Mativ Holdings Inc (MATV) 2011 Q3 法說會逐字稿

Welcome to SWM's Third Quarter 2011 Earnings Conference Call. Hosting the call today from SWM is Frederic Villoutreix, Chief Executive Officer. He is joined by Pete Thompson, EVP Finance & Strategy 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 for US and 404-537-3406 for international and enter PIN #20755526.

(Operator Instructions)

It is now my pleasure to turn the floor over to Mr. Humphrey. Sir, you may begin.

Thank you, Jackie. Good morning. I am Scott Humphrey, Corporate Treasury Director at SWM. Thank you for joining us to discuss SWM's third quarter 2011 earnings results.

Frederic will discuss the key factors impacting our business. Pete will then provide additional detail related to our third quarter results and outlook. We will then take your question.

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 are therefore non-GAAP financial measures. At this point, I will turn the call over to Frederic.

Thank you, Scott, and good morning, everyone. On today's call I will share some eye-level comments about our third quarter performance and cover our full-year 2011 and initial 2012 outlook and priorities including updates on the progress meeting EUP and Lower Ignition Propensities cigarette paper requirements and Chinese reconstituted tobacco expansion. Pete will then take you through a more detailed review of our financial results and guidance.

Slide four summarizes our financial results for the quarter. Improvement in third-quarter revenue and earnings measurements primarily reflect gains in our paper business driven by the advance of EUP and LIP requirements partially offset by an expected decline in the sales and earnings from our reconstituted tobacco business.

We also recorded a $15.9 million allowance for a type of value-added business stocks in our Brazilian units which Pete will cover further.

Continued inflationary cost increases, somewhat higher production costs including EU LIP start up and efficiencies, and increased non-manufacturing expenses, primarily from LIP legal actions, partially offset the benefit of increased LIP sales.

Adjusted earnings per share improved to $1.54 an all-time quarterly record for SWM reflecting improved business performance as well as a lower effective tax rate during the third quarter due in part to tax incentives associated with LIP investments in Poland and a reduction in shares outstanding following our $105 million open market repurchase of approximately 2 million shares earlier this year.

Cash generation decreased compared to the third quarter last year primarily due to a less favorable change in working capital while net debt increased primarily reflecting share repurchase activity earlier in 2011.

Total debt has increased versus the prior year due primarily to the share repurchase activity and working capital increases to date in 2011.

Moving to operational trends on slide five. Our third quarter results reflect the expectations we have communicated for our business in 2011 with overall earnings growth due to EUP and LIP implementation despite somewhat decreased demand for RTL.

General macroeconomic activity in terms of inflation rate cost increases and currency volatility had a negative impact on our third quarter results, but at a reduced rate compared to earlier in 2011.

Primarily (inaudible) costs have now swung to a net favorable year-over-year comparison. We also continue to drive improved operational performance for our Lean Six Sigma initiatives, all be it, third quarter overall manufacturing cost performance was negatively impacted by EU LIP (inaudible) costs and the impact of lower RTL demand on overall operate absorption.

Non manufacturing results remain high during the quarter for LIP related legal actions but the rate of these expenses should decline over time given recently announced progress in resolving disputes via license agreements.

In total, we are pleased with our third quarter performance and are poised to build on the positive momentum in our business to finish out a solid 2011 result and achieve further growth in 2012.

We continue to have a full slate of activities and our overall execution remains solid during the third quarter which bodes well for completing the considerable work remaining this year and into next.

Turning to slide six, we have made further significant progress on several of our key growth initiatives. EUP and LIP activities rapidly expanding and we've fully utilized available capacity during the third quarter and anticipate further growth during the fourth quarter as customers act to comply with regulations.

We continue to estimate our share of the EUP market to be approximately 40%, although likely we remain effectively above this level during initial implementation.

We continue to foresee generating more than $50 million in incremental annual pre-tax earnings from the EU LIP opportunity. We recently announced entry into a non-exclusive world-wide patent license agreement with one of our major competitors, which supplements other such agreements with customers.

We continue to work towards resolving LIP legal actions for licensing efforts, which importantly allows the industry to focus on supplying products to meet our respective customer needs.

