Mativ Holdings Inc (MATV) 2017 Q2 法說會逐字稿

Welcome to SWM's Second Quarter 2017 Earnings Conference Call.

Hosting the call today from SWM is Dr. Jeff Kramer, Chief Executive Officer, he is joined by Allison Aden, 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.

(Operator Instructions)

It is now my pleasure to turn the floor over to Mr. Chekanow.

Sir, you may begin.

Thank you, Karina.

Good morning.

I'm Mark Chekanow, Director of Investor Relations at SWM.

Thank you for joining us to discuss SWM's second quarter 2017 earnings results.

Before we begin, I'd like to remind you that the comments included on 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.

Reconciliation 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 operating metric comparisons are to the prior year period and relate to continuing operations.

This presentation and earnings release are available on the Investor Relations section of our website, www.swmintl.com.

I'll now turn the call over to Jeff.

Thank you, Mark, and good morning, everyone.

We are pleased to report a solid second quarter with adjusted EPS of $0.88.

Many of the positive trends across our business from the first quarter continued to develop in the second quarter and our year-to-date results are generally consistent with our guidance assumptions.

I can sum up the quarter’s operating results by highlighting that accelerated organic growth in AMS up 10%, continued execution on the Conwed integration and pockets of strength in our reconstituted tobacco business, essentially offset the anticipated challenges in our cigarette paper operations.

This resulted in flat organic sales, while total sales were up 17% with the Conwed acquisition.

While free cash flow year-to-date is below last year, we expect significantly higher free cash flow in the second half of the year, our seasonally higher cash flow quarters.

While we don't give explicit guidance, we generally expect 2017 free cash flow to approach the nearly $100 million we generated last year.

Moving now to segment discussions.

For the second quarter, AMS net sales were up 10% excluding the Conwed acquisition.

This is a significant acceleration from the 3% organic growth we saw in the first quarter of the year and was largely driven by our specialty films, which are used in automotive paint protection as well as glass lamination applications.

We are currently experiencing growing momentum in this product line especially in Asia, where we have made significant inroads into new sales channels.

While growth in future quarters may not always match the current pace, the underlying long-term demand is strong and we are committed to maintaining our leading position.

We will invest in capacity worldwide to meet this increasing demand and serve our customers in their home regions.

We have recently green lighted an investment to add surface protection film capacity in Europe to service international markets, leveraging an existing AMS plant with strong technical expertise and specialty film production.

Capitalizing on this growth through our existing infrastructure is a key example of the benefits of our scaled AMS platform.

As a medical film facility acquired from Smith & Nephew several years ago, allows a high return investment in the surface protection film business, we acquired with Argotec.

Our other key end-markets in the base AMS business were more mixed, our industrial end-market continued to show growth, while filtration and medical sales were lower.

We are however, encouraged with customer indications pointing to an upturn in RO water filtration in the coming quarters after more than a year of fairly muted activity.

Also, lower medical sales were largely due to delivery timing issues.

The accelerated organic sales growth also had a positive impact on mix and margins as did early-stage Conwed synergies.

These 2 factors contributed to a particularly strong segmented adjusted operating margin of nearly 20% in the quarter and nearly 19% to date.

From a historical perspective, AMS began as a 13% adjusted operating margin business and through building scale and focusing on optimizing this growth platform, we have made substantial progress on our key strategic priority of driving improved profitability.

Speaking specifically on Conwed as a whole, we continued to deliver results consistent with the assumptions embedded in our original accretion estimates.

Similar to the first quarter, erosion control products performed well, as we continue to benefit from strong highway development activity.

Additionally, we are seeing increased penetration of our runoff containment or sediment control products used in oil and gas sites and various construction projects.

As we disclosed last quarter, we have begun a significant footprint consolidation project with the phase closing of a legacy AMS site by the end of 2018.

Synergies from this project are a key component of achieving our $10 million run rate at the end of next year and are on plan.

