Mativ Holdings, Inc. (MATV) Q2 2018 Earnings Report, Transcript and Summary

Welcome to the SWM Second Quarter 2018 Earnings Conference Call. Hosting the call today from SWM is Dr. Jeff Kramer, Chief Executive Officer. He is joined by Andrew Wamser, Chief Financial Officer and Mark Chekanow, Director of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon. At this time all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Chekanow. Sir, you may begin.

Thank you, Catherine. Good morning, I'm Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's second quarter 2018 earnings results. Before we begin, I'd 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 our Securities and Exchange Commission filings including our quarterly reports on Form 10-Q and our Annual Report on Form 10-K. Some financial measures discussed during this call are non-GAAP financial measures, reconciliations of these measures to the closest GAAP measures are included in the appendix of this presentation and the earnings release. Unless stated otherwise, financial and operational metric comparisons to the prior year period and relate to continuing operations. This presentation and the earnings release are available on the Investor Relations section of our website www.swmintl.com. I will now turn the call over to Jeff.

Thank you, Mark, and good morning everyone. Yesterday, we reported second quarter results with sales up 6% to $270 million and adjusted EPS up 13% to $0.99 a share. We were pleased to deliver good performance despite significant inflationary pressures and expenses related to our AMS site consolidation. For the quarter, the key takeaways are solid sales growth coupled with good manufacturing operations driving top and bottom line performance in EP and continued strong organic sales growth in AMS offsetting short-term expenses acquired to realize the Conwed synergies, and finally a positive lift from lower taxes. Year-to-date free cash flow was tracking as planned toward our expectation of exceeding $100 million in 2018. AMS delivered 5% sales growth with no acquisitions benefit, which I'd like to highlight, was on top of an already strong second quarter last year when organic growth was 10%. Overall, performance was propelled by strong growth in both filtration and medical sales, while the transportation segment was down slightly due to a difficult year-over-year comparison. The business remained solidly positive year-to-date. Our infrastructure, construction and industrial sale segments were flat versus last year. To share more detail, our filtration business performed well across its sub-segments. RO water filtration was up double digits, as we continue to benefit from the return of the replenishment cycle and our customers maintain a bullish outlook for the remainder of the year. After being somewhat guarded on this expected rebound at the end of last year, our confidence in the sustainability of this near-term trend has increased. We also saw continued momentum in process filtration driven mainly by gains in semiconductor manufacture and use of our products in heavy equipment, such as components of fuel and hydraulic liquid filters. In medical, we continued its strong momentum from the first quarter. While nearly half of this business is related to the more mature consumer finger bandage category, we also offer variety of specialty products that illustrate our portfolio breadth, which have been the drivers of our 2018 growth thus far. These include niche products like films for medical packaging, hospital IV and Ostomy bags, advanced wound care applications, and air filtration materials for face mask typically popular in Asia. Our transportation business delivered healthy sales, but compared to an extremely strong 2Q 2017 we are down slightly. Year-to-date, this market remained solidly positive and our order backlog and customer indication support a robust outlook for these surface protection films. In our infrastructure and construction business, recall that earlier this year we were affected by severe winter conditions in some of our key markets. These conditions have now moderated and sales have begun to recover with positive go forward expectations. Despite solid sales performance, we did report a contraction of our year-over-year unit margins. We continue to incur expected cost as we get closer to a final exit of Austin site later this year. Similar to the first quarter, the higher costs associated with this site accounted for most of the adjusted segment margin decline. However, we expect significant savings in the fourth quarter when we realize the full synergy from closing this facility. We remain on target for this important project. A second, but smaller issue is polypropylene costs, which remain elevated. We have increased prices on polypropylene based netting products and we estimate we have recovered a majority of the higher cost impact this quarter. We continue to evaluate and execute price increases and have also begun implementing a freight surcharge in response to rising trucking costs in the U.S. Also sales remain strong, our new Chinese manufacturing site is fully up and performing well and we remain on plan with our new European film line. While resin costs continue to rise and pose a challenge to margins, we are in the homestretch of closing the Austin site and to realizing our Conwed related synergy plan. Moving to Engineered Paper, second quarter sales grew 6% with good price mix performance and currency overcoming of 4% volume decline. Of note, the year-to-date segment volume decline was 1% showing relative stability despite some of the quarter-to-quarter variations. In the quarter, we delivered increased Cigarette Paper volumes and high growth in our heat-not-burn business offset by a decline in traditional RTL products. As shown, we remain positive on this segment, but will expect to see some variance in customer order patterns at the scale of their supply chains and learn more about consumer preferences across the globe. One significant headwind remains elevated pulp costs. As many paper suppliers are reporting, the global supply demand for these – balance for these materials is tight, we are actively raising prices were contracts permit, but we should note there is some lag on several customer agreements. As a result, while operating profit dollars increased, margins were slightly lower than last year. We performed well in the quarter from a manufacturing perspective with productivity gains delivering a solid offset to rising input costs and we continue to push hard to counterbalance inflationary pressures with efficiencies. Just a few additional comments on heat-not-burn, sales were again up significantly over the last year and we continue to have very collaborative development discussions with our customers. This area has become a focal point in the industry with heated tobacco product growth attracting the spotlight from the investment community. Recently, announcements have highlighted our earlier comments that these new applications can be lumping in initial phases of introduction. Our growth remains generally in line with our original expectation. The innovation in this category is very exciting and we remain bullish on its long-term prospects as the industry sorts through capacity planning, pricing, consumer preferences, and regulations. We view the product as part of a multiplying plan to drive relative stability in our EP business. I will now turn the call over to Andy.

