Q2 2008 Earnings Call Transcript

Published: 11 Sep 2008

[Operator:]

Welcome everyone to the Schweitzer-Mauduit International second quarter earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to Peter Thompson, Chief Financial Officer.

[Peter J. Thompson:]

I’m Peter Thompson, Chief Financial Officer of Schweitzer-Mauduit International. With me is Mark Spears, our Corporate Controller. Thank you for joining us for a review of our second quarter 2008 financial results which were filed with the United States Securities and Exchange Commission on Form 10Q yesterday evening. I will be leading our conference call today. Various comments or remarks that we may make during today’s conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from the results suggested by these statements for a number of reasons. Such factors are discussed in more detail in the company’s Securities and Exchange Commission report, including the company’s 2007 annual report. Certain financial measures that will be discussed during this call exclude restructuring expenses. Financial measures which exclude this item have not been determined in accordance with accounting principles generally accepted in the United States and are therefore non-GAAP financial measures. I will now review the highlights of the second quarter of 2008 before providing additional discussion of key factors impacting our results. Second quarter 2008 net income totaled $2 million compared with net income of $1 million during the second quarter of 2007. Diluted earnings per share were $0.13 compared with $0.06 in the prior year quarter. Restructuring expenses including amounts associated with the recently announced exit of the Coated Papers Business in Brazil decreased earnings per share during the second quarters of 2008 and 2007 by $0.15 and $0.14 respectively. Excluding restructuring expenses earnings per share of $0.28 for the second quarter of 2008 increased 40% from $0.20 for the second quarter of 2007. Net sales were $202 million during the second quarter of 2008, a 17.6% increase over the prior year quarter. Approximately 50% of the increase or $15.1 million was due to favorable foreign currency exchange rate impacts while the balance was due to an improved mix of products sold and increased sales volume. Operating profit was $4.8 million during the second quarter of 2008 versus $6 million in the prior year quarter. Excluding pre-tax restructuring expenses, operating profit was $8.5 million during the second quarter of 2008 compared with $9.4 million during the second quarter of 2007, a 9.6% decline. The lower operating profit was primarily due to $9 million from inflationary cost increases, especially energy, $3.9 million from start up costs related to the rebuild of a paper machine at our largest French paper mill, PdM, and $1.8 million from unfavorable fixed cost absorption. Partially offsetting these negative factors were higher average selling prices including an improved mix of products sold of $7.6 million, increased sales volume of $3.7 million and lower non-manufacturing expenses. Excluding restructuring expenses from each unit’s second quarter 2008 results, the comparison to prior year quarter results follow

[Operator:]

(Operator Instructions) Your first question comes from Jonathan Lichter – Sidoti & Company, LLC.

[Jonathan Lichter:]

The French paper machine, you mentioned that there’ll be additional downtime but would the comparison be favorable relative to Q2 in Q3 and Q4?

[Peter J. Thompson:]

We would home it would be favorable in Q3 and 4 sequentially as though every quarter getting better. At this point, with the progress that we’ve made so far the remaining issues that are [inaudible] are going to be tougher and tougher to get because we’ve gotten all the low hanging fruit in terms of improvement. So the rate of improvement we saw in the second quarter versus first is probably going to be greater than the rate of improvement we’ll see in third versus second and fourth versus third. So at this point we do expect improvement but it is somewhat with reservation as to how quickly we will be able to get fully through our expectation. My hope and expectation is though that where we are right now in operation, we are not going to be reporting much, if any, of a negative financial impact year-over-year. In other words, we’re back to essentially pre-rebuild levels of productivity.

[Jonathan Lichter:]

So in the second quarter I guess you mentioned or in the release it’s $3.9 million so in the third and fourth quarters it should be closer to break even?

[Peter J. Thompson:]

Yes, yes as that $2.9 million would be reflecting a year-over-year comparison so it would be closer to break even but again, I’m going to give a caveat that that’s our expectation, our best case. I think the reality is we’ll probably fall short and still report some negative impact. What’s very hard to predict about that is how much downtime are we going to need during our troubleshooting process where we make incremental improvements, try them out. Some are successful; some are not. And when they’re not successful results and unproductive period, which you recover then when we go back to making normal, sellable grade paper but you’re still cumulatively not at the same levels of operation as you were historically. So it’s very difficult to predict what success we’ll have with improvement when by their definition their efforts make improvements that you don’t really until you’ve empirically demonstrated they can be achieved. So right now we’re saying sequential improvement but I would not expect third quarter versus second or year-over-year to be zero in the third quarter.

[Jonathan Lichter:]

Moving to Brazil, shouldn’t the losses there sequentially shrink as we move ahead as well?

