Mativ Holdings Inc (MATV) 2009 Q3 法說會逐字稿

Good morning. My name is Chrissie and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter Schweitzer-Mauduit Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Spears, you may begin your conference.

Thank you, Chrissie. Good morning. I am Mark Spears, Corporate Controller at Schweitzer-Mauduit International. Thank you for joining us to discuss Schweitzer-Mauduit's third quarter 2009 earnings results. Participating on today's call are Frederic Villoutreix, Chairman and Chief Executive Officer, and Peter Thompson, our CFO. Frederic will discuss the key factors impacting our business. Pete will then provide additional detail related to our third quarter results and outlook. We will then take your questions.

Before we begin, I would like to remind you that the comments included in today's conference call constitute forward-looking statements. Actual results may differ materially from the results suggested by these comment for a number of reasons which are discussed in more detail in the Company's Securities and Exchange Commission filings, including our 2008 annual report. Certain financial measures discussed during this call exclude restructuring expenses and are therefore non-GAAP financial measures. Last, a more detailed review of our third quarter financial performance is included in our quarterly report filed with the Securities and Exchange Commission yesterday evening. A copy of these reports, along with our earnings release can be found on our website. Also, we're employing a slide presentation to accompany our formal remarks. A copy of this presentation can be found under the Investor Relations portion of our website or you can follow along on the webcast. With that, allow me to introduce Frederic Villoutreix, our Chairman and CEO. Frederic?

Thank you, Mark. Good morning, everyone. Today's call, I will share some high level comments about our third quarter performance. I will also cover a working agenda for the balance of the year and our priorities moving forward including comments about our planned $117 million investment for a Greenfield RTL facility in Asia. Pete will then take you through a more detailed review of our financial results and guidance.

Slide four summarizes our financial results for the quarter and year to date. I am extremely proud of the reserves that we produced for the third quarter of 2009. All of our operating segments are continuing to perform well. For the third quarter in a row, we achieved a records earnings per share with $1.39 if we exclude restructuring and impairment expenses. This brings our adjusted year to date EPS to $3.29 in spite of a $0.33 loss at our Malaucene facility which is on pace to be shut down by the end of the year.

Third quarter EBITDA remains very strong at $17.5 million in spite of a $26.9 million restructuring and impairment charge booked in the quarter. The continued weakness in sales demand for conventional paper products remains the only dark spot in what otherwise would be a remarkable year. Last but not least, we reduced net debt by $30 million or nearly 20% in the third quarter alone.

Moving to slide five, operationally the third quarter kept strong momentum from the previous two quarters. Our employees continue to deliver outstanding results in challenging environments. Growth of our high value products, LIP papers and RTL products, was impressive at nearly 24% over the prior year period.

Our Chinese paper joint venture is also gaining significant traction and posted its first quarterly net income at $1 million. We continue to benefit from cost reduction initiatives and generally more efficient operations across twice as many business units, contributing nearly $15 million to the bottom line year to date.

The inflationary environment remains somewhat favorably even though prices have been on the rise over the past two quarters. All in all, we benefited from the $4 million input cost decrease in the quarter compared to the prior year period. Volume weakness in our core paper segment remains an issue. We expect demand to remain soft and will take some paper machine down time in the fourth quarter to adjust our inventory levels downward. Volume weakness in paper product sales will likely persist for 2010 and we predict a somewhat weaker pricing environment for next year.

Now a word on our restructuring program on slide six. We have now entered the final stage of our multiyear rationalization program. After the decision earlier this year to exit the non-core and non-profitable finished tipping business at Malaucene, we announced in September a 106 person reduction of our factory and general administrative staff in France to reflect our reduced manufacturing footprint in Europe and the need to make it more cost competitive. Consultation with the works council started last month. We've expectations for restructuring to take place during the course of the second quarter of 2010.

Earlier this week we announced a decision to focus our Spotswood New Jersey facility's production on 100% LIP compliance cigarette papers for the US markets. Spotswood will now concentrate on the online LIP technology we operate for Philip Morris USA while the production of base rolls for other US customers is being transferred to our lower cost facilities in France and Brazil. We've laid the transition to take place at our Newbury, South Carolina printing facility.

This move marks the culmination of our efforts to revitalize our core paper franchise by building a truly global manufacturing footprint through expansion in Asia and collapsing non cost effective assets in France and the US, to address industry over capacity and declining demand involves developed markets.

Pete will cover later the amount of restructuring and impairment charges booked in the third quarter that are associated with these two decisions. Base paper is a tough business but we remain committed to doing what is necessary to keep this product segment profitable and to have the growth opportunities in Asia.

Moving to slide seven, as mentioned earlier, we're very pleased with the progress made in recent months, selling out the cigarette paper capacity of our mill in China. We need now to consolidate our gains and drive for further growth on the most attractive premium applications. We announced yesterday the activation of plans to take our reconfigured franchise to Asia for which I will provide further comments on the next slide.

