0001000623-19-000048.txt : 20190301 0001000623-19-000048.hdr.sgml : 20190301 20190301163435 ACCESSION NUMBER: 0001000623-19-000048 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 129 CONFORMED PERIOD OF REPORT: 20181231 FILED AS OF DATE: 20190301 DATE AS OF CHANGE: 20190301 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCHWEITZER MAUDUIT INTERNATIONAL INC CENTRAL INDEX KEY: 0001000623 STANDARD INDUSTRIAL CLASSIFICATION: PAPER MILLS [2621] IRS NUMBER: 621612879 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13948 FILM NUMBER: 19649946 BUSINESS ADDRESS: STREET 1: 100 NORTH POINT CENTER EAST STREET 2: SUITE 600 CITY: ALPHARETTA STATE: GA ZIP: 30022-8246 BUSINESS PHONE: 8005140186 MAIL ADDRESS: STREET 1: 100 NORTH POINT CENTER EAST STREET 2: SUITE 600 CITY: ALPHARETTA STATE: GA ZIP: 30022-8246 10-K 1 swmform10-k12312018.htm 10-K - 12.31.2018 Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K 
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2018
  OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________________ to __________________
1-13948
(Commission file number)
 
SCHWEITZER-MAUDUIT INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware
62-1612879
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
100 North Point Center East, Suite 600
Alpharetta, Georgia
30022
(Address of principal executive offices)
(Zip Code)
1-800-514-0186
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common stock, par value $0.10 per share
 
New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   x     No   o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer  o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No  x
 
The aggregate market value of the outstanding common stock, par value $0.10 per share (the "Common Stock"), of the registrant held by non-affiliates as of June 30, 2018 (the last business day of the registrant's most recently completed second fiscal quarter) was $1.3 billion, based on the last sale price for the Common Stock of $43.72 per share as reported on the New York Stock Exchange on said date. For purposes of the foregoing sentence only, all directors and executive officers are assumed to be affiliates.

There were 30,896,979 shares of Common Stock issued and outstanding as of March 1, 2019.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant's definitive Proxy Statement relating to its 2019 Annual Meeting of Stockholders scheduled to be held on April 25, 2019 (the "2019 Proxy Statement") and filed pursuant to Regulation 14A are incorporated by reference into Part III of this Annual Report on Form 10-K.





SCHWEITZER-MAUDUIT INTERNATIONAL, INC.

TABLE OF CONTENTS
 
 
 
Page
 
 
Part I.
 
Item 1.
 
Business
 
 
 
 
Item 1A.
 
Risk Factors
 
 
 
 
Item 1B.
 
Unresolved Staff Comments
 
 
 
 
Item 2.
 
Properties
 
 
 
 
Item 3.
 
Legal Proceedings
 
 
 
 
Item 4.
 
Mine Safety Disclosures
 
 
Part II.
 
Item 5.
 
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
 
 
 
Item 6.
 
Selected Financial Data
 
 
 
 
Item 7.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
Item 7A.
 
Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
Item 8.
 
Financial Statements and Supplementary Data
 
 
 
 
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
 
 
 
Item 9A.
 
Controls and Procedures
 
 
 
 
Item 9B.
 
Other Information
 
 
Part III.
 
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
 
 
 
Item 11.
 
Executive Compensation
 
 
 
 
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
 
 
 
Item 13.
 
Certain Relationships and Related Transactions and Director Independence
 
 
 
 
Item 14.
 
Principal Accountant Fees and Services
 
 
Part IV.
 
Item 15.
 
Exhibits and Financial Statement Schedules
 
 
Signatures
 
 
Glossary of Terms




PART I.

Item 1. Business

Disclosure Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results, performance or achievements could differ materially from those projected in the forward-looking statements as a result of a number of risks, uncertainties, and other factors. For a discussion of important factors that could cause our results, performance, or achievements to differ materially from any future results, performance, or achievements expressed or implied by our forward-looking statements, please refer to Part I, Item 1A “Risk Factors” and Part I, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.


GENERAL

Background

Schweitzer-Mauduit International, Inc. (referred to, with its consolidated subsidiaries, as "we," "us," "our," the "Company," "SWM INTL" or "SWM" unless the context indicates otherwise) is a multinational producer of performance materials, including papers, nets and films headquartered in the United States of America (the "U.S."). The Company operates under two reportable segments: Advanced Materials & Structures ("AMS"), which manufactures resin-based products used in specialty applications in the filtration, infrastructure and construction, transportation, industrial, and medical end-markets, and Engineered Papers ("EP"), which produces cigarette papers and reconstituted tobacco products for cigarette and cigar manufacturers, as well as various other non-tobacco paper products.

The Company was incorporated in Delaware in 1995 as a wholly-owned subsidiary of Kimberly-Clark Corporation ("Kimberly-Clark"). On November 30, 1995, Kimberly-Clark transferred its tobacco-related paper and other paper products businesses conducted in the U.S., France and Canada to the Company and distributed all of the outstanding shares of common stock of the Company to its stockholders (the "spin-off"). As a result, the Company became an independent public company. We conduct business in over 90 countries and operate 22 production locations worldwide, with facilities in the U.S., United Kingdom, Canada, France, Luxembourg, Russia, Brazil, China, Belgium and Poland.
Our principal executive office is located at 100 North Point Center East, Suite 600, Alpharetta, Georgia 30022-8246 and our telephone number is (800) 514-0186. Our stock is traded on the New York Stock Exchange ("NYSE") under the symbol "SWM."

Strategic Transformation - Overview

Through 2013, the Company operated as a tobacco-centric paper operation. In late 2012, SWM's management and Board of Directors elected to pursue a strategic transformation by increasing profit streams outside the tobacco industry through business acquisitions, while carefully managing the profitable but mature tobacco operations. Over time, this strategy was intended to counterbalance the expected long-term pressures of the tobacco industry and transform SWM into a more diversified and growth-oriented enterprise while maintaining its company-wide focus on several underlying themes: manufacturing and innovation expertise in performance materials, operational excellence, and customer intimacy. The Company selectively targeted acquisition candidates that served diversified and growing end-markets, generated profitability associated with premium differentiated products, and had leading and defensible competitive positions in their core product categories. In addition, management believed many acquisition targets would have unique synergy opportunities when combined with the assets and capabilities of SWM, such as a global infrastructure and a robust operational excellence program, and ultimately, synergies with other similar companies acquired by SWM.

Pursuant to this strategy, management has used free cash flow and liquidity available through our credit facility to support growth investments. From 2013 to 2018 the Company invested a total of approximately $850 million acquiring

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three primary businesses, DelStar, Argotec, and Conwed, and making two “bolt-on” acquisitions. These businesses together now comprise the Advanced Materials & Structures segment, which generated nearly $470 million in net sales in 2018. The combination of AMS with non-tobacco sales in our paper business, resulted in total non-tobacco sales representing 51% of the Company’s total revenue in 2018, up from approximately 6% prior to these strategic actions. The EP segment has remained the source of the majority of the Company's cash flow, enabling the growth investments in the AMS segment and supporting steadily growing dividends to shareholders; the Company has paid more than $285 million in dividends since 2013.

Strategic Transformation - Creating the AMS Growth Platform

In December 2013, the Company acquired DelStar, Inc. ("DelStar"), a manufacturer of resin-based nets, films and non-wovens, focused on the filtration, medical, and industrial end-markets. DelStar established SWM's presence in new industries and added a portfolio of high-value technologies. Management also believed DelStar could benefit from SWM's global footprint, operational excellence program, and ability to fund growth investments.

In October 2015, the Company acquired Argotec Intermediate Holdings LLC ("Argotec"), a manufacturer of urethane films for applications primarily in the transportation end-market. A key growth driver was increasing demand for surface protection films used for automotive paint protection and glass lamination. This business also serves customers in the medical and industrial end-markets. From a technology standpoint, Argotec added to SWM's growing resin extrusion capabilities and added scale to the AMS growth platform.

In January 2017, SWM acquired Conwed Plastics LLC (“Conwed”), a producer of resin-based netting. Conwed’s similarities to the Company’s existing netting production assets presented a compelling opportunity to drive synergies through footprint rationalization, procurement, and organizational realignment. Although operationally similar to AMS’ existing assets, Conwed added further end-market diversification, with approximately 75% of Conwed’s sales serving the infrastructure and construction end-markets. The remaining 25% of sales were split between filtration and industrial end-markets, which also complemented the existing AMS business.

The acquisitions described above comprise the AMS segment. The Company believes that these businesses advance SWM's goal of diversifying its revenue stream and offer long-term growth opportunities across a broad set of attractive end-markets.
 



