Mativ Holdings Inc (MATV) 2004 Q3 法說會逐字稿

Good morning. My name is Lori (ph) and I will be your conference facilitator. At this time I would like to welcome everyone to the Schweitzer-Mauduit International third-quarter 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 period. (OPERATOR INSTRUCTIONS) I will now turn the call over to Paul Roberts. Please go ahead, sir.

Good morning. I'm Paul Roberts, the Chief Financial Officer of Schweitzer-Mauduit International. With me is Wayne Grunewald, our Corporate Controller. Thank you for joining us for a review of our third-quarter 2004 financial results. If for any reason you did not receive our earnings press release issued earlier today, you may access it on our website www.Schweitzer-mauduit.com or call 800-514-0186 and a copy will be faxed or e-mailed to you. Today's conference call will also be available on our website.

Various comments or remarks that we may make during today's conference call concerning future expectations, plans and prospects for the Company, and anticipated financial and operating results constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the Safe Harbor created by that act. The forward-looking statements are based upon management's expectations and beliefs concerning future events and factors impacting the Company. There can be no assurances that such factors or events will occur or that the Company's results will be as estimated.

Many factors outside the control of the Company could also impact the realization of such estimates. Such factors are discussed in more detail in the Company's Securities and Exchange Commission reports, including the Company's annual report on Form 10k for the year ending December 31, 2003. Prior to a detailed discussion of our financial results I will review the highlights of the quarter.

Net sales totaled $164.1 million, an increase of 15 percent. This increase was caused by increased sales volumes and improved mix of products sold, higher average selling prices and changes in currency exchange rates. The Company's gross profit margin was 19.3 percent, compared with 19.6 percent in the prior year quarter.

Operating profit was $16.7 million, an increase of $900,000 or 6 percent from the third quarter of 2003. Diluted earnings per share were 67 cents, compared with diluted earnings per share of 72 cents in the third quarter of 2003, a decline of 7 percent. The improvement in operating profit was more than offset by increased interest expense and the higher effective income tax rate.

Capital spending totaled $10.8 million, compared with $34.2 million during the prior year quarter. Capital spending to implement the Company's new cigarette paper manufacturing strategy continues on schedule with a new cigarette paper machine expected to begin operation in Brazil during the fourth quarter.

I will now provide a more detailed review of our third-quarter financial results and our outlook for the balance of the year. Net sales totaled $164.1 million, an increase of $22 million, or 15 percent compared with the third quarter of 2003. Unit sales volumes increased by 9 percent compared with last year, having a favorable $8.7 million or 6 percent impact on the net sales comparison. Excluding sales of the Indonesian operation that was acquired in February of this year, sales volumes increased by 7 percent.

Sales volumes for the French segment increased by 13 percent year-over-year primarily as a result of increased reconstituted tobacco leaf or RTL, sales supported by the new RTL production line that began operation in the fourth quarter of last year. Excluding sales volumes of the Indonesian operation which are included in the French business segment results, the increase in French sales volumes was 10 percent. French sales volumes are expected to continue to benefit from the new RTL production capacity.

Sales volumes in are Brazilian business improved by 9 percent, compared with the third quarter of 2003. This improvement was primarily a result of increased sales of tobacco related papers. Higher sales volumes were achieved in both the domestic Brazilian market and in exports.

Sales volumes in the United States declined by 2 percent. Lower sales volumes were experienced in tobacco related and commercial and industrial papers. Sales of cigarette paper for lower ignition propensity cigarettes continued during the quarter.

According to the United States Department of Agriculture, export shipments of cigarettes increased by 5 percent from the prior year level during the first 7 months of 2004, the most recent period reported. Imports of cigarettes were down 7 percent versus the same period last year. For full-year 2004, we are anticipating that U.S. cigarette consumption will decrease approximately 3 percent with U.S. cigarette production declining by approximately 2 percent.

Higher average selling prices had a favorable $8 million impact on the net sales comparison increasing net sales by 6 percent. The improvement in average selling prices was primarily in the United States and in the French business unit reflecting in part an improved mix of products sold and price adjustments related to increased woodpulp costs.

