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SWM > SEC Filings for SWM > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for SCHWEITZER MAUDUIT INTERNATIONAL INC

Form 10-Q for SCHWEITZER MAUDUIT INTERNATIONAL INC


31-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our results of operations and financial condition. This discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report and the audited consolidated financial statements and related notes and the selected financial data included in Item 6 of our Annual Report on Form 10-K for the year ended December 31, 2011. The discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and our future prospects. These statements are based on certain assumptions that we consider reasonable. For information about risks and exposures relating to us and our business, you should read the section entitled "Factors That May Affect Future Results," in our Annual Report on Form 10-K for the year ended December 31, 2011. Unless the context indicates otherwise, references to "SWM", "we", "us", "our", or similar terms include Schweitzer-Mauduit International, Inc. and our consolidated subsidiaries.

Summary
 ($ in millions,
except per share
amounts)                               Three Months Ended                                     Nine Months Ended
                          September 30, 2012         September 30, 2011          September 30, 2012         September 30, 2011
Net sales             $    202.0         100.0 %   $   211.2      100.0  %   $    602.9         100.0 %   $   598.1      100.0  %
Gross profit                63.8          31.6          56.3       26.7           190.7          31.6         158.6       26.5
Valuation allowance
on business tax
credits                      0.8           0.4          15.9        7.5             0.8           0.1          15.9        2.7
Restructuring &
impairment expense           0.6           0.3           6.6        3.1            24.6           4.1           8.3        1.4
Operating profit            43.7          21.6          11.2        5.3           103.6          17.2          69.2       11.6
Interest expense             0.9           0.4           1.1        0.5             2.7           0.4           1.8        0.3
Income from
continuing operations       27.7          13.7           9.5        4.5            63.3          10.5          46.4        7.8
Loss from
discontinued
operations                     -             -          (0.5 )     (0.2 )             -             -          (1.4 )     (0.2 )
Net income                  27.7          13.7 %         9.0        4.3  %         63.3          10.5 %        45.0        7.5  %
Diluted earnings per
share from continuing
operations            $     0.87                   $    0.30                 $     1.98                   $    1.35
Diluted earnings per
share                 $     0.87                   $    0.29                 $     1.98                   $    1.31
Cash provided by
operations            $     50.1                   $    25.7                 $    122.4                   $    37.9
Capital spending      $      6.4                   $     9.8                 $     20.4                   $    51.9

Third Quarter Highlights

Net sales were $202.0 million in the three months ended September 30, 2012, a $9.2 million decrease from $211.2 million in the prior-year quarter. The decrease was primarily due to an unfavorable $22.7 million currency impact of a declining euro compared to the U.S. dollar which was mostly offset by favorable impact of higher sales volumes.

Gross profit was $63.8 million in the three months ended September 30, 2012, a $7.5 million increase from $56.3 million in the prior-year quarter. In the third quarter 2012, gross margin improved to 31.6% from 26.7% in the prior-year quarter. The higher gross profit was primarily due to higher sales volumes. During the third quarter 2012, SWM incurred $0.6 million in restructuring and impairment expenses and $0.8 million of valuation allowances on business tax credits compared to $15.9 million of valuation allowances in the prior-year quarter. Other factors impacting the increase in operating profit were higher sales volumes and improved manufacturing costs.

Cash provided by operations was $50.1 million in the third quarter 2012, compared to a $25.7 million in the prior-year quarter. The higher cash generation during 2012 was largely due to higher net income excluding non-cash impairment charges driven by sales of higher-value products and improved manufacturing efficiencies.


Table of Contents

Year-to-Date Highlights

Compared to the prior year-to-date period, net sales increased $4.8 million due to favorable impacts of higher sales volumes, an improved mix of products sold and increased royalties. Gross profit was $190.7 million in the nine months ended September 30, 2012, an increase of $32.1 million from the prior-year period. The gross profit margin of 31.6% increased from 26.5% in the prior-year period. The higher gross profit was primarily due to increased sales of LIP products and an increase of $8.4 million in royalty revenue in 2012. Restructuring and impairment expenses were $24.6 million and $8.3 million for the nine months ended September 30, 2012 and 2011, respectively. Operating profit was $103.6 million for the nine months ended September 30, 2012 versus $69.2 million in the prior-year period. The improved operating profit was primarily due to higher sales volumes, improved manufacturing costs and lower valuation allowances on business tax credits.

