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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from.............to.................
Commission file number 1-13948
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 62-1612879
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 NORTH POINT CENTER EAST
SUITE 600
ALPHARETTA, GEORGIA
30022-8246
(Address of principal executive offices)
(Zip Code)
1-800-514-0186
(Registrant's telephone number, including area code)
NO CHANGE (Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X . No .
----- -----
As of September 30, 1998, 15,923,033 shares of the Corporation's common stock,
par value $.10 per share, together with preferred stock purchase rights
associated therewith, were outstanding.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
1998 1997 1998 1997
------- ------- ------- -------
Net Sales ........................................ $ 134.4 $ 113.4 $ 412.7 $ 342.7
Cost of products sold ....................... 107.7 83.1 327.2 248.1
------- ------- ------- -------
Gross Profit ..................................... 26.7 30.3 85.5 94.6
Selling expense ............................. 5.1 4.3 15.3 13.0
Research expense ............................ 1.7 1.6 4.7 4.7
General expense ............................. 4.7 3.8 14.1 12.4
------- ------- ------- -------
Operating Profit ................................ 15.2 20.6 51.4 64.5
Interest expense ............................ (1.6) (1.1) (4.8) (3.1)
Other income (expense), net ................. 0.2 0.6 0.9 1.2
------- ------- ------- -------
Income Before Income Taxes and Minority Interest . 13.8 20.1 47.5 62.6
Provision for income taxes .................. 5.6 7.4 14.3 23.2
------- ------- ------- -------
Income Before Minority Interest .................. 8.2 12.7 33.2 39.4
Minority interest in earnings of subsidiaries 1.4 1.5 4.2 4.2
------- ------- ------- -------
Net Income ....................................... $ 6.8 $ 11.2 $ 29.0 $ 35.2
======= ======= ======= =======
Net Income per Common Share
Basic ....................................... $ .43 $ .70 $ 1.81 $ 2.19
======= ======= ======= =======
Diluted ..................................... $ .43 $ .68 $ 1.79 $ 2.15
======= ======= ======= =======
Cash Dividends Declared per Common Share ......... $ .15 $ .15 $ .45 $ .45
======= ======= ======= =======
See Notes to Unaudited Consolidated Financial Statements
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents ................................................. $ 2.4 $ 37.2
Accounts receivable ....................................................... 77.3 57.0
Inventories ............................................................... 74.7 56.3
Deferred income tax benefits .............................................. 4.0 3.3
Prepaid expenses .......................................................... 3.1 3.8
------ ------
Total Current Assets .................................................. 161.5 157.6
------ ------
Gross Property ................................................................ 468.0 370.0
Less accumulated depreciation ............................................. 189.2 168.9
------ ------
Net Property .......................................................... 278.8 201.1
------ ------
Noncurrent Deferred Income Tax Benefits ........................................ 22.1 18.4
------ ------
Deferred Charges and Other Assets .............................................. 15.1 13.9
------ ------
Total Assets ................................................................... $477.5 $391.0
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt ......................................... $ 4.6 $ 2.5
Other short-term debt ..................................................... 11.3 0.5
Accounts payable .......................................................... 51.4 43.4
Accrued expenses .......................................................... 56.6 43.0
Income taxes payable ...................................................... (0.4) 1.1
------ ------
Total Current Liabilities ............................................. 123.5 90.5
------ ------
Long-Term Debt ................................................................. 108.6 80.8
------ ------
Deferred Income Taxes .......................................................... 14.1 11.2
------ ------
Other Noncurrent Liabilities ................................................... 26.5 21.9
------ ------
Minority Interest .............................................................. 6.5 7.1
------ ------
Contingencies (See Notes 5 and 6)
Stockholders' Equity
Preferred Stock -$.10 par value - 10,000,000 shares authorized, none issued -- --
Common Stock -$.10 par value - 100,000,000 shares authorized,
16,078,733 and 16,065,443 shares issued at September 30, 1998
and December 31, 1997, respectively ..................................... l.6 1.6
Additional paid-in capital ................................................ 60.6 60.3
Common stock in treasury, at cost - 155,700 shares at September 30, 1998 .. (3.8) --
Retained earnings ......................................................... 135.3 113.5
Accumulated other comprehensive income -
Unrealized foreign currency translation adjustments ..................... 4.6 4.1
------ ------
Total Stockholders' Equity ............................................ 198.3 179.5
------ ------
Total Liabilities and Stockholders' Equity ..................................... $477.5 $391.0
====== ======
See Notes to Unaudited Consolidated Financial Statements
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
U.S. $ IN MILLIONS
(UNAUDITED)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1998 1997
----- ------
Operations
Net income ................................... $ 29.0 $ 35.2
Depreciation and amortization ................ 16.7 10.5
Deferred income tax provision ................ 5.3 9.0
Minority interest in earnings of subsidiaries 4.2 4.2
Other ........................................ 5.0 2.5
Changes in operating working capital ......... (13.8) (23.5)
------ ------
Cash Provided by Operations ......... 46.4 37.9
------ ------
Investing
Capital spending ............................. (23.3) (19.2)
Capitalized software costs ................... (3.0) (4.8)
Acquisitions, net of cash acquired ........... (65.4) --
Other ........................................ (2.2) (3.6)
------ ------
Cash Used for Investing ............. (93.9) (27.6)
------ ------
Financing
Cash dividends paid to SWM stockholders ...... (7.2) (7.2)
Cash dividends paid to minority owner ........ (5.3) (4.5)
Changes in short-term debt ................... 8.4 (0.9)
Proceeds from issuances of long-term debt .... 24.5 5.3
Payments on long-term debt ................... (4.2) (3.6)
Purchases of treasury stock .................. (3.8) --
Proceeds from issuances of common stock ...... 0.3 0.3
------ ------
Cash Provided by (Used for) Financing 12.7 (10.6)
------ ------
Decrease in Cash and Cash Equivalents ............. (34.8) (0.3)
Cash and Cash Equivalents at beginning of period .. 37.2 30.9
------ ------
Cash and Cash Equivalents at end of period ........ $ 2.4 $ 30.6
====== ======
See Notes to Unaudited Consolidated Financial Statements
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
U.S.$ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
NOTE 1. NATURE OF THE BUSINESS
Schweitzer-Mauduit International, Inc., including its subsidiaries,
("SWM" or the "Company") is a diversified producer of premium specialty papers
and the world's largest supplier of fine papers to the tobacco industry. The
Company was formed as a spin-off from Kimberly-Clark Corporation
("Kimberly-Clark") at the close of business on November 30, 1995.
NOTE 2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SWM and
all its majority-owned subsidiaries, including two newly-acquired companies
since the beginning of February 1998 (see Note 7). All material intercompany and
interdivision amounts and transactions have been eliminated.
The accompanying unaudited consolidated financial statements have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission and on the same basis as the audited financial
statements included in the Company's 1997 Annual Report on Form 10-K. All
adjustments which are, in the opinion of management, necessary for a fair
presentation of the results of operations for the interim periods have been made
and are generally of a normal recurring nature. Operating results for any
quarter are not necessarily indicative of the results for any other quarter or
for the full year. These financial statements should be read in connection with
the financial statements and notes thereto included in the Company's 1997 Annual
Report on Form 10-K.
