Q4 2013 Earnings Call Transcript
Published:
- Operator:
- Welcome to SWM's Fourth Quarter 2013 Earnings Conference Call. Hosting the call today from SWM is Frédéric Villoutreix, Chairman and Chief Executive Officer. He is joined by, Jeff Cook, Executive Vice President and Chief Financial Officer; Steve Dunmead, Executive Vice President and Chief Operating Officer; and Mark Chekanow, Director of Investor Relations. Today's call is being recorded and will be available for replay beginning at noon, Eastern standard time. The dial-in for the replay is 1 (800) 585-8367, and enter PIN number 48333402. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Chekanow. Sir, you may begin.
- Mark Chekanow:
- Thank you, Jackie. Good morning. I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's fourth quarter and full year 2013 earnings results. On today's call, Frédéric will share some high-level comments about our fourth quarter and full year performance and strategic priorities. Steve will provide details on our operations and Jeff will then take you through a more detailed review of our financial results and guidance, as reported in our release filed with the SEC yesterday and available on the SEC's website and at our investor relations website. 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, our annual reports on Form 10-K and our 8-K filed last night. Certain financial measures during this call exclude restructuring and impairment expenses, results of discontinued operations, non-cash amortization expenses and valuation allowances and are, therefore, non-GAAP financial measures. Reconciliations of these measures to the closest GAAP measures are included in the appendix. I'll now turn the call over to Frédéric.
- Frédéric P. Villoutreix:
- Thank you, Mark, and good morning, everyone. Late yesterday we released our fourth quarter and full year 2013 earnings, and this morning we are pleased to present our results and update you on our more recent acquisition of DelStar, which was a key fourth quarter highlight and important milestone for Schweitzer-Mauduit. We have long been discussing our intention to carefully and selectively diversify the company, and believe our patience and financial discipline led us to the right targets in the right industry. DelStar is a high-growth, high-margin company in an attractive space. In addition to acquiring a foothold in growing niche filtration market segments, we are uniquely suited to capitalize on several synergistic projects with DelStar, many of which are already underway. We intend to grow this new filtration segments by not losing focus on our core tobacco business to which we remain committed. We will also provide financial guidance regarding our expectations for 2014. As shown on Slide 4, our fourth quarter showed solid earnings performance in the face of a challenging tobacco industry backdrop. Revenue grew 1%, with DelStar contributing $4.2 million of revenue during the fourth quarter. Excluding the DelStar revenue, sales would have been down 1%. Within the Paper Segment, LIP volumes ramped up 1%, a strong performance given the accelerated smoking attrition rates in the U.S. and Europe. While it is difficult to draw conclusions regarding our share from quarter to quarter, our LIP volume growth of 3% for full-year 2013 suggests we have increased penetration with major tobacco customers in this high-margin product line. Despite headwinds in tobacco paper volume, our ability to navigate contract negotiations and strategically position ourselves as a leader in LIP technology and service has enabled us to maintain good profitability. As we discussed on our third quarter call, several of our large RTL customers with annual commitments, fulfilled worth purchases during the fourth quarter driving higher volumes than we saw in the third quarter of 2013. We achieved adjusted earnings per share from continuing operations of $0.91 in the quarter, bringing us to $3.82 for full-year 2013. We are pleased with these results, as it exceeded both our initial guidance of $3.70, and the updated guidance of $3.75, which we provided midyear. It is a testament to a strategic relationship with customers, our technology leadership, our operational excellence program and other old commitment of organization to deliver under challenging circumstances. Cash flow from continuing operations for the full-year 2013 totaled $175.8 million. After capital investments, our full-year 2013 free cash flow was $146.7 million. Our management team remains highly focused on cash flow as it will be the primary driver of our ability to invest in growth initiatives and return capital to investors through dividends and share buybacks. We have a net debt position of $113.4 million, as opposed to our net debt position of $4.8 million at the end of 2012. Largely as a result of funding the full price of the DelStar acquisition through an expanded credit facility at highly attractive rates. As we look forward to 2014, we see a combination of challenges, specifically in RTL, but also opportunities to set the stage for expected profit growth in future years. Without new LIP conversions providing revenue growth, 2014 will be influenced