MATV - NYSE

Good morning, everyone. And welcome to Mativ's Second Quarter Earnings Conference Call. Hosting the call today is Mativ's Julie Schertell, Chief Executive Officer. She is joined by Greg Weitzel, Chief Financial Officer; and Mark Chekanow, Vice President of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon. [Operator Instructions]. It is now my pleasure to turn the floor over to Mr. Chekanow. Sir, you may begin.

Good morning, everyone. And thank you for joining us to discuss Mativ's second quarter 2023 earnings results. Before we begin, I'd like to remind you that the comments included on 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. 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. The earnings release is available on our website at ir.mativ.com as are the slides for today's presentation. You can download the slides and/or click through these slides at your own pace during the call using the webcast interface. To remind you of how Mativ results were reported and how we will be discussing them, recall that the SWM and Neenah merger closed on July 6, 2022. Thus, the second quarter reported results reflect the combined company for the full period. However, the prior-year results reflect only the legacy SWM results. On today's call, though, and in our earnings release, we will provide some comments referring to comparable performance to illustrate how our results compare to prior-year periods on a like-for-like basis. These figures are shown in tables in our earnings release and the appendix of this presentation as well as full reconciliations. With that, I'll turn the call over to Julie.

Thanks, Mark. Good morning, everyone. And thank you for joining today's call. Following our transformational announcement last week about our proposed EP divestiture, we're very pleased to report a solid second quarter, consistent with our messaging in our last earnings call. As expected, Q2 results showed very strong sequential EBITDA improvement from the first quarter, with margins increasing substantially from better manufacturing performance, incremental cost reductions and continued pricing discipline. Adjusted EBITDA of over $87 million in the second quarter compared to $66 million in the first quarter. This result was consistent with our message from the first quarter call when we detailed the impact of the French strikes and some inefficiencies at other sites that we were already working to address. The sequential improvement in EBITDA from first quarter showed no lingering effects from the strikes and good progress on improving manufacturing performance, cost reductions and continued synergy realization. Last year's second quarter was a high watermark for sales and EBITDA for the combined companies over the past few years, with EBITDA close to $100 million. And it was the last quarter that was not yet affected by destocking and the macroeconomic slowdown in manufacturing. With that as a backdrop, I'm pleased to report stable year-over-year margins despite volume headwinds. Importantly, this demonstrates that we are delivering on merger synergies, driving incremental cost reductions and remaining disciplined in market pricing. Given the extent of the destocking and overall volume softness, we were pleased with the significant sequential EBITDA improvement in the second quarter and view this as a demonstration of improved execution on the aspects of the business most within our control. Relative to volume, the end markets most impacted by destocking and soft demand are those influenced by building and construction and premium consumer goods. Many end markets and product lines in release liners, filtration and healthcare remain resilient, though not completely insulated from destocking trends. And while customer destocking was heightened during Q2, we're focused on driving new and incremental business with new products, new geographies and new customers. Let me highlight a few examples. We've invested in new release liner capacity in Mexico, which is expected to come online in Q4 of this year, supporting greater growth in North and South America. Release line volume continues to lead in our portfolio, with a decade of consistent and strong growth. We've gained share in our largest filtration category, transportation filtration, and we continue to have a robust new product pipeline with our large strategic customers. In addition, we've invested in new meltblown capacity, expected to come online in 2024 to support growth in air and life science filtration. The combination of these new capacity additions provides the opportunity to continue to grow and add over $50 million of new revenue in the future. In protective solutions, we've launched a new optical film used in ballistic resistant materials for the military, law enforcement, buildings