Mativ Holdings, Inc. (MATV) Q1 2012 Earnings Report, Transcript and Summary

Welcome to SWM's First Quarter 2012 Earnings Conference Call. Hosting the call today from SWM is Frederic Villoutreix, Chief Executive Officer. He is joined by Jeff Cook, Executive Vice President, Chief Financial Officer and Treasurer; and Scott Humphrey, Corporate Treasury Director. Today's call is being recorded and will be available for replay beginning at noon, Eastern Daylight Time. The dial-in number is (800) 585-8367 and for international, (404) 537-3406, and pin number 72097671. [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 first quarter 2012 earnings results. Frederic will discuss the key factors impacting our business. Jeff will then provide additional detail related to our first 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, good morning, everyone. On today's call, I will share some high-level comments about our first quarter performance and cover our 2012 outlook and priorities. Jeff will then take you through a more detailed review of our financial results and guidance. Slide 4 summarizes our financial results for the quarter. Improvements in first quarter revenue and earnings primarily reflect gains in our LIP paper business driven by increases in profitable EU LIP volume, as well as LIP royalty income. It also reflects a 13% increase in RTL sales volumes compared to the first quarter of 2011. Our operational excellence programs continue to provide benefits more than offsetting inflationary cost increases and slightly higher non-manufacturing expenses. Adjusted earnings per share from continuing operations finished the quarter at $1.78, an 83% increase on the first quarter 2011, reflecting SWM's focus on growing our high-value LIP and RTL franchises, as well as the impact of our share repurchase programs. Cash generation increased substantially compared to the first quarter of last year, primarily due to higher adjusted net income and a reduction in working capital. In total, we are pleased with our first quarter performance and are poised to build on the positive momentum to achieve further top and bottom line growth in 2012. Moving to operational trends on Slide 5. Our first quarter results benefited from the full quarter of LIP sales in Europe and the recognition of $3.9 million in LIP royalty income, as well as strong RTL demand. RTL volumes are expected to remain relatively steady in the coming quarters, and we now project some moderate growth year-on-year. In Poland, we are no longer incurring the startup expenses, which we experienced in 2011 due to the EU adoption of LIP. EU LIP demand in the first quarter was somewhat affected by some temporary de-stocking at key customers. This is not unexpected considering the large inventory build that took place in 2011. Full year customer commitments remain in line with our original projections and should translate into stronger activity in the second half of the year. These benefits, combined with our company-wide operational excellence programs, provided for a solid increase in operating profit versus the first quarter of 2011. We continue to drive improved operational performance through our Lean Six Sigma initiatives, which is demonstrated by our first quarter overall manufacturing cost performance. We did experience a negative impact on inflationary cost increases and currency volatility versus the first quarter of 2011, despite pulp and energy costs providing a net favorable year-over-year comparison. Non-manufacturing costs were marginally higher during the quarter, primarily due to higher selling costs driven by higher level of sales. Turning to Slide 6. We have made further significant progress on several of our key growth initiatives. We continue to estimate our share of the European market to be approximately 40% and reiterate our expectation of LIP licensing revenues exceeding $12 million in 2012. Activity continues to increase related to our greenfield RTL facility in Yunnan province, China called CTS. Construction is ongoing, and we continued funding our equity share in the first quarter of 2012 with a $4.5 million contribution. We expect CTS to begin commercial operations in early 2014. Slide 7 summarizes our key business drivers for 2012. Our objectives and priorities remain clear, and we continue to focus on extracting growth and value from our product portfolio. 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 a fourth consecutive year of record earnings in 2012, fueled by a full year of EU LIP regulation and moderate growth in RTL. Looking beyond 2012, we see potential for further growth of our higher value products for 2 compelling reasons: first, with LIP regulation advancing to new markets; and second, as a result of increased demand of reconstituted tobacco leaves as tar delivery limits are implemented in China. I will now turn the call over to Jeff to discuss our financial results in more detail.

