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Schweitzer-Mauduit International (NYSE:SWM)

Q2 2014 Earnings Call

August 07, 2014 8:30 am ET

Executives

Mark Chekanow - Director of Investor Relations

Frédéric P. Villoutreix - Executive Chairman and Chief Executive Officer

Stephen D. Dunmead - Chief Operating Officer

Jeffrey A. Cook - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Alex Ovshey - Goldman Sachs Group Inc., Research Division

DANIEL JACOME

Operator

Welcome to SWM's Second Quarter 2014 Earnings Conference Call. Hosting the call today from SWM is Frédéric Villoutreix, Chairman, Executive Vice President and Chief Financial Officer; Steve Dunmead, Chief Operating Officer; and Mark Chekanow, Director of Investor Relations.

Today's call is being recorded and will be available for replay later this afternoon. The dial-in number is (855) 859-2056. And the pin number, 75619045.

[Operator Instructions]

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

Mark Chekanow

Thank you, Kate. Good morning. I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's Second quarter 2014 earnings results.

On today's call, Frédéric will share some high-level comments about our second quarter performance and strategic priorities. Steve will provide details on our operations and Jeff will take you through a detailed review of our financial results. We'll then take your questions.

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

Certain financial measures discussed 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 second quarter 2014 earnings, and this morning we're pleased to present our results and update you on our operations, initiatives and tobacco industry developments.

In addition, we'll provide an update on our DelStar operations and some of the projects that are already on their way to build-out our filtration platform. Our financial results from the second quarter and industry trends impacting us, were largely consistent with the first quarter of 2014, with the exception of a more beneficial effective tax rate. Tobacco industry attrition, as well as customer industry de-stocking in both RTL and paper products continue to provide volume challenges.

To offset those pressures, we remained focused on providing efficiency across the company, capitalizing on the positive trends in China, pursuing non-tobacco paper products and supporting the growth of our Filtration segment. Despite burning challenges across our tobacco businesses, we delivered EPS in the first half of 2014, which strikes well to our annual 2014 EPS guidance.

Although net sales grew by 3.6%, but excluding DelStar, our revenue declined 12.7%. DelStar's revenue in the second quarter of $32 million, and $64 million year-to-date, put us on plan to deliver on our Filtration segment financial expectations for the year, and we look forward to continued strong performance in the back half of the year.

LIP volumes were down only 1.6%, which we believe represents good execution and shared performance in the face of other [indiscernible] attrition in the U.S. and Western Europe.

While the quarterly results might not always match directly to the industry's reported volumes, we note this decline appears to be better than industry attrition in our key geographies. We consider tobacco segment volumes were down 27%, similar to what we reported in the first quarter.

While we expect year-over-year volume declines to be somewhat more favorable than 27% in the second half of the year, we now think the full year volume decline in excess of 20% is likely. Regarding overall tobacco industry attrition, we are seeing a more moderate decline compared to the heightened figures seen in early 2013, especially in Europe.

We achieved adjusted earnings per share from continuing operations of $0.91 and operating cash flow from continuing operations of $38 million in the second quarter of 2014. Our management team remains highly focused on cash flow, and we're already seeing improved conversion of operating profits to cash on the realignment of key global assets and the resulting tax benefits.

Now, I would like to review the status of several of our strategic priorities and actions. We are pleased to announce a long anticipated opening of our Chinese RTL mill, a JV with China National Tobacco. We often refer to this JV as CTS, China Tobacco-Schweitzer. This project was a significant undertaking and was delivered generally on time and on budget, which we believe is a testament to the quality and dedication of our employees and our ability to execute on a global basis with the world's most powerful tobacco enterprise.

As you are all aware, we've been operating a paper joint venture in China for many years, and this new RTL mill solidifies our leadership position as a strategic industry partner to China National Tobacco. We expect Chinese related consumption to have a long-term trend to more premium cigarettes, we've reduced our attributes and Reconstituted Tobacco Leaf should pay a key role in that migration.

We continue to develop improvements to our RTL product regarding taste and ingredient simplifications. As we have said, these are long-term in nature; however, these initiatives could provide a solid support to RTL usage and are thus critical to pursue now.

