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Edited Transcript of SWM earnings conference call or presentation 2-May-19 12:30pm GMT

Q1 2019 Schweitzer-Mauduit International Inc Earnings Call

ALPHARETTA May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Schweitzer-Mauduit International Inc earnings conference call or presentation Thursday, May 2, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey Kramer

Schweitzer-Mauduit International, Inc. - CEO & Director

* Mark Chekanow

Schweitzer-Mauduit International, Inc. - Director of IR

* R. Andrew Wamser

Schweitzer-Mauduit International, Inc. - Executive VP of Finance & CFO

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Conference Call Participants

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* Daniel Andres Jacome

Sidoti & Company, LLC - Equity Research Analyst

* Steven Pierre Chercover

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to SWM's First Quarter 2019 Earnings Conference Call. Hosting the call today from SWM is Dr. Jeff Kramer, Chief Executive Officer. He is joined by Andrew Wamser, Chief Financial Officer; and Mark Chekanow, Director of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon. (Operator Instructions)

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

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Mark Chekanow, Schweitzer-Mauduit International, Inc. - Director of IR [2]

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Thank you, Dmitria. Good morning. I'm Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's First Quarter 2019 Earnings Results.

Before we begin, I'd like to remind you that the comments included in today's conference call include forward-looking statements. Actual results may differ materially from the results suggested by these comments for a number of reasons, which are discussed in more detail in our Securities and Exchange Commission filings, including our quarterly reports on Form 10-Q and our annual report on Form 10-K.

Some financial measures discussed during this call are non-GAAP financial measures. Reconciliations of these measures to the closest GAAP measures are included in the appendix of this presentation and the earnings release. Unless otherwise stated, financial and operational metric comparisons are to the prior year period and relate to continuing operations. This presentation and the earnings release are available on the Investor Relations section of our website, www.swmintl.com.

And I'll now turn the call over to Jeff.

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [3]

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Thank you, Mark. Good morning, everyone. Yesterday, we reported first quarter results with sales of $258 million and adjusted EPS of $0.68. Our AMS segment continued to demonstrate good performance, delivering on our promises of organic growth and expanding margins as we completed our system optimization, and we saw some easing on raw material costs.

EP was a bit more mixed for the quarter. A strong performance in our papers unit was offset by relative year-over-year weakness in RTL as the first quarter of fiscal year '18 had strong heat-not-burn volumes as customers loaded their pipeline.

Finally, some nonoperational items pressured the business. As the rapid rebound in our stock price in the quarter triggered a higher deferred compensation accrual, the euro was unfavorable versus the prior year, and we incurred higher interest expense related to our 2018 debt refinancing. Overall, we are executing against our operating plan commitments and maintaining our full year guidance.

Now shifting to our operating segments. AMS delivered 5% organic sales growth, and we were pleased with market trends as our portfolio leaders continued to demonstrate strong growth. While global macro uncertainties remain, demand for our key specialty applications remains healthy. Our surface protection films for the transportation market delivered another strong quarter. Increasing consumer awareness of this product line and our gains in global distribution, particularly in Asia, are supporting robust sales growth that continues to outperform the global auto market.

Filtration also had another strong quarter and customer indications remain bullish for 2019. Our flagship RO water filtration products remain some of our fastest growing products continuing their 2018 momentum. We were also pleased to report another good quarter for Medical, where we saw strength across several of our product lines, including our consumer finger bandage category and our higher-end materials for advanced wound care and specialty hospital products, both benefiting from strong demand and new business gains.

Infrastructure and construction was essentially flat versus last year. Recall, last year's first quarter was also relatively muted and picked up throughout the year, and we believe this year will likely mirror that same pattern as we are already seeing a pickup for the second quarter.

Regarding margins, we are encouraged that sales growth is translating through to the bottom line. After some challenging quarters in 2018, we are back on plan with expanding margins. In addition to strong sales growth, first quarter margins benefit from reduced fixed costs stemming from the Austin site closure.

