Mativ Holdings Inc (MATV) 2009 Q4 法說會逐字稿

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions). Thank you. Mark Spears, you may begin your conference.

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

Before we begin, I'd like to remind you that comment included in today's conference call constitute forward-looking statements. Actual results may differ materially from actualities suggested by these comments for a number of reasons discussed in more detail in the Company's Securities and Exchange Commission filings, including our third quarter 2009 form 10-Q. Certain financial matters discussed during the call exclude restructuring expenses and are therefore non-GAAP financial measures. I want to point out that our earnings press release includes fairly significant forward-looking statement language. We did so out of prudence, given that we are between SEC filings until we issue our annual report on Form 10-K in early March. A slide presentation accompanies our formal remarks today, a copy of which can be found in the investor relations portion of our Web site, or you can follow along on our Webcast. With that, I'll turn it over to Frederic.

Thank you, Mark and good morning, everyone. To this call, I would share some high level comments about our fourth quarter and full-year performance. And will also cover our working agenda the for 2010 and our progress moving forward, including comments about our RTL expansion plans in Asia and departments in North America and beyond. 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 full year. 2009 was a standout year for Schweitzer-Mauduit International In the face of a very challenging economic environment marked by a large increase in taxes and a strong decrease in consumption of cigarettes and cigars in the North American and western European markets, Schweitzer-Mauduit made impressive gains and significantly strengthened our financial and liquidity position. Our fourth quarter results were largely in line with our expectations. We advanced our key strategic initiatives during the quarter and were able to mitigate the planned downtime by maintaining a strong focus on cost control and operational efficiencies.

We achieved sold earnings per share of $0.96 in the period, if we exclude restructuring expenses without standing contributions from our Chinese paper joint venture and despite significant planned downtime. Adjusted for $0.06 per share of impact of our 2009 November liquidity offering, the fourth quarter adjusted EPS would have been $1.02, our second best quarter last year. Our adjusted full-year EPS now stands at $4.25. For future comparisons, 2009 EPS would have been $3.91 per share, assuming the November liquidity offering done at the start of 2009. Now, moving to slide five, operationally, we experienced paper machine downtime as expected in all segments, finely related to investment adjustments and lower system demand. This aside, the fourth quarter kept strong momentum from the previous three quarters.

Growth of our high-value products continue to be strong. In fact, all cigarette paper sales to US customers were converted to LIP product by the end of the fourth quarter, which caused a 111% increase in sales volume over the prior-year period. CTM, our Chinese paper joint venture, operated at full capacity and was successful in selling off investments built in prior quarters. It produced an outstanding $2.5 million contribution to Schweitzer-Mauduit net income, fully offsetting prior-year 2009 losses.

Throughout the fourth quarter, we continued to benefit from cost reduction initiatives and a somewhat favorable inflationary environments, even though prices continue to rise, becoming a source of concern for 2010. All in all, we continue to benefit from favorable pricing and input cost lag throughout the fourth quarter. Lower sales and resulting production volume declines and scheduling downtime negatively impacted operating result comparisons by $5.4 million versus the fourth quarter of 2008. Volume weakness in paper product sales will likely persist in 2010 in the somewhat weaker pricing environments.

As such, we are maintaining a strong focus on cost reductions, particularly as it relates to implementation of restructuring actions announced in the third quarter. And we fully expect to complete the transfer of LIP-based paper production from the US to Brazil and France during the first quarter of 2010. Moving to our growth plans on slide six, we continued to advance strategic actions to grow our high-value product business. As mentioned earlier, we are very pleased with the progress made in the second half of 2009, in selling out the cigarette paper capacity of our mill in China. As a result, China tobacco mill managed to close the year with a profit.

For the full year, net income was $1.0 million. Our ambition for 2010 is to consolidate gains, drive solid growth on the most attractive premium applications and generate an additional 50% in earnings. We have now begun construction of a new 30,000 ton reconstituted tobacco production facility in the Philippines. With expectations to start operations in late 2011, with approximately 50% of the added capacity already being secured.

We have raised our expectation to reach full-year profitability in 2012. As previously stated we project revenue potential of $65 million to $70 million, operating at capacity and EBIT margins exceeding 40%. Over the last month, with we made good progress in finalizing the commercial terms of the RTL joint venture in China, and fully expect to announce the signing of the JV agreement with our partners during the first half of 2010.

This will generate incremental earnings in line with our projects, of which we will earn a share. On the LIP front, the US market is now essentially convert to LIP cigarettes. We'll cover certain aspects of our intellectual property and recent competitive activity in the next two slides.

Outside of North America, our focus is on serving the Australian and Finnish markets, with LIP regulation coming into effect in March and April, respectively. We are about to start our first European-based production of LIP paper and are firming up capacity plans for supplying LIP to the European markets. We continue to expect growth in the demand for in the IP growth in 2011. With the European Union finalizing its plan in the second half of this year to mandate all 27 member countries to become LIP compliant over a 12 to 18-month period. Expansion of LIP regulation beyond North America continues to provide an opportunity to substantially grow earnings. In the EU alone, we estimate the earnings potential to be at least equal to North America's.

