SWM
#Thank you, <UNK>, and good morning, everyone.
Although we were pleased with our first-quarter adjusted EPS of $0.80, we highlight that constant currency net sales and adjusted EPS were up 17.5% and 12%, respectively.
Consistent with the factors incorporated into our guidance, LIP volumes remain strong.
RTL volumes were weak.
Argotec performed well.
DelStar's top- and bottom-line reserves continue to be hampered by certain volume challenges.
And currency had a negative impact across our business.
Other key factors of first-quarter earnings were a first-quarter loss on our Chinese Recon joint venture due in part to sales signing and a gain on the sale of water rights.
However, normalizing for these factors, first-quarter adjusted EPS marked a solid start to the year, and is consistent with assumptions we incorporated into our full-year adjusted EPS guidance of $3.15.
Broadly speaking, execution was strong across the business, and we maintained our focus on the 2016 key strategic priorities that support our long-term transformation.
Non-tobacco sales presented nearly 40% of our total net sales in the first quarter.
Trailing 12-month free cash flow remains stable, although we expect it to trend lower through the year, reflecting our expected decline in earnings versus 2015.
In our engineered paper segments, LIP momentum from 2015 continued through the first quarter.
Though, as we have discussed, we believe much of the trend is related to customer inventory builds which we expect to unwind in the coming quarters.
In total, our cigarette paper volumes, including our Chinese joint venture, CTM, were up 8% in the first quarter driven by modest LIP growth and supported by growth in other cigarette paper products such as [volume].
Our non-tobacco paper volume showed some strong growth, while our higher-margin battery separator was up, the bulk of the increase was from printing and writing [paper] volumes.
First quarter Recon, volumes including the new Chinese joint venture, CTS, were down 24% in the first quarter, driven by a difficult comparison for French RTL mill and a low-volume quarter for CTS.
Regarding the difficult comparison for the French mill, recall that first-quarter 2015 had 6% volume growth, as orders shifted into that quarter following a full quarter of 2014 labor disruption.
While Recon has presented volume challenges accompanied by [trade equality] timing issues of Q1, reconstituted reserves are consistent with the assumptions we made in our annual guidance.
All told, versus last year's first quarter, the engineered paper segments had generally flattish overall volume and some mix improvements.
With respect to CTS, it is still in the process of normalizing its sales and production partners, as quality profit and losses have exhibited significant [higher AT] since late 2014 launch.
The JV's low volume in the first quarter of 2016 represented a large decline versus the first quarter of 2015.
And it's essentially tied to the timing of customer orders.
We expect the remaining quarter of this year to have higher volumes, and we expect that CTS will generate profits over the remainder of the year.
Regarding marketplace trends, our key customers have reported consumption trends that show sustained improvement versus historical smoking attrition rates.
Europe is showing stability, with indications that lower consumption of illicit trade cigarette is benefiting the internationals which comprise the majority of our customer base.
In the US, generally lower attrition rates, meaning more favorable trends continue; while data coming out of China indicates that although smoking trends have turned from slightly positive to slightly negative, we're still seeing solid performance on the premium brands our joint ventures supply.
Lastly, I would like to comment on our 2016 segment priorities which we outlined in February.
As demonstrating our results, we believe our LIP share continues to move marginally higher, though the recent inventory build somewhat cloud our ability to completely isolate our share gains.
Also, you recall that last year we initiated LIP patent infringement actions against a competitor, to support our LIP margin and protect our intellectual property.
While we have received a favorable verdict in one patent suit, it is being stayed, pending appeal.
The other three LIP patent suits remain pending.
At this point, while we are pleased to with the progress of our LIP litigation, we cannot give any assurances to its ultimate outcome.
We also are progressing with our programs to apply a plant fiber reconstitution technology outside of tobacco, and believe that this has long-term potential in the cosmetic and food and beverage industries.
I will now turn the call to <UNK> to review AMS.
Thank you, <UNK>k.
AMS segment sales performed to our expectations in the first quarter.
We had very strong performance from the newly acquired Argotec business, while DelStar experienced an organic sales decline of 5%, or 4% on a constant currency basis.
In addition to the currency in oil, gas, and mining themes we have discussed in recent calls, important drivers of the organic revenue decline are the exit from some low-margin industrial business and significant lumpiness in certain customer orders.
For example, one particular industrial customer placed an unusually large order in the first quarter of 2015, and the quarter-over-quarter sales decline attributable both to this customer alone accounted for roughly half of the first-quarter sales decline.
Despite these sales challenges, DelStar delivered bottom-line results consistent with our expectations, in part due to effective SG&A management and manufacturing cost reductions implemented late in 2015.