by smoking attrition rates in our key U.S. and European geographies. Regarding RTL, as we communicated in our third quarter call, 2014 will be a difficult year. Since then, we have concluded our customer commitment discussions and forecast 2014 RTL volumes in our Recon Segment declined close to 20% from 2013. This is due to a combination of external factors as well as a planned transfer of some Chinese customer volume, from our French mill to our Chinese joint venture. Viewing are Recon Segment and Chinese joint venture in aggregate, total Recon volumes are expected to be down approximately 10% in 2014. During 2014, however, we expect a strong financial contribution from DelStar lay foundations for multiple joint commercial projects to grow our newly established Filtration Segments, and continue to innovate in our core LIP and RTL product areas. In addition, our Chinese RTL merely set to open volumes will run over the next 3 years, with party contribution expected to begin in 2015. I would now like to introduce Steve Dunmead, our Chief Operating Officer, who joined SWM almost 1 year ago. Steve has been immersed in our tobacco operations and also played an integral role in the DelStar acquisition. The heads of 3 segments
- Stephen D. Dunmead:
- Thank you, Frédéric. It's a pleasure to join the call. Referring to Slide 5, tobacco paper volumes in the fourth quarter including CTM, our joint venture of China, were down 8%, with LIP volumes up 1%. For the full year, tobacco paper volumes were down 2%, with LIP volumes up 3%. Strength in LIP and non-tobacco volumes were key in supporting our profit margin as we gain share in high-margin LIP paper, while backfilling the lower conventional cigarette paper volumes with higher levels of non-tobacco products. We believe this strategy paid off well in 2013, contributing to our ability to exceed our EPS guidance despite the higher than expected declines in smoking rates. While we have successfully gained share in 2013, it's difficult to assume further gains in 2014 that we work diligently to optimize our mix and drive as much profitable volume through our paper mills as possible. RTL volumes rebounded sequentially from an unusually low third quarter 2013, but still saw volume declines of approximately 7% versus last year's fourth quarter. Full-year 2013 Recon Segment volumes declined 10%, consistent with the expectations we communicated on our third quarter call. As anticipated, our customers with annual purchase commitments met those obligations during the fourth quarter that we believe it has left some of them with -- at some levels of excess inventory. Now turning to Slide 6. Regarding the LIP contract extensions referenced in our earnings release, we proactively worked with several key customers to extend our existing contracts. Here, our strategic focus is on the combination of share and term in exchange for some levels of price concession. Solidifying ourselves as the market leader for several years is strategically important. As we believe locking in shares is the best way to protect ourselves amidst tobacco industry volume declines. The impact of these extensions is incorporated into our ready 2014 EPS outlook. Although Western Europe, the primary region where our RTL products are currently sold, will face challenges next year, we remain enthusiastic about the opening of our Chinese RTL mill in 2014, a JV with the Chinese tobacco monopoly. Demand is expected to be strong as government regulations being adopted in China on harm reduction in cigarettes should bolster long-term demand for RTL in this large and growing Chinese tobacco industry. As we've communicated, we expect start-up losses in 2014 for the JV, profit contributions in 2015 and achievement of full profitability of approximately $8 million to $10 million of net income on a run rate basis during 2016. Moving on to DelStar. Our integration processes are largely complete and we're settling into a business-as-usual state as DelStar begins to execute on its 2014 plan. As intended, there were very few changes to the DelStar organization, with integration mainly focused on IT and financial reporting. In addition to the strong growth prospects we see in DelStar's base business through its long-term relationships in the filtration space, our teams have begun to work closely together on several projects that could provide exciting synergistic gains. These projects are in both product development and geographical expansion as the SWM paper technologies in global footprint are paired with DelStar's expertise in customer relationships in the growing filtration industry, particularly in water filtration. We'll be updating our general presentation on our Investor Relations website in the coming days to include several slides about DelStar's operations, products, end markets and growth prospects. This will build upon what we've presented on our November call when we announced the deal. In short, DelStar and SWM are great fit and we look forward to sharing updates on this business and our progress on these initiatives with you. Now I'll turn the call back over to Frédéric to share his comments on our outlook and strategic priorities.