At the same time, we continue to work towards establishing an RTL joint venture in China and remaining optimistic of concluding an agreement sometime during the first part of 2010 combined with ongoing efforts to expand our LIP franchise to Europe over the next two years and the rate legislation taken into effect. We are on the pathway to becoming a premier specialty Company and to leading up to a vision of being the undisputed leader of engineered solutions to the tobacco industry.

Now moving to slide eight, we are announcing today a major growth initiative with the decision to establish a wholly owned Greenfield RTL production facility in the Philippines. The strategic decision to build a new 30,000 ton stand alone production facility in the Philippines comes in response to securing significant additional demand beyond the capability of our French mill which is now operating at its maximum 80,000 ton capacity.

It also positions our sales to drive significant earnings growth by taking full advantage of increased worldwide regulatory efforts to reduce tar in nicotine delivery and midterm to grow more chance for selective reduction of other and desirable tobacco complements in cigarettes.

The chart on slide eight reflects prudent assumptions for incremental volume growth with only 15,000 tons of additional sales and the decision to cut back somewhat on operating schedules at our French mill to fully leverage the lower cost position of the machine in the Philippines. We clearly expect to grow sales beyond those projections. Even under this cautious scenario, the return on investment is attractive with a rate of return greater than 20%. Given we have already started to pre-sell capacity, we expect to commence operations late in 2011 and achieve full year profitability during 2012.

We are currently exploring options to fund the expected $117 million investment including using our existing credit agreement as well as potentially securing new debt or liquidity capital.

Slide nine summarizes our key business drivers for 2009. Although we have already achieve considerable progress on our action agenda, looking ahead our teams are working hard to address three important issues which are, first, minimize the impact on our fourth quarter results of isolated production downtime in France and Brazil by maintaining a strong focus on cost controls and operational efficiencies. Second, complete the closure of Malaucene. Production and shipments start in September and October respectively. Most employees have received their layoff notices and will be off our payroll by the end of the year. We're looking now at selling off individual assets. Last, we need to manage effectively the transferred waste paper production from Spotswood to France and Brazil to take place by early 2010.

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

Thank you, Frederic. I will now review our results for the quarter, comment on financing alternatives for our reconstituted tobacco leaf expansion and update our financial guidance.

Beginning first on slide 11, in terms of our recent revenue trends, net sales declined 7.4% from the third quarter of last year due to the following reasons; unfavorable foreign currency impacts primarily due to a 3.5% strengthening of the US dollar to the Euro in the third quarter of this year versus last year as well as decreases in unit sales volumes. This was offset by improved product mix and higher selling prices which reflects the impact of our strategic shift towards higher value products. We achieved a 1.6% increase in revenue on a constant currency basis during the third quarter.

On slide 12, our volume trends reflect an increasing rate of growth in high value products as the red chart columns show, with LIP regulation advancing in the US and strong performance in RTL during the third quarter. Overall, sales volumes declined primarily from strategic decisions. The process to shut down our French finished tipping paper facility and the shutdown of the Lee Mills in 2008 and the resulting impact on our North American based tipping business.

Continuing cigarette consumption declines of around 10% in the US market and a lower but increasing 2% to 4% in Europe caused the majority of the core tobacco papers decline which is reflected in the tan chart column. Only China is currently showing growth around the world at 3.4% year to date through August.

On slide 13, we present the year to date operating profit comparisons. The chart shows the causes of year to date changes in operating profit, including a shift in product mix to higher value LIP and RTL products and to a lesser extent, improved selling prices. Also we continue to experience lower input costs from lower wood pulp while energy, labor, and other material purchase costs were largely unchanged during the third quarter and year to date.

We have now achieved a year to date $14.6 million net cost improvement due to efficiencies gained from last year's French paper machine rebuild and cost reduction efforts, including the benefits of restructuring activities. Non-manufacturing expensing increased during the third quarter and year to date, reflecting higher incentive accruals for the quarter as well as strategic studies through the earlier part of the year. The volume impact on operating profit continues to be minor, primarily due to the loss of volume on lower margin sales. Currency remains neutral to operating profit, benefiting Brazil but unfavorable from the Euro to dollar translation, primarily out of our French segment. The absolute Malaucene facility that is being idled in France third quarter 2009 operating loss was $4.4 million excluding restructuring expenses, substantially worse than last year's third quarter and most of the year to date unfavorable comparison. Not shown here on the operating profit trend is that CTM, our China paper joint venture generated its first quarterly profit during the third quarter and contributed to our overall earnings per share improvement.

