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Executives

Frederic Villoutreix - Chairman and CEO

Pete Thompson - Treasurer, CFO and Strategic Planning Officer

Analysts

Jonathan Lichter - Sidoti & Company LLC

Ann Gurkin - Davenport & Company LLC

Schweitzer-Mauduit International, Inc. (SWM) Q4 2008 Earnings Call February 5, 2009 10:30 AM ET

Operator

Good morning. My name is April, and I will be your conference operator today. At this time, I would like to welcome everyone to the Schweitzer-Mauduit Fourth Quarter 2008 Earnings Release 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. Frederic Villoutreix, you may begin your conference.

Frederic Villoutreix

Thank you, April. Good morning, I am Frederic Villoutreix, CEO and Chairman of Board of Schweitzer-Mauduit International. And along with me Pete Thompson, our CFO we would be leading our conference call today. With us today is Mark Spears, our Corporate Controller. Thank you for joining us as we review our fourth quarter and full year results. I will discuss the key factor impacting our business. Then Pete will provide highlights of full year and fourth quarter 2008 financial results.

A more detailed review of fourth quarter financial performance is included in our earnings press release issued this morning. The copy of the press release can be found on our website. The comments included in today's conference call constitute forward-looking statements; actual results may differ materially from the projected results. Certain financial measures discussed during this call exclude restructuring and impairment expenses and are therefore non-GAAP financial measures.

I will now review the highlights of the full year and fourth quarter of 2008.

Earnings per share excluding restructuring and impairment expenses, were $0.97 for the full year and $0.14 for the fourth quarter. The fourth quarter results contain approximately $0.13 per share on tax impacts appreciated with the reorganization of legal entities and severance expenses associated with management changes finally impress.

Excluding these items as well as item losses from start up of our China joint venture paper mill and final cost on the shut down of the Lee Mills. Our business improved compared to fourth quarter of 2007.

As we continue to realize benefits from increased sales volume, only consist of equities and cigarette paper lower ignition propensity cigarettes, and began to realize favorable foreign currency impacts and the lower level of inflationary cost increases.

Our most significant achievement in 2008 was a purchase of a 28% minority interest in our reconstituted tobacco leaf operation in France LTR industries or LTRI.

We completed the $51 million acquisition in January 2008 and thus retained for shareholders 1% of this substantial earnings improvement in the year caused by 21% increase in sales volume.

The LTRI acquisition was accretive to earnings $0.32 during 2008. 2008 was also a very strong year for our cigarette paper for lower ignition propensity cigarettes or LIP.

Our LIP paper of sales volume grew 56% during 2008 as regulatory requirements across North America reached an estimated 34% of cigarette consumption by year end.

Essentially 1% of the North American market of cigarette will be LIP by January 2010. Thus we expect to realize even greater increases in sales volume of this value added product during 2009.

We continue to maintain our leadership position in LIP technology and our advancing plans to expand our capacity outside of North America to meet demand as other markets move toward implementing LIP regulations.

Currently, Australia, the entire European Union, Finland, South Africa, South Korea and the Philippines have taken actions towards implementing LIP regulations.

We expect demand for LIP outside of North America to begin by late 2009 with EU likely to require compliance by 2011 or 2012. Let me now turn to cost initiatives. We made significant progress during 2008 implementing restructuring actions in France, the US and Brazil initiated since 2006.

Essentially all restructuring related expenses for these actions have been recorded as of year end 2008. The key achievements are, in France progress continues to be made in implementing of strategy to become a low cost and the highest quality cigarette along side our paper manufacturing in Western Europe.

Our capital investments including improved performances of rebuilt paper machine, workforce reduction and other paper machine restructuring activities are in place and improvement in operations was realized during the fourth quarter.

In the US, the LEE Mills facility, in Massachusetts, seized operations earlier in 2008. Production of total of its products has been transferred to other locations including base tipping paper to our Brazilian mill. And the sale of remaining assets is progressing.

We exited the non-profitable coated papers business in Brazil in mid-2008. The restructuring actions announced for the Malaucene Mill remains to be fully implemented. But severance expenses associated we have announced plan and substantially all being recorded. All these restructuring actions will benefit annual pre-tax earnings by approximately $25 million.

Now, a word on Brazil. The currency situation in Brazil has become more favorable and along with selling price increases and the transfer of base tipping paper production from the US. We expect substantially improved operating profit in 2009.

