Mativ Holdings, Inc. (MATV) Q4 2012 Earnings Report, Transcript and Summary

Welcome to SWM's Fourth 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 Mark Spears, Corporate Controller. Today's call is being recorded and will be available for replay beginning at noon Eastern Standard Time. The dial-in for the replay is 1 (800) 585-8367, and enter PIN number 85655319. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Spears. Sir, you may begin.

Thank you, Lori. Good morning. I am Mark Spears, Corporate Controller at SWM. Thank you for joining us to discuss SWM's fourth quarter and full year 2012 earning results. On today's call, Frédéric will share some high-level comments about our fourth quarter performance and priorities. 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 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 and impairment expenses, significant reserve adjustments on business tax credits, income tax valuation allowance, changes in the Philippine inventory impairment charge, and are, therefore, non-GAAP financial measures. I will now turn the call over to Frédéric. Frédéric P. Villoutreix: Thank you, Mark, and good morning, everyone. Late yesterday, we released our fourth quarter earnings, and we'll discuss our results in the next several slides. We also announced long-term capital allocation strategy for SWM, and I will provide more details later in this call. In line with that strategy, our Board of Directors has authorized a 100% increase in our quarterly dividend, increasing it from $0.15 per share to $0.30 per share. They had also authorized up to $50 million of share repurchases through December 31, 2013. These actions show our continued confidence in the company's long-term strength and our commitment to progressively increasing shareholder value. Now we comment on our financial results. Overall, 2012 was a record year for operating profit and cash flow. Our performance indicates strong traction that position SWM well for continued success in 2013. As shown on Slide 4, fourth quarter sales were down year-over-year. However, this reflects unfavorable changes in foreign exchange rates and onetime royalties paid in the prior year period. Excluding these impacts, fourth quarter net sales would have exceeded the prior-year period. Full year sales performance was in line with our expectations and were driven largely by a 13% annual increase in LIP cigarette paper volumes, as EU LIP sales remained strong through the second half of the year relative to first half levels. RTL volumes also contributed with a 6% annual increase in sales volumes, which was also in line with our expectations. Adjusted earnings per share from continuing operations of $3.55 came in slightly below our expectations. However, this reflects some onetime nonrecurring expenses related to a now resolved quality issue and special consulting studies pertaining to longer-term strategic planning. Finally, cash generation in 2012 was quite robust and was a result of higher profitability, as well as a favorable net change in working capital. Strong cash flow generation also enabled a significant reduction of our net debt. Looking ahead, we remain focused on growth with strong profitable cash flow and a healthy balance sheet with reasonable leverage. We are committed to maintaining our track record of diligent capital allocation focused on the innovation, long-term growth and superior shareholder value. We will address these imperatives further on -- in this call. Moving to operational trends on Slide 5. Once again, RTL volumes increased by 6% over the prior year, as demand remained strong in the fourth quarter. We are entering 2013 with steady RTL demand while we accelerate the construction activities of our plant in China with the expectation to reignite RTL volume growth in 2014. Full year 2012 tobacco paper volumes, including CTM, our Chinese joint venture, decreased by 2% on 2011, essentially due to weak sales in the Philippines. However, LIP cigarette paper sales volumes increased 4% over the prior-year quarter and 13% over full year 2011. Strength in LIP can be attributed to EU LIP customers completing their full year commitments, resulting in an overall gain in market share year-over-year. With respect to cost optimization, we have a superb track record of eliminating cost from our business, removing approximately $25 million in cost every year. 2012 was no exception as annual cost savings and benefits from operational excellence exceeded $27 million. Operational performance and productivity improvements continue to be a key focus for us, led by our Lean Six Sigma initiatives. Our success in these efforts helped to offset the negative impact from inflation rate cost increases. Lastly, currency volatility negatively impacted our results as the euro and Polish zloty weakened against the U.S. dollar in 2012 versus 2011. However, recent strength in the euro is encouraging for 2013. Slide 6 summarizes our key business objectives. Despite these challenging environments, our objectives and priorities are clear. A continued focus on execution in a stringent regulatory environment has led SWM to market leadership, global growth and attractive shareholder returns over the past several years. We will continue to make quality execution a primary objective. Second, strong and predictable cash flow allows SWM to drive growth in higher value products like LIP and RTL, but also to invest in key new growth opportunities, including new and adjacent markets. Third, we will look to enhance the profitability of our core paper operations through optimizations and continuous collaboration with our global customers. Fourth, we intend to further leverage our 2 joint venture investments to innovate and grow profitably with our strategic partners in China. Lastly, we'll continue to identify opportunities to take costs out of the business, led by our Lean Six Sigma initiatives, which we plan to further expand in 2013. In total, our focus on these key business objectives should drive long-term growth, attractive cash flow and increasing shareholder returns. I will now turn the call over to Jeff to discuss our financial results in more detail.