On the LIP front, we mentioned last quarter that South Korea will adopt regulations effective mid-2015. While there are no new developments to report, we are engaged in discussions with key cigarette makers in the region.

Regarding potential LIP regulations in Russia, no votes has taken place, and it is our view that while adoption is expected in the next several years, we feel that it is no longer appropriate to convey expectations for the timing of the vote to the investment community. With the uncertainty caused by escalating geopolitical evidence in the region, we have to wait for a public announcement of regulations before further discussing timing expectations.

Moving on to DelStar, our Filtration segment aided another solid quarter of financial performance. And we remain excited about its near-term prospects and long-term opportunities to unlock significant value to our combination.

One of our international facilities is currently undergoing an expansion to accommodate multiple production lines in DelStar's key product areas. We can't provide details at this time for competitive reasons, but we can disclose that this project is progressing well.

Regarding the core development of new papers for use in filtration, our teams are collaborated by multiple opportunities, but they are longer term in nature. Regarding M&A, we're actively pursuing bolt-on and adjacent opportunities at DelStar, as well as remaining open to businesses that complements our paper-based operations.

To summarize, we are focused on several key initiatives that we hope will begin to provide improved profit performance in 2015 and beyond. Steve will provide more details on these opportunities and we will, of course, continue to provide updates during each of our conference calls.

Let me now turn the call over to Steve, to discuss operations in more detail.

Stephen D. Dunmead

Thank you, Frédéric. I'll now walk through the volume trends and operational highlights. Tobacco Paper volumes in the second quarter, including CTM, our joint venture in China, were down 10% with LIP volumes down 1.6%. These declines were partially offset by strong non-tobacco paper sales growth. While our tobacco paper sales year-to-date are tracking worst than industry attrition, we note that our full year 2013 tobacco paper volumes were down only 2%, thus, our longer-term historical volumes are tracking closer to the attrition rates in our key regions.

In 2014, our conventional non-LIP cigarette paper business has been facing a difficult comparison versus a strong 2013, smoking attrition, customer de-stocking, and some isolated cases of share loss driven by very competitive and unattractive pricing.

Regarding LIP specifically, we believe that we continue to have gained share this year, but remain cautious as to whether some of these gains will carry into the second half of the year or if our customers will rebalance their allocations.

In addition, some of our customers are in the process of facility consolidations and a portion of our order strength and LIP may, in fact, be related to some precautionary inventory build to cushion any disruptions caused by these changes.

As discussed last quarter, our strategic focus remains on LIP versus conventional cigarette papers, as it generates superior profit margins. RTL segment volumes were down 27%, roughly mirroring the first quarter of 2014 performance. While we expect volume declines in the segment to be less pronounced in the back half of the year, we believe our full year volume decline will be between our original expectations of approximately 20% and the 27% we saw in the first half, which results are disappointing. We should note that the revenue in this segment was down 21% as pricing, mix and currency have been favorable year-over-year.

While we are facing significant volume declines in 2014 at our French RTL mill, we're excited that our Chinese RTL JV began production during the second quarter. Initial products are currently being approved by our partners, and we expect that JV to begin generating revenue in the coming months.

To put the size of this project into perspective, our French mill has roughly 80,000 tons of capacity, and it's currently operating 2 machines at roughly 65% of capacity. Our Chinese JV, CTS, will have 30,000 tons of capacity and is expected to ramp to full production over 3 years, as our partners steadily introduce RTL into the tobacco volumes.

All told, we expect that the annual increase in volumes at CTS will more than offset the attrition-based declines in Europe that impact our French mill. Thus, we expect that overall SWM RTL volumes will grow over the next several years as a result of our new sales into China.

Although the mill will generate startup losses in 2014, 2015 should be profitable and SWM share of the net income is expected to be in the range of $8 million to $10 million or $0.25 to $0.30 per share once we reach full production in 2016.

CTS will operate at high margins, consistent with the historical profitability of our Recon segment, that will be reported below the operating profit line, similar to our Chinese paper JV.

