Schweitzer-Mauduit International, Inc.

Welcome to SWM's second quarter 2021 earnings conference call. Hosting the call today from SWM is Dr. Jeff Kramer, Chief Executive Officer. He is joined by Andrew Walmser, Chief Financial Officer, and Mark Chikanau, Director of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon. At this time, our participants have been placed in a listen-only mode, and the floor will be open for questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touch-tone 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 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, you may begin.

Thank you, Misty. Good morning. I'm Mark Chekhanow, Director of Investor Relations at SWM. Thank you for joining us to discuss our second 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 metric comparisons 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. Yesterday, we reported positive second quarter results highlighted by outstanding sales growth. SWM organic growth, x kappa, was 11%, as we are seeing strong demand from our customers full order books and bullish sentiment for the upcoming quarters, evidence of the attractiveness of our global portfolio and strong customer relationships. And as many companies have been reporting, global supply chains across the world have been strained by surging demand, and we are not immune to these headwinds. In addition to rapid increases in raw material costs and logistical shipping challenges, We also experienced limited availability on some specialty TPU resins, actually capping what should have been an even stronger sales and earnings performance without these limitations. As we demonstrated over the past 12 months, our global supply chain teams have done and continue to do an outstanding job in balancing these pressures and servicing our customers. Our customer base is increasingly realizing that in addition to innovation and quality, our supply chain flexibility and reliability are significant competitive strengths and are key benefits of working with us. Bottom line is that we are very pleased with our strong sales performance, the demand outlook, and our global team's ability to continue to deliver impressive results against a dynamic set of supply chain hurdles. And of course, if that wasn't enough, we have also been quite busy integrating our largest acquisition to date, SCAPA. We closed the transaction in mid-April, and we are already excited by what we see as we bring the two organizations together. Our investment thesis of adding complementary industrial and healthcare businesses with increased global reach, new customers, and expanded capabilities is solidly intact as we plot a bright future together. In AMS, overall sales increased 90% including the benefit of the SCAPA acquisition, while underlying organic sales increased an impressive 18% in the quarter. We saw excellent growth in many of our highest value and most strategic product lines. In transportation, we were up nearly 60%. As you recall, 2020 was a choppy year for our paint protection films business, with significant disruption in the automotive market. But this business has snapped back sharply. Underlying demand fundamentals remain strong, and consumers are driving rapid growth for these high-value paint protection products. In fact, sales could have doubled if not for limited access to some specialty resin used in our manufacturing processes. In round numbers, if we had unlimited access to raw materials, we could have generated up to $10 million of additional sales in our transportation business. Our teams are working diligently to secure additional sources so we can maximize sales of these high-value products. Longer term, this area remains one of the brightest spots in our growth picture. and our expanded capabilities in coding and converting from our last two acquisitions give us new opportunities to improve our technical and competitive position in this highly attractive specialty application. Filtration grew over 25 percent in the quarter. Demand was well balanced across the portfolio, with the fastest growth in our water and process liquid filtration products. We continue to truly like the overall macro trends for this end market. Our water customers continue to relay bullish outlooks to our commercial teams as they restock from depleted inventory levels, see increased activity at processing sites, and convey positive outlooks for additional capacity coming online, especially for projects in the Middle East, Africa, and Southeast Asia regions. Needless to say, With the heavy demand for semiconductors and widely publicized shortages, our process filtration materials used in chip manufacturing are experiencing high demand as well. And not to leave out air filtration, which is a key beneficiary of society's focus on improved air quality in our new COVID reality. We grew strong double digits in this product line on top of the 40% growth we saw in last year's second quarter. Construction sales also increased over 25 percent in the second quarter. Similar to the positive fundamentals in the first quarter, higher activity in the oil and gas industry drove year-over-year gains for perimeter control materials used in the Marcellus shale region. Solar farm activity continued to increase significantly as well, as our sediment control products are an important perimeter protection component in these environmentally beneficial projects. But some of the fastest growth came in our residential and commercial building products and infrastructure-related products for highway developments. With sizable proposed infrastructure spending plans moving forward in Washington and increasing focus on sustainable energy projects, macro trends remain positive here as well. AMS's existing