Mativ Holdings Inc (MATV) 2006 Q3 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the Schweitzer-Mauduit International third quarter 2006 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). Thank you. Mr. Thompson, you may begin your conference.

Thank you. Good morning. I'm Peter Thompson, Chief Financial Officer of Schweitzer-Mauduit International. With me are Wayne Grunewald, our Corporate Controller, and several executive officers of the Company. Thank you for joining us for a review of our third quarter 2006 financial results. I will be leading our conference call today.

Various comments or remarks that we make during today's conference call 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. Actual results may differ materially from the results suggested by these statements for a number of reasons. Such factors are discussed in more detail on the Company's Securities and Exchange Commission report, including the Company's annual report on Form 10-K for the year ending December 31, 2005.

Prior to a detailed discussion of our financial results, I will review the highlights of the quarter. The diluted loss per share was $0.11 compared with diluted earnings per share of $0.37 in the third quarter of 2005.

Restructuring expenses of $12.4 million or $0.52 per share were incurred during the quarter. Earnings without restructuring expenses would have been $0.41 per share for the quarter, an increase of 11%, marking the first year-over-year improvement in quarterly results in two years.

Schweitzer-Mauduit has initiated three restructuring activities in 2006, expected to improve the Company's competitiveness and profitability, but causing significant restructuring expenses impacting both the third quarter and year-to-date results. A discussion of restructuring activities follows later in this call.

Net sales totaled $161.5 million, 3% below the prior year quarter due to decreased sales volumes, partially offset by somewhat higher average selling prices and improved mix of products sold, and favorable currency impacts. The operating loss was $2.8 million, a decline of $13.5 million from the prior year quarter operating profit of $10.7 million. Excluding restructuring expenses, operating profit would have been $9.6 million for the quarter, a decrease of $1.1 million or 10%.

The Company's gross profit margin, which does not include restructuring expenses, was 14.1% compared with 14.7% in the prior year quarter. The decline in profitability excluding restructuring expenses compared with the third quarter of 2005 was the result of the inability to fully offset inflationary cost increases, unabsorbed fixed costs, and lower sales volumes through improved mill operations or higher selling prices.

Inflationary cost increases unfavorably impacted operating results by $3.8 million in the quarter, or roughly $0.15 per share. The unabsorbed fixed costs were carved by lower production volumes and had an unfavorable impact on the operating results of $3.5 million, or roughly $0.14 per share. Lower sales volumes decreased operating profit by $2.7 million or roughly $0.11 per share.

We are encouraged with our increasing success in offsetting these unfavorable impacts through cost reduction activities across all our business units combined with a better sales mix, primarily reflecting increased sales of cigarette paper for lower ignition propensity cigarettes.

Before providing a more detailed review of our third quarter financial results, and our outlook for the year, I will cover a discussion of restructuring activities. As noted earlier, Schweitzer-Mauduit initiated three restructuring activities during the first nine months of 2006, which are expected to substantially improve the Company's competitiveness and profitability, as well as address the present imbalance between sales demand and paper production capacity in France and the United States. Restructuring expenses totaling $12.4 million associated with these three actions were recognized during the third quarter.

For the first nine months of 2006, restructuring expenses totaled $16.3 million. The restructuring activities included two previously announced actions at the Lee, Massachusetts facility. The first resulted from a notice by Kimberly-Clark Corporation to terminate its agreement effective in 2007 for the operation of a paper machine at the site, and in an attempt to mitigate the unfavorable cost implications of this action, the subsequent transfer of production between paper machines as well as reductions in employment.

The second was associated with the exit of the decor papers business in the United States and resulting shutdown of another paper machine. Restructuring expenses in the United States for these two actions totaled $1.8 million in the third quarter and $5 million through the first nine months, primarily related to noncash accelerated depreciation of fixed assets.

The third and final activity includes the recently disclosed five-part strategy to become the most cost and quality competitive cigarette and long fiber paper manufacturer in Western Europe. This plan includes capital investments of $23 million as well as workforce and paper machine restructuring activities at the largest of the Company's three French paper operations, Papeteries de Mauduit, or PdM located in Quimperle, France.

In September, the negotiation process required by French law began with PdM's labor unions to implement the 209 employee downsizing, which equates to roughly one-quarter of the site's workforce. Additionally, the PdM restructuring plan anticipates the shutdown of two paper machines during 2007. Restructuring expenses in France totaled $10.6 million during the third quarter, and $11.3 million through the first nine months, primarily related to minimum cash severance payments required under French law and accelerated depreciation of fixed assets. Actual payment of any severance amount will occur over time with the final amount and timing not known until the negotiation process is complete.