While Argotec is not part of our organic growth, first-quarter sales showed quite healthy year-over-year growth with particular strength in high-value service protection products, which is positive for our mix.
This strength was in part due to a first-quarter customer inventory build that will likely result in softer second quarter from both a sales and margin perspective.
Regarding execution of our 2016 strategic priorities, we remain highly focused on the achievement of Argotec's financial plan and optimizing the AMS platform, which we expect to result in margin improvements within DelStar over time.
2015 was a year of significant growth investment for us, with integration of two bolt-on acquisitions and the expansion in Poland.
These investments were all strategic, and support our long-term plans for the AMS segment, but admittedly consume much of management's time and attention.
With those activities behind us, our immediate focus is on driving improved margins from our existing operations.
The referenced low-margin products exit support this effort, though they will continue to impact organic sales growth for the next several quarters.
We expect the sales of newly developed products to play a key role in reestablishing consistent long-term organic growth for the base DelStar business.
We also expect to benefit from a broad-based increase in industrial end-market activity, which could increase demand for specialty filtration and other products servicing the global oil, gas, and mining sectors, as well as transportation and construction; though the timing of such a rebound is unclear.
We also believe we can expand our margins, this year and beyond, as DelStar increases its focus on high-value products and begins to realize benefits of SWM's lean Six Sigma expertise.
Key 2016-2017 actions include launching an initiative put in place, a segment-wide common ERP system, as well as continuously enhancing operational and financial analytics to bolster our business intelligence capabilities.
We've already identified potential areas for meaningful improvements, particularly in operating cost, efficiency gains, and production mix management.
We're also advancing our development of unique next-generation filtration materials for the semiconductor industry, as well as developing commercial plans to cross-sell AMS segment products to existing customers.
As we have mentioned, we see promising opportunities to leverage Argotec's specialty film capabilities.
I'll now turn the call over to <UNK>.
Thank you <UNK>.
I'll now review the financial highlights from the first quarter.
First-quarter consolidated net sales grew 14.1%, or 17.5% on a constant currency basis, compared to the first quarter of 2015.
The quarter benefited from the customer-driven LIP inventory build which begin late last year, and the addition of Argotec.
RTL volume, outside of our CTS JV, was weak on a percentage decline basis given the difficult comparison <UNK> mentioned, but was generally in line with our expectation.
First-quarter 2015 EP segment net sales were down 2.6% versus first quarter of 2015, but increased 1.4% on a constant currency basis, driven largely by LIP.
Recall that with the consolidation of the former engineered paper and Recon segment, engineered papers volume now consists of all cigarette volumes, non-tobacco papers, and all of our reconstituted tobacco products.
In general, LIP cigarette paper and reconstituted tobacco products are our highest-margin products, followed by non-tobacco specialty papers such as battery separators and certain high-value cigarette papers.
Our lowest margin products are commodity-grade cigarette papers and non-tobacco paper filler volume such as printing and writing, and food service papers.
With that context, EP segment volumes were flattish, and price of mix were a net positive.
Within the AMS segment, net sales were up significantly in the first quarter versus 2015.
However, excluding the effects of the Argotec acquisition, sales declined about 5% for the reasons <UNK> detailed.
Consistent with EP trends of strong LIP and other cigarette paper volumes in general, we saw good EP segment margin performance, with adjusted segment margins up nearly 400 basis points ---+ versus last year ---+ LIP growth and other positive factors and cost controls more than offset RTL headwinds, LIP pricing concessions, and negative currency impact.
The AMS segment adjusted margin improved by 240 basis points due to the Argotec acquisition, and referenced sales and mix timing benefits.
Shifting to consolidated earnings.
First-quarter 2016 adjusted diluted earnings per share from continuing operations was $0.80, and included a currency impact of $0.03 and a non-operating gain of $0.04 from the sale of water rights, which was factored into our guidance.
Recall we had a $0.09 non-operating gain from water rights in last year's second quarter.
Importantly, as <UNK>k mentioned, quarterly variability of our new Chinese Recon JV makes it difficult to annualize our first-quarter performance as it relates to achieving our annualized adjusted EPS guidance of $3.15.
While we expect the JV's EPS contribution to grow versus the $0.22 they generated in 2015, they were essentially EPS neutral in the first quarter due to a CTS timing loss offsetting the CTM paper JV contribution.
Normalizing for the water rights and the Chinese JV quarterly variations, we consider our first-quarter results a solid start to the year.
And we believe the trends experienced to date are consistent with those we factored into our 2016 outlook.
Our effective tax rate for first-quarter 2016 increased by 360 basis points, driven by both earnings mix and the expected reduction in certain foreign tax credits.