healthcare business faced a tough year-on-year comparison as last year we benefited from the unprecedented demand for materials used in face mask production related to COVID. Outside of that tough comparison, we saw good gains in several specialty products used in advanced wound care, dental films, and medical packaging, demonstrating the broad health of our business. As noted, We closed on the SCAPA acquisition during the quarter, so only have very early but positive views to share. Our combined technical, development, manufacturing, and commercial teams are extremely excited about the projects we've already identified to bring new products and technologies to our growing customer base. We believe our significantly expanded full solutions offering is best in class in the healthcare industry when it comes to skin-friendly products. And SCAPR's leading industrial coating and adhesive capability is highly complementary to our industrial products. This acquisition fits squarely into our strategic intent of adding capabilities which our customers are requesting and which build on our strengths. Regarding SCAPR's performance, We are pleased that it is meeting our expectations and is on track to deliver on the financial results we outlined in our accretion expectations on our May investor call. Andy will add more color shortly, but in short, we are encouraged by the recovery we see from the year-ago period when COVID first began to impact the business. For context, and excluding currency fluctuations and gap accounting conversions, overall sales were up approximately 40% versus last year's second quarter, and we're just below 2019 levels. SCAPR Industrial is seeing similar demand increases as our other growing end markets. Healthcare is seeing upturns, but at a more moderated rate, as consumers have not yet to resume normal patterns with respect to elective procedures and more discretionary hospital visits. We continue to expect consumers to resume more normalized levels of healthcare activity in 2022. As most industries are reporting, supply chain pressures were challenging. We have found creative solutions to the constraints on logistics and shipping, as well as access to some raw materials as lead times expanded. And we have been aggressively raising prices. Our increases to date have been successful, and we will continue to take actions to recoup higher costs as appropriate across our portfolio, though there is an inherent lag in the price-cost recovery of these actions. We expect we will continue to navigate some choppy waters for the near term until more normalized conditions return. Given the COVID-related sales volatility over the past year, We have found it useful internally to use high-level comparisons versus first half 2019 to further test the underlying health of the business, and I thought it might be helpful to share them externally as well. These figures are on apples-to-apples basis, so they exclude the impact of the SCAPR and TECRA acquisitions. Filtration and healthcare are each up over 25% versus first half 2019. Transportation was essentially flat, although without current supply constraints, would have been up approximately 20%, and construction was up over 5%. Although the noise of the past 18 months can make comparisons difficult, we want our investors to understand that the underlying demand across AMS has proven quite robust. Switching to engineer papers, Quarterly bottom line results were softer than last year, though many of the factors were expected. Volume performance was actually a positive 3% with 4% sales growth. It was mixed and raw material increases that were in challenge. On mix, we saw lower LAP volumes compared to last year as several large companies continued to adjust inventories to reflect changing supply chain and COVID outlooks. As you may recall when we outlined our annual guidance, we were expecting tough comparisons versus 2020 when several large customers built inventory ahead of uncertain supply chain risks related to COVID. These inventory builds benefited the second and third quarters and were a key factor in last year's strong profit performance as EP delivered well over the mid $120 million EBIT range we had seen in recent years. Factored into our guidance was a return to more normalized profit levels. Segment profits were also impacted by higher raw material costs and supply chain constraints similar to AMS. In response to rapid increases, we have raised prices across multiple product areas with success in even more contractually specified customers. We consider this success evidence of the very strong positive relationships we have with our customer base. Finally, the last inefficiencies related to the transition of newly developed products from the Spotswood facility to other sites also flow through the P&L, but that transition is now fully complete. On the positive side, innovation within this segment continues to be a positive offset. Our heat not burn product line continues to see rapid growth and we continue to work on new developments with key customers. We are also seeing initially small but encouraging early orders in our new hemp and botanicals product line as interest continues to increase across this specialty product line with favorable legislation helping to fuel demand. I believe it's important to emphasize that this is recently a more dynamic and changing marketplace that plays into our innovation strengths. 