Mativ Holdings, Inc. (MATV) Q2 2013 Earnings Report, Transcript and Summary

Welcome to SWM's Second Quarter 2013 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 Chekanow, Director of Investor Relations. 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 16707638. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Chekanow. Sir, you may begin.

Thank you, Lori. Good morning, I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's second quarter 2013 earnings results. On today's call, Frédéric will share some high-level comments about our second quarter performance and priorities. Jeff will then take you through a more detailed review of our financial results. We will then take your questions. Before we begin, I would like to remind you that the comments included in today's conference call include 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 and are, therefore, non-GAAP financial measures. Reconciliations of these measures to the closet GAAP measures are included in the appendix. I will now turn the call over to Frédéric. Frédéric P. Villoutreix: Thank you, Mark, and good morning, everyone. Late yesterday, we reduced our second quarter earnings. And this morning, we are pleased to present our results, our near-term outlook and update you on our long-term initiatives and opportunities. As shown on Slide 4, we had solid second quarter earnings. Revenue grew 2% as we experienced sales growth in both our paper and reconstituted tobacco segments. Within the paper segments, LIP volumes grew 4% despite challenging tobacco industry conditions, evident from the earnings announcements on some of our customers. Within the RT segments, we saw volumes decline 2%, but positive mix changes versus second quarter last year yearly revenue growth. While our RT volumes decreased in the second quarter, the decline was much less pronounced than the results reported in the first quarter. We are very pleased with our adjusted earnings per share from continuing operations of $0.95 in the quarter, bringing us to $1.96 for the first half of the year. Cash generation also remained strong in the second quarter. We have a net cash position of $48.2 million as opposed to a net debt position of $4.8 million at the end of 2012. Looking ahead, we remain excited about the prospects of our long-term growth initiatives, while still closely monitoring our customers' volume trends as we all navigate the challenging tobacco environment. SWM's Tobacco Paper volume, including our Chinese paper joint venture, grew by 3% in the second quarter. This was accomplished in an environment where mid-single-digit customer cigarette sales volume declines are becoming common, and is a testament to our strong customer relationships, value-added products and ability to gain share. We also continue to reap the benefits of our operational excellence program, which provides support for our 2013 financial goals. I said we'll discuss later, our year-to-date adjusted EPS performance is striking slightly above our plan, albeit, in last part to some non-operating items. We are now comfortable raising our 2013 guidance for adjusted EPS from continuing operations to a currency neutral of $3.75 from $3.70. This outlook does reflect subtle performance in the second half of this year relative to the first half as smoking attrition rates remain high, RT volume is expected to remain soft and product costs are elevated. Moving to operational trends on Slide 5. As I said before, LIP volumes increased by 4% over the prior year. We do not believe there were any unusual channel inventory circumstances. Rather, this growth demonstrate our value proposition to the cigarette manufacturers. Over the long term, our Tobacco Paper volumes may confront the cigarette smoking attrition rates, but we continue to pursue increased share and position ourselves to offset these challenges. We think these efforts are evident in our year-to-date results. Our continued focus on eliminating cost from operations, again, yearly strong results in the second quarter. Year-over-year cost benefits from our various Lean Six Sigma SWM restructuring are expected to deliver our targeted $20 million