Changes in currency exchange rates increased net sales by $5.3 million or 4 percent compared with the prior year quarter. The euro was approximately 9 percent stronger versus the U.S. dollar, while the Brazilian real was approximately 1 percent weaker versus the dollar.

Gross profit was $31.6 million, an improvement of $3.7 million or 13 percent from the prior year quarter. The gross profit margin was 19.3 percent, an improvement from the 18.3 percent gross profit margin in the second quarter of 2004, but a slight decline from the 19.6 percent gross profit margin experienced in the third quarter of 2003. The increase in gross profit was attributable to increased production and sales volumes, and improved mix of products sold and higher average selling prices. These positive factors were partially offset by increased woodpulp, labor, purchased energy, employee benefit and paper machine start-up expenses.

The stronger euro compared with the U.S. dollar also put pressure on the gross profit margin since most of the costs in the French operations are incurred in euros while approximately 25 percent of the sales of the French operation are in U.S. dollars.

The list price of northern bleached softwood kraft pulp, a bellwether pulp grade, averaged approximately $670 per metric ton in the United States during the quarter, compared with $550 per metric ton in the third quarter of 2003, a 22 percent increase. The list price of northern bleached softwood kraft pulp began the quarter at $680 per metric ton, and declined by $30 per metric ton in September. The list price declined by an additional $30 per metric ton in October to $620 per metric ton and is likely to remain near that level during the balance of the year. This would represent approximately an 8 percent increase over the $575 per metric ton averaged during the fourth quarter of last year.

Year-over-year higher per ton woodpulp costs had an unfavorable impact on operating expenses of $1.7 million in the third quarter. Purchased energy cost increased by $900,000 compared with the third quarter of 2003. Higher energy costs were experienced in the French and U.S. business units primarily related to higher natural gas and electricity costs.

Nonmanufacturing expenses increased by $2.8 million or 23 percent with increases in selling, research and general expense. The increase in selling expense was largely the result of sales commissioned in France associated with increased sales volumes. Higher general expense included increased costs for employee compensation and outside services related in part to Sarbanes-Oxley Act section 404 compliance activities. Changes in currency exchange rates contributed to higher nonmanufacturing expenses in France. Nonmanufacturing expenses as a percent of net sales increased from 8.5 percent in the third quarter of 2003, to 9.1 percent in the current year quarter.

Operating profit was $16.7 million, an increase of $900,000 or 6 percent compared with the third quarter of 2003. Operating profit return on sales improved sequentially from 8.7 percent in the second quarter of this year, to 10.2 percent. But it was under the 11.1 percent in the third quarter of last year. The operating profit improvement reflected gains in the French and U.S. business segments partially offset by a small decline in operating profit in Brazil.

Operating profit in the French segment was $16.4 million, an improvement of $1.2 million over last year. This improvement was primarily the result of increased production and sales volumes, partially offset by increased woodpulp, labor, purchased energy and nonmanufacturing expenses. Higher selling expenses were incurred in the French operations in support of the increased sales volumes.

Operating profit in the U.S. business unit was $800,000, an improvement of $700,000 compared with the third quarter of 2003. This increase in profitability in the United States was the result of higher average selling prices and improved mix of products sold and sales of cigarette paper for lower ignition propensity cigarettes. These positive factors were partially offset by increased woodpulp, purchased energy, labor, employee benefit and nonmanufacturing expenses.

Startup expenses totaling $900,000 were incurred related to the operation of a cigarette paper machine at the Spotswood, New Jersey mill that was rebuilt as part of the Company's new cigarette paper manufacturing strategy. Additional startup costs associated with this machine are expected during the fourth quarter with the rebuilt cigarette paper machine expected to be a positive contributor beginning in the first quarter of 2005.

Operating profit in Brazil declined by $300,000 to $1.4 million during the quarter. Increased production and sales volumes were more than offset by higher cost of sales. Preoperating costs of $100,000 related to the installation of a new cigarette paper machine were incurred. Higher nonmanufacturing expenses were also experienced in Brazil.

