Schweitzer Mauduit International's (SWM) CEO Frederic Villoutreixon on Q4 2015 Results - Earnings Call Transcript

Schweitzer-Mauduit International, Inc. (NYSE:SWM)

Q4 2015 Earnings Conference Call

February 18, 2016 08:30 AM ET

Executives

Frederic Villoutreix - Chairman and Chief Executive Officer

Don Meltzer - EVP of Advanced Materials and Structures

Bob Cardin - Corporate Controller

Mark Chekanow - Director of Investor Relations

Allison Aden - Chief Financial Officer

Analysts

Dan Jacome - Sidoti

Operator

Welcome to SWM's Fourth Quarter and Year-end 2015 Earnings Conference Call. Hosting the call today for SWM is Frédéric Villoutreix, Chairman and Chief Executive Officer. He is joined by Don Meltzer, EVP of Advanced Materials and Structures; Allison Aden, 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. The dial-in number is 855-859-2056 and PIN number 32267763. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions]

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

Mark Chekanow

Thank you, Vince. Good morning. I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's fourth quarter and year-end 2015 earnings results.

Before we begin, I would like to remind you that the comments included in today's conference call include forward-looking statements. Actual results may differ materially from the results suggested by these comments for a number of reasons, which are discussed in more detail in our Securities and Exchange Commission Filings, including our Quarterly 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.

This presentation and the earnings release are available on the Investor Relations section of our website www.swmintl.com.

I'll now turn the call over to Frédéric.

Frederic Villoutreix

Thank you, Mark, and good morning, everyone. I would provide some brief comments on how we finished 2015 and then give an update on our strategic transformation, detail of financial outlook for 2016 and share the key business and strategic objectives we will be focused on this year.

Although we are pleased with our fourth quarter results, which provided a strong finish to 2015. Full year adjusted diluted EPS of $3.51, a penny above guidance, was a significant accomplishment given the substantial headwinds we faced. Solid execution in our engineered paper segment and particularly strong fourth quarter LIP volumes more than offset the less controllable macro challenges from currency and the impact on AMS filtration product sales on very soft oil, gas and mining sector.

Our guidance assumes a $0.20 negative impact from currency, whereas the final impact was $0.37. In addition our guidance did not contemplate acquisitions and the Argotec transaction diluted EPS by $0.03 due to transaction integration costs.

Importantly and LIP inventory build by several of our customers provided a $0.13 benefit to fourth quarter results and offset a portion of the currency headwinds we faced during the year. We highlight, and on a constant currency basis 2015 net sales actually would have grown 5.5% and adjusted EPS grown 12%. Also our free cash flow remained strong at approximately $120 million. In 2015, we delivered on several strategic objectives critical to our long-term transformation.

Non-tobacco revenues, including non-tobacco paper sales, were more than $230 million in 2015, and represented approximately 30% of 2015 net sales. With the addition of Argotec and includes growth in AMS, we expect this metric to increase substantially in 2015 to the 40% plus range for approximately $350 million of revenue. As a reference point, in 2015 our non-tobacco sales were only 6% of our total.

The most significant milestone of 2015 was the acquisition of Argotec. With attractive margins and growth and a strong competitive position in the core surface protection end segment, we believe this acquisition marks a substantial step forward in the expansion of our AMS growth platform. We see a future reach with opportunity to scale and optimize the AMS segment. In conjunction with this acquisition, we also expanded our credit facility.

This added balance sheet flexibility coupled with strong cash flow from Engineered Papers support continued M&A and internal growth oriented investments. 2015 also marked the first complete year for our 2014 [air circulation] and medical bolt-on acquisitions. While relatively small these were highly strategic additions to DelStar, and we successfully integrated these operations and achieved our stated profit target for the year.

Additionally, we expect our recent management additions will play important roles in executing our growth strategy. Both Don Meltzer, EVP of AMS and Allison Aden, our new CFO, are making immediate contributions and I am confident that our management team is poised to continue executing our vision of becoming a more diversified growth oriented enterprise.

Other key strategic milestones we achieved in 2015 include the combination of our Paper and Recon segments to a more streamlined and operating structure, the successful expansion of our Altria supply contract and our expansion in China for our recon joint venture.

