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Glatfelter (NYSE:GLT)

Bank of America Merrill Lynch 2013 Smid Cap Conference Call

May, 07, 2013, 03:05 pm ET

Executives

John Jacunski - SVP & CFO

Analysts

John Jacunski

Well, thanks for joining this afternoon to learn a little bit more about Glatfelter and we’ll take a run through the slides and we will be happy to take questions. So Glatfelter is organized along three businesses and as shown here on slide four, about half of our business is our specialty papers business that’s operating in the broad uncoated free sheet market in the U.S. where they make communications papers as well as a number of highly engineered paper products and we will talk a little bit more about the individual products and markets in a little bit.

Composite Fibers makes likely engineering materials for beverage filtrations, so things like single serve coffer applications and tea bag products and they also through an acquisition we just closed last week make non woven wallpaper substrates. And our Advanced Airlaid Materials business makes super absorbing fin product materials for the hygiene market, so our Composite Fibers and our Airlaid business tend to be growth businesses that compliment the special papers business as a cash generator. We have production facilities around the world located in U.S. and Canada, Western Europe and we also have a raw material facility located in the Philippines.

Slide five outlines the evolution of Glatfelter; we have continued to make strategic investments in shifting our overall business portfolio and giving a small exposure growth markets as I pointed on the prior slide. You can see in 2013, as I mentioned, we completed the Composite Fibers acquisitions of the Dresden Papier company in Germany and we also have a capacity expansion project in Composite Fibers with $50 million investment that will expand our capacity to serve the growing tea-coffee and technical specialties markets. As we go forward, we expect to continue to execute this strategy and grow our position in these growth markets going forward.

Slide six, just a bit of an overview on the overall strategy; so I mentioned that half our business is, half our revenue comes from growth businesses and a little bit over half of our EBITDA is also coming from those growth businesses. So our Specialty Papers business has been generating substantial free cash flow; that’s the role and the mission of that business. We then use that cash flow to redeploy and grow our Engineering Materials businesses, doing things like the Dresden acquisition, the capacity expansion for Composite Fibers, we also acquired the Airlaid business in 2010 and we continue to make investments to improve the capacity utilization and capacity available to serve those growing markets.

Through this process of executing on our strategy we put out a strong track record of growing earnings per share. We have a 17% compounded growth rate over the last five years and we've used our cash both to grow our business, but also to return cash to shareholders. So we completed a $50 million share repurchase program primarily in 2011. We also increased our dividend in the first quarter by 11% and this is the first dividend increase the company has done in 20 years and I think it reflects the improved cash flow profile of the business as well as the confidence that our Board and senior management has in our ability to continue to generate those strong cash flows. We also have maintained a strong balance sheet and it’s given us the opportunity to continue to execute our strategy. So we have our leverage even after the Dresden acquisition is quite low at 1.9 times, so we continue to have the firepower to grow the business going forward.

Slide seven reviews the positions we have in our markets. Generally, Glatfelter has leading positions in all three of its businesses. In the Specialty Papers business, we have four market segments where we have generally leading physicians. I will talk a little bit more about the various products, but Engineered Products is a collection of niche markets things like papers for postage stamps, playing cards, green cards, we also have a number of food grade applications. We produce high speed [ink-jet] products, as well as packaging products. That part of the business, 21% of the revenue generally is growing around GDP.

The other elements of the business, book publishing, envelope and carbonless and forms tends to be in secular decline as is the broader uncoated free sheet business. We've been able to maintain our capacity utilization and grow our shipment and we will look at that in a little bit more detail on the next slide.

Composite Fibers is the world leader in making beverage filtration papers, so in teabags we believe we have number one market share in the world with about 55%. Those markets are growing about 3% a year. Single serve coffee applications and this would be things like the green mountain cake cups as well as some sale machine in Europe. We believe we have about a 75% market share; again a number one position and we believe that markets are growing about 12%. And then the most recent acquisition that we announced last week the non-woven wall covering; this is a market that is growing 10% and we will see the slides in a few minutes on more of the details there. So the Composite Fibers as overall, their markets tend to be growing in the 5% to 10% range per year and we expect that we can continue to drive revenue and earnings growth from this business.

