Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Welcome to SWM's Third Quarter 2015 Earnings Conference Call. Hosting the conference for today for SWM is Frédéric Villoutreix, Chairman and Chief Executive Officer. He is joined by Don Meltzer, EVP of Advanced Materials and Structures; Bob Cardin, Corporate Controller; and Mark Chekanow, Director of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon. The dial-in number is 855-859-2056 and the PIN number is 69149860. 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.

[Mark Chekanow:]

Thank you, Shannay. Good morning. I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's third quarter 2015 earnings results. On today's call, Frédéric will share some high-level comments about our third quarter performance and outlook, strategic priorities and details on our tobacco operations. Don will discuss AMS and our recent acquisition of Argotec and Bob will take you through a review of our financial results. We'll 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 our Securities and Exchange Commission Filings, including our Quarterly Report 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. This presentation and the earnings release are available on the Investor Relations section of our Web site www.swm.com. I'll now turn the call over to Frédéric.

[Frédéric Villoutreix:]

Thank you, Mark, and good morning, everyone. Late yesterday, we released our third quarter 2015 earnings, and this morning we will present our financial results and business updates, including the recently announced closing of the Argotec acquisition, expanded credit facility and appointment of a new Chief Financial Officer. I would like to begin the call by quickly reviewing our financial performance, and providing some color on the key factors that influenced our results during the quarter and trends we expect to see through year-end. Third quarter adjusted diluted EPS on continuing operations was $0.89. The unfavorable net translation impact of currency movements was $0.09 per share during the quarter and expenses incurred in relation to the Argotec acquisition equated to $0.03 per share. Excluding currency impacts, our net sales were up 1% in the third quarter versus the year-ago period continuing our 2015 trend at stable constant currency revenue. As we close out 2015, the year in which our 2014 bolt-ons have helped offset tobacco related decline. We are looking forward to 2016 and believe our latest acquisition Argotec will position SWM to deliver a meaningful top line growth. We believe we’ve acquired a high quality asset that advances our strategic plan to diversify SWM and create sustainable long-term growth. Regarding our adjusted EPS guidance of $3.50, which did not contemplate acquisitions. We believe we remained generally on track through the third quarter when excluding acquisition related expenses. Importantly, the full-year negative impact of a lower euro is likely to significantly exceed the $0.20 estimate originally factored into our guidance, as the year-to-date impact has already reached approximately $0.28. Currency impacts remain a significant headwind to achieving our guidance. However, we’ve been working hard to achieve solid execution and cost controls across our business to mitigate this impact as our tobacco operations have performed slightly better than expected. In connection with the acquisition of Argotec, we’ve changed our capital structure and leverage, thought approximately 2.6 times net debt to EBITDA, we still consider ourselves conservatively levered. We believe our expanded credit facility and continued free cash flow will provide the necessary liquidity to pursue additional strategic M&A opportunities when they arise. Year-to-date we have generated approximately $65 million of free cash flow tracking flat with last year and we anticipate strong fourth quarter cash flow to conclude the year. I’ll now provide update on several of our key strategic priorities and developments beginning with Argotec. Our organization is pleased to have recently closed on the Argotec deal. The acquisition expands our AMS segment, giving SWM increased scale in our new strategic growth platform. We anticipate AMS will increasingly transform SWM’s strategic profile and growth rate as we continue to build AMS both organically and inorganically. This will counterbalance the long-term pressure that smoking attrition applies on our tobacco business. That said, we continue to invest in our tobacco business, which still generates the majority of our cash flow. Prior to the DelStar, SWM provides nearly all sales from the tobacco industry. However, with the addition of Argotec on non-tobacco sales which includes AMS and non-tobacco papers, are projected to be well over $100 million next year. AMS as a portfolio of high value resin based nettings, films, and non-wovens that we sell into the growing specialty filtration, medical and industrial end segments. In summary, now that we’ve completed the DelStar acquisition with two bolt-on