Now a word on our restructuring program on slide seven. We are near the end of a long period of restructuring activity to transform a base business into a core strength for Schweitzer-Mauduit. And part of the unique breadth of product offerings to customers, that differentiates from our competition. We have essentially shut down the Madison facility and are now working to sell off the assets. In December we concluded an agreement with our employees in France on the terms of a shareholder staff reduction; an we now expect to complete a reduction in force in the third quarter of 2010, resulting in annual pre-tax savings of approximately $8 million on a full-year basis. The local management team is now refocusing the organization on operational efficiencies and other cost improvement initiatives.

We have made good progress in the past quarter preparing our mill in New Jersey to concentrate on the online LIP technology we operate for Phillip Morris USA with expectation to be essentially complete by mid year. Base paper is a challenging business, but we remain doing what is necessary to sustain profitability achieved during 2009 in these product segments, and we remain acutely focused on the possibilities to increase further effectiveness.

Slide eight is new, and explains the volume mix at play with the migration of the North American market to LIP compliant cigarettes. November of 2009 saw our last shipments of conventional cigarette papers. We expect that all of 2010 demand will be for LIP compliant products. The 2009 market share data reflects our best estimate for total market size, cigarette paper demand converted to LIP products, and sources for non-trade product forms. To the best of our knowledge, combined sales of online vended products to Phillip Morris USA and Schweitzer offline printed papers accounted for 50% of its demand for cigarette paper in 2009. 78% of the demand for LIP compliant papers. Since 2002, we have granted licensed to permit two of our US to have printers to use banded paper, using their own band forming solutions for a portion of their needs.

These accounts for essentially all of the volume LIP US printer section, or 11% of total 2009 demands or about 14% of 2009 demands for LIP-compliant papers. It is worth mentioning that Phillip USA has informed us of an intention to use LIP product printed by US converter on imported base paper as a commercial alternative for one of their low-cost brands. To date, we believe that the volume involved is very small. As previously communicated, we regularly retail competitive activity for the presence of other LIP products, and to determine if those products infringe on our granted patents.

In light of our assessment activities from several European competitors in the market and after completing a number of technical and legal evaluations, we have come to the conclusion that we have at a sound basis for legal action. Hence our decision to file a patent infringement action on Monday against Delfort Group, Julius Glatz, and others. This action is important given the advance of IP regulation in Europe. While it is not possible to predict the outcome of litigation, we would not have initiated this action absent the sound belief that our position is well supported and our commitment is to see it through to its fine conclusion.

Slide 9 gives a high-level view on our intellectual property, particularly as it relates to LIP patent protection. We have been engaged in the study of the mechanisms at work and the means for designing cigarette papers that aid in controlling the cigarette for over 20 years. To our knowledge, this substantially predates work by any of our competitors in this area, and is a foundation on which Schweitzer-Mauduit has built a portfolio of patents around the world, which cover a range of products and processes related to this technology. In our view, our early work has allowed us to establish a strong intellectual property position on many of the fundamental techniques currently employed commercially to produce lower ignition intensity papers and our work continue in developing this technology, including banding.

At the risk of oversimplifying the evaluation of the patents or patent portfolio, making comparisons between patent portfolios, one needs to consider a number of questions, such as: Are that any blocking patents that would prevent the patent owner from freely participating in patent litigation? To what extent does the patent force a competitor into a less desirable or less efficient method for achieving the same end function? To what extent does the patent scope include functionality? In short the assessment of patents and patent portfolios is a highly technical, complex, and repetitive inquiry. One remark on Europe.

In early 2009, the European Patent Office, or EPO, used to achieve munition control properties of cigarette papers. Under our European patent practice any party of nine months following the grant of a patent to file a position. Three parties filed such a position within the deadline. We believe that the EPO was correct in granting the patent and will respond to the oppositions. The patent is valid and enforceable, while the opposition proceeding is pending.

Moving to slide 10 and a summary of our key business drivers for 2010. We have now concluded contract negotiations with key customers that resulted in pricing expectations in line with our internal goals. Of note, the combination of volume decline in US markets and the captive nature of the banded paper production starts with Phillip Morris USA, we reserve an able to maintain the same margins as in 2009 and other cost agreements.

While this margin loss was fully included in our guidance for 2010, it will have meaningful effect on the profit margin of our US segments. An effect that we intend to minimize through the timely realignments and our Spotswood operations on banded paper products, and other cost reduction initiatives already at work. More on this in Pete's coverage of our updated guidance from 2010. Now we fully expect to continue to grow our high-value products, LIP papers and products with growth in the high single digits this year.

Our Chinese paper joint venture will continue to gain traction in 2010, with expectations to grow by at least 50% for our 2009 actual results. Last, our focus remains on the swift execution of our cost reduction plans for our newly revamped operational excellence program and already announce restructuring actions as a way to offset cost increases and continued volume weakness for base paper. As a reserve we foresee our global base paper operations will sustain profitability during 2010 at roughly the same level as 2009.

