UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2009

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

1-800-514-0186
(Registrant’s telephone number, including area code)

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

There were 15,666,207 shares of common stock, par value $0.10 per share, of the registrant outstanding as of October 30, 2009.

 

 

TABLE OF CONTENTS

		Page
Part I FINANCIAL INFORMATION
Item 1. Financial Statements			1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures About Market Risk			32
Item 4. Controls and Procedures			32
Part II OTHER INFORMATION
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			38
Item 3. Defaults Upon Senior Securities			38
Item 4. Submission of Matters to a Vote of Security Holders			38
Item 5. Other Information			38
Item 6. Exhibits			39
SIGNATURES			40
GLOSSARY OF TERMS			41
INDEX TO EXHIBITS			42
EX 3.1 Certificate of Incorporation
EX 10.4 Outside Directors' Stock Plan Amended and Restated as of February 22, 2007
EX 10.14.1 Credit Agreement Extension, dated July 17, 2007, by and among, Schweitzer-Mauduit International Inc., Schweitzer-Mauduit France S.A.R.L. and a group of banks
EX 14.1 Code of Conduct, as amended November 3, 2009
EX 21 Subsidiaries of the Company
EX 23.2 Consent of Independent Registered Public Accounting Firm
EX 31.1 Section 302 Certification of CEO
EX 31.2 Section 302 Certification of CFO
EX 32 Section 906 Certification of CEO and CFO
EX 99.1 Form Indemnification Agreement

PART I

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

NOTE 1. GENERAL

Nature of Business

Schweitzer-Mauduit International, Inc., or the Company, was incorporated in Delaware in August 1995 and is a multinational diversified producer of premium specialty papers headquartered in the United States of America. The Company manufactures and sells paper and reconstituted tobacco products to the tobacco industry as well as specialized paper products for use in other applications. Tobacco industry products comprised approximately 90% of the Company’s consolidated net sales in the three and nine months ended September 30, 2009 and 2008, respectively. The primary products in the group include cigarette, plug wrap and tipping papers, or Cigarette Papers, used to wrap various parts of a cigarette, reconstituted tobacco leaf, or RTL, which is used as a blend with virgin tobacco in cigarettes and reconstituted tobacco wrappers and binders for machine-made cigars. These products are sold directly to the major tobacco companies or their designated converters in the Americas, Europe, Asia and elsewhere. Non-tobacco industry products are a diverse mix of products, certain of which represent commodity paper grades produced to maximize machine operations.

The Company is a manufacturer of high porosity papers, which are used in manufacturing ventilated cigarettes, banded papers for the production of lower ignition propensity, or LIP, cigarettes and the leading independent producer of RTL used in producing blended cigarettes. The Company conducts business in over 90 countries and currently operates 10 production locations worldwide, with mills in the United States, Canada, France, the Philippines, Indonesia and Brazil. The Company also has a 50% equity interest in a tobacco-related fine papers mill in China.

Basis of Presentation

The accompanying unaudited consolidated financial statements and the notes thereto have been prepared in accordance with the instructions of Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and Exchange Commission, or the SEC, and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America, or U.S. GAAP. However, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Management evaluated subsequent events through November 3, 2009, when our financial statements were issued.

The results of operations for the three and nine months ended September 30, 2009, are not necessarily indicative of the results to be expected for the full year. The unaudited consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and the notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as updated by our Form 8-K filed on September 17, 2009.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and wholly-owned, majority-owned and controlled subsidiaries. The Company’s share of the net income (loss) of its 50% owned joint venture in China is included in the consolidated statements of income as income (loss) from equity affiliates. All significant intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, inventory valuation, useful lives, fair values, sales returns, receivables valuation, pension, postretirement and other benefits, restructuring and impairment, taxes and contingencies. Actual results could differ materially from those estimates.