Recent Developments

In the Paper segment, restructuring expenses included $2.6 million to shutdown a paper machine at the Company's Philippine mill of which $2.1 million was related to non-cash accelerated depreciation and impairment charges. Shut down of one of the the two Philippine machines will allow more efficient operation of the remaining machine.

Administrative and Court Proceedings Relating to Papers for Lower Ignition Propensity Cigarettes

In December 2009, Miquel y Costas S.A., delfortgroup AG, and Societe Papeterie Leman SAS filed Notices of Opposition to the European Patent Office's, or EPO, grant of European Patent EP 1482815. The oppositions filed by Societe Papeterie Leman and delfortgroup contend that the claim language regarding the film-forming material to have a certain viscosity was not sufficiently described, that the claims were not patentable due to a prior art reference, a reference that was disclosed by SWM to the examiner and cited by him in granting the patent, and lack of inventive step. Societe Papeterie Leman further alleged that claim 1 is not sufficiently definite and is therefore invalid. Miquel y Costas claims that the patent lacks novelty as to the film-former gum Arabic, that claim 1 of the patent lacks sufficient disclosure and that claim 1 also lacks novelty. The Company will continue to defend the grant of this patent by taking necessary actions including responding to further submissions by the opponents. Once the EPO considers that all positions have been fully briefed, it may hold a hearing to assist it in reaching a final conclusion on the oppositions. There is no mandated timetable by which the EPO must reach a decision. The outcome of this dispute would not prevent the Company from practicing its Alginex® LIP solution. The patent remains in effect and fully enforceable while the opposition proceedings are pending. As a result of the world-wide LIP license agreement with SWM, delfortgroup has withdrawn from this proceeding. The action remains open with the other parties.

On November 12, 2010, the EPO issued a Notice of Decision to Grant SWM European Patent No. 1333729. On December 8, 2010, Julius Glatz GmbH filed a Notice of Opposition to the grant of this patent. In September 2011, Societe Papeterie Leman, Miquel y Costas and delfortgroup each filed opposition papers and Glatz supplemented its previous filing. The EPO opened an an opposition proceeding and the Company's response to the Notices of Opposition was timely filed. The Company believes that the EPO properly granted the patent and it intends to vigorously defend the patent. As a result of the world-wide LIP license agreement with SWM, delfortgroup has withdrawn from this proceeding. The action remains open with the other parties.

The infringement action filed on February 8, 2010 in the United States District Court for South Carolina, Charleston Division, against multiple defendants alleging infringement of the Company's United States Patent No. 6,725,867 and United States Patent No. 5,878,753 was dismissed without prejudice as to the remaining defendants on August 31, 2012.

On June 27, 2012, the European Patent Office granted the Company's applications for two LIP related patents, EP 2127545 and EP 2127544, that are divisional applications related to European Patent No. 1333729. Julius Glatz GmbH filed Notices of Opposition to the grants of these patents on June 28 and June 29, 2012. We do not expect the EPO to proceed with these oppositions prior to the end of the opposition term on March 27, 2013.


Table of Contents

Three Months Ended September 30, 2012 Compared with the Three Months Ended

September 30, 2011

Net Sales
(dollars in millions)

                                    Three Months Ended                                           Consolidated
                           September 30,                                           Percent       Sales Volume
                               2012           September 30, 2011       Change       Change          Change
Paper                    $         146.2     $             157.1     $  (10.9 )      (6.9 )%             2 %
Reconstituted Tobacco               55.8                    54.1          1.7         3.1               19
Total                    $         202.0     $             211.2     $   (9.2 )      (4.4 )%             8 %

Net sales were $202.0 million in the three months ended September 30, 2012 compared with $211.2 million in the comparable prior-year period. The decrease in net sales consisted of the following (dollars in millions):

                                           Amount     Percent
Changes in currency exchange rates        $ (22.7 )   (10.7 )%
Changes in product mix and selling prices    (3.1 )    (1.5 )
Changes due to royalty income                 1.3       0.6
Changes due to sales volume                  15.3       7.2
Total                                     $  (9.2 )    (4.4 )%

• Changes in currency exchange rates decreased net sales by $22.7 million, or 10.7%, in the three months ended September 30, 2012, and primarily reflected the impact of changes in the value of the euro compared with the U.S. dollar in 2012 versus the prior-year quarter.