We also increased our dividend for the fourth consecutive year. Despite achieving our 2015 guidance, delivering on several strategic objectives and gathering good operating momentum into the new year, 2016 presents a combination of negative factors, [Indiscernible] and adjust the EPS decline from $3.51 to $3.15. However, we feel that this decline is not indicative of any long-term weaknesses in our strategy or execution.

As shown on this slide, we expect strong accretion on the Argotec acquisition as well as on several internal growth drivers, including organic growth of AMS and our Chinese joint ventures and operating cost improvements in Engineered Papers. These positive business fundamentals totaled approximately $0.55 of incremental EPS, illustrating the benefit of our diversification efforts, effective management of EP, and growth investments in China.

We expect this positive business [Indiscernible] to more than offset the anticipated decline in RTL volumes, which we estimate will impact EPS by $0.35. As previously discussed, this expected decline is the result of customer replanning activities in response to lower virgin tobacco lease prices.

The lower guidance in 2016 is driven by the anticipated absence in 2016 of certain nonrecurring tax benefits on 2015, representing approximately $0.20 of EPS, which neutralizes the projected net benefit of our business momentum as well as other less controllable issues related to the timing of LIP sales and currency translation impacts.

The LIP sales timing and currency factors together account for the $0.36 projected EPS decline. While we believe that we continue to gain LIP share, our fourth quarter LIP volume growth of more than 20% was a function of two particular one time developments likely to reverse in 2016.

First, more restricted packaging regulations expected in Europe as of May 2016 are resulting in customers building LIP inventory. We expect a reduction in their purchases from us starting Q2. Second, the US customer built inventory ahead of planned manufacturing changes. We estimate the total EPS swing effect between 2015 and 2016 to be approximately $0.26.

Lastly, we estimate a currency translation impact of approximately $0.10 versus 2015, which is reflected in our guidance. As a result of this dynamic and the timing of the RTL volume decline, we expect our first half results to be stronger than our second half result.

All told, we face several near-term issues, which can be characterized as non-operational, such as tax, external, such as currency, and tiny issues such as LIP, which will detract from our positive 2016 business drivers. We view these factors are near-term obstacles with regard to 2016 EPS rather than fundamental roadblocks.

Looking longer term, management is committed to advancing our strategic transformation and thus leading the unique and often less controllable challenges of any particular year [Indiscernible].

In light of the 2016 outlook, we will be highly focused on successfully executing our strategy to ensure we exit 2016 with good operating momentum. Each of our segments has a set of 2016 priorities, while some of these actions will likely extend beyond the year.

For AMS, the successful integration of Argotec and achievement of its financial plans are essential. The basic integration of HR, Finance, and other administrative aspects is largely complete. Argotec has attractive margins and growth prospects and we are confident this momentum will continue into 2016. More broadly, we are in the early stages of implementing our vision for the four acquired businesses, with the creation of a scalable operating model and generate the same bottom line growth. Another priority is replacing lost sales due to the pressure many of our customers’ customers have faced with substantial contraction of the oil, gas and mining sectors.

For Engineered Papers, 2016 priority is centered on several ongoing themes. First, using selective price concessions in LIP to gain and/or maintain share as we believe this strategy has proven effective. While LIP remained competitive earlier, we expect potential future price concessions to be generally less impactful than recent years.

Second we remain focused on efficiently managing our cost and capacity and expect to continue taking measured actions to aligning infrastructure with demand. Specifically in response to the anticipated RTL decline driven by one specific customer continuing with the learning initiative which began in 2014, we will explore additional cost reduction activities.

Lastly, we will continue investing in diversification as we see potential to modify papermaking and reconstitution capabilities in non-tobacco industries. While RTL has been our only commercial reconstituted product, we are optimistic that reconstitution applications for tea, cocoa and [botanical] can be monetized over time. Please visit our site, [Indiscernible] to see examples of our innovative work.

We will now shift to detailing of segment performance. Fourth quarter cigarette paper volumes, including our Chinese joint venture, were up 6% year-over-year finishing at 2% for the year. Within cigarette papers, LIP volumes increased 21% in the quarter due to the customer inventory builds and finished the year up 4%. Throughout 2015 we benefited from positive mix shift from LIP volume trends, favorable mix trends within the LIP product set and growth in volume on papers.

Fourth-quarter and full-year RTL volumes were up 20% and 3% respectively versus 2014 finishing in line with our expectations. Fourth quarter 2014 volumes were soft due to the labor related disruption, creating the favorable fourth-quarter 2015 comparison.