and private vehicles. This is a project that's taken a few years to develop, test and qualify, and we're excited about the launch this year, and believe it will add over $10 million in new revenue over the next 12 months. Other key highlights in Q2 were price versus input costs remaining very positive and cash flow stepping up nicely from the first quarter. We are aggressively managing capital, including continued reduction in inventory levels throughout the year and reduced capital spending as previously communicated. Looking to the second half of the year, visibility on volume remains a challenge, but we are very encouraged by our improved operational execution, disciplined pricing and synergy delivery, as well as the initiatives in place to drive incremental demand through innovation, share gain and customer expansion. This gives us confidence that, as volumes rebound to higher levels, we should see excellent flow through in margins with leaner operations and improved cost position across our business. Turning to the next slide, consistent with the first quarter, the key themes remain price cost and synergies as key positives and destocking and lower volume impacts as the counterbalance. However, I'm pleased to say the manufacturing costs and inefficiency issues we discussed in may have been largely resolved. For price cost, we had about $25 million of net favorability, continuing our strong performance in this area. Price increases have proven successful in offsetting inflation and remain largely intact, highlighting the value our specialty materials bring to the markets we serve. As signaled during our last call, we expect to start to lap some large year-over-year pricing gains in the second half. And as easing input costs work their way through the P&L, we expect to maintain a positive price cost spread. Importantly, the strong price cost performance was seen in both ATM and FBS. Shifting to synergies, we are one year into the merger. And one of the key targets we originally outlined was the execution of half of the $65 million synergy plan within 12 months. We're pleased to say we have achieved that goal and continue to push the team to accelerate synergy execution as well as find upside to the total program target. Synergy delivery has been a key action within our control that is helping to offset the challenges the global economy has presented over the past year. Most of the synergies realized to date have been in SG&A, and you can see that in our reduced level of unallocated corporate expenses. Thus far in 2023, the teams have done a great job executing supply chain and procurement synergies, which will amplify in the second half of the year and with even more significant realization in 2024. This includes contract restatements, expanded supplier agreement and optimized supplier rosters for a number of our shared materials and services. To reiterate the timing of the bottom line readthrough of the $65 million of synergies, we achieved about $5 million in the back half of 2022. We expect $25 million in both 2023 and 2024 and then the remaining $10 million hitting the P&L in the first half of 2025. Although the current pressures of destocking and volume are limiting the visibility of synergies, we believe these actions will be a driving force behind achieving our long term margin goals. Moving to destocking, this remains the most pressing and widespread challenge in the end markets and value chains in which we are operate. Overall, market demand remains challenged and difficult to predict. And while we're encouraged by some customer indications that destocking is mostly behind us, overall volumes remain under pressure. In this environment, it is even more important that we focus on those areas within our control, and that includes cost performance, pricing and driving incremental demand. Moving to manufacturing, we're pleased to have no material impact from the French strikes, which had a large impact on first quarter results. We've also addressed the inefficiencies at several sites as we settle into more stable schedules and with an increased focus on temporary cost reduction actions. Our internal ops excellence program called IMPACT has pivoted to be very focused and targeted on key sites, and it's delivering solid results in improved yields, productivity and waste reductions. Last call, we spoke about $10 million of quarterly cost-out actions, primarily driven by operational staffing and improved manufacturing performance. We executed on these efforts, which partially mitigate the volume softness. Simply put, we remain committed to continued cost-out actions to preserve margins. The results of these are evidenced in our strong sequential EBITDA margin improvement. With that, I'll turn it over to Greg to review the quarter's financials.