• Unfavorable changes in average selling prices and mix of products sold decreased net sales by $3.1 million.

• Unit sales volumes increased by 8% in the three months ended September 30, 2012 versus the prior-year period.

? Sales volumes for the Paper segment increased by 2%

? Sales volumes in the Reconstituted Tobacco segment increased by 19% primarily due to timing of orders.

Paper segment net sales during the three months ended September 30, 2012 of $146.2 million decreased by $10.9 million, or 6.9%, versus $157.1 million in the prior-year quarter. The decrease in net sales was primarily the result of $15.4 million in unfavorable foreign exchange impacts mostly due to changes in the value of the euro compared to the U.S. dollar and $4.9 million impact from lower average selling prices and an unfavorable mix of products sold. These negative impacts were partially offset by a $6.4 million favorable impact of higher sales volumes, $1.8 million tax credit gain recognized upon successful legal resolution of a business tax case in Brazil and $1.3 million in higher royalty income.

Reconstituted Tobacco segment net sales during the three months ended September 30, 2012 of $55.8 million increased by $1.7 million, or 3.1%, compared with $54.1 million in the prior-year quarter. The increase in net sales of the Reconstituted Tobacco segment resulted from the $8.9 million impact of higher sales volumes which was partially offset by a $7.3 million unfavorable foreign exchange impacts mostly due to changes in the value of the euro compared to the U.S. dollar.


Table of Contents

Operating Expenses
(dollars in millions)
                                 Three Months Ended                                                Percent of Net Sales
                        September 30,
                            2012           September 30, 2011       Change     Percent Change       2012           2011
Net Sales             $         202.0     $             211.2     $   (9.2 )         (4.4 )%        100.0 %        100.0 %

Cost of products sold           138.2                   154.9        (16.7 )        (10.8 )          68.4           73.3
Gross Profit          $          63.8     $              56.3     $    7.5           13.3  %         31.6 %         26.7 %

The increase in gross profit for the three months ended September 30, 2012 versus the prior-year quarter was primarily due to $9.9 million favorable impact of higher sales volumes of certain higher-value products. LIP regulations in the EU, which became effective during the fourth quarter of 2011, drove higher demand for LIP cigarette papers. Gross profit was also favorably impacted by $10.5 million in improved manufacturing costs and $1.3 million of royalty income from third-party license agreements. Pulp list prices were lower during the third quarter of 2012 at $850 per metric ton of northern bleached softwood kraft compared to $995 per metric ton during the prior-year quarter. However, changes in other inflationary costs, including other materials prices, energy and labor, contributed to an unfavorable impact of $3.6 million on third quarter 2012 results compared to the prior-year quarter. Other negative factors included $3.4 million in unfavorable currency impacts primarily from the weaker euro compared to the US dollar and $3.0 million from unfavorable average selling prices and mix of products sold.

Nonmanufacturing Expenses
(dollars in millions)
                                      Three Months Ended                                                Percent of Net Sales
                            September 30,
                                2012            September 30, 2011       Change     Percent Change      2012          2011
Selling expense           $           4.3     $                5.7     $   (1.4 )        (24.6 )%        2.1 %          2.7 %
Research expense                      2.4                      2.3          0.1            4.3           1.2            1.1
General expense                      12.0                     14.6         (2.6 )        (17.8 )         5.9            6.9
Nonmanufacturing expenses $          18.7     $               22.6     $   (3.9 )        (17.3 )%        9.2 %         10.7 %

Nonmanufacturing expenses in the three months ended September 30, 2012 decreased by $3.9 million to $18.7 million from $22.6 million in the prior-year quarter primarily due to lower legal expenses to defend the Company's LIP patents.

Valuation Allowance on Business Tax Credits

During the three months ended September 30, 2012, the Company recorded valuation allowances of $0.8 million against certain Philippine value-added tax credits that do not expire but may not be fully recovered due to the Company's expected mix of products sold. During the three months ended September 30, 2011, the Company recorded a $15.9 million valuation allowance against the entire carrying value of its Imposto sobre Circulaç?o de Mercadorias e Serviços, or ICMS, business tax credits in Brazil.


