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Schweitzer-Mauduit International Inc. (NYSE:SWM)

Q1 2010 Earnings Call

May 6, 2010; 10:30 am ET

Executives

Fredric Villoutreix - Chairman & Chief Executive Officer

Pete Thompson - Executive Vice President of Finance and Strategy

Mark Spears - Corporate Controller

Analysts

Ian Zaffino - Oppenheimer & Co

Operator

Good morning. My name is Tracey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Schweitzer-Mauduit, first quarter 2010 earnings 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)

Mark Spears, you may begin your conference.

Mark Spears

Thank you Tracy. Good morning. I am Mark Spears, Corporate Controller at Schweitzer-Mauduit International. Thank you for joining us today to discuss Schweitzer Mauduit’s first quarter 2010 earnings results.

Participating on today’s call are Fredric Villoutreix, Chairman and Chief Executive Officer; and Pete Thompson, our Executive Vice President of Finance and Strategy. Frederic will discuss the key factors impacting our business. Pete will then provide additional details related to our first quarter results and outlook. We will then take your questions.

Before we begin I would like you remind you that the comments included in today’s conference call constitute forward-looking statements. Actual results may differ materially from the results suggested by these comments for a number of reasons which are discussed in more detail in the company’s Security and Exchange Commission filings, including our Annual Report on Form 10-K.

Certain financial measures discussed during this call exclude restructuring expenses, and are therefore non-GAAP financial measures. As slide presentation accompanies our formal remarks. A copy of which can be found under the Investor Relations portion of our website or you can follow along on the webcast.

With that I will turn the call over to Frederic.

Frederic Villoutreix

Thank you Mark, and good morning everyone. On today’s call I would say some high level comments about our first quarter performance. I would also comment on the working agenda for 2010, and our priorities moving forward; including comments of our recently announced LIP plans in Europe and an update on the progress with [Inaudible] expansion in Asia.

Due to current litigation, our comments about LIP pattern actions would be limited. Except to say the suit against our competitors, emerging LIP patent infringement in the U.S. is proceeding for the normal legal process. Pete will then take you through a more detailed review of our financial results and guidance.

Slide four summarizes our financial results of the quarter. We did have good performance across the board, with substantial year on year increases in revenue, net income and earnings per share. Cash generation was strong, and we now have a positive net cash which Pete will discuss.

Our first quarter results demonstrate the continuous strength of our high value product strategy. Base paper operations maintained a possible level, albeit below 2009 levels, despite higher pulp prices and somewhat lower selling prices that became effective in January 2010. We achieved solid earnings per share of $1.19 in the period, which equates to restructuring and internal expenses.

Adjusted for an $0.18 per share dilution impact of November 2009 secondary equity offering, the first quarter adjusted EPS would have been a closed second best quarter in our 15 year public company history. Of course the proceeds of the secondary operating are now being put to work to grow our high margin, highly return, optimal business, which in turn will see further earnings growth beginning in 2012.

Moving to slide five; growth of our high value products, LIP paper and RTL products was impressive at nearly 18% of the prior year period, driven by the full conversion to LIP cigarette paper in the U.S. and new sales to Australia and Finland. Meanwhile, sales for off-year products remained robust and benefited from improved efficiencies.

We announced on Monday all plans to establish capacity in Europe to produce cigarette paper for Lower Ignition Propensity or LIP cigarettes, which I will cover in the next slide. We continued to the pleased by the performance of our paper joint venture in China in spite weak seasonal demand. We now expect to nearly double earnings from last years levels.

We continue to benefit on cost reduction initiatives and generally more efficient operations across Schweitzer-Mauduit business units, contributing over $7 million to the bottom line in the quarter.

We completed the planned shutdown of the paper machine of the Spotswood, New Jersey mill and our now seeing all our base paper for proprietary Alginex LIP cigarette paper from Brazil and France. This move marks an important step in preparing the mill to concentrate on the online LIP technology we operate for U.S.A., with expectation to be essentially complete by media.

