Schweitzer-Mauduit International, Inc.

Welcome to SWM's first quarter 2021 earnings conference call. Hosting the call today from SWM is Dr. Jeff Kramer, Chief Executive Officer. He is joined by Andrew Wamser, Chief Financial Officer, and Mark Chekhanow, Director of Investor Relations. Today's call is being recorded and will be available for replay this afternoon. At this time, all participant lines have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. If you should require any operator assistance, please press star 0. We ask that you please pick up your handset to allow optimal sound quality. It is now my pleasure to turn the floor over to Mr. Chekhanow. Sir, the floor is yours.

Thank you, Tina. Good morning. I'm Mark Checkenow, Director of Investor Relations at SWM. Thank you for joining us to discuss our first quarter 2021 earnings results. Before we begin, I'd like to remind you that the comments included in today's conference call include forward-looking statements. Actual results may differ materially from the results suggested by these comments for a number of reasons, which are discussed in more detail in our Securities and Exchange Commission filings, including our annual report on Form 10-K and our quarterly reports on Form 10-Q. In particular, the extent to which the COVID-19 pandemic continues to impact our business is uncertain and depends on numerous evolving factors which are difficult to predict, including the duration and scope of the pandemic and of actions taken in response to it. Some of the financial measures discussed during this call are non-GAAP financial measures. Reconciliations of these measures to the closest GAAP measures are included in the appendix of this presentation and the earnings release. Unless stated otherwise, financial and operational metrics are to the prior year period and relate to continuing operations. This presentation and the earnings release are available on the investor relations section of our website, www.swmintl.com. I'll now turn the call over to Jeff.