As Frédéric alluded to, this project is our second JV with China National Tobacco. We're proud of the long-term and highly profitable strategic relationship we've formed. China's long-term trend toward premium cigarettes, comparable with those typically consumed in the U.S. and Europe is expected to remain intact with the foreseeable future. The potential remains for China to open its borders to global trade in the long-term. Should this take place, China produced cigarettes will likely need to compete with leading western brands around the world, including the Mainland China. We expect to continue to play a prominent strategic role and assist our Chinese partners in the continuous development of the tobacco industry and the potential opportunities of a globally open marketplace.

Our cigarette paper JV was our first step, this RTL project is the second and we continue to explore further avenues of collaboration.

During our last quarterly call, we discussed the mid-2015 LIP adoption in South Korea, and we spent much of the second quarter in discussions with key cigarette suppliers. We're aggressively pursuing high market shares and are making initial plans to incorporate additional volumes into our LIP facility in Poland. We have capacity to service our customers and do not expect any incremental capital spending to accommodate the additional volumes.

It is unlikely that we'll have final customer commitments until early 2015, but we remain optimistic that this development could generate approximately $0.20 per share on an annual basis, though the 2015 impact will be less due to the mid-year implementation.

Regarding cost controls, we have begun taking actions to align our infrastructure and labor to our current and expected volumes, and will continue to do so as needed. We booked $3 million of restructuring charges during the second quarter in our Recon segment, as we reduced headcount. This is a time-consuming and costly effort in France, but the actions taken so far will -- we expect will generate approximately $1.5 million of annual savings. Obviously, these decisions are not taken lightly by our management team, but we believe that they are appropriate given the reduced utilization of our French RTL mill.

We remain alert to the need for additional restructuring actions across the company, particularly in response to declines in volume. We are also actively engaged in assessing all areas of expense including overhead costs, across the company as we enter the second half of 2014 and work towards settling up for a more profitable 2015.

Moving on to DelStar, which comprises our Filtration segment. Second quarter and year-to-date results have been largely as expected, and we remain comfortable with the transaction contributing $0.25 to $0.27, and adjusted 2014 EPS that we have previously communicated.

The business is building strong order momentum particularly, in its key water filtration products. Many of these products that DelStar sells are components of finite light filter elements. These filter modules lose efficiency over time, resulting in multi-year replacement cycle and creating an annuity-like revenue stream.

With new water filtration facility set to come online in the next 1 to 2 years, the installed base of filter units is set to increase, further bolstering water filtration sales. In addition, DelStar is gaining traction with the recently added large customer and pure filtration and volumes and profitability with that customer are headed upward.

Our international expansion project with DelStar is well underway. We're leveraging our global asset base and infrastructure to deliver on a growth project that DelStar wanted to pursue for some time. New product -- production lines are on order and scheduled for installation during the third and fourth quarters of this year.

[Audio gap]

already servicing customers abroad, but we believe that the global production will result in material cost savings in freight and duties.

Furthermore, this expansion will service a launch pad for more aggressive international sales efforts as we expect DelStar to be much more cost competitive with production localized in key geographies.

We also expect that this project will benefit from our global asset realignment activities and the associated tax benefits.

All told, it's been an extremely busy start to 2014 for the Filtration segment. We've integrated DelStar, implemented Lean Six Sigma disciplines, continued our origination process for bolt-on and adjacent acquisitions, are working on international expansion, have established a collaborative process for new product development and, of course, we're executing on DelStar's existing base business.

I'll now turn the call over to Jeff to take you through a detailed review of our financials.

Jeffrey A. Cook

Thank you, Steve. Second quarter net sales increased 3.6% versus the prior year quarter. Currency impact was positive for the quarter and on a constant-currency basis, revenue was up about 1%. DelStar contributed revenue of $32 million in the second quarter. Excluding DelStar, revenue was down 12.7%.

Second quarter Paper segment revenue, which includes non-tobacco Paper, or excludes sales from our current -- from our Chinese JV was down 9.2%. This decrease was driven by lower tobacco paper volume, and lower LIP pricing. Another quarter of solid double-digit volume growth and certain non-tobacco product lines offered some offset to those pressures.

