Mativ Holdings Inc (MATV) 2006 Q4 法說會逐字稿

Good morning, my name is Jody and I will be your conference operator today. At this time I would like to welcome everyone to the Schweitzer-Mauduit International fourth quarter 2006 earnings conference call. All lines have been place on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Peter Thompson, CFO. Please go ahead sir.

Thank you Jody. 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 fourth quarter 2006 financial results.

Various comments or remarks that we may make during today's conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 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 in the company's Securities and Exchange Commission reports, including the company's annual report on Form 10K 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 $0.28, compared with diluted earnings per share of $0.19 in the fourth quarter of 2005. Restructuring expenses of $4.8 million, or $0.20 per share, were incurred during the quarter. The diluted loss per share, without restructuring expenses, would have been $0.08 per share for the quarter. Results during the fourth quarter reflected planned machine down time across all our French mills, in order to return inventories to more normal levels.

Schweitzer-Mauduit initiated restructuring activities during 2006 which are expected to substantially improve the company's competitiveness and profitability, as well as address an imbalance between sales demand and paper production capacity in France and the United States. For full year 2006, restructuring expenses totaled $21.1 million. A discussion of restructuring activities follows later in this call.

Net sales totaled $166.2 million, 5% below the prior year quarter, due to decreased sales volumes, partially offset by favorable currency impacts, an improved mix of products sold, and somewhat higher average selling prices.

The operating loss was $5.1 million, a decline of $13.4 million from the prior year quarter operating profit of $8.3 million. Excluding restructuring expenses, the operating loss would have been $300,000 for the quarter, a decrease of $8.6 million.

The company's gross profit margin, which does not include restructuring expenses, was 8.8% compared with 12.9% in the prior year quarter. The decline in profitability, excluding restructuring expenses, compared with the fourth quarter of 2005 was the result of unfavorable fixed cost absorption, inflationary cost increases, and lower sales volumes; partially offset by improved mill operations, and a better mix of products sold.

The unabsorbed fixed costs were caused by lower production volumes, primarily in our French mills, and had an unfavorable impact on the operating results of $6 million, or roughly $0.25 per share.

Inflationary cost increases unfavorably impacted operating results by $4.7 million during the quarter, or roughly $0.20 per share. Lower sales volumes decreased operating profit by $2.8 million or roughly $0.12 per share.

We remain encouraged about our business outlook, despite finishing 2006 with disappointing, albeit expected, financial results. We are confident in our previously announced strategies for restructuring our French and U.S. businesses to better balance capacity to available demand.

Sales growth is planned for cigarette paper used in lower ignition propensity cigarettes, and for reconstituted tobacco leaf products. Additional progress is anticipated in cost reduction activities initiated across all our business units.

The benefits from cost reduction activities are expected to further offset the continuing unfavorable impacts of lower production volumes and inflationary cost increases that have been experienced during the last two years.

Before providing a more detailed review of our fourth quarter financial results, and our outlook for 2007, I will discuss our restructuring activities.

As noted earlier, Schweitzer-Mauduit initiated restructuring activities during 2006, which are expected to substantially improve the company's competitiveness and profitability, as well as address an imbalance between sales demand for our products and our paper production capacity in France and the United States.

As disclosed in our filings to the Securities and Exchange Commission on Form 8K, Schweitzer-Mauduit communicated a five part strategy to become a low cost, and the highest quality 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 Quimperiè France.

On December 19, 2006, the union, work council, and management of PDM concluded negotiations and successfully reached agreement regarding the terms and conditions of the workforce reductions associated with the planned restructuring at that site.

In the final agreement, workforce levels will be reduced by 209 employees, in two essentially equal phases during the first quarters of 2007 and 2008. The first phase is associated with reduced machine operating schedules and other organizational changes. The second phase reflects expected employment reductions following capital investments. The PDM restructuring plan is expected to result in the shutdown of two cigarette paper machines during 2007.

In accordance with the applicable U.S. generally accepted accounting principals, we realized restructuring expenses in France totaling $5.4 million during the fourth quarter and $15.8 million for full year 2006, primarily related to negotiated future cash severance payments, and accelerated appreciation of fixed assets.

The restructuring activities also included previously announced actions at the Lee, Massachusetts facility. Restructuring expenses in the United States for those actions totaled $300,000 in the fourth quarter and $5.3 million for full year 2006, primarily related to non-cash accelerated appreciation of fixed assets.