We have taken some initial headcount actions and the first phase of asset relocation has commenced to allow the absorption of this site's volume across our other AMS sites.

Switching to Engineered Papers.

Second quarter again saw expected pressure on sales and profits.

Segment volume was down 2%, driving a sales decrease of 5%.

Volume performance improves sequentially, largely due to stability in our reconstituted tobacco business.

Our portfolio of cigarette papers experience lower volume due impart to the impact of market declines in Russia and surrounding regional markets, mostly related to higher excise tax.

In addition, lower pricing in LIP royalties and currency also impacted sales.

While challenging, these factors are consistent with our outlook as certain LIP pricing concessions and the contractually lower royalty rates were known at that time we gave guidance.

Regarding reconstituted tobacco, I'd like to take a moment to clarify some of the product lines and language we used regarding this product portfolio, as these has evolved in the past year or so.

Historically, this business was largely comprised of traditional reconstituted tobacco leaf or RTL, with a much smaller portion of volume from a niche product line called wrapper and binder using machine made cigars typically sold in the conventional retail channel.

Traditional RTL -- RTL remains the largest volume component and has historically been the focus of our discussions.

However, recent high growth in wrapper and binder has led to more frequent mentions on our earning calls.

More importantly, in recent quarters, we have also been discussing our Heat-not-Burn sales, which is another form of reconstituted tobacco used in certain next generation products launched by several cigarette manufacturers to reduce smoking related health risks.

Going forward, when assessing performance, we will typically refer to total reconstituted tobacco or total Recon, which encompasses all products.

And to the extent we comment on specific areas, we'll use the terms traditional RTL, wrapper and binder and Heat-not-Burn for additional clarity.

To that point, during the second quarter, totaled Recon volume was stable with growth in wrapper and binder and the initial sales ramp of Heat-not-Burn offsetting the decline of traditional RTL.

We note that traditional RTL sales remain lumpy from quarter-to-quarter and volume is expected to remain a headwind in the near term.

Lastly, the non-tobacco paper volume was higher, although most of the increase was in lower margin products.

On another note related to paper margins, we are pleased to report that the majority of the line restart issues that impacted our first quarter 2017 results were resolved.

Recall this temporary issue pushed up paper segment margins towards 20%, well below recent trends.

The 23% margin this quarter showed the sequential improvement we had expected, albeit lower versus last year when our paper segment was running at higher efficiency and elevated margin levels.

Regarding execution of our EP segment priorities, we remain on track with the 2018 commercial launch of specialty filtration papers to leverage redesign legacy paper assets through our AMS sales channel.

In the area of Heat-not-Burn tobacco products, positive momentum continues with further announcements of capacity expansion by cigarette manufacturers.

We believe our technical expertise and available capacity offer an attractive and expeditious option for our customers to capitalize on increasing demand in this product category.

For some perspective, Heat-not-Burn tonnage is currently only about 5% of our total Recon production.

We see escalating demand for the remainder of the year and expect that momentum to continue for the foreseeable future.

At this point, it is fair to say the increase in Heat-not-Burn could provide a solid offset to traditional RTL declines, and could ultimately result in total volume growth for the Recon product suite.

I will now turn the call over to Allison.

Thank you Jeff.

I'll now review our financial results starting with the segment performance.

In the second quarter, AMS net sales increased 64% to $118 million.

Organic sales grew 10%, and the Conwed acquisition drove the remainder of the growth.

GAAP operating profit was $16.6 million or 14.1% of sales.

Adjusted operating profit was $23.3 million or 19.8% of sales, up 310 basis points.

The margin expansion resulted from high organic sales growth and favorable mix, driven by the significant increase in surface protection films.

Lastly, the addition of Conwed's high-margin operation and related synergies also contributed to improved profitability versus last year.

The Engineered Paper segment's net sales were down 5%, driven by the overall volume decline, lower LIP pricing in royalties and negative currency impact.

EP segment sales mix was slightly positive in the second quarter, the adjusted operating margin was 23% down 230 basis points due primarily to lower LIP related sales and the reduced fixed overhead absorption from lower overall volumes.