All in all, we have a lot of work to do, but am confident that we are on a solid trajectory to getting our double digit earnings improvement in 2010. With that, I will turn the call to Pete to cover our financial results and outlook.

Thank you, Frederic. I will now review our results for the quarter and update our financial guidance. On slide 12, for the fourth quarter, net sales increased by 6.6% from the fourth quarter of 2008, or 3.3% on a constant currency basis, due to the following reasons. Improved product mix and higher selling prices, which reflects the impact of our strategic shift towards higher-value products, favorable foreign currency impacts primarily due to a 12% weakening of the dollar to the euro.

Partially offsetting these positives were an 8% decrease in unit sales volumes including the impact of the Malaucene facility shutdown. Although as you will see in an upcoming slide, sales volume grew across SWM excluding the impact of the Malaucene facility shutdown and including sales from our China joint venture. For the full year, net sales decreased 3.6% due to a 9.6% decrease in unit sales volume including the Malaucene facility shutdown and an unfavorable currency translation impact primarily from a 5.2% strengthening of the US dollar to the euro, partially offset by an improved product mix in higher selling prices. On an constantly currency basis and excluding Malaucene impacts, net sales increased 2.7% for the full year.

Slide 13 is new. It helps explain US segment revenue trends given two key drivers, the shift to 100% LIP, and significant volume decline due to lower cigarette consumption as well as restructuring actions that lowered US sales. In 2009, the US segment generated a significant $52.7 million in operating profit excluding restructuring and impairment expenses. Driven largely by a 78% LIP cigarette paper demand level during 2009.

And operating profit return on sales of this high-value product of over 20%. The US operating profit margin was 21.4% in the fourth quarter of 2009. This would have been about 25% excluding the impact of planned fourth quarter paper machine downtime. This illustrates the significantly higher per unit selling price and operating profit of LIP cigarette paper, which drove overall net sales and operating profit and margin increases despite volume losses. We exited the fourth quarter of 2009 shipping 100% LIP cigarette paper to US customers.

Slide 14 shows volume trends. We've seen continued growth in high value products, as the red sharp columns show, primarily from LIP regulation advancing in the US Overall sales volumes declined primarily from strategic decisions. The Malaucene finish tipping paper facility shut down. The transfer of the base tipping paper business to Brazil following the shutdown of the Lee mills in 2008 and the resulting impact on our market share, global tobacco paper sales grew despite negative Malaucene impacts for the first time in 2009 during the fourth quarter on the strength of CTM sales, as only the Chinese market is currently showing growth globally at 3% year to date through the most recent reporting period, which is October.

We've seen continuing cigarette consumption declines of around 10% in the US market and a lower increasing 2.4% in Europe which continued to negatively impact our core to paper volume. The most recent reporting results from key US customers including Altria, Reynolds, and Lorillard show fourth quarter unit declines over the prior year were substantial, in total 7.5%, with as high as 11% from PMUSA. For the full year, unit volumes declined for our primary US customers by 10%.

On slide 15, we show the causes of full-year changes and operating profit. A shift of product mix to higher-value LIP and RTL products and to a lesser extent improved selling prices continue to be the primary causes of increased profitability for the fourth quarter and full year, with approximately two-thirds of the increase due to product mix. We continue to experience lower input costs primarily from wood pulp and energy with the fourth quarter benefiting by $1.7 million and full year by $7.2 million. We achieved net cost improvement of $5.4 million during the fourth quarter, and $20 million for the full year, due to efficiencies gained from last year's French machine rebuild and cost reduction efforts, including the benefit of restructuring activities. Non-manufacturing expense increased by $5.1 million during the fourth quarter and $16.8 million for the full year, primarily from higher incentive accruals, due to improved results.

The volume impact on operating profit continues to be minor, due to losses concentrated among low-margin and our completed restructuring activities that lowered overall fixed-cost levels. Currency remains neutral to operating profit, benefiting Brazil but unfavorable for the euro to dollar translation for the full year, while this trend reversed during the fourth quarter. Our absolute Malaucene fourth quarter 2009 operating loss was $2.1 million and $9.9 million for the full year, excluding restructuring and impairment expenses and added to the full-year unfavorable comparison. Not shown here is that our 50% interest in CTM, our China paper joint venture provided a substantial $2.1 million fourth quarter net income and $1.1 million for the full year and contributed to our overall EPS improvement.

On slide 16, we achieved excellent earnings per share levels for fourth quarter and full year excluding restructuring and impairment expenses. The $0.96 earned during the fourth quarter equaled 2008 full-year performance. The year to date earnings per share of $4.25 is better than any full-year result in our 14-year public company history. For comparison purposes going forward, our 2009 earnings per share excluding restructuring and impairment expenses and adjusted for dilution would be $3.91.

