Mark Chekanow - Director of IR Frederic Villoutreix - Chairman of the Board & CEO Allison Aden - EVP, Finance & CFO.

Julie Li - Drexel Hamilton Dan Jacome - Sidoti & Company.

Welcome to the SWM Third Quarter 2016 Earnings Conference Call. Hosting the call today from SWM is Frederic Villoutreix, Chairman and Chief Executive Officer. He is joined by Allison Aden, Chief Financial Officer, and Mark Chekanow, Director of Investor Relations. Today's call is being recorded and will be available for replay later this afternoon.

The dial in number is 855-859-2060, and the conference ID is 3818935. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation [Operator Instructions]. It is now my pleasure to turn the floor over to Mr. Chekanow. Sir, you may begin..

Thank you, Ronya. Good morning. I am Mark Chekanow, Director of Investor Relations at SWM. Thank you for joining us to discuss SWM's third quarter 2016 earnings results. Before we begin, I would like to remind you that the comments included in today's conference call include forward-looking statements.

Actual results may differ materially from the results suggested by these comments for a number of reasons which are discussed in more detail in our Securities and Exchange Commission filings, including our quarterly reports on Form 10-Q and our annual report on Form 10-K.

Some financial measures discussed during this call are non-GAAP financial measures. Reconciliations of these measures to the closest GAAP measures are included in the appendix of this presentation and the earnings release.

Unless or otherwise stated, 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 will now turn the call over to Frederic..

Thank you, Mark, and good morning, everyone. Entering the fourth quarter, we are generally pleased with SWM's overall performance and that our third quarter and year to date earnings results were in line with our expectations.

Third quarter adjusted EPS of $0.74 puts us at $2.46 and for three quarters, relative to our full year adjusted EPS guidance of $3.15, which we issued at the outset of the year. While year to date, we are performing consistently with our overall expectations, we have several noteworthy puts and takes in the business.

Engineered Papers continued to perform well and is tracking better than we had originally expected. Argotec is slightly ahead of projected accretion, and currency movements versus last year have been less of a headwind than we assumed.

These positive factors have been offset by sales softness at DelStar, underperformance of our Chinese joint venture and a higher tax rate. As we discussed earlier this year, earnings during the first half of 2016 were expected to be stronger than the second half, and our results is like that assessment.

One prominent factor in our quarterly performance in 2016 has been LIP volume liability, as the customer driven LIP inventory builds from late 2015 and early 2016 continued to reverse during the third quarter, and this was fully anticipated.

In addition, our third quarter tax rate increased significantly versus last year, and we will elaborate on that shortly as that was the largest driver of our third quarter earnings decline. Our Engineered Paper segment delivered a solid quarter, despite the expected LIP volume decline as RTL had a strong quarter.

In total, our cigarette paper volumes, including our Chinese joint ventures CTM, we're down 10% in the third quarter, driven by the LIP volume decline as our customers worked through recently built up inventories.

Our non tobacco paper volumes continue to show strong growth, due primarily to increases in printing and writing, as well as furniture laminates. Profitability improvements such as selective price increases have boosted the attractiveness of these typically lower margin products.

Third quarter recon volumes, including our Chinese joint venture CTS, were up 31%, illustrative of the quarterly variability of this business that affects both our French mill and our Chinese JV. Significant volume growth at CTS versus last year when sales were minimal was the primary reason for the sharp overall recon increase.

With respect to our Chinese JVs, third quarter performance improved sequentially compared to the second quarter of this year. Recall from our last earnings release, we had a disruption in paper JV due to changing energy regulations and the resulting impact on our JV facility.

We are raising the operations and are making adjustments to improve margins under the new energy sourcing requirements. The recon JV, CTS, was solidly profitable in the third quarter, following an unprofitable second quarter, and we continue to expect a more moderate ramp towards full capacity.

The transition of the Chinese cigarette industry from the growth phase to an attrition driven industry and the excess supply of cigarettes and virgin leaf are the primary factors affecting recent performance and near term expectations.

While CTS' third quarter results were relatively good, we do not anticipate recovering the volume shortfall experienced in the first half of the year. Results of our multinational customers continue to indicate smoking attrition in Europe and the U.S. remains low relatively to historical norms.