Thank you, Frédéric. Moving to Slide 8. Fourth quarter net sales adjusted for constant currency decreased 5.4% versus the prior-year quarter. However, excluding the receipt of initial fees aggregating $12.6 million during the fourth quarter of 2011 on a new royalty agreement, revenue would have exceeded the prior-year period. Full year 2012 net sales adjusted for constant currency increased 5.4% versus 2011, driven by improved product mix. Turning to Slide 9 and our volume trends. Fourth quarter 2012 reconstituted tobacco sales volumes were down 2% compared to the prior-year period, due primarily to timing of orders. However, for the total year 2012, RTL volume is up 6%. Tobacco paper volumes, including CTM, our joint venture in China, increased by 1% versus the fourth quarter of 2011. Volumes at CTM increased 37% versus the third quarter of 2012, which reflects the expected second half improvement in volume we had previously communicated. Total SWM volumes, including China, were up 1% versus both the prior-year quarter and for the total year 2012 over 2011. On Slide 10, you will see that our full year adjusted operating profit increased $17.3 million or 11.6% versus 2011, as growth in LIP and RTL volume more than offset the negative impact of a weaker euro. 2012 pulp cost overall were essentially flat with 2011, as lower NBSK softwood prices have been offset by higher BEK hardwood prices. Our adjusted operating margin at constant currency for full year 2012 rose to 20.5%, up 190 basis points from 2011. As you will see on Slide 11, adjusted operating profit for fourth quarter of 2012 was down 33% from an exceptionally strong fourth quarter of 2011. Absent the impact of $12.6 million in initial fees received on a new royalty agreement in 2011, adjusted operating profit was down 13%. This decrease was driven by inventory write-offs related to shutdown of our Philippines mill, resolution of a nonrecurring quality issue and incurrence of special consulting fees related to longer-term strategic planning activities. Our fourth quarter 2012 adjusted earnings per share, as shown on Slide 12, was slightly lower than the $0.91 per share from the prior-year quarter. This comparison excludes the impact of initial fees received on a new royalty agreement during 2011, as can be seen on the slide. The slight decline in fourth quarter earnings is primarily the result of expenses related to the resolution of a quality issue and special consulting studies related to longer-term strategic planning. Full year adjusted earnings per share were $3.55, an 18% increase over increase in 2011. Our total year adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, was $211.2 million, an increase of 12% from total year 2011. Turning to Slide 13. SWM net debt decreased by $43.8 million during the fourth quarter of 2012 and is down $64.7 million from the end of 2011 despite $50 million of share repurchases, a midyear doubling of our dividend and a $20.9 million of equity investments into CTS, our new reconstituted tobacco joint venture under construction in China. Strong operating cash flow generation more than offset capital equipment requirements, share repurchases and dividend payments. Total debt was 23.4% of capital, and SWM's net debt to adjusted EBITDA ratio remains low at 0.02 as of December 31, 2012. Now moving to Slide 14. Capital spending was $27.2 million in 2012, well below the $60.9 million in 2011. 2011 capital spending included $30.8 million toward construction of the RTL facility in the Philippines to a mothball state and $9.2 million toward completion of the LIP printing facility in Poland. For 2013, we expect capital spending to be between $30 million and $35 million, slightly higher than 2012 levels but still well below 2011 spending. We expect 2013 equity investments for CTS to be less than half the amount we invested during 2012. Dividend payments will rise due to the 100% increase in our quarterly dividend payable on March 21, 2013 to shareholders of record on February 28, along with a full year impact of the 100% increase created in mid-2012 from the 2-for-1 stock split. This combined 400% increase in our quarterly dividend signals confidence in our growth strategy and our commitment to increased shareholder returns. Frédéric will discuss our capital allocation strategy in further detail in just a moment. Return on invested capital in 2012, as shown on Slide 15, was 21.2%, up from 18.7% in 2011 and well above our