On slide 14, as Frederic noted earlier, we again achieved outstanding earnings per share levels excluding restructuring and impairment expenses during the quarter. The $1.39 earned during the third quarter exceeded any full year performance since 2004. The year to date earnings per share of $3.29 is now better than any full year results in our 14 year public Company history. Restructuring and impairment to date in 2009 totaled $40.5 million. $13 million is primarily from paper machine asset impairments in the US and France recorded during the third quarter. $27.5 million is primarily from French overhead reductions and Malaucene severance accruals. We expect to record approximately $16 million in additional cash restructuring expenses with $9 million in the fourth quarter of this year and the balance through the third quarter of 2010 to finalize the announced efforts. We do not foresee further restructuring or impairment expenses beyond these announced programs at this time.

On slide 15, the increase in trailing 12 months EBITDA, excluding restructuring and impairment expenses underscores the fundamental improvement in our business. The trailing 12 months EBITDA totaled $126 million. On a year over year basis, adjusted EBITDA increased by $18.6 million or 72% from the third quarter of last year. Continued growth in EBITDA is expected based on our full year earnings outlook.

On slide 16, total debt and net debt continue to be reduced which, coupled with the rise in EBITDA led to a net debt to adjusted EBITDA ratio of 1.00 at the end of the third quarter. Some progress was made during the third quarter in reducing working capital. The working capital build in 2009 is expected to turn in France and Brazil from paper machine downtime planned during the fourth quarter to reduce inventory and further in early 2010 by $20 million from a refund of 2009 income tax payments resulting from changes in our French legal entity structure and the reduction of a planned inventory build in the US that is associated with the transfer of base paper production from the Spotswood, New Jersey mill to operations in France and Brazil. We continue focusing on debt reduction in order to have the capacity to fund strategy investment opportunities such as the RTL expansion in the Philippines.

On slide 17 we announced yesterday a $0.15 per share dividend, continuing our long standing focus to return ongoing value to shareholders via a dividend. We continue to control capital spending and other cash uses. Capital spending expectations have been reduced for the full year 2009 to a range of $10 million to $12 million down from a high of $15 million. Other cash needs covering pension payments, restructuring, severance costs, and software development now total $20 million to $25 million for the 2009. Total 2010 cash uses are expected to be significant, ranging from $130 million to $160 million with $80 million to $100 million in capital spending, including our new RTL investment and $37 million to $40 million in cash severance payments in addition to other ongoing cash uses for pension funding and software development.

We continue to use free cash flow to reduce debt in order to have adequate capital to fund expected cash requirements. We are also evaluating a range of options, including raising new debt or equity capital to manage the significant level of spending expected during 2010 and 2011.

On slide 18, we continue to make progress against our long-term return on invested capital goal to exceed our cost of capital. Based on a rolling four quarter average we have significantly improved our return on invested capital and are now meeting our cost of capital. We expect to continue to improve our shareholder returns as we work to sustain and further grow earnings and carefully managed investment decisions.

On slide 19, we now expect full year 2009 earnings per share excluding restructuring and impairment expenses of at least $4.00. This includes a projected $0.50 impact from the closure of the Malaucene facility. They guidance has improved over our second quarter due to strong third quarter results and less uncertainty about the global economic outlook. We are anticipating a weaker fourth quarter due to planned paper machine downtime in France and Brazil to reduce inventory levels. We anticipate 2010 earnings of approximately $5 per share with improvement resulting from continued growth in LIP and RTL in current and new markets, the benefit of restructuring activity, including the elimination of Malaucene losses, sustaining newly profitable operations at our China paper joint venture, and beneficial currency exchange.

The improvements in our business continue to be broad based and robust. The challenges in our business outlook include expected continued volume weakness, albeit not likely any worse than already experienced, softening selling prices, mostly from downward price adjustments expected during 2010 major customer contract renewals and a return of net unfavorable inflationary increases as pulp price benefits level off.

That concludes our remarks. Chrissie, please open the line for questions?

(Operator Instructions) Our first question comes from Ian Zaffino from Oppenheimer. Your line is now open.

Great. Thank you. Very good quarter. The question would be as far as the customer contracts that you have and the price reductions, that is coming in what areas and what type of paper? And then I have a follow-up question.

Good morning. This is Frederic. Most of the contracts we have up from renegotiation at the end of the year concern the base paper business. As part of the investment in the Philippines on the RTL side, we have already made good progress securing the long-term supply agreements for recon and the LIP contracts where we have a lot of them expiring at the end of this year.

Okay. The other question would be, this RTL plant in the Philippines came as a surprise to us. It's certainly good news. Is demand so strong that you woke up one day and said, "Gee, we need another plant in the Philippines." Because we've always heard about the Chinese plant, just give us an idea of what your thinking was or some insight into your thinking there. Thanks.

We have signaled for some time that we were starting to run out of capacity out of our French recon operations. The Chinese project which is still going forward is really focusing on the Chinese domestic market only, China being a monopoly industry. What we are seeing right now is unmet demand for the non-Chinese needs in the range of 10,000 tons and we have been able, working with our largest customers, to secure long-term supply needs but justified the decision to invest in additional capacity. Obviously when you look midterm, the growth for reconstituted tobacco, the growth of cigarette consumption, is in Asia. Therefore, the decision to invest in Asia, in the Philippines. In the Philippines we have both strong experience, we have the management team in place that has delivered very good results over the last couple of years. The Philippines is also a large warehouse for the tobacco leaf for one of our largest customers and we're strategically located to serve some of the bigger users in the region.