We generated a near breakeven level of operating profit during the fourth quarter of 2008 despite $1.1 million in unfavorable impact from currency hedges placed earlier in the year. These unfavorable hedges expired at the end of December and we have rehedged approximately 50% of our net US dollar exposure in Brazil at a favorable exchange rate for all of 2009.

We are currently evaluating placement of additional hedges extending into 2010.

Now, a word on China. Our 50% joint venture of paper mill in China. China Tobacco-Mauduit or CTM has begun to realize growth in sales volume following a slower unexpected customer qualification period.

Sales volumes and new customer orders for cigarette paper are now going steadily and we expect these to continue throughout 2009 as we work to sell out the mill.

Operations are improving; our sales volume grows and enables more efficiency to our machine operations.

Recently we announced several executive level organizational changes including Pete's return as CFO and Head of Strategy and the appointment of Otto Herbst replacing me as Chief Operating Officer.

Otto brings nearly a decade of success in leading a Brazilian and more recently US operations to his extended role. I have now put into place my leadership team and am confident we have the right people, skills and experience to achieve our business objective in 2009 and beyond.

I would now cover our business outlook for 2009. Despite the significant challenges faced by our waste paper business throughout 2008. We are confident that Schweitzer-Mauduit is on track to achieve improvement in results as demonstrated by earnings increases during the second half of 2008.

The key driver, first growth reconstituted tobacco leaf and LIP paper is expected to continue during 2009.

Second includes operational performance on the rebuilt PdM paper machine, third our Brazilian business now expected to generate a substantial improvement in operating costs during 2009.

Fourth, we have completed global customer negotiations and achieved results in line with our expectations and goals for 2009.

Fifth, we are now bringing sales volumes at our new paper joint venture with China and expect to nail losses progressively throughout the year.

Finally, inflationary cost increases are expected to continue to moderate given worldwide recessionary impacts. We have lowered our purchase of wood pulp already having provided a benefit to earnings during the fourth quarter.

And emerging challenge to our business is poor worldwide economic conditions, which will likely cause increases, in cigarette taxation and could lower our to disposable income amongst smoker, especially in developing countries thus negatively impacting demand.

The US Federal Government past yesterday legislation for child healthcare programs founded by an increase in cigarette and other tobacco product excise taxes in excess of $0.62 per pack.

Although we continue to evaluate our best to balance our capacity for traditional paper products in France and the US to a valuable demand. And we likely announced additional restructuring actions during 2009.

We expect that earnings will improve during 2009 as a positive aspects of our business are expected to counter these and other challenges.

The expected earnings and cash generation improvement during 2009 coupled with our existing debt capacity supports our strategy to transform Schweitzer-Mauduit for growth of our high valued franchises for reconstituted tobacco leaf and cigarette paper for lower ignition propensity cigarettes.

While we continue the necessary restructuring of operations to balance capacity between the western and developing country locations.

Although we are fully expecting to realize earnings improvement during 2009 productivity and quarterly earnings will likely consist. Earnings per share excluding restructuring and impairment expenses are expected to improve above 2008 levels.

However the expense is difficult to project with certainty given the breadth of factors impacting results. As conditions warrant we will provide updates of our full year 2009 earnings outlook.

I'll now turn to Pete, to cover the highlights of our financial performance.

Pete Thompson

Thank you, Fredrick. I'm happy to be back as CFO and enthusiastic about the opportunities in our business. I will now review our recent financial performance and outlook.

Net sales increased versus 2007 by 7.4% for the year, and declined by [0.2%] in fourth quarter. Both the full year and the quarter benefited from higher average selling prices.

However, the weakening of the euro compared to the US dollar in the fourth quarter partially offset favorable impact experienced during the first three quarters. For the full year, sales volume declined 1.2% due to closure of the Lee Mills and our exiting of the coated paper business in Brazil.

In the French segment, volumes increased 8.8% due to higher sales of reconstituted tobacco leaf products. Sales volumes for cigarette paper for lower ignition propensity cigarettes also increased during 2008.

Restructuring and impairment expenses were $22.1 million in 2008, compared with $24 million in 2007. The 2008 expenses, mostly related to asset impairment, up $13.5 million recorded in the fourth quarter for write-downs taken on certain French paper grouped assets, given continuing losses that triggered required impairment testing under US GAAP.

Nearly, all announced restructuring activities were completed during 2008, except for they shutdown of Malaucene, France base tipping paper machine which has been postponed until the late first or early second quarter of 2009 depending ongoing customer qualification.

Operating profit excluding restructuring and impairment expenses was $39 million for the year and $11.3 million during the fourth quarter, compared with $21.9 million and $5.5 million for the respective periods of 2007.