Our Advanced Airlaid Materials business, again this is a business that produces very thin super absorbent substrates that go into feminine hygiene and adult incontinence products. We again believe we've the number one position for Airlaid Materials in feminine hygiene and the number two position in adult incontinence. 80% of the revenue of this business does go into feminine hygiene and we think that market is growing by about 5% per year and we think that our share is about a third of the total market.

We’ll take a little bit deeper look at each of our business units. Specialty Papers; as I mentioned, the four market segments that they participate in, three of which are in decline, you can see in the lower left hand corner of this slide, the broader demand for the uncoated free sheet market which has generally been declining 3% or 4% per year. Glatfelter however has grown shipments in seven of the last eight years. The only year that we had decline was in 2009, our shipments were down about 1% compared to a broader market decline of 16%. We have been able to do this through a couple of things.

One is our, what we believe to be superior customer service, so our ability to deliver products quickly and on time, help our customers manage their working capital much more effectively and reduce their supply chain costs, our focus on new products, so bringing new products like food grade products, ink-jet, high speed ink-jet products in to market gives us additional capability to grow our shipments. I also think it’s important to understand the context of the broader market, this is 8.5 to 9 million ton market, we make just below 800,000 tons a year. So if our shipments will decline 3% a year that would equate to about 24,000 tons of business that we would need to generate to stay even, which makes of a very manageable situation for us. So those are some of the things, so that amount the flexibility of our asset base has allowed us to grow our shipments while the broader market has been in decline.

Now in the upper right hand corner you can see our operating profit and EBITDA; we have substantial grown operating profit with $10 million in 2005 growing to $67 million in 2012. We have expanded our margins; depreciation and capital investment tends to be about the same in this business, so this business is generating $60 million, $70 million of pre-tax cash flow per year and again this is a business that we would expect has not to be growing nearly as much as our Composite Fibers and Airlaid business, but to be generating the substantial cash flow it allows us to reinvest in other parts of our business and use excess cash to return to shareholders.

Slide nine is our Composite Fibers business, again Composite Fibers has market leading positions in tea, single-serve coffee and the non-woven wall covering business; markets that are growing 5% to 10% per year. You could see in the lower left hand corner that from 2009 through 2011, the business nearly doubled its operating profit and grew margins by of 220 basis points. This was driven by volume growth as well as the success of our continuous improvement initiatives; continues to improving for Glatfelter is a methodology that’s based on concepts of Lean and Six Sigma that we deploy throughout our business to reduce ways to improve the cost structure and create incremental capacity.

2012 operating profit declined a little bit from $40.8 million and $36.1 million. This was driven by slightly lower volumes. Volumes were down 3% reflected the economic challenges in Europe and those challenges has been affect end market demand so much for our products as it did impact how closely customers manage inventories. So we talked about this with our fourth quarter call that customers were quite aggressive in driving down our inventories and that impact our shipments.

But we also said in our fourth quarter call that we thought that that inventory reduction had largely won its course and that we would get back to a sort of normal shipping patterns in the first quarter and we did see that result, some of this rebound in shipments in Q1 compared to Q4. We saw operating profit in Q1 increased 68% over Q4, so we think we are back to normal operating pattern in Europe in that business.

As I mention, I think the growth prospects for this part of our business are very good. The capacity expansion that we are undertaking is $59 million investment. We are taking existing machine that makes about 7,000 tons per year of low end composite laminate products and we are upgrading it to an incline [wire] machine that will have the capability to make our higher margin tea, coffee and technical specialty products.

The machine was taken down in mid February. We are in the process of upgrading and we will start it up in the next few weeks. So that investment we expect will generate a 15% to 20% after-tax return within three years. So a good opportunity to drive profit growth and margin expansion in this business and of course the Dresden acquisition that we closed last week provides another catalyst for growth for Composite Fibers.

