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Glatfelter (GLT -1.02%)
Q2 2022 Earnings Call
Aug 02, 2022, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day, and welcome to the Glatfelter's quarterly earnings release conference call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Ramesh, your speaker for today.

Please go ahead, sir.

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Thank you, Fergus. Good morning, and welcome to Glatfelter's 2022 second quarter earnings conference call. This is Ramesh Shettigar, senior vice president, CFO, and corporate treasurer. On the call to present our second quarter results is Dante Parrini, Glatfelter's chairman and CEO; and myself.

Before we begin our presentation, I have a few standard reminders. During our call this morning, we will use the term adjusted earnings, as well as other non-GAAP financial measures. A reconciliation of these financial measures to our GAAP-based results is included in today's earnings release and in the investor slides. We will also make forward-looking statements today that are subject to risks and uncertainties.

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Our 2021 Form 10-K filed with the SEC and today's release, both of which are available on our website, disclose factors that could cause our actual results to differ materially from these forward-looking statements. These statements speak only as of today, and we undertake no obligation to update them. I will now turn the call over to Dante.

Dante Parrini -- Chairman and Chief Executive Officer

Thank you, Ramesh. Good morning, and thank you for joining us today. In the second quarter, Glatfelter reported adjusted EBITDA of $27.2 million, which exceeded our expectations at the enterprise level. Our results were driven by strong performances in our airlaid materials and composite fibers segments and were partly offset by weaker-than-expected earnings in our recently acquired Spunlace segment.

Despite the ongoing challenges of raw material inflation, rising energy prices and supply chain disruptions, we made important progress in closing the cost price gap. As we headed into Q2, we were focused on a short list of imperatives, critical to improving overall performance and delivering the quarter, which included actions to migrate more composite fibers customers to a cost pass-through mechanism to offset raw material and energy inflation, achieve meaningful progress in the integration and financial performance in our new Spunlace segment and execute a complex capital project in the airlaid segment designed to improve quality and increase throughput. As reflected in our second quarter results, we made visible and meaningful progress against these initiatives in airlaid materials and composite fibers, but candidly fell quite short in Spunlace. In composite fibers, we've now converted 50% of our revenue base to a dynamic cost pass-through mechanism well ahead of our year-end goal.

This important initiative, combined with other pricing actions and energy surcharges enabled this segment to make significant progress toward mitigating the impacts of continuing inflation. On the airlaid materials side, we fully offset incremental inflation for the quarter due to the effectiveness of our existing cost pass-through mechanisms and energy surcharges. A favorable product mix was generated by higher shipments of colored tabletop and hygiene products. And we executed the planned capital project in Falkenhagen, ahead of schedule and below budget.

In Spunlace, even though we made important progress on the integration cost reduction efforts, the segment was not able to return to profitability, which was our expectation for the quarter. This shortfall was largely due to escalating raw material and energy inflation that far outpaced our pricing actions and lower volume driven by supply chain disruptions and some labor constraints at one of our U.S. sites, thereby limiting production and shipments. During my closing remarks, I will speak more to the additional actions being taken to improve the Spunlace segment.

Now I'll turn the call over to Ramesh to provide more details on our second quarter results. Ramesh?

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Thank you, Dante. Second quarter adjusted earnings from continuing operations was a loss of $1.6 million or $0.04 per share, a decrease of $0.22 versus the period last year. This decline was mainly driven by lower wallcover volumes and downtime in Dresden due to sanctions, severe energy inflation and elevated interest expense from the bond issuance to finance the Spunlace and Mount Holly acquisitions. Slide 4 shows a bridge of adjusted EPS of $0.18 from the second quarter of last year to a loss of $0.04 in the second quarter of this year.

Composite fibers results lowered earnings by $0.08 primarily from reduced wallcover shipments and a direct result of the Russia-Ukraine conflict and requiring us to take market-related downtime. airlaid materials results increased earnings by $0.05, primarily due to strong volume recovery in the tabletop and wipes categories, plus from the inclusion of a full quarter of Mount Holly results compared to a partial quarter last year. Spunlace's results lowered earnings by $0.03, mainly driven by lower volume and unfavorable mix, coupled with higher-than-anticipated raw material and energy costs, which far exceeded recovery through customer price increases. Corporate costs were $0.02 unfavorable driven by relatively higher spending in travel versus last year during the pandemic.

Interest expense lowered earnings by $0.09 due to the issuance of a new bond to finance two acquisitions and taxes and other items were $0.05 unfavorable due to significant changes in international pre-tax income, U.S. pre-tax losses and the absence of U.S. tax benefits on interest expense due to our valuation allowance. Slide 5 shows a summary of second quarter results for the composite fibers segment.