Okay. My final question would be for Pete. It looks like the fourth quarter guidance is -- you always assume a very similar decline in the fourth quarter that you experience in the fourth quarter of last year. Is that kind of how you arrived at your guidance for the fourth quarter? Because it seems to me that, sure, you have the plant shutdowns, similar to last year and, yes, some of the assumptions are down significantly more than last year, but you have a significant ramp up in your LIP which is massive margins which I figure would be more than enough to offset a sequential decline similar to what you experienced last year.

The key driver is the certainty of downtime. In terms of quantifying the effect of downtime, the way that we arrived at our full year earnings guidance is to look at what we know we're going to be taking as days down in both France and Brazil. So, it's really not looking backwards. It's what we know is going to occur this year. And the reasons for that are really not to let inventories get ahead of themselves in terms of meeting demand which is soft. Therefore, for both Brazil and France, we want to take advantage of the year end holidays and the reduced customer demand during that period to either reduce slightly inventories or avoid their build. The US market specifically will continue to run our mill in New Jersey during the fourth quarter more than we otherwise would to consciously build inventories in advance of that machine shutdown we've announced and the transition of sourcing to France and Brazil.

Now, with that we know for sure that we'll have weakness due to downtime in the fourth quarter. Whether or not LIP volume will shift to 100% and the absolute volume will be enough to improve earnings and offset downtime is much less certain because two things are occurring in the US market. A historic high level of dislocation from shipment declines with the two largest customers -- Philip Morris and Reynolds -- announcing a 15% decline in shipments during the third quarter which creates great uncertainty as to what absolute volume level we will have even if it is 100% LIP. So, the combination of the uncertainty of volume increases for LIP and the shift to 100% LIP, we're purposefully quite conservative and consciously unsure of what will be any benefit of further LIP growth during the fourth quarter. Obviously we've signaled for 2010 that we do expect LIP to be a continuing source of year over year earnings improvement. But for the fourth quarter is really much more colored by what we know. We know we're going to take downtime. We do not know what's going to happen with volume and LIP conversion specifically.

Thank you very much. That's very helpful.

Okay.

Your next question comes from Bill Chappell from SunTrust. Your line is now open.

Good morning. I guess for some LIP, I didn't fully understand it. I was surprised that the percentage had only gone from 50% to 58% sequentially. Are there things on the books that have just yet to go through. Or how should we look at this over the next three, four months or the next couple quarters?

The LIP regulation in effect at the end of the third quarter is around that 58% number. That's based on the states that have enacted laws. To give you a comparison against that, during the third quarter, our sales out of the US segment which does include some countries that have not or will not convert to LIP but the total sales of cigarette paper out of the US segment during the third quarter was 60% LIP and 40% conventional cigarette paper which matches pretty closely with the 58% high 50% LIP regulation.

So, what that indicates is that both the cigarette companies and the regulation are moving to 100% effective by early 2010. So, clearly regardless of absolute volume levels, the percentage of LIP product will be fairly dramatically increasing over the next several months and as we speak. Now, again, all things equal, even with lower volume, that should result in higher profitability for Schweitzer-Mauduit. Therefore, that probably is an upside to our earnings projections. The point that we would be focusing on is how much we get as an uplift in the fourth quarter is hard to say because of the points I raised a minute ago; however, we're more certain that we're going to get an uplift from LIP for 2010 over 2009 because of the certainty of going to 100%.

So, I would caution don't put too much credence on one quarter. We're simply saying that we can't predict with very good accuracy absolute volume because the market dislocation in the US with huge consumption declines and the uncertainty of the shape of the curve going from 60% to 100%. What we are more certain about is the downtime we're going to take and in 2010 the market in the US will be 100% LIP.

Sure. I think I understand that. I was trying to understand what's the holdup from 60% to 100%? Is it more legislation? Is it your customer's just slower to roll it out.

This is Frederic. We have to keep in mind that 13 states, representing 25% of US consumption will go into LIP legislation as of January 1, 2010. So, the next big way of converting to LIP will take place in January. What we know is that our customers, the tobacco companies, have for logistic reasons started to go nationwide. What is not known, and that's what Pete was mentioning before, is how quickly they will flush out their inventory of conventional cigarettes and how aggressively will they go with their plan to switch to 100% LIP cigarette production in the fourth quarter of this year.

Right. So on the RTL facility in Asia, where do you see that going over the next two, three years. Is it -- can it -- with the higher margins, can it take off some of the capacity of the French facility? Can it grow organically on its own to do more than the 10,000 metric tons that are being served?