Lastly, we detailed in our fourth-quarter earnings call that our 2016 outlook included a $0.10 hit from currency translation, with the actual impact to first quarter being $0.03.
However, all else being equal, if exchange rates, particularly the euro to dollar ratio, remained at current levels through the rest of the year, this could represent positive upside to our guidance.
Following our second quarter, we will reassess the impact of currency movements.
We do not intend to revisit guidance every quarter based on currency fluctuations.
First-quarter 2016 free cash flow was $13 million, and trailing 12-month free cash flow has remained stable.
However, given the expected decline in adjusted EPS reflected in our guidance, we would also expect trailing free cash flow to soften as we progress through the year.
Per our typical seasonal pattern, we expect to generate a significant portion of our free cash flow in the second half of the year.
From a leverage perspective, for the terms of our new credit facility, we remained at 2.3 times net debt to adjusted EBITDA.
Now, back to <UNK>k.
Thank you <UNK>.
Although we were pleased with first-quarter performance, it was consistent with our expectations, and we made progress on our 2016 priorities as we drive our strategic transformation.
With approximately 40% of our current revenue mix on non-tobacco areas, our transition from a tobacco-driven paper company towards a more growth-oriented, diversified, industrial manufacturer of high-value products has good momentum.
We appreciate your continuing interest and support.
That concludes our remarks.
Catherine, please open the line for questions.
So, as we said, we are pleased with the positive ruling.
Nothing is final, since the decision has been stayed, pending a ruling on appeal.
As it relates to the second part of your question, we can't elaborate on the specifics, other than our view is that if we go back with the bigger picture, we have ---+ they have lost a very strong position, both for direct selling and through our licensee, DelStar.
On the LIP market segment we continue to, we believe, gain incremental share all the time.
And this rule in terms of infringement action is to really secure our position and also protect our emulsions.
Yes.
I think part of that is linked to demographics and a general higher sense of awareness, both at the government level and within the population about health matters, and also the healthcare costs for a country of having such a large population of smokers.
As we released to you all, this new tobacco product directly is going to set the agenda for the next several years.
As you know, this may change in packaging, which is based on different levels of moving towards plain packaging, and flexibility at the country level within the EU to adopt ever increased safety warnings or even a complete shift in plain packaging.
So that's, I would say, for our customers, it's a continued battle beyond May as to whether countries will adopt the plain packaging definition.
And then down the road, several years from now, the ban of menthol in cigarettes, the use of menthol in cigarettes, which obviously could reduce the amount of [actual rate of] attrition in smoking rates, but it's years away.
But in my mind, the main risk remains the economy and excise tax increases that governments may decide, which is unrelated to the tobacco product going into it.
It appears to be dependent upon the market for oil and gas.
And (multiple speakers) mineral extraction.
Sure.
One that comes to mind is semiconductor manufacturing, where the purity of the materials that are used in manufacturing a semiconductor have a direct relationship with the ability of the semiconductors to pack more computing power onto a single chip by decreasing the size of the space between the leads inside the computer chip.
And so we are investing in products that will allow that to happen.
If I may, <UNK>, I think the common theme [acquired] across the market that we see having the higher attractiveness is filtration.
And so we are building for a base of water filtration.
And we are obviously getting the headwind on oil and gas, which uses hydraulic filtration media and so forth.
But we are refocusing instead of moving to more commodity industrial or consumer products, trying to reinvest and increase our [pricing and seeing] demanding filtration indications.
So, as we stated in February, our short-term priority is really integration of Argotec and building the AMS platform.
Now over the last several years, we have built what I would call a healthy pipeline of opportunities with the addition of film and surface protection through Argotec; that obviously add some additional fields, we are invested in in terms of assessing opportunities.
We have capacity with our credit facility.
But we also have demonstrated, we continue to demonstrate patience focusing on quality assets and financial discipline as it relates to valuation.
So there's nothing fundamentally different when I look at the market or the transactions ahead of us right now.
And we continue to apply, again, the same patient and highly disciplined approach, with a clear focus on how do we find synergistic acquisitions as we build the AMS platform (inaudible) to our businesses that we have put together over the last three years.
You mentioned price was flat.
What we said is the price mix was actually a little bit of a positive in the quarter, and that has a lot to do with the strength of LIP, per se.
But I think that before the vision is obviously we see opportunities for better environment, more favorable environment in terms of volume, trying to limit the attrition to a minimum.
And we have obviously good momentum.
As we go into the second quarter, it relates to an improved mix of products within engineered papers that is obviously critical to our earnings guidance.
Thank you, Catherine, and thank you all for attending the call.
We certainly appreciate your interest in SWM.
<UNK>, <UNK>, and I will be in our offices today, and if you have any further questions, please give us a call.
Have a nice day.