Recon segment volumes declined 27%, but improved price, mix and a stronger year all resulted in a revenue decline of 21%. The DelStar business was acquired during the fourth quarter of 2013 and thus we have no year-over-year revenue comparison to report. We will begin reporting year-over-year sales comparisons for DelStar on our first quarter 2015 earnings call.

As you can see on Slide 11, adjusted operating profit was down $8.3 million versus the year-ago quarter. As with first quarter 2014 results, volume, price and other costs, primarily reduced fixed cost absorption were large impacts. Wood pulp price changes were slightly favorable versus last year, as were currency changes.

DelStar contributed $4.7 million of adjusted operating profit. As we look to the second half of 2014, we expect to face similar volume challenges. We also expect to do some modifications to certain paper lines. All of this resulting in additional machine downtime days during the third and fourth quarters. We expect these projects to have long-term efficiency benefits, however. Expenses associated with these projects will offset some of the gains we will see from cost reductions and lower taxes during the second half of the year.

All else being equal, we would expect the analysis on this slide to look largely consistent throughout the year.

Paper segment adjusted operating profits during the second quarter were down approximately 18% versus the same period in 2013. The Paper segment's adjusted operating profit margin in the quarter was 17.3%, 190 basis points lower than the prior year quarter, due to continued volume pressure in the accompanying reduced fixed cost absorption, as well as lower pricing on certain LIP sales.

Adjusted operating profit in the Reconstituted Tobacco segment for the second quarter of 2013 was down 33% driven primarily by lower volume, with adjusted operating profit margin of 32.1% finishing 600 basis points below last year's second quarter results.

While French labor laws present certain challenges to reacting quickly to changing demand, we have taken actions to reduce our cost and expect to see benefits in the second half of this year and beyond. The Filtration segment, which is comprised of DelStar, reported adjusted operating profit of $4.7 million and generated a 14.6% operating profit margin. These results exclude the impact of purchase accounting adjustments, namely the amortization of acquired intangible assets such as technology and customer list.

Our consolidated adjusted operating profit margin was 16.9%, down from 21.8% in the second quarter of 2013. Unallocated corporate expenses increased by $0.7 million year-over-year, due primarily to higher professional services fees from our global asset realignment activities in connection with efforts to improve our liquidity and cash flow.

We have absorbed several million dollars of expense related to this project during the first half of the year, though a relatively smaller burden will be felt in the third and fourth quarter. However, this project is very beneficial to the future financial strength and growth of the company.

Outside of that project, our corporate unallocated expenses remain under control, though as Steve indicated, we are continuously implementing cost improvement measures where possible.

Our second quarter 2014 adjusted earnings per share from continuing operations was $0.91, a $0.07 improvement from the first quarter of 2014, but down from $0.95 in the second quarter of 2013. While we did experience lower operating profit due to challenges in our tobacco operations, a lower tax rate, benefits from the share buyback and the addition of DelStar, nearly neutralize those significant headwinds.

As a reminder, purchase price accounting adjustments for the DelStar acquisition, startup losses on the CTS joint venture and restructuring costs are excluded from our adjusted EPS.

The effective tax rate for the second quarter was 20.8%, down from 32.4% during the year-ago period. The global asset realignment activities we have discussed were a large reason for the decrease. We note that there were some onetime benefits we realized during the second quarter, pushing our year-to-date effective tax rate to the mid-20s -- similarly the rate we would expect in the second half of the year.

Our annual guidance for adjusted diluted EPS that we issued in early February was $3.40. Recall that at that time the guidance was issued, it included the early impact of the share buyback executed at the time of our fourth quarter 2013 earnings call. The buyback was completed during the first quarter and the incremental impact to 2014 EPS of the full buyback, including the interest expense a sort of fund the buyback was an additional $0.06 to $0.07.

Although, we are not updating our EPS guidance for total year 2014, we believe we are on pace to at least achieve our annual guidance with the share buyback as the primary driver of potential upside.

SWM net debt is now $157.7 million, an increase of $44 million since the end of 2013, primarily due to the execution of the company's $50 million share repurchase authorization. Despite the decline in profits during the first half of 2014, net debt to adjusted EBITDA from continuing operations at the end of the second quarter, remained relatively low at 0.8.