Our expectation is that this facility will develop new markets and new demand in Asia. The chart that we showed in our presentation is putting it out and just assumes, based on what we know, what we have secured in discussion with existing customers, the large multinationals and the thought that we will maintain high capacity utilization in the Philippines due to its advantageous cost structure. However, being lower cost RTL production this will -- you have to remember that RTL is a substitute to Greenleaf tobacco. So, if you're imaging that now we have a lower cost structure in Asia in a market where RTL usage is fairly little developed today, we can increase the use of RTL as a substitute to virgin tobacco in the Asian cigarette designs. So, we have full expectations that over a few years this factory will be serving mostly the Asian region.

Just one last one, Pete. As you look to fund this facility, is there a leverage ratio where you are not comfortable at? Do you feel you have plenty of capacity?

We would more look at the nature of the investment requirement relative to cash flow. In other words, the spending that we have which is fairly significant coming up, is capital spending driven because of the RTL expansion in the Philippines and then our other capital spending which does include LIP investment that we expect to be making in Europe. Though we're generating a lot of cash, this cash that we're investing won't return new cash for some time. Obviously we've got to construct a plant and then sell it out. Probably the best way to think about the way we're evaluating financing options is to match the capital sources with the spending curve so that we don't have too much leverage based on our current ability to fund that. Obviously with the higher earnings, we are generating much improved cash and we're now down to the point where we're pretty underleveraged. But we don't feel comfortable getting overleveraged either. So, how high do we go and feel comfortable at? I don't have a precise number but we are mindful not to use debt to match spending requirements that won't be able to service that debt for some time.

Got it. Thanks so much.

Okay.

Your next question comes from Torin Eastburn from CJS Securities. Your line is now open.

Hi. Good morning to both of you.

Hi, Torin.

The 40% operating profit margin you mentioned for the RTL facility in the Philippines, what utilization does that assume?

That would be -- we should be able to achieve that 40% or better once we get to 75% plus utilization rates.

RTL is extremely high incremental margins. I assume it would not be crazy to think that you could do significantly better if you were to eventually sell out that facility?

Yes. There would be -- the exceeding 40% obviously the closer we are to being fully sold out, the more that it will be exceeding 40%. I'd be cautious in projecting that average profitability would get out of the 40%, to get to above 50% or anything like that. But, yes, exceeding 40% will exceed it more as we get closer and closer to a 30,000 ton capacity.

Okay. And the China JV was profitable this quarter. How does what you earned there this quarter compare to what you will earn in the future if utilization stays at 100%?

I would say each quarter is a good, fair representation of the earnings potential of the joint venture. We have been -- we sold out the capacity of the cigarette paper machine throughout the quarter. We are benefiting from the lower input costs. However, I think what I signaled earlier, the emphasis moving forward is obviously to continue to sell out the mill but also to continue to make some inroads in serving the premium brands in China. So, we have an opportunity to further improve margins in future years. But I would say for the time being, the -- what you've seen in the third quarter is a fair representation of the earnings potential on the joint venture for 2010.

Okay. Shifting to LIP in Europe, can you provide any update on how that seems to be shaking out? And also what you think it might cost to build out the capacity there?

I'd say there's been no more progress on the timeline for LIP readiness in Europe since last quarter. The multinationals are still at a stage of assessing device technologies and what we have signaled and will remain true is that we foresee both multinationals to firm up their decisions on technology sometime in the first half of 2010. And in terms of the legislation itself, the standardization committee is making progress on firming up the standards for enforcing the LIP legislation and our customers and our sales continue to see this legislation coming into effect in Europe in late 2011, 2012.

Thank you both, congratulations.

Your next question comes from [Michael Gast] from Bearing Capital. Your line is now open.

Hi. Thanks, guys. Just a couple quick questions. On the LIP regulation where you mentioned you're at 58%, et cetera, does that apply to cigarettes produced or sold? Is the first question because if you've seen some production cutbacks or announced during Q3, I would assume those began in Q3. I could be wrong about that. But wouldn't the -- is it not possible that the cigarette manufacturers trying to manage their production schedules or what they're going to ship to meet the regulation could've already impacted or had a negative impact on industry shipment volumes during the third quarter and some of this transition has already begun.

The answer is yes. There is a phase in period where the regulations require that cigarettes meet the standard at retail as of the effective date. Now, if there are cigarettes that have been on the shelf that are pre-LIP compliant, they're probably still going to be there. How well policed it is in terms of throwing away cigarettes, I doubt that's occurring but the cigarette manufacturers are making the production shift so that the best way to think about the demand side of it from our standpoint is our LIP paper shipments will lead the regulation. So, the fact that our shipments were essentially at the rate of regulation during the third quarter says that the lead is not much. That makes sense. We service our accounts very, very quickly.