The anticipated sequential margin improvement from Q1 2017, materialized as we expected.

Corporate and allocated expenses increased by 8% to nearly $8 million due primarily to CEO transition expenses.

But as a percentage of total SWM sales declined approximately 30 basis points to 3.1%.

On a consolidated basis, net sales increased 17%, but were flat excluding Conwed.

Adjusted operating profit was $47 million, up $5.5 million from the year-ago quarter.

The adjusted operating margin was 18.4%, down 70 basis points.

Regarding items excluded from adjusted operating profit, AMS segment noncash purchase accounting expenses increased to approximately $6 million, due to the added intangible asset amortization related to the Conwed acquisition.

For the EP segment, restructuring and impairment expenses were flat at nearly $1 million an increased by a little more than $0.5 million in AMS due to actions associated with Conwed synergies and organizational optimization.

Shifting to consolidated earnings.

Second quarter 2017 GAAP EPS was $0.72, down from $0.85 in the prior year.

Adjusted EPS was $0.88, down from $0.93 in the prior year.

Outside of the business factors already discussed, EPS was impacted by a higher tax rate of 31% versus nearly 27% in Q2 of 2016.

The increase in the tax rate stems primarily from the greater earnings concentration in high tax geography, such as the United States and legislative changes in Poland where a large portion of LIP profits are derived.

Currency translations remains fairly benign in the second quarter with a negative $0.01 impact to EPS.

In the coming quarters, we expect continued organic sales growth, but at a reduced level and margin expansion in AMS.

Additionally, Conwed integration and synergy realization should progress a continued increase profitability.

In EP, we expect LIP comparisons to improve and Heat-not-Burn sales to continue ramping up with traditional RTL [recon] requiring as a headwind.

We also expect our Chinese Recon JV to remain challenged.

Year-to-date, 2017 free cash flow was $24 million.

Historically, our second half of the year is stronger for cash flow and this year will be no exception, as we anticipate full year free cash flow to approach the $100 million we generated in 2016.

Timing related to working capital was a significant swing factor in the second quarter.

In part, due to our inventory build to ensure excellent customer service while we relocate some production equipment in AMS.

In addition, capital spending increased to $21 million in the first 6 months of 2017.

This increase is in large part due to the previously discussed modifications to an existing line to produce specialty filtration paper and the addition of Conwed's capital spending requirements.

We see significant opportunities across our business to capitalize on our product portfolio and improved profitability to reduced cost.

And we intend to continue investing where we see attractive paybacks.

As such, we now expect CapEx to exceed $40 million this year, up from the $35 million estimate we provided in February.

From a leverage perspective, for the terms of our credit facility, we were at 3.2x net debt to adjusted EBITDA at the end of the second quarter.

Up from 2x at year-end 2016, driven by the increased in debt at the closing of the Conwed acquisition in January.

Over the next 18 months, we expect that ratio to trend back towards the mid-2x range as a function of free cash flow generation.

Now back to Jeff.

Thanks, Allison.

In closing, I'd like to share some initial observation and takeaways from my first 3 months as CEO.

First, I believe SWM is nearing a critical inflection point, where our business is set to grow sales and earnings organically for the next several years.

Since 2013, there has been tremendous activity in establishing and growing AMS, while dealing with a mentally-tough challenge in our tobacco businesses.

The potential for our total reconstituted tobacco business to stabilize in 2018 and beyond, should allow for AMS growth to drive consolidated results higher.

Second, while we have achieved significant milestone regarding diversification outside tobacco with essentially half of total sales from non-tobacco areas.

SWM strategic transformation is still only in the middle innings.

I believe SWM investors have grown accustomed to the M&A discipline, patience and execution we have demonstrated and those principles will remain intact as we write the next chapter of SWM's transformation.

In the near term, our operating plan is largely written with a focus on delivering on the opportunity set at hand, particularly synergy delivery.