Regarding our RTL business, cost actions continue to play a key role in our operations, and our focus on managing capacity should help offset expected volume weakness into 2017 at our French mill.

In addition, we are working on several strategic initiatives that leverage our paper and recon manufacturing assets and technology applications, and could provide meaningful opportunities within the tobacco industry as well as non tobacco end markets.

Now switching to AMS, for third quarter, organic sales for AMS were down 5% and down 2% on a constant currency basis. Outside of currency, a substantial negative sales factor in the third quarter comparison related to a new product launch in the third quarter of 2015.

As we mentioned last year, a customer launched a new air filtration product into the U.S. retail channel, and we supplied the filtration media. Unfortunately, the product was not successful at retail and is being reassessed. Thus the order did not repeat this year.

This factor alone accounted for $1.6 million sales decrease or the equivalent of a 4% segment sales decline. For context, excluding negative currency impact and this singular product, organic sales in AMS would have increased slightly during the quarter.

In addition, the exit and de-prioritization of certain low-margin industrial products continue to weigh on sales.

However, reduction of these sales has a limiting impact to our bottom line, and we intend to continue strategically rationalizing [indiscernible] Lastly, we experienced a weak third quarter for reverse osmosis or RO water filtration, following a good first half of 2016 when we were fulfilling orders for new capacity in the Middle East.

While our positive long-term outlook for water filtration remains unchanged, we are likely headed for a near-term low in these typically high growth end markets due in part to slower economic growth in China. As a reminder, our sales into the global RO filtration end market grew by more than 10% in 2015.

On a positive note, we have seen very strong results in other filtration market segments. For example, filtration products for other liquids such as hydraulics saw solid third quarter growth. This area had previously been affected by volatility in oil, gas and mining industries, and we are seeing a recovery in these sales.

Furthermore, we have solid momentum in other areas of air filtration, as well as filtration applications for semiconductor manufacturing. Argotec delivered another solid quarter of top and bottom line increases with surface protection and industrial products, both delivering high growth in the quarter.

We know that if Argotec's year-over-year growth was included in our organic sales calculations, it would have more than offset a negative factor affecting DelStar's results. The nature of the various factors affecting DelStar and positive momentum in Argotec give us optimism as we conclude 2016 that AMS can resume organic sales growth next year.

Regarding our 2016 strategic priorities, Argotec is on track to slightly exceed our expected accretion targets, and we are taking actions to improve DelStar's topline and margin performance.

While pruning low-margin industrial sales has hampered our reported sales growth, it is strategically important as we position AMS as a high value manufacturer and keep our organization focused on growing our most profitable product lines and driving margin expansion.

Our segment leadership team is also progressing on the new ERP system implementation, which we expect will streamline segment operations and unlock opportunities to improve purchasing, eliminate redundant costs, maximize capacity and efficiency of our assets, enable cross-selling and enhance our business intelligence analytics.

These factors are the primary levers we believe we can pull to expand adjusted operating margins by several 100 basis points on the 13% AMS delivered in 2015. Thus far in 2016, we are making notable progress, largely due to Argotec and some synergies across AMS.

However, we believe we are still only in the middle stages of delivering on our AMS strategy. I will now turn the call over to Allison..

Thank you, Frederic. I'll now review some financial highlights in the third quarter. Net sales grew 13.5%, or 12.3% on a constant-currency basis, compared to the third quarter of 2015. The quarter benefited from the addition of Argotec and solid RTL and non-tobacco paper volumes, which offset the expected decline in LIP as previously discussed.

We note that given the strong LIP volumes in the fourth quarter of 2015, we expect a difficult comparison in the fourth quarter of 2016 as well. Third quarter 2016 EP segment net sales were down 3.9%, or 6.5% on a constant currency basis. Within the AMS segment, net sales were up significantly in the third quarter.

However, excluding the effect of the Argotec acquisition, sales declined about 5% due to unfavorable currency movements, which accounted for about 3 points of the decline, as well as the factors that Frederic described earlier.

The Engineered Paper segment adjusted operating margin was up 150 basis points in the third quarter, consistent with strong recent trends as higher RTL volume, operational improvements, currency benefits and cost control overcame the decline in LIP volume.