The decline in full year operating profit was attributable to higher inflationary costs, which decelerated in the fourth quarter to one thirds of rate realized during the first three quarters of 2008. These higher costs were partially offset with higher average selling prices and the benefits of cost savings program.

Fourth quarter 2008 improvement in operating profit was primarily due to higher average selling prices, primarily due to a favorable mix of products sold of $12.8 million, benefits from higher sales volumes of RTL and LIP products and improved mill operations in Frances and United States.

Partially offset by inflationary cost increases of $5.8 million. As expected fourth quarter results were negatively impacted by lower demand late in the quarter, resulting from reduced customer operating schedule. Higher energy costs, cost about 50% of the $30.4 million of 2008 inflationary cost increase.

Per ton costs for purchased wood pulp and other materials added another $10.5 million, the average per ton lease price in the United States of northern bleached softwood kraft peaked in July and August at $885 before declining to $735 in December. And it's now 16% below the prior year level.

Declines are expected to continue in 2009 and provide year-over-year improvement to earning.

The loss from our 50% joint venture paper mill in China was $4 million for the full year and $2.2 million during the fourth quarter.

Losses are expected to narrow in 2009 as sales volumes improve.

Net debt increased 73% to $167.9 million at year end compared to the prior year end. With an increase of $8.8 million during the fourth quarter primarily due to payment of accrued restructuring related severance liabilities.

The full year increase was primarily due to the $51.3 million purchase of the minority shares of LTRI in January. Our debt to capital ratio at year end was 39.3% versus 21.5% in the prior year.

We had $73 million of contractual availability on our credit and overdraft facilities at December 31, 2008.

Full year 2008 capital spending was $35.3 million. Of which $5.3 million incurred during the quarter.

We spend $9.7 million in restructuring related capital investment in 2008. Operating cash flow decreased to $33.3 million for 2008 versus $71.3 million in 2007.

During 2008 we paid $15.1 million in restructuring related severances and made $5.2 million in contributions to our pension plans.

Capital spending for 2009 is currently expected to range between $20 million and $30 million. The reorganization of legal entities is projected to reduce annual cash taxes paid by approximately $20 million beginning by the second quarter of 2009.

Other cash needs including pension funding and capitalized software spending are projected to be in the range of $20 million to $30 million. Net debt is projected to reach $180 million to $190 million during the first quarter of 2009 due to expected pension funding requirements.

Earlier today Schweitzer-Mauduit we announced a quarterly common stock dividend of $0.15 per share payable on March 23, 2009, the stockholders of record on February 23, 2009.

That concludes our planned comments. April, please open phone line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We do have a question from Jonathan Lichter. Your line is open.

Jonathan Lichter - Sidoti & Company LLC

Yes. How much did the Lee Mills shutdown cost, I think that was said there were $2.2 million worth of cost overall, but nothing had broken down?

Pete Thompson

Yeah, Jonathan in the fourth quarter, well to answer your question in total, the Lee Mills shutdown in 2008, the restructuring expenses that we took were [$159 million]. What we alluded to in the fourth quarter is, we had about $1.4 million in cost associated with shutting down Lee that were restructuring related.

$700,000 of that was due to an accrual for a repair to one of the water dams that we have the site, it really had nothing to do with restructuring. It was repair that we need make in order to hold the integrity of that dam. The other $700,000 that incurred during the quarter was the cost associated with the final winding up of activities at the site.

Jonathan Lichter - Sidoti & Company LLC

So those you wouldn’t to expect to recur then?

Pete Thompson

No.

Jonathan Lichter - Sidoti & Company LLC

Okay. Is that the higher maintenance that you are referring to in another area of the release?

Pete Thompson

Yeah. That’s the part of it and than typically in the fourth quarter we do have higher maintenance expense and we did also our add our increment spots with facilities in the US.

Jonathan Lichter - Sidoti & Company LLC

Okay. And then how much of the restructuring benefit will we see in '09, I guess the overall annual number is $25 million, how much did we see in 08?

Pete Thompson

The best way to think about that, roughly half of the $25 million is the labor savings with the downsizing primarily in France at PdM, and that's largely in place now. We have a very small percentage of that yet to go. And that was put into place aggressively over the last two years, so it's essentially on place now.

The half of the $25 million is in our results from the first quarter going forward, a little bit further to go. And that benefit does not count the difficulties we had with the start up of the number 10 machine at that site.