Thank you, Mark, and good morning, everyone. We are pleased to report a very strong quarter with positive momentum continuing in several key areas of the business, particularly across our fastest-growing and most strategic product lines. As we now operate in the new COVID normal, I want to again commend our global organization for staying nimble and adjusting to challenges as they arise. This quarter, it has been around logistics, as businesses around the world deal with varying constraints related to the positive pulls of an improving economy. And while many areas of the economy will grapple with inflation and tight global supply chains this year, we are confident in our ability to raise prices and manage costs to preserve excellent profitability. We are equally confident in our ability to execute on the SCAPA integration and ultimately deliver another year of strong financial performance. Bottom line, despite the heavy lifting behind the scenes to keep service levels high, Strong AMS organic sales growth and good execution in both operating segments drove 20% adjusted EPS growth in the quarter to $1.02. As you likely saw, we closed the SCAPA acquisition on April 15th, two weeks after quarter end, so none of SCAPA's financials are reflected in our results. That said, in addition to our more typical quarterly discussion, I will elaborate on the exciting new capabilities we added with SCAPA, as well as the expected acquisition, accretion, and overall annual earnings guidance we are finally able to share. Our annual guidance implies mid to high single-digit earnings growth in 2021, which reflects some of the immediate accretion we expect this year from joining the two firms. Importantly, We expect a significant step up in accretion for the following year as we complete our integration and begin our value creation activities. I can confidently say that looking longer term, we have never been better positioned for sustainable top and bottom line growth as we are today. Our end markets are demonstrating good demand, our operations are running well, and our portfolio of products and services continues to expand. furthering our vision of being the supplier of choice of performance materials and integrated solutions for specialty applications. For AMS, overall sales increased 33 percent, including the benefit of the TECRA acquisition, while organic sales increased 15 percent in the quarter. We were particularly encouraged by the breadth of strength across the portfolio. In transportation, We are up 20% overall in this profitable end market with over 50% growth in paid protection films as our customers are seeing returns to normalized demand and restocking after a choppy 2020. Despite some of the swings in sales between COVID impacts and the current recovery, we continue to see our transportation business as a consistent high growth business over the long term. Global demand for the product remains high, Consumers are becoming increasingly aware of the offering and distribution and consumer access continues to increase, especially in Asia. We have also continued to invest in improving our technology and capabilities to stay at the forefront of the industry and are starting to deliver on the benefits of the added capabilities that came with the Tecra acquisition last year. Filtration was another 20% plus glow in the first quarter. Again, demand is recovering from COVID disruptions, customers are restocking to some degree, and the fundamentals across our business are strong. Consistent with the past several quarters, air filtration led the way with over 50% growth. Importantly, though, we saw a solid double-digit growth across our entire filtration business, which includes our water filtration products as well as materials for other specialty applications such as semiconductor manufacturing. AMS's existing healthcare business also had a great quarter. By the way, we had previously referred to this as medical, but given SCAPA's broader product line and services, as well as their branding in the marketplace, we will be referring to this area in our investor communications going forward as healthcare to better represent our increased capabilities. We saw strong performance in our traditional consumer-oriented finger bandage business, as well as more specialty applications like packaging and face masks. The healthcare arena is very attractive long-term, given the need for specialized material and aging demographics, and we are excited to essentially triple our business to about $250 million annually with the addition of SCAPA. Simply put, the more things we can do for a customer, the better positioned we are to win more wallet share. With the increased scale and breadth we will have with SCAPR, our combined teams will have a far greater offering to present to our customers. There will be opportunities to cross-sell products, and perhaps most importantly, bring a variety of value-added services and capabilities like development, formulations, coding, converting, packaging, and even regulatory assistance to our current customers, which goes beyond the materials value proposition we currently provide. Lastly, construction sales also increased in the first quarter. Higher activity in the oil and gas industry drove year-over-year gains for perimeter controls materials used in the Marcellus Shell region, as well as an increased focus on solar farms. In addition, netting for highway infrastructure and other construction projects also grew nicely. Further, we saw gains in our building products there. an area we also expect to drive value from through the SCAPA acquisition, as we will bring its well-regarded specialty construction tapes to business to our customers. I think it is also important to address the budding supply chain pressures that most industries are seeing, and which we expect to experience during the remainder of the year as the global economy awakens. We are seeing pricing and supply chain pressures across many of our inputs as raw material manufacturers have been hit by temporary shutdowns, availability constraints in their key inputs, and shipping challenges just as global demand is starting to rebound. With that said, and as demonstrated by our strong 2020 results with COVID pressures, I am confident in our supply chain's ability to meet customer demands and handle the increased cost pressures although there may be some choppiness due to timing. All told, AMS sales drove over 40% adjusted operating profit growth in the segment, and we look forward to continued strength in 2021. Switching to engineered papers, the business performed as expected in the first quarter. As we had previously noted, we recently closed our Spotswood, New Jersey facility and begun transitioning that facility's key customers to products made in other sites. As part of this transition, that customer worked through legacy inventories before now restocking with new product, which had a temporary impact in the first quarter, contributing to a total segment sales decline of 10 percent. The transition is going in plan, and we are realizing cost savings from this initiative. On the positive side, We had solid performance in some specialty tobacco papers and very strong growth in heat-not-burn volumes as our customers continue to drive sales of these reduced-risk products. Of note, despite the lower sales, segment-adjusted operating profit declined only 6 percent due to good manufacturing performance and cost savings from the site closure. With that, I'll turn the call over to Andy to review the financials in more detail.