Recent Accounting Pronouncements

Effective January 1, 2009, the Company adopted the provisions of the Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 141R, which is a revision of SFAS No. 141, “ Business Combinations ” and is found in the Accounting Standards Codification (ASC) at ASC 805-10. SFAS No. 141R applies prospectively to business combinations after the beginning of the first annual reporting period beginning on or after December 15, 2008. The objective of SFAS No. 141R is to improve the reporting requirements of business combinations and their effects. To accomplish this, SFAS No. 141R establishes the principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and noncontrolling interest in the acquiree, (b) recognizes and measures goodwill in the business combination or a gain from a bargain purchase and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption of this standard had no impact on the Company’s consolidated financial statements and will be applied to future transactions, if any.

Effective January 1, 2009, the Company adopted the provisions of SFAS, No. 160, “ Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” and is now found at ASC 810-10-65. The standard changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, the elimination of “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as a part of consolidated earnings and to apply these financial statement presentation requirements retrospectively. Additionally, SFAS No. 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. The adoption of this standard changed how we present noncontrolling interests in our financial statements and has been retrospectively applied to all periods presented.

Effective January 1, 2009, the Company adopted the provisions of SFAS No. 161, “ Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 ” and is found at ASC 815-10-15 and 815-10-65. The adoption of SFAS No. 161 had no financial impact on our consolidated financial statements and only required additional financial statement disclosures. We have applied the requirements of SFAS No. 161 on a prospective basis. Accordingly, disclosures related to periods prior to the date of adoption have not been presented (see Note 8. Derivatives for more information).

Effective June 30, 2009, the Company adopted the provisions of SFAS No. 165, “Subsequent Events” and is found at ASC 855-10-5. The adoption of SFAS No. 165 had no financial impact on our consolidated financial statements and only required disclosure of the date through which subsequent events have been evaluated.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) which amends the accounting guidance for consolidating variable interest entities and eliminates the concept of qualifying special-purpose entities. SFAS No. 167 will be effective for the Company beginning January 1, 2010. The Company is evaluating the impact of the adoption of SFAS No. 167.

In December 2008, the FASB issued FASB Staff Position, or FSP, No. 132(R)-1, “ Employers’ Disclosures about Postretirement Benefit Plan Assets ,” or FSP 132R-1 (ASC 715-20-65). FSP 132R-1 enhances the required disclosures about plan assets in an employer’s defined benefit pension or other postretirement plan, including investment allocations decisions, inputs and valuation techniques used to measure the fair value of plan assets and significant concentrations of risks within plan assets. FSP 132R-1 is effective for financial statements issued for fiscal years ending after December 15, 2009. The Company will incorporate these required disclosures in its financial statements for the year ending December 31, 2009.

NOTE 2. NET INCOME PER SHARE

Effective January 1, 2009, the Company adopted ASC 260-10-55, or FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities.” The new rules state that unvested share-based payment awards that contain nonforfeitable rights to dividends are participating securities and should be included in the calculation of earnings per share using the two-class method. The Company has granted restricted stock that contain nonforfeitable rights to dividends on unvested shares. Since these unvested restricted shares are considered participating securities, the adoption of the new rules changed the Company’s computation of basic earnings per share retrospectively. Under the two-class method, the Company allocates earnings per share to common stock and participating securities according to dividends declared and participation rights in undistributed earnings.

Diluted net income per common share is computed based on net income attributable to common shareholders divided by the weighted average number of common and potential common shares outstanding. Potential common shares during the respective periods are those related to dilutive stock-based compensation, including long-term share-based incentive compensation, stock options outstanding, and directors’ accumulated deferred stock compensation which may be received by the directors in the form of stock or cash. A reconciliation of the average number of common and potential common shares outstanding used in the calculations of basic and diluted net income per share follows ($ in millions, shares in thousands):

Certain stock options outstanding during the periods presented were not included in the calculations of diluted net income per share because the exercise prices of the options were greater than the average market prices of the common shares during the respective periods. There were no anti-dilutive options for the three months ended September 30, 2009. For the nine months ended September 30, 2009, the average number of share equivalents resulting from these anti-dilutive stock options not included in the computations of diluted net income per share was approximately 491,100, and for the three and nine months ended September 30, 2008, was approximately 790,600 and 681,700, respectively.