I will now cover ongoing business results. Net sales for $161.5 million, a decrease of $4.2 million or 3% compared with the third quarter of 2005. Unit sales volumes decreased by 9% compared with the prior year and had an unfavorable $13.2 million impact on net sales.

Sales volume for the French segment decreased by 15% from the prior year quarter. Sales volumes decreased for reconstituted tobacco leaf products, primarily due to the lower margin tender business during the prior year quarter and for tobacco related papers in the French, Indonesian, and Philippines operations.

Sales volumes in the United States decreased by 16%, reflecting a reduction of commercial and industrial paper sales as a result of the decor papers exit and consolidation of paper production on fewer machines as well as lower sales of tobacco-related papers. Sales volumes of cigarette paper for lower ignition propensity cigarettes increased.

Sales volumes in Brazil increased 24% due to increased commercial and industrial paper sales as well as higher export sales of tobacco-related papers, in part reflecting our strategy to shift production of certain grades from the United States to Brazil.

Higher average selling prices had a favorable $5.3 million impact on the net sales comparison. Higher average selling prices were realized in all three business segments largely attributable to a change in the mix of products sold.

Changes in currency exchange rate increased net sales by $3.7 million compared with the prior year quarter. Both the euro and the Brazilian real were stronger versus the dollar by 5% and 7% respectively, accounting for the positive impact. Gross profit was $22.7 million, a decrease of $1.7 million from the prior year quarter. The gross profit margin was 14.1%, declining from 14.7% in the third quarter of 2005.

Significant inflationary cost increases and lower production in sales volumes unfavorably impacted gross profit. These negative factors were partially offset by improved mill operations and somewhat higher average selling prices.

Inflationary cost increases unfavorably impacted operating results by $3.8 million during the quarter. Purchased energy costs increased by $1.9 million compared with the third quarter of 2005. Higher energy costs related to higher electricity, natural gas, and fuel oil costs in France.

The rate of year-over-year energy costs increases slowed during the third quarter, especially for natural gas prices in the United States. Changes in the per ton cost of wood pulp increased our operating expenses by $1.3 million. The higher wood pulp costs were experienced in all business units.

The list price of northern bleached softwood kraft pulp or NBSK, a bellwether pulp grade, averaged $755 per metric ton in the United States during the quarter compared with $625 per metric ton in the third quarter of 2005, and $705 per metric ton in the second quarter of this year. The world pulp market continued to tighten during the quarter with higher world pulp shipments and increasing pulp prices.

Market pulp inventories at the end of September is measured by days of supply remained near a three year low. The price, the list price of NBSK in the United States increased from $725 per metric ton in June to $770 per metric ton in September. Pulp prices are likely to increase further before reaching a peak sometime in the first half of 2007. Although a new market pulp production capacity is being added, greater demand from Asia and the closure of formally integrated pulp mills are helping to keep the market in balance. Pulp mill operating rates continue to be high on a global basis.

Changes in labor rates also increased manufacturing expenses by $800,000 during the quarter. Reduced machine operating schedules and lower production volumes were experienced primarily in our French operation. This resulted in unfavorable fixed cost absorption impact that reduced operating results by $3.5 million.

Lower sales volumes decreased operating profit by $2.7 million. These unfavorable cost and sales volume factors were largely offset by improved mill operations. Significant operational improvements were achieved in each of our business units through increased productivity, reduced waste, energy-related conservation, and cogeneration projects and other cost reduction efforts.

Nonmanufacturing cost were $600,000 less than the prior year quarter, a decrease of 4%. Selling and research were both lower, reflecting cost reduction efforts in these areas. Nonmanufacturing expenses were 8.1% of net sales in the third quarter, down slightly from 8.3% in the prior year period.

The operating loss was $2.8 million, a decline of $13.5 million compared to the operating profits of $10.7 million in the third quarter of 2005. The operating loss on sales was 1.7% compared with an operating profit return on sales of 6.5% in the third quarter of 2005. Excluding restructuring expenses of $12.4 million, operating profit would have been $9.6 million for the quarter, a decrease of $1.1 million or 10% from the third quarter of 2005.

Operating profit return on sales excluding restructuring expenses equates to 5.9% for the quarter. Operating profit declined primarily in our French business unit. The operating loss in the French segment was $1.1 million, a decline of $12.8 million from the prior year quarter.