So, we also expect on half of the $25 million, we also expect improvement out of France with improving base of operations on the PdM number 10 machine. The other half of restructuring benefit is somewhat spilt between the US and Brazil, and with the Lee Mills now essentially fully down, we are seeing that benefit on a going-forward basis in place starting really here in January.

So we will see that on a going forward. The difficulty with the Lee Mills' benefit is, over the last two years once we announced the shutdown of Lee, we had poor result at Lee, which is why we shut it down, then we built inventory for about nine-month period late '07 into '08 and that benefited result, because we were building inventory and absorbing overhead.

We unwound that inventory now, finish that all up in December, so we have got kind of a mix of results in the past. But from here forward Lees is gone and losses that we were incurring at Lee, go away and then we get the benefit of having transfer based tipping production to Brazil along with the restructuring in Brazil and that brings substantial benefit going forward. So, I would say the best way to think about restructuring the short answer is we've seen roughly half of the $25 million, and the other half will be fully realized this year. And you’ll really see it in all three business segments, US, France and Brazil.

Jonathan Lichter - Sidoti & Company LLC

Okay and then just lastly the difference I guess between what you kind of had as guidance last quarter and this quarter, is that all just related to what your thinking on the overall economy and the earlier passage of the SCHIP?

Pete Thompson

Yeah. The SCHIP really did not factor in at all. That is consistent with actual amount of the tax increase and the timing are too close to call in terms of being any different than our original thinking, so no. That doesn't impact us specifically.

The reason we are not providing a specific earnings guidance number is much like most publicly-traded companies, the uncertainty in the current economic environment makes predicting our business much more difficult.

If we knew right, now that the current rate of lower inflation, selling prices and volume were stable, we would be indicating very positive earnings guidance coupled with the improvements we expect in our business.

The thing that we can't say with certainty is, as quick as oil prices and wood pulp prices drop as much as there has been a worldwide economic contraction in activity, will that show up as higher inflation later this year, significantly lower demand for cigarette consumption and can therefore impact our business one way or the other.

So it’s really the macroeconomic conditions that are causing us just like essentially all other companies to not provide a specific earnings guidance.

Jonathan Lichter - Sidoti & Company LLC

But if economic conditions were let's say the same as they are now throughout the year and you held the other factors steady, what kind of outlook would you think you would expect?

Pete Thompson

Positive, the factors we within our control were quite positive about as, Frederic reviewed. So things in front of us are all better. France will perform better, especially with the number 10 machine improving, we still have restructuring activity ahead of us in the US and in France that is an unknown at this point that's a headwind.

But that aside, we are looking at a better operating situation in France, in the US we have the benefit of LIP, again our France we have got further we can grow, we won't have 21% growth like we did in '08 again in '09, but we do expect further growth narrowing of losses in China, and then a very important swing to what we now know given currency will be a pretty healthy operating profit from a pretty significant operating loss in Brazil.

So factors within our control, we are quite bullish about the outlook of our business. And if we didn’t have the worldwide economic conditions, which is the big if, we would be most likely increasing our earnings guidance from last quarter.

Jonathan Lichter - Sidoti & Company LLC

So it is the current weak economy, not inflation later on that you are concerned about?

Pete Thompson

Both, I would say first we would be concern about volume. If the economy stays depressed and unemployment keeps arising worldwide, eventually two things will happen. The taxation is going to go up in the western world just like yesterday’s announcement SCHIP that will drive consumption lower in North America and Western Europe and Japan.

And then in developing countries, last time we saw this was in the Asian economic crisis of the late '90. If disposable income drops significantly in the developing countries, cigarette consumption will drop with it. That will show up to us is reduced demand for our products and heightened competition, so that is the concern that we have from a macro basis impacting our business as the year goes on and if the economy continues worldwide to be depressed.

Jonathan Lichter - Sidoti & Company LLC

Okay. Thank you.

Pete Thompson

Okay.

Operator

And we have a question from Ann Gurkin. Your line is open.

Ann Gurkin - Davenport & Company Llc

Good morning.

Pete Thompson

Hello Ann.

Ann Gurkin - Davenport & Company Llc

For 2009, can you increase RTO volumes till double-digits is that still the target versus '08?

Frederic Villoutreix

Good morning, Ann.

Ann Gurkin - Davenport & Company Llc

Good morning.

Frederic Villoutreix

This is Frederic here.

Ann Gurkin

Good morning.

Frederic Villoutreix

I think we are still positive in terms of continuing to grow the business. However it’s fair to say that the growth rates we have realized in last two years are not sustainable on an ongoing basis. So we see some growth probably at a reduced rate.