I will now cover details of the fourth quarter business results. Net sales were $166.2 million, a decrease of $9.1 million or 5% compared with the fourth quarter of 2005. Unit sales volumes decreased by 11% compared with the prior year, and had an unfavorable $19.4 million impact on net sales.

Sales volume for the French segment decreased by 16% from the prior year quarter; sales volumes decreased for reconstituted tobacco leaf products, primarily due to lower margin tender business during the prior year, and for tobacco related papers in the French operations. Sales volumes increased for the Indonesian and Philippine operations, which are included in the French segment.

Sales volumes in the United States decreased by 8%, reflecting a reduction of tobacco related and commercial and industrial paper sales. The commercial and industrial paper sales decline resulted from the décor papers exit announced earlier in 2006, as well as a decrease in fill business, which followed consolidation of paper production on fewer machines.

Sales volumes of cigarette paper for lower ignition propensity cigarettes increased in advance of the January 1, 2007 effective date for lower ignition propensity regulations in California.

Sales volumes in Brazil increased 2% due to increased commercial and industrial paper sales, as well as higher export sales of tobacco related papers.

Changes in currency exchange rates increased net sales by $6.6 million compared with the prior year quarter. Both the Euro and Brazilian real were stronger versus the dollar by 8% and 5% respectively, accounting for the positive impact.

Higher average selling prices had a favorable $3.7 million impact on the net sales comparison. Higher average selling prices were realized in France and the United States business segments, primarily attributable to a change in the mix of products sold.

Gross profit was $14.6 million, a decrease of $8 million from the prior year quarter. The gross profit margin was 8.8%, declining from 12.9% in the fourth quarter of 2005. Lower production and sales volumes and significant inflationary cost increases unfavorably impacted gross profit. These negative factors were partially offset by improved mill operations and somewhat higher average selling prices.

Reduced machine operating schedules and lower production volumes were experienced in our French operations, primarily to control inventory levels. This resulted in unfavorable fixed cost absorption impacts that reduced operating results by $6 million. Inflationary cost increases unfavorably impacted operating results by $4.7 million during the quarter.

Changes in the per-ton cost of wood pulp increased our operating expenses by $2.1 million. The higher wood pulp costs were experienced in all business units. The list price of northern bleached softwood craft pulp, or NBSK, a bellwether pulp grade, averaged $770 per metric ton in the United States during the quarter, compared with $640 per metric ton in the fourth quarter of 2005, and $755 per metric ton in the third quarter of this year.

Pulp producers have announced a $20 per metric ton, or 3%, increase in the list price of NBSK, effective in January 2007. We believe pulp prices are likely to increase further before reaching a peak sometime in the first half of 2007.

Purchased energy costs increased by $1.5 million compared with the fourth quarter of 2005. Higher energy costs were primarily related to higher natural gas and electricity costs in France. The rate of year-over-year energy cost increases slowed during the fourth quarter, especially for electricity rates in the United States. Changes in labor rates also increased manufacturing expenses by $600,000 during the quarter.

Lower sales volumes decreased operating profit by $2.8 million. These unfavorable costs and sales volume factors were largely offset by improved mill operations. Operational improvements were achieved in each of our business units through increased productivity, reduced waste, energy related conservation and co-generation projects, and other cost reduction efforts.

Non-manufacturing costs increased $600,000 versus the prior year quarter, an increase of 4%. General expense increased primarily due to higher employee compensation. Selling and research expenses were both lower, reflecting cost reduction efforts in these areas. Non-manufacturing expenses were 9% of net sales in the fourth quarter, an increase from 8.2% in the prior year period.

The operating loss was $5.1 million, a decline in profitability of $13.4 million compared to operating profit of $8.3 million in the fourth quarter of 2005. The operating loss on sales was 3.1% compared with an operating profit return on sales of 4.7% in the fourth quarter of 2005.

Excluding restructuring expenses of $4.8 million, the operating loss would have been $300,000 for the quarter, a decrease in profitability of $8.6 million from the fourth quarter of 2005. Operating profit declined primarily in our French business unit, and more than offset an increase in our U.S. business unit.

The operating loss in the French segment was $4.7 million, a decline in profitability of $15.3 million from prior year quarter. Operating profit decreased $4.5 million due to restructuring expenses. Excluding restructuring expenses, operating profit in the French segment decreased $10.8 million to a near break even level.