Basic net income per common share is computed based on net income
divided by the weighted average number of common shares outstanding. The average
numbers of common shares used in the calculations of basic net income per common
share for the three and nine month periods ended September 30, 1998 were
approximately 16,006,600 and 16,050,600, respectively, and for the three and
nine month periods ended September 30, 1997 were 16,062,900 and 16,058,000,
respectively. Diluted net income per common share is computed based on net
income divided by the weighted average number of common and potential common
shares outstanding. The average numbers of common and potential common shares
used in the calculations of diluted net income per common share for the three
and nine month periods ended September 30, 1998 were approximately 16,099,600
and 16,240,700, respectively, and for the three and nine month periods ended
September 30, 1997 were 16,383,800 and 16,326,500, respectively. The only
potential common shares are those related to stock options outstanding during
the respective periods.
NOTE 3. INVENTORIES
The following schedule details inventories by major class as of
September 30, 1998 and December 31, 1997:
September 30, December 31,
1998 1997
------------- ------------
At the lower of cost on the First-In, First-Out (FIFO)
and weighted average methods or market:
Raw materials ............................................... $ 22.5 $ 20.1
Work in process ............................................. 12.7 11.3
Finished goods .............................................. 32.6 21.4
Supplies and other .......................................... 13.6 9.7
------ ------
81.4 62.5
Excess of FIFO cost over Last-In, First-Out (LIFO) cost .......... (6.7) (6.2)
------ ------
Total ..................................................... $ 74.7 $ 56.3
====== ======
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
NOTE 4. INCOME TAXES
The effective income tax rates for the three and nine month periods
ended September 30, 1998 were 40.6 percent and 30.1 percent, respectively,
compared with 36.8 percent and 37.1 percent for the respective corresponding
periods of 1997. The nine month period of 1998 reflects the benefit of a
reduction in the valuation allowance recorded against certain French deferred
income tax assets arising from net operating loss carryforwards ("NOLs"). This
adjustment reduced the deferred provision for income taxes by $5.2 in the second
quarter of 1998. The reduction in the valuation allowance was recorded because
of continued strong earnings and projected future earnings at the French
businesses that utilize the NOLs, reducing the uncertainty that these NOLs will
be fully utilized in the future. Excluding the impact of this adjustment, the
effective income tax rate for the nine month period ended September 30, 1998
would have been 41.1 percent. The higher 1998 effective income tax rates
compared with the corresponding periods of 1997 were primarily the result of an
increase in the corporate income tax rate enacted in France in November 1997
from 36.67 percent to 41.67 percent for 1997 and 1998, retroactive to January 1,
1997, and to 40.00 percent for 1999. The increase applicable to the 1997 period
was recorded in the fourth quarter of 1997 when the income tax rate change was
enacted.
NOTE 5. ENVIRONMENTAL MATTERS
The Company's operations are subject to federal, state and local laws,
regulations and ordinances relating to various environmental matters. The nature
of the Company's operations expose it to the risk of claims with respect to
environmental matters and there can be no assurance that material costs or
liabilities will not be incurred in connection with such claims. Based on the
Company's experience to date, the Company believes that its future cost of
compliance with environmental laws, regulations and ordinances, and its exposure
to liability for environmental claims, will not have a material adverse effect
on the Company's financial condition or results of operations. However, future
events, such as changes in existing laws and regulations, or unknown
contamination of sites owned, operated or used for waste disposal by the Company
(including contamination caused by prior owners and operators of such sites or
other waste generators) may give rise to additional costs which could have a
material adverse effect on the Company's financial condition or results of
operations.
Prior to the spin-off, Kimberly-Clark was named a potentially
responsible party ("PRP") under the provisions of the U.S. Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA"), or analogous
state statutes, in connection with two waste disposal sites, one used by the
Company's Spotswood, New Jersey mill and the other site used by the Company's
former Mt. Holly Springs, Pennsylvania mill. Prior to the spin-off, the
Spotswood mill also responded to an information request by the New Jersey
Department of Environmental Protection ("NJDEP") with respect to another
landfill site allegedly used by the Spotswood mill. The Company has assumed
Kimberly-Clark's liabilities at each of these sites but does not believe that
any of these proceedings will result in the imposition of monetary sanctions or
have a material adverse effect on the Company's business or financial condition.
The Company assumed responsibility to administer a consent order
between Kimberly-Clark and the Massachusetts Department of Environmental
Protection ("MDEP") governing the post-closure care of the Willow Hill Landfill
in Lee, Massachusetts. The Company is obligated to maintain the integrity of the
cover and to sample groundwater by means of monitoring wells, in addition to
other long-term maintenance responsibilities for this former non-hazardous waste
disposal facility. Under the terms of a January 24, 1997 Administrative Consent
Order with MDEP, as amended ("Consent Order"), the Company was required to
correct a landfill gas migration problem at the landfill property line. The
Consent Order required the Company to reduce concentrations of landfill gases at
the property line to specified levels by September 15, 1998. The Company met the
specified levels at 22 of 26 gas monitoring wells. Four
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
monitoring wells were not in compliance at 30 feet below ground level, but such
non-compliance does not create a safety risk. Nonetheless, the Company must
continue to monitor gas concentrations at the property line until the specified
gas concentration levels have been attained for four consecutive weeks. Although
the literal terms of the Consent Order would subject the Company to penalties
for failing to meet the September 15, 1998 deadline, no penalties are expected
based on current progress toward full compliance. The estimated cost of the
remaining corrective action and annual operating expenses expected to be
incurred under the Consent Order is $0.3, which amount has been accrued as of
September 30, 1998.
Although the Company had previously entered into an agreement with
NJDEP to monitor chloroform emissions at its Spotswood mill, actual monitoring
results make it unnecessary to install chloroform emissions controls at the
mill.
All of the Company's U.S. facilities may be affected by revised air
emissions and wastewater discharge standards under rules commonly known as the
"Cluster Rules". Although the Environmental Protection Agency ("EPA") originally
indicated that the proposed rules would be finalized in 1996, the first set of
rules was not published until April 1998. The EPA is currently engaged in
further rule-making. Based on a preliminary analysis, the first phase of the
Cluster Rules governing wastewater discharges does not appear to affect the
Company's three U.S. mills. However, the later phases of the Cluster Rules
(and/or Title V of the Clean Air Act Amendments of 1990) and National Pollutant
Discharge Elimination System permit renewals may require the Company to install
air and water pollution controls at its U.S. facilities sometime after the year
2000. Due to uncertainty concerning applicable requirements under the
above-mentioned and other possible regulations, potential capital expenditures
which may become necessary for compliance cannot be estimated until after such
requirements, if any, are known.
The Company incurs spending necessary to meet legal requirements and
otherwise relating to the protection of the environment at the Company's
facilities in the United States, France, Brazil and Canada, including the
aforementioned matters. For these purposes, the Company anticipates that it will
incur capital expenditures of approximately $3 annually in 1998 and 1999. The
major projects included in these estimates include upgrading wastewater
treatment facilities at various locations and installation of equipment to treat
volatile organic compound emissions in France. The foregoing capital
expenditures are not expected to reduce the Company's ability to invest in
capacity expansion, quality improvements, capital replacements, productivity
improvements, or cost containment projects, and are not expected to have a
material adverse effect on the Company's financial condition or results of
operations.
