Q3 2007 Earnings Call Transcript

Published: 27 Oct 2007

[Operator:]

Good morning. My name is Julianne and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Schweitzer-Mauduit Third Quarter Results Conference Call. All lines havebeen placed on mute to prevent any background noise. After the speaker'sremarks, there will be a question-and-answer session (Operator Instructions). Thank you. Mr. Thompson, you may begin your conference.

[Peter Thompson:]

Thank you, Julianne. Good morning. I'm Peter Thompson, ChiefFinancial Officer of Schweitzer-Mauduit International. With me are WayneGrunewald, our Corporate Controller, and several executive officers of thecompany. Thank you for joining us for review of our third quarter 2007financial results. I will be leading our conference call today. Various comments or remarks that we may make during today'sconference call constitute forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. Actual results may differmaterially from the results suggested by these statements for a number ofreasons. Such factors are discussed in more detail in the company's Securitiesand Exchange Commission reports including the company's 2006 annual report. Certain financial measures that will be discussed duringthis call exclude restructuring expenses. Financial measures, which excludethis item, have not been determined in accordance with accounting principlesgenerally accepted in the United States and are therefore non-GAAP financialmeasures. I will now review the highlights of the quarter and provideadditional discussion of key factors in passing our results. I will not repeatthe more detailed review of our third quarter financial results included in ourearnings press release issued this morning. The company realized a net loss during the third quarter asa result of restructuring expenses associated with the actions recentlyannounced in the United States, France, and Brazil. Excluding restructuring expenses, net income increasedduring the third quarter due to improved results for reconstituted tobacco leafproducts and lower ignition propensity related cigarette papers as well asagain realizing significant savings from cost reduction activities across ourbusiness. Net sales totaled $184.2 million, 14% above the prior-yearquarter due to increased sales volumes, higher average selling prices,primarily caused by an improved mix of products sold and from favorablecurrency impacts. Restructuring expenses totaling $18.2 million were recognizedduring the third quarter. These restructuring expenses reflect our three-partrestructuring plan in the United States, France and Brazil as announced on October1st, 2007, as well as activities initiated in 2006 at Papeteries de Mauduit orPdM facility in France. The company's gross profit margin which is not -- does notinclude restructuring expenses was 16.5% compared with 14.1% in the prior-yearquarter. The operating loss was $3 million compared with an operating loss of$2.8 million in the third quarter of 2006. Excluding restructuring expenses of $18.2 million and $12.4million recognized in the third quarters of 2007 and 2006 respectively,operating profit would have been $15.2 million for the third quarter of 2007,an increase of $5.6 million or 58% over the prior-year quarter. The diluted loss per share was $0.27 compared with a dilutedloss per share of $0.11 in the third quarter of 2006. Restructuring expenses of$0.73 per share and $0.52 per share were incurred during the third quarters of2007 and 2006 respectively. Excluding restructuring expenses from 2007 and 2006results, diluted earnings per share would have been $0.46 per share for the quarter,a 12% increase over the third quarter of 2006. The following comments provide additional explanation of keyfactors impacting our third quarter financial results. Sales volume increased5% during the quarter over the prior year, primarily due to gains in the Frenchsegment, totaling 11% that resulted from higher sales of reconstituted tobaccoleaf products. Sales volumes in Brazil and the United States decreased by7% and 1% respectively primarily reflecting reduced sales of commercial andindustrial papers. Improved mill operations and savings from cost reductionactivities across -- underway across the company significantly benefited thirdquarter results. During the third quarter, machine-operating schedulesincreased within the French