Interest expense increased by $800,000, caused by a higher lever of outstanding debt required to support the Company's capital spending and working capital requirements. Interest rates also increased somewhat compared with the prior year period. Interest expense is expected to have a continuing unfavorable impact on the year-to-year comparison during the fourth quarter.

Schweitzer-Mauduit's effective income tax rate was 26 percent for the quarter, compared with an effective income tax rate of 24 percent in the third quarter of 2003. The lower effective income tax rate in the prior year quarter was primarily due to a reduction of valuation allowances on deferred income tax assets related to foreign tax credits in the United States.

Net income total, $10.3 million, a decrease of $500,000 or 5 percent from net income of $10.8 million. Diluted earnings per share were 67 cents compared with diluted earning per share of 72 cents in the third quarter of 2003, a 7 percent decline. The decline in both net income and diluted earnings per share was caused by the increase in interest expense and the higher effective income tax rate which more than offset the gain in operating profit.

During the quarter Schweitzer-Mauduit repurchased 134,656 shares of its common stock at a cost of $4 million. Year-to-date share repurchases have totaled 257,556 shares at a cost of $7.5 million. This share repurchase activity was conducted under a Board of Directors authorization for the period January 1, 2003 through December 31, 2004, in an amount not to exceed $20 million. A total of $12.6 million of share repurchases has been completed thus far against this authorization.

Earlier today Schweitzer-Mauduit announced a quarterly common stock dividend of 15 cents per share. This dividend will be payable on December 13, 2004, to stockholders of record on November 15, 2004. The Company has paid quarterly dividends of 15 cents per share since the second quarter of 1996.

Capital spending totaled $10.8 million compared with $34.2 million for the third quarter of 2003. Capital spending in 2004 included $1.9 million for construction of the new reconstituted tobacco leaf production line in France compared with $28.2 million spent on this project during the third quarter of last year. The new RTL production line began operation in the fourth quarter of 2003, and continues to make steady gains. The production rate of the new line has been increasing monthly and has met end of curve expectations.

Implementation of the Company's new cigarette paper manufacturing strategy that was announced during the second quarter of 2003 continued during the quarter. In support of this strategy, $12.7 million is being spent to install a new cigarette paper machine and supporting equipment at a Brazilian operation, and $4.4 million is being spent to rebuild a cigarette paper machine at our Spotswood paper mill. These capital projects are expected to be largely completed by the end of 2004 and should benefit future years. We incurred $3.3 million in spending for these 2 capital projects during the quarter.

The rebuilt cigarette paper machine at the Spotswood mill is still in the start-up phase and the new sacred paper machine in Brazil is expected to begin operation later this year.

Schweitzer-Mauduit is expecting total capital spending for full year 2004 to be approximately $47 million, and to total approximately $30 million in 2005. Schweitzer-Mauduit has continued limited production and sales of cigarette paper for lower ignition propensity cigarettes. A law that implemented fire safety standards for cigarettes in the State of New York took effect in June. Since that date all cigarette sold in New York are required to be cable of self extinguishing when they are not being smoked.

Regulations are still being developed in Canada that would require lower cigarette ignition propensity properties. The proposed regulations mandate an ignition propensity standard for all cigarette manufactured or imported into Canada on or after October 1 of next year. The final standard and the actual implementation date are still subject to change although Schweitzer-Mauduit expects Canada to implement the proposed requirements effective in the fourth quarter of next year.

Schweitzer-Mauduit continues to work with our customers in their development of lower ignition propensity cigarettes in anticipation of the pending Canadian regulations and to also improve the performance of cigarette papers for lower ignition propensity cigarettes that are already being sold. As additional experience is gained, cost improvements are being achieved in the production of these products.

In Schweitzer-Mauduit's earnings press release issued earlier today, we reaffirmed our previously disclosed earnings guidance. Diluted earnings per share for full year 2004 are expected to be approximately at the prior year level. Increased operating profit is anticipated for full year 2004 offset by increased interest expense, higher minority interest and a higher effective income tax rate compared with 2003.