NOTE 6. LEGAL PROCEEDINGS
Under the terms of the spin-off, the Company assumed liability for and
agreed to indemnify Kimberly-Clark from litigation arising out of the operation
of the Company's predecessor businesses, including the following cases:
- - Three purported class actions, defining several different classes of
plaintiffs who allegedly sustained injuries as a result of smoking or
being exposed to tobacco smoke, and two individual actions were filed
in the Circuit Court of Kanawha County, West Virginia in 1997 and 1998
against several tobacco companies, tobacco industry trade associations,
tobacco wholesalers and others, including Kimberly-Clark and, in four
of the five cases, LTR Industries, S.A. ("LTRI"), a French subsidiary
of the Company. Each class representative in two of the class actions
and each individual plaintiff, respectively, seek compensatory damages
of $2 to $3, punitive damages of $3 and, for class members in each
class action, compensatory and punitive damages in an unspecified
amount. In certain cases, equitable relief is also sought. The five
complaints allege several theories of liability against the
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
defendants including negligence, product liability, misrepresentation,
breach of warranty, conspiracy and other theories of liability.
- - In June 1998, three union health and welfare funds on behalf of
themselves and "all labor-management multi-employer health and welfare
trust funds operating in the State of Utah" instituted a purported
class action in the U.S. District Court for the District of Utah,
Central Division, against several tobacco companies, tobacco industry
trade associations, law firms and component suppliers including
Kimberly-Clark, seeking to recover compensatory and punitive damages in
an unspecified amount for health care expenditures caused by tobacco
use, treble damages and attorneys' fees, declaratory, injunctive and
other equitable relief. The 21 count complaint sets forth several
theories of liability including violations of federal and Utah
Racketeer Influenced and Corrupt Organizations statutes, the Sherman
Act, fraud and misrepresentation, breach of express and implied
warranties, negligence, strict liability, aiding and abetting and
conspiracy. Among other things, the complaint alleges that the tobacco
companies used the reconstituted process "to triple or even quadruple
the nicotine content of the reconstituted tobacco in their cigarettes"
and, further, that Kimberly-Clark manufactured and sold reconstituted
tobacco knowing that it would be used by cigarette companies to
manipulate the level of nicotine, a substance known to be addictive, in
their cigarettes.
- - In October 1998, Edward J. Sweeney, Stephen R. Micarek and Lisa A.
Figura filed, in the Court of Common Pleas of Allegheny County,
Pennsylvania, on behalf of themselves and certain residents of
Pennsylvania, a purported class action against several tobacco
companies, industry trade associations and consultants, tobacco
wholesalers and retailers and cigarette component manufacturers,
including Kimberly-Clark, seeking equitable relief and punitive damages
for the class in an unspecified amount. The class consists of those
Pennsylvania residents who, "commencing before age 18...purchased,
smoked...and continue to smoke cigarettes manufactured, marketed and
sold by defendants". The five coUNT complaint alleges that defendants
are liable to plaintiffs for product liability, consumer fraud, breach
of special duty, negligence and civil conspiracy. Among other things,
the complaint alleges that nicotine is an addictive substance, that the
tobacco companies, by using reconstituted tobacco and other additives,
are able to control the precise amount and/or the bioavailability of
nicotine in their cigarettes and that LTRI, formerly a subsidiary of
Kimberly-Clark, specializes in the tobacco reconstitution process and
in helping tobacco companies control the nicotine in their cigarettes.
As a component supplier, the Company believes that Kimberly-Clark has
meritorious defenses to each of these cases. LTRI also has meritorious defenses
to each of the cases in which it has been named as a defendant and will seek to
be dismissed from such actions on the grounds that it is not subject to the
personal jurisdiction of the West Virginia courts and also on the grounds that
it did not sell its products in the United States. Due to the uncertainties of
litigation, the Company cannot predict the outcome of these cases and is unable
to make a meaningful estimate of the amount or range of loss which could result
from an unfavorable outcome of these actions. These cases will be vigorously
defended.
Also, the Company is involved in certain other legal actions and claims
arising in the ordinary course of business. Management believes that such
litigation and claims will be resolved without a material effect on the
Company's consolidated financial statements.
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
NOTE 7. ACQUISITIONS
On February 2, 1998, the Company's wholly-owned subsidiary,
Schweitzer-Mauduit Spain, S.L. ("SM-Spain"), paid approximately $62.0 in cash
for 99.97 percent ownership interest in Companhia Industrial de Papel Pirahy
("Pirahy"), a specialty paper manufacturer located near Rio de Janeiro, Brazil.
In connection with the acquisition of Pirahy, the Company modified its existing
credit agreement to provide a $20.0 term loan to SM-Spain. SM-Spain borrowed the
remaining funds for the transaction from Schweitzer-Mauduit France, S.A.R.L.
("SM-France"), a French subsidiary of the Company, which in turn utilized its
existing cash balances and borrowings from its revolving credit facilities.
Additionally, on February 11, 1998, the Company's second tier
subsidiary, Schweitzer-Mauduit Enterprises ("SM-Enterprises") paid 37.2 million
French francs (approximately $6.1) in cash and assumed approximately $5.8 in
existing net debt for all of the outstanding shares of Ingefico, S.A. and 97.1
percent of the outstanding shares of its pulp and specialty paper manufacturing
subsidiaries, Groupe SAPAM and Papeteries de la Moulasse, located in St. Girons,
France. Subsequently, SM-Enterprises acquired all the remaining shares of the
minority interest for $0.2 in cash and Papeteries de la Moulasse was renamed
Papeteries de St. Girons. In the third quarter of 1998, SM-Enterprises and
Ingefico, S.A. were merged into Groupe SAPAM.
The above acquisitions have been accounted for under the purchase
method of accounting and, accordingly, the acquired assets and liabilities have
been recorded at their estimated fair values as of the respective dates of the
acquisitions. In conjunction with the acquisitions, liabilities were assumed as
follows:
Fair value of assets acquired $ 95.7
Less: Cash paid for the stock (68.3)
Direct costs incurred (2.0)
------
Liabilities assumed $ 25.4
======
The operating results of the newly-acquired companies are included in
the Consolidated Statements of Income beginning February 1, 1998. The following
summarizes unaudited consolidated pro forma results of operations, assuming the
acquisitions had occurred at the beginning of each of the following periods:
For the three months For the nine months
ended September 30, ended September 30,
-------------------- -------------------- For the full year ended
1998 1997 1998 1997 December 31, 1997
---- ---- ------ ------ -----------------
Pro Forma Net Sales..................... $134.4 $141.7 $421.9 $425.4 $570.4
Pro Forma Net Income.................... $ 6.8 $ 10.9 $ 29.1 $ 34.4 $ 44.2
Pro Forma Diluted Earnings Per Share.... $ .43 $ .67 $ 1.80 $ 2.11 $ 2.71
NOTE 8. RESTRUCTURING ACCRUAL
On April 15, 1998, the Company announced that it reached an agreement
with the labor union at its Spotswood mill to modify work rules and eliminate 67
hourly positions. The Company recorded a pre-tax charge of $1.7 in cost of
products sold for the cost of a related voluntary retirement program, reducing
second quarter 1998 earnings. The Company began realizing cost savings in the
third quarter of 1998. On an ongoing basis, this program is expected to provide
annual net pre-tax cost savings of approximately $5.