acquisitions in medical and filtration products, and now Argotec, we’ve significantly expanded our film capabilities, gained access to attractive new industrial segments and create a significant balance and diversity of our income streams. Another key priority has been finding a permanent Chief Financial Officer. Allison Aden, the former CFO of two international companies, Americold and Recall, has just joined SWM. Allison brings an extensive background in financial management of global operations, as well as rich experience in strategy planning, M&A execution, and integration. She joins us at a very important juncture. This addition completes the management transition and the realignment of realignment of my executive team. I’ve every confidence that the team will now have in place is uniquely suited to drive our diversification and strategic transformation for the foreseeable future while maintaining a high level of focus and strong execution within our tobacco business. I’d like to thank Bob Cardin for his substantial contribution as our interim CFO over these past two quarters, an exceptionally active period for SWM. As we have discussed on previous investor calls, the evolution of our non-tobacco operation that progress throughout the year. We have created a new [indiscernible] specific business unit hired an experienced industry leader of that business unit, Don Meltzer, our EVP of Advanced Materials and Structures for AMS and renamed our filtration segment to more accurately reflect our vision and focus on high value technologies in resin based raw goods. This key infrastructure building steps along with the closing of the Argotec acquisition are central to the repositioning of SWM over time. As a diversified engineered materials growth company, we’ve a core technology portfolio targeting a range of attractive end markets. Of course, filtration remains a key end segment in an area in which we seek acquisitions as are the medical and specialty industrial end segments. Our Chinese Recon joint venture, CTS, had a quiet third quarter and generated a small loss. As communicated on our second quarter investor call, when we -- the JV posted a sizable $0.07 profit, quarterly variations are expected. While we anticipate a strong fourth quarter of CTS, and estimate the joint venture will finish the year with a $0.12 adjusted EPS contribution, it will fall short of the original $0.16 expectations. We attribute the shortfall to certain tobacco industry dynamics in China. Tobacco leaf inventory has grown in an even more pronounced fashion than we’ve seen in other geographies, resulting in oversupply and lack of incentives to drive accelerated use of reconstituted tobacco products. In reviewing the 2016 outlook for the JV with our 50-50 partners and customers, profits are forecasted to go substantially from 2015 levels. But we consider it unlikely that the facility will ramp up to full capacity by the end of the year as originally expected. Lastly, after a collaborative effort between SWM and Altria, one of our top customers, we have modified and expanded our supply contract in relation to our dedicated plant in Spotswood, New Jersey, through 2019. I’ll now discuss our operations and quality performance in more detail. Tobacco paper volumes, including our Paper JV in China, gave out a good third quarter growing 3% compared with third quarter of 2014. Within tobacco papers, our LIP volumes grew 3% as well in the third quarter, as volumes across our customer base were quite healthy. While we believe we’ve have gained share with many customers, we also saw some high volumes due to inventory deals, that’s a portion of this volume growth and resulting margin performance is likely now sustainable. Of note, we also saw good volumes in roll your own papers, which also carry higher prices and margins. Our non-tobacco paper volumes declined 15%; it’s primarily due to our continued de-emphasis of printing and writing paper production. Recon segment volumes declined 10% during the third quarter 2015, including the year-to-date volumes down 2%. We believe that certain shipments shifted into the early part of the fourth quarter from the third quarter, driving the decline. However, we expect fourth quarter segment volumes to be up resulting in full-year 2015 segment volumes finishing slightly higher than 2014, consistent with the outlook we communicated earlier this year. These 2015 quarterly results and trends do not alter the fundamental challenge of an oversupply of tobacco leaves that we communicated in our second quarter call, which is expected to drive the Recon segment volume decline of at least 10% in 2016. We expect to have greater visibility later in Q4 of 2016 Recon trends and we will address the volume outlook on a full-year earnings call in February. Wrapper and binder volumes remain a drag on volumes and more importantly on mix and profitability. As noted, volumes on the Chinese Recon JV were minimal in the quarter. I’ll now turn the call to Don to review AMS.

[Don Meltzer:]