Thanks, Julie. As Mark mentioned earlier, reported consolidated Mativ results reflect the merged company for the second quarter, but only for legacy SWM in the prior year, thus skewing year-over-year comparisons. So, my comments will focus on current business trends and margins on a comparable basis. Total second quarter sales were $667 million, with organic sales down 8%. Currency effects were immaterial. Price was up 5% across the company versus last year, partially offsetting a 13% decline in volume and mix. This was attributable to customer destocking across the business and softer economic conditions. The best performing category was release liner with a mid-single digit sales gain, and we saw flattish sales in EP and healthcare. As Julie discussed, the most pressure was felt in industrials and packaging and specialty paper with sales declining more than 10%, while filtration and protective solutions also declined. For total adjusted EBITDA, we grew sequentially by 33% versus Q1 of 2023, demonstrating aggressive cost reductions, disciplined pricing and accelerated synergies. On a year-over-year basis, we comped a very strong Q2 of 2022 of $97 million of adjusted EBITDA with our Q2 2023 adjusted EBITDA of $87 million, down 10%. Despite lower volume, we delivered essentially flat year-over-year margin at 13.1%. Approximately $40 million of favorable price more than offset higher input costs for a net benefit of $25 million. Cost reductions partially mitigated the volume decline and associated impacts on the manufacturing fixed cost absorption, but not completely. We were pleased with the continued positive price cost, progress we made on the manufacturing cost and increased energy delivery. Looking at the segments in the second quarter with the same like-for-like comparable view, for ATM, on a sequential basis, adjusted EBITDA grew 7% with margin expanding 150 basis points. Year-over-year, adjusted EBITDA was down 18% or nearly $14 million with margin contraction of 130 basis points. Again, this was up against an extremely strong second quarter of 2022. For FBS, on a sequential basis, adjusted EBITDA increased over 60%, with margins expanding 680 basis points, reflecting the passing of the strikes in the first quarter as well as improvements and other areas of our operations. Year-over-year comparable adjusted EBITDA grew 1% or approximately $0.5 million, with margin expansion of 130 basis points compared to the prior year. Unallocated expenses were lower by $3.6 million or 14% on a comparable basis the prior year, reflecting synergy realization and effective cost controls. We think this level of unallocated expense is an appropriate run rate going forward for modeling purposes. Interest expense was approximately $28 million for the quarter, and approximately 75% of our total debt remained set at fixed rates. Adjusted EPS was $0.51 for the quarter. The next slide bridges our second quarter adjusted EBITDA to prior year on a comparable basis. First, our price benefit was $40 million. We will look to maintain the price increases implemented in recent quarters, though the magnitude of the year-over-year increases will logically subside as the year progresses and we lap the increases implemented in 2022. Regarding input prices, the inflationary environment continues to ease on most fronts. Several key inputs have come down sequentially in recent quarters, though in some cases either remained higher than prior year or the benefits from the lower prices have not yet flowed through to the P&L. Overall input costs were negative $14 million impact versus the prior-year quarter, improving sequentially from the first quarter impact to $20 million and should continue to trend favorably in the second half. Bottom line, price versus cost was net favorable by approximately $25 million in the second quarter compared to last year. We expect this favorable net trend to continue with pricing gains shrinking and input costs becoming more favorable. With respect to some key inputs, the NBSK pulp index was down about 13% in the quarter, marking the first quarter since late 2020 where the index was lower year-over-year, and prices are generally expected to continue softening with the flow through benefits for us later this year and likely into 2024. For polypropylene, market prices remain well below prior year as uncertain demand and ample industry supply continue to keep a cap on prices. Regarding volume mix and manufacturing and other costs, the net effect versus last year was over $35 million of adjusted EBITDA. This is essentially volume driven. This variance was approximately $60 million in the first quarter, and also showed sequential improvement with the passing of the French strikes, as well as our implementation of efficiency initiatives and cost reductions. We have made strong progress on commercial and manufacturing execution, so that our price cost gains drop to the bottom line and we believe we are still on track exiting 2023 on a solid run rate. While we had been referencing trending toward $100 million dollar EBITDA quarters on our recent calls, with the proposed sale of Engineered Papers, which will be reported as discontinued operations beginning in the third quarter, it is probably appropriate to reframe our expectation as reaching $70 million quarters. This aligns with our high level comments last week around our post close business being approximately $2.2 billion in sales and approximate 13% adjusted EBITDA margins. Turning to the next slide. Per the terms of our credit facility, net leverage ended the quarter at 4.2 times. Recall that our credit agreement net leverage includes adjustments for planned synergies on top of our combined trailing 12-month EBITDA. To reiterate our comments from last week, deleveraging remains a top priority, and we expect the proposed EP sale to reduce leverage by 0.3 turns upon the close later this year, and to be within our targeted range of 2.5 to 3.5 times by the end of next year. Operating cash flow in the second quarter was $40 million, a strong sequential improvement versus the first quarter as expected. This was a function of stronger sequential EBITDA as well as improvements in working capital. In the first quarter, working capital was a $52 million use of cash, whereas in the second quarter was a $10 million source of cash. We will continue to focus on working capital efficiency and reduced inventory through the remainder of the year. For the second quarter, CapEx was $23 million, putting the free cash flow at $17 million for the quarter, marking a strong sequential improvement versus the first quarter. One note for near term margin expectations is that cash flow maximization from inventory reductions is likely to have a temporary negative effect on EBITDA margins. As we draw down the inventory, we're reducing production volumes, thus impacting efficiency and fixed cost absorption. We believe cash flow maximization should be the ultimate financial and operational decision driver. Now back to Julie to wrap up.