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
U.S. $ IN MILLIONS, EXCEPT PER SHARE AMOUNTS
NOTE 9. NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting of
Comprehensive Income" which became effective in the first quarter of 1998.
Currently, the only item of comprehensive income not included in the Company's
determination of net income is the change in unrealized foreign currency
translation adjustments, as shown below for the three and nine month periods
ended September 30, 1998 and 1997:
For the three months For the nine months
ended September 30, ended September 30,
----------------------- ----------------------
1998 1997 1998 1997
------ ------ ------ ------
Net Income....................................... $ 6.8 $ 11.2 $ 29.0 $ 35.2
Other comprehensive income, net of taxes:
Unrealized foreign currency
translation adjustments........ 4.4 (0.5) 0.5 (11.1)
------ ------ ------ ------
Comprehensive Income............................. $ 11.2 $ 10.7 $ 29.5 $ 24.1
====== ====== ====== ======
More than 60 percent of the Company's assets and liabilities are
outside the United States, substantially all of which are in France or Brazil.
The balance sheets of the Company's foreign subsidiaries are translated at
period-end currency exchange rates, and the differences from historical exchange
rates are reflected in accumulated other comprehensive income as unrealized
foreign currency translation adjustments. Unrealized foreign currency
translation adjustments for the three and nine month periods ended September 30,
1998 are substantially all due to the strengthening of the French franc against
the U.S. dollar, partially offset by the strengthening of the U.S. dollar
against the Brazilian real from the date of the acquisition of the Brazilian
subsidiary through the end of the third quarter of 1998. Unrealized foreign
currency translation adjustments for the three and nine month periods ended
September 30, 1997 are substantially all due to the strengthening of the U.S.
dollar against the French franc.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information", which will be effective no later than
for the Company's 1998 Annual Report on Form 10-K. This new statement may affect
the Company's financial statement disclosures. The Company is evaluating how to
implement the new disclosure requirements.
Also, in June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which will require that all
derivative financial instruments be recognized as either assets or liabilities
in the balance sheet. SFAS No. 133 will be effective no later than for the
Company's first quarter of 2000. The Company is evaluating the effects of this
new statement and when to implement the new requirements.
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ITEM 2. SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management believes that the following commentary and tables
appropriately discuss and analyze the comparative results of operations and the
financial condition of the Company for the periods covered.
OVERVIEW
The Company operates principally in one industry segment, which
consists of cigarette paper, tipping paper and plug wrap paper used to wrap
various parts of a cigarette, paper products used in cigarette packaging and
reconstituted tobacco products. The Company's non-tobacco industry products
represented approximately six percent of the Company's net sales in 1997. Due to
the non-tobacco related net sales of the newly-acquired companies, the Company's
non-tobacco industry products increased to approximately ten percent of the
Company's net sales during the first nine months of 1998. The non-tobacco
industry products are a diverse mix of products, certain of which represent
commodity paper grades produced to maximize machine operations.
For purposes of the geographic disclosure in the following tables, the
term "United States" includes operations in the U.S. and Canada. The Canadian
operations exist primarily to produce flax fiber used as raw material in the
U.S. operations and have no material effect on such geographic disclosure. The
Company's Brazilian operations were acquired on February 2, 1998. Accordingly,
the results of its operations are included in SWM's consolidated financial
statements since the beginning of February 1998.
Adjustments to net sales set forth in the following tables consist of
eliminations of intercompany sales of products between geographic areas.
Adjustments to operating profit consist of unallocated overhead expenses not
associated with geographic areas and eliminations of intercompany transactions.
Assets reported by geographic area represent assets which are directly used and
an allocated portion of jointly used assets. These assets include receivables
from other geographic areas and are referred to as intergeographic items.
RESULTS OF OPERATIONS
By Geography for the three months ended September 30, 1998 and 1997
(U.S. $ IN millions)
% of Consolidated
% Change -----------------
Net Sales 1998 1997 vs. 1997 1998 1997
- --------- ---- ---- -------- ---- ----
United States ...................... $ 47.4 $ 46.1 + 2.8% 35.3% 40.7%
France.............................. 72.4 67.0 + 8.1 53.9 59.1
Brazil.............................. 16.9 N.A. 12.5
Eliminations........................ (2.3) 0.3 (1.7) 0.2
------- ------- ----- -----
Consolidated .................... $ 134.4 $ 113.4 +18.5% 100.0% 100.0%
======= ======= ===== =====
% of Consolidated % Return on Sales
% Change ----------------- -----------------
Operating Profit 1998 1997 vs. 1997 1998 1997 1998 1997
- ---------------- ---- ---- -------- ---- ---- ---- ----
United States.............. $ 1.4 $ 4.2 - 66.7% 9.2 % 20.4% 3.0% 9.1%
France..................... 14.7 17.7 - 16.9 96.7 85.9 20.3 26.4
Brazil..................... 0.4 N.A. 2.6 2.4
Unallocated/Eliminations... (1.3) (1.3) (8.5) (6.3)
------ ------ ----- -----
Consolidated............ $ 15.2 $ 20.6 - 26.2% 100.0 % 100.0% 11.3% 18.2%
====== ====== ===== =====
N.A. - Not applicable
11
12
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
By Geography for the nine months ended September 30, 1998 and 1997
(U.S. $ IN millions)
% of Consolidated
% Change -----------------
Net Sales 1998 1997 vs. 1997 1998 1997
- --------- ---- ---- -------- ---- ----
United States .... $146.2 $146.8 - 0.4% 35.4% 42.8%
France ........... 232.4 197.3 +17.8 56.3 57.6
Brazil ........... 43.4 N.A. 10.5
Eliminations ..... (9.3) (1.4) (2.2) (0.4)
------ ------ ----- -----
Consolidated... $412.7 $342.7 +20.4% 100.0% 100.0%
====== ====== ===== =====
% of Consolidated % Return on Sales
% Change ----------------- -----------------
Operating Profit 1998 1997 vs. 1997 1998 1997 1998 1997
- ---------------- ---- ---- -------- ---- ---- ---- ----
United States.............. $ 7.3 $20.5 - 64.4% 14.2% 31.8% 5.0% 14.0%
France..................... 50.1 48.4 + 3.5 97.5 75.0 21.6 24.5
Brazil..................... (1.7) N.A. (3.3) (3.9)
Unallocated/Eliminations... (4.3) (4.4) (8.4) (6.8)
----- ----- ----- -----
Consolidated............ $51.4 $64.5 - 20.3% 100.0% 100.0% 12.5% 18.8%
===== ===== ===== =====
N.A. - Not applicable
Primarily as a result of the recent acquisitions, total assets by
geographical area have changed as follows:
% of Consolidated
September 30, December 31, -----------------
Total Assets 1998 1997 1998 1997
------------ ---- ---- ---- ----
United States.................. $155.4 $155.4 32.5% 39.7%
France......................... 255.3 237.6 53.5 60.8
Brazil......................... 68.3 N.A. 14.3
Intergeographic items.......... (1.5) (2.0) (0.3) (0.5)
------ ------ ----- -----
Consolidated................ $477.5 $391.0 100.0% 100.0%
====== ====== ===== =====
N.A. - Not applicable
Net Sales
Net sales increased by $21.0 million in the three month period ended
September 30, 1998, compared with the corresponding period of the preceding
year. This increase was attributable to net sales by the two newly-acquired
Brazilian and French companies which totaled $24.2 million in the quarter. Net
sales from the Company's other operations decreased by $3.2 million in the
quarter due to unfavorable sales mix and lower selling prices. Changes in both
currency exchange rates and unit sales volumes, excluding the two acquisitions,
had a nominal impact on net sales in the quarter compared with the same quarter
of the prior year. Excluding the acquisitions, worldwide sales volumes were
essentially at the prior year level. Sales volumes from the French businesses
declined by 2 percent for the three month period compared with the same period
of the prior year, excluding the French acquisition, with lower paper sales
volumes partially offset by higher reconstituted tobacco sales volumes. The
lower sales volumes by the French paper businesses were primarily a result of
decreased shipments to China, Russia and southeast Asia. Sales volumes increased
for the quarter at the U.S. business unit by 4 percent compared with the same
three month period of 1997. In Brazil, unit sales volumes improved somewhat
during the third quarter compared with the second quarter of this year. This
improvement was in part due to a one-time increase in unit sales associated with
the introduction of a new product by a major customer.