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 90 percent with organic growth at 18 percent, which, as Jeff noted, could have been even stronger had it not been for limited resin supplies. We had excellent sales performance, particularly in our transportation, filtration, and construction end markets, signaling the broad strength of our diversified portfolio. Adjusted operating profit increased 60%, reflecting the high organic sales growth and the incremental profits from SCAPA. Segment adjusted operating margin contracted 250 basis points to 13.2%, in large part due to the higher resin costs and the addition of SCAPUS business. Higher resin costs, mostly from polypropylene, had a negative effect on operating profits of several million dollars in the quarter, net of the price increases that were affected in that period. At a high level, we recouped about half of the cost inflation. and expect additional price increases will further help us recoup the higher costs as the year progresses. Regarding SCAPA's profit contribution, the acquisition boosted AMS segment adjusted operating profits by over $9 million. However, as noted in our release, approximately $1.5 million of SCAPA's SG&A costs were booked in our own allocated costs, not within AMS, so please be cognizant of that when assessing our segment financial results. In aggregate, SCAPA added nearly $8 million of adjusted operating profits, roughly equaling the interest expense associated with the deal. Consistent with our internal expectations, the transaction was neutral to adjusted EPS in the quarter, which we expect in our plan for $0.10 per share accretion for the full year. In summary for AMS, despite significantly higher input costs and supply chain limitations that constrained our sales growth. Organic sales increased by 18%, and adjusted operating profits excluding SCAPA increased more than 15%, or over 3 million. We believe this growth reflects the resilience and strengths of our business. For engineer papers, second quarter sales were up 4%, with 3% volume growth and favorable currency of 6%, more than offsetting the negative price mix effects during the quarter. The negative price mix was mostly a function of lower LIP volumes, which carry high prices and profitability. On margins, similar to AMS, we saw impacts of higher raw material prices, mainly wood pulp. As Jeff referenced, we have successfully negotiated price increases with our contracted customers in advance of the annual reset terms. Higher pulp costs impacted profits by a couple million dollars in the second quarter, contributing to some margin pressure. The lower LIP volumes and spots with transition inefficiencies were the other factors that drove the lower operating profit dollars and margins. While the top LIP comparisons will continue into the third quarter as expected, the recently implemented price increases are expected to mitigate higher costs during the second half of 2021, and the spots with transition inefficiencies are now behind us. Regarding adjusted unallocated expenses, we saw an increase of nearly $5 million during the quarter. However, as noted, 1.5 million of the increase was SCAPA's unallocated costs booked in our unallocated costs. The remainder of the increase related to timing of certain administrative expenses and increased investments in finance, HR, and IT to support the growth of the business. As disclosed in the earnings release, approximately 12 million of SCAPA-related deal and integration costs were excluded from adjusted unallocated expenses in the quarter. On a consolidated basis, sales for the quarter increased 49% or 11% on an organic basis. Adjusted operating profits increased 3% and adjusted EBITDA increased 9%. Second quarter 2021 GAAP EPS was 6 cents versus 68 cents. The main material on usual comparison items relate to the SCAPA acquisition expenses, which totaled 57 cents per share and included 39 cents of deal costs and 18 cents of higher non-cash purchase accounting expenses. Please refer to our 10Q and press release for additional details on this topic. Normalizing for those and other items, adjusted EPS was 90 cents in line with last year's strong second quarter results. While operating profits increased, we had a slightly lower tax rate, and our JVs contributed nicely. The supply chain challenges and incremental interest expense from the SCAPA acquisition offset those favorable elements and resulted in flat adjusted EPS. To put some of the supply chain and cost headwinds into perspective, We estimate the cost inflation on resins and wood pulp that we did not recoup through price increases had an impact of over 10 cents per share on EPS. And the lost sales on transportation films alone was more than a 10 cent impact as well. When combined, we estimate these two factors had more than a 20 cent negative impact on adjusted EPS in the quarter. This estimate signals the magnitude of the financial impact, and while the costs and challenges are real, you can see how strong our business fundamentals are when normalizing for these factors. We also highlight that our year-to-date adjusted EPS of $1.92 is up 10% over last year. Regarding cash flows, year-to-date operating cash flow was approximately $20 million, down $30 million from prior year, and free cash flow was approximately $2 million, with a similar dollar decline. The $30 million cash flow decrease year-to-date was due to $13 million of cash costs related to fees and expenses with the SCAPA acquisition and a $20 million increase in working capital outflows driven by very strong sales. We expect working capital cash flows to be more favorable as the year progresses and expect very strong free cash flow generation through the remainder of the year. Net debt finished the second quarter just about $1.2 billion. Net debt to adjusted EBITDA for the terms of our credit agreement was 4.4 times at the end of the second quarter, and we expect to deliver towards four times by the end of the year. Please refer to our earnings release and 10-Q for additional details on our debt structure. Now back to Jeff.