As we discussed on our fourth quarter call, the site was closed in late 2018 and the transition of volumes to other sites was complete. This footprint optimization project was a tremendous undertaking requiring more than 18 months of diligent planning and sharp execution to achieve our operational and financial goals, while not disrupting our ability to serve customers.

On a strategic level, this initiative demonstrates our ability to deliver on synergy commitments, further building our track record of successful acquisitions in the AMS segment. All told, the business is off to a solid start to the year with more than 20% segment profit growth.

Concerning strategic priorities, we have made good progress on our recently installed transportation film line in Europe. We are qualifying products with customers and looking forward to sales ramping up this year.

Furthermore, given the global product line momentum, we are looking at putting in another film line in our Chinese site. We are also gaining traction in our new specialty filtration paper product launch as our order book continues to build.

Moving to Engineered Papers. First quarter sales declined 6%, but only 2% excluding currency impacts, mainly from the weaker euro. A very strong price/mix benefit of 7% nearly offset a 9% overall volume decline, not all of which was due to our tobacco-related products. On the positive side, the wood pulp based price escalators on key cigarette paper contracts took effect in the quarter, mitigating most of the year-over-year increase in wood pulp costs.

Mix was also decidedly positive as LIP volumes performed well relative to the overall portfolio. Unfortunately, volume was negatively impacted by 2 factors: first, our nontobacco volumes were down with the biggest contributor being our printing and writing products, an area we have deliberately deemphasized as it is lower margin and commoditized. More importantly, we had lower heat-not-burn recon volumes versus a very strong first quarter last year when we were supporting some of our customers' launch activities.

As we have indicated several times, this remains an exciting growth area. However, as our customers develop and launch products in various geographies outside the U.S., our order patterns may be lumpy. Segment margins for the quarter were impacted by the overall volume decline as well as higher costs. Our contractual price escalators recovered a large portion of wood pulp's year-over-year increase. However, we continue to feel some cost pressures for other materials and energy.

I will now turn the call over to Andy.

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R. Andrew Wamser, Schweitzer-Mauduit International, Inc. - Executive VP of Finance & CFO [4]

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Thank you, Jeff. I'll now review our financial results, starting with segment performance. In the first quarter, AMS net sales increased 5% to $121 million and adjusted operating profit increased 23% to $20 million. AMS adjusted operating profit margin was 16.6%, up 250 basis points versus last year due to several positive factors.

First, we had good organic growth from strong demand across several of our key end markets. Second, we had a full quarter of Austin site closure synergies. And lastly, resin costs were favorable compared to the first quarter of 2018.

Polypropylene prices have contracted from the third quarter of 2018 peak and lower-cost inventories began moving through our P&L during the first quarter. All told, AMS performed quite well during the quarter, achieving strong profit growth consistent with our expectations.

The Engineered Papers segment's net sales were down 6%, though down only 2% excluding the impact from foreign currency. We note currency comparisons should ease in the coming quarters as last year's euro-dollar exchange rate was strongest in the first quarter. Favorable price/mix of 7% nearly offset the 9% volume decline, an encouraging result given the tough comparison for heat-not-burn.

As discussed, strong LIP performance and the continued deemphasis of lower-margin nontobacco paper products were key mix factors. And our strategic mix management has proven an effective method to combat certain volume pressures. The adjusted operating margin for this segment was 20.9%, down 220 basis points versus last year. The year-over-year decline in margin was driven by the negative efficiency impacts of lower volume as well of higher input costs.

Wood pulp was up versus prior year, most of which we recovered with contractual price escalators. We did see some pressure from higher costs for energy as well as other raw materials.

Regarding year-over-year comparisons, I would also note that first quarter 2018 was our highest margin quarter for the EP segment. Corporate unallocated expenses increased approximately $4 million during the quarter due to 2 primary factors. The most significant item was higher deferred compensation expenses. Recall that during our last earnings call, we highlighted a $0.05 benefit during the fourth quarter of 2018 as a result of stock market volatility that impacted SWM's share price. The rapid rebound in our stock price since the beginning of the year has resulted in a $2.4 million or $0.06 per share year-over-year hit to EPS.