Operating profit decreased $10.6 million due to restructuring expenses. Excluding restructuring expenses, operating profit in the French segment decreased $2.2 million or 19%.

Lower sales volumes decreased operating profit by $3.4 million while unfavorable fixed cost absorption from lower production volumes, primarily in reconstituted tobacco leaf, decreased operating profit by $3.2 million. Inflationary cost increases reduced operating profit by $2.9 million including higher purchased energy, wood pulp, and labor expenses.

Exchange rate impacts related to a stronger euro versus the U.S. dollar also decreased operating profit. These unfavorable factors were partially offset by improved mill operations, higher average selling prices, and reduced nonmanufacturing expenses. The U.S. business unit operating profit was $100,000 for the quarter, a $700,000 decrease versus the prior year quarter.

Operating profit decreased $1.8 million due to restructuring expenses. Excluding restructuring expenses, operating profit increased $1.1 million. Improved mill operations and higher average selling prices resulting primarily from an improved sales mix that included increased sales of cigarette paper for lower ignition propensity cigarettes caused U.S. operating profit, excluding restructuring expenses, to improve. In addition, the third quarter of 2005 included an unfavorable impact from exiting the cigarette paper booklets business in the United States, which contributed to the 2006 operating profit improvement.

Inflationary cost increases had an unfavorable impact of $700,000 during the quarter, primarily related to higher wood pulp and labor costs. Unfavorable fixed cost absorption from lower production volumes and increased nonmanufacturing expenses decreased operating profit by $700,000.

The Brazilian business unit had a $100,000 operating loss during the third quarter of 2006, slightly improved from the $200,000 operating loss during the prior year quarter. Improved mill operations and increased sales volumes benefited the operating results.

The stronger Brazilian real versus the U.S. dollar had an unfavorable impact of $600,000 on operating profit during the quarter, while inflationary cost increases totaled $200,000 related to increase the wood pulp expenses. Interest expense totaled $1.5 million during the third quarter, a decrease of $200,000 from the prior year quarter. Total debt declined $14.3 million or 13% during the quarter and our total debt to capital ratio stood at 22% at September 30 compared to 24% at the end of June.

Total debt is being managed lower and in anticipation of future funding requirements. The third quarter of 2006 included a benefit from income taxes due to the lost cost by restructuring expenses recorded during the quarter. Changes in the geographic mix of the expected full-year taxable earnings or losses of our businesses and the favorable tax impact of Schweitzer-Mauduit's foreign holding company structure.

Minority interest in earnings of subsidiaries decreased by $500,000 compared with the prior year quarter. This decrease reflected lower earnings at LTR Industries, a French subsidiary of the Company, which has a minority owner that owns 28% of its shares. The $100,000 loss from equity affiliates represents Schweitzer-Mauduit's 50% share of the preoperating expenses associated with our recently formed joint venture in China.

The net loss totaled $1.7 million compared with the net income of $5.8 million during the third quarter of 2005. The diluted loss per share was $0.11 compared with diluted earnings per share of $0.37 for the prior year quarter. The restructuring expenses caused a decline in both net income and in diluted earnings per share compared with the prior year quarter. Excluding restructuring expenses, diluted earnings per share would have been $0.41 for the third quarter of 2006.

Earlier today, Schweitzer-Mauduit announced a quarterly common stock dividend of $0.15 per share. This dividend will be payable on December 11, 2006 to stockholders of record on November 13, 2006. The Company has paid quarterly dividends of $0.15 per share since 1996.

Capital spending totaled $3.3 million compared with $5.2 million in the third quarter of 2005. No single capital project accounted for a material amount of the third quarter 2006 or 2005 capital spending. Schweitzer-Mauduit is expecting capital spending for 2006 to total approximately $15 million to $20 million. Capital spending for 2007 is expected to be in the range of $55 million to $65 million including the recently announced $23 million capital investment strategy at PdM as well as a planned upgrade of a paper machine in Brazil.

The Company made $5 million in cash pension contributions through the first nine months of 2006. Additional pension contributions are expected to be in the range of $7 million to $15 million through the end of 2007. The capital spending and pension contributions are expected to be funded through internally generated funds and Schweitzer-Mauduit's recently secured five-year revolving bank credit facility.