Including the ramp up of our Chinese Recon joint venture, these volume increases would have been 33% and 19% respectively. Fourth quarter non-tobacco paper volumes increased 12% versus the fourth quarter of 2014, whereas full year volumes decreased 5%.

We shifted some of our production away from sale volumes given solid demand for more profitable cigarette papers throughout 2015. We also saw 2015 growth in high-margin battery separator papers, driving further mix improvements.

Of note, EU and US smoking attrition appears to have slowed in 2015 with consumption estimated to be down approximately 1% as per the reported results from our customers. Regarding China, headlines are slowing tobacco growth and plus flattish consumption in 2016. While we believe it is trueoverall, we continue to see good performance of the mid to premium level brands of joint venture support.

I will now turn the call to Don to review AMS.

Don Meltzer

Thank you, Frédéric. Organic growth for the full year 2015 was down 1%, but excluding the impact of oil, gas and impact of mining currency and business transfers was up mid single-digit. This is versus a strong 2014 in which DelStar grew 10%. While Argotec will not be reported as organic growth in 2016 it continues to deliver excellent growth versus year ago sales.

Demand for filtration products related to the oil, gas and mining industries continued to be quite weak. While our products do not filter oil and gas, they are used in heavy equipment and machinery used in these industries, often filtering fuel and other hydraulic liquids as well as serving other functions in the exploration, processing and transport of oil and gas.

In addition, organic growth was impacted by currency movements and business transfers from our base DelStar operation to the acquired site. Together these impacts comprise the vast majority of the fourth quarter decline. Through the first three quarters of 2015, these factors were largely offset by strong water filtration sales, but this was not the case in the fourth quarter as some customers appeared to push orders out into 2016.

For the year, water filtration sales grew by more than 10% and our end segment outlook for 2016 remained solid. While impossible to predict a commodity rebound and recovery of filtration sales to oil, gas and mining sensitive customers, these filtration customers are finding other areas to further penetrate such as power generation and aerospace.

Similar to our customers, we are also actively assessing opportunities to profitably replace those lost sales and this factor is a key priority. While low value sales are relatively easy to find they are not strategic and do not support our overall vision of emphasizing high value engineered products that compete on innovation and performance.

One exciting organic growth opportunity is the development of a new filtration product to service the semiconductor industry. Our R&D team have worked closely with customers to develop a new technology, which we expect to provide superior performance versus legacy liquid filtration materials used in demanding ultraclean chip manufacturing processes.

AMS’ organic growth is the high-priority and we remain committed to investments that will support long-term top and bottom line expansion. We have also responded to sales weakness with cross actions that began in the fourth quarter and contributed to segment margin expansion. Low resin prices and other operating improvements contributed to the fourth quarter margin expansion of 250 basis points versus the prior year quarter.

2016 also presents opportunities for further integration of our acquired businesses. Our vision is for these companies to run as one seamless unit benefiting from scale, optimized manufacturing, synergized commercial strategies, shared services and aligned R&D. This will be a multiyear transition, but we intend to make significant strides this year and the result should become evident in margin expansion this year and beyond.

We will likely implement a common ERP system across our four acquired businesses in order to gain efficiencies and enhance business intelligence capabilities. This is likely to be a stage two-year project. SWM’s expertise in operational excellence also figures heavily into our plan as this core competency has not yet been fully deployed across the growing AMS operations. With best in class global assets, technologies and sales organizations we believe the opportunities across the segment is significant and we look forward to sharing our progress on this front.

I will now turn the call over to Allison.

Allison Aden

Thank you, Don. I'll now review some financial highlights from the fourth quarter and full year. Both fourth quarter consolidated net sales grew 15.5% or 23.4% on a constant currency basis compared to the fourth quarter of 2014. The quarter benefited from the customer driven LIP inventory build, the Argotec and AMS both on acquisition and soft year-over-year comparison for RTL. Fourth quarter 2015, EP segment net sales were flattish versus fourth quarter 2014. But increased 10% on a constant currency basis, driven largely by LIP.

Within AMS, net sales nearly doubled in the fourth quarter versus 2014, however excluding the effects of acquisition, sales declined about 8% for the reasons Don mentioned. Consistent with positive volume and mix trends, we saw good margin performance in the fourth quarter, with EP and AMS segment adjusted margins up more than 500 basis points and 250 basis points respectively. Full-year results were influenced by our strong fourth quarter finish. Our full-year consolidated net sales were up 5.5% on a constant currency basis versus 2014, excluding currency in acquisitions. Our net sales declined about 1% versus 2014, illustrating fairly stable EP operations and a slight decline in organic growth within AMS.