reconstituted tobacco leaf operation, offsettingthe impact of reduced paper machine operating schedules and lower productionvolumes for tobacco-related and commercial and industrial papers, primarily inFrance and the United States. As a result, operating results were notmaterially impacted by changes in absorption of fixed costs during the thirdquarter. The primary source of inflationary cost increases during thethird quarter was from purchased wood pulp. The average list price of northernbleached softwood kraft pulp in the United States was $835 per metric tonduring the third quarter of 2007, an increase of 11% compared with the thirdquarter of 2006 and 3% compared with the second quarter of 2007. We expect pulpprices could rise between 5% and 10% before reaching a peak in 2008. Purchased energy costs were somewhat lower between the thirdquarters of 2007 and 2006. This is primarily due to lower electricity rates inFrance, resulting from the deregulation of electricity markets. Given therising price of crude oil, we anticipate higher energy costs into 2008 as werenew energy supply agreements. Inflationary cost increases and the unfavorable earningsimpact of machine downtime in the first three quarters of 2007 impacted ouroperating results by approximately $0.40 per share. During the first threequarters of 2006, these two items reduced our earnings by approximately $1 pershare. Non-manufacturing costs increased by $2.1 million or 16%versus the prior-year quarter, primarily due to higher employee compensation.Only minimal incentive compensation was incurred in 2006 due to lower overallfinancial performance whereas 2007 expenses reflect expectations for morenormal levels of incentive achievement. Non-manufacturing expenses were 8.3% ofnet sales in the third quarter, an increase from 8.1% in the prior-year period. The Euro and Brazilian real strengthened during the quartercompared to the third quarter of last year by 8.7% and 14.4% respectively.These stronger currencies benefited the quarterly net sales comparison by $6.5million. However, the stronger Brazilian real unfavorably impacted Brazilianbusiness unit operating profit by $1.1 million during the quarter and by $2.2million year-to-date. Total Brazilian unit operating profit excluding restructuringexpenses has declined $500,000 year-to-date versus 2006, as we have to offsetthe majority of the unfavorable currency impact with increased sales volumesand cost reductions. However, a continued weak, U.S. dollar perpetuatesunfavorable earnings implications upon our Brazilian operation, and we continueto evaluate options to mitigate these impacts. Net debt declined by $8 million during the third quarter,but remained essentially unchanged at $84 million versus December 31st, 2006.Our total debt-to-capital ratio stood at 21% at the end of September 2007, downfrom the end of June 2007 and December 2006. I will now cover cash flow items. Capital spending was $8.5million during the third quarter of 2007. Capital spending for therestructuring-related investments at PdM totaled $2.4 million during the thirdquarter and is expected to total $25 million upon completion, which will nowoccur in early 2008. Spending for the rebuild of a base tipping paper machine inBrazil totaled $600,000 during the third quarter and is expected to total $11million upon completion during the fourth quarter of 2007. In part, due to thelater completion of the PdM investment, capital spending for the full year of2007 will now likely be in the range of $45 million to $55 million. Our currentprojection for capital spending for 2008 is in the range of $25 million to $35million. The projected full-year cash requirements in 2007 forcapital projects, deferred software development spending, pensioncontributions, employee severance payments and joint venture equity paymentsnow total approximately $80 million to $90 million. These cash requirements areexpected to be funded primarily through internally generated cash flow. Cash provided by operations totaled $52.6 millionyear-to-date and $30.7 million for the third quarter of 2007. During the thirdquarter of 2007, changes in working capital increased cash provided byoperations by $21.3 million. Working capital decreases during the quarter inpart reflected increased restructuring-related liabilities. The company hasreduced working capital by approximately $40 million since the