- Frédéric P. Villoutreix:
- Thank you Steve. When we reported our third quarter 2013 earnings in November, we were in the process of customer discussions regarding RTL commitments for 2014, but had limited information. Thus, while we expressed directional caution about 2014 expected volumes, we were not in a position to provide further details. At the same time, we were approaching several customers to expand LIP contracts with a goal of securing our market segment shares in future years in exchange for some pricing concessions. These discussions were also in early stages and their recent conclusions had left us with more clarity on our 2014 tobacco paper outlook. With both of these developments, we now have a clearer view of financial impact each are expected to have on our 2014 financial performance. We now expect Recon Segment volume to decline close to 20% in 2014, due to a combination of factors, which we discussed last quarter as well as a planned volume transferred to CTS. First, we believe many of our customers are holding excess inventory following their fulfillment of 2013 purchase obligations. Second, the higher-than-expected smoking attrition rates in 2013, have created a very cautious environment with respect to 2014 purchase commitments. Lastly, as we discussed last quarter, a few customers are preparing to potentially alter their tobacco blends in an effort to reposition certain brands. While the longevity of the success of these efforts by our customers remain to be seen, we believe they will impact our 2014 RTL volumes and are reflected in our guidance accordingly. We should note that over its 50-year history, RTL has expanded these types of inventory overruns and customer reformulations and has consistently bounced back to grow over the long term. In summary, while Recon Segment volumes may be down close to 20%, we will likely see total RTL volumes for SWM including of Chinese JV down approximately 10%. The trends of volume as well as new volumes for the CTS mill will partially offset the decline in our Recon Segments. However, as a new mill we'll be not running at a high utilization rate in 2014. The associated profit from the transferred volume previously produced in France will be overshadowed by the solid expenses for the Chinese mill. As indicated in our earnings release, we expect the DelStar acquisition to add $0.25 to $0.27 to our adjusted EPS in 2014. These excludes the impact of non-cash purchase price accounting charges. As a result of these 2 factors and the addition of DelStar, our guidance for adjusted diluted EPS from continuing operations is $3.40 for 2014. Jeff will provide more details on our guidance shortly. Moving to Slide 8, I will now provide an update on several initiatives that support our long-term growth strategy. Within reconstituted tobacco, while much focus has been placed on gaining clarity on customer commitments in 2014, our R&D teams continue to work with customers on developing improved RTL products, which could result in higher RTL use in our customers' tobacco blends over the long term. Initial test have been promising and this remains effort a multi-year effort, a key to rejuvenating growth in our Recon Segments. As we enter 2014, CTS or Chinese RTL mill is still said to open in midyear. Given the success of a conventional paper JV with the Chinese tobacco monopoly, we expect similarly strong results of CTS. To help our investors understand, our confidence in this project given the expected weakness and impairment charge in our Recon Segment, I would like to refresh everyone on the history of the Philippine RTL mill, the Chinese JV and their key differences. In the late 2000s, we began assessing potential RTL demand in Asia, outside of China, as our customers indicated increasing needs for RTL material to the point that future demands could no longer be met by our existing facility in France. We began to construct a new mill in the Philippines. In 2010, a Chinese tobacco monopoly accelerated talks for a second joint venture, this time to RTL to help China tobacco to comply with new armed reduction regulations set to go into place in 2015. Without the resources to develop and construct 2 RTL mills concurrently, we halted work on the Philippine mill to focus on the Chinese JV, which is now nearing completion. The Chinese mill will exclusively serve China with a solid business plan supported by multi-year commitments from several large customers. Concurrently, without the benefit of regulations, demand for RTL in the rest of Asia has developed slower than we originally expected, while attrition rates accelerated in the western geographies. With the decline expected to continue in 2014, our French mill would have more than enough capacity to serve all geographies outside of China for the foreseeable future. This news development effects on our mothballed Philippine mill