Thank you, Frederic. Moving to Slide 9, net sales adjusted for constant currency increased a strong 14.2% for the quarter on higher LIP and RTL volume. $21.7 million of the increase in sales was due to improved volume and mix and $3.9 million of it was due to royalty revenue. Turning to Slide 10, volume trends, changes in unit volume reflect general trends within the industry. LIP growth of 47% during the quarter from EU LIP implementation and resulting SWM share gain was partially offset by cannibalization of conventional cigarette paper requirements. However, we are pleased with an overall tobacco paper sales volume increase in the first quarter of 2012, up 2%. This is the first year-over-year quarterly increase in tobacco paper sales volume in the past 6 quarters, primarily from share gains in EU since the LIP adoption. Reconstituted tobacco sales volume increased 13% during the first quarter, compared to the prior year, and we now expect moderate growth in RTL sales for the total year 2012. Slide 11, operating profit comparisons. First quarter operating profit, adjusted for $18.7 million of restructuring and impairment charges, increased $15.7 million or 57% from the first quarter of 2011 due to an $11.9 million benefit of higher sales volume and favorable product mix combined with $3.9 million in royalty income. Lower wood pulp prices and other cost of sales offset higher non-manufacturing expenses, inflation and currency translation effects. The $18.7 million in first quarter 2012 restructuring and impairment expense included a $16.9 million non-cash impairment charge in North American property, plant and equipment. North American NBSK wood pulp prices averaged $870 per metric ton for the first quarter, down from $970 per metric ton during the first quarter of 2011 and down 5.2% versus the fourth quarter of 2011. However, pulp prices are projected to increase slowly beginning in the second quarter. Our adjusted operating margin for the first quarter rose to 21.3%, up 610 basis points from the first quarter of 2011. Foreign currency translation impacts were net unfavorable to operating profit by $0.9 million during the first quarter, due mainly to impacts from the euro in relation to the U.S. dollar. In Slide 12, this shows the strength of SWM's first quarter adjusted operating profit by business segment. Both the Paper and RTL segments, as well as SWM in total, improved significantly on a year-over-year basis. Further year-over-year increases in SWM adjusted operating profit are expected in 2012 as we realize the first full year of EU LIP regulation. Our first quarter 2012 adjusted earnings per share as shown on Slide 13, was the second-highest quarter in SWM history at $1.78 per share behind only Q4 of 2011. However, if you adjust to fourth quarter 2011 EPS to exclude those portions of the Delfor royalty income that did not relate to that quarter sales activities, our first quarter 2012 EPS is in line with the prior quarter's strong performance in spite of weaker euro currency. The impact of our 2012 share repurchase program was only $0.01 per share on first quarter results. Through April 27, 2012, we have purchased approximately 673,000 shares in the 2012 share repurchase program aggregating $45.6 million of the authorized $50 million. Moving to Slide 14. Our adjusted EBIT improved by 54% or $15.4 million from the first quarter of 2011 due to the onset of EU LIP regulation in late 2011 and strong performance in our RTL business. Adjusted EBITDA from continuing operations totaled $54.1 million for the first quarter of 2012, which is up from $36.8 million in the first quarter of 2011. Our trailing 12 months of adjusted EBITDA is now slightly in excess of $200 million. Turning to Slide 15. SWM net debt decreased by $7.3 million during the first quarter, despite a $21.6 million use of cash for share repurchases and $4.5 million for an equity injection into CTS. The decrease in net debt versus year-end 2011 reflects solid cash generation from operation, including cash provided by a decrease in working capital of $4.8 million during the quarter. Total debt was 23.4% of capital and SWM's net debt to adjusted EBITDA ratio remains low at 0.30 as of March 31. In the short run, we do not expect slightly -- we do expect slightly higher net debt at the end of the second quarter due to the level of share repurchases already completed in April and substantial equity injections for CTS planned for the next quarter. However, net debt is expected to decline in the second half of 2012 as any remaining share repurchases and other cash requirements will be more than offset by continued strong generation of cash from operation. Now moving to Slide 16. For 2012, we expect cash usage to be considerably below 2011 levels. Capital spending was $7.8 million during the first quarter of 2012, well below the $27.7 million incurred during the prior year quarter. The 2011 capital spending included $19 million toward construction of the RTL facility in the Philippines to a mothball state and $4.4 million toward the completion of the LIP printing facility in Poland. For the full year of 2012, we expect capital spending of approximately $35 million, more in line with historical maintenance levels. We expect other cash usage, including funding the China RTL joint venture of between $30 million and $40 million. Return on invested capital in 2012, as shown on Slide 17, increased to 21.1%, well above SWM's cost of capital and above prior year levels, primarily due to increased net income in 2012 compared to 2011. Return on invested capital is expected to remain strong in 2012 due to the earnings gains from EU LIP on relatively stable levels of invested capital. Slide 18 summarizes our financial guidance. Despite the negative year-over-year impacts of the euro, already experienced in the first quarter, and assuming no worsening during the remainder of 2012, we expect 2012 adjusted diluted earnings per share of $7.20. This guidance also excludes the benefit from 2012 share repurchases. Based on share repurchases through April 27, 2012, we estimate the current-year benefit from repurchases to be approximately $0.22 per share. We continue to expect to realize royalty revenue in 2012 associated with our existing LIP patent license agreement that will be greater than $12 million. The key risk to 2012 earnings continued to be volatile currency markets, as well as further legal expenses related to LIP patent actions. This concludes our remarks. Jackie, please open the line for questions.