The second, though smaller, piece was an increase in IT spending of approximately $1 million or about $0.02 per share of EPS, which we previously referenced in February and was factored into our guidance. This investment is targeted to support the continued growth in our AMS business. On a consolidated basis, net sales decreased 1%, but without the impact of currency, it would have increased 1%. Adjusted operating profit was $35.5 million and adjusted EBITDA was $44.7 million, both down versus last year for the reasons just discussed.

Shifting to consolidated earnings. First quarter 2019 GAAP EPS was $0.56 versus $0.68 in the prior year. Adjusted EPS was $0.68 versus $0.83 a year ago. These results were in line with our plan, and we are maintaining our annual guidance.

Recapping the first quarter earnings impacts that we would consider less related to business fundamentals, we had $0.06 of higher deferred compensation expense, $0.04 of higher interest as a result of the bond issuance last year, $0.02 from higher IT expenses and $0.02 from currency.

While difficult to forecast some of the underlying drivers of these items, such as currency, stock price and interest rates, it's fair to say that deferred compensation volatility might subside, the euro could have easier comparisons and the higher interest expense comparisons will ease later this year as we lap the timing of the bond issuance last September.

Lastly, we note that our third quarter of 2018 was the toughest quarter from a raw material standpoint for both segments, which could likely create an easier comparison for earnings growth in 2019. Our normalized first quarter tax rate was 22.7%, consistent with our expectation for slightly higher tax rate for full year 2019 compared to last year.

Moving to cash flow and liquidity. First quarter 2019 free cash flow was $4 million. Recall, this is our seasonally low quarter for cash flow, and our full year outlook of over $100 million of free cash flow remains unchanged.

CapEx was approximately $9 million in the quarter, which annualizes within our $35 million to $40 million guide range. From a leverage perspective, for the terms of our credit facility, we were at 2.6x net debt to adjusted EBITDA at the end of the first quarter, up slightly from 2.5x at year-end 2018.

Now back to Jeff.

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [5]

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Thanks, Andy. To summarize our quarter, we were encouraged by our results as they were in line with our expectations. As I consider how we are positioned in the marketplace and how our operations are performing, I see several bright spots underscoring our results.

First, the AMS growth story remains healthy. Sales in our key product lines are off to a strong start. The Austin site closure is behind us, and we are seeing the savings. And resin costs have come down recently, all contributing to outstanding first quarter segment profit growth. Within EP, while we had some tough comparisons for heat-not-burn in overall segment margins versus last year, our cigarette paper business did well and our efforts to drive price and mix improvement were successful.

On unallocated costs, most of the issues were related to stock price movements, and we hope to see those fluctuations subside following pronounced volatility in both directions over the past 6 months, but obviously, that remains out of our control.

Our management team remains committed to excellence in running the day-to-day operations, while still advancing the key strategic initiatives that set us up to capitalize on the long-term opportunities in our business, and of course, we continue to evaluate potential M&A to drive additional long-term enterprise growth. We appreciate your continued interest and your support. That concludes our remarks.

Dmitria, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And our first question comes from Dan Jacome with Sidoti & Company.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [2]

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Can you first talk a little bit about the raw material outlook for the AMS segment? I know you touched on it a little bit earlier and that you expect raw material cost to somewhat ease. Can you just give us some more details? Are you suggesting that those costs are going to hold flat, the raw material costs themselves and then you have now some pricing leverage? Or is there the possibility that as the year plays out, some of these wood pulp costs and resin costs on the spot market could decline further?

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R. Andrew Wamser, Schweitzer-Mauduit International, Inc. - Executive VP of Finance & CFO [3]

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So let me take a first stab at that. So as it relates to the AMS business, most of the volatility, if you recall, it was related to polypropylene. And if you think about what happened last year as we went throughout the year, the second and third quarter really was the high mark in terms of where polypropylene prices were for us.

