from the EU LIP opportunity at constant exchange rates or approximately EUR 38 million. Activity continues to increase related to our greenfield RTL facility in Yunnan province, China called CTS. Construction has commenced and we began funding our increased share in December 2011 with a $6 million contribution. Along with our existing Chinese paper joint venture, CTM has delivered earnings of $4.7 million in 2011 versus earnings of $3.2 million in 2010. We are well on our way to establishing a significant market position in premium applications in the world's largest and fastest-growing tobacco markets. We expect CTS to begin our commercial operations in early 2014. Slide 7 summarizes our key business drivers for 2012. Our objective and priorities remain clear, and we continue to focus on extracting growth and value on our LIP and RTL products, improving our global capabilities and driving operational excellence in all that we do. We are confident in our ability to execute against these objectives and deliver our fourth consecutive year of record earnings in 2012, fueled by the few years [ph] of EU LIP regulation. We are very pleased with our revenue growth and strength of earnings delivered by our China paper joint venture. CTM is now operating at near capacity and the focus is now shifting to improve its cost control and introduce new premium grades to continue to fuel the growth and further establish a leadership position on top cigarette brands. RTL volume was down less than 1% in 2011 and we project volumes to remain even in 2012 despite of a still volatile tobacco lead markets. Looking beyond 2012, we see potential further growth of our higher value products for 2 compelling reasons. First, with LIP regulation advancing to new markets, and secondly, as a result of increased demand of reconstituted tobacco leaf as start being [ph] are implemented in China. Quality Results Review and Guidance. I will now review our results for the quarter and update our financial guidance. Moving to Slide 9. Net sales increased 19% in the quarter compared to prior-year fourth quarter. Thanks to $21.3 million benefit from changes in volume price and mix and $15.6 million in royalty revenue. This was partially offset by $1.3 million in unfavorable currency impacts related to the euro. Excluding currency impacts, net sales increased a strong 20% for the quarter on higher LIP cigarette paper unit volume. The fourth quarter marked the third consecutive quarter, where we showed steady growth of the strength of the LIP EU revenues. Moving to volume trends. Although the 8 quarters presented changes in unit volume reflect general trends within the industry, LIP growth of 60% during the quarter from EU LIP implementation and resulting to share gain was offset by cannibalization of conventional cigarette paper requirements and, excluding China, decreased market needs. Only China is showing consistent volume growth among major world markets and although mitigated, total SWM tobacco paper sales declined to a small 1% for the quarter, including volume from CTM of Chinese paper joint venture. Reconstituted tobacco sales volume increased during the quarter compared to third quarter and ended even with prior-year fourth quarter. As our results, full-year reconstituted tobacco sales volume declined less than 1% compared to 2010. We are pleased with the full-year performance of this segment given the volatile conditions within the leaf tobacco sector. Moving to Slide 11. Fourth quarter adjusted operating profit increased by $26.6 million due to $16.5 million from higher sales volume, selling prices and favorable product mix combined with $15.6 million in royalty income. These positives were partially offset by higher non-manufacturing expenses, inflation and a residual amount of European LIP startup expenses. North American NBSK wood pulp prices averaged $920 per metric ton for the fourth quarter, down from $967 per metric ton during the fourth quarter of 2010 and decreased 7.3% from the third quarter of 2011. Pulp prices are expected to remain flat in the first half of 2012 before rising later in the year as we see tightening in our supply due to some pulp mills stoppages. Volume currency translation impacts were net unfavorable by $0.4 million during the fourth quarter, due to impacts on the Brazilian real and the Polish zloty in relation to the U.S. dollar. Higher volatile currency relationships worldwide likely will continue to cause a mixed impact on SWM earnings during the first quarter of 2012. Slide 12 shows the strengths of SWM's fourth quarter operating profits. Both the Paper and RTL segments, as well as SWM in total, improved on both sequential basis and year-over-year. This increase in the global paper segment is attributable to both royalty income and an increase in EU LIP volume. Several year-over-year increases in SWM operating profit are expected in 2012. Moving to Slide 13. Similar to operating profit trends, SWM's fourth quarter EPS reserves improved sequentially and year-over-year. Fourth quarter EPS included royalty payments from Delfor, corresponding to the EU ramp-up in 2011 as well as a settlement of past sales. And during the fourth quarter, we recalled deferred tax benefits of $6.9 million, approximately $0.41 per share. Adjusted EBITDA from continued operations totaled $66 million for the fourth quarter of 2011, which like operating profit and EPS, is improved due to net income generation driven by EU LIP [indiscernible] sales and royalties. SWM net debt decreased by $34 million during the fourth quarter. Increase in net debt versus year-end 2010 reflects cash uses but include $105 million in share repurchases and the $21 million planned increase in working capital requirements to support our EU LIP operations. Total debt was 23.5% capital and SWM's net debt to adjusted EBITDA ratio remains low at 0.38 as of December 31. Net debt is expected to decline in 2012 despite CapEx requirements in investment in our RTL JV in China, as a result of continued high generation of cash from operations. For 2012, we expect cash usage to be considerably below 2011 levels. With capital spending of approximately $35 million, we should be more in line with historical maintenance levels and other cash uses including funding the Chinese RTL joint venture of about $45 million. Return on invested capital in 2011 increased to 19.9%, above SWM's cost of capital and above prior-year levels, primarily due to increased net income in 2011 compared to 2010. ROI [ph] is expected to further grow in 2012 due to the earnings gains on EU LIP on stable levels of invested capital. We are initiating a full-year earnings guidance to be at least $7.20 per share, excluding restructuring and assuming constant currency. We reiterate our underlying expectations for business proponents during 2012, including February increase in earnings on European LIP sales growth. Included in the $7.20 guidance, it is our expectation to realize royalty revenue in 2012 associated with our existing LIP license agreements of at least $12 million. We continue to gather market share information for our competitors in the EU and we'll update our expected royalty income as we progress through 2012. The key risks for 2012 earnings are volatile currency markets and further legal expenses related to LIP patent actions. Given macroeconomic instability, the impact of currency is difficult to predict. So we have provided guidance on a constant currency basis. If the average exchange rate for full 2012 remain at current spot rates, currency translation would decrease expected full-year earnings per share by approximately 5%. As you may have seen yesterday, Judge Gildea granted his initial decision in the ITC actions filed by SWM in December of 2010. The initial decision found that our claims were not infringed by the German competitor, Glatz. It clearly was not the outcome we were expecting and we responded in a press release with some key statements and comments, which I will be ready to address during our Q&A session. That concludes our remarks. Jackie, please open the lines for questions.