[Operator Instructions] Your first question comes from the line of Alex Ovshey with Goldman Sachs.

Frederic, can you comment on whether you're still on track to do at least $50 million of EBIT from EU LIP? And given some of the de-stockings you saw in the first quarter, could you give us a high-level overview of how the profitability in that segment is going to be broken out throughout the course of the year? Frédéric Villoutreix: Sure, I think, certainly we maintain our projections for the full year of 2012. We've an estimated market share of 40% in Europe and a posit contribution from LIP Europe in the range of $50 million. So there's no chance to our vision -- I think what I mentioned during the prepared remarks is that what we have seen in the first quarter is some level of de-stocking. Few customers, which is to be expected considering the magnitude of the inventory build that took place in the second half of last year and the fact that now the cigarette companies are in steady-state in terms of producing LIP compliant cigarettes. Based on the discussions -- ongoing discussion with those customers to [indiscernible] survey in terms of the timing for the balance of the year, I think we should see slightly stronger activity in the second quarter. But clearly the strengthening of the LIP contributions to earnings will take place during the second half of 2012.

And is there an update on how you anticipate to protect your intellectual property in the EU around LIP? Frédéric Villoutreix: Sure, I think right now, as you know, the focus is really still in the U.S. with the ITC case which is proceeding. Just to refresh the mind of everyone here, we are in the final stage of the ITC review by the full commission. And the decision is scheduled to be rendered by the full panel on June 5. So that's really the short-term focus. In Europe, we have 2 patent positions that are outstanding. They are moving slowly. Do not expect any major breakthrough on those during the course of 2012. And again, both patents are positions are very common. As patent gets granted, there's a period of time for other parties to file remarks, which is what we have seen the last 2 years. And in terms of litigations for infringements, as we have said in the previous calls, I mean right now with the license agreements already in place in our direct share of the European business, we are above 80% coverage of the market demand, and it could be more as the situation settles after the focus on getting ready for compliance in the late fourth quarter of 2011. And obviously, we are monitoring the market. We are monitoring the designs of our competitive products. And we'll initiate actions if warranted. But do not expect anything in the very short term. As Jeff mentioned in his last comments, we -- as part of a risk factor or at least other points for consideration, the amount of legal expenses that we expect to incur in 2012 is not totally known. And I think the major unknown is whether we will initiate a patent infringement action in Europe this year or not. So it's too early to call for that and -- but clearly it’s something that is on our radar screen.