Restructuring and impairment in 2009 totaled $50.2 million. $13.5 million primarily from non-cash, paper machine asset impairments in the US and France, $36.7 million primarily for cash expenses from French overhead reductions and Malaucene severance accruals. Cash payments of previously accrued severance expenses totaled $9.1 million during 2009. We expect to record approximately $11 million in additional cash restructuring expenses in 2010 to finalize the announced efforts. We will continue to assess capacity and demand balances across our paper operations and communicate any further restructuring or impairment expenses if and when any plans are developed.

On slide 17, the nearly doubling of our trailing 12 months EBITDA to $142.1 million for 2009, excluding restructuring and impairment expenses, underscores the fundamental improvement in our business. Fourth quarter EBITDA generation was lower sequentially, primarily due to lower earnings largely as a result of paper machine downtime and lower customer demand. We expect continued growth in EBITDA of at least $23 million during 2010, approximately equal to the projected earnings increase.

On slide 18, total debt and net debt declined substantially during the fourth quarter as a result of the $117 million in equity offering proceeds and $10 million in cash flow generated from operations. Working capital increased during 2009 by $20 million, primarily due to a French law change impacting vendor payment terms as well as by building a favorable -- as well as by building a receivable for French income tax overpayments partially offset by accruals for employee severance expenses. Both of these items will turn in 2010 as severance payments occur and the tax refund is received. We anticipate slowly building debts through 2010 as we invest the new Philippines recon operation, pay the accrued employee severances expenses associated with restructuring activities and fund expected LIP capacity expansion in Europe. However, net debt will likely remain below $50 million through the 2010.

On slide 19, we announced yesterday a $0.15 per share dividend, continuing our long-standing focus to return on going value to shareholders via a dividend. Total 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 payment in addition other cash uses for any pension funding and software development. Capital spending in 2009 was significantly reduced; and in 2010 we will concentrate spending toward strategic activities, including RTL and LIP expansion. We invested $27 million into the US pension plan in 2009, and are evaluating further funding plans for 2010.

On slide 20, we made tremendous progress during 2009 towards our goal of generating returns on invested capital, consistently exceeding our cost of capital. We expect to continue our shareholder returns in 2010 and beyond, as we work to sustain and further grow earnings and carefully manage investment decisions. On slide 21, we now expect full-year earnings per share of $4.60, an 18% increase over 2009 results. All amounts reflecting current share count, and excluding restructuring and impairment expenses. The improvement of earnings includes projected $0.40 benefit from the closure of the Malaucene facility.

Overall, our earnings guidance has improved $0.20 per share or 5% over our previous 2010 guidance due to continued strong business performance and despite $0.25 per share increase in wood pulp inflationary impacts, and a currently unfavorable euro to dollar exchange relationship. Customer negotiations including approximately $6 million to $8 million lower expect profit on LIP sales to Phillip Morris in the US, under our cost-plus agreement are fully included in our updated guidance and are in line with our original estimates. Global base paper operations are expected to sustain profitability during 2010, at roughly the same level as during 2009. Non-manufacturing expenses are expected to decline somewhat in 2010, despite expected increases in legal expenses. CTM results are not expected to sustain their fourth quarter pace, but are expected to achieve full-year profitability in 2010, at least 50% above full-year 2009 actual results.

Brazil results are challenging, due to lower volume requirements in North America, but will benefit from further current hedges placed for late 2010, we've also entered further currency hedges through the second half of 2012. Growth of high value RTL and LIP are also expected to benefit 2010 results. The opportunities in our business during 2010 are likely from better than expected CTM results, further benefits of cost-reduction activities through operational excellence efforts underway across SWM and the potential for higher than projected sales of LIP cigarette paper in the US

The challenges in our near-term business outlook include expected continued base paper volume weakness, albeit not likely any worse than already experienced and any continued pulp price inflation and likely unfavorable euro to dollar currency translation impacts. Beyond 2010, we remain bullish about our growth prospects, especially by 2012, given RTL expansion in Asia, both the Philippines project plus China market prospects and LIP regulation in Europe and beyond. We anticipate generating sustained and significant earnings improvement in the years ahead as a result of these opportunities and remain focused on executing well against these.

That concludes our remarks. Natasha, please on the line for questions.

(Operator Instructions). We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Ian Zaffino from Oppenheimer. Your line is open.

Thank you very much. As far as the pricing environment, when you mentioned the weakness in pricing, can you just go over that as far as, is this more of a competitive thing in is this more, they're in your contract agreements or they're just concessions you make as you go forward. Any type of color there be helpful, thanks. Thanks.