Thank you, Jeff. I’ll now review our financial results starting with segment performance. In the second quarter, AMS net sales increased 5% to $124 million. Adjusted operating profit was $22.6 million or 18.2% of sales, down 160 basis points versus last year. As a reminder, second quarter of last year's results benefited from a favorable mix effects in segment margin was a record 19.8%. Consistent with the first quarter of 2018, the market contraction in AMS was primarily driven by the inefficiencies of our Austin plant, which is scheduled for closure later this year. As anticipated, we flesh through high cost inventory incurred redundant labor costs as we transferred production line and added new engineering capabilities at the sites that are expanding their capacity. The second primary driver of margin compression was higher resin costs. Though as Jeff highlighted, during the quarter we were able to recapture much of the cost through pricing actions. On a sequential basis, adjusted margin improved from the 14.1% level we delivered in the first quarter to 18.2%. This improvement is due to moderating site quarter expenses as well as the price increases that went into effect during the second quarter. We believe the price increases to customers will provide an offset to higher resin costs though we caveat that the recent uptick in polypropylene prices may require further actions. Regarding a site quarter the annualized synergies from the Austin consolidation in the fourth quarter will exceed these short term pressures. The Engineered Paper segment net sales were up 6%, positive foreign currency movements of 5% and favorable price mix of 6% more than covered the volume decline. Given the current euro exchange rate we do not expect a meaningful benefit from currency for the balance of the year given the late 2017 rally in the euro to 120. EPs adjusted operating margin was 22.9% down 70 basis points versus last year, but in line sequentially with first quarter results. The year-over-year margin decline was driven by significantly higher pulp costs, however, with the combination of modest price recovery improved productivity and the higher euro providing almost a full offset. Adjusted corporate unallocated expenses increased by 4%, but as a percentage of total SWM sales declined by approximately 10 basis points to 3%. On a consolidated basis, net sales increased 6% and were up 3% excluding currency. Adjusted operating profit was $47.9 million flat with last year and adjusted EBITDA was $57.9 million up 2% year-over-year. Overall we were pleased to report a moderate EBITDA growth despite the pressures from rising raw material costs and the near-term expenses associated with our Austin synergy plan. Shifting to consolidated earnings, second quarter GAAP EPS was $0.83 up from $0.72 in the prior year. Adjusted EPS was $0.99 up from $0.88 representing 13% growth. As adjusted operating profit was flat, EPS growth was supported by a lower tax rate and currency translation. Our second quarter tax rate was 24.9% down from 31% last year due primarily to the changes in U.S. tax reform. Our year-to-date tax rate stands at 25.2%. However, we continue to access and interpret the new tax laws and we caution that there could be some variability in our tax rate in the second half of the year. Also of note currency translation was a positive $0.04 impact to second quarter EPS. With the first half of the year now complete, I’d like to now provide some highlights on the key puts and takes shaping our 2018 results. On the positive side we're seeing broad organic growth across our AMS segments. However, it's also fair to say that raw material costs are up significantly in our tracking higher than our expectations at the beginning of the year. Fortunately, we've been able to recover some of the impact through pricing actions and productivity improvements. But we expect both pulp and resin costs to be an even stronger headwind in the second half of the year. Other positive offset have been a slightly lower tax rate than expected and a favorable euro, although the benefit of the euro rate should moderate in the back half of the year. Moving to cash flow and equality, year-to-date 2018 free cash flow was $42 million up from $24 million. For our usual pattern we expect free cash to accelerate in the second half of the year and we will achieve our projection of more than $100 million in 2018. CapEx was approximately $8 million in the quarter and $14 million year-to-date, which annualizes below our guidance for approximately $40 million. But we anticipate spending will pick up closer to anticipated range in the back half of the year. From a leverage perspective for the terms of our credit facility, we were at 2.8 times net debt to adjusted EBITDA at the end of the second quarter down from 3.0 times at year-end 2017. We reduced that by approximately $41 million thus far in 2018. And without M&A activity, we expect to continue to pay down additional debt. Now back to Jeff.