Okay. I have 2 quick questions and then I'll turn it over. In the press release, you talked about restructuring the contract with PM USA in North America. Can you give us a sense of how we should be thinking about the potential financial impact on the company? I would think that, that allow you for an opportunity to further streamline the North American asset base over the next 12 to 18 months? Can you just provide some color there? Frédéric Villoutreix: Yes, I would say other than the noncash as impairment transactions that we reported in our first quarter earnings, I would say you should expect no material impacts to our earnings in 2012 or in the years to come. As we mentioned, the amendment, I think, the key dimension here is to remove a contractual commitment to stand ready to produce commercial quantities of banded cigarette paper during the contract's final phase-out period. So you're looking at 2016 and beyond. And obviously for us, it means that there's no change in the volume requirements for PM USA for the banded cigarette paper. There's no change to the expected term of the agreement, but certainly it eliminates requirements to maintain underutilized capacity potentially to make banded cigarette paper during this phase-out period, so it's obviously a positive, but nothing that will impact earnings in '12 or in the coming years.

Okay. Last question, given the meaningful spread between your return on invested capital and your cost of debt and the low leverage that you currently have, what would be the appetite from your point of view to take on some leverage for incremental share buyback throughout the course of this year?

Well, as you know, the $50 million that's been authorized by the board that we're getting pretty much close to wrapping that up, we continue to look at that opportunity but -- and we take it in light with all our other opportunities for where we may want to invest cash and what might be the opportunities. We always remain opportunistic if we feel that it's a good time to take some additional repurchases. But at this point, we have the $50 million, and that's what we're targeting to complete.

Your next question comes from the line of Bill Chappell with SunTrust.

Just a couple of quick things. One, did you quantify or can you quantify what the LIP de-stock, what that impact was on the quarter? Frédéric Villoutreix: No, we have not quantified it. It's not a major de-stocking. I mean obviously -- for me, the message here is our quarter could have been stronger without the de-stocking, which mainly goes back to us reaffirming or tightening our guidance for 2012, including, this time, the current rates for foreign currencies. I think it's part of the lumpiness but to be expected after a major event involving a massive inventory builds. And for me, this is more to signal to our investors that we should expect stronger contributions from our Paper segments and -- throughout the balance of the year.

And I know this isn't exactly the way you look at your business, but doing the real simple math, if I take $1.78 x 4 gets me to $7.12, which is a little below the $7.20, and we're excluding the share purchase. What's the upside? What are the other things that you see over the next few quarters with pulp kind of being a little more adverse with that probably being offset by RTL? What gets me to that $7.20 or higher as I look through the year? Frédéric Villoutreix: The topic we just discussed will be #1 on the list, which is we will see stronger contributions from our Paper segments in the next 3 quarters. And so that's #1. We continue also to make good progress with cost improvements, initiatives, our Lean Six Sigma programs, so I remain confident we had a good performance in the first quarter, but I remain confident that we can do better and more. And I would say then it's a matter of mitigating the effect of the possible -- or at least we see some increases in pulp pricing obviously -- especially on the hardwood pulp at the moment. But you also have to take into consideration during the winter months, energy cost expense will be higher than the following quarters. So all in all I would say, in terms of our confidence to achieve $7.20 full year is really driven by the timing if you want the recognition of the full earning potential in LIP in Europe, which will shift it somewhat towards the second half of the year and continuing solid execution of our plans.

And just to clarify on the guidance. I think before you had said based on constant currency rates now, it looks like you're looking at current spot rates, is that fair? Frédéric Villoutreix: Yes, I think it is. Last year -- early February, I mean the euro to dollar relationship in ‘11 was at $1.40 average, and then suddenly dipped in December, got to a very low level at some point in January. And so there was a lot of uncertainty, which to some degree I think is still a lot of uncertainty. But the bottom line now, we are in early May. We have experienced 4 months of 2012. The euro dollar relationship averaged $1.32 for that period of time. And now we are restating our guidance to reflect current foreign exchange rates.