to $25 million of annual savings. These achievements are critical to meeting our financial goals as we offset the negative impacts on higher pulp prices and other inflationary increases, as well as general pricing pressure and some mix issues in our non-LIP paper product portfolio. Although industry sources expect some of the recent pulp price increases to reverse, we continue to see elevated prices in the markets and these costs will likely prove to be higher in the next few quarters and those of year-ago periods. Our operational excellence program provides current upsides to these challenges, as well as sets the foundation for long-term margin protection. As I indicated previously, RT volumes decreased by 2%. While this decline is an improvement from the first quarter decline, it was below our expectations. We continue to monitor this trend closely and work with our customers to meet their needs. However, we now expect RT volumes for the year to be lower than 2012 in response to higher cigarette smoking attrition, particularly in Europe. While it is much too early to project 2014 volume levels for RT, we look forward to increasing our volume in China with the 2014 opening of our Chinese RTL joint venture, China Tobacco-Schweitzer. We believe this will bring an increasing profitability beginning in 2015 after we absorb higher solid cost during 2014. I will now provide an update on several initiatives that support our growth strategy. First, we remain dedicated to serving our core tobacco customers at high level with both existing products and the development of innovative improvements. On the LIP front, we are rigorously pursuing next-generation products with 2 primary areas of focus: Cost reduction, and minimizing taste impact. Leading the industry on these attributes should underpin our long-term success within the LIP space. Within the RT segments, we continue to collaborate with our customers to advance flavor improvement and reduce harmful attributes. These projects are long-term in nature, but as we continuously deliver on these commitments, we expect to secure our position in this important area. In China, we are moving closer to the 2014 opening of our RTL joint venture. We have forged solid relationships in this large and growing tobacco area, which will be key to unlocking long-term value. Over the long term, 2 key potential developments could drive sizable profit growth to SWM in China. The adoption of the LIP standouts and the opening of a tobacco marketplace. Our relationships with the government and the leading cigarette manufacturers, as well as our operating experience in China, puts SWM on solid footing to be a valuable partner to existing international customers, as well as our Chinese partners. Regarding new LIP geographies, there has been one new regulatory development, which some of you may have seen. A vote in Russia is expected by the end of the year on LIP standards. I note, this is not a vote on if and/or when to adopt regulation. But rather, the product standouts will be part of any future regulation. This is a key milestone in the process that we hope will ultimately end in LIP regulations being adopted in Russia and several other countries in the CIS. It is too early to make any timing predictions or provide financial parameters of a potential impact, but we want to highlight that this region is a large consumer of tobacco and could prove to be a substantial revenue and earnings driver for us over the next several years. We are also actively engaging our customers and developing plans for potential adoptions in other countries, such as Brazil and Japan. On the diversification efforts, particularly M&A, we are dedicating resources to exploring adjacent spaces. Adjacencies can take many forms, such as products, technology and markets, et cetera. But rest assured, our criteria is strict regarding retail and investments. We ultimately answer to our shareholders and expect to make strategic decisions to grow and diversify without sacrificing the strong financial performance, to which we have become accustomed. Let me now turn it over to Jeff, to discuss our financial results in more detail.