Despite currency headwinds, our overall adjusted operating margin increased slightly in 2015, as EP performed better than originally expected. Recall that 2015 results included a meaningful impact from LIP price concession, which were offset by cost improvement and positive shift in product mix. Fourth quarter 2015 adjusted diluted earnings per share from continuing operations was $0.91, putting our full-year adjusted EPS at $3.51, just above our guidance. As mentioned, currency headwinds were $0.17 worse than assumed in our 2015 guidance and the Argotec solution was not contemplated in our guidance.

Of note, the dilution from Argotec came entirely from transaction fees and integration cost. Both the currency headwinds in Argotec solution were overcome through strong results from Engineered Papers. In addition, our affected tax rate for 2015 was approximately 20% at the bottom of the low 20% range we had projected. A portion of the tax benefits realized in 2015, as part of the company's global asset realignment efforts are non-recurring in nature. Hence, our expected tax rate will trend higher in 2016. Going forward, our effective tax rate will fluctuate depending on our mix of earnings in various jurisdictions within differing tax rate, as well as potential changes in the business such as M&A and business realignment.

While we achieved 12% constant currency EPS growth in 2015, from $3.46 to $3.88, our guidance reflects a decline in 2016. However, when viewed over a two year period, the compounded results is more stable. As shown in this slide, a cumulative two year currency impact on adjusted EPS from 2015 and the projection for 2016, totaled $0.47. Adding this impact to our 2016 guidance of $3.15, implied total constant currency growth of nearly 5% from our 2014 adjusted EPS of $3.46. This multi-year perspective demonstrates and while our annual growth might vary depending upon the unique challenges of the tobacco industry. We've offset that pressure with successful diversification investments in AMS and other improvements in our paper business.

Regarding cash flow liquidity, SWM remains in a solid position. 2015 free cash flow were approximately a $120 million, declined an 11 million from last year, with exchange rate movement creating a meaningful downward impact. Additionally, we benefitted from lower CapEx in 2015 versus 2014, and our depreciation add back declined by $4 million. From a leverage perspective, for the terms of our new credit agreement, we were at 2.3 time's net debt to EBITDA as of year-end 2015. Our credit facility terms had certain adjustments to our EBITDA and net debt calculations. Such a leverage cannot be derived solely from our reported balance sheet and EBITDA matrix.

In the fourth quarter, we repay created nearly a $150 million of oversea cash in a tax efficient manner, demonstrating the effectiveness of our global asset realignment in improving access to these funds. We use the repatriated cash to repay a portion of the debt related to the Argotec acquisition, asking significant investment for acquisition, we would expect to continue paying down our debt. Regarding our announced reporting structure change effective for our fourth quarter in year-end results, we consolidated the former paper and reconstituted tobacco statements into a single reporting unit, Engineered Papers.

Reporting change near the organizational and managerial realignment that consolidated two operations under a single business leader and combine sales and support function. Additionally, we concluded that our Paper and Recon operations, product and customers, were no longer [indiscernible] different on a relative basis, compared to our AMS operations, which produce resin based goods sold into multiple end segments. In the future, the key matrix we intend to provide for the Engineered Paper segment will be total cigarette paper volume including our Chinese JV, total RTL volumes including our Chinese JV. And non-tobacco paper volume, who report sales and adjusted operating profit for the combined segment and intend to comment generally on volume trends for key products such as LIP and RTL as appropriate to explain our results. There will be no changes in how we report results for the AMS segment.

Now, back to Frederic.

Frederic Villoutreix

Thank you, Allison. In closing, I want to reiterate two key messages. First. The successful placing confirmation of SWM is ongoing. And we made considerable progress this year. We've Argotec acquisition to expand AMS. The credit facility expansion and management team be on that. Not to mention, the solidification in our high cash flow Engineered Paper segments. Second. Despite the headwinds affecting our 2016 outlook, we take a long-term view in our focus on key business and [indiscernible] largely within our control. Executing on this plans, we have helped say the solid foundation for improved financial results of the [indiscernible] horizon.