Activity is speeding up related to our Greenfield RTL facility in Eunan Province, China to be called CTS for China Tobacco Schweitzer. Progress has been made toward completing of the remaining steps to enable the start of construction and we expect to begin funding our $27 million to $30 million equity share yet in 2011.

Along with our existing Chinese paper joint venture, China Tobacco Mauduit or CTM, which delivered another increase in quarterly profitability we are well on our way to establishing a significant market position for a range of products in the world's largest and fasted growing tobacco markets.

We expect CTS to begin commercial operations during 2013. Activity to suspend the Philippian RTL project was completed during the third quarter and work has begun to modify equipment for transfer to CTS for which we recorded restructuring charges during the third quarter.

Slide seven summarized our key business driver for 2011. Our objectives and priorities remain clear and we continue to focus on improving our execution.

We remain confident to deliver a third consecutive year of record earnings in 2011 on this ramp of EU LIP expansion. Further growth is expected to follow as LIP regulation advances to new markets and we commence RTL expansion in China.

Although RTL performance began to show a decrease in sales, volume, and earnings as we expected, we remain optimistic that the full-year performance for this business will be down only somewhat from 2010 levels.

We remain diligent in monitoring and adapting to market forces impacting RTL and will be opportunistic as time goes by in how to best take advantage of non-China, Asian, RTL growth.

With that, I will turn the call over to Pete to cover financial results and outlook.

Thank you, Frederic. I will now review our results for the quarter and update our financial guidance.

On slide nine, net sales increased 16% year-over-year for the third quarter. Excluding currency impacts, net sales increased to strong 8.7% for the quarter on higher LIP cigarette paper unit volume partially offset by lower RTL sales.

On slide 10, over the seven quarters presented changes in unit volume reflect general trends within the industry. LIP growth of 63% during the quarter from EU LIP implantation and resulting SWM share growth was offset by cannibalization of conventional cigarette paper requirements and excluding China, decreased market needs.

These same market trends negatively impacted RTL demand. Only China is showing consistent volume growth among major world markets in overall mitigated total SWM tobacco paper sales declines to a small 1% for the quarter.

The overall increase in SWM sales volume for the quarter among all products reflects increased low-margin non-tobacco paper sales that primarily serve to fill available machine capacity.

On slide 11, third quarter adjusted operating profit increased $2.3 million due to $13.3 million from higher sales volume, selling prices, and favorable product mix combined with $1.4 million in royalty income for LIP. These positives were partially offset by higher non-manufacturing expenses, inflation, and European LIP start-up expenses.

North American NBSK wood pulp prices average $995 per metric ton for the third quarter, slightly decreased from $1000 per metric ton during the third quarter 2010, and decreased 2.9% from the second quarter 2011. Pulp prices are expected for further decrease slowly into 2012 before rising later next year.

Energy costs rose $2.1 million during the third quarter approximately at the same rate seen during the first half of 2011. Energy costs are expected to continue to rise relative to prior year levels but within the range seen to date.

Foreign currency translation impacts were net unfavorable by $0.8 million during the third quarter. A favorable $2.3 million benefit from a 7% weakening of the US dollar to the euro was more than offset by an unfavorable $3.3 million impact from our net US dollar exposed Brazilian operation due to a 4.8% weakening of the US dollar to the real.

Highly volatile currency relationships worldwide likely will continue to cause a mixed impact on SWM earnings during the fourth quarter.

Slide 12 shows the strength of SWM's third quarter operating profit. The paper segment in SWM in total improved on both a sequential basis and year-over-year.

The RTL segment declined sequentially and versus the prior year. Further sequential and year-over-year increases and SWM operating profit are expected for the balance of 2011 and into 2012.

On slide 13, similar to operating profit trends, SWM's third quarter EPS result is improved sequentially and year-over-year. Earnings per share is expected to increase further as 2011 concludes both due to growth and earnings from European LIP and the expected continued benefit of a reduced share count partially offset by a likely somewhat lower lever of RTL results as seen during the third quarter.

During the third quarter, we recorded a $15.9 million valuation allowance against the book value of a Brazilian business tax credit called ICMS. After much effort, we were very pleased to have secured during the third quarter special government action to obtain tax-exempt status for the paper industry to enable more rapid utilization of these credits.