Thanks, Andy. So to wrap up, we are proud of the results we delivered and the strength of demand across our expanded portfolio. While supply chain challenges were evident in the quarter, our team again demonstrated their value and experience. We believe that through all the supply chain and inflationary noise, which we believe will prove temporary, the underlying demand fundamentals of our business are quite strong. Given our financial strength and capable teams, we are also able to press ahead on strategic growth initiatives across the business in areas like sustainable products, advancing our transportation film capabilities and technologies, investments to support growth and filtration, innovation in reduced risk tobacco and other specialty fiber applications like hemp materials. To underline these opportunities, we are also investing in manufacturing 4.0 and advanced analytics so that our operational capabilities will continue to meet increasing customer expectations. The SCAPA acquisition only serves to further enhance our portfolio innovative technology and help us further penetrate attractive markets. We look forward to the second half of the year, addressing the external challenges presented to us and capitalizing on the strong demand we see in so many areas of the business. So that concludes our remarks. Misty, if you could please open the line for questions.

At this time, if you would like to ask a question, press star 1 on your telephone keypad. Again, that is star number 1. We have a question from the line of Chris McGinnis with Sidoti & Company.

Yeah, good morning. Thanks for taking my questions and nice results. I guess just a lot of detail around the inflationary environment, the impact. Thanks for that. I guess in thinking about continued demand going forward, any impact there that you see as you kind of implement the price increases that that could kind of impede growth at all? Thanks. Thanks.

Yeah, it's always a good question. I think what we're seeing is universally everybody is raising prices because we're not the only people impacted by it. I think you always need to watch carefully if there's going to be some impact about share loss. We might see some shedding of some low-value added customers, but for the most part, I think our customers really value our relationship and understand this is probably a short-lived environment. So I'm not seeing... huge pressures right now at that point, but we're staying real close to it. I think the only challenge that we will continue to see in the coming quarter might be around some of those supply constraints we're seeing with some of the specialty TPU resins. I mean, we're going to continue to see good growth, but we might not be able to fulfill all the demand that we're expecting to see.

Great. And just thinking of SCAPA, can you just I may have missed it if you mentioned this, just around, you know, how that business is trending and rebounding, and then, you know, it sounds like your targets are still on track, if I'm correct.

Yeah, as we said, I think they're rebounding, you know, pretty much in the industrial side, just like all of AMS. I mean, we're really excited about what we brought in from the industrial side. It's really complementary, and the market applications are similar to ours, and we're seeing that to be strong demand year on year. We're also seeing good comparisons year-on-year in the healthcare business. I think the one place that we've always cautioned had some sensitivity to the COVID environment is this advanced wound care, you know, from discretionary hospital visits, et cetera. That seems to be slowly moderating, but not at the rate that we had hoped because of the uptick in COVID, but we are expecting that to return to more normalized levels in the coming year.

And Chris, let me just add a little bit more color for you. So just for context, you know, we had about $95 million in sales, you know, in the quarter. And, you know, if you kind of look at where they were year over year, I mean, that's up 40%, as Jeff mentioned in his script. So, you know, as we thought about this business sort of returning back to the 2019 sort of levels, we're exactly right there. As we talk to the business in terms of thinking about what their order book looks like, even particularly in industrial, the order book is exceptionally strong. We talked a lot about some of the supply chain challenges that we've had, mostly at legacy SWM business, but even SCAPA is having, I would say, some supply chain challenges and their results would be even stronger as well. I would say the punchline is that the business is on track, a really good second quarter, particularly in the context of where they were in 2019 and being up 40% year over year. So bottom line, it's on track.

Great. Thanks for taking my questions, and good luck next quarter. Great. Thanks, Chris.

There are no further questions at this time.

Okay, well then let me wrap up with a couple of closing comments. You heard I'm incredibly proud of the performance that the team has turned in over the year. I didn't specifically make COVID comments during the call because I think we're all aware of the challenges we're seeing globally. I think our team continues to do a great job of benefiting, you know, each other, taking care of each other, and making sure we're able to supply our customers. I just want to close the call again, thanking our global teams for the outstanding job they do. I'm really proud to be part of this team. So thank you all.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.