triggered the fourth quarter impairment charge. All told, while RTL dynamics are challenging within our Recon Segments, our Chinese JV is set for a solid launch and we expect it have a profitable future. On the LIP front, we have been informed that the vote on standards in Russia and several neighboring countries has been postponed until May 2014. We remain in discussions with key regional players on how to support them when LIP is mandated in Russia and other countries around the world. In addition to anticipating new adoptions, we are focused on continuous innovation of the LIP product line to better serve our customers. Our R&D teams are developing next-generation LIP products focused on both improved taste profiles as well as other production processes and technologies to lower the cost. Success in these efforts should help to mitigate the impact on our margins from pricing pressure in the marketplace. On our diversification and M&A initiatives, we chose to diversify into the filtration arena due to its adjacent technology and its sound long-term growth and margin fundamentals. We launched this long-term commitments by closing the DelStar acquisition in mid-December. The strategic entry into filtration sets the stage for a new and exciting trajectory for SWM, as we expand and diversify our product line and customer base. DelStar has strong and growing presence in filtration, health care and several niche industrial segments. The DelStar leadership team shares the enthusiasm about our combination, and will be focused on delivering the DelStar 2014 financial goals as well as pursuing several growth opportunities not previously available to them. We believe that over the next several years, DelStar will provide growth revenues above and beyond what was originally expected, as we continue to uncover new synergies to take opportunities. In addition, our Lean Six Sigma experts are working with DelStar teams to efficiently expand capacity, reduce scrap and derive other operating efficiencies. Let me now turn it over to Jeff to discuss our financial results and guidance in more detail.
- Jeffrey A. Cook:
- Thank you, Frédéric. Fourth quarter net sales increased 1% versus the prior year quarter. Currency continued to benefit us in the fourth quarter, and on a constant-currency basis, revenue is down 2%. The DelStar acquisition, which closed on December 12, 2013, contributed revenue of $4.2 million in the fourth quarter. For full-year 2013, consolidated revenues declined approximately 1%, and 2% on a constant-currency basis. Fourth quarter Paper Segment revenue, which includes non-tobacco paper, but excludes sales from our Chinese JV was down 3%. This decrease was driven by lower tobacco paper volume as LIP volume growth was offset by lower margin conventional cigarette paper volume declines. Our Recon Segment volumes declined 7%, but improved mix and a stronger euro drove a revenue increase of 2%. For the full-year 2013, Paper Segment revenue was essentially flat and Recon Segment revenue was down nearly 4%. As you can see on the chart on Slide 11, adjusted operating profit was essentially unchanged versus a year ago, but we did have several puts and takes. Volume was the biggest negative factor, mostly tobacco paper as well as some Recon products. Offsetting these declines, were profit lifts from nonmanufacturing costs as the fourth quarter of 2012 had some elevated expenses due to certain strategic initiatives and the currency benefits we continue to experience from a strong euro in the fourth quarter of 2013. Wood pulp prices continue to have a limited impact on profits, though they remain at high levels. In our 2014 outlook, we have assumed modest gains for a reduction in wood pulp prices. Paper Segment adjusted operating profits during the fourth quarter were down 7% versus the same period in 2012. The adjusted Paper Segment margin in the quarter was 17.8%, 90 basis points lower than the prior year quarter, in part due to planned machine downtime at year end. For the year, adjusted Paper Segment profit was up 3%, with segment margin up 50 basis points. This illustrates the positive trade-off discussed earlier regarding our strategy to focus on high-margin LIP and other non-tobacco papers. Operational excellence was also a strong contributor to this performance. Adjusted operating profit in the Reconstituted Tobacco Segment for the fourth quarter of 2013 was down 8% and 10% for the year. Volume declines and reduced fixed cost absorption were partially offset by improved mix and pricing. The Filtration Segment, which is comprised of DelStar, reported a loss of $1 million for the 2 weeks from mid-December through the end of the year, primarily driven by the impact of inventory step-up charges necessitated by purchase price accounting adjustments. Absent this non-cash purchase accounting item, filtration was breakeven for those weeks. We