The fourth quarter is expected to benefit from increased production and sales volumes supported by the new RTL production line in France. Sales of cigarette papers for lower ignition propensity cigarettes are also expected to continue during the quarter. These papers sell for a higher price than the conventional cigarette papers they replace.

Market conditions for our businesses continue to be largely favorable with improved sales volumes and selling prices. Schweitzer-Mauduit is beginning, however, to experience some weakness in our tobacco related paper sales in Western Europe. This weakness is caused in particular by reduced cigarette consumption in France and Germany which are reportedly experiencing double-digit declines in consumption in 2004 following recent tax increases on cigarette sales in those countries.

New sacred paper manufacturing capacity was added in Western Europe in mid-2004 which is also contributing to the more competitive situation.

Schweitzer-Mauduit will continue to face various cost pressures during the fourth quarter. The per ton cost of wood pulp is expected to be above prior year levels with purchased energy costs also expected to be unfavorable. Increases have also been experienced in our employee benefit costs and labor rates. Interest expense will also remain above prior year levels.

Capital spending associated with the Company's new cigarette paper manufacturing strategy should be largely completed in the fourth quarter. Start-up costs will be incurred during the quarter related to the cigarette paper machines in both the United States and Brazil. These start-up costs are likely to exceed the benefits of these projects during the fourth quarter with a positive contribution expected in 2005.

That concludes our planned comments. Lori, could you please open the phone lines for questions?

Terry O'Connor (ph) of Cedar Creek (ph).

A couple of things. One is, am I correct that the U.S. operating profit was about 1.7 (ph) million before the start-up expenses in Spotswood?

That is correct.

That is a pretty delta on minus 2 percent volumes. Is it largely price or mix or can you give us a little more color on that?

It's really a combination of several things. Part of it is some improvements in mill operations, higher selling prices are starting to kick in a little bit as we have adjustments in some contracts related to pulp price increases. Also a significant contributor compared to the prior year quarter is an improved mix of products sold in a couple of different product lines but probably the most notable one is the sale of cigarette papers for lower ignition propensity cigarettes which was a positive contributor during the quarter.

When is the last time you made $1.5 million in the U.S. in a quarter? It's been awhile hasn't it?

I'd have to go back and look. Again we didn't make that much, but on a -- without the start-up cost, it certainly, as you say would have been in that range.

Next year you are still looking for 30 million-ish round numbers in CapEx? Is a good D&A run rate about 50 million bucks?

Again, I think if you annualized through the first 9 months of this year we were at $27 million.

But this most recent quarter was significantly higher than that.

It was up a little bit and part of that was currency in France.

So maybe a $40 million number? So maybe 10 million of excess depreciation next year?

Yes and again, that may be a little bit on the high side.

What about deferred tax? What should we think about for next year in that regard?

Again, it would probably be somewhat similar to what we're experiencing this year. Part of that is the benefit now in France of accelerated depreciation on the new equipment. That started up. So we would expect to see deferred income taxes on the cash-flow statement continuing to be more in the range of the 2004 number than the 2003 number.

Okay. Let's pick a number like 50 million of free cash flow next year off of kind of a similar earnings and just make up a number -- similar EPS number plus excess depreciation and deferred tax gets you $50 plus million which is pretty significant. What are your intentions for that going forward? You have interest expense significantly higher this year. Is your first goal here to pay down debt?

Again, first of all I wouldn't comment on your projections on free cash flow because we have not given those, that level of projections. But again, we would expect to bring down debt to some degree if we had that level of free cash flow. We would certainly be looking at share repurchase again depending on where the stock is at. We would expect to go forward to our Board later this year asking for another share repurchase authorization although that's still subject to their approval. We have commented in the past also that if we were to find any strategic opportunities, and we have talked in the past that we continue to have negotiations in China relative to a possible joint venture, that also would be a possible use of cash for the business. And I think strategic opportunities, a chance to grow our core business would probably be our first priority.