Okay, and then just on the cash flow. I guess I was under the impression at some point there'd be some kind of cash coming back from the Philippines project. And can you talk a little bit about use of cash over the next year, be it dividend, be it share repurchase? Be it also kind of how much of your cash is locked in terms of not being in the U.S. and how you could use that since you can't bring it all back?

I mean from the standpoint of what we're looking at in terms of the timing, I mean fortunately we do get some good generation out of the U.S. as well, which is helping us fund some of these activities. We are looking at ways to leverage some of the cash that is sitting outside the U.S. in those plants, but -- and then on the issue of the Philippines, we're not quite sure what will be the timing of that cash coming in right now. So it's kind of an overall balancing of the various sources and uses here to get the best end result.

Okay. But you do feel like you have good cash flow that you could address the dividend share repurchase just with what you're generating next year?

Yes, absolutely. Absolutely. As I said in my remarks, the second quarter will see a bit of uptick because of the amount of buying that was done in April. But in second half, the strong generation will be able to pay that down.

Great. And then last question on the Philip Morris USA agreement, just -- does that change the economics? I don't believe it's been the most profitable venture over the past few years. And I mean are you -- does it change working out of that Spotswood facility, any other changes that come out of that?

No. Frédéric Villoutreix: No. Again as I said, you have to think more in terms of some adjustments to make it more practical, cost-effective for both bodies in order to deal with the future years of the operations in Spotswood, but really no substantial change to the economics or the contract itself.

Your next question comes from the line of Ann Gurkin with Davenport.

I wanted to start with the slight change in the outlook for RTL volume. Is that driven by inventory rebuild by customers or increased orders? Or can you help me understand that? Frédéric Villoutreix: Well, I think it's combination of probably all of that. I think as we discussed over the last year plus, we have been expecting a tightening in the demand/supply relationship on leaf tobacco, which will give us opportunities to grow our RTL business. We also say that we were aggressively pursuing new ventures or new business opportunities in Asia ahead of the startup of the Chinese joint venture. And also to build the foundation for the RTL Philippine investments in terms of building demand in Southeast Asia. And obviously, we are making good progress on that. Last year was -- we finished the year better than the outlook we issued in February 2011. Our guidance or projection in February was to have a flattish volume environment for '12. I think the first quarter result showed that in fact we are off to a good start, and we have secured commitments from customers to, in fact, see what I would qualify as low to mid-single-digit growth in 2012, which is a little bit better than what I shared with you 3 months ago, which our target was to enter 2013 with some growth. And now we're seeing that as early as the first quarter of '12. And obviously, this is part of the rebalancing of demand and supply that continues to take place, projections all that, the leaf tobacco pricing should start to inflate, maybe later this year or more likely in 2013. And for us, it is continuing to make progress with key customers and new customers and they will bring additional demand of RTL.

Do you now look for it to grow low to mid-single digits for this year in volume? Frédéric Villoutreix: That's the projection I gave you. Now if we can do better, we will. But it’s only -- it's not just one flash in pan thing. It's really to build the ongoing demand stream, so that we continue to grow. And obviously, we have the China investment that will come along in 1.5 year's time, transfer activity from our French mill to the Chinese joint venture then. And so we know that we have capacity available -- we'll have capacity available in the coming 2 years to continue to fuel growth. And that growth is what we want to establish in order to reinitiate the project in the Philippines in the second step.

Are you maintaining margin on that higher growth rate? Frédéric Villoutreix: Yes, I think if you look at the return on sales for the first quarter, 42% is kind of above the historical range. I think we have to be careful. You can't extrapolate from just one quarter. But I mean definitively we have seen solid demand in the first quarter and great execution on the RTL business team in terms of cost containment and efficiencies.