Unfavorable fixed cost absorption from planned machine shutdowns across all the French sites decreased operating profit by $6.4 million, while lower sales volumes had an unfavorable $3.6 million impact. Inflationary cost increases reduced operating profit by $3.6 million, including higher purchased energy, wood pulp, purchased materials, and labor expenses. These unfavorable factors were partially offset by higher average selling prices, and lower non-manufacturing expenses.

The U.S. business unit operating profit was $1.9 million for the quarter, a $3 million increase versus the prior year quarter. Excluding U.S. restructuring expenses of $300,000, operating profit increased by $3.3 million. Improved mill operations and higher average selling prices, resulting primarily from a better sales mix that included increased sales of cigarette paper for lower ignition propensity cigarettes, caused U.S. operating profit to increase.

Favorable fixed cost absorption from less machine down time during the fourth quarter of 2006 relative to the prior year period increased operating profit $400,000. Inflationary cost increases had an unfavorable impact of $600,000 during the quarter, related to higher purchased wood pulp costs.

The Brazilian unit had a $500,000 operating loss during the fourth quarter of 2006, unchanged from the prior year quarter. Increased sales volumes and reduced non-manufacturing expenses benefited operating profit by $500,000 and $300,000 respectively. Inflationary costs increases totaled $400,000 related to increased purchased wood pulp expenses, and higher labor rates. The stronger Brazilian real versus the U.S. dollar had an unfavorable impact on operating profit of $400,000 during the quarter.

Interest expenses totaled $1.2 million during the fourth quarter, a decrease of $500,000 from the prior year quarter. Total debt increased $4.9 million or 5% during the quarter, but declined $16.4 million or 14% for full year 2006. Our total debt to capital ratio stood at 23% at December 31, compared to 22% at the end of September 2006, and 27% at the end of December 2005. Total debt has been managed to a lower level in anticipation of future funding requirements.

The fourth quarter of 2006 included a benefit from income taxes due to the loss caused by restructuring expenses recorded during the quarter, changes in the geographic mix of 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 is a minority owner that owns 28% of its shares.

Loss from equity affiliates representing Schweitzer-Mauduit's 50% share of the pre-operating expenses associated with our recently formed joint venture in China, was less than $100,000 during the fourth quarter. The net loss totaled $4.4 million compared with net income of $2.8 million during the fourth quarter of 2005. The diluted loss per share was $0.28 compared with diluted earnings per share of $0.19 for the prior year quarter.

The restructuring expenses significantly contributed to the decline in both net income and diluted earnings per share compared with the prior year quarter. Excluding restructuring expenses, the diluted loss per share would have been $0.08 for the fourth quarter of 2006.

Earlier today Schweitzer-Mauduit announced a quarterly common stock dividend of $0.15 per share. This dividend will be payable on March 12, 2007, to stockholders of record on February 12, 2007. The company has paid quarterly dividends of $0.15 per share since 1996.

Capital spending totaled $4.2 million compared with $5.4 million in the fourth quarter of 2005. No single capital project accounted for a material amount of the fourth quarter 2006 or 2005 capital spending. Capital spending for full year 2006 totaled $9.6 million, below the expected range of $15 million to $20 million, due to the timing of project spending during the fourth quarter.

Capital spending for 2007 is still expected to be in the range of $55 million to $65 million, including the recently announced $23 million capital investment at PDM, as well as a planned upgrade of a paper machine in Brazil. Additionally, spending for a capitalized software project in France is expected to total $5 million to $7 million in 2007.

The company made $5 million in cash pension contributions during 2006. Pension contributions during 2007 are expected to be in the range of $7 million to $12 million. Cash payments of negotiated severance amounts associated with the French restructuring actions are expected to total approximately $11 million to $13 million during 2007.

Planned equity investments for Schweitzer-Mauduit's tobacco-related papers joint venture in China are expected to be approximately $12 million to $13 million during 2007.

The projected cash needs in 2007 for capital and software development spending, pension contributions, employee severance payments, and joint venture equity payments, total approximately $90 million to $110 million. These cash requirements are expected to be funded through internally generated cash flow and increased borrowing in the range of $45 million to $55 million from Schweitzer-Mauduit's five year revolving bank credit facility, that as of December 31, 2006 had $130 million available out of a total capacity of approximately $195 million.