Thank you, Andy. At mid-year, we are pleased with our financial performance and we believe we are generally on track to deliver adjusted EPS within our original guidance. We are delivering solid sales growth particularly the organic growth in AMS with most of our key markets showing strong momentum and continued sales strength will be a key factor in delivering on our 2018 plans given our cost pressures. Unfortunately, the raw material cost increases have been higher than our original forecast and the tariff activities are somewhat cloudy in the immediate future. Regarding our Austin site closure, we are nearing project completion and the expected synergies are around the corner. Completing this project on time will set us up nicely for 2019 and the incremental savings should be a solid boost during our fourth quarter. Overall, 2018 has been an active year of strategic projects between commissioning our new Chinese facility, our U.S. footprint rationalization activities, construction of a new European film line for AMS, and the ongoing development in commercialization of heat-not-burn. While executing on these projects and driving toward our operating plan, we also continue to screen for additional inorganic opportunities that will complement our current capabilities. We believe demonstrating our ability to execute against our original commitments is critical to pursuing further deals given the synergy plan we've targeted, which should ultimately result in AMS be in a more scaled integrated and profitable platform on which we can continue to build. We appreciate your continued interest and support. And that concludes our remarks. Catherine, please open the line for questions.

Thank you. [Operator Instructions] And our first question comes from Dan Jacome with Sidoti. Your line is open.

Good morning.

Good morning.

Couple questions here. First, let's stay on the Austin site. Sorry if I missed it. What was the exact operating profit drag in the quarter?

Yes. So Austin, we did some framework for that, so we have high cost inventory running through the system. We also have just a general inefficiencies of running a site that is in wind down. And then lastly, we had accelerated depreciation. But when you look at it in aggregate, it's about a 1.5 million headwind.

1.5 million. And I should know this, but that was inherited with the Conwed?

I think that was a dull start facility.

Dull start, okay. All right. Now let’s turn to the construction markets. What are those keep lagging? Any high level thoughts there?

Yes. The construction markets are lagging primarily because if you recall in the first quarter the weather patterns in the United States were terrible. There were a lot of blizzards and then a lot of rain. And so the first quarter was a downturn for the entire construction industry. We've seen those conditions moderate and the business is gaining momentum, and we believe the Board look for the construction industry will be much more positive.

Okay. That's helpful. So in second quarter there was no weather headwinds, what was there if anything?

There were probably some slight ones, you've seen a lot of rain and things of that nature, but it's materially moderated.

Okay, great. Then turning to HnB, so you did mention that the markets are lumpy and it is still very early, let's call it growth phase, but do you have any high level comments, is PMI pretty tepid outlook from – on their last call, anything you could help me clarify there?