Moving to slide six; we continue to execute a key strategic initiative during the quarter. The construction of our new 30,000-ton reconstituted tobacco production facility in the Philippines is progressing according to plans, inline with objective to stop operations in late 2011. We reiterate our expectation to reach full year profitability during 2012.

Negotiations continued during the quarter to finalizing agreement by midyear 2010 for an RTL joint venture in China.

We announced on Monday, our capacity expansion plan for supplying LIP cigarette paper to the European markets. In addition to the already established third party manufacturing facility in Belgium, we are investing some $25 million in our very own operation in Lodz, Poland. Lodz to be pronounced [Luj] in polish, is the third largest city in Poland, and located about 84 miles southwest of Warsaw.

The Luj facility is expected to be our main production center at LIP solutions in Europe and can be readily expanded in capacity beyond the initial plan level. It is projected to be operational in November of this year.

The initial capacity investment in sites meet up to one hour per the union market requirements, and to come online as LIP demand is expected to ramp up next year.

Plans remain for the final EU LIP standouts to be established in May Q3, 2010 triggering adoption of the regulation by EU countries of a six to 18 month period.

We have already secured LIP supply agreements, which could initialize approximately 30% of the capacity, and are in advanced discussions with several international cigarette companies regarding their EU LIP cigarette paper requirements.

Securing additional commitments is expected to standout in the second half of the year, with several customers waiting for the publication of the EU standout before finalizing their supply decision. However, we expect that the remaining capacity to be fully committed for additional customer agreements. Also, we recently renewed two existing EPS supply agreements for North American activities of two of the same top form international operations.

Now, a word on our restructuring program on slide seven. Last December we concluded an agreement with our employees and plants on the terms of the general staff reduction and expect to complete the reduction workforce in the first quarter of 2010, resulting in annual pretax savings of approximately $8 million on a full year basis.

In the U.S., we have now entered the final stage of our plans to refocus our spots with the New Jersey facility on the online LIP technology we operate for USA. Again with expectations to be essentially complete by the end of the second quarter.

Base paper is a highly competitive business, but we remain committed to doing what is necessary to keep this part of the segment possible and tap the growth opportunities in Asia.

Slide eight summarizes our key business driver for 2010. Although we are making solid progress on our agenda, our teams are working hard to carry out our plans, with an acute focus on the quality of execution, whether it is benching our expansion plans in Asia for RTL products or in Europe with LIP, securing customer agreements and licenses in light of the LIP legislation becoming effective in Europe next year, delivering strong earnings growth with our high value products on our Chinese paper joint ventures as it strengthens its position in the premium cigarette paper market in China, as well as litigating the potential impact of product price and euro translation by executing the deployments of our operation and it’s program and other cost reduction measures, and last, completing the restructure measure in France and the U.S.

All in all we still have a lot of work to do, but I’m confident that we are on a solid trajectory to deliver double-digit earnings improvement in 2010 and beyond, in spite of what is likely to be a more challenging environment over the coming months.

With that, I will turn the call over to Pete, to cover our financial results and outlook.

Pete Thompson

Thank you, Frederic. I will now review our results for the quarter and update our financial guidance.

Net sales of $193 million for the first quarter increased 4.8% over the prior year. Net sales grew in all of our segments, primarily due to improved selling prices, and a richer product mix, reflecting our continued shift to higher value LIP and RTL products.

Currency exchange also benefited the annual comparison, but this will likely swing to an unfavorable comparison in coming quarters, due to the weakness of the Euro to the US dollar. Unit volume grew 3.3% across SWM as we’ll discuss on the next slide.

Excluding currency impact and the idled Malaucene facilities prior year volumes, we grew revenue 5.4% during the first quarter, which is inline with our goal to exceed 3% annually.

Our unit volume performance was good during the first quarter in all three of the presented views of our business. We realized significant growth in high value products, reflecting both growth in LIP from 100% regulation in the U.S. market, combined with strong sales of RTL during the first quarter, which reflected our French RTL facility’s good production performance.

Global tobacco papers volume decline 0.9% year-over-year as losses, primarily from the closure of Malaucene facility, along with market related declines in North America were nearly fully offset by growth in sales from our China paper joint venture. We expect a less favorable volume comparison in coming quarters due anticipated declines in demand for global tobacco paper markets, excluding China.