As we entered this year, we have seen a pullback in those prices, in the raw material prices. And so there was, I would say, a moderate benefit in the first quarter. Where we'd expect it to go throughout the year, prices are stable and the expectation is that they actually could slightly increase at least from where we stand today as we go throughout the year.

There will be some benefit in the second quarter, but I think you're going to see the biggest year-over-year improvement particularly in the third quarter as it relates to raw materials.

If we go to the -- on the pulp side. Pulp was pretty elevated as we went throughout most of last year. We've seen a modest, I would say -- well, for the first quarter, we're still up year-over-year for pulp costs. But as we go through the second and third quarter, I think there's potential for easing, but it's too early to discuss what we think the benefit for pulp could be for our EP business.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [4]

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Okay. That's helpful. Staying on the AMS segment, so the new film line that you're -- I think you said Europe, what are you going to do -- remind us again, just the cost on that and how quick to speed of the learning curve do you expect that new capacity will look like as the year plays out? And then is that new capacity going to be targeting strictly the transportation sector? Because I think you said it's going to be making films.

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [5]

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Yes. So a couple of things. We don't disclose the exact price of what those types of investment is, but it's going into a facility that is already operating, and those lines are not that expensive when you put them all in compared to other CapEx that we might have. So they're very reasonably priced.

In terms of the learning curve, they're already qualifying materials with customers. So they're well up that learning curve. I mean it was a really nice example of our experts in our U.S. facilities really going over there and getting the team started up. And that facility already had expertise in making high-quality films. So the start-up has gone nice and relatively smoothly. We're expecting to see commercial orders coming through in the second half of the year and we're already starting to see the early pieces of it. And that is -- overall, I think you'll see us try to have flexibility in where we supply materials out of. Certainly, that's going to be directed primarily to our European customers because of the location, but it also gives us the flexibility to be able to export to Asia or back to the U.S., depending on where we need. And so you're starting to see us get increased flexibility from our global supply system. And those films are primarily targeted at the transportation film, surface protection film that we use in automobiles in the aftermarket. And as we indicated, that market seems to be getting additional traction around the world as people become more familiar with that product line.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [6]

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Okay. Very helpful. And then one quick last one, just housekeeping. On the EP segment, sorry if I missed this. So total volume is down 9%. It looks like LIP paper volumes directionally were up. Do you have the delta for us? And sorry if I missed that number earlier.

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R. Andrew Wamser, Schweitzer-Mauduit International, Inc. - Executive VP of Finance & CFO [7]

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Yes. So the biggest volume declines were in some of our nontobacco papers that we talked about. Printing and writing, which Jeff mentioned, there's some softness in some of our battery separator volumes, and then also heat-not-burn, which was also mentioned. But that's probably the lion's share.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [8]

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Yes, but what was the change in LIP papers? Did it -- what was the percentage change in LIP paper volume versus last year?

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [9]

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It was effectively flat.

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Daniel Andres Jacome, Sidoti & Company, LLC - Equity Research Analyst [10]

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Flat. Okay.

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Operator [11]

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And our next question comes from Steve Chercover with D.A. Davidson.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [12]

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So in the past, you guys have pointed to seasonal strengths in the middle of the year for AMS. And since you started as strong as you did, will that improvement be diminished? Do you still expect a good ramp going forward and I guess, weakness in the fourth quarter?

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [13]

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Yes. We think our first quarter was off to a solid start. Typically, as we said, our seasonality is first and fourth quarters are our slower quarters and the middle is -- usually are the stronger quarters. We expect that seasonality to continue. I don't know if you could read in the strong start to flow exactly through the same way, but we would still expect second and third quarters to be our stronger quarters.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [14]

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Great. And then, forgive me if I missed this, I got on a bit late but was there any price embedded in the AMS sales growth? Or was that volume?