[Operator Instructions] Your first question comes from the line of Bill Chappell with SunTrust.

You talked a little bit -- but just kind of understanding capital allocation in terms of your cash flow, I mean it seems like now for the next few years, you had almost annuity of cash coming through and hopefully, more cash than you know what to do with. Will we hear from the Board a dividend share repurchase step-up, something else near term, if you really feel like the cash has better use there than earning kind of 0.1%?

This is Scott. We do presently have a new share repurchase authorization from the Board for up to $50 million in share repurchases. Any additional share repurchases or changes to dividend levels will be determined in balance with other potential strategic cash uses. In the meantime, any excess cash generation will be used to reduce debt. Frédéric Villoutreix: And I think, Bill, it's fair to say that we will remain opportunistic as we progress throughout the year in terms of share buyback, as demonstrated with actions we took last year. And I think we also will progress on our thinking in terms of whether there is value to split the stock and modify the dividend yield.

Okay. And then in terms of cash, just make sure I understand you, shouldn't you in 2012 also be getting something from the joint venture in terms of the property that was in the Philippines that's being sold, the equipment being sold to the joint venture? Frédéric Villoutreix: Yes, this is our expectation that we will transfer equipments that are currently on our books to do the CTS joint venture and get some cash as a result. On the other hand, when we mentioned the equity injection that we require, the net-net of this should be a positive for SWM. So that will be an upside to cash flow generation.