One last question and then I will let somebody else jump on. Research expense doubled year-over-year. Is there timing issues there? Is there something new you are doing?

Part of that really is just the timing of when different expenses were incurred on a full-year basis. Again, I think it'll probably be consistent with what we've been running.

Thank you very much.

Thank you Terry.

Mark Anderson (ph) of Axiom Capital (ph).

Paul, my question really was along the capital allocation plans for next year, sort of like the earlier question. You are going to be generating an awful lot of free cash as your CapEx plans come down. I'm just wondering what the maintenance level of CapEx is for your business, and any other thoughts you might have on capital allocation going forward?

Historically our maintenance level of CapEx has approximated or been a little bit less than depreciation. Our depreciation has grown a bit with the heavy level of capital spending, so our maintenance level of CapEx going forward would probably be less than what our depreciation and amortization rate is. It may be in the range of roughly $25 million a year. Again, if we had strategic things above and beyond that such as the new cigarette paper machine going into Brazil, that would be added to that.

Great. My last question really was regarding the strategy of being able to produce globally, how do you feel about the decision to move into Brazil and to rebuild the plant down there?

We believe that over time both the demand for higher quality cigarette papers would attract the move to more sophisticated cigarettes will really require us to have a stronger presence in developing countries. We also have a more attractive cost picture in developing countries. By that I would mean countries like Brazil or Indonesia where we did the acquisition earlier this year. We believe that is really the right direction to be moving as a corporation that additional capacity that we might be adding would be in a lower-cost part of the world and that's also where increasing demand is coming from.

Again I think our strategy for really trying to be able to service our customers more effectively is better served by expanding Brazil which we are doing and by having a stronger production presence in Asia which we really got into that area of the region with the acquisition in Indonesia in February at this year.

Apart from a joint venture in China, should we expect further capital investment in Indonesia going forward?

Again, up to this point we have not announced anything that would be significant or large enough that we could comment separately. It's not a large operation but it's a good business for us and our plan right now is incremental investments in that business to improve the quality, to improve the productivity. Again, we would have to assess what the business plan of a more significant investment would be in that region, in that particular location before we would go forward with something like that.

Okay. Great. Thank you.

Thank you Mark.

(OPERATOR INSTRUCTIONS) Ann Gurkin at Davenport.

Starting with the sales increase, if you break out the components that you all highlighted at higher volume, higher average selling prices and higher benefit from currency, but if you look at the mix, it looks like there was a greater portion from the volume this quarter versus the second quarter than the average selling price as a percent of the increase in the sales? Any comments on that?

That is correct. Volume did have a little bit more of a contributor this year, this quarter than last year. We had particularly strong sales growth in our French operations and part of that was driven by the additional capacity that we've added. So that was almost 6 percent of the 15 percent increase in sales was due to higher volume.

That is a lower average selling price that skewed the mix?

Again, selling prices (multiple speakers)

But RTL was a higher?

And average selling prices again were up $8 million quarter-to-quarter.

Yes, but as a percentage of the increase, it was not up as great as the second quarter.

I guess I'd have to go back and look, Ann, to see. Again, I wouldn't say there's anything significantly different quarter-to-quarter relative to our pricing.

And you touched a little bit on China. Should we hear any update, any news regarding work there? Sooner than later or any kind of timing there?

China continues to be an interesting opportunity for us. We have made several comments publicly in the past and in our 10Ks that we do continue to be in what we consider pretty serious discussion with the Chinese government as far as going in with a joint venture in China for making tobacco related papers. Again, until something is definite, it's not definite but we believe we are continuing to make good progress. What we want to be sure is that we, if we do go forward, we are doing so on a basis that we feel protects our interests and is in our shareholders best interest and will look out for our technology and the needs of our Company on a long-term basis.

So the negotiations are challenging; they're difficult, they take an extended period of time that's not inconsistent with what we've learned from talking to other people that have gone into that country. All I can say is we continue to work very seriously on that and to narrow differences. I couldn't really give a projection on if or when we'd reach final conclusion on those negotiations or when we would be announcing something but certainly as soon as we are in a position to do so we would say something publicly.