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [15]

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Yes. There is -- the sales growth is primarily volume. There is some small contribution from price. But again, the underlying continues to be that we're delivering on that organic volume growth that we're hoping to see throughout the year.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [16]

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Okay. And you just kind of touched on this, but resins will be a tailwind. You just got an escalator in pulp on the paper side, right as pulp is apparently rolling over. So will that undermine your pricing initiatives? Or do we have to be concerned that there are any deflators that kick in if it's a material drop in pulp?

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [17]

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No. First of all, we're not predicting a material drop in pulp. You are seeing some moderate decrease. It's been very hard for us to get a good handle on how pulp has played out over the last year as it hasn't acted traditionally over the past, I would say, 12 months.

But we're seeing a little bit of good news. But -- no, we don't see a deflator activity coming from that. On the resin side, our price increase is rolling through, we put them through when the prices were up. We're seeing some improvement in the raw material cost, but you're also hearing rumors that polypropylene might be reversing and going back up again. So we're going to have to stay close to raw materials as there just seems to be more volatility in them over the past 12 to 18 months.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [18]

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Sure. And forgive me, can you remind me what grade of pulp is your principal input?

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R. Andrew Wamser, Schweitzer-Mauduit International, Inc. - Executive VP of Finance & CFO [19]

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NBSK.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [20]

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NBSK, got it. Okay. And then staying on the paper side, I recognize that Philip Morris isn't a client or at least I don't think they are. But on Tuesday, the FDA announced that they would permit the sale of IQOS in the U.S. Does that have any impact on you guys, positive or negative? Either because the category grows or...

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [21]

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Yes, this is all related to this heat-not-burn technology. There are a couple of different kinds out there. They're all similar in scope. The PMI product, as we've indicated, is based on an internal material and so it will not have any impact for us. But I think it just underscores that the alternative smoking has an opportunity for us, and we are a major contributor to many other products in that category, and we're hoping to see approvals from that flow through afterwards.

Hard to say when, though. That's going to be the big question. It's hard to predict what the FDA does.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [22]

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I was thinking that if -- the FDA approval could make the whole pie bigger, so that's my glass is half full spin. And final question...

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [23]

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Well, thank you for having a half full, I always like a half full analyst. Thank you.

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [24]

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Well, I mean sometimes I like to have it full. Just plain old full glass depending what I'm drinking, but that's another story. How are your efforts to cross sell coming along?

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [25]

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In terms of cross sell from our paper group to our AMS group?

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Steven Pierre Chercover, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [26]

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Yes, I mean -- if I recall, both of the things that you sell are kind of very thin extruded materials, whether it's paper or film, and you thought that there were opportunities to, my words, cross-pollinate using your kind of global sales force.

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [27]

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Yes. Well, I mean the one example that we talk about quite a bit is our new filtration paper product. And again, we've been a little hesitant on the full details around that because it's in its initial stages of rolling out. The performance of that paper though is garnishing a lot of interest in our filtration customers, which are handled by our AMS side, and the material is made in our French facilities on our paper side, and we're seeing very good pickup on that. So that's a good example of some of the cross selling that we're seeing.

And of course, we're seeing some other opportunities throughout the businesses that we're continuing to pursue as well.

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Operator [28]

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(Operator Instructions)

Okay. That now concludes our Q&A portion of today's conference. I would now like to turn the call back over to Dr. Jeff Kramer, CEO, for any closing remarks.

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Jeffrey Kramer, Schweitzer-Mauduit International, Inc. - CEO & Director [29]

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So thank you, everyone, again. We appreciate your strong support. And the short story is closing, we met our expectations for the quarter. It was masked by a few key factors. We talked a little bit about the impact of deferred comp in the euro, but we also want to emphasize that some of the factors are growth investments, which is the way we consider our debt refinancing as well as our investments in IT. And we think we're continuing to demonstrate the growth story that we're putting together here at SWM, continues to be robust. And we hope to continue to get your support. So thank you very much.

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Operator [30]

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Ladies and gentlemen, thank you for attending today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.