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AVAILABLE INFORMATION

Our filings with the Securities and Exchange Commission ("SEC"), which filings include this Annual Report on Form 10-K, Proxy Statements, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all related amendments, are available, free of charge, on the SEC's website at www.sec.gov and on the Investor Relations section of our website at www.swmintl.com. Information from our website is not incorporated by reference into this Annual Report on Form 10-K. These reports are available soon after they are filed electronically with, or furnished to, the SEC. The website allows access to historical financial information, press releases and quarterly earnings conference calls, our Code of Conduct, corporate governance guidelines, Board of Directors committee charters, as well as disclosure of any amendment to or waivers of our Code of Conduct granted to any of the principal executive officer, principal financial officer or principal accounting officer. The website provides additional background information about us including information on our history, products and locations. Requests for information, requests to contact our audit committee chairman, lead non-management director or the independent directors as a group, or requests to report concerns about accounting or other issues can be made in writing and sent to the Investor Relations Department at our principal executive office address listed above.

Our quarterly earnings conference calls are typically held the morning after our quarterly earnings releases and are available through our website via a webcast. The tentative dates for our quarterly earnings conference calls related to 2019 financial results are May 9, 2019, August 8, 2019, November 7, 2019 and February 20, 2020. These dates are subject to change. Instructions on how to listen to the webcasts and updated information on times and actual dates are available through our website at www.swmintl.com.

We have provided a Glossary of Terms at the end of this Annual Report on Form 10-K.

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DESCRIPTION OF BUSINESS

Segment Financial Information. We operate and manage two reportable segments based on our product lines: Advanced Materials & Structures and Engineered Papers. The Advanced Materials & Structures segment manufactures resin-based products used in specialty applications in the filtration, infrastructure and construction, transportation, industrial, and medical end-markets. This segment is comprised of the five businesses we acquired from 2013 to 2017: DelStar, the Pronamic and SNN acquisitions, Argotec and Conwed, which the Company has integrated into a more holistically aligned operating segment. Our Engineered Papers segment produces both tobacco-related papers and non-tobacco-related papers. Our tobacco-related papers, which comprise a large majority of EP's sales, include various papers used in cigarette production and reconstituted tobacco ("Recon"), a reprocessed tobacco material.

Additional information regarding "Segment Performance" is included in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation. In addition, selected financial data for our segments is available in Note 21. Segment Information, of the Notes to Consolidated Financial Statements and a discussion regarding the risks associated with foreign operations is available in Part I, Item 1A, Risk Factors, Market Risk. In conjunction with the change in reportable segments, corresponding information for all prior periods presented has been restated to correspond to the presentation in the current year.

Financial information about foreign and domestic operations, contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operation" appearing in Part II, Item 7 herein and in Notes 13, 14, 17 and 21 ("Restructuring and Impairment Activities," "Debt," "Income Taxes" and "Segment Information," respectively) to the Consolidated Financial Statements contained in "Financial Statements and Supplementary Data" in Part II, Item 8 herein, is incorporated by reference in this Item 1.

Advanced Materials & Structures

Products. We manufacture and sell a variety of highly engineered resin-based nets, films, and other non-wovens. These performance materials are often used in growing applications serving the filtration, infrastructure and construction, transportation, industrial, and medical end-markets. Most of our production technologies are extrusion-based, meaning resin pellets are heated, softened, and forced through a metal die to form continuous sheets or strands. We have significant technological expertise in proprietary die construction, which our competitors often outsource, and we consider this an advantage in protecting our technology and competitive position. However, unlike the EP segment which relies primarily on patent protection for key innovation protection, AMS relies more heavily on trade secrets and manufacturing "know-how."

Our thermoplastic nets are used in a variety of applications, the most prominent of which is their use as spacer netting in reverse osmosis water filtration (“RO filtration") devices. We have established a strong presence in this application by customizing products to meet demanding customer specifications, such as thickness/weight, flow characteristics, and heat and pressure resistance. Our nets are also used in a variety of other filtration applications such as fuel and hydraulic fluid filters, pharmaceutical filters, and food and beverage filters. Another key netting application is erosion and sediment control products for the infrastructure and construction end-markets. Our nets are the outside layers in erosion control blankets, which are used to prevent erosion on sloped terrain. We also produce sediment control “socks” which are used to set perimeters around various development sites to contain sediment and prevent contamination of water sources. Our nets can also be found in a variety of industrial applications such as carpet cushion support and retail food packaging.

We manufacture our thermoplastic polyurethane films ("TPU") to have combinations of the following attributes; UV, scratch and water resistance and ultra-clarity. The ability to demonstrate these rare combinations make them ideally suited for demanding transportation-related surface protection applications, primarily automotive paint protection and security reinforced glass. These products are also used in certain niche applications such as graphics and laminated textiles in the industrial end-market, and also in the medical end-market. Other films, including apertured film products, are used in wound care applications, such as finger bandages and wound dressings for the medical end-market and are also used in specialty liquid filters for ultra-pure semiconductor manufacturing processes.


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Our non-wovens are typically air-laid resin-based materials often used in liquid filtration and residential and commercial air filtration. In addition to rolled goods, SWM also manufactures rigid core tubing, an extruded resin product that also is primarily used in reverse osmosis water filtration devices, and flexible tubing used in various medical and industrial applications.

With the growth of our AMS division, our technical expertise around resin-based materials is increasing. We believe we have industry-leading innovation capabilities and an expanding product portfolio which we expect to support growth through collaborative product development opportunities with our customers.

Markets and Customers. The AMS segment supplies customers serving the filtration, infrastructure and construction, transportation, medical, and industrial end-markets. Generally, the applications and customers the AMS segment serves are in growing end-markets, and as a percentage of total AMS segment sales are as follows: filtration - 25%, infrastructure and construction - 30%, transportation - 25%, medical - 10%, industrial - 10%. These products are highly engineered and often customized. In some cases, we are the sole supplier of certain products to our top customers, though no customer represents more than 10% of our consolidated net sales.

Within the filtration end-market, reverse osmosis water filtration has exhibited historical long-term growth due to increasing global demand for drinkable water and we expect global infrastructure investments in this area to continue long-term. Our other filtration products are often used in the food and beverage industries and heavy equipment and machinery used in the oil and gas industries, filtering fuel and other hydraulic liquids, as well as serving other functions in the exploration, processing, and transport of oil, gas, and metals. We refer to non-RO liquid filtration products generally as process filtration. While sales of process filtration products, particularly those used in the oil, gas, and mining sectors, can be subject to cyclicality and commodity price volatility, we expect strong long-term demand across the product line.

Our sales to the infrastructure and construction end-market are largely comprised of erosion/sediment control products. Our netting is used in the production of erosion control blankets, which are used in highway development projects to cover roadside slopes during and after construction until vegetation has stabilized the ground. This is a primarily U.S. business, with expected growth supported by continued highway infrastructure investments. We also offer customers a unique sediment control solution, a filled “sock”, used to seal perimeters of development sites which could contain harmful contaminants. This product has gained adoption in the oil and gas exploration and production industry, and also has potential to displace legacy competitive products such as silt fence, which is often used to surround various construction sites to control sediment. In the construction segment, our netting products are used as support material for carpet cushion, construction materials protection, and support backing for sod production.

The majority of our TPU films are used in transportation-related surface protection applications, specifically automotive paint protection. This product is typically sold and installed in the after-market through dealerships or auto body shops. Recently, we have benefited from global adoption of paint protection films, particularly in Asia. Other surface protection applications, such as ballistic-resistant and security glass used primarily on vehicles can be impacted by government and military contracts. These films are also used in commercial architectural glass.

Our industrial applications are spread across a variety of other industries, such as apparel, food manufacturing, graphics and energy, while our medical film products largely serve the wound care management area of the medical end-market.

Sales and Distribution. AMS products are primarily sold by the marketing, sales and customer service organizations of our AMS operations directly to manufacturers, however, in some geographic regions, we use sales agents to assist us in the sales process. As part of our enterprise transformation and integration efforts related to our recently acquired companies, we re-branded the acquired companies and transitioned our AMS sales operations toward a more unified organization. All acquired companies have been re-branded as SWM and the AMS sales organization will operate and go to market under the SWM trade name, with sales resources deployed by end-market and focused on selling products from across the totality of AMS offerings.