Our near-term liquidity needs, as well as capital required for internal and acquisition related activities to a certain extent fit comfortably within our current financial profile. We continue to believe that we can achieve our growth strategy, while still maintaining a relatively conservative capital structure.

Our second quarter 2014 operating cash flow was $37.9 million compared with $40.8 million during the year-ago period. Lower pretax income was partially offset by improved working capital utilization. Capital spending was $7 million in the second quarter of 2014, up from $3.6 million in the second quarter of 2013, mostly due to timing of capital projects, but also the addition of DelStar.

We expect 2014 CapEx to be approximately $30 million, including DelStar maintenance requirements and investments required for the international expansion. In conjunction with the finishing steps to open our Chinese RTL joint venture, we made our final cash contribution to the project in the second quarter of $5.5 million, bringing our 2014 total contribution to $8.8 million.

With the completion of the $50 million buyback during Q1 2014, SWM had bought back more than $200 million of stock over the past several years. We did not buy additional stock during the second quarter, and currently have no buyback program authorized.

As we have said, our buyback program is opportunistic and will be balanced with other cash needs of the business. In considering our capital allocation strategy, we will clearly be on track to return well more than 1/3 of free cash flow to our shareholders in 2014, when aggregating the buyback and the $45 million of dividends we expect to pay. Going back several years, we believe that $200 million of share buybacks and the five-fold increase in dividends per share have offered our shareholders an aggressive return of capital, which was balanced with our investment in the Chinese RTL joint venture and the DelStar acquisition, both of which are expected to provide long-term profit growth.

In aggregate, these investments and capital returns are consistent with our capital allocation strategy, and we plan to continue to return capital to investors and invest in our business with discipline and using both our free cash flow and a relatively unlevered balance sheet.

I will now turn the call back to Frédéric for his closing comments.

Frédéric P. Villoutreix

Thank you, Jeff. We realized that our results to date are reflected not only the difficulties of dealing with ongoing cigarette consumption declines, but also significant declines specific to our RTL business. However, while we've been focused on execution and achieving our financial guidance for 2014, we have also been hard at work to put the pieces in place for improved profit performance in 2015 and beyond.

Our management teams remain focused on resuming long-term earnings growth and activities such as our Chinese RTL joint venture, South Korean LIP and paper diversification opportunities, new product introductions, cost-reductions, tax efficiencies and working capital improvement projects, which we believe will bear fruit for years to come.

We are also supporting our filtration growth platform, which we expect to build aggressively through internal efforts, such as international expansion, paper-based filtration products, [indiscernible] deployments and externally through M&A.

You can also expect us to prudently manage our tobacco-based businesses, investments in high-profit projects and drive strong cash flows which will be used to fund dividends and potential buybacks, as well as grow their business. We expect to finish 2014 as global plan and enter 2015 with momentum from several fronts.

That concludes our remarks. Kate, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Ovshey with Goldman Sachs.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Couple of questions for you. First of all, is it possible to parse out the revenue breakout in the Paper segment between LIP non-tobacco papers, and then non-LIP tobacco papers? Just to kind of give us a sense of what that breakdown looks like?

Frédéric P. Villoutreix

This is Frédéric. We've historically not disclosed this breakdown. I think what -- on the past disclosures that we did at this time, the U.S. market -- the size of U.S. market, the size of European markets for LIP, we have a strict order of what's the rate of growth or decline of our LIP margins. So I think if you sense that obviously, it is a very large component to our revenue and it's even a larger component to our operating profit, as far as non-tobacco products, we are disclosing -- in fact, our revenue as of last year was 93% tobacco, 7% non-tobacco prior to the acquisition of DelStar. So it's also a point to tell us to -- with the fact we are 2 quarters now generating double digit growth on that segments that obviously, it's collective weight is growing.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay. I got it. Actually, that's helpful data point there. And then is it possible to say that the non-LIP tobacco papers and non-tobacco papers are those positive EBITDA businesses, right now?