Full year growth for RTL is still expected to be at the mid single digit level, but likely somewhat below the strong first quarter shipping rate, due to customer inventory bills. A major multinational cigarette companies are largely reporting first quarter cigarette sales inline with our expectations, including low single digit unit volume declines in developed markets, offset by growth through acquisition and emerging market needs.

LIP demand will likely remain at first quarter rate, given stable market requirements, improved shipments to Australia and Finland, offsetting North American market demand declines. The major cigarette companies in the U.S. are citing general rates of U.S. market declines returning to a more normal 2% to 4% so far in 2010. This is inline with our expectations.

SWM again delivered a significant 47% increase in operating profit, excluding restructuring and impairment expenses during the first quarter of 2010. The gains were driven by good cost performance, and improved pricing, largely from a greater mix of higher value LIP and RTL products.

Cost performance improved in each of our segments, and was caused roughly half from gains achieved through our operational excellence process, and half from benefits associated with restructuring actions. We delivered good cost performance and realized excellent productivity during the first quarter, in operations at our French RTL facility, which as mentioned help meet available sales demand.

Inflationary cost increases weren’t favorable during the first quarter, with higher wood pulp cost impacting operating profits by $2.2 million. North American northern bleached softwood kraft pulp list prices averaged $880 per metric ton during the first quarter, an increase of 30% over the first quarter of 2009. Other inflationary changes during the quarter largely offset each other.

Currency translation remains favorable to earnings for the quarter-to-quarter comparison, as the dollar to euro exchange averaged $1.37 during the first quarter of 2010 versus $1.29 during the prior year quarter.

Earnings per share increased to $1.19. Excluding restructuring and impairment expenses, in addition to the growth in earnings from increased operating profit, the first quarter benefited from an increase of $1.9 million in our share of the net income of CTM, our China paper joint venture. Decrease is interest expense for the first quarter resulting from our low levels of debt, were more fully offset by foreign currency transaction losses during the quarter.

Adjusted EBITDA totaled $41.7 million for the first quarter, increasing 36% over the prior year, and largely reflecting operating profit performance. Depreciation and amortization totaled $10 million for the first quarter, approximately the same as the prior year level.

As a result of generating $31.4 million in cash from operations during the first quarter, and despite a combined increase of $8.9 million in capital and deferred software spending during the first quarter, SWM debt net cash, totaled a negative $21.3 million as of March 31, 2010. This is comprised of remaining largely euro denominated borrowings, and cash holdings, of which approximately two-thirds our U.S. dollar based.

Our current positive net cash position is expected to return to net debt, although still likely at a lower level as 2010 progresses, and we continue the significant capital investments in high value products, including RTL expansion in the Philippines in creation of LIP capacity in Europe.

During March we received as expected, an approximate $20 million refund of income taxes paid in France during 2009, as a result of beneficial use of net operating losses. This enabled SWM in total to hold the working capital investments flat for the quarter, despite increased trade receivables. Cash employee severance payments of $5.5 million were made during the first quarter.

We continue to expect 2010 cash needs to be significant, ranging from $165 million to $185 million. We are increasing 2010 projections for capital spending to $105 million to $115 million, which includes $85 million to $95 million in strategic high value product investments for RTL capacity in the Philippines, and LIP in Europe.

The Philippines RTL investment is being funded with the proceeds of the November 2009 secondary equity offering, and EU LIP investments will be financed from cash generation in our existing credit facility. Old projects include a large amount of euro denominated expenses, and thus total project costs are benefiting from the stronger dollar.

Restructuring related cash severance payments and other cash needs, including differed software projects, continue to be expected to total $50 million to $60 million. Not shown here is any equity investment required for an RTL joint venture in China, which is depended upon timing of an agreement to proceed. We expect to be able to readily manage the up to $25 million in equity investment required, when the opportunity comes to fruition.

We continue to increase performance as measured by a primary indicator of shareholder value creation return on our invested capital. The 16.4% level we are averaging over the last 12 months, reflects the success of our strategy to shift our business to higher margin LIP and RTL product, as well as success in sustaining a profitable base paper operation, which still accounts for a significant share of SWM invested capital.