Table of Contents

Restructuring and Impairment Expense

The Company incurred total restructuring and impairment expense of $0.6 million in the three months ended September 30, 2012. Restructuring expenses during the third quarter were due to $2.6 million as a result of a restructuring action to shutdown a paper machine at the Company's Philippine mill of which $2.1 million was related to non-cash accelerated depreciation and impairment charges. Partially offsetting these expenses was a $2.2 million reversal of previously recorded special termination charges as a result of a change to French retirement laws allowing earlier retirements for qualified workers, which became effective during the third quarter 2012. The change to the retirement law allows qualified workers to receive their government benefits earlier; therefore, the workers will be paid less from the Company's early retirement plan.

In the prior-year period, the Company's restructuring and impairment expense was $6.6 million related to costs to suspend the construction of the RTL Philippines facility and employee severance expenses in France.

Operating Profit
(dollars in millions)
                                   Three Months Ended                               Percent      Return on Net Sales
                       September 30, 2012       September 30, 2011      Change       Change       2012         2011
Paper                 $           25.6         $            0.5       $    25.1         N.M.      17.5 %         0.3 %
Reconstituted Tobacco             21.8                     15.2             6.6         43.4      39.1          28.1
Unallocated expenses              (3.7 )                   (4.5 )           0.8
Total                 $           43.7         $           11.2       $    32.5         N.M.      21.6 %         5.3 %

N.M. - Not meaningful

Operating profit was $43.7 million in the three months ended September 30, 2012 compared with $11.2 million during the prior-year quarter.

The Paper segment's third quarter 2012 operating profit was $25.6 million, an increase of $25.1 million from the prior-year period. The increase was primarily due to the following factors:

• $15.1 million in lower valuation allowances on business tax credits

•$7.3 million in improved manufacturing costs

• $5.7 million in favorable impacts from higher sales volumes of certain higher-value products

• $2.6 million in lower restructuring and impairment expenses

• $1.8 million tax credit gain recognized upon successful legal resolution of a Brazil business tax case

• $1.3 million in increased royalty income

• These positive factors were partially offset by $5.2 million impact from lower average selling prices and an unfavorable mix of products sold and $2.5 million in increased inflationary costs


Table of Contents

The Reconstituted Tobacco segment's third quarter 2012 operating profit was $21.8 million, a $6.6 million increase from $15.2 million in the prior-year period. The increase was primarily due to the following:

• $4.2 million in higher sales volume impacts

• $3.3 million of lower restructuring and impairment expenses

• $3.0 million in improved manufacturing impacts

• These positives were partially offset by $2.7 million in unfavorable currency impacts and $1.1 million in higher inflationary costs

Non-Operating Expenses

Interest expense was $0.9 million in the three months ended September 30, 2012, a decrease from $1.1 million in the comparable 2011 period. The decrease in interest expense is due to lower average outstanding debt balances due to higher cash generated from operations. The Company capitalized $0.5 million of interest expense in the third quarter of 2011 related to the construction of the RTL facility in the Philippines and the EU LIP facility in Poland. The weighted average effective interest rates on our debt facilities were approximately 1.6% and 2.1% for the three months ended September 30, 2012 and 2011, respectively.

Other income, net was $0.3 million during the three months ended September 30, 2012 due to foreign currency transaction gains and interest income. During the three months ended September 30, 2011, other expense was $1.1 million primarily due to foreign exchange losses.

Income Taxes

A $16.7 million provision for income taxes in the three months ended September 30, 2012 resulted in an effective tax rate of 38.7% compared with 10.0% in the prior-year quarter. The third quarter 2012 effective tax rate was higher than the 35% statutory rate due primarily to the absence of income tax benefits for losses incurred by the RTL Philippines facility, including restructuring expenses. During the third quarter of 2011, the effective tax rate reflected start-up expenses at the Polish operation and restructuring expenses of RTL Philippines for which no income tax benefits were recorded.

Income from Equity Affiliates

Income from equity affiliates was $1.3 million in the three months ended September 30, 2012 compared with $1.4 million during the prior-year quarter. These results reflected the operations of the joint venture in China to produce cigarette papers, CTM, and the start-up costs of the Chinese reconstituted tobacco joint venture, CTS.