Frédéric P. Villoutreix

Yes. I think -- if you go back many years -- many years ago, we deployed a very expensive restructuring program, and that the goal was essentially to bring all our paper assets above this positive EBITDA. And obviously, this is a constant focus of our management to, in spite of declining volumes and poor absorption of fixed overhead at any given moment of time to continue to rationalize our footprint to stay positive EBITDA.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay. Got it. That's very helpful, Frédéric. And then just on the LIP side in North America and Europe, in terms of the renewal of the contracts there, so there's all that behind you, have all your LIP contracts in North America and Europe been renewed at this point?

Stephen D. Dunmead

Alex, this is Steve. As we talked about it, I think in the last quarter call, that we have done some earlier renegotiation to extend some contracts. We always, if you take our biggest customers, our key customers, we always have at least one that is in some stage of renegotiation, but there's nothing significant that is sitting out there, waiting to be renewed at this point in time.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Got it. And then, is it possible to give us a sense for the duration of the new contracts? I believe the first generation contracts were, what, about 3 years kind of relative to that 3-year benchmark will be possible to give us a sense of the length of these new LIP contracts?

Frédéric P. Villoutreix

I think it varies from customer to customer. So we have -- I think the only thing we can say is our multiyear agreements.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Multiyear. Okay. Got it, Frédéric. Okay. And RTL, in the context of the difficult volume numbers and it seems like there's not a lot of visibility in terms of when or if that necessarily picks up for the Western European business. So looking at the margin profile and if volumes don't pickup from here, what sort of the goal for the margin profile in the RTL segment? Where do you think you can sort of get that margin through a cost-savings restructuring initiative, if volumes don't get better from here?

Stephen D. Dunmead

Certainly, that is our focus to continue to increase the margins, so I get them back up toward where we were before. But given, as you said, the lower volumes that were seen in 2014, coupled with the amount of time that it takes to do the restructuring that's necessary in France, it's going to take us some time to get there. But certainly, our focus is to increase it from what you're seeing today, back up toward the number that you've seen in the past.

Jeffrey A. Cook

Yes, and some of the savings there, Alex, they'll be -- the benefits next year will be better than this year, given that you got a full-year impact next year as well. And there are some other improvements we're making there that don't involve restructuring costs that are just smart to do from an operational excellence standpoint. So we're taking actions on several fronts to improve that and strengthen that.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay. Makes sense, Jeff. And maybe just some commentary around just the marketplace for RTL, I mean, obviously, the volumes continue to be soft, destocking, but sort of -- give us a little bit of flavor of how the conversations with the customers are going right now? I mean, I know you have some new generation RTL products in the pipeline. I mean, is there potential that some of those customers that may have moved away, slight destock, come back into the mix over the next 12 months?

Frédéric P. Villoutreix

Yes, I think one of the -- we are putting emphasis on destocking because we know from the conversation with customers that this is a driver in the current outlook and demand projections. And by the way, we -- the large customers are renewing their contracts for this year. I think some of the shortfall we're seeing is more for the independents that, obviously, are sitting on large amount of inventory. The reality of the market also is this, still a large amount of good quality natural tobacco leaf available at low prices. Now I think when we look at the forward outlook from the tobacco traders, they tend to point as maybe a reversal of the trend and more tighter situation in 1-year's time based on the quality and quantities that are projected for this year. But the reality is there is a fair amount of gluts in the supply chain and this is something that limits the visibility and I would say both -- at the customers' level where we see what they share with us.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay, Frédéric. So it seems like you're thinking now, it's more of just a cheaper substitute available, given that the price of virgin tobacco is sort of the consumer preference towards this product that all changed in your mind or again, is it just more of just a cheaper alternative that's available out there and that's what's causing the weakness in the near term?

Frédéric P. Villoutreix

We have also mentioned, if you recall, that we were made aware by some customers, also, of reformulation changes and we have been able to confirm on the limited scale, some of those changes. However, it's still early and I'm clear as to whether the level of changes will sustain or how they will evolve. So there's a [indiscernible] -- but I think the underlying driver over the long term is really the availability of price attractive, good quality natural tobacco leaf or lack of and the impact it can have on decision making of our procurement teams at our customers.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay. I got you, Frédéric. And then on the DelStar business, you talked about an M&A pipeline that you're highly focused on executing on sort of just thinking about the timeline, I mean, do you think we potentially see a bolt-on opportunity within the filtration business before the end of the year, or how are you thinking about the timeline or potential bolt-on M&A filtration?