Thank you, Jeff. Starting with AMS, first quarter sales increased 33% with organic growth at 15%. The organic growth calculation assumes we had owned Tecra for the entire first quarter of 2020, rather than the partial period ownership. As Jeff discussed, we had strong demand in most of our end markets, particularly transportation and filtration, two of our higher margin areas. Given the substantial positive swing in our transportation business, we think it is noteworthy that even without this end market, our organic sales growth would have still been up about 10%, signaling the strength of the entire portfolio. The strong sales mix also led to excellent profitability. Despite higher input costs, first quarter adjusted margin in AMS of 17.1%, was on par with our highest ever first quarter segment margin, demonstrating the continued operational improvements we have made over the years and successful integration efforts for businesses we have acquired. We achieved the 140 basis points of margin expansion despite the initial impacts of higher resin costs, mainly from polypropylene. Looking ahead, Higher input costs are expected to become more significant. However, we are actively raising prices, which should provide an offset as we head into the third quarter. We are encouraged by the early signs of our ability to recapture the higher costs in most of our key product lines. For engineered papers, first quarter sales were down 10 percent, with key factors being the Spotswood site transition, and associated customer inventory drawdown, as well as the continued de-emphasis of lower margin products. During the quarter, currency offered a slightly positive offset, mostly due to the rising Euro. On margins, similar to AMS, we saw initial impacts of higher raw material prices, mainly wood pulp, though we still achieved 100 basis points of operating margin expansion in the quarter to 25.2%. The cost reductions from the Spotswood shutdown and broader operating and SG&A cost actions continue to support strong segment profitability. Although we have some customers where timing of our contracts will limit our ability to recapture higher costs with price increases on some of our large contracts, We are raising price where possible and exploring multiple avenues to offset higher pulp prices. Regarding adjusted unallocated expenses, we saw an increase of approximately $1 million during the quarter, mostly due to timing of administrative expenses. However, as a percentage of total sales was essentially unchanged versus the prior year quarter. The expenses that were adjusted out all were due to the SCAPA transaction. and included advisory, diligence, and other related costs as we prepared to close the acquisition. In upcoming quarters, we will book additional one-time expenses related to the deal, which we will also exclude from our adjusted financials. On a consolidated basis, sales for the quarter increased 10% or 3% on an organic basis. Adjusted operating profit increased 14% and adjusted EBITDA increased 13 percent. First quarter 2020 GAAP EPS was 68 cents versus 72 cents. The most material comparison items relate to the SCAPA acquisition expenses, which totaled 22 cents per share and included both the unallocated expenses within operating profits, but also the negative impact of a currency hedge to lock in the price of the British pound at the time when the deal was announced. Please refer to our 10-Q and our press release for additional details on this topic. We also booked an 11 cent per share gain in the quarter from a favorable settlement related to our Brazil tax assessments, which was also backed out of adjusted EPS. Normalizing for those items, as well as the typical non-cash purchase accounting expenses, Adjusted EPS was $1.02, up 20% versus last year's first quarter. In addition to the strong growth in operating profits, our tax rate was slightly lower and our JV income was slightly higher as well. The tax rate embedded in first quarter adjusted EPS was 20.5% in 80 basis point improvement versus last year's first quarter. While we normally provide annual adjusted EPS guidance in February in conjunction with year-end results, recall that due to regulatory restrictions related to our acquisition of SCAPA, a UK-based public company, we were unable to do so at that time. However, with the transaction closed, we have issued 2021 adjusted EPS guidance of $3.75 to $4.05. This guidance includes expected accretion of approximately 10 cents from the SCAPA acquisition, which we will own for essentially three quarters. Looking beyond this year, we believe SCAPA will be significantly more accretive in 2022. We estimate at least 50 cents of adjusted EPS accretion next year as a business returns toward pre-COVID levels. Consistent with our comments in February, we expect our EP business operating profit to revert back toward the multi-year trend in the mid $120 million range after a particularly strong 2020. We believe this pullback to normalized levels will be more than offset by anticipated profit growth in AMS due to expected strong organic sales performance. Unfortunately, the rapid and unexpected rise in certain raw material costs is certainly tempering what would have otherwise been a much more positive outlook for 2021. We believe that the cost headwinds, the 10% earnings growth implied that the top end of the range is achievable and would represent a very positive outcome. Before Jeff offers a more strategic perspective on SCAPA, I'd like to recap some of the financial aspects of the transaction and some key points on the expected accretion. We acquired SCAPA for approximately $630 million, including net debt. We financed the deal with a new $350 million term loan B, as well as our revolving credit facility. Though, of course, the closing is not reflected in our March 31st balance sheet. Pro forma, based on the covenants in our credit agreement, our net debt to adjusted EBITDA at close was approximately 4.3 times in line with our range at the time of announcement. The table on slide eight is intended to help frame SCAPA's recent financial performance and our expected accretion in 2021 and 2022. Please note these numbers are approximate and rounded, meant to be illustrative, and reflect a British pound exchange rate of 1.38 for all periods to improve comparability. At today's exchange rates, SCAPA generated approximately $440 million of sales and $55 million of EBITDA in its fiscal year 2020, which ended in March 2020, and what we refer to as pre-COVID. The pandemic impacted both SCAPA's healthcare and industrial segments, as shown in fiscal 2021 results, which just ended in March. While sales in the industrial business have been steadily recovering, the healthcare business remains somewhat challenged with consumers around the world opting to minimize hospital and clinic visits as they postpone elective surgeries and procedures. We believe elective surgeries will recover as consumers steadily return to more normalized lifestyles, vaccinations increase, and the backlog of delayed medical activities is fulfilled. However, for 2021, we want to remain conservative in our thinking. We note that during the pandemic, SCAPA took actions to reduce costs. Thus, we expect to see improved margins despite lingering sales headwinds. In addition, we've identified $5 million of public company and related administrative cost synergies that we can execute in the near term and the potential for more cost savings and sales synergies down the road. When considering our 2021 accretion estimate of $0.10 per share, we note that this represents nine months of ownership. Also, in 2022, we do not assume a full recovery to arrive at $0.50 accretion. If SCAPA sales ramped back towards the pre-COVID levels faster than we had assumed, we would be in good position to meaningfully exceed our $0.50 accretion guidance. given higher margins on SCAPA's lower cost base and the realization of synergies. From a high-level modeling standpoint, we estimate interest expense for the transaction at approximately $22 million in 2021 and $29 million in 2022, and would assume a low to mid 20% range for our tax rate. Now back to Jeff.