know this abbreviated period is not indicative of DelStar's expected performance giving the low-volume nature of the year-end holidays. Our consolidated adjusted operating profit margin was 19.7%, down 30 basis points from the fourth quarter of 2012 and down 60 basis points to a 21.6% on a full-year basis. Excluding the DelStar revenue, which had no associated operating profit for that 2-week period, adjusted operating profit margin would have been 20.2% in the fourth quarter, up slightly from the year-ago period. Our fourth quarter 2013 adjusted earnings per share from continuing operations was $0.91, down from $0.95 in the fourth quarter of 2012. Full-year adjusted EPS was $3.82, versus $3.77 in 2010. We exceeded our initial and mid-year guidance of $3.70 and $3.75 respectively. Excluded from our fourth quarter and full-year 2013 adjusted EPS is the non-cash, non-tax-deductible impairment charge of $37.2 million, related to our Philippine RTL mill assets. However, we still remain hopeful that our future Asian market demand for RTL will grow and support resumption with no construction. We did not write down the full value of the assets as the facility and related equipment does have resale value. While we are pleased with our accomplishments in 2013, including our financial performance and acquisition of DelStar as a new growth platform, we now turn our attention to 2014. As Frédéric mentioned, we expect 2014 adjusted EPS from continuing operations to be $3.40, assuming currency exchange rates remain in line with current levels. Included in this projection is a combination of several factors, primary challenges are the expected RTL volume decline, pricing concessions on LIP and other tobacco papers and continued elevated smoking attrition rates in the U.S. and Europe. While we don't provide segment profit guidance, proportionately, we would expect RTL to account for 2/3 of the decrease in year-over-year operating profit, with the remaining 1/3 in the Paper Segment. On the positive side, operational excellence should continue to help offset cost increases and provide additional efficiencies. We will also benefit from our share buyback program being executed in early 2014, and we expect a lower tax rate as a result of certain legal entity realignment activities. Our annual effective tax rate for 2014 is expected to be in the mid-to-high 20% range, higher in the earlier quarters and trending lower throughout the year. While these tax savings will be mostly offset in 2014 by several million dollars of expenses incurred to execute the legal entity realignments, which will appear in unallocated corporate expenses, they will support our earnings and even more importantly improve cash flow for years to come. We also continue to pursue additional actions that will enhance our conversion of operating profits into cash flow such as working capital improvements. Lastly, we note that our new legal entity structure will allow improved access to our cash balances currently held in Europe. Embedded in this guidance is the accretion from the DelStar acquisition. Consistent with our previous discussions on DelStar, we expect revenue to grow from its $110 million base at the time of the deal with continued high-teens EBITDA margins. Our financing terms were attractive, and we assume the 36% tax rate given its U.S.-centric operations. Prior to the impact of purchase accounting items, the acquisition is expected to add between $0.25 and $0.27 to 2014 EPS. Included in the $0.25 to $0.27 estimate, our integration costs and near-term management retention expenses. Regarding purchase accounting impacts, some of these items are one time, specifically a non-cash inventory step-up charge and some are ongoing such as the amortization of acquired intangibles. These ongoing amortization expenses equate to approximately $0.06 in EPS. However, 2014 charges will be higher due to the inventory step-up, which is expected to be fully expensed by the end of the first quarter. Once again, our consolidated adjusted EPS guidance excludes all of these non-cash purchase accounting items. Lastly, our guidance excludes the impact of onetime startup expenses associated with the upcoming launch of the Chinese RTL mill, which we estimate will have a $0.12 impact on GAAP EPS. As a reminder, our JVs are reported below the line as equity income from affiliates. SWM net debt is now $113 million, an increase of $109 million since the end of 2012, primarily due to the acquisition of DelStar aggregating $231.3 million, offset by continued strong cash flow from operations during the year, net of capital expenditures and dividend payments. SWM remains a high-quality credit and the recent expansion of our credit facility at attractive rates demonstrates confidence in our future cash flows despite our outlook for lower EPS in 2014. We have ample liquidity to fund our internal