While we integrate Conwed, and execute our existing plans, we will be carefully planning our next strategic actions and laying the groundwork to support that roadmap.

Third, I am optimistic about many of the growth drivers I've seen across our business.

We are a specialty materials business within an increasingly diversified customer base and our reputation for technical expertise, and our present in attractive end-markets is presenting our team with actionable growth opportunities across both business segments.

Lastly but certainly not least, I'd like to thank SWM employees across the organization, who have welcomed me and shared their insights during the early parts of the CEO transition.

I've been tremendous impressed by a companywide talent levels and dedicated to excellence.

And believe my leadership experience can help channel our efforts to further drive SWM's transformation and foster a vibrant growth oriented enterprise.

We appreciate your continued interest and support and that concludes our formal remarks.

Karina, please open the line for questions.

(Operator Instructions) Your first question is from Dan Jacome from Sidoti.

A lot of questions here.

I'll just start with AMS segment and then switch over to RTL.

So first on the AMS, it sounds like you guys are now leveraging that what you bought from Smith & Nephew, couple of years ago and you said it's for the Argotec specialty films, I was just wondering why now it seems like it took a while.

I was just looking for some clarity there.

That was my first one.

I think what we've been doing is taking detailed look at the opportunities and how best to leverage our resources around the world.

We're always having good discussions about where are our new customer channels going to be located and where are the best places to make those investments and again, I think that's an example of really the discipline we take around using our capital effectively.

So this discussion has been going on for several months.

You heard us mention that we are establishing new sales channels in Asia, and we felt this was the opportune time for us to make an investments outside the U.S. to support that business and [gilbert hazardous waste] facility with a history of being able to handle high-performance material seems like a perfect location and so we just green lighted that investment and we're excited and hopefully that will not be the last one we make around the world to support this business.

Okay, great and then I need to do more research on this.

But why are these films exactly been kind of so popular in the Asia market?

What's happening there?

Is that the transportation market you said?

Yes, I think there's a number of different things that are happening out in the Asian market that are really playing into our trends.

I think we have a rising middle class, which means investments in transportation are becoming more important.

Some of the infrastructure is probably not at this stage to be able to handle that and so these large investments people are looking for ways to actually protect that investment long-term.

And I think what they're finding is that the surface protection films for automobiles or other aspects of transportation are a perfect fit to be able to really present -- being to protect their investment for the long term, and we actually have some unique technology that is allowing us to be able to basically make a high-performance film that is very optically attractive and I think that works really well.

Okay, good.

And then water filtration, just remind me again why was that market muted the last year or so and why exactly is it picking up now?

Yes, when we talk about water filtration, one of the primary end-used markets we're talking about is reverse osmosis system.

Those are large capital investments and there are 2 things that really drive those investments.

One is a replacement cycle, so once they have these investments up and running, they need to replace the filter media on a regular basis.

However, there is a little bit of a trade off with energy prices, so as these reverse osmosis facilities become a little bit more mature, the efficiency drops down, but that can be compensated if the cost -- energy cost are little bit lower and that extends their maintenance cycle.

Eventually though, that cycle does have to be -- does have to be completed and so we're starting to see a little bit of that.

The second is just the investment in these large long-term facilities.

That's a lumpy business, these are major investments as countries or facilities install them.

And so that tends to be a little lumpier.

We were in a little bit of slower cycle, but we're starting to see again that, that cycle is starting to pick up again and if you recall, long-term water capacity is going to be a driving force in many countries around the world and so we're -- we continue to be positive on the long-term prospects of the segment.

Great.

For those osmosis facilities, globally, just out of my curiosity, where are they based?

They are based around the world, a lot of them are in the Middle East and Asian countries right now.

Okay, okay, okay, good to know.

And then just staying on specialty films, specifically for this vertical, that you seem excited about on transportation.

What are the very high level industry wide capacity trends?

I'm just curious or is capacity overall increasing a lot?

Declining?

Flattish?

Just wondering.