The gross carrying amount and accumulated amortization for amortizable intangible assets consisted of the following (dollars in millions):

Amortization expense of intangible assets was $0.6 million and $1.6 million for the three and nine months ended September 30, 2009, and $0.7 million and $2.0 million for the three and nine months ended September 30, 2008, respectively. The Company’s customer-related intangibles are amortized to expense using the 150% declining balance method over a 6-year life. Estimated amortization expense for the next 5 years is as follows: 2009—$2.1 million, 2010—$1.9 million, 2011—$1.6 million, 2012—$1.2 million, and 2013—$0.4 million.

NOTE 5. INVESTMENT IN EQUITY AFFILIATES

China Tobacco Mauduit (Jiangmen) Paper Industry Co. LTD, or CTM, the Company’s joint venture with China National Tobacco Corporation, or CNTC, has 2 paper machines which produce cigarette paper and porous plug wrap, both of which started production in 2008. The Company uses the equity method to account for its 50% ownership interest in CTM. At September 30, 2009 and December 31, 2008, the Company’s equity investment in CTM was $15.0 million and $15.4 million, respectively. The Company’s share of the net income (loss) of CTM was included in income (loss) from equity affiliates within the consolidated statements of income. CTM is obligated to the Company and CNTC for a 2% royalty on net sales of cigarette and porous plug wrap papers, payment of which has been suspended, by agreement of the parties, since 2008, but is accrued. At September 30, 2009, the Company had a related-party receivable from CTM of $0.3 million. CTM sells its products to CNTC and its subsidiaries.

Below is summarized balance sheet information as of September 30, 2009 and December 31, 2008 and statement of operations information of the China joint venture for the three and nine months ended September 30, 2009 and 2008 (dollars in millions):

NOTE 6. RESTRUCTURING ACTIVITIES

As a result of our decision to close the Company’s finished tipping paper production facility in Malaucène, France, management expects to reduce employment by approximately 210 people. This action resulted in restructuring expense of $8.5 and $19.9 million during the three and nine months ended September 30, 2009, mostly related to employee severance. We expect to record approximately $4 million of employee severance and other cash expenses during the remainder of 2009 related to this plan.

In the third quarter and year-to-date September 30, 2009, the Company recorded $0.1 million and $1.1 million, respectively, of restructuring expense related to severance accruals in connection with general staff reductions in France announced in the second quarter of 2009.

In September, the Company announced a reorganization of its mill in Quimperlé, France as part of its continuing strategy to restructure its base tobacco-paper business to make it more cost competitive. Employees at PDM, located in Quimperlé, France were notified September 10, 2009 of the initiation of consultations with the unions and the Work’s Council regarding intended reductions of employment levels by 106 people, or 15% of the current workforce. The contemplated reduction of PDM employment levels, among factory and general staff, is made possible by the installation of an enterprise resource planning computer system as well as the now nearly concluded closure of the Malaucène finished tipping facility, both of which reduce administrative requirements.

Meetings with the unions and the Work’s Council must be completed before the amount of the restructuring expenses, timing and ongoing benefits of the changes can be definitively known. However, cash severance expenses associated with this action are expected to total approximately $14 million through the planned completion of the actions in the second quarter of 2010.

In the third quarter of 2009, we also recorded asset impairment charges of $11.9 million. These charges include a $9.2 million impairment charge for a large paper machine and related equipment at our Spotswood, New Jersey facility. During the third quarter evaluation of alternative courses of action related to recovering the carrying amount of our long-lived assets, management decided the most likely course of action was for our Spotswood operations to concentrate on the online LIP technology we operate for Philip Morris USA. We plan to transfer the remaining production of other cigarette papers from the affected Spotswood machine to our facilities in France and Brazil. As a result of this decision, we determined the machine’s carrying value was not recoverable and the net book value exceeded its fair value by $9.2 million. Impairment charges during the third quarter of 2009 also included a $2.7 million impairment charge for an idled small paper machine and related ancillary assets at our PDM facility in Quimperlé, France.