Okay. And then just trying to understand in a good way, RTL missed your expectations in terms of -- we started this year, assuming it was going to be almost -- or started at '11, thinking it was going to be a $0.50 hit to earnings, down 10% volumes and it really outperformed. Now what gives you confidence that it remains flat in 2012 and why shouldn't actually, we see it start to pick back up as we move closer to 2013 and virtually prices seem to be picking back up as well. Frédéric Villoutreix: Yes, I think we need to refine this. Let's go back a year ago. I mean, a year ago, we got very short notice from 2 of our customers about reducing their projected purchases of RTL, which led us to making some adjustments with our business strategy for that segments and being cautious in February of 2011, as to the outlook of last year. Now we -- obviously, our business has outperformed that projection in a big way. I think it shows the resilience of our business model that in a down cycle, '11 and '12, our down cycle in terms of being balanced between demand and supply of virgin tobacco, that we are able to maintain our ground at the very high ground level because both in terms of revenue, volume and earnings, 2011 RTL segment is the best year ever for SWM. And we project to maintain it at about that level in 2012, which for me is obviously, that's stage 1. Stage 2 is, as you pointed, we need to go back on the growth mode based on a lot of actions that are ongoing and we certainly expect, we're trying now coming on board by the end of 2013, early 2014, to be a significant step-up in revenue and sales volume levels. And obviously, this doesn't happen overnight. So this is what we're working on. And we only expect to see growth in 2013 and maybe some in 2012 but it's still too early to call.

And then just one last one on Glatz. You competed with Glatz in Europe over the past year and from my understanding, all the competitors in Europe kind of assumed your patents weren't valid and they just kind of go into money market, that you still kind of come up with the share you did. Why wouldn't -- why haven't other players like Glatz taken a bigger share? I mean, if they have a cheaper better product and it was just patents, how come they haven't taken such a bigger share in Europe? Frédéric Villoutreix: Well, because the LIP technology is a lot more than patents. It's about knowing the right products that performs, that gives the technical performance that the cigarette producers need in terms of making low-cost, high efficiencies cigarettes and also the consumer acceptance factor is important. And I think you're touching on some important facts, which is right now, as we enter 2012, we reiterate our views with approximately 40% of share without excelling, which is a significant increase from the past where we had about 30% share of the EU market prior to LIP regulation coming along. And also that, with existing license agreements in place, we see right now at least another 40% of the EU market that is covered by both license agreements. So obviously, we do not have a license agreement with Glatz. Otherwise, we have announced it. And so it clearly shows that competitors like Glatz today within an industry that did not look at intellectual property as the major criteria, as far as EU is concerned, that does not get a lot of share, which to some degree, speaks for the value of our product proposition -- the value proposition of our product and also the other players covered on their license agreements.

Our next question comes from the line of Alex Ovshey with Goldman Sachs.

A couple of questions, Frederic. On the non-manufacturing expense, I'm assuming most of that was legal in the fourth quarter. It seems like there was a meaningful step-up in that legal expense relative to where it was running for the first 3 quarters. Can you just comment on that and whether you have any incremental outlook for what that legal expense could look like for you in 2012? Frédéric Villoutreix: Yes. I think you're right. Our legal expenses in the fourth quarter were in the higher level than we have seen even in the third quarter. That is in line with also the amount of activities possibly related to the IPC case that took place in the fourth quarter. The trial, the preparations for these hearings, it's very labor intensive in terms of legal services and also drafting and negotiating the global license agreement with Delfor. All of that took place in the fourth quarter. So this being said, we certainly expect this intensity of legal expenses to decrease in 2012, starting with first quarter of the year.

Fred, is that a decrease relative to the fourth quarter run rate or relative to the full-year 2011 expenses? Frédéric Villoutreix: As for the quarter, definitively to the run rate of the fourth quarter. For the full-year of 2012, the latter, which to a decrease -- projected decrease at this stage, from the total amount of legal expenses we incurred in 2011.

That's helpful. Would you be able to comment on what the implied revenue base is that the $12 million royalty figure covers in 2012? Frédéric Villoutreix: That, I will say, this is what I just mentioned. Our view is approximately 40% plus of the EU market covered by license agreements. [indiscernible] So you see the 40% becomes 50% or more, expect this number to climb.