Discontinued Operations

Operations at our Malaucène mill were reported as discontinued operations for all periods presented. Consequently, results of the Malaucène mill have been removed from each line of the statements of income and the operating activities section of the statements of cash flow. In each case, a separate line has been added for the net results of the discontinued operation, including previously reported restructuring and impairment amounts. During the fourth quarter of 2011, a Malaucène liquidation petition resulted in a loss of control. Consequently, consolidated results for 2012 do not include that entity's results.

Net Income and Income per Share

Net income in the three months ended September 30, 2012 was $27.7 million, or $0.87 per diluted share, compared with $9.0 million, or $0.29 per diluted share, during the prior-year period. The increase in net income was primarily due to the benefits of increased sales of LIP cigarette paper volumes in Europe and lower valuation allowances on business tax credits.


Table of Contents

Nine Months Ended September 30, 2012 Compared with the Nine Months Ended

September 30, 2011

Net Sales
(dollars in millions)

                                       Nine Months Ended                                                Consolidated
                                                                                         Percent        Sales Volume
                           September 30, 2012      September 30, 2011       Change        Change           Change
Paper                    $         430.3          $             425.4     $     4.9         1.2  %            (4 )%
Reconstituted Tobacco              172.6                        172.7          (0.1 )      (0.1 )              9
Total                    $         602.9          $             598.1     $     4.8         0.8  %             1  %

Net sales were $602.9 million in nine months ended September 30, 2012 compared with $598.1 million in the comparable prior-year period. The increase in net sales consisted of the following (dollars in millions):

                                           Amount    Percent
Changes due to sales volume               $ 34.6       5.8  %
Changes in product mix and selling prices   12.7       2.1
Changes due to royalty income                8.4       1.4
Changes in currency exchange rates         (50.9 )    (8.5 )
Total                                     $  4.8       0.8  %

• Unit sales volumes increased by 1% in the nine months ended September 30, 2012 versus the prior-year period.

?         Sales volumes for the Paper segment decreased by 4%. Sales volume for
          traditional tobacco-related paper products declined in certain markets
          and were partially offset by a 16% increase in LIP paper sales volume.
          The dollar impact of increased LIP volumes more than offset the dollar
          impact of the decline in traditional paper volume.


?         Sales volumes in the Reconstituted Tobacco segment increased by 9%
          primarily due to higher demand of certain reconstituted tobacco leaf
          products.


•     Favorable changes in average selling prices due to improved sales mix
      positively impacted net sales by $12.7 million.


•     Changes in currency exchange rates decreased net sales by $50.9 million, or
      8.5%, in the nine months ended September 30, 2012, and primarily reflected
      the impact of changes in the value of the euro compared with the U.S.
      dollar in 2012 versus the prior year.

Paper segment net sales during the nine months ended September 30, 2012 of $430.3 million increased by $4.9 million, or 1.2%, versus $425.4 million in the prior-year period. The increase in net sales was primarily the result of $20.8 million impact of increased volumes of high-value products, $10.6 million favorable impact of an improved mix of products sold, $8.4 million of increased royalty income and a $1.8 million tax credit gain recognized upon successful legal resolution. These positives were partially offset by $36.6 million in unfavorable foreign exchange impacts mostly due to changes in the value of the euro compared to the U.S. dollar.

Reconstituted Tobacco segment net sales during the nine months ended September 30, 2012 of $172.6 million decreased by $0.1 million, or 0.1%, compared with $172.7 million in the prior-year period. The decrease in net sales of the Reconstituted Tobacco segment resulted from $14.3 million in unfavorable foreign exchange impacts mostly due to changes in the value of the euro compared to the U.S. dollar and was mostly offset by $13.8 million favorable impact of higher sales volumes.


Table of Contents

Operating Expenses
(dollars in millions)
                                    Nine Months Ended                                                    Percent of Net Sales
                        September 30, 2012      September 30, 2011       Change      Percent Change       2012           2011
Net Sales             $         602.9          $             598.1     $    4.8            0.8  %         100.0 %        100.0 %

Cost of products sold           412.2                        439.5        (27.3 )         (6.2 )           68.4           73.5
Gross Profit          $         190.7          $             158.6     $   32.1           20.2  %          31.6 %         26.5 %

The increase in gross profit for the nine months ended September 30, 2012 versus the prior-year period was primarily due to $34.9 million favorable impact of higher sales volumes. LIP regulations in the EU, which became effective during . . .

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