Business Context and Reporting Period
This Form 10-K covers the fiscal year ended December 31, 2003, for Schweitzer-Mauduit International, Inc. (SWM), a diversified producer of premium specialty papers and the world's largest supplier of fine papers to the tobacco industry. The Company operates manufacturing facilities in the United States, France, Brazil, and Canada. In February 2004, SWM completed the acquisition of a tobacco-related papers manufacturer in Indonesia. The Company's financial statements for 2002 and 2001 were restated to reflect a change in inventory accounting from LIFO to FIFO for its U.S. operations.
Key Financial Metrics
| Metric (in millions, except per share) | 2003 | 2002 |
|---|---|---|
| Net Sales | $566.9 | $501.4 |
| Gross Profit | $108.9 | $105.3 |
| Operating Profit | $53.9 | $56.2 |
| Net Income | $34.5 | $33.0 |
| Diluted EPS | $2.28 | $2.17 |
| Cash Provided by Operations | $64.8 | $63.9 |
| Capital Spending | $92.0 | $30.3 |
| Total Debt | $96.9 | $52.5 |
| Stockholders' Equity | $250.2 | $201.3 |
Margins: Gross profit margin was 19.2% in 2003 (down from 21.0% in 2002). Operating profit margin was 9.5% in 2003 (down from 11.2% in 2002).
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 13.1% to $566.9 million, driven primarily by favorable currency exchange rates ($43.1 million impact), increased sales volumes ($13.0 million), and higher average selling prices ($9.4 million).
- Operating Profit Decline: Despite revenue growth, operating profit decreased 4.1% to $53.9 million. This was due to increased costs for wood pulp ($5.8 million), purchased energy ($3.3 million), and labor, as well as $2.3 million in pre-operating costs for a new production line in France.
- Capital Expenditures: Capital spending surged to $92.0 million (up from $30.3 million), primarily funding a new reconstituted tobacco leaf production line in France ($63.0 million) and capacity expansions in Brazil and the U.S.
- Debt Levels: Total debt increased significantly to $96.9 million from $52.5 million to fund record capital spending. The debt-to-capital ratio rose to 27.2%.
- Segment Performance: The France segment contributed 99.4% of consolidated operating profit. The Brazil segment saw a 48.5% decline in operating profit due to higher costs and currency impacts. The U.S. segment returned to profitability ($2.0 million) after a loss in 2002, aided by the absence of strike-related costs.
Guidance, Outlook, and Risks
- Outlook: Management expects markets to remain relatively stable in 2004. The new RTL production line in France and the Indonesia acquisition are expected to boost operating profit. Increased sales of reduced ignition propensity cigarette papers (driven by New York regulations) are anticipated but not expected to be significant in 2004.
- Cost Pressures: The Company expects higher wood pulp costs, labor rates, employee benefits, and depreciation in 2004. Interest expense is also expected to rise due to higher debt levels.
- Capital Spending: Projected at approximately $42 million for 2004 and $30 million for 2005.
- Tax Rate: The consolidated effective income tax rate is expected to be approximately 30% for 2004.
- Key Risks:
- Customer Concentration: Philip Morris (30%) and BAT (19%) accounted for 49% of 2003 sales. Loss of either would be material.
- Legal Proceedings: A significant ICMS tax assessment in Brazil totaling approximately $11.6 million (net exposure ~$6.4 million) is being contested. The Company believes it is more likely than not to prevail and has recorded no liability.
- Commodity Prices: Wood pulp is the largest cost component; a 10% price increase could impact pre-tax earnings by ~$6 million if not passed to customers.
- Foreign Operations: Exposure to currency fluctuations, political instability, and regulatory changes in over 90 countries.
Investor Verification Checklist
- Verify the status and potential outcome of the ICMS tax litigation in Brazil ($11.6 million assessment) and the Solvay calcium carbonate dispute in France.
- Monitor the renewal of supply agreements with major customers Philip Morris and BAT, particularly the Souza Cruz agreement in Brazil which was extended only through 2005.
- Assess the impact of rising wood pulp and energy costs on future margins and the Company's ability to pass these costs to customers.
- Review the pension plan funded status, which was underfunded by $36.8 million as of year-end, and the expected $10 million contribution in 2004.
- Track the integration and performance of the new Indonesia mill and the new RTL production line in France.