cost of capital, primarily due to increased adjusted net income in 2012 compared to 2011 and continued prudent use of capital. ROIC is expected to remain strong in 2013 due to higher earnings and relatively stable levels of invested capital. I will now turn the call back over to Frédéric to provide an overview of our capital allocation and growth strategies. Frédéric P. Villoutreix: Thanks, Jeff. In keeping with our proven track record of judicious capital allocation, focus on innovation, long-term growth and superior shareholder value, we have mapped out our go-forward capital allocation strategy on Slide 16. First and foremost, we will invest in our core business when and where appropriate to continue building on the success of our highly differentiated products. This, in conjunction with the balance allocation of the capital, is expected to produce continued growth in EPS over the long term. Second, we will return at least 1/3 of free cash flow to shareholders via balanced dividends and share repurchase programs. Our announcement today of $50 million share repurchase program and a 1% increase in the quarterly dividend to reflect this commitment. Third and finally, we will remain opportunistic but prudent in pursuing growth opportunities in adjacent markets. Ultimately, our innovative and research-driven culture generates an expertise that can be successfully applied to other specialized tangential industries with attractive fundamentals. Any transaction will have to meet stringent criteria and be accretive in 12 months. Command margin similar to existing business and financed through a combination of cash, debt and equity. Finally, new investment opportunities will target an ROIC threshold in the range of 15% to 20%. Overall, SWM is committed to the optimal capital structure that allows for investment and growth while providing attractive returns to investors, and this without overly burdening our balance sheet. We believe this capital allocation strategy will help us to achieve our goal. With a clear capital allocation strategy in place, let's address our first priority, our core business growth. Slide 17 provides an overview of our growth strategy. SWM's focus on delivering superior customer value through continuous collaboration with our global partners to create custom-engineered solutions aims to produce sustainable annual long-term sales growth, starting with progressive global adoption of LIP and RTL. In addition, our commitment to operational excellence and taking cost out of the business should maintain, if not improve, our margin structure and continue to support EPS growth. We will enhance our profitability by also ensuring that our facilities and equipment are state-of-the-art in order to maximize our value to our customers. This is a core tenet of our future growth. Along those lines, we'll continue to invest in Asia, as we further strengthen our relationships in this region and demonstrate our technical expertise. By exiting operations in Indonesia and the Philippines, neither of which provided the proper footprint for operational capabilities to penetrate the Asia market meaningfully, we can better focus on our 2 existing China joint ventures while continuing to serve the LIP needs in Asia from other SWM operations. Finally, as a leading global provider of highly engineered and proprietary solutions for the tobacco industry, we can leverage our core strengths to introduce our existing products to new markets and enter adjacent markets with equally attractive economics. Specifically, the progressive expansion of LIP and RTL and nontobacco applications for engineered fine papers provide us with a valuable opportunity to leverage our existing product portfolio for both organic and inorganic growth. We have the requisite experience to integrate new businesses and deploy operational excellence best practices critical to the success of any expansion opportunity. And once again, acquisition in adjacent growth areas will be immediately accretive and provide economic returns and cash flows similar to existing business. Ultimately, it is our view that a diverse yet stable growth portfolio better positions SWM to weather market situations and improve infrastructure productivity. And a comprehensive growth strategy such as ours enables us to build this portfolio, generate strong cash flow and provide attractive shareholder returns. Let me now turn it over to Jeff for our financial guidance for 2013.