Despite a net loss, cash provided by operations totaled $51.8 million for full year 2006 compared with $38.1 million during 2005. The increase in cash generated primarily reflected lower working capital, which decreased by $20.4 million during 2006, as well as the non-cash impact of restructuring related accelerated appreciation. In 2005 working capital increased $14.6 million. The decline in working capital reflected efforts to improve performance in this area.

Schweitzer-Mauduit's 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, continues to progress.

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.

On December 20, 2006, Schweitzer-Mauduit provided Philip Morris USA with a notice of phase out of the fine paper supply agreement, or SSA, between the two companies effective December 31, 2006. Notice of phase out had to be given no later than December 31, 2006 in order to avoid a four year extension of the SSA under its terms.

Schweitzer-Mauduit has been the sole supplier to Philip Morris USA of cigarette, base tipping and plug wrap paper since January 1993. While we continue to value our close relationship with Philip Morris USA, we have concluded that the existing SSA no longer adequately addresses current business and industry conditions.

It is our intent to work with Philip Morris USA to replace the SSA with a new form of supply agreement. This notification of phase out does not affect the supply agreement between Philip Morris USA and Schweitzer-Mauduit concerning banded cigarette paper used to produce lower ignition propensity cigarettes. No immediate financial impact is expected as a result of this notice of termination.

Inflationary cost increases totaled $18 million in 2006, or $0.75 per share. However, purchased energy cost increases have begun to slow and even reverse in the United States. Wood pulp prices continue to increase, but at a slower 2% rate during the fourth quarter 2006, which brought the full year 2006 increase to 12%.

While inflationary cost increases persist, we believe the rate will slow, and will be increasingly offset through improved mill operations and continued efforts to systematically control all areas of cost.

Overall PDM restructuring expenses are now projected to be in the range of $26 million to $28 million for 2006 through 2008, including cash severance and other related costs in the range of approximately $23 million to $25 million, and approximately $3 million for non-cash accelerated deprecation of fixed assets.

The actual amount of severance expenses will be dependent upon the final number of individuals within each of the three possible categories for employee severance, that include early retirement, other voluntary means, and involuntary terminations.

The PDM workforce reductions are expected to generate annual pre-tax labor savings of approximately $14 million, or $0.58 per share, due to both restructuring activities and capital investments. Full realization of the labor savings is expected to occur after the first quarter of 2008. We expect to realize annual pre-tax benefits greater than $14 million upon full implementation of all elements of the PDM strategy, including the planned capital investments.

Sales of cigarette papers for lower ignition propensity cigarettes continue to positively contribute to our operating results, especially as we realize manufacturing efficiencies. We began to realize increased sales during the fourth quarter prior to the January 1, 2007 effective date for lower ignition propensity regulations in California, which becomes the third state in the United States, along with Canada, to require cigarettes to meet such standards.

With further increases in sales volumes of this cigarette paper projected in 2007 and 2008, as previously enacted regulations become effective in New Hampshire, Illinois and Massachusetts, combined with expecting continuing improvements in manufacturing costs, this product should provide additional improvement to the U.S. business unit results.

We continue to experience weakness in tobacco-related product sales. Reduced demand for tobacco-related 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 in unabsorbed fixed costs, unfavorably impacted 2006 operating results by $18 million, or approximately $0.75 per share.

Our actions to reduce inventories, especially in the fourth quarter of 2006, as well as the restructuring actions already announced, place us in a better position to reduce these impacts in 2007. However, 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.

Following our disappointing financial results in 2006, we expect to make progress during 2007 in mitigating the continuing impact of inflationary cost increases, and reduced production schedules that have decreased our earnings over the last two years. We intend to do this through improved worldwide mill operations, the benefits in France and the United States from previously announced restructuring activities, and the continued growth in cost improvement in producing cigarette paper for lower ignition propensity cigarettes, as well as reconstituted tobacco leaf products.

We reiterate that full year 2007 earnings per share, excluding restructuring expenses, are anticipated to be at or above the $1.26 level achieved in 2005, as a result of the benefits of announced restructuring activities and our other business improvement actions more than offsetting lower sales volumes and continuing inflationary cost increases.

That concludes our planned comments. Jody would you please open the phone lines for questions?

[OPERATOR INSTRUCTIONS]

Your first question comes from Jonathan Lichter of Sidoti and Company.

Hi guys.

Hi Jonathan.

What do you see for RTL in '07, where do you see the growth coming from?