Thanks, Andy. I'd like to now reiterate some key strategic highlights of the SCAPA acquisition before closing our comments. We first set out to diversify and reposition SWM for growth back in 2013, and we have made a series of highly strategic acquisitions in the creation and expansion of AMS. We have established a good track record for integration and execution. and had built a $500 million diversified business on the vision of offering customers high-performance materials designed for specialty applications. Along the way, we expanded our product set, capabilities, and end market exposures, all with the goal of offering our customers a full suite of solutions to help solve their most pressing product design and performance challenges. SCAPA while larger than our other acquisitions, is simply an extension and even an acceleration of this strategy. We have extensive overlap as far as healthcare, construction, transportation, and industrial exposures. And with SCAPA, we took a significant step forward in broadening the full solutions platform we want to bring to our customers. Recall, we first added more significant downstream coding and converting capabilities when we acquired TECRA. and believe SCAPA represents a step function increase in capabilities when it comes to fulfilling our vision. We now bring customers more advanced upstream capabilities in innovation, product design, and chemical formulations, as well as more downstream offerings with coding, converting, and packaging, continuing our evolution as a full solutions provider. As I said earlier, the more we can do for a customer, the more ways we can help the better positioned we are to earn their business. I'd also note that while we have talked a lot about SCAPA's sizeable healthcare business, given our increased scale and the opportunities to bring new capabilities to our larger customer base, I also want to focus on that, like SWM, SCAPA is in a number of attractive specialty applications serving a diverse set of end markets. cable wraps, construction tapes, consumer products, electrical harnesses for automotive, just to name a few. And just like SWM, SCAPA has built a reputation for quality and service and leadership in many of these key product lines. And what does it all mean for SWM's long-term financial performance? I believe the short answer is it improves our growth outlook. With nearly two-thirds of our business being generated in expanding end markets, our portfolio continues to shift towards a stronger organic growth profile. We are better positioned than ever to drive positive, sustainable, long-term results. We look forward to another year of earnings growth, solid execution, and, of course, welcoming SCAPA into our global organization. That concludes our remarks. Tina? Please open the line for questions.

As a reminder, to ask a question, simply press star 1 on your telephone keypad. Our first question is from Chris McGinnis with Sidoti & Company.

Good morning. Thanks for taking my questions and a nice start to the year. Thanks, Chris. Can we maybe just start with the double-digit increase on the filtration products? Can you just talk about is that demand trend still at that rate as you exit the quarter? You know, you did talk about a little bit of pent-up demand in some of those end markets. How much do you think that drove it versus the rebounding economy? Thanks.

Yeah, so, Chris, just a couple of things. Filtration continues to be one of those segments that we have high confidence is going to be a long-term grower for us. It's been a great performer even before COVID, and we're really confident that it's going to continue to do that. Yeah, it's still in that, I think it's exiting the quarter as strong as we discussed in the results, and so I have confidence that that demand is there. Some of it is a little bit of pent-up demand, I think, but it's a hard question to answer. I think the water, for instance, our increases in water is going back to that normal strong demand that we see. I think that demand for purity, et cetera, that trend isn't going to change. I think there has been a fundamental change in the air filtration market where demand is going to increase. I don't think we're going to go back to the old days, and I think we're well-positioned to take advantage of that. I think you'll see some less demand on the mask material, but the filtration material, I think, will remain strong. Overall, our process fluids filtration is snapping back because that goes into automotive, industrial, etc., So we like that position, and I think it's going to remain strong for the remainder of the year. Great.