Despite lower net income, cash provided by operations totaled $50.5 million through the first nine months of 2006 compared to $12.9 million in the first nine months of 2005. The increase in cash generated primarily reflected lower working capital, which, as of September 30, 2006, decreased $21.2 million since December 31, 2005, with essentially all of the reduction occurring in the third quarter of this year.

During the first nine months of 2005, working capital increased $28.6 million. The decline in working capital reflected efforts to improve performance in this area, but was also impacted by the accounting for the French restructuring activity, which increased accrued liabilities to reflect minimum legal severance payments.

The non-cash impact of accelerated depreciation also contributed to the improvement in cash provided by operations. In mid-2005, Schweitzer-Mauduit announced a joint venture with the China National Tobacco Corporation to produce tobacco-related papers, both cigarette paper and porous plug wrap, at a new state-of-the-art paper mill in China. Current activity includes construction, equipment procurement, and establishment of administrative functions. The project is advancing smoothly and on schedule with mill operations currently expected to commence as planned in early 2008.

Sales of cigarette papers for lower ignition propensity cigarettes continue to positively contribute to our operating results, especially as we realize manufacturing efficiencies. In addition to the current demand in the United States -- in the states of New York and Vermont plus all of Canada, we anticipate increased sales during the fourth quarter prior to the January 1, 2007 effective date for lower ignition propensity laws in California.

Additionally, lower ignition propensity laws go into effect in the states of New Hampshire in October, 2007, and in Illinois and Massachusetts in January of 2008, at which time over 20% of the combined U.S. and Canadian cigarette sales will require compliance with lower ignition propensity regulations.

With further increases in sales volumes of this cigarette paper combined with expected continuing improvements in manufacturing cost, this product should continue to provide additional improvement to the U.S. business unit results. We expect to record additional restructuring liabilities during the fourth quarter of 2006 for severance offered to and currently being negotiated with the PdM labor union that is in excess of the legally required minimum amounts. Such minimum amounts were recorded during the third quarter of 2006. Negotiations with the PdM labor unions are expected to conclude during the fourth quarter. These additional severance amounts will be amortized to restructuring expense over the affected employees' service period during 2006 and 2007.

The three restructuring activities underway in France and the United States are expected to increase full-year 2006 expenses by $20 million to $22 million or approximately $0.80 to $0.90 per share.

We continue to experience weakness in tobacco-related product sales. Reduced demand for tobacco-related paper products in Western Europe and the United States as well as below planned levels of growth in new markets for our reconstituted tobacco leaf products have caused us to have excess production capacity and increased machine downtime. The impact of this downtime reflected an unabsorbed fixed cost is expected to unfavorably impact our full-year 2006 operating results by roughly $20 million or approximately $0.80 per share.

In addition to the three restructuring actions already announced, we continue to evaluate how to operate our worldwide production facilities more effectively with the reduced volumes of tobacco-related papers. Analysis continues into possible further restructuring activities that could result in additional expenses.

Inflationary cost increases are expected to have an unfavorable impact on the full-year 2006 of approximately $15 million or roughly $0.60 per share. Purchased energy cost increases have begun to slow. However, we continue to experience significant wood pulp price increases with per-ton list prices rising 7% during the third quarter alone, and with accumulative list price increase of approximately 20% expected during the year.

While over $13 million in inflationary increases have been realized already this year, the rate of cost increases is expected to further lessen in the fourth quarter and into 2007, as well as being increasingly offset through improved mill operations and continued efforts to systematically control all areas of cost.

It will take more time to fully realize the expected benefits of the significant and broad restructuring activities now underway. However, it increasingly appears progress and earnings will be possible over the coming year.

In the meantime, further restructuring expenses, reduced operating schedules, and inflationary cost pressures, although abating, are expected to continue during the fourth quarter. However, we also expect to continue to improve mill operations, benefit from cost control activities implemented earlier this year, and further growth, sales volume and profitability from cigarette paper used in lower ignition propensity cigarettes.

Even though earnings through the third quarter, excluding restructuring expenses, stand at $0.91 per share, 2006 will continue to be a challenging year. We reaffirm our guidance at full-year 2006 earnings, also excluding restructuring expenses, will be in the range of $0.85 to $0.95 per share. Earnings at or above the 2005 level of $1.26 per share, excluding any restructuring expenses, are expected to be achieved during 2007 after the benefits of the announced restructuring activities, further increased sales of cigarette paper for lower ignition propensity cigarettes, and reconstituted tobacco leaf products, and increased fixed cost absorption from improved production schedules are realized. That concludes our planned comments. [Operator], would you please open the phone lines for questions?