Thank you, Frédéric. AMS net sales were up 26% in the third quarter versus last year. Our bolt-on acquisitions provided strong growth and performed well delivering more than $9 million on the top line with good profitability. The base DelStar business, however, continues to feel the consequences of volatility in commodity prices, as it’s been the case for most of this year. Organic growth was a negative 2% during the third quarter. Industrial filtration customers largely those who service the oil, gas and mining sectors, as well as negative currency impacts were the primary fundamental drivers impacting sales performance. In addition, throughout 2015, we’ve been migrating the manufacture of certain products to the sites acquired in late 2014, shifting sales out of the DelStar base business, further impacting year-over-year comparison of reported organic growth. Importantly, reverse osmosis water filtration sales delivered another quarter of steady growth and the DelStar expansion in Poland is now generating revenue and is tracking towards breakeven in the fourth quarter, with profit contributions beginning next year. Despite several challenges, some of which are pure -- purely external macro factors, AMS margins in the third quarter improved year-over-year from 13.2% to 13.8% in part due to declining resin prices. As we look to set the stage for multi-year sales growth, we are moving our DelStar operation in China into a bigger more modern facility over the next two years. This project is intended to upgrade our infrastructure increase -- and increase our capacity by approximately 13% with state-of-the-art new production lines to accommodate the regional growth we anticipate in both high-end filtration and medical applications. Shifting to Argotec, we’ve added another exciting growth catalyst to a mass and are pleased with Argotec’s positive momentum on both sales and margins. We’ve added a significant amount of new film technology to our portfolio and while Argotec is already well positioned in the specialty industrial applications, such as paint protection and safety glass lamination, we believe our existing presence in the medical space can help Argotec accelerate penetration in this attractive area. Now that we have achieved more critical mass in the AMS segment, we'll be looking at longer-term initiatives to maximize the value and create synergies across the platform. The four AMS businesses we acquired have many similar attributes including technology, production techniques, customers, and market segments that we believe will produce long-term strategic and financial benefits. Our intention is to optimize our manufacturing assets and commercial interfaces to capitalize on strength of our organization, which now offer -- offers a broad spectrum of high-value nets, films, non-wovens across a defined set of growing end segments. Regarding Argotec integration we’ve already begun our process, which will largely entail HR, Finance, and IT as well as a transition of the currency yields responsibilities to other executives. The currency yield was part of the investment group that previously owned Argotec and moving forward, he has kindly agreed to assist us over the next few months with the transition and integration execution. I'll now turn over the call to Bob.

[Robert Cardin:]

Thank you, Don. I'll now review our financial performance during the third quarter, beginning with sales. Third quarter net sales decreased to 9.7% versus the year-ago period. On a constant currency basis, third quarter net sales were up 1% as the Euro remains lower versus the prior year period. Excluding the fourth quarter 2014 acquisitions, net sales would have been down 14.3% or down 3.5% on a constant currency basis. The acquisitions contributed $9.3 million of net sales during the third quarter and currency movements had a $22 million negative impact on net sales. Third quarter Paper segment net sales, which includes non-tobacco paper, but excludes sales from our Chinese Paper JV were down 13.7% versus the prior year period. Currency had a large impact on segment net sales accounting for more than 90% of the decrease with constant currency segment net sales estimated to be down 1%.Lower volumes and planned LIP pricing concessions were largely offset by favorable mix. In the Recon segment, net sales declined by nearly 27% versus last year's third quarter. The Euro decline accounted for nearly half of the sales decrease with the remainder resulting from the 10% volume decline and also negative mix impacts. The AMS segment generated 26.1% net sales growth in the third quarter versus the prior year period. The currency impact was negative approximately 200,000. Excluding the December 2014 acquisitions, the base business declined nearly 2% due to the factors Don detailed earlier. Adjusted operating profit was up nearly $5 million in the second quarter versus the year-ago quarter. Note that in the table shown on this slide, the four bars on the left represent changes due to gross profit items, non-manufacturing represents changes in SG&A, and net currency is shown on the far right. The late 2014 acquisitions are not material to SWM's overall results and have been consolidated into the table. We experienced another quarter of strong improvements in other cost of sales this was primarily a result of improved capacity utilization coupled with ongoing cost reduction activity. The positive impact of other costs control efforts is evidenced in the reduction in nonmanufacturing costs. Net currency continued to present a headwind which we believe will continue through the fourth quarter as well. Paper segment adjusted operating profit during the third quarter was up $4.6 million versus the same period in 2014, with adjusted operating profit margin of 20.5%, up nearly 600 basis points versus the prior year quarter. Our tobacco paper volume, specifically LIP, were particularly robust which drove better fixed cost absorption as well as contributed to a more favorable mix. However as Frédéric noted, a portion of that volume benefit and its translation to margin may not be sustainable, as certain customers appear to be building LIP inventory. Also, as we have discussed previously, we rebuilt a line in one of our paper mills in France and are encouraged by the recently improved results. For the Recon segment, adjusted operating profit in the third quarter of 2015 was down $3.2 million versus the year-ago period, though adjusted operating margin in the third quarter was flat versus the year-ago period. Our team has made significant strides in cost controls as we right size our business for current demand. Currency movements accounted for nearly half of the profit decline. The AMS segment reported adjusted operating profit of $5.8 million in the quarter, up $1.4 million versus last year's third quarter. The base business continued to experience start-up process from DelStar Poland, as well as weakness in the high margin sales of industrial filtration products related to the oil, gas and mining sectors. These challenges are offset by the contribution of our acquisition which maintained the operating momentum we saw in the second quarter of this year. Looking forward, we anticipate that Poland will deliver improved results as well as sales traction from new product across the business. Furthermore, as we close 2015 and enter 2016, we expect the impact of negative industrial filtration comparison to ease and AMS to exhibit improved organic sales growth. Unallocated corporate expenses decreased by $2.1 million in the third quarter of 2015 versus the third quarter of 2014. The decline was primarily due to timing of certain SG&A expenses compared to the prior year. Our third quarter 2015 adjusted diluted earnings per share from continuing operations was $0.89 and included approximately $0.09 of negative currency translation impacts, as well as a $0.03 hit from transaction expenses related to Argotec. Excluding the impact of Argotec, we believe we remain generally on track to achieve our guidance through the third quarter. Though as Frédéric mentioned, currency remains a significant headwind. In the fourth quarter, we expect the Argotec transaction to result in an $0.08 hit to adjusted EPS. The combined $0.11 total for the third and fourth quarters reflect the total effect of profit contributions from the business offset by diligence expenses, transaction fees, and the incremental interest expense associated with the transaction and expansion of our credit facility. Please recall, that the impact of acquisitions including transaction expenses were not contemplated in our adjusted EPS guidance of $3.50 we issued earlier this year. For the third quarter of 2015, our tax rate was 18.8% versus 8.8% in the year-ago period. And for the full-year, we continue to project a tax rate in the low 20% range. The large increase in the quarterly tax rate was a function of geographical earnings mix, as well as the year-ago rate being exceptionally low due to certain discrete tax items. Regarding cash flow and liquidity, the above table represents figures from the close of the third quarter. However, our current cash and debt balances reflect the closing of the Argotec acquisition and expansion of our credit facility in late October. Our net debt is currently approximately $500 million and our net debt to adjusted EBITDA is approximately 2.6 times on a pro-forma basis per our new credit agreement. In summary, our new facility has the total availability of $1 billion, of which $680 million is currently outstanding. We believe the remaining $320 million is ample to pursue additional transaction. We’ve also announced a 5.3% increase in our quarterly cash dividend and we remain on track with our intention to return at least one third of our free cash flow to investors. I will now turn the call back to Frédéric for his closing comments.