Total revenues were 4% lower on a constant currency basis, mainly due to shipments being down 30% compared to the same period last year. Wallcover accounted for approximately 80% of this decline as this category was significantly impacted by EU sanctions. The impact of lower shipments and market-related downtime primarily in our Dresden facility was approximately $6.4 million, which exceeded the $5.3 million decline in operating profit for the entire segment. Selling prices were higher by $14.4 million as a result of multiple pricing actions and energy surcharges taken in 2021 and 2022 to offset inflationary pressures.

Prices of energy, key raw materials, and freight negatively impacted results by $16.9 million versus the same quarter last year. Foreign exchange was favorable $3.6 million, mainly driven by the weakening of the British pound and currency hedging gains. To counteract the impact of inflation, we have been actively working with our customers to migrate our commercial relationships to a dynamic pricing model via cost pass-through arrangements. For our customers who are not on cost pass-through contracts, we have initiated pricing actions and energy surcharges on a frequent basis with the ultimate goal to recoup inflation and return the segment back to pre-pandemic margin levels.

We expect input costs, particularly European energy prices to be elevated and highly volatile in the near term driven by the high dependence of European markets on Russian gas. We will be taking every effort to minimize our energy consumption and execute energy efficiency projects and continue to implement surcharges as needed with minimal lag. Looking ahead to the third quarter of 2022, we expect selling prices to continue to increase and generally offset raw material and energy inflation. Volume is projected to be 5% higher and favorably impact results by $1 million, and operations are expected to be $1 million unfavorable due to lower production.

Overall, operating profit in Q3 for this segment is expected to be in line with Q2. Slide 6 shows a summary of second quarter results for airlaid materials. Revenues were up 48% on a constant currency basis versus the same prior-year period, supported by the addition of Mount Holly. Shipments of wipes increased 50%, while tabletop category grew by 32% driven by strong post-pandemic recovery.

Selling prices increased meaningfully from contractual cost pass-throughs, as well as ad hoc price increases, initiated for customers without such arrangements. We also implemented energy surcharges for our customers served from Europe to specifically offset the sharp rise in energy costs. Such actions have successfully allowed us to mitigate inflation, favorably impacting results by approximately $1 million on a net basis. Operations were slightly favorable by $300,000 compared to the prior-year period, driven by higher production across nearly all product categories.

This from post-pandemic recovery was mostly offset by higher general inflation. Foreign exchange was unfavorable by $1.6 million, mainly due to the weakening of the euro. For the third quarter of 2022, we expect a continuation of higher selling prices given the effective cost pass-through mechanisms we have in place in this segment to offset inflation and volume is expected to be 5% higher. When combined with increased production, operating profit is expected to improve by $1.5 million.

Slide 7 shows a summary of second quarter results for the Spunlace segment. Revenues for this segment was approximately $97 million, while shipments were 7% lower than the prior quarter and below our expectations. The decline in volume was mainly driven by supply chain disruptions affecting raw material availability, a labor shortage at one of our U.S. sites and the resulting machine downtime impacting profit by approximately $900,000.

Selling prices and energy surcharges favorably impacted results by $3.6 million versus the previous quarter, but were more than offset by raw material inflation, particularly fiber purchases, totaling $5.4 million. Input costs rose higher than anticipated, driven by a sharp move in oil prices in the second quarter, which impacted certain petroleum-based feedstock thereby far outpacing our price increases to customers. Operations, FX, and other items were a net $2.5 million favorable, mainly driven by integration cost reduction efforts. For the third quarter of 2022, we expect higher selling prices to partially offset raw material and energy inflation, resulting in a net unfavorable price-cost gap of $3 million.

Volume and mix are expected to be slightly favorable versus Q2, and we expect operations to be favorable by $1 million. In aggregate, we project Spunlace to have a $2.5 million operating loss for the quarter. Slide 8 shows corporate costs and other financial items. Year to date, corporate costs were slightly higher by $300,000 versus the same period last year, mainly due to higher overall inflation.

For the full year, corporate costs are estimated to be approximately $24 million or $1 million lower than our previous guidance. We expect full year interest and other financing costs to be approximately $35 million or $1 million higher than our previous guidance. Our Q2 tax rate on adjusted earnings continues to be unusually high as a result of applying the marginal tax rate to earnings in certain jurisdictions without the corresponding tax benefit in the U.S. due to our valuation allowance position.