(OPERATOR INSTRUCTIONS). Jonathan Lichter, Sidoti & Company.

What tax rate are you assuming for the fourth quarter?

Well, during the fourth quarter, we're going to continue to see a situation on taxes much like we saw through the third quarter with restructuring activities causing it to be anomalous. Probably the better way to look at that is as we have projected earnings per share excluding restructuring expenses to increase, we would expect to return to a more normal or historical effective tax rate that, for us, is in the high 20s to low 30s.

And then, what was the, I guess, difference between Q2 and Q3 in terms of the French operation that the operating margin increased so much sequentially?

Really, of course, there's a lot of activity back and forth between the quarters, but what occurred within the third quarter for the French unit is, despite lower sales volumes, we have had success in cost reduction activities and we did have a good mix of products sold within the quarter that helped in terms of underlying profitability excluding restructuring activities.

Was that higher sales of RTL there?

Actually, RTL sales within the quarter, as we said, declined year-over-year, especially because the absence of the tender order that we filled in 2005 primarily affected us during the third quarter. Excluding that, RTL sales are more or less where they've been, which is a small growth to flat versus the prior year.

So, no, more of the effect is, despite the lower sales volume, it was a good mix of products sold, which doesn't necessarily signify a mix in our permanent business. It was more the particular customers and volumes that we shipped during that quarter.

The U.S. operating margin was down. Was that due to timing in terms of the low ignition paper sales?

No, the lower ignition paper sales were a key contributor for the profitability improvement year-over-year in the third quarter in the U.S. The big difference within the third quarter is, historically, July is a down month for us in the U.S. and that was true again this year. That's associated with customer downtime, lower shipments, and then downtime we take at our mills, especially for maintenance activity.

And you made some comments that Indonesian and the Philippines also were somewhat weak.

Yes, in the third quarter, this is the first year that we really had a year-over-year comparison for the Philippines because we did the acquisition in June 2005. But yes, sales were off in those units as well -- sales volumes -- but that, again, is more timing related. Those units, of course, are much smaller. When there's a relatively small absolute volume change, it can be large on a percentage basis. So it was an off quarter in terms of sales, but not necessarily signifying that we've seen any permanent shift in our businesses there.

And then I guess you still expect some weakness for RTL in the fourth quarter. What makes you think that that's going to turn around next year?

Well, the key there, and that is a key that we're signifying, is we expect to reduce inventories to ongoing levels once we get through the fourth quarter, which, again, we signaled will be weak with downtime, and then we'll be in balance again between what we expect for ongoing sales and production at LTR; which would mean even with no sales growth at LTR, that we would return to higher levels of production because we wouldn't be in an inventory decreasing mode. And once we return to a better balance, even at current sales at LTR, then we are able to avoid that expense of downtime and profitability would improve. So we're fairly confident about LTR prospects for improvement next year, let alone any growth on top of that in sales.

Is there any possibility of workforce reduction there?

We don't have any plans that we've announced at this time.

Ann Gurkin, Davenport & Company.

I wanted to start in referencing a comment that [Altria] made on their call yesterday that their production is ramping up slower into China than they expected. I'm listening to your comments, it sounded like you all are still on track. I just wanted to make sure you aren't having any kind of slowdown in your planned startup of production in China.

No, no. We're, of course, at this point, we're completely in physical construction of the factory itself, but no, everything is on pace in terms of our activities there, both construction-wise and administratively. So no changes in our business outlook or in the progress against our plan.

And then can you tell me what your marketshare is now on a worldwide basis?

Our current estimate would be the same as what we had at the end of 2005, which is 26% on a global basis. During the year, it would be hard for us to get a super accurate update on that, because it is quite a process to estimate total worldwide requirements for paper and then what our share is of that. But right now we would anticipate our share is constant at 26%.

We're also watching what happens in California with Proposition 86, a significant hike in excise taxes and if that occurs, have you all run any kind of scenarios as to what that may or may not do to your business?

Yes, we have, but basically it's based on what our customers are telling us. It would likely have, if passed, a long-term negative effect, of course, because it would reduce cigarette sales in California. The range of estimates of that impact are pretty significant and to the extent that California becomes a lower ignition propensity cigarette paper state, that wouldn't be good for us.