We typically deliver our products to customers by truck, rail and ocean-going vessels. As is typical in the industries in which we operate, ownership of the product generally transfers to our customer upon shipment from our manufacturing

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facilities, except for certain export sales where ownership typically transfers at the foreign port or customer facility. In certain instances, we produce and hold or consign products for a limited number of customers for which title does not transfer until shipment from our manufacturing facility or the products are used by the customer. In these instances, we recognize revenue related to these products when control of the product transfers to the customer.

Competition. Our AMS products are typically leaders in their respective categories and compete against specialty products made by competitors such as Marshall Manufacturing Company, Johns Manville, a subsidiary of Berkshire Hathaway Inc., Shaoxing Naite Plastics Co. Ltd., 3M Company, Covestro AG, Tenax Corporation, Intermas Group, and Hollingsworth and Vose Company. We believe our AMS products compete primarily on product features, innovations and customer service across the end-markets we serve. Of the end-markets we serve, industrial is generally the most price competitive due to a higher portion of commodity-type products that we often sell in order to maximize our machine utilization.

Raw Materials and Energy. The primary raw material used in our AMS products is plastic resin, and we rely on a variety of commodity grade and specialty resins, including polypropylene, polyurethane, polyethylene, polyamide (nylon) and a selection of specialized high temperature engineering grade resins. Our thermoplastic nets and apertured films are produced using a blend of specialty resins and commodity grade resins like polypropylene. Resin prices can fluctuate significantly and can impact profitability. Commodity grade resin prices typically correlate with crude oil prices while specialty resin prices often do not. Our TPU films are produced using specialty resins which are significantly more expensive than commodity grade resins.

We have multiple sources for most of our resin needs. However, some of our specialty resins are supplied by fewer manufacturers. We believe that our purchased raw materials are generally available from several sources and that the loss of a single supplier would not likely have a material adverse effect on our ability to procure needed raw materials from other suppliers. Our total resin purchases in 2018 and 2017 totaled $143 million and $129 million, respectively.

The majority of our energy requirements relate to electricity in the U.S. We consider this to be a relatively stable energy source.

Backlog and Seasonality. In the AMS segment, customer orders are generally manufactured and shipped within 30 days or, in certain instances, within three months. Sales of our products within AMS are generally not subject to large seasonal fluctuations: however, we would expect the second and third quarters to be relatively stronger than the first and fourth quarters. As of December 31, 2018 and 2017, the AMS segment order backlog was approximately $65 million and $71 million, respectively.

Engineered Papers

Products. Our EP segment produces both tobacco-related and non-tobacco-related papers. Our tobacco-related papers include various papers used in cigarette production and reconstituted tobacco ("Recon"), a reprocessed tobacco material, and comprise a large majority of EP's sales.

One of our key cigarette paper products is low ignition propensity ("LIP") cigarette paper. LIP cigarettes are designed to self-extinguish when not actively being smoked, thus offering a fire-safety feature. The U.S., the European Union ("E.U."), and several other smaller jurisdictions have mandated the use of LIP papers. Our solutions pioneered this cigarette paper category, and we remain a leader in this cigarette paper sub-segment through either direct sales or through licensing agreements. The Company maintains an extensive and active intellectual property portfolio.

Recon is another key component of EP's total sales and profits. The most significant of our Recon products is reconstituted tobacco leaf, (“RTL” or “traditional RTL”), which cigarette manufacturers often blend with virgin tobacco to achieve certain attributes in cigarettes, such as taste or reduced delivery of tar, nicotine, or other tobacco-related smoking constituents. Historically, the production of RTL has often been a cost-effective use for tobacco leaf scraps, though virgin leaf price and inventory supply conditions can shift the relative attractiveness of our products. We also produce a similar line of Recon products referred to as wrappers and binders for use in machine-made cigars. Recently, a new generation of tobacco industry products generally referred to as Heat not Burn (“HnB”) have been introduced into the

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marketplace with a goal of reducing harmful effects of smoking. We generated commercial sales in 2018, and continue to develop products to meet potential demand should global consumer adoption gain momentum and the technology gains support from appropriate regulatory authorities.

Our non-tobacco paper products include a mix of lightweight papers including low-volume, high-value, engineered materials such as alkaline battery separator papers, as well as high-volume commodity paper grades for printing and writing, flooring laminates, and food service packaging, which are intended to maximize machine utilization. We intend to make continued diversification investments in our EP segment to broaden our offerings, utilize existing machine capacity, and/or further monetize our paper making and reconstitution technologies.

Our wet-laid paper making technologies can be broadly classified into two main production processes: flat-wire production and incline-wire production. Generally, our machines are flat-wire, meaning a liquid slurry of short pulp fibers and water are laid onto flat-wire conveyor belts, with the water draining through the wire as the fibers (wood, flax, tobacco, etc.) bond together to form a paper sheet. Incline-wire machines allow for increased drainage, enabling the use of longer fibers which bond into a more open web, increasing the porosity. Incline wire machines are typically associated with higher-value products given this added porosity, which is important in filtration and other specialty applications that tend to justify premium pricing.

The Company continues to focus resources on innovation through activities in our OneFiber lab where paper customers can work closely with our technologists to develop improved paper-based products and our LeafLab fiber reconstitution incubator at our facility in France. Our reconstitution technologies have potential to be utilized in products serving the cosmetics and packaging industries reprocessing botanical, vegetable, or other plant fibers. Furthermore, SWM’s Recon technologists are active in joint development with several cigarette manufacturers to drive continued innovation and product commercialization in the rapidly emerging Heat not Burn tobacco product area.

Markets and Customers. Our EP segment is heavily influenced by global smoking trends, particularly in the U.S., the E.U. (both LIP markets), and Brazil where we have the majority of our operations and highest share of the category's volume. Historically, mature geographic regions, such as the U.S. and the E.U. have exhibited a steady decline in smoking rates, often to the low-to-mid single digits. Overall, approximately 88% of EP segment sales are to customers in the tobacco end-market, with the majority of tobacco sales comprised of cigarette papers, and approximately 12% of EP segment sales are related to a variety of non-tobacco customers and applications.

We supply the major, and many of the smaller, cigarette and cigar manufacturers. We sell our products directly to the major tobacco companies or their designated converters in the Americas, Europe, Asia and elsewhere. Philip Morris-USA, a subsidiary of Altria Group Inc., Philip Morris International ("PMI"), Japan Tobacco Inc. ("JT"), and British American Tobacco ("BAT"), are our four largest customers and, together with their respective affiliates and designated converters, accounted for 28%, 31% and 35% of our 2018, 2017 and 2016 consolidated net sales, respectively. Although the total loss of one or more of these large customers could have a material adverse effect on our results of operations, we do not believe that such a loss is likely given our significance in the worldwide supply chain of cigarette-related papers.

Sales and Distribution. Our internal marketing, sales and customer service organizations sell most of our tobacco-related products directly to cigarette manufacturers or their designated converters. Most of our EP segment's non-tobacco related products are sold directly to manufacturers. In some geographic regions, we use sales agents. We do not sell our products directly to consumers or advertise our products in consumer media. We typically deliver our products to customers by truck, rail and ocean-going vessels. As is typical in our industry, ownership of the product generally transfers to our customer upon shipment from our plants, except for certain export sales where ownership typically transfers at the foreign port or customer facility.

Competition. The specialized nature of tobacco-related papers requires unique papermaking equipment, technical expertise, and research and development capabilities to meet exacting customer specifications. These factors have limited the number of competitors capable of servicing global cigarette manufacturers.


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As the sole domestic producer of cigarette papers in North America and Latin America (SWM production in Brazil), we believe that we have a significant majority of the category share in those regions. Our paper plants in France and LIP printing facility in Poland sell a large amount of their products in the E.U. We estimate that we have a direct share of more than 40% of cigarette paper sales in the E.U., and coupled with royalty payments from a key competitor to whom we have licensed our LIP technology, we believe we are able to monetize over 80% of the LIP-compliant E.U. cigarette market. Our principal competitors include delfortgroup AG (" delfort"), which licenses our LIP technology, Miquel y Costas & Miquel S.A. ("Miquel y Costas"), Julius Glatz GmbH ("Glatz") and PT Bukit Muria Jaya ("BMJ"). In December 2017, the Dusseldorf Court of Appeals affirmed the German District Court judgment of patent infringement against Glatz including an injunction against making and selling LIP cigarette paper. We believe that the basis of cigarette and our non-tobacco papers competition is price, consistent quality, security of supply, and level of technical service.