Since this special legislation has a sunset provision after four years and despite that we are working aggressively and fully plan to implement other actions to utilize these credits, the accounting determination was to essentially write off the total current balance.

Going forward, we will write back on any amount of the credits which do not expire upon implementation of these other actions. This item is completely non-cash and non-recurring which is why we reported it separately.

On slide 14, adjusted EBITDA from continuing operations totaled $44.4 million for the third quarter of 2011, which like operating profit in EPS, is improved relative to recent experience and not yet fully benefiting from full implementation of EU LIP requirements.

On slide 15, SWM net debt remained relatively stable during the third quarter compared to the second quarter while the increase versus year-end 2010 is due to share repurchases in working capital increases that occurred earlier in the year.

Total debt was 27.2% of capital and SWM's net debt to adjusted EBITDA ratio remains low at 0.64 as of September 30. Net debt is expected to decline by year-end as cash uses decrease and cash generation from operations grows coincident with expected earnings growth.

On slide 16, the increase in net debt to date in 2011 reflects cash uses that include $105 million in share repurchases, $29 million increase in working capital requirements including employee severance liabilities as well as European LIP related increases in trade working capital amounts, and $52 million in capital spending including $31 million for the RTL project in the Philippians and $9 million for EU LIP capacity additions.

For the full year, we now project all cash uses to range from $225 million to $240 million. Given the completion of the authorized share repurchase in early July, no further working capital increases during the third quarter and the winding up heavy Philippian RTL and European LIP capital spending, cash uses during the fourth quarter are expected to be well below the first nine months of 2011.

For 2012, we expect cash uses to be considerably below 2011 levels. Capital spending should be more in line with historical maintenance levels of approximately $35 million and other cash uses including funding the China RTL joint venture of about $45 million.

On slide 17, we turn on invested capital to date in 2011 is remaining steady at 15.3% above SWM's cost of capital but below prior year levels primarily due to increase in vested capital as net income is relatively unchanged so far in 2011 compared to 2010.

RLIC is expected to achieve year-over-year growth by the end of 2011 and further grow in 2012 due to the earnings gains from EU LIP on stable levels on invested capital.

On slide 18, we are maintaining our full-year earnings guidance to be at least $5.40 per share excluding restructuring and impairment expenses and the allowance for the Brazilian business tax.

We reiterate our underlying expectations for business performance during 2011 including further increase in earnings from European LIP sales growth.

Additionally, we expect to realize about $4 million in royalty revenue in the fourth quarter associated with LIP patent license agreements that are not specifically included in our earnings guidance.

The key risk to 2011 earnings continue to be inflationary cost increases with energy continuing to be more of a risk than any benefit from pulp prices. Remaining European LIP start-up expenses and further legal expenses related to LIP patent actions.

Given macro economic instability, the impact of currency is difficult to predict and therefore likely presents an equal range of risk or opportunity to our earnings guidance.

These risks are not projected to result in SWM's 2011 earnings differing materially from our expectations. We expect growth in 2012 earnings likely to be in line with an annualized rate of fourth quarter 2011 results but are not providing a specific range at this time given the difficulty in projecting full run rate LIP earnings that now include a higher level of royalty income.

That concludes our remarks.

Jackie, please open the line for questions.

(Operator Instructions). Your first question comes from the line of Bill Chappell with SunTrust.

First question, just trying to understand the LIP ramp this quarter and how that compares going forward. Is there any way to gauge -- did you see 60%? Did you see 75% of full capacity and how we'd look at that going into the next quarter?

Good morning, Bill. I think it's difficult to give you a very precise answer because we are still in the inventory build mode, and we obviously have an idea of what we contracted with the major customers, but we may be in fact running slightly ahead of that contract level if you want, without knowing it due to the noise that comes with building inventory ahead of implementation.

I would say based on our capacitization or learning curve and the fact that we have a new capacity that came along during the third quarter, you should expect a stronger volume output in the fourth quarter.

And as we stated in our talking points that this fourth quarter will be more in line with what we'd expect as a running rate for next year. So expect a little stronger, but not necessarily a major shift - a step-change from third quarter getting into the fourth quarter.

Looking at it another way, were you at full ramp in September or has it incrementally improved as it's moved into October?