end of 2005. Earlier today, we announced a quarterly common stockdividend of $0.15 per share. The dividend will be payable on December 10th, 2007,to stockholders of record on November 12th, 2007. I will now conclude my comments with updates about ourbusiness strategies and outlook for the balance of this year and 2008. The fullscale of restructuring activities announced by the company are regrettable interms of the impact on the affected employees in the local communities in whichour mills have long operated. But these actions are necessary to restore a balance betweeneffective and profitable utilization of our paper making capacity and availabledemand. We are confident that these actions will not only improve earnings oncefully implemented, but will also improve the stability of our earnings bydecreasing exposure to the weaker North American and Western European marketsfor tobacco-related papers. Upon full implementation, the restructuring activitiesannounced in both 2006 and 2007 are expected to generate annual pretax benefitsof approximately $21 million to $23 million or $0.88 to $0.96 per share. Full realization of this range of earnings improvement fromthe restructuring actions is not certain and is dependent upon other factorsthat impact on our business, including continuing weakness in cigaretteconsumption in developed parts of the world. Implementation of these actions is proceeding. The PdMrestructuring announced in 2006 is nearing completion with approximately 70% ofthe 209-person employment reduction now complete. The majority of theadditional employment reductions will occur in the fourth quarter of 2007 andend upon completion of the capital investment in early 2008. A 60-person reduction was achieved in Brazil during thethird quarter. In the United States and France, actions are underway internallyand with customers to prepare for the transfer of base tipping paper productionupon completion of the base tipping paper machinery build in Brazil scheduledfor completion in the fourth quarter of 2007 and subsequent customer productqualifications during 2008. Further, we are in negotiations with labor unions in boththe United States and France to finalize severance agreements. Under the recently announced three-part restructuring plan,we project pretax restructuring expenses of $27 million to $30 million,comprised of $15 million to $17 million in fixed asset impairment charges,accelerated depreciation and other non-cash costs and $12 million to $13million in severance and other cash costs. Combined with restructuring activities announced in 2006,total restructuring expenses from 2006 through 2008 are now expected to be inthe range of $56 to $61 million comprised of $34 to $36 million in severanceand other cash costs and $22 to $25 million in fixed asset impairment charges,accelerated depreciation, and other non-cash costs. We expect further increases in sales volume in 2007 andthrough 2008 in both reconstituted tobacco leaf products and lower ignitionpropensity related cigarette papers that will benefit our operating resultsrelated to these products. Regarding lower ignition propensity, a total of 22 states,representing approximately 40% of the U.S. cigarette consumption, have enactedregulations that will progressively become effective through January 2009. During the third quarter, we initiated operations at our newproduction facility in South Carolina, dedicated to expanding our processingcapacity and capabilities to meet the growing demand for this cigarette paper. Given the strength of third quarter 2007 results, we nowproject full-year earnings excluding restructuring expenses to exceed the high-endof our previous earnings guidance of $1.15 per share. The fourth quarter of 2007 is expected to be weaker than thethird quarter of the year given planned downtime for the paper machine rebuildin Brazil and normal operational downtime in our mills around the year-endholidays. Diluted earnings per share in 2008 excluding restructuringexpenses are expected to exceed $1.50 per share for the full year. Growth inearnings in 2008 is expected to come from increased sales volumes forreconstituted tobacco leaf products and cigarette paper for lower ignitionpropensity cigarettes as well as from benefits of the announced restructuringactivities. That concludes our planned comments. Julianne, please openthe phone lines for questions.