12
13
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Net sales increased by $70.0 million in the nine month period ended
September 30, 1998, compared with the corresponding period of the preceding
year. This increase was primarily attributable to sales at the two
newly-acquired companies, whose results are included in the Company's
consolidated results beginning in February 1998, and stronger sales volumes in
France. Net sales of the newly-acquired companies totaled $67.7 million in the
period. Excluding the acquisitions, worldwide sales volumes increased by 6
percent, favorably affecting net sales by $16.8 million. Sales volumes from the
French businesses grew by 13 percent for the nine month period, excluding the
French acquisition, with gains in the plug wrap, tipping paper and reconstituted
tobacco leaf product lines. Sales volumes declined at the U.S. business unit by
4 percent for the nine month period, due to reduced domestic cigarette
production by the Company's customers. Sales volumes in the U.S. declined in all
major product lines. Compared with the same nine month period of the preceding
year, changes in average selling prices and sales mix had an unfavorable effect
of $5.6 million. The net sales comparison was unfavorably affected $8.9 million
by changes in currency exchange rates, primarily related to a strengthened U.S.
dollar versus the French franc.
Operating Profit
Operating profit decreased by $5.4 million in the three month period
ended September 30, 1998, compared with the corresponding period of the
preceding year. Operating profit from the French business unit was $3.0 million
lower than in the same quarter a year ago due to the lower sales volumes of the
French paper businesses, lower average selling prices, and the impact of a
planned mill-wide maintenance down at the newly-acquired St. Girons mill.
Operating profit in the U.S. declined by $2.8 million compared with the same
prior year quarter. The favorable affects of higher volumes in the U.S. business
were more than offset by poor start-up operations associated with a planned
mill-wide maintenance down at the Spotswood mill, new computer systems expenses,
unfavorable sales mix and lower average selling prices. Amortization of
capitalized software costs related to the new integrated computer systems in the
U.S. and associated incremental operating expenses began in January 1998 and
negatively impacted the current three month period by $0.9 million. In Brazil,
improved mill operations compared with the second quarter of this year and a
one-time increase in volume related to the introduction of a new product by a
major customer resulted in operating profit for the three-month period of $0.4
million. Changes in currency exchange rates had a nominal impact in the quarter.
Non-manufacturing expenses increased by $1.8 million during the quarter. This
increase was solely caused by expenses at the two newly-acquired companies.
Excluding expenses of the newly-acquired companies, non-manufacturing expenses
were at the same level as the corresponding period of the prior year. Changes in
per ton wood pulp costs compared with the prior year favorably affected
operating profit by $0.9 million in the three month period, although this
benefit was offset by changes in selling prices.
Operating profit decreased by $13.1 million in the nine month period
ended September 30, 1998, compared with the corresponding period of the
preceding year, as lower operating profit in the U.S. and an operating loss in
Brazil were partially offset by improved operating profit in France. The U.S.
business unit's operating profit declined by $13.2 million primarily as a result
of lower sales and production volumes, increased computer systems expenses,
unfavorable sales mix, lower selling prices and a one-time second quarter
pre-tax restructuring charge of $1.7 million related to the Spotswood mill (see
Note 8 of the Notes to Unaudited Consolidated Financial Statements).
Amortization of capitalized software costs related to the new integrated
computer systems in the U.S. and associated incremental operating expenses began
in January 1998 and totaled $2.7 million for the first nine months.
Additionally, start-up costs of $1.2 million were incurred in the first quarter
related to the new U.S. computer systems. The Brazilian operations had an
operating loss of $1.7 million in the year-to-date period primarily because of
unfavorable second quarter
13
14
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
results. In France, operating profit improved by $1.7 million as a result of
higher French sales and production volumes, partially offset by unfavorable
changes in average selling prices and sales mix, and changes in currency
exchange rates. Changes in currency exchange rates had an unfavorable impact of
approximately $1.6 million. Non-manufacturing expenses increased by $4.0 million
during the nine month period. This increase was solely caused by expenses at the
two newly-acquired companies. Excluding expenses of the newly-acquired
companies, non-manufacturing expenses were 3 percent lower than in the
corresponding period of the prior year. Per ton wood pulp cost decreases
compared with the prior year favorably impacted operating profit by $1.5 million
in the nine month period, although this benefit was offset by changes in selling
prices.
NON-OPERATING EXPENSES
Interest expense increased by $0.5 million and $1.7 million in the
three and nine month periods ended September 30, 1998, respectively, compared
with the corresponding periods of the preceding year. The increases were
primarily a result of increased debt related to acquisitions in Brazil and
France, partially offset by changes in currency exchange rates for the nine
month period. Other income (expense) consists primarily of interest income and
foreign currency transaction gains and losses in the 1998 and 1997 periods and a
one-time favorable litigation recovery in France in the first quarter of 1998.
INCOME TAXES
The effective income tax rates for the three and nine month periods
ended September 30, 1998 were 40.6 percent and 30.1 percent, respectively,
compared with 36.8 percent and 37.1 percent for the respective corresponding
periods of 1997. The nine month period of 1998 reflects the benefit of a
reduction in the valuation allowance recorded against certain French deferred
income tax assets arising from net operating loss carryforwards ("NOLs"). This
adjustment reduced the deferred provision for income taxes by $5.2 million in
the second quarter of 1998. The reduction in the valuation allowance was
recorded because of continued strong earnings and projected future earnings at
the French businesses that utilize the NOLs, reducing the uncertainty that these
NOLs will be fully utilized in the future. Excluding the impact of this
adjustment, the effective income tax rate for the nine month period ended
September 30, 1998 would have been 41.1 percent. The higher 1998 effective
income tax rates compared with the corresponding periods of 1997 were primarily
the result of an increase in the corporate income tax rate enacted in France in
November 1997 from 36.67 percent to 41.67 percent for 1997 and 1998, retroactive
to January 1, 1997, and to 40.00 percent for 1999. This higher French income tax
rate increased the provision for income taxes by approximately $0.7 million and
$2.4 million, and reduced net income by approximately $0.6 million and $2.0
million, for the three and nine month periods ended September 30, 1998,
respectively. The increase applicable to the 1997 period was recorded in the
fourth quarter of 1997 when the income tax rate change was enacted.
