Mativ Holdings, Inc. (MATV) Q2 2012 Earnings Report, Transcript and Summary

Welcome to SWM's Second Quarter 2012 Earnings Conference Call. Hosting the call today from SWM is Frédéric 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 enter PIN number 99972652. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Humphrey. Sir, you may begin.

Thank you, Lori. Good morning. I am Scott Humphrey, Corporate Treasury Director at SWM. Thank you for joining us to discuss SWM's second quarter 2012 earnings results. On today's call, Frédéric will share some high-level comments about our second quarter performance and priority. Jeff will then take you through a more detailed review of our financial results and guidance. 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 Frédéric. Frédéric Villoutreix: Thank you, Scott, and good morning, everyone. Late yesterday, we released our second quarter earnings and I will talk about that in the next several slides. But we also announced a 2-for-1 stock split, the first time in SWM history. This split shows our confidence in the company's long-term strength and it also demonstrates our commitment to increasing shareholder value. Specifically, the stock split has several benefits. For instance, we expect an improvement in market liquidity and our shares should become more accessible, both of which should position SWM as a more attractive investment to a larger shareholder base. Current shareholders will benefit directly, thanks to the doubling of our dividend yield, which is made possible by maintaining the $0.15 per share quarterly dividend in combination with the split. Now, I will comment on our second quarter results as summarized on Slide 4. Improvements in second quarter earnings versus 2011 primarily reflect gains in our LIP paper business, driven by increases in profitable EU LIP volume as well as LIP royalty income. RTL sales volumes were down 2% compared to a strong quarter of 2011 as well as timing of customer shipments, but increased 5% year-to-date compared to the first 6 months of 2011. Our operational excellence programs continue to deliver solid benefits, more than offsetting inflationary cost increases and slightly higher nonmanufacturing expenses. Adjusted earnings per share from continuing operations finished the quarter at $1.64, a 36% increase over second quarter 2011, reflecting SWM's focus on growing on higher-value LIP and RTL franchises as well as the impact of our share repurchase programs. Last, our cash generation was strong compared to the second quarter last year on stronger earnings and less use of working capital. Moving to operational trends on Slide 5. Our second quarter results benefited from a full quarter of LIP sales in Europe and the recognition of $3.2 million in LIP royalty income as well as continued strong RTL demand. EU LIP demand in the second quarter was better sequentially versus the first quarter of 2012 as inventory levels of customers have become more balanced. In fact, customer shipments picked up in June and we entered the third quarter with solid momentum. We expect EU LIP volumes to increase strongly in the second half of 2012 in line with our original expectations for full year customer commitment and a direct share of the European market to be approximately 40%. We also reiterate our expectation of LIP licensing revenues exceeding $12 million in 2012. We continue to drive improved operational performance through our Lean Six Sigma initiatives, which more than offset negative impact on inflationary cost increases. On the downside, paper segment volumes declined 9% versus second quarter 2011 due to reduction in Western world tobacco consumption, timing of customer orders and elimination of unprofitable business in selected areas. We addressed these volume declines via temporary machine shutdowns during the quarter, which negatively impacted order rate absorption rates. Current demand forecast leads to better overall capacity utilization in the second half of this year. And as always, we continue to closely monitor the balance of demand and supply and will take appropriation -- appropriate actions as needed. Last, we did experience negative currency volatility versus second quarter 2011. The weakening of the euro against the U.S. dollar affected earnings unfavorably in the quarter. Slide 6 summarizes our key business drivers of 2012. Our objectives and priorities remain clear, and we continue to focus on extracting growth and value from our higher value 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 an expected 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 regulations expected to advance to new markets; and second, as a result of projected increased demand of reconstituted tobacco leaf as [indiscernible] are implemented in China. I will now turn the call over to Jeff to discuss our financial results in more detail.