The Company incurred restructuring and impairment expenses of $26.9 million and $40.5 million in the three and nine months ended September 30, 2009, respectively, and $2.6 million and $8.3 million for the three and nine months ended September 30, 2008, respectively. The following table summarizes the associated cash and non-cash, pre-tax restructuring and impairment expense for the three and nine months ended September 30, 2009 and 2008 and the associated cumulative expense incurred since the 2006 inception of restructuring activities through September 30, 2009 (dollars in millions):

Restructuring liabilities were classified within accrued expenses in each of the consolidated balance sheets as of September 30, 2009 and December 31, 2008. Changes in the restructuring liabilities during the nine month period ended September 30, 2009 and the twelve month period ended December 31, 2008 are summarized as follows (dollars in millions):

Credit Agreement

The Company’s Credit Agreement provides for a $95 million U.S. dollar revolving credit facility, or U.S. Revolver, and an 80 million euro revolving credit facility, or Euro Revolver. Availability under the U.S. Revolver increased to $20.0 million as of September 30, 2009 from $3.0 million as of December 31, 2008. Borrowings under the Euro Revolver decreased to 25.0 million euros, or $36.5 million, as of September 30, 2009 from 32.1 million euros, or $44.6 million, as of December 31, 2008. Availability under the Euro Revolver increased to 55.0 million euros, or $80.3 million, as of September 30, 2009 from 47.9 million euros, or $66.6 million, as of December 31, 2008.

As of September 30, 2009 and December 31, 2008, the applicable interest rate on the U.S. Revolver was 0.6% and 3.2%, respectively. As of September 30, 2009 and December 31, 2008, the applicable interest rate on the Euro Revolver was 0.8% and 5.4%, respectively.

The Credit Agreement contains representations and warranties which are customary for facilities of this type and covenants and provisions that, among other things, require the Company to maintain (a) a net debt to equity ratio not to exceed 1.0 and (b) a net debt to adjusted EBITDA ratio not to exceed 3.0. Under the Credit Agreement, interest rates are at market rates, based on the London Interbank Offered Rate, or LIBOR, for U.S. dollar borrowings and the Euro Interbank Offered Rate, or EURIBOR, for euro borrowings, plus an applicable margin that varies from 0.35% to 0.75% per annum depending on the Net Debt to Adjusted EBITDA Ratio, as defined in the Credit Agreement. The Company incurs commitment fees at an annual rate of either 0.30% or 0.35% of the applicable margin on the committed amounts not drawn, depending on the Net Debt to Adjusted EBITDA Ratio as defined in the Credit Agreement. The Company also incurs utilization fees of 0.25% per annum when outstanding borrowings exceed 50% of the total credit facility.

Bank Overdrafts and Other

The Company had bank overdraft facilities of $36.2 million as of September 30, 2009. Bank overdraft obligations outstanding decreased to $4.8 million as of September 30, 2009 from $23.6 million as of December 31, 2008, which increased availability under bank overdrafts to $31.4 million as of September 30, 2009.

French Employee Profit Sharing debt relates to French government-mandated profit sharing. Each year, representatives of the workers at each of the French businesses can make an election for the profit sharing amounts from the most recent year ended to invest the funds in a financial institution or to invest the funds with their respective employer. To the extent that funds are invested with the Company, these amounts bear interest at the 5-year treasury note rate in France, 3.97 percent and 4.57 percent at September 30, 2009 and December 31, 2008, respectively.

Other debt consists of non-interest bearing French segment debt with deferred capital repayment from governmental and commercial institutions primarily related to environmental capital improvements and debt in Brazil from governmental financing programs. The Brazilian segment debt has market interest rates in Brazil ranging from 8 to 11%.

