Schweitzer-Mauduit International, Inc. Q3 2008 Earnings Call Transcript

Schweitzer-Mauduit International, Inc. (NYSE:SWM)

Q3 2008 Earnings Call Transcript

November 6, 2008, 10:30 am ET


Torben Wetche – CFO and Treasurer


Good morning. My name is Adriane and I will be your conference operator today. At this time, I would like to welcome everyone to the Schweitzer-Mauduit International conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions)

Thank you, Mr. Wetche, you may begin your conference.

Torben Wetche

Thank you, Adriane. Good morning, my name is Torben Wetche, thank you for joining us for a review of our third quarter 2008 financial results which were filed with the United States Securities and Exchange Commission on Form 10-Q yesterday evening. I will be leading our conference call today. I have been the CFO for Schweitzer-Mauduit since August 11, 2008. Prior to this, I was Chief Financial Officer for Performance Fibers, a $1 billion global high tenacity fiber manufacturer owned by a private equity company. I have spent more than 60% of my time so far with Schweitzer-Mauduit learning the business through visits with our key managers and travels to our mills in the US, Brazil and France. I have had several meetings with our banks, investors in New York and Boston and I would like to say that I continue to be very excited about having joined Schweitzer-Mauduit. With me today is Mark Spears, our Corporate Controller.

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 reports 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 third quarter 2008 before providing additional discussion of key factors impacting our 2008 full year. Our third quarter 2008 net income totaled $6.7 million compared with a net loss of $4.3 million during the third quarter of 2007. Diluted earnings per share were $0.43 compared with the loss of $0.27 this year in the prior year quarter.

Restructuring expenses decreased earnings per share during the third quarter 2008 and 2007 by $0.11 and $0.73 respectively. Excluding restructuring expenses, earnings per share of $0.54 for the third quarter of 2008 increased 17% from $0.46 for the third quarter of 2007. All announced restructuring activities are expected to be completed during 2008 except for the shutdown of the Malaucene, France base tipping paper machine which has been postponed pending ongoing customer qualifications.

Net sales were $199.2 million during the third quarter of 2008, a $15 million increase over the prior year quarter. $12.8 million of this increase was due to favorable foreign currency exchange rate impacts plus $10.6 million increase from higher average selling prices and an improved mix of products sold partially offset by $8.4 million volume decrease mainly related to the announced closing of the Lee Mills and the exit of the Brazil coated paper business.

Operating profit was $14.6 million during the third quarter 2008 versus a $3 million operating loss in the prior year quarter. Excluding pretax restructuring expenses, operating profit was $17.2 million during the third quarter of 2008 compared with $15.2 million during the third quarter of 2007, an improvement of 13%. The third quarter 2008 improvement in operating profit was primarily due to improved mill operations in France and in the United States and a favorable mix of products sold of $2.8 million due to benefits from reconstituted tobacco and cigarette paper for lower ignition propensity or LIP cigarettes partially offset by inflationary cost increases of $8.3 million. Excluding pretax restructuring expenses from each unit’s third quarter operating results for 2008 and 2007, the French segment improved by $2.5 million, the US segment improved by $2.4 million, and the Brazilian segment increased by $1.8 million.

Interest expense totaled $3.1 million during third quarter of 2008, an increase of $1.5 million from the prior year quarter due to higher average debt levels. The loss from equity affiliate of $1.6 million is related to the start-up of our joint venture paper mill in China. We recorded a $2.6 million provision for income taxes during the third quarter of 2008 compared with a $2.6 million benefit during the third quarter of 2007, mainly due to higher taxable earnings. There was no minority interest in earnings of subsidiaries in third quarter of 2008 compared with $2.2 million during the third quarter of 2007 as a result of our acquisition in January 2008 of the 28% minority interest in our French reconstituted tobacco leaf business LTRI.

Net cash provided by operations totaled $15.7 million for the third quarter 2008 compared with $20.3 million in the second quarter of 2008 and $8 million used by operations during the first quarter of 2008. Our third quarter 2008 net operating cash flow was positively impacted by $9.8 million improvement in operating profits compared to second quarter 2008 whereas working capital was flat. Capital spending was $6 million during the third quarter compared with $24 million during the first six months of 2008 reflecting the absence of any major capital projects during the third quarter. Increased net cash provided by operations enable us to reduce net debt during the third quarter of 2008 by $19.5 million to $159.1 million as of September 30, 2008 or a decline of almost $61 million from the peak level reached in early May 2008.

Due to the current credit crisis, we also believe it is important to state that our Credit Agreement does not expire until July 31, 2012 and that our contractual availability under that facility and our overdraft as of September 30, 2008 totaled $96.5 million. Today, Schweitzer-Mauduit announced a quarterly common stock dividend of $0.15 per share payable on December 15, 2008 to stockholders of record on November 17, 2008.

I will now cover Schweitzer-Mauduit’s business comments and outlook. The expected third quarter 2008 financial results for Schweitzer-Mauduit improved both sequentially and versus the prior year quarter. Earnings increased primarily due to higher sales volumes for reconstituted tobacco leaves or RTL and cigarette paper used in lower ignition propensity or LIP cigarettes. Additionally, we benefited from the LTRI minority interest exhibition. Our reconstituted tobacco leaf business continues to realize sales volume growth and increased earnings. Full year sales growth well above 10% is expected for 2008 and we continue to evaluate capacity expansion projects including continuing efforts to complete negotiations to construct a Greenfield reconstituted tobacco joint venture in China.