Thanks, Greg. So to recap, I'll hit a few key takeaways from the quarter, talk briefly about the remainder of this year, and then reiterate some of the highlights of our recent announcement on the proposed sale of engineered papers and the capital allocation rebalancing. The first takeaway on the quarter is that price cost remained strong, and we expect the net benefit to remain intact through the back half of the year. The second takeaway is that we made a lot of progress on operations and execution, like we said we would. First quarter was an anomaly in our view, a bit of a perfect storm of strikes and inefficiencies, but we're on the right track and demonstrating strong progress. Third, from a cost takeout standpoint, synergies are on plan and we've aggressively reduced cost and inventories to align with current demand. we'll continue on this path. Overall, we're encouraged with our progress this quarter, with the expectation for continued improvement in the future. As we think about the remainder of this year, we expect the back half to be similar to Q2 performance, and with some potential upside later in the year as volume stabilizes and synergies accelerate as we exit 2023. Now shifting to the highlights from last week's announcement. The proposed sale of Engineered Papers repositions as both strategically and financially. We were pleased with the headline price of $620 million or about 6.5 times trailing EBITDA. The expected net proceeds of approximately $575 million will be used to pay down approximately 35% of our net debt. And once the transaction closes, our portfolio is immediately leaning more toward our growth categories. As such, we see accelerated top line and EBITDA growth potential. We laid out some high level parameters of post close financial expectations of a $2.2 billion revenue business, with 13% EBITDA margins and a 3% to 5% top line multi-year CAGR. Importantly, approximately 40% of our sales will be from our three growth platforms – filtration, release liners and protective solutions. This is where we will continue to bias our investments and our resources. From a leverage standpoint, we expect an immediate deleveraging when the deal closes later this year and a clear path to be within our target range by the end of next year. Leverage is our top near term financial priority. And we're focused on both debt reduction and EBITDA growth to drive that metric lower. And lastly, we've rebalanced our capital allocation, rightsizing our dividend to approximately 25% of expected annualized cash flow post close, which is more aligned with our repositioned portfolio that has a faster growth outlook. And we approved a $30 million stock buyback program, which we expect to execute opportunistically. We believe our stock represents an attractive value and expect to begin executing share repurchases. But to be clear, debt reduction remains our priority use of cash in the near term. So in our view, it was a good quarter in light of some top line headwinds. And we're especially pleased with how the announced transaction and rebalanced capital allocation approach set us up for accelerated growth, stronger financial performance, and long term value creation. That concludes our prepared remarks. I'd like to open the line for questions.

[Operator Instructions]. Our first question comes from Jon Tanwanteng from CJS Securities.

It's Pete Lucas for John. You covered almost everything Jon had in terms of questions. Just I guess in terms of cost reductions and what you had mentioned on the last call, just kind of wondering, you mentioned in the prepared remarks, aggressive cost reductions continuing, just kind of update us on where we stand on those in terms of what inning we're and any major ones still to come?

I'd say cost reductions, we have implemented the majority of what we had communicated. And we had started that even as we were doing our last call. So cost reduction is really focused on reduced staffing, operating labor, maintenance, marketing, and advertising, as well as inventory. So in this type of demand environment, we view it as really significant that we take control of our own destiny as much as possible and drive cost out to maintain margin levels. And then as volume returns, and we're working to drive volume as well, but as the market improves and volume returns, our expectation is that we're even more efficient than we were in the past and that flows through to the bottom line.