Outside of China, SWM is the only non-cigarette company that produces RTL through a paper-making process. Some cigarette companies such as Philip Morris-USA, British American Tobacco, JT and STMA (China) produce RTL primarily for their own internal use. Our customers' cigarette blending decisions, which affect our traditional RTL sales volumes, can be influenced by worldwide virgin tobacco prices and availability as well as the general attractiveness of various competing in-house Recon products. Huabao International Holdings Ltd, a Hong Kong company, produces Recon in China. We believe that the basis of competition in this geographic region is primarily quality and price. Similarly, for HnB products, we believe we are the only non-cigarette manufacturer with production capabilities.

Raw Materials and Energy. Wood pulp is the primary fiber used in our EP segment. Our operations consumed approximately $54 million and $42 million of wood pulp in the years ended December 31, 2018 and 2017, respectively, all of which we purchased. While EP uses other specialty fibers, such as flax, in our operations, we believe that purchased raw materials are generally available from several sources.

Paper production uses significant amounts of energy, primarily electricity, natural gas and fuel oil. We believe that energy supply is generally reliable throughout our manufacturing footprint, although prices can fluctuate significantly based on demand. We enter into agreements to procure a portion of our energy requirements for future periods in order to reduce the uncertainty of future energy costs. We also have a sustainability program focused on reducing our impact on the environment.

Additional information regarding agreements for the supply of certain raw materials and energy is included in Note 20. Commitments and Contingencies, of the Notes to Consolidated Financial Statements.

Backlog and Seasonality. While our U.S., Polish and Brazilian EP operations do not calculate or maintain records of order backlogs, we typically receive forecasts of future demands from certain larger customers which are used to manage production and ensure sufficient supply of paper products. Our French paper operations order backlog was approximately $27 million and $34 million on December 31, 2018 and 2017, respectively. Paper orders are typically received and shipped within a 30-day period. The RTL business operates predominately under a number of annual supply agreements. The order backlog for RTL was approximately $92 million and $100 million on December 31, 2018 and 2017, respectively, and is typically filled within one fiscal year.

Generally, sales of our paper and Recon products are subject to seasonal fluctuations due to periodic machine downtime and typically lower order volumes in the fourth quarter.


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Research and Development

As of December 31, 2018 we employ approximately 93 research and development employees in research and laboratory facilities in France, Brazil, Poland, and the U.S. We are dedicated to developing product innovations and improvements to meet the needs of individual customers. We believe that our research and product development capabilities have played an important role in establishing our reputation for high quality, superior products in both our AMS and EP segments. Within AMS, we have a history of finding innovative design solutions, including developing products that improve the performance of customers' products and manufacturing operations. We believe that our commitment to research and development, coupled with our investment in new technology and equipment, has positioned us to take advantage of growth opportunities in many places around the world. Within EP, our research and development has enabled us to establish and sustain leading shares in various cigarette paper products, specifically LIP paper. We also are working with customers to meet potential future demand for reduced-harm tobacco products.

Patents and Trademarks

As of December 31, 2018, we owned 38 patents and had 52 pending patent applications in our AMS segment. While we consider our patents, and the protection thereof, to be important, no single patent or group of patents is material to the conduct of our AMS business segment.

In our AMS segment, as described in the branding initiative discussed above, SWM made a strategic decision to transition away from certain legacy business trade names associated with our recent acquisitions in favor of a streamlined SWM enterprise branding approach. Thus, in 2016, the Company recognized an impairment of our DelStar trade name asset as further described in Note 11. Intangible Assets, of the Notes to Consolidated Financial Information. The Company will continue to market its products under the long-standing product-level brand names and trademarks such as "NALTEX®," "DELNET®," “ARGOGUARD®” and “ARGOTHANE®.”

As of December 31, 2018, we owned 234 patents and had 110 pending patent applications in our EP segment, covering a variety of cigarette papers, RTL, cigar wrapper and binder and other products and processes in the U.S., Western Europe and several other countries. We believe that our patents, together with our papermaking expertise and technical sales support, have been instrumental in establishing us as the leading worldwide supplier of cigarette papers. We believe that patents have contributed to our position as the world's leading independent producer of papers used for LIP cigarettes.

Management believes that in the EP segment, our "ALGINEX®" water-based technology trademark, our "GLUCIGENTM" trademark for use in banded papers for the production of LIP cigarettes, and the "SWM" logo and trade names have been important contributors to the marketing of our products. Further, we have developed, individually or in conjunction with customers, technologies to address the demand for cigarette paper for LIP cigarettes in the U.S., Canada, Australia and the E.U. We have licensed to others the right to use certain of our LIP intellectual property, excluding ALGINEX® related intellectual properties.

Management of a large portion of SWM's research and development activities is provided from our Luxembourg City, Luxembourg operation ("SWM Luxembourg"). These activities are often performed at other SWM locations under contract by SWM Luxembourg, and funded by SWM Luxembourg. SWM Luxembourg has the authority to initiate and manage research and development projects in areas such as, but not limited to, LIP paper, Recon for heat-non-burn devices, netting and other extruded resin products, and our non-tobacco products unit (Advanced Fibers and Materials). This operation also provides global oversight and active management for much of the Company's intellectual property rights.




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Employees

As of December 31, 2018, we had approximately 3,500 regular, full-time, active employees.

North American Operations. Hourly employees at the Spotswood, New Jersey, Ancram, New York and Minneapolis, Minnesota plants are represented by locals of the United Steel Workers Union. The two-year collective bargaining agreement with hourly employees at our Spotswood plant is effective through July 28, 2020. The three-year collective bargaining agreement with employees at our Ancram plant is effective through September 30, 2020. The three-year collective bargaining agreement with hourly employees at our Minneapolis facility is effective through October 31, 2020. We believe employee and union relations continue to be positive at the Spotswood, Ancram and Minneapolis operational facilities.

Our operations in Canada, South Carolina, Massachusetts, and the former DelStar and Conwed facilities, other than Minneapolis, are non-union. We believe that employee relations are positive.

French Operations. Hourly employees at our Quimperlé, Spay, and Saint-Girons, France plants are union represented. We believe that employee relations in France are positive.

Luxembourg Operations. Employees at our Luxembourg office are non-union. We believe that employee relations in Luxembourg are positive.

Brazilian Operations. Hourly employees at the Pirahy, Brazil plant are represented by a union. The one-year collective bargaining agreement with employees at SWM-B is effective through May 31, 2019. We believe that employee relations are generally positive and comparable to those of other similarly situated Brazilian manufacturing operations.

Polish Operations. Employees at our Strykow, Poland facility are non-union. We believe that employee relations in Poland are positive.

Chinese Operations. Employees at our Suzhou, China facility are non-union. We believe that employee relations in China are positive.

English Operations. Some hourly employees at our Gilberdyke, England facility are represented by a union. We believe that employee relations in England are positive.

Belgium Operations. Employees at our Genk, Belgium facility work in accordance with Belgium labor regulations. We believe that employee relations in Belgium are positive.

Environmental Matters

Capital expenditures for environmental controls to meet legal requirements and those relating to the protection of the environment at our facilities in the U.S., United Kingdom, France and Brazil were $1.0 million in 2018, no material amount of which was the result of environmental fines or settlements. We expect such expenditures to be $1.0 million or less in each of the next two years, of which no material amounts are expected to be the result of environmental fines or settlements. Should the Company make material changes in the operations at a facility, it is possible such changes could generate environmental obligations that might require remediation or other action, the nature, extent and cost of which are not presently known. These expenditures are not expected to have a material adverse effect on our financial condition, results of operations or competitive position; however, these estimates could be modified as a result of changes in our plans, changes in legal requirements or other factors.

Working Capital

We normally maintain approximately 50 to 90 days of inventories to support our operations. Our sales terms average between 15 and 60 days for payment by our customers, dependent upon the products and market segment served. With respect to our accounts payable, we typically carry approximately 15 to 40 days outstanding, in accordance with our

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purchasing terms, which vary by business location. The accounts payable balance varies in relation to changes in our manufacturing operations, particularly due to changes in prices of wood pulp, resins and purchased energy and the level and timing of capital expenditures related to projects in progress.

Executive Officers of the Registrant

The names and ages of our executive officers as of March 1, 2019, together with certain biographical information, are as follows:
Name
 
Age
 
Position
Dr. Jeffrey Kramer
 
58

 
Chief Executive Officer
R. Andrew Wamser
 
45

 
Executive Vice President, Finance and Chief Financial Officer
Michel Fievez
 
61

 
Executive Vice President, Engineered Papers
Daniel Lister
 
46

 
Executive Vice President, Advanced Materials & Structures
Ricardo Nunez
 
54

 
General Counsel and Corporate Secretary
Robert Cardin
 
55

 
Corporate Controller

There are no family relationships between any of the directors, or any of our executive officers. None of our officers were selected pursuant to any arrangement or understanding between the officer and any person other than the Company. Our executive officers serve at the discretion of the Board of Directors and are elected annually by the Board.