We believe that we have been patient and disciplined in our transformation process and taking the right strategic actions, moving some years and maybe overshadowed by external factors such as currency, inherent challenges of the tobacco industries such as RTL weakness, or variations in tax rates. Our commitment to our diversification strategy remains strong, and our management team is up to the task for managing 2016 challenges and emerging better poise for long-term growth. Our commitment to return capital to investors also remain unchanged, as demonstrated by raising our dividend this year, marking a fourth consecutive annual increase.

We appreciate your continuing interest and support. That concludes our remarks. James, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Dan Jacome of Sidoti. Your line is open.

Dan Jacome

Good morning.

Frederic Villoutreix

Hey, Dan. Good morning.

Dan Jacome

Thanks for taking the time. I've several questions. Some bigger picture, some housekeeping. Just first on LIP, sorry I missed it. Did you provide some sort of level of order of magnitude for how much pricing could be down this year?

Frederic Villoutreix

We have not, but we have said, I recall last year during the course of the year, in fact we are seeing some modulation in the price pressure. We had quantified the impact in 2014, in the range of $8 million to $9 million and we say that the pressure on pricing in '15 was greater than '14. However, as you can see, we have mitigated that through market share gains, improved mix in LIP, as reflected in the performance of the Paper segments, throughout 2015. When we look at 2016 and forward, we see moderation of a price [indiscernible] they provides to incrementally gain share or maintain existing share.

Dan Jacome

I appreciate that. And then turning to [RGO], I know 2016 kind of works Allograft the challenges, but in the press release I think you guys mentioned continued volume challenges in future years. Just wondering if you could provide some color there, is that a function of just kind of dynamics in virgin leaf supplier or is there something else in the marketplace that is happening?

Frederic Villoutreix

I think like we’ve had since in 2014, we’ve seen some rebranding going on in the formulation of the cigarettes and 2016 is impacted by the continuation about strategy by our key customer which impacts volume projection down. The French assets while Recon obviously is impacted by the attrition outside of China which compounds the effect. These [indiscernible] actually we believe is linked to the availability of large quantity of natural leaf tobacco right now. Now, the view is that the 2016 tobacco crop is expected to be down which would help with the balancing supply with demand.

Now it’s too early to say what the impact will have on rebranding sales because it’s typically a cycle but the drive for the rebranding we believe has been this availability of cheap leaf tobacco material.

Dan Jacome

Okay, great. And then, couple of housekeeping questions, is the resin, I guess the resin prices are lower so its tailwind for your costs, is that carrying to 2016 as well?

Frederic Villoutreix

So far yes.

Dan Jacome

Okay, great. And then just Argotec, the contribution $0.20 for 2016 looks intact, is that just a reminder, is that net of the incremental interest expense, correct?

Frederic Villoutreix

Yes.

Dan Jacome

Okay, great. And just wondering if the ERP project is that in your guidance the cost associated with that over the next, I think it’s going to be phase over two years?

Frederic Villoutreix

Yes, it is.

Dan Jacome

Okay. And then, lastly just big picture, I was kind of just wondering about, do you guys FX challenges came in a little bit worse than expected. Do you have a formal hedging program or how do you guys view that?

Frederic Villoutreix

I think in general the way that we pulled in the currency into us and then based on recent currency levels and so, in general our hedging policies are very balanced and I think it’s probably fair to say that our 2015 assumptions on currency prove now to be conservative enough. So, we’re trying to take recent rates into account and not over rely on just today’s rate when we’re setting our full year guidance. And remember when we think about currencies in relation to our business, we’re affected by the euro, by the Brazil Riel and we do business in Poland and China so those currencies also have effect upon us.

Dan Jacome

Okay, understood thank you. And then, last one on the repatriation of cash, is there something like lead time, significant lead time associated with that or are you basically able to go out and kind of implement that when you need to as quickly as you can?

Frederic Villoutreix

The repatriation of cash that we see was a result of a multiyear global asset reallocation so these are larger longer term projects in nature.

Dan Jacome

Okay, great, I think that’s all I had right now. Thank you.

Operator

Thank you. At this time I’d like to turn it back to management for any closing remarks.

Frederic Villoutreix

Thank you, Vince. Thank you very much for everyone for your participation and interest in SWM. Allison, Mark and I are in the office today and available to take any question you may have. We look forward to updating you on our progress and results again in May. Have a good day.

Operator

Ladies and gentlemen thank you for your participation in today’s conference, this concludes the program, you may now disconnect. Everyone have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!