Thank you, Frédéric. Moving to Slide 8. Second quarter net sales increased about 2% versus the prior-year quarter. Paper segment volume and revenue both grew. Our key segment volumes declined, but mixed changes resulted in 3% revenue growth in that segment. There was minimal impact from currency translation on the year-over-year comparison. Turning to Slide 9. Tobacco paper volumes, including CTM, our joint venture in China, were up 3%, with LIP volumes up 4%. Overall, SWM volumes, including CTM, were up 4% from the same quarter in 2012. Nontobacco paper volume was strong, specially shipments of wrapping materials for drinking straws. Second quarter 2013 reconstituted tobacco volumes were down 2% compared to the prior-year period. Our key segment volume is tracking slightly below our expectations due to the higher-than-anticipated cigarette smoking attrition rates, and as Frédéric indicated, we now expect 2013 RT volume to be somewhat lower than 2012. As you can see on the slide, on a chart on Slide 10, year-over-year operating profit was essentially flat for the second quarter at nearly $43 million. While we did experience volume increases across our paper business, the decline in our key segment volume and mix issues in our non-LIP paper products drove a slightly negative impact on profitability. There are sizable differences in pricing and profitability over our various paper products, and during the quarter, we saw a significant volume growth in some of our lower margin products. This contributed to the volume pricing mix profit impact shown on the chart. These mix issues were offset by improvements in cost of sales, supported by the increased volume and again, demonstrating our ability to preserve margins through operational excellence. As you will see on Slide 11, paper segment profits grew on higher volumes and LIP products, and excellent manufacturing cost performance. The operating profit margin for this segment increased from 18.4% to 19.2%. We continue to see a year-over-year decline in royalty revenue, although not as pronounced as in the first quarter of 2013. We feel that this data point, as well as our paper segment volume, represents -- suggests that we are currently gaining share. Adjusted operating profit for the second quarter of 2013 was down from last year and the reconstituted tobacco segment due to lower volume, although we have some favorable mix in the second quarter driving revenue growth of 3%. Our second quarter 2013 adjusted earnings per share, as shown on Slide 12, was $0.95, up $0.07, or 8% from the second quarter of 2012. We benefited from lower net interest expense, transactional foreign exchange gains and a slightly lower effective tax rate. To date, we are tracking ahead of our $3.70 guidance for adjusted EPS from continuing operations, largely due to some non-operating items, such as the foreign currency and tax benefits, much of which is difficult to forecast. As we discussed on the first quarter call, it was not reasonable to annualize the period's EPS, and we believe that it remains true for year-to-date results. However, we are comfortable with the increase in our total year guidance to $3.75. Overall, the tobacco industry faces some headwinds, and we believe our guidance reflects our strong year-to-date financial performance, as well as a prudently conservative stance going forward. Cigarette smoking attrition rates were a key consideration in forming our guidance, as well as higher pulp cost and continued weakness in RT segment volumes. These guidance does not contemplate any potential stock buybacks and assumes foreign currency exchange rates remain at recent levels. As we have discussed, the timing of new LIP regulation adoptions is unknown, and without the benefit of any such regulations during 2014, our volume and revenue mixture will be influenced largely by the attrition rates experienced in the mature North American and European regions. 2014 will also be impacted by higher one-time start-up cost of our Chinese RTL joint venture, although it's too early to quantify the amount and timing of these costs. We expect to see profits from this joint venture starting in 2015. Turning to Slide 13. SWM net debt has decreased by $53 million since the end of 2012, as we now sit with a $48 million net cash position. This cash accumulation improves the impact of our dividend increases from earlier this year. Total debt was 23.7% of capital. Our cash levels have risen to $212.7 million. We remain committed to returning at least 1/3 of our free cash flow to shareholders as evidenced by the four-fold dividend increase in the past year. We expect this return to be largely in the form of dividends as share repurchases will be used only on an opportunistic basis. In addition, they will be balanced with other strategic demands of the business. We do expect to invest as much as $200 million in the next 3 or 4 years and support of LIP expansion around the globe, completion of the RTL mill at our China joint venture and activities aimed at securing our longer-term position in the large and growing Asian region. Now moving to Slide 14. Capital spending was $9.2 million year-to-date in 2013 versus $14 million last year. Although this run rate is below our revised 2013 CapEx guidance of between $25 million and $30 million, we still expect to finish the year in that range. Our previous 2013 guidance for CapEx was $30 million to $35 million. We currently have a number of capital projects that we expect to execute in the second half of this year. We expect 2013 equity investments for CTS to be less than half of the amount we invested during 2012. We did not purchase any stock under the $50 million authorization established in the fourth quarter of 2012. Despite ample capacity to repurchase stock, our buyback program is intended to be opportunistic. As I indicated previously, we will balance our uses of cash between buybacks and dividends versus growth projects, both organic and acquisition-related. Our strategy is not to accumulate excess cash, and we believe we have demonstrated a strong track record of the buying back stock opportunistically and increasing our dividend. Return on invested capital for the trailing 12 months ending in the second quarter, as shown on Slide 15, was 22.2%, well above our cost of capital. We continue to drive this metric as we believe it is the best measure to align management with our shareholders. As you may know, ROIC is a key component of our executive compensation program. ROIC is expected to remain strong in 2013 due to stronger earnings in relatively stable levels of invested capital. 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.