That's great, okay. And then in terms of your outlook for the year for global cigarette volume excluding the U.S., what are you using in your forecast? Frédéric Villoutreix: So global cigarettes excluding U.S. -- I mean, I think right now, we're using a number that is between 0.5% to 1% driven -- continued to be driven essentially by China. I think we -- for Europe, the attrition rate is back to a more normalized 2.5%, 3%. And what is interesting is we see, like our customers growth opportunities volume wise in Eastern Europe, Africa, Middle East and Southeast Asia. So it's -- I would say it's still an area to scrutinize because there's a lot of activities in terms of both excise tax increase -- potential increases and the fight against counterfeiting, which obviously is affecting some of the addressable market volumes for us. But with the shift of focus to Asia and the market share gains that we secured in Europe -- in Western Europe with the LIP adoption, I think we are optimistic that we can continue -- we can see some growth in volume in our Paper segment for the balance of 2012.

Okay. And then, Frederic, you talked about anticipated continued growth for LIP as countries -- additional countries adopt or require the use of that LIP product. Are there any changes to the timeline for any of those countries coming on? Frédéric Villoutreix: No, I think these 2 markets that are adopting this year LIP, South Africa and Switzerland are the only built-in plans for sometime already. I think the key, as I mentioned to you and others in previous discussions, there is an important meeting under the other side of the World Health Organization that will take place in Korea in November of this year. And 5 working groups, one of them is dedicated to establishing an LIP standout for the world. And this could be a trigger for countries, governments announcing their intention to adopt LIP regulation. So for me this is kind of the next important milestone. Obviously we monitor the activity, and there are some activities in a few countries around the world. But maybe we’re going to have a better view of who's next, and the timing of those future adoptions around the 4 quarters of this year.

Right. And then for the year, have you changed what you're assuming for legal expenses? Frédéric Villoutreix: At this stage, we've not. And I -- as we addressed earlier, I think it's -- the guidance is built under the assumption that any active litigation overseas is taken care of. So there's no risk there. The question is whether or we initiate new litigations or we have competitors initiating the litigations against us, which likely would be in Europe and again as I say the 2 products before. I think it's related to whether or not we feel that the timing is right for us to undertake an infringement -- not an infringement action in Europe this year I’ll know.

Great. And what tax rate shall we use for the year?

I would say they remain very low 30s. You saw where it's just over 32% here in adjusted basis this quarter. So very, very low 30s is a fair number.

[Operator Instructions] Your next question comes from the line of Steve Schurr with Brahman Capital.

Two quick questions. In your 10-Q, you mentioned the $16.9 million impairment charge on the carrying value of the mill. Could you explain what drove that decision? And is that due to expecting less volume at the mill under the Philip Morris contract? Or is that for some other reason?

No, no, it's not really. It's more reflective of greater clarity that came out of the amendments in terms of after the expiration in terms of what our requirements are for keeping certain production capability on hand and certain back-up production capability. So it was more of that reflection. But really just a clarification of how that's all going to work out. But certainly over the next several years, we see no change there at all. That relationship has continued along with very good volume.

That's very helpful. And just one other quick question. Forgive me if you addressed this in your earlier remarks. But can you just reconcile the Slide 10 with the unit volumes versus what you put in the 10-K about -- you say, unit sales volumes decreased by 2% for the quarter? And then in the slide presentation, the sales were up. I think I'm just missing something there. Could you explain to me the difference? Frédéric Villoutreix: The slide in the earnings presentation include volume of our nonconsolidated joint venture in China CTM. This is the key -- compared to previous period's quarter, first quarter 2011.

At this time, we have no further question. Frédéric Villoutreix: Well, Jackie, thank you. Thank you, everyone, for your participation, and we look forward to meeting you and talking to you, answering your questions in the days, weeks to come. Have a great day. Bye-bye.

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