Frédéric P. Villoutreix

So I think what we are disclosing is, we are actively looking, but obviously nothing has met all of our criteria as of yet. And I think as much as we want to build the platform around the DelStar business, and we see opportunities for bolt-on and adjacencies. We're also very disciplined in our approach in terms of the fits and the value creation that such a bolt-on acquisition would bring. So I think it's premature to give any indication as to timing, but clearly, this is our strategy to build around DelStar on the filtration -- a larger filtration platform.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Right. Okay. That's make a lot of sense, of course. Okay, and then maybe just one last one for you guys. On the China RTL opportunities, so can you just talk about the competitive landscape for Chinese RTL? Are there any other players right now in that market? And if there are

[Audio Gap]

ultimately be differentiated from others in the marketplace if there are any competitors?

Frédéric P. Villoutreix

Well, there are competitors. If you think about China, many different provinces, the big customers are aligned around provinces, and they have developed their own sources of recon. What we have disclosed and will continue to stick with is that a lot of these small -- smaller players are not really recycling wastes and the properties of the recon are not where we position our technology and products. And our two investors are also -- 2 of the largest cigarette companies in China are in the top 5. And we build the business plan together with them and the loading of the mill is primarily driven by their own needs, which, obviously, both from a combination of growth and upgrading their cigarette design so there is competition, there is probably more competition in terms of number of players in China, but the demand for recon is increasing, increasing relatively fast, considering that 2015 is the deadline, given by the monopoly for compliance with the low tar deliveries, and we remain confident with both the backing of all shareholders and partners. And with technology difference that we can bring to China.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay, that's a very helpful read. And then just one last one here, just a follow-on on China RTL. In terms of thinking about the cash flow, can you just talk about what the process will be to be able to get the cash out of that JV? And what the sort of initial plans are in terms of whether or not you would expect to take cash out next year, what sort of the timeline for how you're thinking about taking the cash out of that JV as it ramps to profitability?

Jeffrey A. Cook

I mean, it will work something like -- the other joint venture we have there after a few years in the business, gets on solid footing and starts generating the profits we're looking forward to. They would then be paying a dividend to us. So on an annual basis, much like CTM does right now. And that money we could either use for potentially other opportunities in China or leverage it for use elsewhere, and that's also been facilitated by the changes we've made in moving around our global assets in this realignment we discussed. It gives us more flexibility to use that money elsewhere in the world. So yes, we're looking forward to those dividends and begin to pull some cash out and hopefully use it for other good opportunities there.

Operator

[Operator Instructions] Our next question comes from the line of Dan Jacome with Sidoti.

DANIEL JACOME

The Russia LIP, what was driving that? Did you get any new data points over the quarter or is that just a function of the macro and you guys being conservative?

Frédéric P. Villoutreix

Well, the initial votes was scheduled for late 2013, until some of these developments in Eastern Europe, it was softly, informally announced that the vote will be postponed to May of this year. And nothing really happened, nothing publicly released and very difficult at this stage to have a new schedule. Now I think what's important, if you look at Russia, Russia has implemented and it continues to implement some very tough measures to ban, to curb down smoking and our view is that the LIP regulation is one of the various elements of this policy that the government has committed to a couple of years ago, and there is no indication that they will change their strategy going down -- moving down, forward.

DANIEL JACOME

Okay. And then I guess back to China RTL, how much of the volume decline -- I don't know if you can break this out, but was sort of the destocking element and then how much was just sort of run rate -- attrition rate across industry?

Stephen D. Dunmead

So if you're trying to break that down, Dan, if you take the China RTL part of this, that a couple of points of the decline over the long term is associated with transfers to the CTS joint venture. And then if you look at destocking versus the attrition rate, you've seen what the accretion rates were last year in Europe, they were 6%, 7%, 8% and you can -- so you can do the math on what the destocking part of that thing is. Certainly, the CTS part of it is only a couple of points out of that decline.

DANIEL JACOME

Got you. That make sense...