Now, as a second effect unrelated to LIP is that because of the significant rise in taxation and prices of cigarettes in the US market in 2009, consumers are buying less and retailers are adjusting their cigarettes whether they are LIP or not, downward in terms of the amount of inventory they carry because they're turning them less frequently. People are buying less. That destocking activity at retail for finished cigarettes is unrelated most likely or largely unrelated to the LIP regulation effect. But both factors drive us. So, I think the LIP regulation conversion is much more logical. The fact that we're shipping roughly what the law requires makes sense. The fact that our volume is so volatile is more effected by total cigarette consumption regardless of whether it's LIP or conventional.

It almost seems like your under shipping a little just because that product is going to have to work its way through the distribution and into retail by January 1. I understand what you're saying. There's a lot of noise and it probably started in the third quarter. It will continue in the fourth quarter. And by midway through the first quarter you should have a better sense of what the real run rate is on LIP, et cetera.

My second question is on the Philippines, I would think that in the current environment you should be able to get some sort of local project, government or some local finessing for at least a portion of this. Is that something you've explored? It would seem that in Asia there's lots of entities looking to bring new manufacturing plants these days.

Yes. In fact we do have fairly significant incentives that are associated with the project. They're more on tax free zones. It would be similar to the US duty free zone or an enterprise zone where there's an exemption on value added taxes for construction costs and an exemption on value added taxes for export of finished goods which is very important to that overall cost effectiveness of our operation. In terms of financing sources, there are programs that could be available in the Philippines for incentive but they're not that significant. It wouldn't be a way all by itself to do project financing. We have explored that but there are not program especially for an investment of this size that would really come close to covering the total investment cost. So, we don't anticipate doing project financing. It is still something that we're considering, but it would be down the list of viable alternatives.

Then the last would be your comment that you wouldn't want to take on the leverage too far in advance of when you'd be starting to get to cash flows from that facility, et cetera, given that it's going to take two years to fully build this out and when you talk about a potential mix of debt and equity, can I assume that you also would not want to issue equity years in advance of when you really need that capital given that you've got a reasonable amount of capacity in your current credit lines, et cetera?

Yes. To answer directly your question, clearly we've announced this investment and our board of directors has approved the investment without any matching definitive financing which says that we do have confidence that we can at least start off the project and we don't have to do anything. Obviously we would not announce a major investment and say, "We don't know how to pay for it." We're okay right no in the short-term.

So, it's phase one sort of, at least what you would see for next year, you feel you could probably do with some form of debt?

Yes. We could. But I emphasize we are valuing alternatives. Now, from a pure treasury capital planning standpoint in pro of equity, obviously there's dilution issues, there's all kinds of issues around the proper valuation of an equity offering if we would do so. But from a pure capital planning standpoint, equity is nice because you don't have to pay it back right away. It's a great way to pay for a long-term capital investment.

Would you consider doing equity at that subsidiary level through some perhaps Asian investment sources that would want to invest in that factory, in that plant?

Yes. We did evaluate that closely; however, all the available sources of equity investment through a joint venture partner of some type or even a financial private equity investment would've been almost Draconian in terms of the return requirement and would've just been unacceptable and are unacceptable in terms of the cost of that form of capital. So, we passed on -- we looked at but we will not do a joint venture locally in the Philippines. China joint ventures are a totally different reason for the joint venture. It's a requirement for doing any form of a project and it's much less onerous in terms of the sharing requirements. A joint venture in the Philippines, we would've given up too much of the return potential of the project to the partners.

Okay. Great. Thanks a lot.

Thank you.

(Operator Instructions) Our next question comes from Ann Gurkin from Davenport. Your line is now open.

Good morning.

Morning, Ann.

As you look out to 2010, what are you assuming for US cigarette volume outside of the US and RTL volume from the French facility?

Outside of the US we would expect cigarette consumption to be declining at the more normal rates. So, 2% ish, maybe 3% in the Western Europe zone. Flattish in everywhere else in the world and then up in China. So, not like this year where China's the only country showing growth or the only region and all the other regions are down at a higher rate than normal. Europe, some of the most recent statistics are down as much as 4%. The US side, what we are expecting is that given the 10%, what will likely be 10% decline in US consumption in 2009 that 2010 will be at the lower end of the range of 2% to 4%. So, more like a 2% decline because the odds of having a significant further decline after such a large decline this year are unlikely. That is potentially a risky forecast to a certain extent. But we think it's likely to hold true.

So, in total, 2009 and 2010, we'll probably see worldwide growth at 0.5% this year and back up closer to above 0.5% towards 1% next year, especially if China continues to grow.

And for RTL, demand continues to be strong. As I had mentioned earlier, we have unmet demand in 2009. So, even though we foresee that for some of the multinationals, our side to see an origin in demand which ultimately will affect RTL needs. We are looking, for 2010 growth in RTL sales in I would say the neat single digit range.

Sales or sales and volume?

I'm sorry? Sales?

Sales volume, yes.