Just looking at in 2014, you highlighted several potential headwinds, specifically on the volume side and on the cost side. But as you think about the opportunity to continue to take more cost out of the business, this year you're tracking really well there. I mean, as you think about '14, what is the run rate to continue to take cost out of the business? And do you think that would be enough to offset some of the other headwinds that you guys have talked to where you can potentially keep the earnings run rate flat up a little bit even if you don't see LIP conversions play out next year. Frédéric P. Villoutreix: Yes. Let me address your question, at least on the business side and Jeff, you may want to add comments on his perspective as well. Clearly, we are embarked on a company-wide program, Lean Six Sigma 3 years ago, and we are still gaining momentum. So I see it's tough work, but we advocate the ability to continue to lower our cost base through operational excellence, initiatives, getting into 2014. You mentioned the headwinds, we should not forget we also have opportunities in terms of introducing new products, continuing to gain market share and potentially the effect of new LIP markets opening up with adoption in '15 that could drive some additional revenue and earnings in the tail end of 2014, just to name a few.

That's a helpful detail there, Frédéric. And then on the market share front, can you just update us where you see your current market share position in Europe, and the runways there to potentially take incremental share over the next 12 months? Frédéric P. Villoutreix: Yes. I mean, obviously, as our year-to-date reserves, support the fact that we are gaining market share in Europe. I mean, our customers are reporting consensus is around the 9% attrition rates in smoking year-to-date in Europe, and we are pushing some growth, 3% to 4% growth in our LIP. Now, again, we have to be cautious here. We are achieving goals through the value proposition that we offer to our customers and this could change, but right now, we feel good that we have increased marginally our share in Europe from what it was last year. And in terms of the outlook for next year, I mean obviously, there's a lot of uncertainly within the industry as to whether attrition rates will recover, will improve in the second half of this year or next year. A lot of that has to do with the economic situation in Europe. Tax measures that government may or may not take. And also effective are some of the measures to counter illicit trade in the region tend to be. But clearly, we anticipate that attrition rates will remain probably slightly higher than historical levels, which puts more pressure on us to lower cost and through new product introduction, our commercial initiatives continue to increase our market share in the region to stay ahead of where we are today.

Last one on capital allocation. The free cash generation has been really solid. Stock is up a lot this year to the extent that the stock continues to work and may not necessarily be such a great opportunity to be buying it back and acquisition doesn't necessarily present itself by the end of the year. What is the appetite for potential special dividend in order to make sure that the cash flow doesn't just build up on the balance sheet and doesn't utilize effectively?

Well, I mean, we're always looking at what would be potentially an opportunity to any future adjustments in dividends. I mean, we do want to stick with returning at least 1/3 and there's always the chance that we could make a change there. But again, with the opportunities we're looking at in terms of growth of the business, both organic and inorganic, we want to retain the dry powder there and the opportunity to do something. So I think, what we've been doing in the past, from a dividends standpoint and continuing to improve the yields, we'll try to stick with that kind of moving forward.

Your next question comes from the line of Ann Gurkin of Davenport. Ann H. Gurkin - Davenport & Company, LLC, Research Division: I've got to just start with like customer orders for both paper and RTL. Are you seeing a change in the second half? Are customers changing their expected orders for the second half of '13 or even going into '14 at this point? Frédéric P. Villoutreix: Not really. I mean, I think what we have said in our prepared remarks, clearly, we have seen a softening of the demand for RTL products, which clearly, we see as an adjustment of inventory levels and our customers to reflect more of the ongoing demand for cigarettes. I think there has been an improvement in the second quarter of -- no, the first quarter in terms of the market conditions in Europe. I believe our customers have restated in their earnings release are cautiously optimistic that this improvement will at least continue and may improve -- and may further open up the situation in Europe. But again, this is -- a lot of that is driven by the economic situation in Europe. And the fact that there are alternative tobacco products to cigarette smoking that today are less taxed in Europe, which only creates headwind in terms of our customers -- in terms of pushing their sales of cigarettes. Ann H. Gurkin - Davenport & Company, LLC, Research Division: So RTL volume for the year now, do you think down low-single digits for you? Is that what you are indicating?