You'd mentioned industrial and packaging still under pressure, kind of what's your outlook for that and the main causes of the pressure there that you're seeing?

I think it's a couple of things. Destocking, as much as I believe we're getting past that, it was pretty significant in our packaging and specialty papers business, particularly in the merchant channel. So where there's premium discretionary spending driving demand, we saw a heightened level of destocking. And then, I would tell you in industrials, the greatest impact is in our tapes and abrasives categories where it's very construction related. So I'd say it's a combination of destocking primarily in premium packaging, especially papers, and then softer volume in our industrials business. We had, I'd say, solid revenue in release liners and in healthcare where we have new business, strong contracts that we've renegotiated, particularly in consumer wellness and device fixation, and then I'd say pockets of strength in filtration, particularly in transportation filtration and air, and also in premium films. Some nice pockets of strength in medical and optical.

Our next question comes from Daniel Harriman from Sidoti.

Congrats to the team on a great quarter and strong sequential improvement. Julie, I know you mentioned this in your prepared remarks and also a little bit just now. But from that commentary, it seems that destocking and volume in the second quarter was more of an issue than you may have expected based upon comments in the first quarter call. And then demand obviously was a bit weaker. You obviously still performed well in this environment. So could you maybe just give us a little bit of an insight into what you're hearing from customers through the first six weeks of the third quarter and then maybe how these conversations are impacting your outlook for margins in the back half?

I'd say it's a little bit of mixed signals from customers. And again, where we really felt the heightened level of destocking, and I would tell you we're still feeling it early Q3, is in packaging and specialty papers. And that's primarily in our merchant channel in our packaging business. Our consumer products business is performing quite well in that category. Same thing in industrials, that's where we're feeling the greatest continued destocking and inventory rightsizing. And at some point, Dan, it becomes really hard to separate destocking and soft volume. So internally, we've said, no more discussion about destocking. We have to be taking all the efforts that we can to drive volume ourselves and drive demand. And we've really worked to do that in a number of areas, new products that we've launched across the board. In packaging, we have new mailers we've launched. In filtration, we have new prefilter media that we've launched. In protective solutions, we have a new premium, bulletproof film that we've launched that we're really excited about. So I think innovation continues. And we continue to invest there and drive volume in that regard. Customer programs that we've worked on to drive volume and gain share, we're seeing that in filtration, as well as in our paper segment. And then the cost efforts that I've about, and really ensuring that we're getting cost out to manage our facilities at the lowest cost possible. And we think that's a big value for us. And synergies is helping us drive that. So we continue to deliver on synergies. We had committed to $65 million. We're on pace for that. We had committed to half of that in the first year and we're on pace for that. So all of that to say, I think from a customer standpoint, the feedback is pretty mixed. And our position is we have to drive volume and we have to control our own destiny as much as possible. I think customers are working really hard to understand their demand profile. We work very closely with them. But it's a challenge right now from a visibility standpoint, but we're pleased with where margins ended up for the quarter. Constant with last year, which was a super strong quarter for both companies. And we're pleased with the sequential improvement.

I've made a note not to ask you about destocking ever again. So don't worry about that.

You and everybody else in our building.

My second question. Greg, this may be a little bit more for you, but y'all talked about this last week. And, obviously, leverage is top of mind for the investor base and it's a major focus of the capital allocation strategy moving forward. The sequential EBITDA improvement in this quarter and then positive cash flow and sequential EBITDA improvement back half of the year. Do you anticipate being able to pay down a larger portion this year in addition to the 35% reduction upon close of the EP sale?

I think the EP sale, specifically the 35%, and there is a potential for a little bit beyond that. Overall, you have that debt leverage of 4.2 at the moment, and we expect that to come down by another 0.3 turns with the EP sale.

For 2024, still anticipating the $90 million in free cash flow that you talked about last week?

Yep, that's right.

Thank you very much. There are no further questions on the line. I'd now like to hand back to Julie for any closing remarks.

Thank you for your time today and your interest and we look forward to speaking to you on our next update.