Most of the change that we've seen that's been negative has been on the base paper or more commodity type products, and we had three of our major customers have global negotiation processes conclude through the fourth quarter, and we had expected that we would see low single-digit price declines on the base paper, and that's essentially what we saw. The other significant item, of course, was the change in our pricing agreement with Phillip Morris on the banded project, as we mentioned, a $6 million to $8 million impact, included in our original guidance for 2010 and still included in our guidance for 2010. On the high-value products, reconstituted tobacco and LIP, there we enjoy a much more stable pricing environment and don't see any issues with price declines. On LIP if there's price declines it would be part of our strategy to pass along cost improvement and lower the price point of the LIP proprietary product. Most of the price increase we saw were through negotiations. The customers benefited from negotiations this last fall, taking place at a time when there's been deflation. There's still softness in volume, especially in parts of the world like western Europe, and so they enjoyed more leverage, but it was in line with our expectations.

Okay. And then the other question would be the timing of these lawsuits that you're following, what was really, I guess, the straw that broke the camel's back here? Because it seemed like they had some market share. Why wasn't it done earlier? Have they reached a threshold that triggered something -- any information will be helpful.

Let me take this question, as we've been consistent said, we've been monitoring the market for any sign of activity for the last several years. We have been conducting what I call our homework in terms of the business, the technical, the legal evaluations of some of these products we have seen in the marketplace, and each of these evaluations has its own timing and requirements and information to go forward. As we indicated in our earnings release, and the release about us finding a claim we have completed this process, we have built the database, and also the conviction that it was time to take legal action, which is always the last resort.

Have you filed any type of cease and desist, or are they still producing or --

I would say, right now, we have filed a claim, which gives us the option down the road to ask when appropriate, and petition the courts for such relief. In other words, we kept all of the options open.

Okay. All right. Thank you very much.

Thanks, Ian.

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

Good morning.

Good morning, Bill.

Just want to hit on one issue that may or may not be in stock, but your comment on Phillip Morris sourcing to third party for printing outside your license, can you give us a little more detail on why they're doing that? Is it their ability to take the same licenses and do it for all their business, and how much of a hit if at all is that to your profitability?

Yes. Let me answer this. It's possible, through the supply agreement that we have in the USA, they have the able to source offline print banded products outside of the contract. So their online banded product, we have an exclusive arrangement with them where 1% of the online products is to be supplied from Spotswood New Jersey. In the discussions we had with Phillip Morris USA last year, it appears to us that the intention to assess an alternative product is essentially driven by security of supply considerations.

Now 100% of the US market has moved to LIP regulation, and and having one product, one mill to support their franchise. The current volume involved is very, very small, and, I would say on our side, you know, the technical evaluation is in progress terms of whether this product may or not infringe with our patents. So we are doing the technical evaluation as well. But as you will understand, since it's in progress, I cannot elaborate further on this matter.

Can you just help me, I mean, can that product be sourced to others? Can they take that to Phillip Morris international, or is it a completely separate agreement.

I cannot answer the question to you. The product they are using is to a large part similar to other solutions that we are seeing, but we don't know.

In terms of the profitability to the US, you implied the LIP should be equal to the US Now I would think you have a good idea of what US LIP should be? Is it as easy as taking the 2 million in the US at 70% LIP conversion and coming up with the algebra of $70 million $75 million or am I looking at that wrong?

I think the best way to do it -- we'll point to the US segment as being the barometer for Europe. Europe is a market 2 times larger than the US. In the US, we have now essentially two products that make profit. One would be the LIP paper. The other would be reconstituted tobacco product for little cigars. Those two make up the majority of the profit in the US, however, the wrapper and binder business for little cigars has been around for a long, long time. It's not what's driving the change in profitability.

So that's how we've indirectly and continue to point to the pickup in profitability in the US as being indicative of what LIP is worth. On the one end, using that, and extrapolating, Europe should be at least double what the profitability of LIP has been in the US market. So if it's $52.7 million in full-year 2009, some of that was another product, it's somewhere south of 52.7, but that's not a full-year number, and it's times 2 for the Europe opportunity at a similar level of profitability, then come down to our current share. Our current share of Europe is at about a third. We would expect it would grow to 40% or thereabouts on a direct basis, and then the big upside what's the percent of the market we can take through licensing of our LIP technology?

Okay. And then just looking at the litigation, any idea if those on timing and costs you're expecting and what you're baking in for legal fees this year?

I'll take the cost question first. We've included in our earnings guidance what we think will be the expense of the LIP litigation in 2010. That would be included in our manufacturing expenses. So we've got -- without saying what the specific amount is, we've got a substantial amount that's included for legal fees. That should cover us based on what we expect today.

And in terms of your question on tiling, I think it's hard to answer precisely. I think what we pointed to is that a particular case will be a two-to four-year period.

And in terms of what you were talking about in Europe was potentially working with your customers and competitors to get a license-type solution. Now that you're in litigation with two of the competitors, how does that change negotiations over the next three to six months?

Not clear to me whether it will change substantially the discussions for Europe as the opportunities are the same. What I can say is the time line for the LIP regulation getting to Europe is the same. So we have all reasons to believe that before the end of the year 2010, the standard will be set and pub accomplished and then there will this a transition period of 12 to 18 months for all of the 27 other countries to comply with this standard. So the time line is the same, and as we indicated in the past and continue to reiterate, our view is that technology decisions would actually be made this year, and as such, the options for our customers -- the cigarette companies to use the technology and continue to maintain multiple sources of supply for base paper we consider to be attractive to the industry.