Based upon the states that have passed LIP regulations, demand for this product is expected to grow from the current levels of approximately 32% of North American cigarette consumption to approximately 80% by early 2010. In addition, jurisdictions representing essentially all of North American consumption have either passed or proposed LIP regulations and several cigarette producers have announced voluntary national distribution of this technology supporting the likelihood that LIP cigarettes will be sold nationwide by late 2009 or early 2010. As a result, we expect to realize continued growth and demand for cigarette paper used in LIP cigarettes which would continue to benefit our US business units’ results. International LIP efforts are also accelerating especially in the European Union. Continued EU rule-making activities including the passing [ph] in June 2008 of a mandate to prescribe an LIP test protocol indicate that it is increasingly likely that LIP cigarettes regulations will be required in the European Union by 2012.

Finland, for example, issued a draft tax in February 2008 of its proposed LIP legislation and is expected to implement LIP legislation by April 2010 and Australia has passed LIP legislation with an effective date of March 2010. All these actions indicate that it is increasingly likely that LIP cigarette regulations outside North America will become effective within the next two to four years increasing demand for cigarette paper used in these cigarettes. We expect this to be a positive development for Schweitzer-Mauduit and we continue to expand our US LIP capacity and we are undertaking capacity planning activities for European LIP expansion. Operation of the rebuilt paper machine at our PdM mill in France continued to improve during the third quarter and we are not expecting this machine to reach targeted output during the first quarter of 2009.

Inflationary cost increased by $8.3 million during the third quarter of 2008 compared to the third quarter of 2007. However, earnings were not as negatively impacted during the second quarter of 2008 primarily due to improved product mix from increased RTL and LIP sales. During the first nine months of 2008, inflationary cost increases have totaled $24.6 million or approximately $1.03 per share, well above the impact seen in 2007. Energy cost increases caused half of this impact while wood pulp prices contributed about 30% of the increase. The balance was equally due to increased purchased material prices and labor rates. With the recent increases in pulp inventory levels and the declines in global oil prices, we are cautiously optimistic that our energy and pulp cost will begin to decline by the end of this year.

Furthermore we are currently negotiating price increases with our customers in an effort to recover the cumulative inflationary cost increases we have absorbed since 2005. We incurred $6.6 million of unfavorable foreign currency impacts during the first nine months of 2008 primarily in France and Brazil, however we expect these currency impacts to decline in 2009 as we are working on achieving a natural hedge for our euro US dollar exposure and as we were able to enter into beneficial 2009 real hedges during the recent real weakening against the US dollar.

The overall restructuring activities initiated during the last two years across Schweitzer-Mauduit are progressing well and we expect that all announced restructuring activities should be completed during 2008 except for the shutdown of the Malaucene base tipping paper machine which has been delayed pending ongoing customer qualifications.

Full realization our recently expected earnings improvements from the restructuring actions across Schweitzer-Mauduit continues to be uncertain due to other factors impacting our business including prospects for continuing inflationary cost increases, unfavorable currency impacts and most importantly the outcome of our current 2009 customer contract negotiations. Decisions regarding further restructuring actions would therefore still be forthcoming during the fourth quarter of 2008.

During the third quarter, progress continued with the startup of our Greenfield cigarette paper and porous plug wrap joint venture in China. In spite of a somewhat slower than expected China customer qualification process, we continued to expect to achieve positive earnings contributions from this investment during 2009. We are pleased with the improved performance seen in the third quarter both in terms of earning and cash generation. Increases in sales of reconstituted tobacco leaf products in France especially given full ownership of this business and cigarette paper for LIP cigarettes in the United States are expected to further benefit earnings this year and beyond. However, significant improvement in our traditional tobacco papers business is less certain.

In spite of the good results in the third quarter, Schweitzer-Mauduit faces challenges for earnings in the fourth quarter of 2008 due to seasonal cigarette customer plant shutdowns, continuing unfavorable inflation and foreign currency impact until January 1, 2009 when existing commercial supply agreements and past currency hedging contracts expire. We are also impacted by finalization of certain restructuring activities and slower than expected growth in sales for our new joint venture paper mill in China. We expect that most of these impacts will be contained through the fourth quarter 2008 however we do anticipate that our fourth quarter 2008 earnings per share excluding restructuring expenses will be low and we therefore maintain that our full year 2008 earnings excluding restructuring expenses will be at the upper end of our previously expected range between $0.75 and $0.90 per share.

Due to an expected fourth quarter 2008 seasonal working capital increase in the Americas combined with a newly planned $5 million to $6 million increased pension plan funding in the fourth quarter caused by the recent drop in the equity markets, we expect that our bank borrowings will increase by $15 million to $18 million during the fourth quarter 2008. For 2009, we expect our earnings per share excluding restructuring expenses to be better than 2007 due to the benefit from the following, further increased sales volume for RTL and cigarette paper used for LIP cigarettes, increased operating profit in Brazil due to finalization of restructuring actions. Furthermore, in October 2008, we entered into currency exchange rate hedging contract locking in a more favorable exchange rate for approximately half of the Brazilian entity’s US dollar exposure which will significantly benefit our 2009 operational result in Brazil avoidance of the 2008 paper machine start-up cost of CDM [ph] and availability of global customer price increases to recover cumulative inflation since 2005. The extent to which our 2009 earnings will exceed 2007 primarily depends on the success of our 2009 customer price and volume negotiations to be concluded by early 2009.

That concludes our planned comments. Adriane, please open the phone lines for questions.

Thank you for your time and thank you for joining us today.

Question-and-Answer Session

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