Slide 9 shows our cash flow summary. On a year-to-date basis, our 2022 adjusted free cash flow was lower by approximately $90 million versus the same period last year, mainly driven by a higher working capital usage of $51 million, and lower cash earnings and higher capital expenditures also contributed to the shortfall. Higher working capital was due to multiple factors, including previous -- including the previous termination of our U.S. Spunlace factoring program, elevated accounts receivables due to price increases and higher inventory values reflecting inflation in raw materials and energy.

Cash interest was $13 million higher, driven by acquisition financing and higher interest rates. Cash taxes were about $8 million higher, driven by Canadian income taxes, withholding taxes on Canadian dividends and one-time taxes related to the Spunlace integration. We expect capital expenditures for 2022, including Spunlace and Mount Holly to be between $45 million and $50 million, $5 million to $6 million of which pertains to Spunlace systems integration costs. Depreciation and amortization expense is projected to be approximately $68 million, in line with our previous guidance.

Slide 10 shows some balance sheet and liquidity metrics. Our bank covenant leverage ratio increased to 5.3 times as of June 30 versus 4.8 times as of March 31 due to lower trailing 12-month earnings in the calculation. Our available liquidity at the end of Q2 was approximately $200 million, and our near-term focus continues to be on earnings growth, cash flow generation and delevering of the balance sheet. This concludes my prepared remarks.

I will now turn the call back to Dante.

Dante Parrini -- Chairman and Chief Executive Officer

As you just heard from Ramesh, our Q3 earnings expectation is to generate approximately $27 million of EBITDA despite the continued headwinds facing our business. Our top imperative remains improving Spunlace's profitability given the importance of this segment to our near-term results and long-term strategy. We recently implemented aggressive cost actions and made additional key personnel changes to further rightsize the legacy [inaudible] leadership team and more deeply integrate this segment into our existing operating model. The synergy actions being taken on SG&A are projected to deliver roughly $10 million of annualized savings as we exit 2022.

In addition to the pricing actions enacted during the first half of the year, we are actively working to expand dynamic pricing concepts to the Spunlace customer base, which is being led by the same commercial leadership team that successfully converted our composite fibers customers. We'll also focus on minimizing the lag in existing cost pass-through contracts to match the timing of escalating input costs more closely. We're encouraged by the progress we're making in our legacy composite fibers and airlaid materials segments, especially with pricing actions and moving more customers to dynamic pricing. These initiatives will be critical to continue in our ongoing efforts to combat ongoing inflation and energy prices, while achieving EBITDA and cash flow growth.

Furthermore, we will continue to aggressively execute cost control projects across the company until we restore margins to more normalized levels. At the same time, we see opportunities to further leverage our expertise in plant-based engineered materials to advance our sustainability goals. This includes projects such as compostable tabletop materials, plant-based wipes, and the exciting introduction of a new-to-the-world fiber-based screw cap being developed for Absolut Vodka by our joint venture partner, Blue Ocean Closures that is planned to hit the market in 2023. Finally, as we navigate this ongoing period of unprecedented market and geopolitical turbulence, we remain confident that the company's reshaped portfolio of engineered materials used to produce essential consumer staples will successfully deliver strong growth and more stable profitability over the long term.

This concludes my remarks. I'll now open the call for questions, and just want to inform our participants that our conference call operator also recently went through an acquisition and may be experiencing some post-merger integration challenges themselves. So if you can't get through, please follow up directly with Ramesh after our call. Thank you for your understanding.

Questions & Answers:


Operator

[Operator instructions]

Mark Wilde -- BMO Capital Markets -- Analyst

Dante?

Dante Parrini -- Chairman and Chief Executive Officer

Good morning, Mark.

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Hi, Mark.

Mark Wilde -- BMO Capital Markets -- Analyst

Hey, how are you? They are having a few bugs. Could we start off by just talking about the energy situation around your European operations and also how you're thinking about the potential of some energy rationing this winter?

Dante Parrini -- Chairman and Chief Executive Officer

Yes. So as you may know, we have 16 manufacturing sites around the world and 10 of them are located in Europe, five of those are in Germany. So in all of composite fibers manufacturing assets are in Europe. And the composite fibers manufacturing processes are most energy-intensive when compared to airlaid and Spunlace.

So we are very actively monitoring the situation. We are active in scenario planning in the event that there could be some curtailments of energy availability. And we're testing that hypothesis at a range of curtailment levels. And we will be ready if this situation presents itself.