On the other hand, depending on if the law passes and when it's effective, it could cause on the front end a spike in cigarette purchases, and if it's after the LIP law, that could be temporarily good for us. So we're waiting to see what happens with it and obviously that legislation, if passed, would significantly reduce cigarette purchases in California.

And then, lastly, any update on Australia in terms of adopting or requiring the use of LIP?

No update. It's still in the same legislative status which is, at this point, not passed into law but still an active piece of legislation. During this quarter, there has been some additional -- nothing firm, but additional activity outside the United States with the EU and with several Scandinavian countries. And also, there still is pending legislation in South Africa, but we haven't seen anything concrete develop outside of the United States.

Steve Riccio, Landmark Capital.

I don't know your story, so please forgive the basic nature of my question here, but on your low ignition cigarette paper, that's currently, I guess, driving margins, I'm trying to get a sense as to sort of what type of competitive position you have in that area. I assume that's all wrapped up in trademarks and patents and all that kind of stuff. Can you just give me an idea of how sustainable that is going forward?

Well, there's presently two technologies that are primarily used in the locations that require lower ignition propensity cigarettes. They're both paper technologies to achieve the end cigarette standard for lower ignition propensity. Those two cigarette paper technologies, we developed both, one in partnership with Philip Morris USA, one on our own, working with other customers. And so presently, we have essentially all of the market. There are competitive products we're aware of, but they are very limited in use and, of course, the customers, at this point, have voted to go with our technologies based on their selections.

We have very good intellectual property protection on those technologies as well as commercial agreements with our customers. But we can't take anything for granted, so we work hard to become more cost-competitive in those products. But right now, we're in a pretty good position, but of course, new technology could come along and we would have to compete against it.

Are you aware of anything in that area or --

No, we watch that very closely, and again, at the moment, we've got a very good position in the market and we continue to see our products be the preferred products selected by our customers.

And your agreements with your customers for this product, are they sort of the specified time period or can they pretty much switch at any point in time?

No, without getting into the particulars because each one would be different and we wouldn't have necessarily disclosed those particulars, but suffice it to say, if a better mousetrap did come along, we would have to compete against it. Our customers wouldn't be locked into using a inferior technology. But as of the moment, ours is not only the preferred technology, our view is it performs better than any other available technologies.

I know you don't comment specifically, but could you just give us an idea as to sort of the margin differential versus your existing products? Just in general how much -- what are the (multiple speakers) benefit?

Yes, the way that is probably, certainly just directionally, there's two good things about lower ignition propensity cigarette paper. We haven't said how much of a higher price it sells for, but it's higher and on top of that, it's a better margin than the conventional products it replaces. But that's all directional. Probably the best way to get an idea of what's happening with U.S. business unit results related to lower ignition propensity is to look at the trends in quarterly results absent restructuring expenses. Because as we've said, the key driver in those improvements over the last several quarters has been lower ignition propensity cigarette paper. So that's probably the best way to get an idea on the trend.

[Don Noon, VN Capital Management].

In sort of the late part of the quarter, we saw a significant slide in the price of natural gas. I was wondering if given that higher energy cost that bedeviled you for quite some time now, whether you've taken this as an opportunity or seen this as an opportunity, maybe to lock in some lower costs and at least some certain costs going into 2007?

Starting really in 2005 when we saw significant energy inflation, we, like a lot of companies, stepped up our efforts to make sure we were bought ahead on energy. And the way that we've implemented that allows us to -- we're never at any point at 0% bought ahead, and we're never at any point 100% bought ahead. So right now we are able to take advantage on some level of consumption as we see natural gas prices decline. And we've seen that in the trends in terms of the inflationary impact, especially for the U.S. business unit in terms of sequential quarters and how much inflation is impacting us. It definitely has flowed.

And then in terms of the restructuring of France, just speaking broadly, have you contemplated sort of really brought radical moves in terms of how to deal with the drop-off in business over there? I mean, is it in the cards that you might contemplate putting the machines on a truck and moving them out of France? Given that you don't have a lot of operational flexibility, given that it's a relatively high cost place to do business and the country has just placed further restrictions on smoking, it would seem at least thematically, that you would entertain maybe moving production basis elsewhere. Is that on the table, off the table or how do you think about these challenges?

I think there's two answers to your question, which is a very good one. One is we do feel that the announcements we've made during the quarter are radical at our PdM facility. We're doing really two things there. We are collapsing older, higher cost capacity, but we are also improving the remaining machines, the configuration, to be what we are confident will be the lowest cost, highest quality cigarette paper and porous plug wrap, long fiber product producer in Western Europe. That doesn't say it will be the lowest cost in the world, it will be the lowest cost in Western Europe.