Okay, understood. Last question. Can you comment on what the profitability in EU LIP was in the fourth quarter, relative to what you expect the full run rate to be, which is north of $50 million or about $12 million to $13 million of operating earnings per quarter? Frédéric Villoutreix: Different ways to look at it. So one, in terms of manufacturing efficiencies, we have a minimum amount of start-up expenses. We have more in the beginning of the fourth quarter. So I think, we still have opportunities to improve efficiencies. But we are kind of getting well to that into the learning curve, if you want. I think, when you look at the fourth quarter, you always have to be careful that there is a major impact of royalty income, which is much more than just one quarter. And so some adjustment needs to be made there. But I think it's fair to say that if we were to adjust the fourth quarter for a normal level of royalty income on an ongoing basis, the possibility of the paper segments will be somewhat in line with what we expect in '12 and we probably are a little bit more upside due to the deflation projected at least on wood pulp prices compared to previous year and the gains in efficiencies in manufacturing of those LIP products.

[Operator Instructions] The next question comes from the line of Ann Gurkin with Davenport.

I wonder if you could help me with what should be your tax rate for '12, given the business in Poland now and the Brazilian tax credit adjustment.

Ann, this is Mark Spears. I'll take a shot at that question. We're projecting an ongoing normalized tax rate in 2012 in the range of 30%. In fact, that takes into account that we have recorded as a deferred tax asset the credits that we'll be utilizing in Poland, 2012. So that's it. The use of those credits then is part of our expense in 2012.

Okay. And then you all, at the start of your presentation, talked about the potential for additional LIP market. Can you give me an update on how things are progressing? Any markets close to requiring the use of LIP on cigarettes? Frédéric Villoutreix: But it's still rumors and activities in various countries. We mentioned South Korea and Japan in Asia, the CIS countries, Russia, Turkey in the whole of Europe. And I think for us, there is enough activity to think that new markets will come long, whether in 2013 or 2014. But there's also an important event later of each year with the World Health Organization and the SCTC convention, which will meet and discuss the working agenda for new regulations around tobacco and LIP regulation is one of the 5 priorities of the SCTC. So I would expect we'll have greater clarity as to which countries and the timing of adoption around that meeting, which is scheduled to take place in early November of 2012.

Okay. And then in your earnings outlook for 2012, do you incorporate your share repurchase program? How should we think about that? Frédéric Villoutreix: The one last year?

The $50 million that has been approved by the board. Frédéric Villoutreix: No, we have not. Because, again, it's opportunistic and we'll [indiscernible] as we go through the year. But no, there's no -- for this $50 million authorization, none of that has been built in the $7.20 guidance.

Great. And then what are you assuming for worldwide cigarette volume in 2012 and U.S. cigarette volume? Frédéric Villoutreix: Well, I think we are assuming for U.S. market continuation of experience 2011, which was around 3.5% decrease in consumption of cigarettes. I think Europe is in the same ballpark, 3%, 3% to 4%, and probably more tax increase activities in some of the European countries to come in 2012 and worldwide, it's just going to be a small -- a slight increase and it's all coming from China. I mean, China continues to be a healthy -- show healthy growth in the [indiscernible]. And I don't see a reason for that to change.

Okay. And then plant downtime in Q4, was that in line with your targets? Frédéric Villoutreix: Can you repeat the question?

The plant downtime you took in the fourth quarter, was that in line with your expectations? Frédéric Villoutreix: Yes. It think this -- again, this is induced by actions taken by our customers [indiscernible] saying they want to maximize shipments but also optimize their working capital as we close the year. So as you know, historically, cigarette factories are taking downtime in December and I think this year was probably -- maybe slightly higher than what we are used to. This one we have seen on key customers. But all in all, I think it’s part of the seasonality of the business and it was something that we had in mind when we discussed the outlook for the year end last November.

At this time, we have no further questions. I'll turn the floor back over to management for any closing remarks. Frédéric Villoutreix: Thank you, Jackie. And thank you, everyone, for your attendance and the support and confidence you put in SWM and look forward to talking to you or meeting you in the foreseeable future. Bye-bye.

Thank you. This concludes today's conference call. You may now disconnect.