Okay. And just one last question. I'll turn it over. On the China joint venture, I'm just trying to understand, I mean, if you analyze the fourth quarter number you did on profitability you come up with a lot higher than 50% improvement year over year for 2009 to 2010. Are there some push backs there? Is there a reason why you should only do $700,000 to $800,000 of profit per quarter.

This is a good question. The way to look at it is in the fourth quarter we probably saw six months of demand of market share that we captured. This is the way it works in China turned control of monopoly for companies with cigarettes and also in terms of the supply of paper. We have anticipated a strong second half. By producing the head of the customer orders in first half of the year, and a search -- I think the fourth quarter alone is not indicative of the earnings -- the ongoing earnings potential.

However we firmly have made, you know, a breakthrough in the Chinese market, and we have opportunities to further grow our share in China and this is something that is not a factor in our guidance right now. That's why when I say our target or expectation is to increase full-year earnings in 2010 by 50%, Pete signalled that this is an area where we have upside because of the gains that we made in the second half of 2010. However, some of the gains are related to breakthrough qualifications to replace European imports on premium brand, and the timing of the qualification of our products out of the China tobacco joint venture is something that we don't control fully. So we prepare to guide on that side and update the guidance as we go through the full year.

Okay. Thank you.

Thank you.

Your next question comes from the line of Richard Skidmore from Goldman Sachs. Your line is open.

Thank you. Good morning. Just to follow up on a question a moment ago with regards to the LIP patent infringement case and the cease and desist. Did you say that the case is -- typical cases normally take two to four years to get resolved, or would you expect there to be a decision earlier than that on these competitive products with regards to ceasing the production, and then the case gets worked through the system to decide ultimately if it infringes or not.

No, I think again the typical case gets resolved in 2 to 4 period, two-year period. So it doesn't mean we can't seek an injunction at any point in time when we consider that it is appropriate, but the resolution of the case itself based on other similar cases, we see a window of between 2 to 4 years.

Okay. Maybe just shifting topics to the fourth quarter specifically, Pete you did $0.96 in the fourth quarter, but it looks like there was about a $6 million headwind from incentive compensation. How do you see the SG&A line moving going forward, and if you were to exclude that, it seems to me that your fourth quarter number would have been higher, in the 120 range, and yet your guidance is 460. It seems like there's something missing in the guidance in terms of bridging from what you did in the fourth quarter to what you're guiding to for 2010. Can you just help us maybe bridge the difference?

I think first on on the non-manufacturing costs, the variable comp situation will turn some in 2010 because obviously we will not be performing at the same levels, because we've reached the objectives. However, at the same time, we've got, as we alluded to patent litigation expenses that will come in. So anything that's lower in terms of variable comp, we're also picking something up.

So we won't see a net-net as much as of a reduction. And that's obviously influencing then the full-year 2010 amount. Probably more important and the real big change is we now know where we stand with pulp prices much more firmly, and it looks like pulp prices have settled out. The big difference is we've now picked up, $0.25 higher pulp cost when we last gave guidance, full year over year from pulp prices is probably closer to $0.40 a share at least based on our current thinking. And that was going up through the fourth quarter. So we didn't see that effect.

The other significant change is the strengthening of the dollar to the euro, and obviously, with such higher euro-sourced profits, any strengthening of the dollar hurts us from a translation standpoint. That would be a new effect clearly starting here in the beginning of 2010. And obviously on that aspect it depends on what happens going forward. So the primary drivers would be we're not going to see as much of an improvement in non-manufacturing that you would otherwise expect, because we have the new expense legislation even if there is an improvement in the comp, but the two big pickups in terms of cost are pulp-price increases and the effects on payroll and currency.

And then just one last question. In your risk section, you have the $9 million of disputed revenue from Phillip Morris USA. Can you talk a little bit about that and how you see that evolving?

Sure. Phillip Morris has disputed the calculation under our cost plus agreement for the pricing of the banded product, LIP product, and that dispute has been in place through since about the middle of 2009. It updated -- the amount updated here based on the fourth quarter release based on purely the additional invoicing that we had. We don't know the way that Phillip Morris is determining that disputed amount. They're just saying, "This is the disputed amount," which reserves their rights to seek relief against that amount. Yet at the same time they're paying their bills, and we're collecting that cash. We believe that we've calculated the pricing correctly under the formula. It's the same formula that that's been in place for many, many years, so we don't believe the dispute has any merit. The fundamental issue is with that the volume declines in the Spotswood facility, the cost-plus for that arrangement is going up, and as Frederic alluded to, when we get to the point where Phillip Morris is the only product being made at that facility, 100% of the cost is essentially going into that product. So I think it's more of a reaction to the situation that we face than any mechanical issues two the calculation of the price.

Thank you.