Thanks, Frédéric. Slide 18 provides our earnings expectations for 2013. On a constant currency basis, we expect 2013 adjusted diluted earnings per share to be $3.70, an increase of 4.2% over 2012's results. Our guidance assumes steady volumes, as well as continued success in our operational excellence efforts to offset expected inflationary cost pressures. The outlook is also reflective of expected increases in wood pulp prices during 2013 and includes startup cost related to the RTL joint venture in China. In addition, this outlook does not include any impact from potential share repurchases during 2013 and reflects foreign currency exchange rates similar to those seen thus far in early 2013. That concludes our remarks. Lori, please open the line for questions.

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

A couple of questions for you. First, would you be able to provide more color on what actually happened operationally and what the quality issues were and what the impact on the profitability of the business was during the quarter? Frédéric P. Villoutreix: Sure. I think for obvious confidentiality reason, we are not going to close in our specific product nor the customer involved. All I have to say is that while we were not pleased that the incident occurred, I think we have done extremely well responding proactively to the issue. As soon as we discovered the problem, we alerted the clients and solved the issue promptly without major disruptions to their operations. And I think the reason our results were impacted this quarter is because of the fact that we took appropriate steps to solve the issue and protect the customer's end product, and therefore, maintaining our strong relationship. And we also have learned from it, and we made changes to ensure it doesn't happen again. And in terms of the impact on the business for the quarter, it is certainly substantial. We -- I can cite it around $2 million on our guidance GAAP, or about $0.05.

Okay, that's helpful. And then on the consulting fees, is the incremental fee just a difference between the corporate expense in the fourth quarter versus what it's really averaged for the first 3 quarters of the year?

No, no. There's -- and you'd probably see this when you look at last year's fourth quarter. We always have kind of year end true-ups and different accruals and different expense activities, some of the compensation levels. So no, the year-over-year change you see there, only a smaller portion of that was related to these studies.

Okay, Jeff. And then a few more and I'll turn it over. On the royalty side, can you tell us what the income was from royalties in the fourth quarter, and what are you expecting that number to be for 2013? And what's reflected in your guidance for royalties in 2013? Frédéric P. Villoutreix: Yes, I think if you will recall, we had guided for 2012 at least $12 million in royalty income. And I think we are not going to report it precisely, but I'd say we ended 2012 in line with expectations, and 2013 will be about the same.

Okay. And then just last thing on the LIP markets. Can you update us on the new markets that you hope will move to LIP over the near future, and how you see that shift playing out over the next couple of years in those markets that you think could potentially move to LIP? Frédéric P. Villoutreix: Okay. Just 2 markets adopted LIP regulation during the quarter of 2012. Now they are small markets, south Africa and Switzerland, but we certainly are pleased with the level of market share we were awarded. The inventory build impacted our second half 2012 results, and we expect steady demand to continue throughout 2013. So it's a small amount of carryover linked to these 2 markets. Now if you recall, there was a WHO, World Health Organization, Conference of Parties that was held in Korea last November. And the Conference of Parties confirmed the strategic importance placed on establishing global LIP standards in line with the strict requirements already in place in North America and the EU. Now no new country has firmed their intentions since that conference, but discussions remain active, and we continue to see additional jurisdictions looking into adopting LIP standards over the next few years, namely Japan, Korea, Croatia, Brazil, Russia, Turkey to name a few. And we are working closely with our customers to ensure readiness and to expand our market presence when decisions are made.

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

This is Vijay on for Bill Chappell. I just have 2 questions. The first question is, can you just give us more color on the current spot rates and how you see that affecting EPS guidance going forward?

When you say spot rate, you mean the currency rates?

Yes, the currency spot rates.

Yes. Now I think if you look at the -- obviously, the euro has the most impact on us. And if you look at where it's been in early -- particularly, earlier in January, kind of the level that which we've used to gauge our 2013 outlook.

Okay. And then my second question is with regards to pulp pricing, can you just talk about where you see it going forward for the rest of the year? And did you guys take any pricing in the beginning of the year so far?

We are seeing some increases. It started probably later in 2012, and the outlook that I gave you does reflect an increase year-over-year. I mean, it's not huge, I mean, but it certainly is an impact on our 2013 outlook. Frédéric P. Villoutreix: In terms of pricing to customers, the business we do with large multinationals, the pulp cost change is embedded in the formula -- in the pricing formula. And we believe there was no price increases in the second half of last year to speak of but will have been reflected in the pricing of January 1, 2013. But again, it's just a 6- to 12-month lag, which we are used to been -- doing these patterns and practices for many years.