needs, our dividends and potential future acquisitions, and we remain committed to the capital allocation strategy communicated earlier in 2013. Net debt to adjusted EBITDA from continuing operations at the end of the fourth quarter was a relatively low 1.5x EBITDA. Capital spending was approximately $29 million in 2013, up from $27 million in 2012. As you may recall, we recently raised our dividend per share by 20% to $1.44 on an annualized basis, marking a nearly fivefold increase in our dividend per share in the past 2 years. In 2013, we paid out nearly $40 million and absent any further changes in our dividend rate would expect to pay out approximately $45 million in dividends in 2014. Although we did not purchase any stock under our $15 million authorization in 2013, we have begun purchases in early 2014. To date, we've have bought approximately 294,000 shares, aggregating $13.6 million in total purchases, demonstrating our confidence in SWM's long-term prospects. As we look to the remainder of 2014, it is possible that we may continue to make purchases under our buyback agreement, as well as make further acquisitions in filtration and/or specialty papers to strengthen and diversify the company. In addition, while we're looking at diversification, we will continue to selectively invest where appropriate in our core tobacco operations. Lastly, we expect to contribute our final capital infusion into our Chinese RTL joint venture in an amount less than $10 million. Return on invested capital in 2013 was 24.9%, well above our cost of capital. This measure excludes the impact of the DelStar transaction. Further, ROIC calculations will be impacted by acquisitions. We expect to acquire companies with strong top line growth prospects, which typically cannot be acquired for book values, DelStar's invested capital base will not just reflect our depreciated asset base in tobacco, but also the market values of acquired higher growth enterprises. Our acquisition criteria are highly driven by discounted cash flow and IRR methodology and our acquisitions are expected to exceed our conservative cost of capital assumptions. DelStar for example, exceeded our hurdle rate even before consideration of long-term joint commercials synergies. We will continue to focus on ROIC. However, given the acquisition of DelStar and potential future transactions, we will likely expand our key metrics to include other measures and financial benchmarks. I'll now turn the call back to Frédéric for some closing remarks.
- Frédéric P. Villoutreix:
- Thank you, Jeff. Before we take questions from the investment community, I would like to comment on our near-term and long-term outlook. As we have said for some time, tobacco is a challenging industry due to consistent volume declines in the U.S. and Europe. Despite that, there are areas of highly attractive growth and profitability including LIP and over the long-term RTL, both due to their favorable attributes on safety and harmful component reduction. For several years, we have capitalized on positive trends in RTL and LIP regulations, and we have been benefited from our strong customer relationships, leading technology and global platform. 2013 was a year where we saw RTL declines and no new LIP regulations to boost volumes. However, SWM strength in LIP penetration, cost reductions, currency benefits and other efforts by our management team and worldwide organization, support a strong financial performance in an otherwise difficult year. Finally, we were pleased to conclude the year with the acquisition of DelStar, the culmination of several years of patient, financially disciplined strategic planning. We remain highly focused on optimizing our organization and capacity, prudently capturing share where possible and investing for long-term growth both in tobacco and now filtration. We are actively pursuing new innovations in both LIP and RTL, working to ensure the long-term success of DelStar and provide support for acceleration in several Filtration Segment areas and assessing new acquisition targets. We are also focused on maximizing cash flow to support further investments as well a maintaining a strong return of cash to our stockholders. While 2014 maybe a recent year of source, we believe we have multiple catalysts to resume earnings growth in the long-term and look forward to providing updates on those initiatives as the year unfolds. That concludes our remarks. Jackie, please open the line for questions.
- Operator:
- [Operator Instructions] Our first question comes from the line of Alex Ovshey with Goldman Sachs.
- Alex Ovshey:
- On the RTL side, so you transferring 10% of the volume from the French facility into the Chinese joint venture. So you're essentially going from being the sole owner of the volume to having to split that with the joint venture partner. Are you getting reimbursed for that in anyway?