Thank you, Frédéric. Moving to Slide 8. Net sales adjusted for constant currency increased at strong 8.1% for the quarter on higher LIP volume. $13.4 million of the increase in sales was due to growth in our LIP business and $3.2 million of it was due to royalty income. Currency translation provided an unfavorable variance of $24 million, due primarily to a weakening of the euro versus the U.S. dollar. Turning to Slide 9, volume trends. Changes in unit volume reflect general trends within the industry and timing of customer orders. On the positive side, growth continued in LIP during the quarter from EU LIP implementation and resulting SWM share gain rising 16% over the prior year quarter. We expect strong growth in the second half as customers increase their order levels to meet full year commitments. Reconstituted tobacco sales volume, although down 2% compared to the prior year due to timing of customer orders, were up 5% for the first half. We still expect moderate growth in RTL sales for the total year 2012. Overall paper segment volume declined 10%, including volumes from CTM, our joint venture in China, versus the second quarter of 2011. This was due to reduction in Western world tobacco consumption, timing of customer orders and elimination of unprofitable business in selected areas. Volumes at CTM, our Chinese joint venture, are off to a slower-than-expected start in 2012. However, customers remain committed to their annual forecasted volumes and we should see an improvement during the second half. Year-to-date operating profit, adjusted for $5.3 million of restructuring and impairment charges, increased $24.2 million or 41% from the first half of 2011 due to a $22.6 million benefit of favorable product mix combined with $7.1 million in royalty income. Lower wood pulp prices and other cost of sale offset higher nonmanufacturing expenses, inflation and currency translation effects. North American wood pulp list prices averaged $900 per metric ton for the second quarter, down from $1,025 per metric ton during the second quarter 2011, but up 3.4% versus the first quarter of 2012. However, pulp prices are now projected to decrease slowly, beginning in the third quarter. Our adjusted operating margin for the first half rose to 20.9%, up 550 basis points from the first 6 months of 2011. Foreign currency translation impacts were net unfavorable to operating profit by $8 million during the first half of 2012, due mainly to impacts from the euro in relation to the U.S. dollar. Slide 11 shows the strength of SWM's second quarter adjusted operating profit by business segment. The RTL segment declined slightly compared to the second quarter of 2011 due to sales volumes and currency translation. However, RTL remains ahead of 2011 for the first 6 months of 2012, thanks to higher volumes. The paper segment, as well as SWM in total, improved significantly on a year-over-year basis, thanks to EU LIP implementation and LIP royalty income. Our second quarter 2012 adjusted earnings per share, as shown on Slide 12, increased 36% over the second quarter of 2011, but was down $0.14 sequentially versus the first quarter of 2012. The combination of currency translation and some machine downtime due to a lower level of orders contributed to the sequential decline in EPS. Our paper joint venture in China, CTM, has experienced a negative variance in earnings versus 2011 due to both the timing of orders and gains booked in 2011 on the revaluation of U.S. dollar loans, thanks to renminbi appreciation in the prior year. The impact of our 2012 share repurchase program was $0.05 per share on second quarter's reported adjusted earnings per share. Through July 27, 2012, we have purchased approximately 677,000 shares in the 2012 share repurchase program, aggregating $45.9 million of the authorized $50 million. Although this slide does not include restructuring and impairment expense, we did incur $5.3 million in this area during the quarter. A portion of these costs were contract breakage fees in support of our ongoing cost savings programs. The remainder were noncash impairment charges related to the transfer of certain equipment from RTL Philippines to our Chinese RTL joint venture, CTS. Moving to Slide 13. Our adjusted earnings before interest and taxes improved by 22% or $7.4 million from the second quarter of 2011 due to the onset of EU LIP regulation in late 2011. Adjusted EBITDA from continuing operations totaled $15.5 million for the second quarter of 2012, which is up from $41.6 million in the second quarter of 2011. Our trailing 12 months of adjusted EBITDA is now $215 million. Turning to Slide 14. SWM net debt increased by $23.2 million during the second quarter. The additional debt was used to cover a portion of the share repurchases and $16.4 Million for equity injections into CTS, our Chinese RTL joint venture. The remainder was provided by cash from operations. Activity continues to increase, related to CTS. Construction is ongoing, and we expect to begin commercial operations in 2014. The $16.1 million increase in net debt year-to-date reflects the return of cash to shareholders and equity investments into CTS, offset partially by solid cash generation from operations. Total debt was 27.8% of capital and SWM's net debt-to-adjusted EBITDA ratio remains low at 0.40 as of June 30. Net debt is expected to decline in the second half of 2012 as any remaining share repurchases and other cash requirement will be more than offset by continuous strong generation of cash from operations. Now moving to Slide 15. For 2012, we expect cash usages to be considerably below 2011 levels. Capital spending was $14 million during the first half of 2012, well below the $42.1 million incurred during the first 6 months of 2011. The 2011 capital spending included $29 million toward construction of the RTL facility in the Philippines to a mothball state and $4.5 million towards completion of the LIP printing facility in Poland. For the full year of 2012, we expect capital spending of approximately $30 million, more in line with historical maintenance levels. We expect other cash usages, including funding the China RTL joint venture and the increased dividend payout of between $35 million and $45 million for the year. Our return on invested capital in 2012, as shown on Slide 16, increased to 22.2%, well above SWM's cost of capital and above prior year levels, primarily due to increased net income in 2012 compared to 2011. Our 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 17 summarizes our financial guidance. Due to the negative impact of the euro on our translation of earnings, we are lowering our 2012 adjusted diluted earnings per share guidance from $7.20 to $7.05. Our revised guidance assumes currency rates equivalent to what we experienced in the second quarter. This guidance also excludes the benefit from 2012 share repurchases. Based on share repurchases through July 27, 2012, we estimate the current full year benefit from repurchases to be approximately $0.22 per share. The key risk to 2012 earnings continues to be volatile currency markets. If currency rates stay at the levels seen during July, SWM will encounter an additional headwind of $0.12 to $0.15 in earnings per share from currency. That concludes our remarks. Lori, please open the line for questions.