LIQUIDITY AND CAPITAL RESOURCES
Nine Months Ended September 30,
-------------------------------
(U.S. $ IN millions)
Cash Provided by (Used for): 1998 1997
- ---------------------------- ---- ----
Changes in operating working capital.................. $(13.8) $(23.5)
Operations............................................ 46.4 37.9
Capital spending...................................... (23.3) (19.2)
Capitalized software costs............................ (3.0) (4.8)
14
15
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
The Company's primary source of liquidity is cash flow from operations,
which is principally obtained through operating earnings. The Company's net cash
provided by operations increased from $37.9 million for the nine months ended
September 30, 1997 to $46.4 million for the nine months ended September 30,
1998, primarily as a result of changes in operating working capital, excluding
the added working capital obtained with the two recent acquisitions. Changes in
operating working capital contributed unfavorably to cash flow in both periods,
by $13.8 million and $23.5 million in the nine month periods ended September 30,
1998 and 1997, respectively. Excluding working capital of the two acquisitions,
the 1998 increase in working capital was primarily due to an increase in
accounts receivable and an increase in finished goods inventories in the French
businesses in the third quarter of 1998, primarily for the Chinese market. The
1997 increase in working capital was primarily due to a decrease in accounts
payable, mainly associated with 1997 payments for capital expenditures and
capitalized software costs included in accounts payable at December 31, 1996,
and an increase in finished goods inventories in the U.S. business unit in the
second and third quarters of 1997.
Cash provided by operations exceeded the level of capital spending
during the first nine months of 1998. Capital spending for the nine months ended
September 30, 1998 included $2.5 million toward the expansion of the Malaucene,
France mill, $1.4 million to modify a paper machine at the newly-acquired St.
Girons mill, $1.2 million toward upgrades to a paper machine at the Spotswood
mill, and $1.1 million toward speed-ups of two machines in the French mills.
During the first quarter of 1998, the Ancram, New York mill successfully
completed a rebuild of the wet end of a long fiber paper machine. The Quimperle,
France mill successfully started up a new long fiber paper machine in March
1997. During the first quarter of 1998, the Quimperle mill initiated a speed-up
program for this machine. By late 1998, this speed-up program and the completed
Ancram project will, together, increase the Company's annual long fiber
production capacity by 10 to 12 percent.
In addition to capital spending, the Company incurred, and deferred on
the balance sheet, additional software development costs of $3.0 million in the
nine month period ended September 30, 1998, toward new company-wide integrated
computer systems. These computer systems are replacing the previously used
Kimberly-Clark systems and are expected to provide Year 2000 compliance for the
Company's computer systems.
In February 1998, two acquisitions were completed. On February 2, 1998,
SM-Spain paid approximately $62.0 million in cash for 99.97 percent ownership
interest in Pirahy. In connection with the acquisition of Pirahy, the Company
modified its existing credit agreement to provide a $20.0 million term loan to
SM-Spain. SM-Spain borrowed the remaining funds for the transaction from
SM-France, which in turn utilized its existing cash balances and borrowings from
its revolving credit facilities. Additionally, on February 11, 1998,
SM-Enterprises paid 37.2 million French francs (approximately $6.1 million) in
cash and assumed approximately $5.8 million in existing net debt for all of the
outstanding shares of Ingefico, S.A. and 97.1 percent of the outstanding shares
of its pulp and specialty paper manufacturing subsidiaries, Groupe SAPAM and
Papeteries de la Moulasse. Subsequently, SM-Enterprises acquired all the
remaining shares of the minority interest for $0.2 million in cash.
On April 24, 1997, the Board of Directors authorized a program to
permit the repurchase of the Company's common stock through December 31, 1998 in
an aggregate amount not to exceed $20 million. Through September 30, 1998, the
Company has repurchased a total of 155,700 shares of its common stock for $3.8
million under this program. All of these repurchases took place in the third
quarter of 1998.
15
16
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
On October 29, 1998, the Company announced that the Board of Directors
had declared a quarterly cash dividend of fifteen cents per share of common
stock. The dividend will be payable on December 14, 1998 to stockholders of
record on November 9, 1998.
The Company's ongoing requirements for cash are expected to consist
principally of amounts required for capital expenditures, the new company-wide
integrated computer systems, stockholder dividends and working capital. Other
than expenditures associated with environmental matters (see Note 5 of the Notes
to Unaudited Consolidated Financial Statements) and other capital projects
mentioned in the Outlook section below, the Company had no material outstanding
commitments as of September 30, 1998. The principal sources of cash are expected
to be cash flow from operations and borrowings from commercial banks.
The Company believes its cash flow from operations, together with
borrowings available under its revolving credit facilities, will be sufficient
to fund its ongoing cash requirements.
YEAR 2000 COMPLIANCE
Historically, many computer systems and other equipment with embedded
chips or processors utilize computer programs written using two digits to
represent the year rather than four digits. These programs may not properly
recognize a year "20XX". As a result, these programs may be unable to accurately
process certain data before, during or after the year 2000 and could result in
major governmental and business systems failures or miscalculations causing
disruptions in operations after December 31, 1999. This problem is commonly
referred to as the "Year 2000" issue.
Because of the numerous information systems, mill process controls and
operating systems, and vendors and service providers that the Company uses, as
well as the Company's many customers and customer locations around the world,
the Company anticipates that there may be some disruption in its business due to
the Year 2000 issue. Due to the interdependent nature of the Company and its
systems with those of so many customers, vendors and service providers, as well
as domestic and foreign governmental agencies, the Company and its operating
subsidiaries are exposed to many possible systems failures or processing errors.
As a result, the Company and its operating subsidiaries could be materially
adversely affected if utilities, private businesses and governmental agencies
with which they do business or that provide essential materials or services are
not Year 2000 compliant. The Company believes that the most reasonably likely
worst case scenarios would be temporary mill closings, delays in the receipt of
supplies, delays in the delivery of its products, delays in collection of
amounts due the Company, delays in payment of amounts owed by the Company to
others, and delays in receipt of needed services. As a consequence of one or
more of these scenarios, the Company's results of operations could be materially
adversely impacted by a temporary inability to conduct its business in the
ordinary course for some period of time. However, the Company believes that its
plans, including its contingency planning discussed below should minimize the
adverse effect of any such business disruptions if they occur.
Each of the Company's business units has inventoried its business
operations, assessed its susceptibility to system failures or processing errors
as a result of Year 2000 issues and developed a plan to address those issues,
focusing on three elements: information systems software and hardware, mill
process controls and operating systems, and vendors and service providers. Each
element is being subdivided according to risk potential of high, medium and low.
High risk is defined as being critical to uninterrupted operation of the
business. Medium risk is defined as being necessary to support the business but
temporary work-arounds can be accomplished. Low risk is defined as being minor
inconveniences that should not impact the Company's business. Those issues which
are considered most critical to continuing operations are being given the
highest priority.