Jeffrey A. Cook

Another thing to remember there, Dan, is that if you look in perspective, the RTL -- our RTL volumes were up 6% in 2012, down 10% last year. So net-net, we've only been down about 4% over the last 2 years against attrition that was running at fairly strong in both years. So this year, as we said before, kind of represents a little bit of a catch up on the part of customers that were taking the hit for right now.

DANIEL JACOME

Right, yes. Cycling 2012 was a big year, obviously. That makes sense as well. And then I guess last quarter you had talked about some pricing concessions on -- for a couple of customers, which made sense to lock in market share, but do you have any new -- any call outs this quarter on what's happening there?

Stephen D. Dunmead

No, Dan. As I said both in the prepared remarks, but also in the -- one of the previous questions, that we always have something that's been negotiated with one of the key customers that there are pricing pressures, I don't think that there's any expectation that, that's going to change. But nothing significantly different than where we were 3 months ago.

DANIEL JACOME

Okay. And then I guess back to the one-time tax benefits in the quarter, what -- was there -- what were the one-time items that you said were kind of abnormal versus...

Jeffrey A. Cook

Yes, there was a one-time adjustment from first quarter and the second quarter, it wasn't a material item. But it did have a small impact on Q2, so we just didn't want to make it look like that rate was going to be something we live with permanently. As I said, it wasn't material, but it was a small adjustment. Going forward for the rest of year, we see ourselves in the mid-20s or so on an effective tax rate.

DANIEL JACOME

Okay. But you don't want to give any further details on where exactly it was coming from, was that -- I'm assuming it wasn't DelStar or anything on that?

Jeffrey A. Cook

No. It's just some general adjustments.

DANIEL JACOME

Okay. And then I guess -- do you have any thoughts on the -- kind of maybe a silly question, but sort of elephant in the room, on the Lorillard and Reynolds combination, it's probably not -- it's probably 6 to 12 months away if it happens. But do you have any thoughts on that?

Frédéric P. Villoutreix

Yes, Dan, we usually do not publicly communicate details our relationship with specific customers, especially as it relates to the U.S. markets. We are the industry leader in cigarette paper and have good positions with all the key manufacturers. And we do not believe the potential combination of 2 of our customers in the U.S. will have an adverse impact, neither on our operations or even at our strategy as it relates to North America.

DANIEL JACOME

Okay, great. And then I guess 2 more. It doesn't sound like anymore buybacks near term, likely we see some M&A, but what about debt pay down, is that in the cards at all for this year?

Jeffrey A. Cook

Well, what we're doing as part of the global asset realignment is working to create a structure that gives us greater access to the cash that's been in Europe. And allows us over a period of years to start paying down the debt. So that is a goal of ours, and over -- as I said, over a gradual period of time, we look forward to being able to do that, net of, of course, any acquisition activity that might come up that would change that course of time.

DANIEL JACOME

Okay, great. And then last one, back to China RTL, I think Alex has asked about the competitive landscape out there and you suggested that I guess some of these players wouldn't have, I guess good enough products, but do you think they won't be able to meet the tar regulations? Is that what you're suggesting?

Frédéric P. Villoutreix

No. I think there are different ways to reduce tar in the cigarette, and just you've mentioned an obvious one, which is to increase the length of the filter, so more capacity to filter the smoke. And so -- and also the use of different quality of tobacco. So there are different ways. I think the very effective way is to introduce reconstituted tobacco, and obviously, the local producers are improving their quality. It's all, in fact, a combination of how do you reduce tar, meet regulation, but also continue to have this unique taste signature that smokers look for in a particular brand. And our focus has been the premium brands, because we see growth long term in the premium brands in China. Those are more expensive, obviously, products and they're more sophisticated in design, and we feel that our technology of RTL fits well with the expectations of customers for those premium brands.

Operator

And I'm not showing any further questions at this time, I'd like to turn the call back over to management for closing remarks.

Frédéric P. Villoutreix

Thank you, Kate, and thank you, all, for attending the call. And we certainly appreciate your interest in the SWM company, and Mark, Jeff and I would be in offices today. If you have any follow-up questions, please give us a call. Have a nice day.

Operator

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

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