We turn to Advanced Airlaid Materials on slide 10, Advanced Airlaid Materials has seen some very good shipment growth with a top end growth rate since we acquired the business up 8% where the markets are growing about 5% so they are growing a little bit faster than the broader market. The business has a good pipeline of new products. They bring next generation hygiene products as well as the adult retirement products and new products into the baby diaper market that give this business also a good runway for growth as we go forward.

The operating profit and margin shown in the low left hand corner of this slide, we've seen very good growth and literally 2010 was a difficult year for this business. The year we acquired it, margins were about cut in half from the prior year driven by rising input costs as well as foreign currency exchange rate changes, but since that time we've seen substantial growth in operating profit, we've seen margins nearly double and we think we have continuing opportunity to both expand the margins and continue to grow the revenue. So between Composite Fibers and Advanced Airlaid Materials we think we have a very good opportunity to continue to drive earnings growth and strong free cash flows.

I want to take a few minutes now and speak about the Dresden Papier acquisition that we just completed last week. Dresden has a state-of-the-art 60,000 metric ton capacity facility in Germany. They serve the non-woven wall covering business. So in contrast this is against traditional wall paper, traditional wall paper products tend to be thinner and less stable in nature. The non-woven product with its embedded synthetic fibers provide it more dimensional stability and higher tear resistance and also does not shrink or expand when it gets wet and dries.

So it is a superior product to traditional paper based wallpaper. It allows installers to apply paste right to the wall and install the wallpaper. There's no issue as you have with traditional wallpaper of the product needing to be wet and then shrinking as its on the wall and creating some issues and it’s also some product that can be stripped right off the wall.

So given the tear strength that it has, you can peel this off like it’s a post now from the wall so it is much easier to change out the product compared to traditional wallpaper. Those product characteristics have allowed it to gain market share in the market and we will see that on the next slide.

This acquisition, Dresden, is a cost and quality leader. We paid about -- we paid $210 million for this business. 2012 had revenue of about $151 million and it had EBITDA of $38 million so we paid about 5.5 times and it has about 25% EBITDA margin. So it’s a very profitable company with continuing growth prospects.

Our expectation is that this acquisition will be immediately accretive to earnings by about 25% per share on an annualized basis. During 2012 we earned a $1.25 a share so this is very highly accretive to the business and we expect to earn a very substantial return on investment.

Slide 13 provides a little bit more about the market that address and serves. You can see in the chart on the right hand side, the non-woven substrate has about 35% market share as compared to the traditional wallpaper base. Dresden shipped 59,000 metric tons in 2012 compared to a market size of 125,000 tons. So it's just below 50% market share.

We expect that the broader wallpaper market will continue to grow slowly and that the non-woven share of that market will continue to increase as we go forward and that provide you opportunity for about 10% per year market growth.

The Dresden facility is larger serving markets in Western Europe, so Germany, France, the UK as well as Eastern Europe, Russia, Ukraine and increasingly the Chinese market is a market of significant potential growth. Dresden does have a position there. Although because of their essentially a capacity is utilized fully, the product stay closer to the home in the Europe region.

Unidentified Analyst

Are there local suppliers in the Chinese market?

John Jacunski

Yes, there are some local suppliers in Chinese market and there is also a competitor that has a machine that they have recently started up to serve that market.

Unidentified Analyst

But they are still lot of the opportunities.

John Jacunski

Certainly, I mean, it's obviously a fast growing economy, even though it's slower than perhaps had been recently. There is still some substantial growth and there is opportunity for substitution of non-woven for the traditional paper base provides a significant growth opportunity.

Unidentified Analyst

(Inaudible)

John Jacunski

The US market is generally the non-woven or small component of the broader market. There are no manufacturing plants in the US making this product. Manufacturing is all sort of Western Europe and in Asia. And given that the very high capacity utilization rates it just -- it's not a significant presence here. There is little bit of, sort of training of the market and education and as you got the market both the distributors of the product as well as installers and so before investments in those kinds of things take place, you want to make sure you have the capacity available to serve them. But it's another for us over the next year or so as we assess the capacity we need going forward, it's a market that's certainly one need to look at and determine what kind of opportunity there is.