Ann Gurkin - Davenport & Company Llc

So that is the long-term target of mid to high single-digits, is that fair?

Frederic Villoutreix

Yeah. That sounds reasonable, that is reasonable.

Ann Gurkin - Davenport & Company Llc

And then baked into your outlook right now in the US, can you comment on what you forecast for domestic cigarette volumes?

Pete Thompson

Yeah, Ann. $we specifically took in to account kind of a normal what’s been normal here in the last several years of a 2% to 4% decline in cigarette consumption, plus the impact of SCHIP. And so we have a fairly significant negative one-time impact from SCHIP that we built into our thinking about 2009 volumes in the US.

Ann Gurkin - Davenport & Company Llc

So that’s in your comments that you made today?

Pete Thompson

Yes.

Ann Gurkin - Davenport & Company Llc

Okay and then…

Frederic Villoutreix

And, Ann if I may, keep in mind that our franchise wrappers and binders serves the small cigars is likely to be more impacted than the average paper business supplying the cigarette industry.

Ann Gurkin - Davenport & Company Llc

Okay. Because I start with the $0.97 reported in '08, and if you add back improvement for number 10 PdM, favorable currency, I think you should pick up a little bit more from the LTRI acquisition, and then any benefit from restructuring or easily a $1.20 which was the number you all indicated you had meet in last quarter's press release. So, can you help a little bit more? I know you just talked about this a little bit, but what are we missing?

Pete Thompson

No. I don’t think you're missing anything. The positive items that you listed and then add to that Brazil and narrowing losses in China will be all be positive for the business. The only negative that we would really have is the macro economic issues, plus any further impact on restructuring, should we decide to do anything further.

And that would potentially hurt us significantly in terms of earnings. So, absent what we don't know, we would be giving guidance that’s probably more bullish, more upbeat than we gave last time. However, with so much uncertainty, we think it's more prudent not to give any guidance at all.

Ann Gurkin - Davenport & Company Llc

Okay. And at what point, or what data point or what timeline should we look for when you will give more concrete?

Pete Thompson

What we will do is as quarter-by-quarter it goes by, I don’t think we will do anything outside of earnings releases. As quarter-by-quarter goes by, obviously we can talk more specifically about what have we achieved and what's our in our control outlook, and then that will give more visibility as to what's happening with the overall economy as time goes by.

So I think we are going, each quarter, we will make a decision, do we give specific guidance, but at each quarter we will for sure stay qualitatively where do we see earnings going.

Ann Gurkin - Davenport & Company Llc

Okay, moving to China, we have a positive contributor to earnings in '09, so I think that's too aggressive, our results in China can be more flat to down a couple pennies this year?

Pete Thompson

Yeah, I would say that given from where we ended up in 2008 on China, that’s way to think about it will narrow loss through the year ideally getting to a near breakeven or slightly positive level by the fourth quarter of 2009, of course that was a original expectation for the fourth quarter of 2008.

So what we are going to see about a year long delay in getting to that point. Now the rate that which losses go from, $4 million our share of losses in 2008 was $4 million, $2 million in the fourth quarter, how quickly that goes to zero, it's hard to say.

Obviously, we are working to do is build sale as quick as we can ideally we will see good efficiency of the paper machine and good cost performance. But that that's harder to predict, but it will be moving from where it is towards zero as the year goes on, but what that line looks like is hard to project.

Ann Gurkin - Davenport & Company Llc

Okay. And then if you could update. In the press release, you commented on your success in negotiating contracts and pricing with customers last year, particular towards end of last year. And is there a growing risk that those prices aren't going to stick or move to the year. Are you getting pressure from customers to get back some of that margin?

Frederic Villoutreix

I would say Ann, that Arkansas are more the impacts of the global academy and price increases on volume, which in my mind would be more in the second half of the year, which could affect the volume commitments of our customers, I think in terms of pricing, the pricing that we have negotiated is good for 2009. However, the situation of the economy inflationary factors and volume demand situation will certain impact the picture as we look to 2010 pricing.

Ann Gurkin - Davenport & Company Llc

Okay. That’s great. Thank you.

Pete Thompson

Thank you.

Operator

At this time there are no other questions in queue.

Pete Thompson

Okay. Alright then April and all on the call, thank you for joining us today.

Operator

Thank you, sir. And you have a great day, sir.

Pete Thompson

Okay.

Frederic Villoutreix

Bye-bye.

Operator

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

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