The AMS segment adjusted operating profit margin improved by 210 basis points and benefited from the Argotec acquisition and lower resin costs.

However, despite increases in adjusted segment margins within EP and AMS, our consolidated operating margins declined year over year due expenses incurred in Q3 2016 related to certain tax and treasury projects and our ongoing LIP litigation actions. The tax and treasury projects are completed and already delivering financial benefits.

Shifting to consolidated earnings, third quarter 2016 GAAP EPS was $0.61, down from $0.84 in the prior year, driven by the operational trends already discussed and a higher reported tax rate of 38.8% versus 18.8% last year.

Restructuring expenses, intangible asset amortization and the 2016 discrete tax items are excluded from adjusted EPS, which was $0.74, down from $0.89 in the prior year.

To clarify the third quarter tax rate increase versus last year, the most significant factor was the non recurring tax benefit we realized primarily in the third quarter of 2015, which resulted in a lower quarterly tax rate.

We highlighted this prior year benefit in our 2016 earnings guidance bridge presented during our February earnings call and noted that this non recurring item would create a $0.20 headwind to our year over year EPS comparisons. The remainder of the third quarter 2016 tax rate increase relate to two factors.

First, there were discrete items in the quarter related to recurring expenses, which netted to a $0.04 negative impact and are exclude from adjusted EPS. Second, we booked a tax true up during the third quarter as we now expect our full year effective rate will approach 30%.

This true up was driven by our geographical earnings mix varying from our original expectation. Moving on from tax, the Chinese JVs delivered a solid profitable third quarter versus the breakeven results in the third quarter of 2015. And lastly, the impact of currency translation was neutral to both GAAP and adjusted EPS.

In summary, taking all the aforementioned items into account, our results are generally on plan and reflect the relative strength of the first half results versus the second half results that we incorporated into our 2016 outlook.

Year to date 2016 free cash flow was approximately $64 million and trailing 12-month free cash flow was approximately $118 million. From a leverage perspective, for the terms of our credit facility, we are at 2.1 times net debt to adjusted EBITDA, down from 2.3 times at the beginning of 2016.

We highlight that as a result of previously-referenced tax and treasury projects, year-to-date we've utilized in a tax-efficient manner, more than $125 million of non-U.S. cash to pay down debt. We expect these actions to reduce interest expense going forward. We also announced an increase to our quarterly dividend rate of 5%.

This marks the fifth consecutive year we've increased our dividend and is consistent with our balanced capital allocation strategy to return at least one-third of our free cash flow to investors. We believe these steady dividend increases demonstrate the confidence we have in the Company's financial health and long-term growth prospects.

Now back to Frederic..

Thank you, Allison. Overall, our results to-date are generally as we had anticipated. Very strong execution in Engineered Papers and Argotec are supporting our business as we navigate the pockets of unexpected headwinds within DelStar and our Chinese joint ventures.

Outside of day-to-day operations, our global team continues to currently plan and execute longer-term initiatives to support the transformation of SWM from a tobacco-driven a paper company towards a more growth-oriented, diversified, value-added industrial manufacturer.

Of note, non-tobacco sales presented approximately 42% of total sales in the third quarter, and we aim to drive that metric higher over the long term through AMS segment topline growth. To complement long-term sales growth, we have [indiscernible] focus on AMS segment margin expansion, which we think remains a significant long-term opportunity.

Candidly, top-line balance is only the first step on our path of transformation as ultimately, we are pursuing a more balanced profit split between our tobacco and non-tobacco businesses. As such, we continue making investments and focusing our resources to succeed on this path. We appreciate your continued interest and support.

That concludes our remarks. Ronya, please open the line for questions..

Thank you. [Operator Instructions] And our first question comes from the line of Julie Li from Drexel Hamilton. Your line is now open..

My first question is on RTL volumes. We saw very strong growth from Chinese JV, 31%. That was pretty impressive.

I'm wondering, how should we expect the growth rate going forward?.

So, we have to remind the audience that during the start, we're seeing a very lumpy quarter out of CTS. The prior year, in 2015, there was very low sales in Q3. So, we have to be careful with the comparison. But we had a good quarter.