And obviously, if the curtailments are at the lower end of the continuum, it's a lot easier for us to manage through creative planning and scheduling and leveraging our industry-leading asset bases. If it's a very large curtailment, then we will need to reflect on that and determine which assets run, which ones don't and how we might deal with customer demand.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. And then I wondered, Dante, when we think about the Spunlace business, it seems like there are some really unique, high-value relatively proprietary products there. Why wouldn't you have the ability to move price in line with costs or maybe even a little above cost?

Dante Parrini -- Chairman and Chief Executive Officer

I think we do. We just haven't executed to our full potential yet, Mark. So if I look at our business, the Spunlace segment has a larger number of customers and they're more dispersed around the globe in terms of what constitutes the majority of the customer base. So there are many more discussions and negotiations.

And not to be overly critical of the legacy management team because we own the business, so it's a Glatfelter, and we own the results and the performance. But the internal systems, the prioritization of how work got done, the sense of urgency around addressing short-term volatility in the business was very different in the legacy culture versus the GLT culture. And we saw that when we did our diligence, and that's why we identified $20 million of synergy opportunities because we felt that there would be opportunities to bring a different set of business tools, processes, and priorities to this business. We did get hit with a bit of a perfect storm, as you noted.

And so that will expose your flat spots and limitations. And so we could be criticized for giving the legacy team a little bit more time to prove themselves and to determine if they were willing and able to run the business the way we need it to be executed or not. And candidly, the results weren't there. So we've made changes.

We've taken out the legacy leadership team. We've put in all Glatfelter leaders, and we're taking the same people that successfully helped institutionalize pass-through pricing in composite fibers and have been working our model in airlaid very successfully for many years, and now we're putting them in place with the Spunlace team. And we've also brought in some new talent that has industry subject matter expertise from a financial perspective that can help us do deep analytics and modeling more effectively. So our expectation is that during the third quarter we'll bottom this out, we'll get much more connectedness with the visibility around the data, the movement in the oil-based feedstock prices.

So oil spiking also had an impact on the synthetic fibers and Spunlace has more exposure to synthetic fibers than our other legacy segments. So I fully expect us to get much better at pricing than we've demonstrated to date, and it can't happen soon enough. But we will find a way to get it done, and we will act as industry leaders no different than we do in our other two segments. It's just taking a little bit longer than we had anticipated or that we would prefer quite candidly.

But we've been through this before, and we know how to do the work.

Mark Wilde -- BMO Capital Markets -- Analyst

So it sounds like Chris is going to be pretty busy.

Dante Parrini -- Chairman and Chief Executive Officer

Yes. And his leadership team. So we have people like Patricia Sargeant, who have done a great job with our composite fibers; and Phil Reese, who's an industry veteran. He's done a great job with our airlaid segment.

Dustin Heslep, our financial analyst who we just brought on, who had great experience with Georgia-Pacific. So we're putting the right resources and people focusing on the most important issue.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. Then Dante, just turning to Russia for a second. Were there any significant Russian sales in the second quarter that are going to be falling away in the third quarter? Or will it be essentially flat at a nonexistent level sort of second quarter going into third quarter?

Dante Parrini -- Chairman and Chief Executive Officer

Yes. Not much. So if you recall, 2021 sales to Russia were just below $100 million at the enterprise level. Q2 revenue was about $7 million for Russia.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. And then a number of questions for Ramesh on the financial side. Ramesh, can you just help us a little bit in terms of where you expect your debt levels to be on a covenant basis when we hit year-end '22.

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Yes, Mark. First of all, we don't project out -- in terms of guidance, we don't guide to do anything past Q3, right? But I think it is suffice to say that as we continue to make progress on the initiatives Dante was talking about, we expect not just EBITDA improvement, but we expect cash flow improvement as well, which will allow us to bring the leverage down from where we are today. This is something that is a continued work in progress. The covenant amendment that we got gives us the ability to operate with a lot more flexibility than we had before.

But we're not right now guiding to where leverage will be at the end of Q4. But we expect these initiatives to add value in terms of earnings growth, cash flow generation and then continuing our delevering effort, Mark.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. And understanding you don't forecast beyond sort of one quarter out, is it possible to help us a little bit in thinking about cash flow and working capital in the second half versus the first half? Because you did have a number of kind of one-timers that really reduced cash flow in the first half, which should mitigate in the second half.

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Yes, absolutely. So in the first half, really, it was a big -- the big chunk was the use of working capital primarily on the accounts receivable side, right? So we are aggressively going after collection of any past dues. We are -- we will see the unwind of that working capital come through here in the second half of the year. We are continuing to keep a tight lid on travel and entertainment and any just general corporate spending.