Dr. Jeffrey Kramer was appointed Chief Executive Officer in May 2017, after serving as Co-Chief Executive Officer since March 2017. Prior to joining SWM, Dr. Kramer served as Vice President, Lubricants of Brenntag AG, a distributor of chemicals, from January 2016. Dr. Kramer previously served as President and Chief Executive Officer of J.A.M. Distributing Company from January 2013 through December 2015. J.A.M. Distributing Company is a distributor of high-performance lubricants and fuels. Dr. Kramer previously held various senior positions at Air Products and Chemicals, Inc., an industrial gases company, including Vice President and Chief Technology Officer from June 2012 through December 2012 and Vice President and General Manager, Packaged Gases, from 2005 through June 2012.

R. Andrew Wamser was appointed Co-Chief Financial officer on February 5, 2018 and, effective March 2, 2018, became the sole Executive Vice President, Finance and Chief Financial Officer and the Company's Principal Financial Officer. Prior to joining SWM, Mr. Wamser served as Vice President, Finance; Investor Relations and Treasurer of AutoNation, Inc., the largest automotive retailer by revenue in the US. Prior to that Mr. Wamser served as Managing Director, Investment Banking; Diversified Industrial Group of Barclays Capital Plc, now known as Barclays Investment Bank, the investment banking division of Barclays PLC. He also previously held other investment banking roles at Barclays Capital and UBS Investment Bank.

Michel Fievez was appointed Executive Vice President, Engineered Papers in December 2014. He previously held the title of Executive Vice President, Reconstituted Tobacco at the Company since March 2010. Prior to that, he held the position of President - European Operations from June 2007 to March 2010. From 2003 to May 2007, Mr. Fievez served as General Manager One Side Coated Papers and then Vice President and General Manager Packaging, Metalizing and Office and Graphic with Ahlstrom Corporation, a fiber-based materials company. From 1998 to 2003, he held key management positions, including Managing Director, with Chesapeake Display and Packaging in Europe, and from 1994 to 1998, held the position of Vice President Manufacturing and Technology with Mead Packaging Europe. Before that, he worked for five years as Associate and Engagement Manager with McKinsey & Company.

Daniel Lister was appointed Executive Vice President, Advanced Materials & Structures on July 5, 2016. Mr. Lister joined SWM from Greif, Inc., a global leader in industrial packaging and services, where he worked since 2005. From 2009 to 2016 Mr. Lister held key international roles including, Vice President, Middle East Development and Division President and CEO of Greif Flexible Products & Services, a Joint Venture with the Al Dabbagh Group. Prior to his international assignments, Mr. Lister led key businesses in North America. Mr. Lister worked for The Dow Chemical Company from 2001 to 2005 where he held several commercial strategy, business growth, and business management roles.

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Ricardo Nunez was appointed Senior Vice President, General Counsel and Corporate Secretary in September 2017, after serving as Interim General Counsel since November 2016. Prior to joining SWM, Mr. Nunez served as General Counsel for Vivex Biomedical, Inc. a Marietta, GA based biologics company from April 2015 to July 2016. Prior to that, he served as SVP, General Counsel and Corporate Secretary for HD Supply, Inc. a spinoff from The Home Depot from March 2007 to April 2015. Mr. Nunez's previous experience also includes senior legal responsibilities at The Home Depot, General Electric, and Esso Inter-America, Inc. (the Latin America affiliate of Exxon Corporation), as well as private practice.

Robert Cardin has served as Corporate Controller since November 2013. Previously, Mr. Cardin served as Controller for Syncreon International Group, a specialized provider of integrated logistics services to global industries, since 2011. Prior to that time he was employed by DENTSPLY International Inc., a worldwide manufacturer of dental products, as Assistant Corporate Controller from 2010 to 2011 and as Group Controller - Dental Consumables Business from 2004 to 2010.


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Item 1A. Risk Factors

Factors That May Affect Future Results

Many risk factors both within and outside of our control could have an adverse impact on our business, financial condition, results of operations and cash flows and on the market price of our common stock. While not an exhaustive list, the following important risk factors could affect our future results, including our actual results for 2018 and thereafter and could also cause our actual results to differ materially from those expressed in any forward-looking statements we have made or may make.

We expect our business to continue to be adversely impacted by governmental actions relating to tobacco products, as well as by decreased demand for tobacco products due to declining social acceptance of smoking, new smoking technologies, and litigation in the U.S. and other countries.

In 2018, approximately 49% of our net sales were from products used by the tobacco industry in making cigarettes or other tobacco products. Cigarette consumption outside of Asia has generally declined due to, among other things, the diminishing social acceptance of smoking, public reports with respect to the possible harmful effects of smoking, including effects of second-hand smoke, the use of other tobacco products, the development and use of new tobacco-related or substitute products or technologies, such as e-cigarettes, that do not use our products, and, particularly in the U.S., to litigation and actions on the part of private parties to restrict smoking. For instance, litigation is continuing against major U.S. manufacturers of consumer tobacco products seeking damages for health problems allegedly resulting from the use of tobacco in various forms. It is not possible to predict the outcome of such litigation or the effect adverse developments in pending and future litigation may have on the tobacco industry or its demand for our products, but in the past litigation has adversely affected demand for consumer tobacco products. These factors have led, and could lead, to certain merchants deciding not to sell tobacco products. As a result, the overall demand for conventional tobacco cigarettes outside of Asia has generally been declining in terms of volume of sales. These declines have had an adverse effect on demand for our products in these regions. We expect these trends to accelerate and thus to continue to reduce smoking levels and adversely affect demand for our products, which could have a material adverse impact on our future financial condition, results of operations and cash flows.

In recent years, governmental entities around the world, particularly in the U.S., Brazil, Russia, Australia and Western Europe, have taken, or have proposed, actions that had, or are likely to have, the effect of reducing consumption of tobacco products which, in turn, reduces demand for our products. These actions, including efforts to regulate, restrict or prohibit the sale, advertisement and promotion of tobacco products and their components, to limit smoking in public places, to control or restrict additives that may be used in tobacco products and to increase taxes on such products, are intended to discourage the consumption of cigarettes and other tobacco products. For example, in the U.S., the regulatory jurisdiction of the federal Food and Drug Administration was extended in 2009 to include tobacco products, and again in 2016 to include cigars and additional tobacco products. These products are now subject to product component disclosure regulations, new controls on ingredients and design changes, and additional restrictions relating to marketing and labeling. The federal Food and Drug Administration could promulgate additional regulations. In Brazil, regulations limit the use of additives to cigarettes. In the E.U., the Tobacco Products Directive regulates the content, effects, marketing and labeling of tobacco products, and both revisions to the Directive and the ongoing phase-in of the Registration, Evaluation, Authorization, and Restriction of Chemical Substances regulation ("REACH") may further restrict product ingredients. Additionally, the World Health Organization is actively promoting tobacco regulation, and other countries worldwide are in the process of adopting some or all of these restrictions. It is not possible to predict the additional legislation or regulations relating to tobacco products that may be instituted, or additional countries that may adopt such legislation or regulations, or the extent to which such legislation or regulations may impact the design or formulation of our customers' products. Such legislation or regulation may adversely impact the demand for traditional cigarettes and cigars, with corresponding impacts on our sales of cigarette papers, RTL and associated items, which could have a material adverse effect on our future financial condition, results of operations and cash flows.

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Our joint ventures in China serve only the local market. Declines in Chinese cigarette consumption could have a material adverse effect on our future financial condition, results of operations and cash flows, including our China Tobacco Schweitzer (Yunnan) Reconstituted Tobacco Co. Ltd. (“CTS”) and China Tobacco Mauduit (Jiangmen) Paper Industry Ltd. (“CTM”) joint ventures.

Our technological advantages are unlikely to continue indefinitely.

We consider our intellectual property and patents to be a material asset. We have been at the forefront of developing new products and technology within our industries and have patented several of our innovations, particularly with regard to cigarette paper used to produce LIP cigarettes. This has enhanced our ability to sell products and to provide added functionality and other value to the products we sell allowing them to command higher margins. This advantage has also enabled us to license certain of our patents and know-how to, and earn royalty income from, third parties. Ultimately, our patents will expire (generally before 2023) and some may be held invalid in certain jurisdictions before their expiration dates. In addition to protecting certain of our technological advantages through patenting, we also protect a significant amount of our technological advantages as trade secrets, especially with regard to our AMS segment and our RTL products. As we expand our operations to more locations and countries, the risk of the loss of proprietary trade secrets will increase, and any significant loss would result in the loss of the competitive advantages provided by such trade secrets. While we cannot predict the impact or the timing of these trends and eventualities, they likely will reduce our sales and margins from the levels that we otherwise would have achieved.