We do not expect to make up for the weakness in sales out of CTS that we have seen in the first half of the year, but we have a good ramp going forward as we're looking at Q4 and getting into 2017..

And my second question is about the Engineered Paper segment operating margin improvement of 150 basis points year over year, was that mostly due to the volume pickup of RTL or because of cost reduction?.

It's a combination of many factors. If we think specifically about Q3, RTL's strong volume was a big driver.

If I look at the year to date numbers, which is probably more meaningful, when we take a big picture, it's really the combination of solid revenue from LIP and recon and very strong execution, cost control of the plants, and we have designed, the performance we can achieve when we have the right balance in terms of capacity utilization across our paper mills..

And my next question is about AMS, the DelStar platform, do you have any updated end market movements?.

Could you, what do you mean, the DelStar, do you mean the AMS platform?.

Yes, in AMS, the DelStar platform, let say, business, did you see. .

What do you mean by market movements?.

Is there a specific end market, customers experienced weakness and lowered the demand?.

Yes, I think if we take into the third quarter with this air filtration product launch last year, that was did not repeat. I think the puts and takes is that we have a stability in our revenue from DelStar and what we are signaling is that the OR water filtration is a little softer than the first half, which was solid.

But on the other hand, we are seeing a recovery in other liquid filtration tied partially tied to oil, gas and construction, which was really the main headwind in 2015. And we are very encouraged by the rebound that we see in activity in that important, in particle sector.

So, all in all, it's a the view is that we are in a position within DelStar to look at some level of organic growth going forward. But clearly, when you think about AMS, we are already growing organically, if we put together DelStar and Argotec..

And my last question is about Argotec, do you have any updated outlook for the business and when do you see more cross selling opportunities happen in the future? How do you think of the synergies?.

So, the outlook for the markets served by Argotec are solid. We are growing our participation overseas in a very nice way, and that's one of the -- leveraging one of the capabilities that we bring to a business like Argotec.

So, I'm very optimistic when I look at those opportunities going forward, both in the U.S., solid trends if you want in terms of the market segments we're in, and our ability to boost overseas sales. In terms of cross-selling, as we have mentioned in the past, there's two areas of opportunities.

Probably the largest one is on the medical side, and we are making good progress there, combining our coverage and also expanding our product offering to the historical DelStar medical accounts. And the other one is wind turbine blades where we have commercial synergies, which we also are pursuing and that would be an upside going forward..

[Operator Instructions] And our next question comes from the line of Dan Jacome from Sidoti & Company. Your line is now open..

Just a couple of quick ones. First on the AMS, how much room do you have left to further rationalize the SKU? I know you mentioned you're kind of like in the middle innings of your strategy.

Does that also apply to where you stand on a SKU reduction of lower margin products, et cetera? Can you just remind us on that?.

Sure. In terms of pruning revenue with a focus on improving profit margins and also putting our investment dollars in launching higher value products, I would say we are just at the beginning, and so the runway is pretty important, which is why I'm very pleased with the expansion that we have seen year-to-date in AMS of the profit margins.

I think we can continue to do that through a combination of new product introduction, product SKU rationalization, but also manufacturing improvements, and in some cases, optimization of our footprint..

And then is there any update -- I know you mentioned LIP litigation, any color you could provide there? And then lastly, maybe you're seeing any change in the valuation of the M&A landscape?.

So, nothing to report as it relates to LIP litigation. We continue to spend some money, which is part of the pickup in the unallocated corporate expenses. But we still see that as a prudent use of time and resources in support to our strategy of maintaining and gaining share in this very profitable market segment.

As it relates to M&A, we have said in the previous quarters that our focus this year is the integration of Argotec. We have made good progress there. It's on building the AMS platform, so very scalable. We have made some progress, but long runway there.

But in tire, we continue to actively look at opportunities, but we will be patient and disciplined as we have been over the three plus years..

[Operator Instructions] And I'm not showing any further questions at this time. I would like to turn the call back to Mr. Frederic Villoutreix for any further remarks..

Thank you, Ronya, and thank you all for attending the call. We certainly appreciate your interest in SWM. Allison, Mark and I will be our offices today, and if you have any follow up questions, please give us a call. Have a nice day..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day..