We are also going to be actively focused on capex. And just broad initiatives across the company to watch cash wherever we can. So it will be a series of factors, including working capital, capex, our interest costs, we're being very thoughtful about that as well in terms of balancing where we keep the debt in the revolver, whether if it's in the U.S. or in Europe, depending on the interest rate arbitrage and so on.

So we've got multiple levers that we can pull to try and improve the cash flow position here in the second half of the year.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. And is it possible also to just give us some sense of the maturities on the bank term loans, Ramesh?

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Yes, yes. Absolutely. So we have our euro-denominated term loan that comes due in February of 2024. That is really our next biggest slug of debt maturity, Mark.

And then we've got our revolver, which goes out to September of 2026. But that is a revolver, as you can imagine, right? So we are paying down borrowing as we need to, but there are no mandatory prepayments or repayments of the revolver debt. What we do have is also some amortization of some euro-denominated term loans that we have taken over the years in Europe, but those are nominal. So the main one, I would say, is the euro term loan that comes due in February of '24.

And that's about $180 million or so.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. All right. And then just exposure to increasing interest rates in your debt stack?

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Yes. We've modeled that already in the guidance that we're giving for interest and financing costs, Mark. So we don't expect it to go up from there. Again, we've contemplated any Fed hikes that may be coming down the pipe here.

But for now, we feel pretty good about the $35 million that we've guided to for 2022.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. All right. And then just the last question, going back to Dante. Dante, can you talk about any impact from retailer and manufacturer destocking that you're feeling in your portfolio?

Dante Parrini -- Chairman and Chief Executive Officer

Yes. So I would say that we are not seeing any material signs of demand destruction coming from either inflation or destocking. So the areas where we fell short on volume in Q2 and potentially in Q3 are more closely correlated to some of the supply chain dislocations and a few of our sites that have some labor shortages, which will create bottlenecks either on a manufacturing line or in a converting line. So I mean, it's reasonable to believe that as banks around the world raise interest rates to destroy demand and take some of the gas out of their respective economies that some demand will be destroyed.

But I point to the rebuild portfolio of products that we have now, which 90% of everything we produce goes into an essential consumer staple. These products in large part are going into hygiene applications, wiping materials, food packaging. And so these are staples that people tend to use through the cycle. You may also -- we'll see consumers start to make trade-off decisions between premium brands and either store brands or private labels.

We supply both channels. So I think we have some level of insulation around those dynamics. And then you'll also see customers asking us to help them mitigate inflation through down-gauging. And this is where, again, our leading asset bases across all three of our segments give us, I think, the best competitive opportunity to come up with innovative and cost-effective solutions to provide our customers what they need to supply consumers without us having any impacts on our wallet share or overall market shares.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. And just one final question. You mentioned that you had one facility that was out in the second quarter in the U.S. because of labor shortages.

And I wondered, if you could just help us with that, if that's mitigated at this point? My impression had been that kind of labor issues were starting to ease a little bit. So I was surprised to hear about that outage.

Dante Parrini -- Chairman and Chief Executive Officer

Yes. So it wasn't an outage. All of our facilities ran and operated. But in one Spunlace location, we have and still have -- we're not at full complement in terms of our converting operations.

So we can make the roll goods, but we can't necessarily fully convert everything that we could ship and invoice. So that was the bottleneck, and that was part of the shortfall in Spunlace. And then even in airlaid, which had a very good quarter, there's more upside opportunity there. And at Mount Holly, we're still focusing on getting full complement and getting them trained correctly so that our OEE and quality and throughput metrics are consistent with the rest of the portfolio.

So that one wasn't quite as obvious in our financial results because the segment did pretty well. But we have some spots where we're not at full complement, but we're not taking facilities down. We're not taking lines down for any meaningful periods of time, but it's suboptimizing our ability to ship and invoice.

Mark Wilde -- BMO Capital Markets -- Analyst

OK. I'll turn it over. Thanks, Dante.

Operator

That concludes today's question-and-answer session. Mr. Dante, at this time, I will turn the conference back to you for any additional or closing remarks.

Dante Parrini -- Chairman and Chief Executive Officer

OK. Well, once again, thank you for joining us today. Apologies for any of the technical difficulties on behalf of our provider here, and we look forward to speaking with you again after the third quarter. Have a good day.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Ramesh Shettigar -- Senior Vice President, Chief Financial Officer, and Corporate Treasurer

Dante Parrini -- Chairman and Chief Executive Officer

Mark Wilde -- BMO Capital Markets -- Analyst

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