[Peter J. Thompson:]

They should especially given now that in the third quarter, right at the start of it, we’ve excited the Coated Papers Business. The real driver of going forward earnings improvement is going to be the success that we have in realizing price increases and the pace at which we transfer base tipping volume and those are expected to begin and ramp up in the second half of this year. But the pace of selling price increases probably isn’t going to reach a full peak until the first of the year when some of the major accounts have adjusters that come into play, which would be positive for pricing. So there should be some improvement but probably not a marked improvement in the third and fourth quarter. The more marked improvement should come in the first quarter.

[Jonathan Lichter:]

And what do you expect out of China? Would the losses, the $600,000 this quarter, will it be similar in the third and fourth quarters?

[Peter J. Thompson:]

Yes, I would say the same or slightly better. It depends on the same thing there, the rate of, of PdM, the rate of the qualification of the customers and then how fast we can start selling paper and filling orders which will kick in the revenue side and would pretty quickly make a positive effort or positive contribution to results. Right now that qualification effort with customers is proceeding very well. Operationally, we’re having a good startup for our Greenfield operation. So it’s really down now to completing the customer qualifications and then starting initiating the sales process. So I would say it would be unlikely that we would be much worse than what we saw in the second quarter and the opportunity would be to improve from there. And then of course full year 2009 we still expect to have profitable operations for the full year.

[Jonathan Lichter:]

Lastly, energy, is there any reason to think that it’ll be worse in Q3 relative to Q2 when it was negative by $4.8 million?

[Peter J. Thompson:]

Right. No, I would not expect so. With watching, knowing what our energy contracts are doing and what spot rates have done which even if we have contracts in place there’s still always some spot purchases, it doesn’t look the rate of increases in energy costs are going to be at the same pace as they were in the second quarter. And historically, the third quarter coming into the fall is one of the more benign rate periods for energy. The winter months can be the more severe. So it looks pretty good that the third quarter be no worse than the second quarter but probably not an improvement on the second quarter.

[Operator:]

Your next question comes from Ann H. Gurkin – Davenport & Company LLC.

[Ann H. Gurkin:]

Wanted to start with, I guess with the comments you made in the 10Q about price increases of 20% in North, Central and South America. Can you break out where you got that pricing, where the bulk of that pricing came and which region?

[Peter J. Thompson:]

That would be primarily with independent accounts, so non-majors and the up to 20% would be the peak. The average would be, of this most recent round, would be more in the range between 10% and 20% and it would have been equally applied across all of the markets served by Brazil. So with cigarette paper coming to the North American market, all of the products

[Ann H. Gurkin:]

Is there a potential for additional price increases previously successful in negotiating additional price increases in the second half with other major accounts or independent accounts?

[Peter J. Thompson:]

Yes, that would be the intent is that we would see continuing negotiation efforts, not just for Brazil but globally with Brazil still being the most aggressive. And those would be with multi-nationals especially as any contracts would come up late this year. Then the effectiveness of those increases would be more towards the first quarter as I’ve just mentioned in the previous answers to the Brazil situation. We would expect to see probably our most marked increase in selling prices come in the first quarter of 2009. That’s when some of the multi-national accounts either would have new pricing become effective through automatic adjusters or through successful negotiations.

[Ann H. Gurkin:]

With the restructuring you’ve announced to Brazil and with the pricing you’ve gotten so far, can that business turn profitable in 2009?

[Peter J. Thompson:]

Yes, that’s our projection; that’s our expectation is that –

[Ann H. Gurkin:]

For the first half of 09?

[Peter J. Thompson:]

Yes. Starting really in the first quarter. The three key drivers are the exit of Coated Paper, the action to move a tipping paper production to Brazil from both the U.S. and from France and then price increases. See, the real caveat of course is what happens continuing with currency but our pricing actions do include lessening our exposure to the dollar and we’ve been pretty successful with that. But some of those three with base tipping paper transfers still continuing into 2009 won’t be done on January 1 but it’ll be largely in place is our expectation. We would expect that we’ll come out of the blocks in 2009 near break even or profitable and generate a modest profit for the full year.

[Ann H. Gurkin:]

Switching to RTL, with a strong double digit growth, is there any risk to an inventory build with various customers and that we might see a slowdown in the back half of that business?

[Peter J. Thompson:]

No, that’s not our expectation. We’re actually holding the line on inventories right now. We have a tough time building much of an inventory level at the present. So no, I don’t think that will be any type of an issue.

[Ann H. Gurkin:]

Okay. And then, I’m sorry, going back to the plant downtime in France. Excluding the PdM line, are you taking downtime in your other lines in the fourth quarter like you normally do?

[Peter J. Thompson:]

It would not be of any great extent. It would only be for normal holiday downs. There is, at this point, no significant inventory correction downs that we’re expecting really anywhere.

[Ann H. Gurkin:]

So that’s an improvement from last year?