Operating profit margins, excluding restructuring and impairment expenses support this transformation. The U.S. segment, largely reflecting high value LIP products, attained 24% operating profit return on sales. The French segment, including high value RTL reported 17.5% operating profit return on sales; and the Brazil segment, which is exclusively base paper, and therefore has a high exposure to pulp price, sustained positive operating profit return on sales at 6.2%.

With SWM’s investment in high margin RTL and LIP, we expect to continue earnings, superior levels of return on invested capital in the coming years. We confirm expected 2010 EPS of at least $4.60 a share, excluding restructuring and impairment expenses.

We face an increasing challenge to earnings from higher pulp prices and unfavorable foreign currency translation impacts from a weaker euro versus the dollar. However, given the strong start to the year, we are confident in our ability to deliver earnings of at least $4.60 per share, largely from expected continued strength in RTL and LIP high value products in our China JV.

We are working to sustain the important cost reductions already achieved this year and further build upon these through full deployment of operational excellence in realizing planned benefits of restructuring activities.

Our current earnings guidance is based upon pulp prices, averaging 5% to 10% above first quarter levels for the balance of 2010, and the U.S. dollar to euro exchange ranging from a $1.30 to $1.35.

[Technical Difficulty]

Question-and-Answer Session

[Technical Difficulty]

... under contractor adjustments. So we’ll get a chance to reset selling prices for a fairly significant percentage of our revenue, and again this is mostly on the base paper side, the more commodity part of the business, where margins are thinner to begin with.

It’s hard to give an exact percentage, because it depends on what happens with pulp prices, yet this next two months, May and June, in terms of the reset mechanism. Kind of the way that we are viewing it in terms of looking at both pulp price movement, and then recovery of pulp price through revenue, is we will be short, we will not be fully recovered through 2010. It’ll be a negative as we’ve explained in our earnings guidance.

Then of course 2011 full recovery will be dependent upon negotiations this fall, but to the extent that we have major customers, and we are taking action to raise prices with non-contract business, more short-term business, we do expect to see a pretty good level of pulp price recovery mid-year.

Operator

(Operator Instructions) Your next question comes from Ian Zaffino - Oppenheimer & Co.

Ian Zaffino - Oppenheimer & Co

The question would be really more on the LIP you are at the strengthening, what would you think is allowing you to [Inaudible]. The first move or advantage, is it here your customers fear that they’ve got to come out with pending patent litigation and that we expect these.

Then maybe I guess you could just walk us through how your agreements work with the cigarette manufacture as far as when they are specing out, how long to place on, how closely we work with them before you actually launch the cigarette, and then what are the barriers to entry. Thanks.

Frederic Villoutreix

Good morning and let me take this question. I think its’ all of the above and more. I think security of supply will become the main drive for the international to secure a solution that works and also proving in the market place, and also to be ready when the regulation hits the European market.

As I think as you know, and as we discussed a little bit earlier, the milestone right now is very important as far as the time out to be published and the mandate of the CM which is the European citation committee to publish or standout in August, September; and then it will be up to individual countries to adopt regulation where the traditional player can be short of six months.

So for the internationals, they want to make sure that there is capacity installed to meet their need, that could come as early as even the last first quarter of 2011, and then from then to ramp up production to fill the retail pipeline. This is a matter of four plus months as we demonstrate it with some sales for Australia and Finland, say to impact the fourth quarter of 2009.

Now we are being in discussion with all internationals and customers in Europe for several years as we communicated before. We have been engaged in activity to qualify our technology, our products, in the various brands in Europe, and I think it’s a combination of the timing, the combination of the value proposition that we offer, a combination of the proven capabilities of our products, and the need for these companies to add a competitive product that allow them to compete effectively in the marketplace.

Operator

(Operator Instructions) There are no further questions at this time.

Pete Thompson

Okay good. Thank you very much.

Frederic Villoutreix

Thank you, Tracey. Thanks you everyone. Have a good day. Bye, bye.

Operator

This concludes today’s conference. You may now disconnect.

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