- Frédéric P. Villoutreix:
- Alex, let me correct this impression that we may have left with our prepared remarks, the amount of the volume transfer to China is in fact small. We are talking about incremental revenue growth in China out of the joint venture. And that was the plan all along in order to prime the pump if you are in terms of demand for the Chinese market, we served a few customers including the ones that our JV partners out at France. But the significant volume growth that we expect out of China is purely based on having the technology into place in China with CTS. There are very large import duties into China for RTL and other tobacco products that makes it cost-prohibitive to address the market, the domestic market from abroad. The effects really the volume drop our French mill is really the consequence of some number of factors and I will list the three of them by I would say degree of importance in terms of magnitude of the impact on volume. First one is, we are the inventory adjustments, excess inventories on the balance sheet of our customers at the end of 2013 that is being corrected in 2014. The second one is the challenging environment in terms of smoking attrition rates, in particularly in Europe that are leading our customers to be very prudent as we forecast 2014, in fact, it's fair to say that most customers see 2014 to be in line with '13. So no real improvement in terms of smoking attrition rates. And then the third factor which is somewhat unclear at this stage of how much it will impact our RTL segment. That's the information we got from a few customers of their intent to do reformulations of cigarette designs as they are struggling to either maintain share or in an environment where the demand is dropping, the smoking attrition rates are accelerating to gain market share at the expense of others through some marketing programs.
- Alex Ovshey:
- Shifting to the LIP side, and the contract extensions. So is the majority of your LIP business both in Europe and in North America now under the extent of contract and is there any risk to having to negotiate any of the business again in 2015?
- Stephen D. Dunmead:
- Alex, this is Steve. Certainly we're not going to into specifics on the percentages but more than half of it is under contract. If we get the opportunity, quite honestly, to continue to extend contracts and protect share or grow share, we will certainly do that, but certainly it's more than half.
- Alex Ovshey:
- Is that more than half common, does it apply both to Europe and North America or is one region sort of above that level and 1 below?
- Frédéric P. Villoutreix:
- Applies to both.
- Alex Ovshey:
- Then on the DelStar front, you talked about some exciting projects that you guys are doing there with the legacy SWM business. Do you expect any financial benefit in terms of revenue than the profits in 2014 or is that all going to be potentially beneficial to the company beyond this year?
- Stephen D. Dunmead:
- I think, Frédéric in his prepared remarks talked a little bit about the fact that we've got some operational excellence, things going on that should start to pay dividends this year. We may, on a couple of the more strategic synergistic projects toward the fourth quarter, see a little bit. But certainly it's mostly focused on 2015 and beyond. But really exciting work going on between the 2 teams.
- Alex Ovshey:
- And just 1 last question for me and I will turn it over. Just looking at the M&A pipeline in infiltration, is the expectation that you could potentially do another deal in 2014 or do you view 2014 as really a year where you really try to fully integrate DelStar and work on the organic growth profile of sort of the combined DelStar and legacy SWM business, how do you see that?
- Frédéric P. Villoutreix:
- Alex, clearly the #1 priority for us is to leverage the acquisition of DelStar. The integration, as Steve mentioned in his prepared remarks, is for most part behind us, and now we are really focusing on growing the core DelStar business and pushing hard for those synergies both commercial and industrial synergies, that frankly speaking, we see as an add-on in terms of the benefit of that investment and so it was not part of how we look at the business when we acquired it. And with our synergies having impact in '14 was clearly meaningful impact in 2015. In parallel, we are looking at ways to build on the platform, on this filtration platform with some bolt-on acquisition moves. And I think we are advanced enough at this stage to say that we could be acting in 2014 and as the could is moderated by the fact that we'll maintain the same financial discipline that we have used in the past. So we are not going to rush into anything, but we clearly see opportunities and will be exploring those opportunities during the course of the next several months.
- Operator:
- Our next question comes from the line of Ann Gurkin with Davenport.
- Ann H. Gurkin:
- I wanted to start with customer demand for your products. As you moved from Q3 into Q4, was there any change in customer's plans or order rates for 2014?
- Frédéric P. Villoutreix:
- Not really. I think on the RTL, we already commented that we probably we had a little spike due to the annual commitments. But I think on the paper side, we have experienced the same kind of a slower fourth quarter with machine downtime in December, which we experience every year due to customers making inventory adjustments, cigarettes then sales. I think this trend have been unchanged for the past 2 to 3 quarters, and I think it's also reflected in the forecast that customers add-on whether it's Europe, Russia, the rest of the world, which seems to unfortunately is at that stage does not see a lot of improvements from the challenging conditions of 2013, but for the most part no worsening either.
- Ann H. Gurkin:
- Okay, that helps. And then you referenced share repurchase to date, is that -- is the share repurchase in your 3 40 guidance?