Okay. We will switch to our financial overview on slide 15. Again I think we, Glatfelter has established a solid track record of growing our revenues and our EBITDA. You can see from this chart that the five-year company growth rate on revenue at 7% and our EBITDA at 9%. This has been driven by our organic growth as well as acquisitions and our continuous improvement initiatives that have allowed us to expand our margins.

And given the growth prospects we see in Composite Fibers and Advanced Airlaid Materials including supplemented by acquisition growth, we believe we have a good opportunity to continue to growth trajectory.

There is couple of things on, in 2006, we acquired a couple of businesses, our Chillicothe, Ohio facility, we acquired from NewPage, it's an old meet facility. Again the business itself had quite little margins. Now we paid $80 million for the business. It included $87 million of net working capital as part of the acquisition. So we paid along the value of working capital and paid about four times EBITDA, and we had a very good success with our continuous improvement initiatives to improve the profitability of that business and that was reflected in the specialty papers chart on growing of its operating earnings and then also we saw the composite fibers had expanded margins pretty substantial between 2009 and 2011 it helped to drive margin expansion.

Slide 16 our just release per share we will show this two ways. I will talk about our pension here in a minute because it’s important that investor understand. But when we address for pension our five year competent growth rate on earnings per share is 17% with [good] earnings per share 24%. In 2012 that was supplemented by our share repurchase program. And again when you look at the growth drivers that we have in front of us between acquisitions and organic growth, we have the opportunity to continue to drive this kind of earnings per share growth. From the cash flow perspective on slide 17, its 2003 through 2008 we had pretty anemic cash flow and also reflected the acquisitions we did in 2006. Since that time from 2009 forward we have implemented very aggressive and disciplined working capital management practices that has helped generate $47 million of cash flow in 2009 and we’ve also were able to sustain our free cash flow generation in the $70 million to $80 million range per year and it’s certainly a key objective of our going forward to continue to generate this type of healthy free cash flow.

On slide 18, you know the combinations of growing earnings of generating good free cash flows and being disciplined with our capital deployment has allowed us to substantially improve our return on invested capital. So in 2012 our return on capital was 9.3%, well ahead of our weighted average cost of capital which is in the 8% to 8.5% range. This is a key metric for the company. It drives our decision making and it’s also embedded in our compensation programs. We believe it is the single best measure to evaluate the performance of the business. So it will continue to be an important measure for us as we go forward.

Slide 19 a few comments on our pension plan. I think it’s important to understand where we have been [apple] from a funded status as well as P&L perspective. So at the top we have been over funded for quite some time. We have stayed over funded through the significant market declines in 2008 as well as the ongoing declines to discount rates. So we have not had to make cash contribution to our (inaudible) plant in many years and we don't expect to have to make a contribution for the foreseeable future. So this is not an economic issue for Glatfelter; however it has had a significant influence on our earnings per share. So if you look at the table that's shown at the bottom of this slide; in 2008 we had $16.1 million of pretax pension income reflected in our P&L, that (inaudible) expense of 2009 and we expect to have about $16 million of expense in 2013. This comes from the issues I talked about around the declines in markets in 2008 and the ongoing declines in discount rates both of which are reflected in the funded status. But the actual declines that result from these get hung up on the balance sheet and amortized in the future. So it’s been a significant drag on our earnings per share, it’s not an economic issue for Glatfelter and I think it’s important that investors understand that situation.

Unidentified Analyst

(Inaudible)

John Jacunski

Well, I think it’s a little bit of a difficult question to answer because I don't know where interest rates are going to go. You know we'd like to think that they are not going to go lower, but I have been thinking that for a few years now. It would be about another four or five years. The amortization it takes place over by the 10-year period. So if we were to see discount rates increase then we could see the amortization of these losses go down because we've had gains that would help to offset some of those losses. But if things stay exactly where they are at it could be four five long years before that amortization runs its course. Well hopefully the interest rates will rise for the right reason.