Your next question comes from the line of Ann Gurkin from Davenport. Your line is open.

Good morning.

Hey, Ann.

Historically with higher pulp prices you were able to pass that through customers. Usually it lagged a quarter or so. Is that still the mechanism in place?

Yes, it is. And the way that would work is with the negotiations that took place in the fall, which is ruffly around 40% of our base per volume. Again, the issue is pulp prices is primarily a base paper impact. It does not affect constitute reconstituted tobacco nor have as much an effect on LIP profitability, because we have pricing leverage, plus the value-added cost of LIP product is much greater than traditional papers. Therefore, pulp as a percentage of the overall cost structure is much smaller.

We're talking about the interplay of selling price on commodity-based paper and the input cost for pulp. The prices that reset through negotiations with customers this fall would have been a traditional negotiation process to establish a new price and taking into account what pulp is, along with all other factors in the business at the time of the negotiations. So, say, for example, with customer X we set a new price effective 1/1/2010, we don't adjust that price for what pulp price is. That would occur at the next reset period which would either be July 1 or December 1 a year out. So in the interim, if pulp prices move up or down, we either keep or give up that benefit or cost.

In terms of the non-negotiated prices, prices that rolled over the New Year, there would been pulp price adjusters and the amount of adjustment would have been dependent upon the calculation, which is they look back on the price over a period of time, usually one quarter relative to a base period. So those resets could be up, could believe down, again, depending on the two factors. Now all the told, we have much more price increase than we have cost increase in 2010.

Do you have a price catch-up factored into your outlook for 2010 for the second half for pulp?

Yes.

Okay. Switching to RTL, you had what looks like a tremendous pickup in profit for 2009. Can you tell us what you look for in terms of operating growth for RTL for 2010?

Good morning. I'll take this question. I think what we signal and reiterate is that we are continuing to see earnings growth out of the RTL operations in the years where we are adding capacity in China -- in Asia. In the meantime for productivity gains and also pricing leverage, we're continuing to grow the franchise and grow the earnings power of that franchise. And I would say a good number for you to use would be in the mid to single digit range.

Great. And switching back to the suit, do you expect to file additional suits against any other competing products either in the US or the EU in the next year?

Well, I would say, are in evaluation is ongoing. As we also go through the claim procedure and through some exploratory process we'll have to reassess claims and the list of defendants. In terms of Europe, it's really not a market, per se, but Finland goes through LIP regulation, Australia goes through LIP regulation, we'll apply the same for competitive activities and we'll proceed with the policy, which is to vigorously enforce our patent rights.

And can you just review, again, your confidence in -- I think you referenced you have been producing paper and your basis goes back for 20 years or so. Can you review that thought process and the basis for the confidence behind your patents?

Well, again, I think, if you -- you know, we have disclosed some information about our patents, and something -- we have not disclosed a lot more as we'll be taking a risk of weakening our patent right if we share our patents My comments are going to be I would say a high level. They're at a high helpful. But if you look at the IP technologies, where they were 20 years ago and we were involved from day one, if we look at some -- the patents and patent portfolio that we have developed over time, and we continue to level off around LIP, it's very broad, and it's also something that we apply around the world. So we have sales to the US market. And, feel very strongly about -- I think we're in a position of strength. Obviously we are seeing some challenges right now, but it's fair to say that all companies will encounter these kinds of challenges. We have a great legal team that are advising us, including key partners of Jones Day in New York City and Europe, and I think we are, again, in a position where we have to enforce and exercise our rights.

And the last question. Back on PM USA it's my understanding you slashed the cigarette paper that you produced out of Spotswood. Is there any risk that they are looking at changing that cigarette paper on their Marlboro brand in the US?

No. I think at this stage, the only new developments last year, which is still am the very small scale is to use a printed band product on one of Phillip Morris USA's low-cost volume, talking about one or two stock-keeping units. A very small amount. And so at this stage, my answer to your question would be no.

Okay. Great. Thank you.

Thanks, Ann.

Your next question comes from the line of [Emil Arouac from Ark and Hamilton]. Your line is open.

The majority of my questions have been answered, but just a quick few. On pulp, if you look at the overall costs, what is pulp of the overall input including if you put in LIP and RTL for the whole business?

Sure. It would be -- in 2008, it was 12%. The updated number from memory is right around 10%, if I recall. So it would be about 10% of the cost structure.

And on currency, what kind of euro dollar rate have you built into your numbers for 2010?

Just below a $1.40.

$1.40. And then just last question, just on Europe, you gave some kind of the potential for LIP. What have you factored into your numbers on Europe for 2010?

For LIP?

Yes, for LIP.

I think it's essentially an approximation in Finland, the only market in Europe norms of LIP will have an impact on our business in 2010, which is a very small market. Europe is going to become very significant opportunity starting in 2011 and fully materializing our views in 2012.

Okay. Thank you. Thanks for your time.

Your next question comes the line of Jim Rice from GWI Asset Management. Your line is open.