Interest Rate Swap Agreements

The Company maintains interest rate swap agreements on portions of its long-term debt. As a result, as of September 30, 2009, the LIBOR rates on $30 million, $17 million, and $16 million of the Company’s variable-rate long-term debt were fixed at 1.6%, 1.4%, and 1.8%, respectively, through May 30, 2010, March 16, 2010, and May 1, 2010, respectively. The Company also has a contract to fix $33 million of variable-rate debt at an average rate of 2.4% effective March 2010 through April 2012. The impact of the swap agreements on the consolidated financial statements was not material for the three or nine months ended September 30, 2009.

Fair Value of Debt

At September 30, 2009 and December 31, 2008, the carrying value of substantially all of the Company’s outstanding debt approximated fair value since the interest rates were variable and based on current market indices.

NOTE 8. DERIVATIVES

In the normal course of business, the Company is exposed to foreign currency exchange rate risk and interest rate risk on its variable-rate debt. To manage these risks, the Company utilizes a variety of practices including, where considered appropriate, derivative instruments. The Company has no derivative instruments for trading or speculative purposes nor any derivatives with credit risk related contingent features. All derivative instruments used by the Company are either exchange traded or are entered into with major financial institutions in order to reduce credit risk and risk of nonperformance by third parties.

The Company utilizes currency forward, swap and, to a lesser extent, option contracts to selectively hedge its exposure to foreign currency transaction risk when it is practical and economical to do so. The use of these contracts minimizes transactional exposure to exchange rate changes. We designate certain of our foreign currency hedges as cash flow hedges. Changes in the fair value of cash flow hedges are reported as a component of other comprehensive income (loss) and reclassified into earnings when the forecasted transaction affects earnings. For foreign exchange contracts not designated as cash flow hedges, changes in the contracts’ fair value are recorded to net income each period.

The Company selectively hedges its exposure to interest rate increases on variable-rate, long-term debt when it is practical and economical to do so. The Company utilizes various forms of interest rate hedge agreements, including interest rate swap agreements, typically with contractual terms no longer than 24 months. Changes in the fair value of our interest rate swaps are recorded to net income each period. See Note 7, Debt for more information about our interest rate swaps.

The following table presents the fair value of asset and liability derivatives and the respective balance sheet location at September 30, 2009 (dollars in millions):

The following table provides the effect derivative instruments in cash flow hedging relationships had on accumulated other comprehensive income (loss), or AOCI, and results of operations (dollars in millions):

The following table provides the effect derivative instruments not designated as hedging instruments had on net income (dollars in millions):

NOTE 9. COMMITMENTS AND CONTINGENCIES

Litigation

The Company is involved in various legal proceedings and disputes (see Note 15, Commitments and Contingencies, of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as updated by our Form 8-K filed on September 17, 2009). There have been no material developments to these matters during 2009.

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 exposes 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. While the Company has incurred in the past several years, and will continue to incur, capital and operating expenditures in order to comply with environmental laws and regulations, it believes that its future cost of compliance with environmental laws, regulations and ordinances, and its exposure to liability for environmental claims and its obligation to participate in the remediation and monitoring of certain hazardous waste disposal sites, will not have a material adverse effect on its financial condition or results of operations. However, future events, such as changes in existing laws and regulations, or future claims for remediation of contamination of sites presently or previously 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 its financial condition or results of operations.

NOTE 10. POSTRETIREMENT AND OTHER BENEFITS

The Company sponsors pension benefits in the United States, France, the Philippines and Canada and postretirement healthcare and life insurance, or OPEB, benefits in the United States and Canada. The Company’s Canadian and Philippines pension and OPEB benefits are not material and therefore are not included in the following disclosures.

Pension and OPEB Benefits

The components of net pension and OPEB benefit costs for U.S. employees and net pension benefit costs for French employees during the three and nine months ended September 30, 2009 and 2008 were as follows (dollars in millions):