Your next question comes from the line of Ann Gurkin of Davenport. Ann H. Gurkin - Davenport & Company, LLC, Research Division: I want to start with RTL. The volume decline in the fourth quarter, you said was due to customer timing. Did some of that move either into Q3, or is it moving into 2013? Frédéric P. Villoutreix: Let me take that. I think it's every quarter the same situation. Either we sit here and talk about really great performances or we can show off from the previous quarter, it's the lumpiness of the business. If you go back in time, fourth quarter of 2011 was extremely strong but following a very weak third quarter of 2011. This, in '12, second and third quarter were extremely strong and fourth is down slightly. Maybe most important is the 6% growth in '12 versus '11, which is above our past track record. And our view is that we are entering '13 with steady volume. So we are certainly -- it's not anticipated orders of '13 were produced in last year. It's the fact that we are gaining share with our RTL products, and we expect to continue to remain at that level as we said in my prepared remarks. The next step up clearly for us is the start of our China joint venture in the first half '14. That will allow us to really significantly increase our sales and presence in the largest potential which is China. Ann H. Gurkin - Davenport & Company, LLC, Research Division: So RTL volume outlook for '13 is flat with '12, is that correct? Frédéric P. Villoutreix: The way we build the guidance and at this stage, early in the year, we are looking at that volumes from the highest level we have ever had in 2012. Ann H. Gurkin - Davenport & Company, LLC, Research Division: In '13 it's going to be flat with -- I'm sorry, with '12? Frédéric P. Villoutreix: That's what we have in the guidance, but obviously every day, we will... Ann H. Gurkin - Davenport & Company, LLC, Research Division: Don't they usually grow low single digits at least, so why flat? Frédéric P. Villoutreix: Because I think we -- right now, we -- last year, we outperformed the historical growth of that business. And we feel it's prudent in our guidance at this stage to build it based on a flat picture, but obviously every day, every week, our teams are looking to continue to grow and push for sales volume increase of RTL. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Perfect. And then regarding your joint ventures in China, any change in expectations for profits either on the cigarette paper side or RTL side? Frédéric P. Villoutreix: No, I think the expectations for CTM on the paper side as we continue to gain market share, we continue to push for highly differentiated products and so, therefore, improve our margins. And we have a good track record, we've been able to do that for 4 years in a row. And for CTS, I think the market is ready to receive our technology, and it's a matter of moving quickly through the construction, start up of the mill. And we remain optimistic as to a quick ramp up of capacity and sales.

In our guidance, Ann, there are some startup costs for CTS that are reflected in the earnings there, so that's probably under $3 million, but there is an impact from that in the 2013 EPS guidance. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Okay. And your decision in Indonesia, does that reflect any change in customer business? Frédéric P. Villoutreix: Not really. I think the decision to divest our Indonesian operation is related to really the infrastructure of the sites and the fact that we could not expand it. And also the primary products of our Indonesian operation is really a unique design for the Indonesian markets, and we work closely with the main customer of the mill to ensure that they are comfortable with the change of ownership, and they are. And so no impact to the global relations we have with that particular customer. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Okay, great. And then finally, in terms of what are you incorporating for cigarette volumes in the EU and also globally in your numbers in '13? Frédéric P. Villoutreix: I think that it's a pretty steady picture from 2012. So the market accretion in Europe is in the range of 3.5%, 4%. Global for the world is flat to 0.5%, but essentially coming from one country, China, growth in China, 3.5% to 4%. And pretty much a continuation of the trends that we have seen in '12 by region into '13. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Great. And then is there any inventory build with your customers either on the cigarette paper side, LIP side, or RTL as we go into '13 that would make quarters lumpy? Frédéric P. Villoutreix: Nothing out of the ordinary, no.

[Operator Instructions] Your next question comes from the line of Kenneth Smith of Lenox Equity Research.

A question on your share buyback. Are there any conditions attached to it? You're not including the benefit of it in your guidance. So are you just being conservative because you don't know exactly when it's going to occur, or are there any...

Yes, yes, I mean, obviously, when you set those up, you put out parameters on what levels that you want to make the purchases at. So we don't know how much would be acquired this year, so we just -- it would be a wild guess if we try to put anything in our EPS number.

Okay. And then on the facilities that you announced, you're closing over in Philippines and Indonesia, the sales from that during the first 3 quarters of 2012, we're going to have to back that out when we do our models. So how much would they have contributed?

If you look at total year 2012 between both of the operations, we're probably in revenue-wise around $25 million or so. The Indonesia sale would close sometime in the first quarter, so we'll have some carryover there, but -- about $25 million.

Okay. How much do you expect to receive from the sale of that facility? Is it a minor amount?

It's not a real significant amount as far as SWM goes. I mean, it's important to us, but it's not a huge material amount that we felt it was appropriate to disclose at this point.

At this time, there are no further questions. I'll now return the call to management for any closing remarks.