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

Just want to get -- as you look out past the next couple of quarters into 2013, kind of an outlook for both RTL and then any update on kind of what you're hearing on LIP into new countries or are we still a quarter or 2 away from that? Frédéric Villoutreix: Okay, so let me focus first on the remainder of the year. So in terms of RTL, we continue to expect very good volume, capacity utilization and as such, strong earnings from the RTL business segment in line with what we have seen year-to-date. And the key for us is to post some incremental growth as we get into 2013 to rebound after a period of '10, '11 being more flattish in terms of volume. And I mean, so far, we have seen that strengthening of the activity and then obviously the major milestone for 2014 will be the start-up of our joint venture in China with expected strong growth from this market in the years '14, '15, 16. For LIP, we are forecasting a very strong second half of 2012, based on customer contractual commitments have been renewed and the momentum that we see as we enter the third quarter. For 2013 and out, in terms of -- the growth will have to come from new territories, new countries adopting LIP regulation. And at this stage, while there are activities at government levels or at the World Health Organization level with a working group dedicated to establishing a global standard for LIP regulation, they have no firm schedule established yet or communicated yet. However, there is some pre-planning work taking place jointly with some of our key customers that lead us to believe that if not in '13, in '14 we should see the addition of new markets that will continue the growth path that we have seen for LIP over the last several years.

I understand, and thanks for the color on that. But going back to the RTL front, is there enough activity or if you're looking kind of virgin leaf prices over the next couple of years to actually restart or relook at the Philippines project or is that still probably a ways off? And then on the LIP front, had there been any countries, in addition, that are going this year or even next year that are not as meaningful but just other ones that are moving? Frédéric Villoutreix: So on the RTL side, I think the strength of our volumes this year speaks for the focus that we have on developing new business with an eye on Asia, excluding China. And as such, I think we remain confident that we will restart the RTL Philippines in time. Now with this being said, our priority in terms of capacity addition is the Chinese markets. And it is unlikely that we'll restart our investment in Southeast Asia prior to having established a solid position in China or at least a site to commercially sell products out of our Chinese joint venture. For LIP, I mean, the 2 markets that have adopted LIP regulation this year; one is Switzerland, which is already in effect; the other one is South Africa, which will come the latter part of this year where we intend to build node [ph] in South Africa, so there's clearly going to be a carryover effect into 2013. But both markets are relatively small in size. And again, I think there is an important event later this year in November. The World Health Organization has a seminar with the working commissions reporting on progress in November, in Korea. And that's probably where we could see more clarity as to the schedule for further adoption of LIP regulation.

Okay. And then just last one. Jeff, can you maybe just help me on the tax front? Was the higher tax rate this quarter always in your original guidance? And shouldn't we expect, especially as Polish operations going to kick in, tax rate continue to kind of drift lower and lower?

Yes, the higher effective tax rate you saw this quarter was driven by some of the restructuring actions, the impairment on the RTL P equipment being transferred. We didn't take a tax credit on that so that boosted up our effective rate on our overall GAAP earnings per share. And then, we did have a small additional valuation allowance on the Philippines operations. So that's why you saw that numbers remain high. But the outlooks we're giving you are excluding those restructuring and impairment activities and also the tax valuation allowances. I would expect -- for the total year, I would expect to see our effective tax rate probably around 35% or so at the total year, which includes the impact of what we've already seen in the first half. But, again, the things that swing that are some of these unusual impairment entries.

So as I move to 2013, getting back down to 30% is more realistic?

Yes, getting down to low 30s is more realistic, yes. And you're right with Poland starting to be more profitable on a lower tax rate, that will help us, yes.

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

I wanted to start with -- to follow on some comments you're talking about -- talked about LIP. Is that still on the agenda for the WHO meeting in November? Any changes in that? Frédéric Villoutreix: No, there's no changes on the agenda.

Okay, great. And then RTL demand looked softer in Q2, is that a timing effect or was there a change in order patterns, I mean, in any of your customer emerged for RTL for the year? Frédéric Villoutreix: I think it's pure timing. As fact, the lumpiness of the RTL business and the fact one quarter to another you will see, in terms of the timing of closing and production orders, some small swings. But really, the demand against our factories remain steady and relatively strong.

And then -- I guess, this is asked a lot, any price erosion for the LIP business as you look to the back half of '13 -- I'm sorry, '12 and as you go into '13? Frédéric Villoutreix: No, I think as we said before, I mean, we secured fixed pricing agreements with the LIP contracts in Europe with multi-year supply agreements. There is always, outside of Europe, some contract negotiations taking place, but nothing of substance.