Effectively policing our domestic and international intellectual property and patent rights is costly and may not be successful.

Our portfolio of granted patents varies by country, which could have an impact on any competitive advantage provided by patents in individual countries. We cannot guarantee that any U.S. or foreign patent, issued or pending, will provide us with any continued competitive advantage.

We rely on patent, trademark, and other intellectual property laws of the U.S. and other countries to protect our intellectual property rights. However, we cannot guarantee that one or more of our patents will not be challenged by third parties and/or ultimately held invalid by courts or patent agencies of competent jurisdiction, which could remove the legal barriers preventing competitors from practicing our LIP technology among others.

Further, there can be no assurances that we will be able, or that it will be economic for us, to prevent third parties from using our intellectual property or infringing our patents without our authorization, which may reduce any competitive advantage we have developed. In the event that we need to enforce certain of our patents against infringement through judicial or administrative actions, the litigation to protect these rights is often costly and time consuming and diverts management resources; moreover, there can be no assurance that our efforts to protect our intellectual property will be successful, or that a defendant will not assert counterclaims against us or challenges to other intellectual property we may own.

Some of our patents have been the subject of opposition hearings. Like the actions we undertake to enforce our IP rights, oppositions filed against us in respect of our intellectual property are expensive and divert management time and resources.

Even when the Company is initially successful, there can be no assurance that the counterparty will not appeal, or that the appeal will not be successful. Even when successful at the appeal level, as with respect to patents such as EP 1,482,815 (relating to a low-viscosity polymers to print LIP bands), there can be no assurance that a patent will not be later successfully challenged in individual national court jurisdictions.

We do not believe that any of our products infringe the valid intellectual property rights of third parties. However, we may be unaware of intellectual property rights of others that may cover some of our products or services or a court or other governmental body may come to a different conclusion from ours. In that event, we may be subject to significant claims for damages or disruptions to our operations.

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Because of the geographic diversity of our business, we are subject to a range of international risks.

Our operations are located in many countries around the world and operate, to a degree, in a decentralized manner. There are inherent control and fraud risks in such a structure. Moreover, we have manufacturing facilities in eight countries and two joint ventures in China and sell products in over 90 countries, many of which are emerging and undeveloped markets.

As a result, our manufacturing operations, sales and results, depending on their location, are subject to various international business risks, including, but not limited to, the following:

Foreign countries can impose significant import, export, excise and income tax and other regulatory restrictions on our business, including limitations on repatriation of profits and proceeds of liquidated assets. While we attempt to manage our operations and international movements of cash from and amongst our foreign subsidiaries in a tax-efficient manner, unanticipated international movement of funds due to unexpected changes in our business or changes in tax and associated regulatory schemes could materially affect our financial position, results of operations and cash flows.

We are exposed to global as well as regional macroeconomic and microeconomic factors, which can affect demand and pricing for our products, including: unsettled political and economic conditions, including as they relate to Brazil, Russia and the Ukraine; expropriation; import and export tariffs; regulatory controls and restrictions; and inflationary and deflationary economies. These factors together with risks inherent in international operations, including risks associated with any non-compliance with the U.S. Foreign Corrupt Practices Act, the 2013 Brazilian Clean Companies Act, the U.K. Bribery Act of 2010, the 2013 Russian Law on Preventing Corruption and other non-U.S. anti-bribery law compliance, could adversely affect our financial condition, results of operations and cash flows.
    
We participate in two joint ventures and have one manufacturing facility in China. The joint ventures sell our products primarily to Chinese tobacco companies. Operations in China entail a number of risks including international and domestic political risks, the need to obtain operating and other permits from the government, adverse changes in the policies or in our relations with government-owned or run customers and the uncertainty inherent in operating within an evolving legal and economic system. There are also risks inherent with 50% joint ventures, such as a lack of ability to control, and visibility with respect to operations, customer relations and compliance practice, among others.

Changes or increases in international trade sanctions or quotas may restrict or prohibit us from transacting business with established customers or securing new ones, including as to Russia and the Ukraine, which are areas where the Company has offices and/or significant customers and as to which the applicable sanctions have changed unexpectedly on a number of occasions since 2014.

Changes in the laws and regulations described above, adverse interpretations or applications of such laws and regulations, and the outcome of various court and regulatory proceedings, including in Europe and Brazil, could adversely impact the Company's business in a variety of ways, including increasing expenses, increasing liabilities, decreasing sales, limiting its ability to repatriate funds and generally limiting its ability to conduct business, all of which could adversely affect our financial condition, results of operations and cash flows.

New tariffs and other trade measures could adversely affect our consolidated results of operations, financial position and cash flows. 
In 2018, the Trump Administration imposed tariffs on steel and aluminum and a broad range of other products imported into the U.S. In response to the tariffs imposed by the U.S., the European Union, Canada, Mexico and China have announced tariffs on U.S. goods and services. The new tariffs, along with any additional tariffs or trade restrictions that may be implemented by the U.S. or retaliatory trade measures or tariffs implemented by other countries, could result in higher manufacturing costs and increased prices for our products, and we may not be able to pass the higher

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manufacturing costs and price increases on to our customers. Through our joint venture partners, we also manufacture certain EP products in China. While sales of our products manufactured in China are currently sold only in local markets, any exports of our products manufactured in China to the U.S. may also be impacted by the tariffs and other restrictions on trade between the U.S. and China. While tariffs and other retaliatory trade measures imposed by other countries on U.S. goods have not yet had a significant impact on our business or results of operations, we cannot predict further developments, and such existing or future tariffs could have a material adverse effect on our consolidated results of operations, financial position and cash flows.

We may be adversely affected by recent developments relating to the U.K.’s referendum vote in favor of leaving the European Union, particularly if the U.K. and the European Union are unable to reach a mutually satisfactory exit agreement before the current deadline of March 29, 2019.
The U.K. held a referendum in 2016 in which a majority voted for the U.K.’s withdrawal from the European Union, which is commonly referred to as “Brexit.” As a result of this vote, the U.K. and the European Union are negotiating to determine the terms of Brexit and their relationship going forward. The effects of the Brexit vote and the perceptions as to the impact of the withdrawal of the U.K. from the European Union may adversely affect business activity and economic and market conditions in the U.K., the Eurozone, and globally and could contribute to instability in global financial and foreign exchange markets, including volatility in the value of the pound sterling and the euro. For example, since the Brexit vote, the value of the pound sterling has incurred significant fluctuations. If the value of the pound sterling continues to incur similar fluctuations, unfavorable exchange rate changes may negatively affect our operations located in the U.K., which may impact the revenue and earnings we report. In addition, if no formal agreement is made between the European Union and the U.K. prior to the deadline for the U.K.’s exit, which is currently set for March 29, 2019, continued deflation of the pound sterling could result. Any of these effects could have an adverse impact on the value of our assets in the U.K., as well as our business, financial condition, results of operations and cash flows.

We are subject to the U.S. Foreign Corrupt Practices Act and other anti-corruption laws or trade control laws, as well as other laws governing our operations. If we fail to comply with these laws, we could be subject to civil or criminal penalties, other remedial measures, and legal expenses, which could adversely affect our business, financial condition and results of operations.  
We are subject to anti-corruption laws, including the U.S. Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws that apply in countries where we do business. The FCPA, the 2013 Brazilian Clean Companies Act, the U.K. Bribery Act of 2010, the 2013 Russian Law on Preventing Corruption and these other laws generally prohibit us, our employees, consultants and agents from bribing, being bribed or making other prohibited payments to government officials or other persons to obtain or retain business or gain some other business advantage. We operate in a number of jurisdictions that pose a high risk of potential FCPA violations, and we participate in joint ventures and relationships with third parties whose actions could potentially subject us to liability under the FCPA or local anti-corruption laws. In addition, we cannot predict the nature, scope or effect of future regulatory requirements to which our international operations might be subject or the manner in which existing laws might be administered or interpreted.
We are also subject to other laws and regulations governing our international operations, including regulations administered by the U.S. Department of Commerce’s Bureau of Industry and Security, the U.S. Department of Treasury’s Office of Foreign Asset Control, and various non-U.S. government entities, including applicable export control regulations, economic sanctions on countries and persons, customs requirements, currency exchange regulations and transfer pricing regulations, or collectively, Trade Control laws.
However, there is no assurance that we will be completely effective in ensuring our compliance with all applicable anti-corruption laws, including the FCPA or other legal requirements, including Trade Control laws. If we are not in compliance with the FCPA and other anti-corruption laws or Trade Control laws, we may be subject to criminal and civil penalties, disgorgement and other sanctions and remedial measures, and legal expenses, which could have an adverse impact on our business, financial condition, results of operations and liquidity. Likewise, any investigation of any potential violations of the FCPA other anti-corruption laws or Trade Control laws by U.S. or foreign authorities could also have an adverse impact on our reputation, business, financial condition and results of operations.