[Operator:]

(Operator Instructions) Your first question is from the lineof Ann Gurkin with Davenport.

[Ann Gurkin:]

Good morning.

[Peter Thompson:]

Hello, Ann.

[Ann Gurkin:]

Wanted to start with the LIP in the U.S., Reynolds talkedabout voluntarily converting to the use of fire-safe paper about the end of2009. So are you including that in your '08 outlook?

[Peter Thompson:]

No, we are only including the currently passed legislationin the various states.

[Ann Gurkin:]

Okay. But that could be a pickup in the back half of 2008?

[Peter Thompson:]

Yes.

[Ann Gurkin:]

Correct. Okay.

[Peter Thompson:]

Yes.

[Ann Gurkin:]

Brazil, you talked about moving tipping paper volume toBrazil and reworking a line. Have you built up tipping paper inventory to meetcustomer demand while the products getting qualified?

[Peter Thompson:]

We started that process yes in the U.S. We will be buildinginventory. During the third quarter, we started the process fourth quarter. Andthen it'll probably top out maybe a little bit more growth in the first quarteras we prepare to shut down the leaf mill operation and begin to transferproduction.

[Ann Gurkin:]

So you've built inventory both in the U.S. and Brazil fortipping paper?

[Peter Thompson:]

No. In Brazil it's really building in the U.S. And thenthat'll tide us over as we begin to phase in supply from Brazil next year.

[Ann Gurkin:]

Okay. You are currently negotiating for business from BAT.Can we get an update on where that stands?

[Peter Thompson:]

We're still in the process of that negotiation. It'sreaching conclusion. It should be concluded I would guess in the next month orso. But at this point, it's still not conclusive across the board. So it wouldbe premature to talk about results.

[Ann Gurkin:]

Do you expect a final decision pre-Thanksgiving still?

[Peter Thompson:]

I would anticipate yes, that we should be done before them.

[Ann Gurkin:]

Okay. Any update on China RTL?

[Peter Thompson:]

No. We continue to work on that project in terms ofnegotiations and government approval. The primary task right now is withgovernment approval of a joint venture project. We still expect it to proceed but it's very difficult topredict the approval process. One of the complexity factors that we faced inChina with that is just by coincidence, the approval process in China for majorcapital projects, which we would qualify as changed. So we kind of had to startback over again in the queue to get the project approved. But we do expect approval. Upon project approval, we woulddefinitively negotiate our joint venture agreement with our partners andannounce. But at this point, we're still working on it.

[Ann Gurkin:]

Okay. And I've seen increased discussions about thepotential use of LIP paper in the EU. Can you comment on your level ofconfidence and the strength of your LIP patents in the EU environment, not theU.S. but EU?

[Peter Thompson:]

Yes. We feel we have the same level, an adequate protectionwith patents in the EU. Our patents are international. The bigger issue wouldbe when demand in the EU will firm up, when the legislation process will be notspeculative but concrete and then how we would prepare to serve that market. But in terms of both our market position, our productofferings, etc. We feel as confident about the EU market as we do about theNorth American market for our product.

[Ann Gurkin:]

Great, thank you.

[Peter Thompson:]

Thank you, Ann.

[Operator:]

Your next question is from the line of Jonathan Lichter withSidoti & Company.

[Jonathan Lichter:]

Good morning.

[Peter Thompson:]

Hello, Jonathan.

[Jonathan Lichter:]

In terms of RTL, what gives you the confidence that demandwill continue into the next year? Is backlog up there?

[Peter Thompson:]

Yes. What we're seeing in terms of confidence in LTRvolumes, recon volumes is growth in emerging markets. That gives us pretty goodconfidence for further growth. And stability in our primary markets or WesternEuropean markets, where we've long sold. As you recall, the weakness that wesaw from a sales side in recon was more in the Western European side of thebusiness. And we're not seeing as much weakness there. In fact, we'rereally seeing year-over-year, some small levels of increase. But we're moreconfident with our growth that we're seeing in emerging markets especially inAsia.

[Jonathan Lichter:]

Has anything changed in the market that has made that morestable in Western Europe?

[Peter Thompson:]

No. I think-- well there's two things, one for sure that wecan point to. One is the Western European market declines have not been as severe.There have been declines in consumption of cigarettes but not as severe asthere was in 2005 and early 2006 following a period of fairly significant taxincreases in a number of the major countries. So we're not seeing that change in demand causingvolatility. The other thing that we're not seeing develop as quickly as we didinitially after those tax increases was the development of value for moneybrands. The premium brands are holding their own throughout, Western Europe,which is more favorable to our recon business.

[Jonathan Lichter:]

And then I saw that there was a-- I guess machine rebuildwas put on hold for a period of time. Was that due to increased demand and whatcaused that?

[Peter Thompson:]

Yes. As we noted the final equipment rebuilds at the PdMfacility associated with the restructuring are now pushed into early '08. It isbecause of stronger sales, not in total for our French businesses as we signalthe overall tobacco-related papers business is still soft but that particularmachine, which is our number 10 machine at PdM is specialized on certain gradesand that would be for Asian markets. And it just turned out that the order log was strong enoughthat we couldn't take the machine down in December as we planned. And so we'vemoved the machine down into January. So it's a slight shift but the-- there wasa bit of an equipment delay issue. But the primary reason was we couldn't fully build theinventories that we needed in time to take the machine down.