And we feel that we can have an ongoing leadership position in that market from France. Competing against other producers that are also in high cost Western Europe. Then, in terms of our broader global strategy, not necessarily putting machines on trucks, but we clearly have increased the production capacity we have in lower-cost markets around the world -- Brazil, Indonesian, Philippines, and soon, China. So we do view this as a long-term structural shift in terms of our cost position, but not abandoning a production facility in France. I feel we can be competitive there.

There's no possibility that you could manufacture cheaper with your current machines, let's say, located in Poland?

I don't know.

Theoretically? So you've not even done that analysis?

No, we are committed that and again, we are confident that we can be cost-effective in Europe from France.

I'm just wondering, given that these problems have really bedeviled you, why you're not thinking more broadly. And given how Western Europe is, it's sort of a decreasing market and Eastern Europe seems to be doing a little bit better, why you wouldn't sort of lose the weddedness, I guess, to manufacturing in France.

I think there's two --

I think it's a sort of intellectual exercise.

Sure. I guess there's two responses to that. I think conceptually, your point is a good one and again, we would agree with that because that's why we have moved to lower-cost production countries around the world. Not only because it's lower-cost, but it's where cigarette paper demand growth is for our product.

But in terms of within Europe, the practical issue is to recreate the capacity and the scale that we have, that our customers require, that's presently in place in France, say in Poland, would be so prohibitively expensive and would be such an undertaking that the risks of doing so and keeping our current market position would be quite high.

Our customers value the security of supply in the present situation that we have. So, to shut down a mill and startup somewhere else -- even if theoretically it made sense, it would be practically very difficult to achieve.

Oh, that's fair, that's kind of what I wanted to get at. Maybe just the continuity is important and that's the answer. Thanks.

(OPERATOR INSTRUCTIONS) Thomas Russo, Gardner Russo.

Just to follow up with that question you just finished with, can you just for a second tell me about the stickiness of the French operations even if you were to pack up and go to Poland. Wouldn't you still have extraordinarily large fixed costs trying to exit France from a work rules standpoint? If you shut it down and then moved, the costs beyond just the organizational costs to move are also considerable. How would you estimate that structural cost of exit if you tried?

We haven't estimated it, but obviously, it would entail two very significant elements -- one would be the non-cash book value write-off but then the other would be a very significant shutdown cost for labor or severance payment for labor. Certainly, you know the scope of the severance payments that we've already announced with our restructuring of PdM on 209 people scaled up to four times that would be tremendous. It would be approaching the total investment of building a new mill in China.

So it becomes quite prohibitive to do that. And that's, I think, important too why one of the five elements of our strategy that we've announced at PdM is to have a more flexible human resources policy at the facility, so that we're not kind of stuck in a mold where we're not flexible enough to move between machines or adjust capacities on an interim basis efficiently.

So we haven't abandoned France as being a place that we can make money and have a good base of operation servicing Western Europe. And to just walk away from it even over a period of time, we just don't view would be the best way to go.

And are you extracting those work plate concessions that allow greater workplace flexibility?

Well, that is on the docket. Obviously that has to be achieved.

Pete, you mentioned that one way to assess the list from LIP is to observe the trends in U.S. quarterly results absent restructuring, and the one puzzle to those trends is the third quarter, where the -- I gather, the impact from July is shut down both by you and your customers is significant -- but what would the like for like comparison be for the third quarter last year? And what type of lift to profitability this third quarter was there even despite the relatively lackluster overall numbers in third quarter U.S.?

Well, it wasn't as much, even excluding the July effect of that being a down month, the lift from LIP within the third quarter wasn't as much as it was in the first and second quarters, because the third quarter of 2005 started to include the selling period for the October 2005 effective date of the Canadian legislation.

So we're getting to the point now where year-over-year volume growth was through the third quarter more flat. That now will change again because we have California effective January 1, so we have a selling period to California now in front of us.

To the extent that third quarter of '05 bulked because of presell into Canada, Q4 of '06 will bulk because of presell into California.

Correct. It should. That's correct. Yes.

And that would explain why the third quarter seemed like relative to the pattern of improvements that you saw from LAP.

Yes.

Question on the pension contributions. I wasn't quite clear what you said about the forward spending that still remains. You said $5 million cash contribution year-to-date '06. What's left now to fund? And what's your status once you've finished this next run? How much have you put in and what's left?