Okay. And then you still generated a good amount of cash flow this year. Jeff, can you comment at all on other potential uses for the cash flow?

No, we're looking forward to second half to good generation and now with the stock buyback, very little left in the $50 million. So I think we'll see good generation in the second half.

Any chance of additional buyback?

We haven't even finished the current one yet. So got to get through that and then look at the overall picture again.

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

A couple of questions. On FX, I was surprised by the magnitude of the impact on the EBIT line. In the past, you've also talked about the impact from changes in the Brazilian currency and you didn't really call that out in the second quarter. So maybe you can just talk to us about any rule of thumbs we should thinking about, about sensitivity to the euro [ph] in Brazil?

In the real, I mean, we have hedging contracts in place going out several years there. So you won't see terrific variations, plus or minus, as the real changes and goes in different directions. So the impact there of any change is muted because a large portion of that is hedged.

Got it. So on a go-forward basis, the FX exposure is largely to the euro?

Yes, that's the primary one for us.

And is it largely translational? is there any transactional exposure?

No, it's mostly translational of the earnings. I mean, we do some hedging activities on certain transaction activities and balance sheet things. But it's mostly upon the translation of earnings.

Got it. Helpful, Jeff. And then any update on litigation in the U.S. post the ITC stuff wrapping up and any change in the competitive landscape in the U.S. now? Saw it in the Q, there was a commentary on Europe around [indiscernible] , I think, challenging some of the patents that you've been granted. If you have any incremental color you'd like to add there, that'd be helpful as well. Frédéric Villoutreix: So Alex, I think on the U.S. front, there's really have been no new developments on the litigation side post the ITC ruling. And on the market's coverage, I think looking at our direct sales, they remain well oriented, strong. Looking at revenue from the license agreements in place, I think we continue to see extremely good coverage of the -- and extraction of value from this segment. In Europe, we have a handful of patent positions that were filed right after our patents, LIG patents got granted over the last few years. We keep seeing new patents granted for us, which strengthen our present portfolio in this strategically important region. And we do expect that those patents get granted to see some position activities. However, there's a position that really not progressed much. That's still in the, let's say, brief paper exchanges mode and so we've nothing of substance to comment at this stage.

Your next question is a follow-up from Ann Gurkin of Davenport.

Just wondered if you can comment on what you've included for volume estimates for the U.S. globally and China now for 2012? Frédéric Villoutreix: So the volume estimates in terms of the growth? Yes, I think, in the U.S., our view it's in line with what is being reported by the major players. So right now, we're talking about, let's say, a 3% attrition rate, which is somewhat slower -- lower level than prior years. The growth in China, at least the first half, was somewhat of a flattish profile, which is quite unusual. I think some of that is the timing of some of the promotional activities and maybe some other production in the second half of 2011. The statistics, as you know, are today, showing or forecasting a growth in the 3%, 3.5% range for China for 2012. And on our side, our joint venture, CTM, as Jeff alluded to in his prepared remarks, we have seen a soft first half due to the timing of orders. However, we are entering the third quarter with strong orders and renewed commitment from customers for the full year demand. And so we continue to grow in China at a faster pace than the overall market because we are positioned there at #1 or #2 supplier on most of the major brands in China, which, through the government program of concentration of cigarette producers and brands is playing to advantage with stronger growth than the average market rate.

And then in Europe? Frédéric Villoutreix: In Europe, I think, this is kind of a mixed crowd. If I look at the rest of the world, we're talking about the U.S. China and then the rest of the world. I mean, Western Europe certainly, its attrition rate in terms of consumption decline and switch to other tobacco products have been pronounced this year than in prior years. The Eastern European market also is kind of cooling off as well and the growth is primarily coming from key markets in Asia and the Middle East, which obviously [indiscernible] everybody, all cigarette companies and ourselves are concentrating our efforts on.

So we did have numbers of down 3% or 4%. Is that still a reasonable range for the year? Frédéric Villoutreix: For Europe, yes.

For Europe. So it's still in line with what you're modeling?

At this time, there are no further questions from participants. Gentleman, are there any closing remarks? Frédéric Villoutreix: Well, thank you, Lori, and thank you for everyone attending. Again, we remain confident in the outlook for the balance of the year. The volatility of euro to the dollar lately has only added a little bit of headwind to our earnings. However, when I look at the operating plan, this plan of our strategy remains intact and with growth potential getting into 2013, '14, which, in my mind, is going to continue to carry the earnings of SWM up and we certainly are excited with the stock split and the ability to improve our dividend yield as a result of that action. So we look forward to talking to you all in the coming weeks, and wish you a good day.

Thank you for participating in today's SWM's second quarter 2012 earnings conference call. You may now disconnect.