Yes. It's going to be hard for me to comment directly on what our end use customers are saying. I think we've been pretty consistent in our view how the market will develop. We're still very excited about it, but we also were clear in our expectation that it's still a new product introduction. And that means supply chain, billing, and execution sometime were little lumpy. As they go to more test markets, they're starting to see their flavor characteristics or other performance characteristics that they might need to tell or et cetera. So it's going the way we expected it to be in the way we've actually been planning for it to be. We're continuing to have a lot of new product development commercialization work done with many of the customers. And so many of these trends are actually a reinforcement of the positives of working with SWM, because it's not a simple thing, you are going to need to tell it just like normal products. You are going to need to tell, it’s a local conditions, meet local regulations et cetera. So overall, we’ve remain positive on it. I think we've been pretty clear also that this is going to be a game changer for SWM in terms of volume in the short-term because of many of these issues as we scale up.

Got it, and that make sense. Okay. So long-term is still rather favorable and then two quick housekeeping questions. Why is CapEx going to be more second half weighted? And then on tax, I think you’re the first company I've heard talk about a lot of variability in the tax rate. Maybe I'm wrong, but maybe can just talk a little bit about those two?

Sure. So at the beginning of the year we did say that we thought CapEx would be approximately $40 million for the year and we are trending below that. But that being said, just a cadence of certain projects, in the back half of the year, we knew would be able to more back half weighted and so you know our expectation is that, we'll be close to that $40 million or maybe slightly below from where we are today. But that still our expectation.

Okay.

With regards to tax, so – beginning of the year, we talked about how tax would be a few 100 basis points like we below from where we started the year. So think of it in that 26% to 27% sort of rate. If you looking us, if you think about our different jurisdictions, based on where we earned profitability. That rate can vary. And then also I think many other corporate, they talk to other companies as well that they are seeing how they're – making sure that they are incorporated in U.S. tax reform and that they're getting the proper deductions. So I don't expect a meaningful swing in our tax rate. But I just caution that we're at 25.2% today and it could go a little bit lower to go a little higher, but our expectation is in and around like 25.2% where we landed now.

Okay, fantastic. That helps. Maybe I’ll throw in one more, I mean, so transportation I know you are lapping a stiff comp, but year-to-date seems to be in good shape. Is there – can you remind us again what you think the long-term run rate, growth rate, normalized growth is for these end markets as we think about the business beyond the one quarter?

Yes, I mean for us as you said, we're really lapping at just a very positive quarter last year. We recall we – that was when we introduced our new Asian distribution agreement. We’re still very positive on this. We think its 5% to 7% growth rates long-term.

Okay.

It's one of our more positive market trends I think.

Okay, great. Thank you, guys.

Sure.

Thank you. [Operator Instructions] And we have a follow-up from Dan. Your line is open.

Hi, just let me one more, can you comment a little bit more of what you're seeing, if there was any significant change quarter-to-quarter kind of in filtration and market product replacement cycle, I even phrase it correctly. Was there any thing to comment on or kind of steady as it goes?

Yes, if you recall, we actually have two major categories in our filtration business. We have one that's reverse osmosis focused and one that is more processed industries focused. On the reverse osmosis, if you recall, last year we were a little disappointed in the growth rates of that marketplace. It was below the long-term trends. And we’d indicated at the time that that is really being driven by an extension of the replenishment cycles as low energy prices enable them to be able to put that off for a while. But we always said that that would trend differently and eventually you would need to see that replenishment cycle increase. The combination of that extension and energy prices starting to creep up, we're starting to see that replenishment cycle increase. We're hearing our customers talk much more confidently about their forward projections around that. And so that has been a good performing segment for us over the last couple of quarters, and we're hoping that will continue to see that same trend going forward. On the process industry side, we've just seen very strong orders coming in through semi – use of our products and semiconductor manufacturing and also in hydraulic vehicles where they play a role in a lot of the filters that are used for the fluids in those construction equipment et cetera. So overall those two key segments are operating well our air business is stable and so the filtration marketplace has just been good for the quarter.

Okay. That's good. Is there any reason to think there's a differential in margins between process in RO or about the same?

No. It's about the same. I mean they're good margin products for us [indiscernible].

Terrific. Thanks again.

Okay. Thanks Dan.

Thanks Dan. End of Q&A

Thank you. And I am showing no further questions at this time. I'd like to turn the call back to management for any closing remarks.

I appreciate everybody participation we're working hard and we hope to speak with you again in a positive light in the coming quarters. So thank you.

Thank you, Ladies and gentlemen for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.