We were not in full -- I think you still have a learning curve, so until the capacity we have -- we were going through the learning curve for the additional equipment that we installed during the third quarter so even across all the production lines we are seeing efficiency gains month after month.

So again, I think you should expect a strengthening of the sales and earnings from LIP during the fourth quarter over the third quarter and that fourth quarter representative of what we would expect next year.

Bill, this is Pete. Just to add on to that. within the quarter, there was a significant different and profitability in September versus July. So to say, as Frederic has said, to predict at this point where will we plateau, all we can say directionally is it definitely will be higher than the third quarter, but where does that plateau end in terms of volume, cost performance, is difficult to say at this point.

OK. And then one last question. You had said in the release that you're still holding steady at 40 share, is that kind of a best guess because I would have thought you'd probably picked up a few points of share as you picked up from competitors who couldn't meet the needs of their customers.

Again, right now we affirm that we have secured a share of approximately 40% of EU LIP market, but we also are signaling that we may be running slightly above that level right now during the implementation stage but cannot project whether this additional volume will be sustained over the next several years.

So I think right now, per contract and our view is that we have secured approximately 40% share and maybe running slightly above that rate for the time being.

And then last question and I'll turn it over. On RTL, your comments going into next year, I know you've been surprised that you've been able to make up lost orders this year, just trying to understand why profitability might step down next year.

And then in the update as you look to the restarting the Philippians in 2013, 2014 as we get closer to the next years' crops and orders from that standpoint.

While I think you're right to say that 2011 is shaping up to be a better year than we had initially projected from a volume standpoint, right now, getting into 2012 our view is that revenue will be flatish in euro currency and obviously you have to apply all the caution as to what currency volatility may happen next year.

And we continue to do well with our operating efficiencies, our cost reduction program, so 2011 is going to be a very good year and 2012 right now is somewhat in line with 2011 but probably a little bit more exposure to uncertainty as to volume in currency as we would have -- so that we cannot give more precision to our projection, but this is going to be another solid year 12 in terms of volume output, but it's difficult to expect growth at this stage year on year from a revenue standpoint.

And on the Philippines is that kind of on hold for a while?

And on the Philippines I think we continue to make good progress in developing demand with Asia. We are seeing some significant increase in demand for Chinese customers. We're projecting increases in demand for Chinese customers in the two years to come ahead of the start up of a joint venture in China.

We are making progress developing demand and new products for Asia, excluding China, customers and I think we also expect the pricing of natural tobacco leaf to strengthen over the next two years.

So I think all data points will point to us revisiting the opportunity restart the Philippines operations over time, but the priority right now is to start up the Chinese business with the understanding that there will be some transparent production from France to the Chinese joint venture when that happens in late 2013.

So it is premature to set up a date as to when we would expect the Philippines investment to be reactivated even though we continue to see mid-term, the trends pointing to the opportunity to manufacture and sell [recon] in Southeast Asia in the years to come.

Great. Thank you.

You're welcome.

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

Good morning.

Good morning, Ann.

Congratulations on a great quarter and a good ramp up of LIP into the EU.

Thank you.

Starting with the LIP market share, you talked about this a little bit. Is there any pull forward in volume in '11 that'll be pulled forward from '12?

It's difficult to say with precision because we don't have full visibility of the plans our customers, but I would say no, we should continue to see -- right now the focus is on building inventories not necessarily in excess of what the steady state customers would want to keep because it's a big effort for the industry to get ready for this November implementation, and I do not anticipate any substantial inventory builds in 2012 and probably no inventory build at all.

Okay, great. And then the $4 million in LIP royalty numbers that you called out that you'll run in Q4, is that a quarterly run rate we can use going forward?

No it is not. I think part of the agreement on this license deal is that there is a $4 million minimum royalty payment every year for the first five years of the contract since we signed this agreement in early November, this $4 million will fall into - sorry in October - this agreement will fall into the fourth quarter, but it's not representative of the quality activity.

Okay. That helps. And then can you comment on expected plant downtime in Q4?

I think we should have the typical downtime in some of our paper mills around the Christmas, New Year's Eve period. We have a solid order book for most of our facilities getting into the fourth quarter, so I would anticipate the downtown to be no greater and probably a little bit less than what we have seen in the previous years.