Well the growth that we currently see in RTL is going to both be from emerging market growth, but also not necessarily driven by increases in cigarette consumption, but what appears to be growth in our traditional western European markets.

What often occurs, and we've talked about through time, is that since we're the sole supplier of reconstituted tobacco, in many respects, in Western Europe, we can see timing, order timing differences that appear to be underlying changes in demand, but they're really just order timing differences.

And the way that things look right now is that the pendulum has swung up again in terms of our traditional businesses in Western Europe and their order levels. So all things considered, true organic growth in emerging markets as well as more positive order timing in our traditional markets, at this point bode pretty well that we're going to see a fairly good level of growth in sales over 2006 actuals for LTR.

How much downtime did you take in your RTL plants?

At the LTR facility there's three machines; one machine was down for the full month, the second machine -- the one machine down for the full month was the smallest, the second largest machine was down for half the month, and the new machine was down for five days. So it was almost down essentially the entire month of December.

OK. Have you seen any indication of either a price war or other action by your competitors in advance of your restructuring?

No, we have not. Now that doesn't mean there wouldn't be reaction from competitors. Probably more so it's because there are no major contracts that have really come up at the present, and since there's multi-year agreements with most of the multi-national cigarette companies, the pricing environment sometimes takes a while to unfold. But we have not seen any reaction.

OK. And could you give a little bit of a timeline on how you just see the Philip Morris negotiations playing out?

Yes, we've already met in January with PM USA, we've agreed to a schedule, we've worked through what the primary issues and objectives for both sides are, an in fact we're getting back together again coming up here in the next two weeks. So without setting a deadline, because we haven't set one for ourselves, I would anticipate that we'll reach agreement on a new contract sometime in certainly the first half of the year, but hopefully in the first quarter of the year.

OK. Lastly, when will the worker -- I guess how many workers were actually let go in the first quarter, or will be?

Will be let go, it will be, the number is 125 roughly, the 209 kind of in half. So the 125 are the first wave. Most of those employees at PDM will be out by the end of the first quarter, but it will probably be late in the first quarter. And then there's going to be, because of training requirements and the way that the transitions of positions occur, there'll actually be individuals who will be going out through the summer months, with the final wave getting to the 209 person reduction, occurring once the investments on the machine, the PM10 machine and the floaters are complete.

And our timing now is we would push that out, we think it's going to be early 2008. But the first big wave should be complete by the end of March, which means by April 1 forward we'd see the first labor saving benefits of any size.

OK, thank you.

Your next question comes from Ann Gurkin with Davenport.

Good morning.

Hello Ann.

I just wanted to start in France; it looked to me like through the nine months RTL operating profit was down about 30%, and for the year it was down about that same rate. So for cigarette operating profit it looks like that dropped off significantly in the fourth quarter, and did you lose a contract?

No. Now your observations are correct, there was a more significant drop off in profitability for paper operations in the fourth quarter in France, but that's purely due to the downtime impact. The previous question concerned downtime at LTR, downtime at our French paper mills, especially PDM, was even more significant for two reasons. And the specific is, we took 14 days of downtime, two weeks, across the entire PDM facility, all machines.

And the reason for that was following the conclusion of our labor negotiations we had built up inventories as a contingency to planning for strikes. We were very fortunate in not having strikes of any significance. Unfortunately, we had all the inventories we built up. So we chose to reduce those inventories fairly dramatically in the fourth quarter in order to return them to normal levels and not have that be an ongoing issue.

OK so for '07 can cigarette paper operating profit in France grow low single digits?

Operating profit in cigarette related papers in France should grown more than low single digit just because it's coming off of such a bad comparison in 2006.

OK, great. Switching to the U.S., and you talked a little bit about the contract negotiations with PM USA, does your earnings outlook for the year include any kind of factor or hedge clause that you may lose some business in the U.S.?

No, our earnings guidance does not, but we do not --

You supply 100% to Philip Morris USA?

Correct, correct, and we don't anticipate, as we said in the comments, we don't anticipate any financial impact from the phase out notice.

OK, and in your earnings release you kind of put a cautionary statement in there ahead of your earnings guidance paragraph, and why not take the earnings down a little bit lower if you're putting in that cautionary statement?

Well the cautionary statement you're referring to is continuing softness in demand for our products. We believe, all told, that the positives from growth in LTR profitability, benefits from restructuring, and growth from lower ignition propensity cigarette paper sales should be more than offsetting any continuing negatives that we would see from underlying volume declines.