I mean, I think you can see our run rates year-to-date. We are down from what was an exceptional year last year. I think we are still, in terms of run rate, probably would be the second best year ever for our French RTL facility, so it's certainly not a bad, terrible situation, but it's only a start to the growth and we have seen in the past few years. And the current demand is one thing. I think it's important to mention. And as you probably know, Ann, Europe is going through some revisions to their tobacco product directives, which is kind of the body of laws that are regulating the tobacco industry. Those directives date from 2001, and it's up for revision, expected to be finalized next year. And I think that is creating a lot of pause for our customers. They want to see what will be adopted, what will not be adopted among the many propositions. And it's certainly slowing down the rates of innovation, introducing new cigarette designs, which is an important factor for RTL growth. And obviously, on the paper side, we are able to more than mitigate the softer market conditions. Whether that can continue over the next 18 months, remain to be seen. So it's hard work and it's our goal, but the reality is that the market is shrinking in Europe at the moment. Ann H. Gurkin - Davenport & Company, LLC, Research Division: And with RTL volumes down, are there any concern about capacity utilization for the RTL business? Is that softer than expected now? Frédéric P. Villoutreix: No. I mean, the capacity utilization remains very high. And obviously, it's putting some burden on our overhead absorption cost. We continue to invest heavily in research and quality development, because we believe it's essential to the midterm outlook of our RTL franchise. And as reflected in the slight erosion of our profit margins for the RT segments, volume is a negative factor for sure. But the efficiencies are good and we have plans to continue to improve our productivities and improve our cost position on RTL as well. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Right, switching to the China RTL joint venture, I thought that was going to start adding to profit in '14 so it looks like it's getting pushed out to '15 now. Can you comment on what's changed in your -- in the press release highlighted increase start-up cost? But is there anything else in that analysis? Frédéric P. Villoutreix: I think all targets for the past 18 months has been to start up RTL in 2014. What we say is that there are 12 months of operation then there would be -- expected to be breakeven. In RTL [ph] we see the start-up to take place around the second quarter of next year. And so therefore, we see start-up expenses impacting 2014, but getting into the first quarter of '15, obviously with the profits being contributed from China Tobacco-Schweitzer.

Yes. The start-up cost, there's nothing unusual about it. I mean, it's typical when you open a mill, it's just in the timing of when we think we'll open versus when the profits start to grow. It's just you'll see the profitable overall come in 2015, but the start-up costs are typical just in the common thing where you have to take the hits from when you first start up. Ann H. Gurkin - Davenport & Company, LLC, Research Division: That's great. And then I'm not asking specific details, but are there M&A opportunities that you're still reviewing out there for potential use of your cash? Can you comment on kind of what that pipeline looks like? Timing? Any kind of detail you could give us there. Frédéric P. Villoutreix: We certainly don't have anything to discuss specifically at this point. As we have said in the previous quarter calls, we are investing both in developing organic growth opportunities, leveraging paper assets and knowledge in reconstituting fiber materials. And we continue to invest heavily in this area. And as we also stated that we are looking very selectively in organic opportunities, but really nothing that we expect to see coming in the immediate future. And for us, it's a matter of thinking long term in terms of the growth profile for SWM. And we believe, and I think it's confirmed, with the recent outlook on tobacco that it is the right thing to do mid- to long-term to look at diversifying our product portfolio with non-tobacco reputations added to the very strong core that we have for the past several years. Ann H. Gurkin - Davenport & Company, LLC, Research Division: And then just let us get the pulp cost that you're including for the second half?