So slide 20 is our balance sheet. Today we have one debt issue outstanding, our 5.38% notes that we issued last year, $250 million to refinance the 7.18% notes we had outstanding and provide a little bit more liquidity to the company. So at the end of March of our first quarter our leverage was one times. We had $76 million of cash and we had about $345 million available under our revolving credit facility. Since the end of the quarter in early April we closed a 42.7 million euro 10-year term loan at a fixed rate of 2.05%. This is related to some of the composite fibers capacity expansion project. We also completed the drugs and acquisition. We funded that with 70 million euro of cash and 90 million euro of borrowing under our revolving credit facility. So on a pro forma basis for the Dresden acquisition at March 31 we had leverage of 1.9 times so we continue to have a low leverage. We continue to have financial flexibility to execute our strategy and also do things like increase the dividend like we announced earlier this year.

So far on slide 21 just to wrap up, again I think the leading position we have in key global growth markets around key single-serve coffee, the non-woven wall coverage market and the feminine hygiene space with all of the markets growing at 5% to 10% range give us a good run rate for ongoing growth. The multi acquisition and capacity expansion give us the capacity we need to continue to grow our execution, our focus on execution, continue some proven initiatives, our help to improve our cost structure as well as productivity and that gives us the confidence that we can continue to grow our earnings and generate very healthy returns on invested capital and continue with the generation strong free cash flow.

So that’s the overview of the business and certainly happy to take any further questions or maybe.

Question-and-Answer Session

Unidentified Analyst

(Question Inaudible)

John Jacunski

60. Dresden machine produces 60,000 metric tons per year currently.

Unidentified Analyst

And how many utilizes currently?

John Jacunski

It's pretty well fully utilized. We do have a number of targeted investments that will help us to improve the productivity and capacity of that machine. So we think that we can get the capacity over the next year or so up to 70,000 to 74,000 metric ton. So we think if we were to grow at the market rate, we have about three years of market growth that we can absorb with that machine. Over the next year or so, we will be continuing to look at whether there is further opportunities to improve the productivity of that machine and continue to grow with the market or whether we need to bring new capacity into the market and that could take the form of small investments on some existing machines we have to create capacity to serve market in order to be looking at acquiring capacity in some other way.

Unidentified Analyst

(Question Inaudible)

John Jacunski

Only a few thousand. While the market is certainly much bigger than a few thousands that’s all that Dresden is currently shipping.

Unidentified Analyst

(Question Inaudible)

John Jacunski

Yeah. Make a little higher. Any other questions I can help answer?

Unidentified Analyst

(Question Inaudible)

John Jacunski

Yeah. Sales motivation, this business was owned by a public company in Canada, Fortress Paper, they have three businesses two of which need a fair bit of capital, so I think that they are public are an opportunity to rake some liquidity.

Unidentified Analyst

(Question Inaudible)

John Jacunski

I believe they bought it from [Mercer] in 2006. The management team here did a great job of improving the manufacturing process and improving the profitability of that machine.

Unidentified Analyst

(Question Inaudible)

John Jacunski

Yeah. I think that the weak environment in Europe from the non-woven wallpaper space. With some of the strength, some of the Eastern Europe economies that are non-euro based and the substitution effect of non-woven is taking share from crucial paper base wall paper. We feel pretty good about the growth rates of September.

Unidentified Analyst

(Question Inaudible)

John Jacunski

No the non woven substrate is more costly but I think if you consider on an installed basis the.

Unidentified Analyst

(Question Inaudible)

John Jacunski

That is right, there’s certainly a better value proposition to the consumer from the substrate versus the traditional paper (inaudible) substrate.

Unidentified Analyst

(Question Inaudible)

John Jacunski

In just Europe it will be certainly higher then 48% number but I don't recall that off the top of my head I have to look at that for you.

Unidentified Analyst

(Question Inaudible)

John Jacunski

There is a couple of competitors; [Holmstrum] which is a Finnish base company, if you can put it on that space, they are the largest competitor and then your companies like in the paper has some, make some of this substrate those will be other two larger. Okay thank you very much. I appreciate your time today.

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