Yes, we happened to be one of the market leaders of this and it seems like it would be a relatively straight forward product line to produce.

These are thermoplastic urethanes and that actually hard to make optically pure and with the right performance in layering characteristics.

So we're actually the market leader in this and we're going to continue to invest and make sure that we maintain that leadership position around the world.

Okay, good.

And then what about future end markets and technologies.

What are you most excited about not just about -- what are you excited about there?

Yes, I think we are excited about a number of our end-markets on the AMS side.

Transportation continues to be good.

We talked about erosion control and sediment control product lines.

We think that's a big in investment in the infrastructure around the world.

We are excited about that.

Filtrations, we've just discussed.

I think we have a number of end-market segments that we're going to be able to leverage and that's what's really exciting about reaching this critical mass, that we talked about with AMS.

I think when we've talk to people for instance as the Conwed acquisition et cetera.

They are excited about being able to join our global company, so that can accelerate their ability to penetrate into these market places.

So part of what we're doing over the next 6 months while we continue to act -- execute against our operating plan is to continue to find ways to grow those businesses organically and leverage the entire SWM infrastructure around the world.

I think those are nice opportunities for us that we can really exploit.

Okay, and where's the erosion control opportunity coming from?

Is that from the assets that you got from Conwed?

Yes.

Okay, and then what about just a last question on AMS, would the acquisition synergy buckets remind us again where the most of the low hanging fruit is for you guys?

Well, there's a number of different buckets I guess that you can consider for the integration synergies.

One of the largest is, as I mentioned, we're going to be closing 1 facility, a legacy AMS facility and absorbing that around the world.

We have some organizational cost synergies that we are finding.

There some resident synergies as we become more in critical mass.

So it's a pretty diverse bucket list of areas that we have to execute on.

But good news is that the integration is going accordingly to plan.

We're executing on most of the synergies that we are identified early on and we're finding some additional potentials that I think could be exciting for us in the longer-term.

Okay, great and then just switch over to RTL.

Sounds like you're more bullish on Heat-not-Burn, which is encouraging, can you just remind us again what are the adoption trend.

Let’s call it forecasted projections for North America.

I know it's picked up a lot in Asia, but there has been some uncertainty here state side, if I'm not mistaken.

Can you clarify that?

Yes, it's interesting and you might have seen there was a new FDA director that came out talking about the tobacco industry and everybody still kind of wrestling with what that means for the Heat-not-Burn activities.

In some respects that could be very positive for the adoption of it.

We've also seen announcements from people like BAT and PMI about they have made applications for both of their technologies in the U.S. And so both of those are progressing as well, so I don't really have a good crystal ball at the adoption rates, but I can tell you both companies are pushing very aggressively because the market segment seems to be attractive, but we do have to worry about what the FDA's interpretations are et cetera so that complicates it a little bit.

Yes, I saw that proposal.

It look, my best guess is it's going to take a while to play out.

Are you on the same mind frame?

Or do you have any high level thoughts on that keeping in mind you don't have a crystal ball here?

Yes, well my crystal ball is cloudy on that, but I think your observation is right, this isn't something that's an immediate impact that you are going to see tomorrow is have -- dramatic incline -- dramatic impact in the business.

We're having conversations actually with our customers to try to get their insights.

So this is only about a week old, so I'd rather not conjecture too aggressively at this time we are probably be able to comment more intelligently in the future.

Okay, and then wrapper and binder, how large is that exactly?

If you care to say on this call -- percent of your, kind of, total EP segment.

Is it small but Growing?

It's a small.

It's a small but profitable segment for us.

(Operator Instructions) I'm showing there are no further questions at this time.

I would like to now turn the conference back over to Dr. Jeff Kramer.

Well if there are no further questions.

Thank you, everyone, who has participated on this call.

We're available of course for additional discussions as needed for the rest of the day and we look forward to further calls in the future.

Thank you very much.

Ladies and gentleman, this concludes today's conference.

Thank you for your participation and have a wonderful day.

You may all disconnect.