Would you comment on your projections for cost in "05?

We haven't really said a lot about '05 at this point. We would expect to say more when we're releasing our fourth-quarter results. Again, it does look like pulp costs will probably -- if the economies continue to grow, it could be up a little bit next year compared with this year as well. Energy costs are expected to be up a little bit as well. Several of the things that the one-time type of costs that we incurred this year we expect to be largely behind us next year.

We did incur, as we've laid out in our press release during the first 9 months of the year, we had $1.8 million of start-up cost in the United States for a rebuilt cigarette paper machine. We had start-up costs for our French RTL operation in France. We had 1.2 of costs to shut down the Paris office in France. Those should all be behind us. We will also be incurring start-up costs in Brazil in the fourth quarter of this year and probably a little bit in the first part of next year although the lion's share of those should be in the fourth quarter of this year. So on the year-over-year basis, we should not see near the one-time type of costs that we've incurred so far this year.

What about the outlook for labor cost?

Labor costs I think are still going to be a challenge given the performance of the equities market and what is interest rates for long-term bonds really have not moved very much. So I'd expect a pension expense is going to continue to be a negative as it was this year. Medical costs will probably continue to be a negative year-over-year as well. Again, based upon preliminary indications we've seen on what rates are likely to be, we're still in the process of negotiating those plans out and looking at possible planned modifications and so forth. But again, the indication is that those benefit expenses will probably continue to be higher again primarily driven by pension and medical.

How about costs for like Sarbanes-Oxley, what do you protect for those?

Again, we have not given a number, we probably will. It will be large enough I'm afraid in the fourth quarter that we would comment on it. We have been incurring Sarbanes-Oxley costs for about 18 months now, but the pace of those expenses has certainly accelerated. We have added people this year in France, in Brazil, in the United States to support Sarbanes-Oxley. Our outside auditor fees are up dramatically as a result of Sarbanes-Oxley. Part of that will be a higher cost in the fourth quarter, year-over-year though it would be premature but I'm not sure that I'd expect Sarbanes-Oxley costs to be higher next year than this year.

Looking at your balance sheet, the inventory number is up versus last year? Can you comment on that?

Our working capital in total is up a bit and I guess my comments really and more than what we've typically seen this time of year. The inventory number being up $10 million from the end of last year, a part of that is inventory that we acquired with the acquisition in Indonesia. I think that may have been in the range of 1.5 to $2 million so that would have been part of that.

Part of the change in inventory since the end of last year is the increase in pulp costs that we've seen. Pulp is a fairly large inventory item for us and as our inventories have -- or as pulp costs have gone up that is reflected in higher inventories. And then also supporting the increase in higher sales volumes there has been some increase in inventories as well. That is something we're looking at to see if again we can manage that down a bit lower before year end.

Great. Thank you very much.

Thank you Ann.

Terry O'Connor of Cedar Creek.

Could you just describe where you are in utilizing the new RTL machine and at some point do you anticipate going back to the third machine?

We are running, again just to kind of -- a little bit of color on it. We do have 3 RTL machines now in France. The new one that began operation of last year which has a capacity of 33,000 metric tons and then the 2 existing ones that combined head capacity of 47,000 metric tons. After we started up the new machine, our plan was to fully load the 2 most efficient machines which were the number 2 and the never 3 machines, the 2 newest machines, and those 2 machines have been running full since we started up the new machine.

We continued to run the third machine the first part of 2004 until we kind of got caught up with order backlogs and made sure that we knew where we were in terms of the performance of the number 3 machine. We have had needs since that time to intermittently operate the number 1 machine to keep up with additional demand. Number 1 is already operating a little bit, Terry, as an on-needed basis and over time we will continue to have the flexibility to utilize that machine.

Thank you very much.

You are welcome. Thank you.

At this time there are no further questions.

Okay, I would like to thank everybody then for taking the time to join us today. Goodbye.

Thank you. This concludes today's Schweitzer-Mauduit third-quarter earnings release conference call. You may now disconnect.