I appreciate that. That makes a lot of sense. Just on the transportation, obviously, it's been improving. Do you think it stays this kind of growth as we go throughout the year, just given the impact that COVID had on it last year? You just talked about your expectations, I guess, for the year on that.

Yeah. You know, again, that's another area of that whole transportation marketplace we like a lot. I think we mentioned in my comments that we saw the surface protection component of that transportation industry up 50%. That one's probably a little bit high for a long-term demand, but we still think that whole paint protection marketplace has a lot of growth. It's a penetration play. And we're seeing a lot of attention into it now, and I think that one is positioned well for the long term as well with double-digit growth.

And then just on EP, you know, can you just talk maybe a little bit about, you know, the down quarter, the impact those spots would, and I get your thoughts around how that played out for the remainder of the year? Last year was a little weird, so if you could just help us in any way on, you know, how you think about that for the remainder of the year on the volume side.

Yeah, sure. So, you know, we announced a 10% decrease in the business for the segment, but that was really driven by two major factors. One, you know, just a normal transition when you close one, you know, facility and move to a new product, you always build up inventory for to ensure that you have that material for a smooth transition just in case. The transition's going smooth, but we just worked that inventory down, and so that had some pressure on our LIP-type materials. The second is we had a material drop-off in volume of printing papers, which we use as a filler. It's a low-margin business for us, so volume-wise it had a big impact, but profitability-wise it didn't have a material impact in the same way. So that's why we still had, you know, leverage in terms of top line versus the bottom line. I think we've been very consistent. We think the EP business is reverting just to the long-term trend that we've shown over the last four or five years, very consistent cash flows, very consistent profitability. Last year we said, I think, in our comments that part of that was the extraordinary results was part built to inventory builds as people were handling, you know, material supply chain constraints, and that we expected it to revert to a normal, and that's what we're seeing.

Okay, great. And just the accretion numbers, thanks for, one, providing the slides and going to SCAPA. Congrats on closing that. I guess a couple things on SCAPA. One, can you just talk about how that changes? You know, I know it's very early, but how does it change your go-to-market strategy? How does it improve it, especially as you're renaming medical health care? And then just the confidence in that rebound and how much leeway is there with that 50-cent number and the $400 million in revenue in 2022? Thanks.

Yeah, so let me address a couple things. I don't think it changes our strategy at all. It's an evolution of our strategy. So the things that we are doing, right, we have always been – you know, more of a performance-type company, which means we need to provide solutions to problems that our customers bring to us. And so our strategy has always been to reinforce that solutions orientation and bring additional capabilities that our customers are asking us to bring. So SCAPRA is exactly that. We've always had a very strong position in what we used to call our medical business, SCAPA has established itself as a leading outsourcing company for the healthcare industry with very strong relationships to a lot of customer overlaps. And so they bring additional capabilities to our medical business that I think we're going to be able to leverage. And that has been our strategy on the medical healthcare side. On the industrial side, we don't talk about it as much, but if you look at the markets that SCAPA brings and their ability to bring us adhesive capabilities and knowledge and skills highly complementary to many of our industrial marketplaces. So again, very consistent with the strategy of bringing additional capabilities that our customers are asking us to bring to them and then giving us greater exposure to additional markets and additional customers. So I'm very excited about that. In terms of our you know, accretion estimates. You know, we tend to be, I think, optimistic, but we're not a company that tries to get out over our skis in giving forecasts. So I think what you see is a forecast we have great confidence in, and I think as, you know, Andy mentioned, if, you know, we can get some elective surgeries coming back, you know, that COVID starts to settle down, we think there's upside to that number.

Great. Thanks for taking my questions, and good luck in Q2.

Thanks, Chris.

And we have no further questions. I'll now turn the call back over to Dr. Kramer for closing remarks.

All right. Well, thank you, everyone. I want to close with, again, we appreciate everything that you do to support us. I want to thank my global team. I want to welcome the SCAPA employees as they join us into a team. You can tell we're counting on you to add valuable contributions to us globally, and we're going to continue to do our best to execute positively and grow this company organically. So thank you very much.

Thank you again for joining us today. This does conclude today's presentation. You may now disconnect.