[Frédéric Villoutreix:]

Thank you, Bob. As you just heard, there have been quite an active several months for SWM, with key developments on our existing operations, strategic guide expectations, organizational alignments, and capital structure. As we approach the end of 2015, we’re pleased with our overall performance as our paper operations are demonstrating resilient results in the face of the typical challenges of the tobacco industry. Furthermore, the addition of Argotec is setting the stage for AMS to make greater contributions to SWM’s overall results in 2016. Viewing our transformation from a longer term perspective, we believe we’ve maintained good financial discipline and have selected highly complimentary businesses to acquire over the past two years. Although we’ve made meaningful progress, our task is clearly not yet completed and we will remain active in our effort to execute some additional attractive opportunities. The expansion of our current facility and the appointment of our new CFO, solidify our financial position and management team, and have been critical steps to support these plans. Regarding the increased dividend, our confidence in the solid cash generation of the business allows us to continue returning capital to our shareholders, despite the steady pace of acquisitions that are transforming our financial and strategic profile. That concludes our remarks. Shannay, please open the line for questions.

[Operator:]

Yes, sir. [Operator Instructions] And our first question is coming from Alex Ovshey. Your line is now open sir.

[Alex Ovshey:]

Excellent. Thank you so much. Good morning, everybody.

[Frédéric Villoutreix:]

Good morning, Alex.

[Alex Ovshey:]

Frederic, three quick questions for you. So one, is any financial impact from the extension of the Philip Morris contract? Two, if you guys can just talk about what the exposure to the oil and gas mining sector and the AMS business is pro-forma for Argotec? And just the last one on leverage, if there is appetite to go beyond 2.6, if incremental opportunities present themselves in the next 12 months? Thank you.

[Frédéric Villoutreix:]

Right. So let me address the first question. Just as a reminder for everybody, in the past we’ve been discussing the cost plus arrangement with SPL in the U.S and the contract extension is related to this. Can’t give you any specific comments, but obviously some improvements were made as noted in our prepared remarks and I think I want the investors to think about it as a strategic win-win agreement between the two partners as we are in SWM.