- Jeffrey A. Cook:
- Yes. What we've done to date probably looking around $0.02 or $0.03, so pickup from what we've already done so that is in the 3 40.
- Ann H. Gurkin:
- Okay, great. That helps. And then, maybe just get an update on potential LIP adoption in Russia. I know you commented that you don't see any kind of pick up in LIP sales in '14 in Russia, but can I just get an update on the status of that?
- Frédéric P. Villoutreix:
- Sure. I think the vote by the parliament in Russia and the common unions of 2 adjacent countries initially scheduled for December has been moved to May. And at this stage, I think there is still the same activity and on the discussions with customers is the same. The need to achieve a state of readiness, but just the shift of full norms and then how it would impact our color 2014, at this stage we don't, at least we have not included in our guidance any pick-up in demand in 2014, but obviously we will update the investment community as we know more about -- around the May period.
- Ann H. Gurkin:
- Great, that helps. And then finally, as you integrate DelStar, I'm just curious -- positive surprise challenges kind of just get an update on how that integration progressing?
- Frédéric P. Villoutreix:
- Yes, I think so far, it's been going very smoothly. We have a great teamwork happening at the management level. We've been able to deploy our synergy teams and we they have already identified some short wins and longer-term opportunities. At this stage, we are encouraged by what we have seen, progress we have made, and again I think some of the synergies that we see ahead of us could be transformation.
- Operator:
- Our next question comes from the line of Kenneth Smith with Lenox Equity Research.
- Kenneth Smith:
- Couple of years ago, you had forecasted a difficult RTL environment and then it turned out to be a much better year than you anticipated. Is there anything about the current environment that could cause your pessimistic outlook to really change for the better or is this much more a clearer situation than it was a couple of years ago?
- Frédéric P. Villoutreix:
- I would like to be wrong a second time. Let's see, but I think, what we know is that many of our customers have worked a balance sheet to reduce inventories of both those in tobacco and RTL. The magnitude of this correction is not necessarily clear and is somewhat related to the attrition rates in Europe, in Russia, based on excise taxes that are being implemented in Russia, which are really causing the market to shrink at a pace that has not being seen in many years. So I think this is probably the area to monitor whether or not the attrition rates remain in line with the forecast of our customers or whatever there is the improvements. I would say at this stage, we feel comfortable relying on this forecast of the customers they have given us to build our guidance, and obviously we are working hard, the teams are working hard to go after additional volumes.
- Kenneth Smith:
- Second question, more for Jeff. On the guidance on the tax rate and your ability to move more of your operating profit into cash flow, you said that the tax rate will be lower in the second half, later in the year than the first part. Where do you sort of see this settling out as a tax rate you'd expect to get to in, what is the overall impact going to be on your cash flow relative to the, say, 2013?
- Jeffrey A. Cook:
- For 2014, there will be some improvement overall, but not significant because we are spending money to implement a lot of these changes, so -- but we will net-net have a benefit this year. But I'm talking maybe $1 million or $2. The important thing is going forward, when you get to 2015, then I would see our tax rate getting down to the mid-20s, if maybe not even a bit lower.
- Operator:
- [Operator Instructions] At this time, it appears that we have no further questions. I'd like to turn the floor back over to management for any additional or closing remarks.
- Frédéric P. Villoutreix:
- Thank you, Jackie, and thank you all for attending the call. While disappointing the 2014 outlook, we remain confident in the strength of our business model and the ability to bounce back as evidenced by the 20% increase in our quarterly dividend we announced last quarter. I feel very good about our Paper Segment as performed in 2013, and the competitive strength of the -- of our paper business as we enter 2014. We obviously headwind on the RTL but we have this growth opportunity on DelStar. And so for me it's a balanced outlook if you want with some ups, some downs, some opportunities. But we will continue to work hard on execution as we have done for many years to generate some growth, and be diligent on the cost and capacity efficiencies of our units. So we appreciate your interest in the company. Mark, Jeff and I would be in our offices today, and if you have any further questions, please give us a call. And have an nice day. Thank you.
- Operator:
- Thank you. This concludes today's conference call. You may now disconnect.
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