[Jonathan Lichter:]

Okay. Are you seeing any other competition, particularly inEurope, for LIP?

[Peter Thompson:]

Well, not in Europe. On the European side, it would only bein developments, which wouldn't be as visible to us. We're certainly workingclosely with our international customers on LIP requirements and specificallyfor Europe. We're not aware specifically in Europe or in general of anynew developments with LIP by our customers or by our competitors.

[Jonathan Lichter:]

Do other-- I thought I'd seen something that Miquel Costas,I think it was had developed an LIP paper.

[Peter Thompson:]

Yes. Miquel Costas, which is the Spanish competitor that weface, has noted or said to have had an LIP product available even for the NorthAmerican market for a number of years now. But we have not seen that product commercially at any of ouraccounts in North America and we're not aware of that product. Again there'snot commercial demand in Europe. But we're not aware of that product beingrecently improved or developed further.

[Jonathan Lichter:]

Okay. And then just a question on taxes. What do you expectthe tax rate to be in '08?

[Peter Thompson:]

I would say-- well we're going to still have restructuringexpenses. So as long as we have significant restructuring expenses that tendsto cause, like we saw in the third quarter where we actually booked a taxbenefit. But exempting that, we should continue to be around 25 to27% effective tax rate as a company. But the caveat to that is when we havelarge periods of restructuring expenses that take us to a near or at a taxableloss position, the effective rate kind of goes upside down and we turn into atax benefit position. So on an ongoing earnings basis, 25 to 27%.

[Jonathan Lichter:]

Thank you.

[Peter Thompson:]

Thank you.

[Operator:]

(Operator Instructions) Your next question is from the lineof Thomas Russo with Gardner, Russo, Gardner.

[Thomas Russo:]

Hi, Pete.

[Peter Thompson:]

Hello, Tom.

[Thomas Russo:]

Hi, good morning. I just wanted you to bring us up to dateon your capital structure. And in particular whether and if at some point asoperating cash continues to mount you have ability to direct share buybackactivities back to Schweitzer?

[Peter Thompson:]

That is an accurate observation that we continue to be in abetter debt position than we thought we would. We have not raised debt thisyear as expected because we've had strong cash flow. So going forward from a cash flow management standpoint, werecognize that continually paying down debt at some point doesn't make sense. And so, we would look at share repurchases depending uponthe share price in the market for our stock and then of course any requirementsthat we project having for strategic investment.

[Thomas Russo:]

Yes.

[Peter Thompson:]

And we anticipate that the additional activity will occur inChina in terms of expansion that would require cash. And then of course, ifanything would come up from an acquisition standpoint that would require cash. But absent the large cash requirement, then share repurchasewould probably be either that or leveraging up even to do share repurchaseswould be a source or use of cash.

[Thomas Russo:]

Thank you. Congratulations.

[Peter Thompson:]

Thank you.

[Operator:]

There are no further questions at this time. I apologize youdo have a follow-up question from the line of Jonathan Lichter with Sidoti& Company.

[Jonathan Lichter:]

Quick question on -- is there any indication that the restof LTR Industries is up for sale or will it be?

[Peter Thompson:]

Well, there's no indication of that. The obvious point to beraised about LTR is our partner at LTR is Altadis, a cigarette company, whichis currently being acquired by Imperial Tobacco Company out of the U.K. And it's been announced as a part of that process, theintent to sell non-core assets so whether or not a non-core asset is our --their share in our recon business that would be the only connection. But there's nothing definitive that we can say about that.Certainly, we would be of interest. But it depends on a lot of factors. And thekey factor would be that it become available.

[Jonathan Lichter:]

Thanks again.

[Operator:]

There are no further questions.

[Peter Thompson:]

All right. Thank you all for taking the time to join ustoday. Goodbye.

[Operator:]

This concludes today's conference call. You may nowdisconnect.