[Peter J. Thompson:]

Yeah, now, as you know, and following we typically do have a weaker December within the fourth quarter and therefore the fourth quarter, historically, the last two have been bad. Prior to that, we’ve had fourth quarter some time be pretty good. But specific to an inventory correction or a planned machine downtime, at this point we do not expect anything significant.

[Ann H. Gurkin:]

Can we get an update on negotiations with Phillip Morris USA regarding their cigarette paper business? Where do we stand with that?

[Peter J. Thompson:]

Well, on cigarette paper and once the SSA ends, which is the end of this year, in 2009 with the significant move towards LIP which is covered under a surviving agreement of course that has commercial terms already spelled out, there is really not much of a conventional cigarette paper negotiation left to have. So we haven’t had any specific conclusions or even really definitive negotiations with PM USA on conventional cigarette paper pricing or sourcing. I would again expect that that will become, if not the top priority because the volume is lessening and that will become more of a likely one-year agreement or even a purchase order type business and of course, we would be seeking to have price increases as we consistently are doing elsewhere in the world. But nothing specific has been negotiated but again I emphasize the cigarette paper negotiations for conventional product are the small tip of the iceberg because the majority of the papers starting in 09 will be LIP paper.

[Ann H. Gurkin:]

Going back to energy, is there a potential that energy costs if they continue down like they seem, you could get slight benefit in the fourth quarter or less of an impact?

[Peter J. Thompson:]

Less of an impact; I think flattening out. It would take a pretty parked change to see any type of a benefit. Now, we did start to see the real ramp up in energy in the fourth quarter of last year so I guess there’s the possibility that year-over-year it could be somewhat favorable but generally I think the best we could expect is a flatter inflationary environment; not as severe as the last three quarters in a row but I would not expect it to be swinging positive.

[Operator:]

Your last question comes from Thomas Rousseau – Gardner, Rousseau, and Gardner.

[Thomas Rousseau:]

A couple of questions. Is there anything going forward that you envision will substantially add to the RTL volumes in France over the course of the next 12 to 18 months?

[Peter J. Thompson:]

I think the biggest thing that will continue to benefit RTL’s lines is the move of cigarette production from PM USA to PMI and we continue to realize increased volume as a result of that production. And that’s a significant part of the increase in RTL volumes and that transition is not fully in place yet. The other –

[Thomas Rousseau:]

How much have we picked up so far and what’s your [inaudible]?

[Peter J. Thompson:]

Right now, because it’s a process in movement, I would say that we’re probably over halfway done on a pace that we’re in the second quarter, the rate of sales volume would be to what we would expect it to fully be is probably three quarters of the way there. So we’d expect some more growth. That’s why we can say here halfway through the year we expect well above 10% full year growth in volume. Then going forward, I think RTL growth in 2009 will be more flattish. We’ll see back to single digit growth, not the more rapid rate of growth we’ve seen over the last, not it’ll be coming up on two years.

[Thomas Rousseau:]

As to the ramp up in China, does the fact that all three has commenced production of Marlboro to their joint venture with the CPC in China already start to have an impact? As they ramp it up, how will that affect your business there?

[Peter J. Thompson:]

That’s not expected to be a specific source of key volume growth. The key volume growth for the cigarette paper joint venture will really be general sales to targeted cigarette account that are domestic in China. So that would not be expected to have positive but not expected to have a key impact on our CTM sales outlook.

[Thomas Rousseau:]

Just to highlight what’s developing, if anything material, at Philippines or Indonesia.

[Peter J. Thompson:]

The biggest thing that’s happening with the Philippines and Indonesia and financially those results are included in our French segment so it’s hard to see them specifically. Indonesia’s apparently a stable operation; we’re pleased with the margins we have there. We haven’t seen great volume growth but that’s more reflecting what’s happening within the Indonesian market. The Philippine operation we’ve been very, very pleased with. We’ve had a significant improvement in operational performance. We’re very happy with the improvements in profitability that we’ve seen and we’re pretty optimistic about what our growth prospects can be out of the Philippines.

[Thomas Rousseau:]

And is there any reason why those are going to be gapping up or non-linear in terms of their development? Anything sort of step change that will affect either one meaningfully?

[Peter J. Thompson:]

At this point, no. The biggest thing that would be a step change in the Asian region outside of China would be if we would be successful in either adding capacity because of increased market demand or an opportunity to significantly increase our share at any of the multi-nationals present in Southeast Asia or the addition of new lines of business. But at this point, there’s nothing specific that would be on the horizon.

[Thomas Rousseau:]

And so to increase your involvement with the multi-nationals would in turn then lead to the increase in capacity, to serve them?

[Peter J. Thompson:]

Yes, that’s right.

[Operator:]

And at this time there are no further questions.

[Peter J. Thompson:]

Alright. Well, thank you and if there are no more questions thank you for your time and joining us today. Goodbye.