Yes, that was purposely worded the way it was. Here, as we stand here in the fourth quarter of 2006, our present projection is that cash contributions from today through the end of '07 will be in the range of $7 million to $15 million. If any of that $7 million to $15 million occurs in the fourth quarter of this year, we haven't specifically said. But what we've said is that it will occur between today and the end of next year in that range; that the specific timing of whether we would do a payment, yes, this year or do all the payments next year is tied up in our strategies of what's the best way to manage pension funding.

So at this point, we haven't said specifically how it will fall between years. Simply that from now through the end of next year, we projects $7 million to $15 million.

And then when you're done with that $7 million to $15 million next year, are you finally on top of this? Are does it continue to drawdown cash?

No, we would continue to have pension funding requirements. As of the end of 2005, our funding, our fair value of assets to obligations was around 70%. So we have a ways to go to get fully funded. However, if you look at pension liabilities, you'll see that they have decreased both because of contributions, but also because of a good plan performance in terms of our investment returns on the assets.

But most likely going forward, we will be in a position where we're putting more cash into pension like we have -- are currently saying we will -- in order to work it towards a fully funded status. One of the other benefits we have towards that, but still it's going to not be that we're putting cash into pensions, but having frozen the salary pensions and one of the hourly pensions in the United States and working to do the rest with the other two hourly plans, that will stop the obligation growth from being as much as it otherwise would be. But still, net-net we're going to be putting cash into pensions in order to improve the funding status going forward.

And then the last question -- the $11.3 million year-to-date spent in France is split between cash severance and salary depreciation affects assets. What is that split?

So far in France this year, that would be essentially, the vast majority of it would be cash.

So far?

Yes. And the accelerated depreciation, we do breakout -- in the press release, we've added a new table that breaks down total restructuring expenses -- France, U.S., and then cash non-cash. We don't separate cash non-cash by business segment, but as you can see, the numbers almost match up perfectly that the France piece is equal to the cash fees because it reflects -- it's not exactly that way, but it does reflect much more cash payments in France, much more accelerated depreciation in the U.S.

(OPERATOR INSTRUCTIONS). Jonathan Lichter, Sidoti & Co.

The question just about the California tax increase, what do you think the net effect will be, given that I'm sure some of the smokers will go to neighboring states to get their cigarettes?

That's the key question and I don't know. The cigarette companies I'm not sure know, but that likely will be what will occur. So we really -- we're not currently building into any of our projections of significant negative from California volume changes. That's based on our customers' input. Regardless of what direction the law goes, in terms of LIP, it could be depending on what happens with neighboring states requiring LIP or not, if California passes Prop 86, it could be a downer on the LIP benefit we get -- until other states that surround California would maybe pickup LIP legislation. It's really hard. It's very speculative, but clearly a 300% increase in cigarette taxes is going to be a negative.

[Nathan Start], Ramius Capital

Just a quick question. The depreciation and amortization for the third quarter, if I read the cash-flow statement correctly, came in about $6.5 million. Is that a run rate that we should expect going forward or can you give us some guidance on that line?

Yes, it's fine excluding restructuring. I think we break out now in the cash flow statement. Depreciation and amortization kind of on a straight basis and then restructuring-related accelerated depreciation. If you look at depreciation and amortization on a straight basis, especially through the first nine months, we're basically unchanged. It is going to go down all things equal because we've been spending less capital and we've been accelerating write-off of assets, but depreciation and amortization is kind of trending right now to be in that $38 million to $40 million range last year with $39.5 million, so it's pretty stable.

I apologize if I missed this, there's a lot in the press release, but is there any sort of guidance that you could give us in terms of possible future restructuring in terms of either dollars charges or sort of where the areas that you're looking at right now?

What we said right now is that we expect this year to be $20 million to $22 million in restructuring on top of the $16.3 million we've seen so far this year. What is going to drive restructuring going forward -- and we haven't set a number for '07 yet because we don't yet know -- what's going to drive it is the accelerated depreciation pieces for the three announced events, that we do know. But the big driver is severance in France and that has to be renegotiated. So until it is negotiated, we don't know what that full amount would be. So as soon as we complete negotiations, we will update our guidance on expected restructuring expenses including the amounts in 2007.

There are no further questions at this time.

I think if there's no further questions, we've had the one follow-up, I think we're all set, so thank you for taking the time to join us today.

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