Yes. We haven't specified a particular number. As you can see in the first half, we were able to offset some of the higher costs with some purchasing activities and also some currency benefits from locations where we buy it, but I think as we start to consume more of the inventory we bought in the first half, just start to see more pressure and some headwinds on that in the second half. Not a hugely material number, but certainly higher cost than we've seen in the past.

[Operator Instructions] Your next question comes from the line of Larry Stavitski of Sidoti & Company. Lawrence Stavitski - Sidoti & Company, LLC: I just had a couple of questions on the -- you spoke about the uncertainty with the attrition rates in Europe and North America, and also the LIP adoption in some of the -- Brazil, Russia and China. Would you have any idea of when you would get a better grasp of these -- of when you get a better outlook on these concepts? Would it be towards the end of 2013? Would it be '14? Is there anything you could expand out of that? Frédéric P. Villoutreix: Okay. So to answer the question on the market conditions in North America and Europe. I think it's fair to say that North America attrition rates, around 4%. Today our kind of [ph] of know normal outlook. So there's really nothing unexpected there. In Europe, we -- this has been the -- somewhat of a surprise to many stakeholders in the tobacco industry to see the drop 10% in the first quarter, 8% in the second quarter. I mean, historical level, that was more 4% to 6% in recent years. Again, whether value is going to continue to improve, we can't comment. I mean, we'll take the news as it comes, but we are certainly planning for pursuing the slow economic recovery in EU for somewhat of a depressed market for the next several quarters. But again, we take the news as it comes. And in terms of the new LIP market adoptions, I mean I mentioned Russia because we see -- we have seen a movement towards getting ready for adopting LIP regulation. And Russia and some of its surrounding markets, and I just want to remind everybody, a very large market potential. And if you size the CIS region, it is, in fact, slightly greater than the EU markets in terms of potential. So it's obviously a very important development for us. It's good reasons to believe that these LIP standouts will be adapted in late 2013 by the parliaments there. But whether they would be also a communication as to a targeted implementation date for the LIP standout is totally unknown. However, working with customers, whether it's Russia, whether it's Brazil, whether it's Japan, we have quality dialogue with them to anticipate and make sure that the industry is ready to match and comply with new regulations. And based on the activities that we have with our customers, I mean we remain hopeful that within the next 2 to 3 years, at least one of these countries will have adopted LIP regulation. And again, all of them are pretty large in nature and will be impactful to our earnings, probably 6 months ahead of the implementation date. And again, because of that, I think we expect next year to have clarity as to whether one of these markets will adopt the LIP even at the tail end of 2014 or sometime in '15. So we'll report it as we're able to see it, becoming aware of that. Lawrence Stavitski - Sidoti & Company, LLC: Okay. And then also just, I guess, adding on to the RTL, the decline in shipment. Was there any area specific that's an area of concern for you that you had forecasted better-than-expected results in terms of shipments there? Frédéric P. Villoutreix: I think the EU markets is kind of a sweet spot for RTL business. And obviously, that's the one that probably is the main driver for the slowdown in RTL volumes versus last year. And we continue to develop new customers, new repetitions for RTL outside of the EU zone. So I think it's primarily an EU market concern at the moment. And not only the attrition rates, but again, I'll remind everyone that there's clearly a very important change or set of changes, revisions that are planned for next year in these tobacco product directives, whether it's affecting the packaging of cigarettes, it's affecting the disclosure of the ingredients, the ban of menthol or other flavors in cigarettes. So there's a lot of stakes for cigarette companies looking at possible changes to this product directive, and but in itself it's kind of not freezing, but certainly slowing down the pace of innovation, which obviously, is something that we tend to strive in terms of creating growth in the market that has no growth in it.

At this time, there are no further questions. I will now return the call to management for any additional or closing remarks. Frédéric P. Villoutreix: Thank you, Lori, and thank you, all, for attending the call. And we certainly appreciate your interest in the company. Mark, Jeff and I would be in our offices today and if you have any follow-up questions, please give us a call. Have a nice day.

Thank you. That does conclude today's conference call. You may now disconnect.