Sales volume?

Yes.

Okay. And then second, the concern for us is always that there will be excess capacity added either on the traditional cigarette paper or for LIP. Any comment on potential risks that there's too much capacity for either product over the next several years?

I would say we have a decision to refocus the Spotswood, New Jersey facility on LIP products and transfer base paper product to France and Brazil. We feel comfortable that even in a depressed environment next year, we will achieve good capacitization on our core paper machines.

t this point there's indication that competitors are adding capacity or anything that would throw off core cigarette paper demand and supply?

No. The only project that you're likely aware of is the German competitor, Glatz, who started, invested two years ago in a Greenfield facility in Vietnam and this paper machine is supposed to be coming live on the production stage later this year, early next year. But that was anticipated by the industry.

Okay. Great. And then third, in your Q, you reference a dispute with Philip Morris USA. Any other details you can share on that? Or is there any risk that that contract can change and you will no longer be a sole supplier of LIP to PM USA?

The nature of the dispute that we disclosed in the Q is over the mechanics of how the current agreement works with Philip Morris USA for pricing of the banded cigarette product. Obviously there's a mechanism that's implied with that dispute because it's not a fixed price contract. And there's a dispute over one step in the calculation of pricing that obviously has fairly significant impact because of the stated $3 million to $4 million value of the dispute. But that's a specific issue related to current invoicing. In terms of any change with Philip Morris USA going forward in our supply to them of the banded cigarette paper product, at this point, no, if there were a change in terms of an awareness that we had on a different sourcing or a different product form that was going to materially effect our operations, we would have to say so, or a change in the conditions of the supply agreement that we have, we would have to say so. That's always a potential. Clearly, especially as the US market declines and there's less and less volume, the Philip Morris USA product is dependent on the New Jersey mill. And as we've just announced, at some point, if volume gets too low, it's very difficult to effectively operate a facility. So, the risk of the product that Philip Morris currently uses for LIP is more tied to the volume issues and the economic viability of that single New Jersey facility than any other issues. So, no, there's no specific news on changes in sourcing. But certainly that could happen at some point.

Great. Thank you. Congratulations on a great quarter.

Thank you.

Your next question comes from [Brandon Smith] from Cobalt Capital. Your line is now open.

Congratulations on the quarter, guys.

Thank you.

Question on the France segment. Essentially in Q1 and Q2, we saw flat revenues and in Q3 we saw a nice little bump up there. Where is that coming from?

The largest change in revenues in the French segment is through the recon business. The paper business is actually including the Malaucene shutdown, the revenues on the base paper side in France are down fairly substantially. If you strip out the Malaucene noise because of the shut down, then base paper revenue would be up year over year because of pricing and flat volume. But the real movement that's occurring is on the recon side and it's not pricing driven. We are having success in driving volume growth, as Frederic noted and even though we're currently sold out, we are managing to improve productivity of our existing three machines in France and drive unit volume growth. So, most of the revenue growth in France is really come from -- underlying revenue growth is coming from higher unit volume with recon.

Sure. What is your earning capacity there? Is it 80,000 total capacity? What's the utilization rate?

80,000 is the nominal capacity and utilization is at 100%. We're basically running full. But in any industrial operations, especially like reconstituted tobacco, we can usually drive 2% to 4% productivity improvement year over year over year and get some incremental capacity. Plus we're doing several small projects to speed up the operation.

Sure. I guess the improvement in operating income in that segment too is a better product mix. How much is actually coming from restructuring initiatives benefits that are starting to flow through?

In the French segment?

Yes.

Year over year more than half of the improvement in the French segment is due to base paper operations getting better. The benefits of restructuring, we had a very difficult execution on the rebuilt paper machine in 2008 at our PDM facility. So, year over year more than half of the improvement in the French segment that is reported, stripping out Malaucene, stripping out restructuring, is from base paper.

Sure. Great. Thank you very much.

Your last question, from Cris Blackman from Empirical Capital. Your line is now open.

First, congratulations on your continued strong performance and also thanks for disclosing your expected margins on RTL. That's very exciting and perhaps maybe under appreciated in the past of the potential there. My question is, can you comment or give some guidance on potential timeframe which you could possibly come to potential licensing agreements in Europe on LIP whether it be with customers or potential competition. Could we expect something potentially by fall of next year?

Good morning, Cris, this is Frederic. As you know, we have started the discussion with the key customers in Europe and I fully expect that we will have made some meaningful progress and we'll have something to report sometime during the first half of 2010.

Excellent. All my other questions have been previously answered. Again, thank you.

You're welcome.

(Operator Instructions) Our next question is from David Sachs with Hocky Capital. Your line is now open.

Two questions, one if you could just go over the global landscape for LIP legislation? You'd mentioned early that LIP would be the end of 2011, beginning of 2012 in Europe. I believe you had announced an agreement to supply Australia for 2010. If you could just go over a couple of other countries that you know are evaluating LIP and sort of where we stand on the legislative front?