[Alex Ovshey:]

Okay.

[Frédéric Villoutreix:]

As it relates to our exposure to oil, mining, and gas markets, I think what we signaled earlier in the year is -- it was the second market in terms of size for DelStar, behind water filtration, and obviously now we’ve the addition of Argotec, you’ve to consider that it’s diluted even further. And maybe consider it’s an important market exposure to it for $300 million of revenue going into the next year is going to be in the teens, as a percentage of total revenue. Okay.

[Alex Ovshey:]

Okay.

[Frédéric Villoutreix:]

As it relates to your third question, maybe Bob you want to address?

[Robert Cardin:]

Yes, certainly. As it relates to leverage, as we’ve mentioned before, four additional transactions we feel comfortable that we could stretch up to a range of about three going forward, but would fully anticipate over the longer term we’d migrate that down more to the 2, 2.5% or 2.5 times leverage ratio.

[Alex Ovshey:]

Okay, very helpful, Frederic. I appreciate it. I will turn it over.

[Frédéric Villoutreix:]

Thanks, Alex.

[Operator:]

And our next question is coming from Daniel Jacome. Your line is now open.

[Daniel Jacome:]

Good morning.

[Frédéric Villoutreix:]

Good morning, Dan.

[Daniel Jacome:]

Appreciate you taking the questions. Nice to see the pickup in the LIP papers. Just wondering if you could give us some flavor for what you’re seeing with the customer discussions? What exactly is causing them to build all this LIP inventory right now? I’m just curious.

[Frédéric Villoutreix:]

So it’s specific to the European markets. There is the adoption becoming effective of the revised tobacco product directive, TPD, and it’s called TPD2, because it’s again a revision from a 15-year old set of regulations within Europe for tobacco. And so there is -- our view is there are some inventory build ahead of the enforcement of new labeling, changes on the packaging and one of them being precise of the safety warning on the tobacco pack. And so, there is some wholesale inventory adjustments that are being made ahead of this regulation becoming effective in Europe next year.

[Daniel Jacome:]

Okay, appreciate that. Do you think LIP still would have been up excluding that?

[Frédéric Villoutreix:]

Well, we’re clearly saying is that we’re gaining market share in a market that is showing a 3% decline in Europe. So we don’t -- can’t provide a higher level of precision than we have been gaining market share this year as we did the previous years. But we have also considered that the opportunity served, the size of the market that we’re serving with LIP product is slowly declining year-after-year.

[Daniel Jacome:]

Okay, that helps. And then, just sticking to the papers segment line, how much fat do you have left to cut on those lower grade non-tobacco papers?

[Frédéric Villoutreix:]

So I think we still have space for further adjustments. I mean, this is very volatile environment, so I still want to make sure that we remain opportunistic when we look at mix of, let’s say, filler business across all assets. And right now due to the weakening of the Brazilian real that has happened in the last four, five months, we actually are accelerating the focus on other paper products in printing and writing. But that may change down the road based on exchange rate situations.

[Daniel Jacome:]

Okay. That’s good. And then, on Argotec -- sorry if I missed it, are you going to keep most of the assets and the workforce there in the key Massachusetts area where they’re based out of?

[Frédéric Villoutreix:]

Yes.

[Daniel Jacome:]

Okay. And then, on Altria, congratulations. Is that for LIP? That is done out of the New Jersey mill, I take it?

[Frédéric Villoutreix:]

Yes, it is for LIP compliance, the paper made out of Spotswood, New Jersey, yes.

[Daniel Jacome:]

Okay. Okay, thanks a lot.

[Frédéric Villoutreix:]

You’re welcome.

[Operator:]

[Operator Instructions] I would now like to turn the call over to -- back to Mr. Frédéric.

[Frédéric Villoutreix:]

Thank you, Shannay and thank you all for attending the call. I just want to stress some of the progress we’ve made on our continued strategic transformation for the past couple of quarters; obviously we see the third quarter giving solid financial performance. The 5.3% increase in dividend continues the journey of commitment to return a large part of our free cash flow generation to our shareholders, the closing of the Argotec acquisition, the expansion of the credit facility, enabling stats in terms of building the AMS platform and so is the appointment of our new CFO. So we certainly appreciate your interest in us. Mark 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.