Great. And then finally, we're expecting a significant step-up in cash flow next year can you comment on the use of that cash flow?

Ann, this is Pete. The two key uses will be $35 million that we've indicated for capital spending and then the second will be funding for the Chinese [recon] joint venture. How that falls, the $27 million to $30 million equity contribution, how that falls this year versus next year, we're still working through that there'll be still a considerable amount of it next year. Those will be the two major items and we've indicated that total cash uses will be about $80 million at this point is what we see.

That's great. Thank you very much.

Sure.

(Operator Instruction) Your next question comes from the line of Alex Ovshey with Goldman Sachs.

Good morning.

Good morning, Alex.

On the royalty income side, it looks like you were booked $1.4 million in the third quarter; you'll book another $4 in the fourth, so that's $5.4 million for '11. As we think about '12, is that $5.4 million the base number we should be thinking about, and ultimately what's the right way to think about the upper end of the royalty income stream. I mean what drives that number to be potentially be higher or lower than $5.4 million next year?

I think, again, somewhat difficult to give you a precise answer. I think because we simply don't know what the market share commitments are that this competitor that we signed a deal with has achieved or whether it's sustainable. At the time, we don't have this visibility.

So we will take a cautious approach and I think the way to think about it is being in the third quarter of '11, we are specifically reporting revenue associated with royalty income, the $1.4 million that you're referring to, you will see that materializing with further increase in royalty income during the fourth quarter and then we'll report it every quarter from then on.

Obviously, we will incorporate royalty income in our guidance in the quarters to come, but it's going to be difficult to give a forward look that is quite precise because again, this is not something that we have direct control over.

Okay, Frederic. And then on the second quarter call, you talked about signing licensing agreements before year-end - you feel comfortable with the ability to do that. Certainly you signed a very big one earlier in the third quarter or the beginning of the fourth quarter. Are you expecting to sign more licensing agreements for the LIP technology before year-end 2011?

Well, we're certainly continuing to work on this front. As you know, we still have legal action proceeding in the US and to some degree in Europe as well, and as such, there is incentive for all parties to continue to entertain settlement options through license agreements and we continue to have this kind of discussions with customers as well as they are also worried about security of supply with the (inaudible).

So yes, we continue to have discussions. Difficult for me to answer precisely on whether there will be productive outcomes before the end of the year, but activity continues on.

Okay. Two last quick questions. On the legal expense side, would you be able to tell us what your legal expenses have been year-to-date in 2011 and really how to think about that legal expense number in 2012 given that you have signed such an important licensing in 2011.

What we disclosed in the queue, Alex, for the first time is that in the third quarter, LIP related legal expenses caused a $3 million increase year-over-year in non-manufacturing costs and through the first nine months, its $7 million.

In the fourth quarter, we're within our at least 540 guidance. We're anticipating fairly high continued legal expenses. We're right in the midst of the ITC trial so this is still a heavy expense period.

With the settlement with one of our competitors, we would expect that legal expenses will decline or should decline over time; however, if we still have infringing product in Europe and have to enter new disputes, patent infringement suites in Europe, then it may not decline that much.

So it's been significant. $7 million is a lot. It's difficult to say though at this point, other than it should go down. How much will it go down -- and there is a risk it might not, depending on future legal actions.

Thanks a lot for that, Pete. And just one last question. Can you talk about the tax rate for 2012 and how should we be thinking about that?

Yes, we're seeing right -- we saw a low effective tax rate in the third quarter because we're burning through the tax credit that we have Poland, so it's quite beneficial.

We'll see more of that in the fourth quarter and then we should plateau out for this full year 2011 at around a 30% effective tax rate and that high 20% around 30% should be where we're at going forward in 2012.

The key to that is even once we've used the Poland tax credit, the ongoing Poland corporate tax rate is 19% so it'll bring down our consolidated rate. Again, we should be averaging, all told, high 20s, around 30%.

Okay. Thanks very much.

Sure.

At this time, we have no further questions.

Okay. Thank you, Jackie. Thank you very much for joining the call. We appreciate your interest in the company. Pete, Scott, and I will be in our offices today and if you have any follow up questions, please give us a call. Have a nice day.

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