16
17
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
On January 1, 1998, the Company's U.S. operations, including the
research and headquarters areas, began utilizing new integrated information
systems to replace the Kimberly-Clark systems formerly used in the U.S. A
benefit of the new systems is that they are expected to provide Year 2000
compliance in the area of information systems. In the U.S., mill process
controls and operating systems have been reviewed for nearly 3,000 pieces of
equipment and systems. Only six high risk equipment or systems issues have been
identified. For these issues, modification requirements and a schedule for
compliance are being developed with the applicable equipment and systems
vendors.
The Company's French businesses have inventoried and evaluated all
their information systems. Approximately one-fourth of these information systems
are believed to be Year 2000 compliant. Upon implementation in mid-1999 of
certain new integrated computer systems in France, substantially all of the
French businesses' information systems are expected to be Year 2000 compliant.
Less than three percent of the approximately 2,000 pieces of mill process
control equipment and operating systems will require modification or
replacement. Such corrective action is expected to be completed by the end of
the first quarter of 1999.
The Company's Brazilian business has inventoried and evaluated all of
its information systems. Nine of its systems will require modifications to
become Year 2000 compliant. Of these, upgrades have already been developed for
eight systems. Upgrades for all nine systems are expected to be developed and
implemented by the end of the second quarter of 1999. Of its mill process
control equipment and operating systems, ten will require modification. The
required modifications have already been developed for nine of the systems and
all ten are expected to be developed and implemented by the end of the second
quarter of 1999.
Inquiries have been mailed to all vendors and service providers for the
Company's U.S., French and Brazilian operations as to the status of their Year
2000 compliance. Thus far, approximately one-third have responded. Second
requests have been sent to those vendors and service providers that had not yet
responded to the first inquiry and to those whose responses were incomplete or
inadequate. Critical vendors and suppliers are being contacted either by phone
or in person to review the status of their Year 2000 compliance plans.
Coincident with the actions described above, the Company and its
operating subsidiaries are developing and evaluating contingency plans to
further mitigate the effects of possible disruptions that may occur and are
developing and evaluating related cost estimates for such plans. All of the
Company's operations are assessing the need for alternative supply arrangements
and increased inventory levels of raw materials, supplies and finished goods, as
well as other possible measures based on the responses from vendors and service
providers. Contingency plans will be developed to try to reasonably ensure that
operations are not interrupted and unexpected costs are minimized. However,
there can be no assurances that all possible negative consequences can be
identified and avoided. The Company presently plans to address each of its
systems which are critical to its operations by the end of the second quarter of
1999.
The Company currently estimates that the total cost of implementing its
Year 2000 compliance plans will be in the range of $1 million to $2 million,
substantially all to be incurred in 1999, excluding the costs of the new
integrated computer systems. Approximately two-thirds of this amount is expected
to be expensed and one-third included in capital projects. These preliminary
estimates are subject to change, since they are based on presently available
information, and will be updated as the Company continues its assessments,
proceeds with implementation of modifications and replacements necessary to
become compliant, receives further feedback from vendors and service providers
and formulates reasonable and necessary contingency plans.
17
18
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
EURO CURRENCY CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union are scheduled to establish fixed conversion rates between their
existing currencies ("legal currencies") and one common currency - the euro. The
euro will then trade on currency exchanges and may be used in business
transactions. Beginning in January 2002, new euro-denominated bills and coins
will be issued, and legal currencies will be withdrawn from circulation. The
Company established a committee to identify and implement changes necessary to
address the systems and business issues raised by the euro currency conversion.
These issues include, among others, the need to adapt computer and other
business systems and equipment to accommodate euro-denominated transactions,
competitive implications of increased price transparency within European Union
countries, changes in currency exchange costs and rate exposures, continuity of
contracts that require payment in a legal currency, and tax implications of the
conversion. The Company's French subsidiaries currently utilize multi-currency
software that will be capable of euro-denominated sales and purchase
transactions on January 1, 1999. Consideration has also been given to other
potential issues in connection with the conversion, including those mentioned
above. The Company does not anticipate any significant negative consequences of
these issues and does not anticipate that the euro conversion will have a
material adverse impact on its financial condition or results of operations.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information", which will be effective no later than
for the Company's 1998 Annual Report on Form 10-K. This new statement may affect
the Company's financial statement disclosures. The Company is evaluating how to
implement the new disclosure requirements.
Also, in June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which will require that all
derivative financial instruments be recognized as either assets or liabilities
in the balance sheet. SFAS No. 133 will be effective no later than for the
Company's first quarter of 2000. The Company is evaluating the effects of this
new statement and when to implement the new requirements.
OUTLOOK
The difficult market conditions experienced in the third quarter of
1998 are continuing. U.S. cigarette consumption is being impacted by adverse
publicity and by increases in the retail selling price of cigarettes. U.S.
cigarette consumption in 1998 is approximately 4 percent under the 1997 level.
Year-to-date, the export of cigarettes from the United States is approximately
at the prior year level. Although the Company's shipments to China have improved
during the beginning of the fourth quarter, these shipments have not returned to
the levels experienced during the first six months of 1998. Continued lower
sales to Russia and southeast Asia are also expected for the foreseeable future.
The weakness in shipments to China, Russia and southeast Asia are related to
import controls, currency convertibility and decreased demand. With weakness in
demand, pricing has come under pressure in some markets. The uncertain pricing
environment for the Company's paper products is expected to continue into 1999
due to market conditions and the results of global pricing negotiations with
multi-national cigarette manufacturers.
With weakening demand for the Company's paper products, some production
downtime is likely to be taken during the fourth quarter in France, the United
States and Brazil to manage inventory levels. The Company's customers in the
U.S. traditionally reduce their operating schedules around holidays during the
18
19
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
fourth quarter, which could further soften the demand for the Company's products
and allow for additional maintenance and capital work.
Compared with the prior year, the Company's net sales will benefit in
the fourth quarter from sales by companies acquired in Brazil and France during
the first quarter of 1998. The Company continues to integrate these
acquisitions. Earnings of the Company's Brazilian operations improved during the
third quarter. However, operating results in Brazil in the fourth quarter may
not be as strong as in the third quarter, due to the absence of a one-time third
quarter increase in volume related to the introduction of a new product by a
major customer and possible production downtime during the fourth quarter. On
October 28, 1998, the Brazilian government announced its plans to reduce its
spending deficit. The proposed plan includes measures that, if implemented,
would increase both the social security tax on companies and the tax on
financial transactions. If implemented as proposed, these two tax changes would
reduce the full year 1999 pre-tax operating profit of the Brazilian operations
by an estimated $0.9 million.
The amortization of capitalized software costs related to the new
integrated computer systems in the U.S. began in January and is expected to
reduce full-year 1998 earnings by approximately $.05 per share compared with
1997. Additionally, operating expenses for the new computer network in the U.S.
over and above the amount previously paid to Kimberly-Clark for utilization of
its systems are expected to have an unfavorable full year effect of
approximately $.08 per share in 1998 compared with 1997. These increased
computer-related pre-tax expenses will total approximately $0.9 million during
the fourth quarter. The Company expects to incur approximately $4 to $5 million
of capitalized software costs in 1998, primarily in France, and an additional $3
to $4 million of capitalized software costs in 1999. Start-up of the new systems
in France will occur in phases, commencing in mid-1999.