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Fluctuations in foreign currency exchange rates could adversely impact our financial condition, results of operations and cash flows.
A significant portion of our revenues are generated from operations outside the U.S. In addition, we maintain significant operations and acquire or manufacture many of our products outside the U.S. The functional currency of our international subsidiaries is generally the local currency in which each subsidiary operates. In particular, a large portion of our commercial business is denominated in euros and Brazilian reals. Our consolidated financial statements are presented in U.S. dollars. Therefore, we must translate revenues, expenses, assets and liabilities from functional currencies into U.S. dollars at exchange rates in effect during, or at the end of, the reporting period. As a result, our future revenues, costs, results of operations and earnings could be significantly affected by changes in foreign currency exchange rates, especially the euro to U.S. dollar exchange rate and the Brazilian real to U.S. dollar exchange rate.
In addition, some of our sale and purchase transactions are denominated in a currency other than the local currency of our operations. As a result, changes in exchange rates between the currencies in which the transaction is denominated versus the local currency of our operation into which the transaction is being recorded can impact the amount of local currency recorded for such transaction. This can result in more or less local currency revenue or cost related to such transaction and thus have an effect on our operating profit. Our Brazilian and Polish operations are more fully exposed to currency transaction risk, especially as a result of U.S. dollar sales in Brazil and euro denominated sales in Poland. We also hold a significant amount of our cash balances in euros, thus any weakening of the euro versus the U.S. Dollar would reduce the amount of U.S. Dollars for which such balances could be exchanged.
Changes in foreign currency exchange rates also impact the amount reported in other income (expense), net. For instance, when a non-local currency receivable or payable is not settled in the period in which it is incurred, we are required to record a gain or loss, as applicable, to reflect the impact of any change in the exchange rate as of the end of the period. We also have to reflect the translation rate impact on the carrying value of our foreign assets and liabilities as of the end of each period, which is recorded as Unrealized Translation Adjustment in Other Comprehensive Income.

We utilize a variety of practices to manage this risk, including operating and financing activities and, where considered appropriate, derivative instruments. All derivative instruments we use are either exchange traded or entered into with major financial institutions in order to reduce credit risk and risk of nonperformance by third parties. Counterparty risk cannot be eliminated and there can be no assurance that our efforts will be successful. We generally hedge foreign currency transaction risk primarily through the use of derivative instruments, including forward and swap contracts and, to a lesser extent, option contracts. The use of derivative instruments is intended to mitigate or reduce transactional level volatility in the results of foreign operations, but does not completely eliminate volatility. If our future revenues, costs and results of operations are significantly affected by economic conditions abroad and/or we are unable to effectively hedge these risks, they could materially adversely affect our financial condition, results of operations and cash flows.

Uncertainties in the interpretation and application of the U.S. tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Tax Act”) could materially affect our tax obligations and effective tax rate.

On December 22, 2017, President Trump signed into law legislation that significantly revised the Internal Revenue Code of 1986, as amended (the “Code”). The Tax Act, among other things, contains significant changes to corporate taxation. To date, the U.S. Department of Treasury has issued proposed regulations and guidance on some aspects of the Tax Act, but there remains considerable uncertainty as to the application of certain provisions of the Tax Act that may be relevant to us. As additional regulatory guidance is issued and finalized and as we perform additional analysis there could be material impacts to our tax obligation and effective tax rate. Any changes as a result of new or finalized regulations will be recorded in the period of adoption.

The Company could be subject to changes in its tax rates, the adoption of new U.S., or foreign tax legislation or exposure to additional tax liabilities.

The Company is subject to taxes in the U.S. and in foreign jurisdictions where a number of the Company’s subsidiaries are organized. The Company’s future effective tax rate could be affected by changes in the mix of earnings in countries

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with differing statutory tax rates or future changes in tax laws or their interpretations as to the legality of tax advantages granted under various current and past corporate structures. Although none of the Company’s international tax arrangements are currently being challenged or threatened to be challenged, recent developments, such as the European Commission’s investigations on illegal state aid as well as the Organization for Economic Cooperation and Development project on base erosion and profit shifting may result in changes to long-standing tax principles or new challenges to our cross-border arrangements, which could materially affect our effective tax rate or require a restructuring of the holding of foreign subsidiaries. If the Company’s effective tax rates were to increase, or if any ultimate determination of the Company’s taxes owed is for an amount in excess of amounts previously accrued, the Company’s operating results, cash flows, and financial condition could be adversely affected.

We face competition from several established competitors and, in our RTL business from tobacco leaf; we have limited market transparency.

Our four largest competitors for our EP business are delfortgroup AG ("delfort"), Julius Glatz GmbH ("Glatz"), Miquel y Costas & Miquel S.A. ("Miquel y Costas") and PT BUKIT Muria Jaya ("BMJ"). All four primarily operate from modern and cost-effective plants in Western Europe and Asia and are capable and long-standing suppliers to the tobacco industry. Further, three such competitors, delfort, Glatz and BMJ, are privately held and the third, Miquel y Costas, is a closely held public company. Thus, their financial results and other business developments and strategies are not disclosed to the same extent as ours, which provides them some advantage in dealing with customers. Given the concentration of most of our competitors in Western Europe, which has seen declining demand for tobacco products and has labor laws that make reducing capacity expensive and slow, excess capacity exists and therefore price competition is acute. We believe that all four competitors have good relationships with the multinational cigarette companies, as does the Company. The multinational cigarette companies have been known to use these close relationships to encourage the development of enhanced competition through supporting competitive products and facilities, especially when confronted with new, high-value technologies such as porous plug wrap in the past and LIP today. We believe our Engineered Paper products compete primarily on product features, price, innovations and customer service. Due to many of the factors described above, we have a limited ability to predict trends in the industry and there may be a time lag before we become aware of developing trends in the industry.

Our AMS segment products compete to some degree against specialty products made by Marshall Manufacturing Company, Johns Manville, a subsidiary of Berkshire Hathaway Inc., Shaoxing Naite Plastics Co. Ltd., 3M Company, Covestro AG, Tenax Corporation, Intermas Group, and Hollingsworth and Vose Company. We believe our AMS products compete primarily on product features, innovations and customer service. Some of these competitors are larger than we are and have more resources, thus the actions of these competitors could have an impact on the results of our AMS segment operations.

As a result of the foregoing, the Company faces significant selling price, sales volume and new product risks from its competitors, especially during periods (often annually) in which the Company's contracts with its major customers are subject to renewal or renegotiation.

Currently, fine papers used to produce cigarettes are only exported on a limited basis from available capacity in China and other Asian locations to western multinational cigarette companies due to government taxes and tariffs, which limit price competitiveness, as well as due to customer preferences. Should conditions change in this regard, capacity that currently is operating in China and elsewhere in Asia would present a risk to our competitive position outside Asia and place further pressure on our legacy paper production platforms. Similarly, we are starting to see increased competition for some of our AMS products from companies in China, which, we believe, may have lower operating costs than us, resulting in a potential price advantage for such companies.

In the RTL end-market segment, demand is a function, among other things, of smoke delivery regulations, the cigarette manufacturer's desire for a uniform and consistent product, the taste profile sought by cigarette manufacturers and the cost of recycling the tobacco by-product scraps relative to the cost of virgin tobacco products. Thus, our RTL business is also subject to competitive risk from lower cost virgin tobacco leaf or other, cheaper, cigarette fillers. These factors have resulted, and are likely to continue to result, in materially lower sales volumes for our RTL business, resulting in

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downtime of certain production machines and, in some cases, accelerated depreciation or impairment charges for certain equipment as well as employee severance expenses associated with downsizing or restructuring activities.

Further, as a result of excess capacity in the tobacco-related papers industry and increased operating costs, competitive levels of selling prices for certain of the Company's products are not sufficient to cover those costs with a margin that the Company considers reasonable. Such competitive pressures have resulted, and could result in the future, in downtime of certain paper production machines and, in some cases, accelerated depreciation or impairment charges for certain equipment as well as employee severance expenses associated with downsizing or restructuring activities.