The concern is, you know the caution that we're saying is, in times past we've seen that same issue where the secular issues of underlying demand and then excess capacity, downtime, pricing pressures, etc., have offset our expectations.

But right now we feel that the earnings positives that we face will more than offset any continuing inflation, which is swinging more to wood pulp from energy, and impacts of any downtime.

OK. What is your capacity utilization currently in Brazil?

We're running full in Brazil.

Full, OK. And then any update on interest in reduced propensity paper usage in the EU or in Australia?

Australia there's nothing new to report. The EU is picking up some interest, especially out of the UK. Nothing concrete though in terms of proposed EU wide or even individual country legislation. There has been some new recent news out of the Scandinavian countries, especially Finland, proposing legislation, but nothing concrete.

OK. And then lastly, do you expect further working capital improvements in '07 versus '06?

We haven't signaled any specific benefit from that. That certainly is going to continue to be a focus area following the significant reduction that we achieved in 2006, especially with the inventory reductions at the end of the year. We feel that right now we're in pretty good shape, especially in terms of inventories, which is a key component of overall working capital.

So we don't think we can achieve the kind of reduction we saw in '06 again, but that will continue to be a focus area.

Great, thanks a lot.

OK.

[OPERATOR INSTRUCTIONS]

Your next question comes from James [Benifac] with Feehan Capital Management.

Hi there, yes, I have a couple of questions. One on this last comment that you made about running flat out in Brazil, and I look at your segment information where you still have an operating loss in Brazil. If you're running the plant at full capacity what are some of your plans to try and get that to turn from a negative loss into a positive profit?

The key issue in Brazil continues to be currency. In fact within the numbers 100% of the loss in Brazil for the quarter was currency related, and for the full year 2006 we offset almost two-thirds of the currency impact. So if you look at the full year Brazil loss it was actually much worse, just due to currency, which shows what we're achieving in terms of underlying business improvement. So why do we continue to run full in that environment?

Obviously we can only hope on what will happen with currency and there is no real financial strategy for hedging that can offset that. In terms of the business fundamentals, we continue to see excellent costs and improvement in cost position in local currency out of Brazil. We've obviously announced plans to further increase capacity in Brazil, so we see it as one of our low cost areas that can best service certain markets.

Our current projections, and what we're working toward, are to continue to improve the business fundamentals through cost reduction, through the investments in Brazil that will get the site to profitable operations even at the current real to the dollar relationship. Should we see improvement in currency then it would only further improve that outlook.

My other question sort of touches upon a bit of your answer, which is your cap ex program. You stated that you're looking at around $55 million to $65 million, if you subtract out the amount from Brazil and you subtract out the amount from France that you've committed to as far as the restructuring, you're still looking at about $10 million to $20 million of cap ex. I guess my question to you is in your comments you've been talking about how there's excess capacity in the industry; there's downtime with the machines. Given sort of that soft operating environment, what are you planning on spending that cap ex on? If it's new machines why would you do that in the face of kind of softening demand?

And then second of all, what are your kind of internal rates of return that you're expecting from that type of cap ex spending?

That's an excellent question. Typically we spend about $20 million a year in kind of base level capital spending that is more or less replacement activity for assets on existing paper machines in our operations around the world. Paper machines being fairly capital intensive for their ongoing maintenance, just to keep them up to date in terms of process capability for quality and productivity.

So it's not necessarily capacity increase related. The capacity related investments are the two you mentioned, and both of those, especially in PDM, are really targeted to replace existing capacity. So the strategy is get more output from a fewer number of paper machines. We are conscious not to be adding capacity to an already over served world market. Rather what we're doing is either improving our existing assets, having fewer of them in the developed areas, or like with Brazil, and in our joint venture in China, creating capacity for Schweitzer in low cost regions of the world that are where cigarette consumption is growing.

In terms of our return criteria, we have a cost of capital of 10%, so what we use internally is a hurdle rate that's above that by some margin. And that really forms the basis for our decisions on capital investments.

Great, thank you.

Sure.

[OPERATOR INSTRUCTIONS]

At this time there are no further questions sir. Are there any closing remarks?

No, thank you Jody. I just want to thank everybody for taking the time to join us today. Goodbye.

Thank you. This concludes today's conference call, you may now disconnect.