Sure, David, let's start with what we know for sure. We mentioned 100% of the US market would be under LIP regulation early next year. Australia and Finland are the next two countries that have already made LIP regulations to be in effect in March and April of 2010. The next markets going into LIP regulation is likely to be the EU with 27 member states of the European Union and that's early 2011, 2012. There are discussions and talks in other countries whether it's South Korea or the Philippines, South Africa, Brazil. But nothing that I would say take on enough ground to be able to put a date on the bills passing.

Okay. Second question, just in terms of the cash flows and the funding program here, earlier in the call you mentioned you were expecting a $20 million tax refund for 2009 and 2010. So, we're going to take in $20 million. Using the $5 number, that's around $80 million of net income, deprecation something around $45 million. That would suggest sources are $145 million and your cash tax rate is lower than your book tax rate by probably $10 million or $15 million. So, we would have $155 million to $160 million in sources in 2010 against the uses that you projected. It would appear that we would generate - if there's a $10 million dividend outflow, so it would appear that we would generate about as much cash as we would spend next year, including the pension funding, including the restructuring and the capital programs, we would end the year with debt similar to slightly higher than where it is going to end this year. Is that the right look at the flows?

Yes.

That might suggest that we don't necessarily need additional equity.

I would agree with both your numbers and the premise that whether it's debt of equity capital that obviously again we're going forward with this major investment, the largest investment we've ever undertaken as a Company and we have not secured specific financing. The only way that we can do that is we obviously do have confidence that we've got adequate capital today through existing credit facilities and our cash generation to proceed with the project and then in terms of the math I would agree with the numbers that you put together in terms of cash uses and cash sources should roughly match as we see today. However, we are obviously at the same time saying that we're evaluating capital and it's for the reasons I mentioned earlier. We're prudent. We don't want to get to a position where we have too much debt outstanding at any one time and are uncomfortable that we don't have adequate cushion. We know that we face a maturity on our existing credit facility by 2012. That's a ways off. It's a low cost facility. We don't want to break it open early because obviously it is a low cost facility. We would like to preserve it. So, there's other capital planning considerations that are behind our statement that we are evaluating other capital sources. So, I'd answer your question yes and yes in terms of the numbers and our ability to handle everything with no new capital but at the same time reiterate we are evaluating alternative capital sources.

Okay. Then as far as the NOL and the cash tax rate compared to book tax rate, how long do you expect there to be a significant difference between your cash taxes and what you're accruing on the P&L.

At least three years. Because of the NOL balance that we've built up in France. So, we should be able to see at least $60 million of sheltered cash tax payments. That would mean $20 million refund in 2010, $20 million of voided in 2010, and at least another $20 million in 2011 and most likely depending on profitability and taxable earnings, we could see that continue into 2012.

Then you mentioned in this RTL facility in the Philippines, you'd be in a favorable tax position there as well with credits?

That's more on the value added tax, not on the income tax side. On the income tax side, we probably wouldn't see any significant benefit over time. There it's more on a trade basis that we would avoid having value added taxes on exports and so have a higher exported cost from a customer pricing standpoint, as well as not paying value added taxes on purchased equipment.

One last question. The 19.9% operating margin in France in the quarter, that's including operating losses at Malaucene. So, that number would even be slightly higher. Is that a reasonable run rate level? Or is there something unusual in there that skewed that higher?

I would say the strength of our RTL franchise in Europe and the emerging proved base paper operations -- this is a rate that we can foresee maintaining in the years to come.

If we switch over to LIP in Europe, assuming now the intellectual property that you have will carry over there, is there anyone that has a competitive offering or the European market could look similar to the US market given your IP and possible market share increase from your current 33% or 35% of the base paper business?

I would say, David, that there is a significant amount of competitive activity in the evaluation of products but as of today none that have been validated by the multinationals. My belief is it has a lot to do with the strength of our IP and patent portfolio. And so, when we look at Europe, I think what we have signaled in the past is that we foresee the European market to be more competitive than the US markets, elsewhere it's the position, our flagship technology as the preferred choice by the top four multinationals who command 90% market share in the EU and elsewhere to achieve that is to go with a combination of direct selling and licensing agreements.

And the licensing would be with the manufacturer directly, not to perhaps another paper mill? You license directly?

We are looking at all the options.

Great. Congratulations on a good quarter and a good year.

Thank you.

There are no further questions at this time. Mr. Thompson, I turn the call back over to you.

Thank you very much, Chrissie. We want to thank everybody for joining us on today's call. Needless to say we are very excited about what's happening. We are moving with great speed to reengineer the Company and to put Schweitzer-Mauduit into a position of durable strength in our industry. As we embark on the next stage of our journey, we have a lot of growth expansion actions. We will remain acutely focused on value creation and superior execution. Thank you again for your paritcpation.

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