Pete, a little bit confused. I thought you guys had agreements with all of your major manufacturers that you sell to recognizing your IP. So how is Phillip Morris able to go and have a third party produce LIP paper? Are they paying any sort of license fee to you for that?

As we disclosed in material today, we have relationships with two customers where there's licenses that are in place for LIP technology, and then there's a portion of the market that's being supplied with imported paper that there's no license in place, and that's where the infringement is occurring that we have the litigation occurring.

What we will do is evaluate any other products that come toward as to whether or not they infringe. Obviously if it's sold through a license, then we've agreed to it whether we participate directly or not. So it really comes down to if a product is being used by any customer or supplied by any competitor that causes a cigarette to go out and meet an LIP standard, we then have to evaluate it and determine whether or not we feel it infringes on our patent and then take action. Now, it could be with a customer who has an existing agreement for us for a product like PMUSA using an alternative product. If they're using a product that's licensed by us -- and there's two cases, then all is fine. If they're using a product that's not licensed by us, we'll evaluate whether or not it's a problem and take appropriate action. In no case would we have an alternative product being used by a customer that is for an LIP application where at this point we would say it's okay. In other words we are evaluating any other LIP products to determine whether or not they infringe.

So the Phillip Morris purchase, that they've agreed to, is that under license or not?

With Phillip Morris, to be clear there's one product supplied under contract, which is an LIP product, the banded online product, we codeveloped with them, and that's the extent of our relationship with PM USA for LIP products. So anything else isn't under that agreement, and that's the only agreement we have with PM USA.

Okay. Do you anticipate also bringing action against Phillip Morris?

Well, as we said we're not going to make that decision until we would evaluate the facts of any other alternative products that they're using or being supplied not only to Phillip Morris, but to any customer. So it's fact-dependent. It requires us to do an evaluation of the physical product against our patent and then we make that determination.

All right. Thank you.

Okay.

(Operator Instructions). Your next question comes from the line of Thomas Russo from Gardner Russo. Your line is open.

Hello?

Hi. This is Thomas Russo. Congratulations on the great results. The success to your investment by LIP. I have a couple of quick questions. Can the consumer taste the difference between banded online and offline LIP that they're being asked to consume?

What we're hearing from our customers regarding banded product is that end markets where banded product is first introduced, there are customer complaints mostly around the cigarettes going out, and then, if the cigarettes go out and are re-lit it tastes bad. There's not been that we're aware -- it's been a uniform level of complaints against all forms of banding. What we haven't seen from any customers where LIP is here in the US or the North America market are specific complaints about one banding approach or another in terms of taste of the band itself, or any taste that the band imparts.

Thank you. And then are there legitimate alternative technologies for applying off-line banding that would be permitted with -- going into the market without violating your IP?

Well, we couldn't categorically say that. What we would say right now is that of the product in trust that we're not supplying either direct or through licenses or codeveloped with Phillip Morris is where we're filing suit.

And over time, as Spotswood increasingly lose the volume and the online product that comes has to absorb the whole burden of the operation, what will happen to the price differences between the offline and online branded products and Phillip Morris will ultimately have to choose the sourcing?

The online product will continue to rise in cost and, therefore, price as the volume declines.

And what would that price spread be for the moment justice by contrast?

Today it's pretty similar.

Okay. Good. And then finely Frederick, in terms of CTM, you made a reference to the fact that there was a question about gaining market share, and I'm just curious as to how you look at the opportunity in China relative to existing competitors from whom I suspect most of which you can produce is as available as the level of quality. So when you talk about the market share story. What does that actually refer to?

Good morning, Tom.

Good morning.

If you remember our expectation is to grow our market share in China the teens. A certain level was around 5% before we started the joint venture of CTM. We are getting very good progress in 2009, gaining share, in fact, a number of it would be displayed in the investors presentation that we posted on our Web site by tomorrow, and I can tell you we are now in the market share position that is around 9% north, and still gaining share. The real challenge for CTM is to establish itself as the quality leader in China, so the focus is on premium brands in China, but historically have been using paper from do you remember, so we have made good progress in replacing European paper in 2009, but we still have opportunities there, and obviously this is where the pricing, the margins are the most attractive. On the other hand, these premium brands have been the most successful, gaining share in China and the cigarette companies are very cautious before making any changes, but we are making very good progress involving the image and the reputation of being the quality leader, I'm very pleased with that, an fully expect that we continue to gain share in 2010.

Thank you very much, and congratulations to the rollout of the LIP.

Thank you.

There are no further questions at this time.

Thank you very much. Well, thank you, Natasha and thanks everybody for joining today's call. Let me close by restating our continued confidence in reaping significant earnings benefit from our plans, and the other opportunities on multiple fronts. We are talking about LIP going beyond North America, recon tobacco in our investment expense in Asia in general, and so the earnings power that I see for 2010 of growing EBIT in double digits in my view, this is the same kind of earning power we have steps, even more important in 2011 and 2012. Thank you for your participation.

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