Cost savings are expected to continue from recently implemented capital
projects and from the Spotswood mill restructuring program that was announced in
the second quarter of 1998. The per ton cost of wood pulp declined during the
third quarter of 1998, with an additional decrease expected in the fourth
quarter of the year. The expected lower per ton wood pulp cost should offset
some of the possible pricing weakness.
The higher corporate income tax rate in France is expected to
negatively impact full year 1998 earnings by $.15 to $.20 per share compared
with 1997. The French corporate income tax rate is scheduled to decline from 41
2/3 percent in 1998 to 40 percent in 1999. Such a reduction would improve 1999
earnings compared with 1998 by approximately $.05 per share.
The company expects capital spending for 1998 to be approximately $35
to $40 million in total, focused primarily on internal capacity expansion,
product quality improvements and cost reduction opportunities. As a result of
recent changes in market conditions, the Company is in the process of
reassessing its capital spending plans for 1999. In the second quarter of 1998,
the Company initiated an expansion of the Malaucene mill, which is expected to
increase the mill's capacity for finished tipping paper by approximately 45
percent. This project includes spending for increased printing and slitting
capabilities and should be completed in the second half of 1999. Capital
spending in 1999 will also include spending for a $9.9 million project
authorized to increase reconstituted tobacco leaf ("RTL") production capacity at
the Spay, France mill by approximately 10 percent. With the authorization of
this project, current inventory levels and customer order patterns, the decision
was made to cease production of RTL products at the Spotswood mill in the fourth
quarter of 1998. The Spotswood RTL production line had been temporarily
restarted during the fourth quarter of 1997 to support the French RTL operation
until a plan for adding permanent RTL capacity was developed.
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Certain comments contained herein concerning the business outlook and
anticipated financial results of the Company constitute forward-looking
statements and are based upon management's expectations and beliefs concerning
future events impacting the Company. There can be no assurances that such events
will occur or that the Company's results will be as estimated. Many factors
outside the control of the Company also could impact the realization of such
estimates. Certain such factors that could cause the Company's future results to
differ materially from those expressed in any such forward-looking statements
are discussed in the Company's 1997 Annual Report on Form 10-K, Part I, Item 7,
under the heading "Factors That May Affect Future Results".
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Under the terms of the spin-off, the Company assumed liability for and
agreed to indemnify Kimberly-Clark from litigation arising out of the operation
of the Company's predecessor businesses, including the following new cases:
- - In September 1998, Sinette Newkirk, personal representative of the
estate of Delbert Newkirk, filed a complaint in the Circuit Court of
Kanawha County, West Virginia, against several tobacco companies,
industry trade associations and consultants, Kimberly-Clark and LTRI
seeking $2 million in compensatory and $3 million in punitive damages
allegedly sustained as a result of the death of her husband, which
plaintiff contends was caused by smoking Kool cigarettes during the
period 1966 to 1993. The fourteen count complaint alleges several
theories of liability including intentional and negligent
misrepresentation, breach of warranty, intentional infliction of
emotional distress, product liability, sale of an unreasonably
dangerous product and conspiracy.
- - In October 1998, Edward J. Sweeney, Stephen R. Micarek and Lisa A.
Figura filed, in the Court of Common Pleas of Allegheny County,
Pennsylvania, on behalf of themselves and certain residents of
Pennsylvania, a purported class action against several tobacco
companies, industry trade associations and consultants, tobacco
wholesalers and retailers and cigarette component manufacturers,
including Kimberly-Clark, seeking equitable relief and punitive damages
for the class in an unspecified amount. The class consists of those
Pennsylvania residents who, "commencing before age 18...purchased,
smoked...and continue to smoke cigarettes manufactured, marketed and
sold by defendants". The five coUNT complaint alleges that defendants
are liable to plaintiffs for product liability, consumer fraud, breach
of special duty, negligence and civil conspiracy. Among other things,
the complaint alleges that nicotine is an addictive substance, that the
tobacco companies, by using reconstituted tobacco and other additives,
are able to control the precise amount and/or the bioavailability of
nicotine in their cigarettes and that LTRI, formerly a subsidiary of
Kimberly-Clark, specializes in the tobacco reconstitution process and
in helping tobacco companies control the nicotine in their cigarettes.
The Company believes that Kimberly-Clark, as a component supplier, has
meritorious defenses to each of these cases. LTRI also has meritorious defenses
to the Newkirk case in which it has been named as a defendant and will seek to
be dismissed from such action on the grounds that it is not subject to the
personal jurisdiction of the West Virginia courts and also on the grounds that
it did not sell its products in the United States. Due to the uncertainties of
litigation, the Company cannot predict the outcome of these cases and is unable
to make a meaningful estimate of the amount or range of loss which could result
from an unfavorable outcome of these actions. These cases will be vigorously
defended.
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ITEM 5. OTHER INFORMATION
During the third quarter of 1998, a new three-year labor agreement was
ratified at the Ancram mill. This mill employs approximately 100 employees. The
settlement included a lump sum payment of four percent of affected
employees'1997 earnings in the first year of the agreement and a general wage
rate increase of three percent per year in years two and three.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Amended and Restated Agreement between Philip Morris
Incorporated and Schweitzer-Mauduit International, Inc. for
Fine Paper Supply, effective April 1, 1998.*
10.2 Technology Ownership, Technical Assistance and Technology
License Agreement among Philip Morris Incorporated, Philip
Morris Products, Inc. and Schweitzer-Mauduit International,
Inc., effective April 1, 1998.*
15. Independent Accountants' Report, dated October 21, 1998 from
Deloitte & Touche LLP to Schweitzer-Mauduit International,
Inc.
23. Independent Accountants' Consent.
27. Financial Data Schedule (for SEC use only).
* Exhibit has been redacted pursuant to a Confidentiality Request under
Rule 24(b)-2 of the Securities Exchange Act of 1934.
(b) Reports on Form 8-K:
(1) On July 7, 1998, the Company filed a Current Report on Form
8-K dated July 7, 1998, which reported the Company's expected
second quarter earnings.
(2) On July 14, 1998, the Company filed a Current Report on Form
8-K dated July 14, 1998, which reported that the Company had
signed a new Supply Agreement with Philip Morris Incorporated.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Schweitzer-Mauduit International, Inc.
(Registrant)
By: /s/ PAUL C. ROBERTS By: /s/ WAYNE L. GRUNEWALD
-------------------------------- ---------------------------
Paul C. Roberts Wayne L. Grunewald
Chief Financial Officer and Controller
Treasurer (principal accounting officer)
(duly authorized officer and
principal financial officer)
November 10, 1998 November 10, 1998
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SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ------------------- ------------
10.1 --- Amended and Restated Agreement between Philip Morris
Incorporated and Schweitzer-Mauduit International, Inc. for
Fine Paper Supply, effective April 1, 1998.*
10.2 --- Technology Ownership, Technical Assistance and Technology
License Agreement among Philip Morris Incorporated, Philip
Morris Products, Inc. and Schweitzer-Mauduit International,
Inc., effective April 1, 1998.*
15. --- Independent Accountants' Report, dated October 21, 1998 from
Deloitte & Touche LLP to Schweitzer-Mauduit International,
Inc.
23. --- Independent Accountants' Consent.
27. --- Financial Data Schedule (for SEC use only).
* Exhibit has been redacted pursuant to a Confidentiality Request under
Rule 24(b)-2 of the Securities Exchange Act of 1934.