We are dependent upon a small number of customers for a significant portion of our sales; the loss of one or more of these customers, or changes in their cigarette blending approaches, could have a material adverse effect on our business.

Four customers, together with their respective affiliates and designated converters, accounted for over 28% of our net sales in 2018. The loss of one or more of these customers, or a significant reduction in their purchases, particularly those that impact our sales of LIP papers or Recon, could have a material adverse effect on our financial condition, results of operations and cash flows. The enhanced capabilities provided by RTL in the area of product design and regulatory compliance are important to our customers. However, future RTL results could be adversely affected by fluctuations in customer inventories, changes in the cigarette tobacco blending approaches by our customers, changes in regulations and tariffs and the price of virgin tobacco leaf.

In addition, significant consolidation has occurred among our tobacco customers and may continue to occur, thereby increasing our dependence upon a fewer number of tobacco industry customers and increasing the negotiating leverage of those customers that remain. If any of our customers were to change suppliers, in-source production of Recon or cigarette papers (including those used to produce LIP cigarettes), institute significant cost-cutting measures or experience financial difficulty, then these customers may substantially reduce their purchases from us, which could adversely impact our financial condition, results of operations and cash flows. In addition, adverse results in the negotiation of any of our significant customer contracts, the terms of which are typically negotiated every one to three years, could significantly impact our financial condition, results of operations and cash flows.

We are dependent upon the availability of credit, and changes in interest rates can impact our business.

We supplement operating cash flow with bank borrowings under a secured credit agreement with a syndicate of banks. Borrowings under this agreement will mature in September 2023 and September 2025. To date, we have been able to access credit when needed and on commercially reasonable terms. However, deterioration of credit markets, including an economic crisis in the U.S. or elsewhere, whether or not caused by the U.S. or European debt ceiling, deficits and budget issues, could have an adverse impact on our ability to negotiate new credit facilities or access or renew our existing one. Constraints on the availability of credit, or the unavailability of credit at reasonable interest rates, would negatively impact our business, including potentially impairing our ability to declare dividends, conduct share buy-backs and make acquisitions.

Our secured credit facility contains certain financial covenants. In the event of material unforeseen events that impact our financial performance, particularly during a time when we have material amounts of debt, a situation could arise where we are unable to fully draw from our existing credit facility notwithstanding that there is otherwise available capacity.

Our credit facilities are secured by substantially all of the personal property of the Company and its domestic subsidiaries. In the event of a default on these agreements, substantially all of the assets of the Company could be subject to foreclosure or liquidation by the secured creditors.

We may utilize a combination of variable and fixed-rate debt consisting of short-term and long-term instruments. We selectively hedge our exposure to interest rate increases on our variable rate long-term debt when we believe that it is practical to do so. We have utilized various forms of interest rate hedge agreements, including interest rate swap agreements, forward rate agreements and cross currency swaps. There are inherent risks associated with interest rate

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hedges, including those associated with the movement of interest rates, counterparty risk and unexpected need to refinance debt, thus there can be no certainty that our hedging activities will be successful or fully protect us from interest rate exposure. As of December 31, 2018, the percentage of the Company’s fixed and floating interest rate debt was 56% and 44%, respectively.  The Company has entered into a number of interest rate hedge transactions to convert floating rate debt to fixed.  Including the impact of these transactions, as of December 31, 2018, the percentage of the Company’s debt subject to fixed and floating rates of interest was 85% and 15%, respectively.

Our use of interest rate hedge agreements to manage risk associated with interest rate volatility may expose us to additional risks, including the risk that a counterparty to a hedge agreement may fail to honor its obligations. Developing an effective interest rate risk strategy is complex and no strategy can completely insulate us from risks associated with interest rate fluctuations. There can be no assurance that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Termination of interest rate hedge agreements typically involves costs, such as transaction fees or breakage costs.

Changes in the method pursuant to which LIBOR rates are determined and potential phasing out of LIBOR after 2021 may adversely affect our results of operations.

LIBOR and certain other “benchmarks” are the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms may cause such benchmarks to perform differently than in the past or have other consequences which cannot be predicted. In particular, on July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, publicly announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. It is unclear whether, at that time, LIBOR will cease to exist or if new methods of calculating LIBOR will be established. Any uncertainty regarding the continued use and reliability of LIBOR as a benchmark interest rate could adversely affect the performance of LIBOR relative to its historic values. If the methods of calculating LIBOR change from current methods for any reason, or if LIBOR ceases to perform has it has historically, our interest expense associated with the unhedged portion of our outstanding indebtedness or any future indebtedness we incur may increase. Further, if LIBOR ceases to exist, we may be forced to substitute an alternative reference rate, such as a different benchmark interest rate or base rate borrowings, in lieu of LIBOR under our current and future indebtedness and interest rate swaps. At this point, it is not clear what, if any, alternative reference rate may be adopted to replace LIBOR, however, any such alternative reference rate may be calculated differently than LIBOR and may increase the interest expense associated with our existing or future indebtedness.

Finally, the replacement or disappearance of LIBOR may adversely affect the value of and return on our LIBOR-based obligations and the availability, pricing and terms of LIBOR-based interest rate swaps we use to hedge our interest rate risk. Alternative reference rates or modifications to LIBOR may not align for our assets, liabilities, and hedging instruments, which could reduce the effectiveness of certain of our interest rate hedges, and could cause increased volatility in our earnings. We may also incur expenses to amend and adjust our indebtedness and swaps to eliminate any differences between any alternative reference rates used by our interest rate hedges and our outstanding indebtedness.

Any of these occurrences could materially and adversely affect our borrowing costs, business and results of operations.

Our internal and external expansion plans and asset dispositions entail different and additional risks relative to the rest of our business.

From time to time, we consider acquisitions either within the tobacco industry or outside the industry in connection with our diversification initiatives, such as our acquisitions of DelStar Technologies, Inc., Argotec LLC and Conwed Plastics LLC. This acquisition activity could involve confidential negotiations that are not publicly announced unless and until those negotiations result in a definitive agreement. It is possible that an acquisition could adversely impact our results, credit ratings or the outlook of our business, due to, among other things, integration and employee retention challenges, contrasting company cultures and different information technology and reporting systems. Also, acquisition opportunities are limited and present risks of failing to achieve strategic objectives, smooth integrations or anticipated synergies or returns. There can be no assurance that we will be able to acquire attractive businesses on favorable terms, that we will realize the anticipated benefits or profits through acquisitions or that acquisitions will be accretive to our earnings. Changes in our portfolio of businesses, assets and products, whether through acquisition (such as our

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acquisitions of DelStar, Argotec and Conwed), disposition or internal growth, present additional risks, including causing us to incur unknown or new types of liabilities, subjecting us to new regulatory frameworks and new market risks, and acquiring operations in new geographic regions with challenging labor, regulatory and tax regimes. The potential future expansion of our AMS business unit or other operations could cause these operations to face additional competition from larger and more established competitors than is currently the case.

Our ability to dispose of idled assets and the value that may be obtained relative to their book value can result in significant impairment charges. Building a new plant or other facility or relocating, rebuilding or otherwise modifying existing production machinery is a major undertaking and entails a number of risks, including the possibility that the contractors and sub-contractors who are expected to build the facility or rebuild the machine and supply the necessary equipment do not perform as expected, the possibility of cost overruns and delays, or that design defects or omissions cause the facility or machine to perform at less than projected efficiency or at less than projected capacity. In addition, commencement of production at a new site or at a rebuilt or relocated machine is time consuming and requires testing and acceptance by customers and potentially by regulators, of the facility and the products that are produced. Also, while we anticipate sufficient demand for the facility's or machine's output, there can be no assurances that the expected demand will materialize. For more information on our expansion plans, see Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operation" of this report.

We also expect to continue to expend resources to diversify and expand our product portfolio. Research and development and product diversification have inherent risks, including technical success, market acceptance, new regulations and potential liabilities. We cannot guarantee that such efforts will succeed, that we will not incur new or different liabilities or that we will achieve a satisfactory return on such expenditures.

We may not successfully integrate acquisitions or integrate other SWM operations into AMS and we may be unable to achieve anticipated cost savings or other synergies.

The integration of the operations of acquired companies involves a number of risks and presents financial, managerial, reporting, legal and operational challenges. We may have difficulty, and may incur unanticipated expenses related to, integrating information systems, financial reporting activities, employee retention and integrating and retaining management and personnel from acquired companies. Among these risks are potential loss of consumer awareness and demand for the acquired companies’ products based on the rebranding of those products under the Company’s legacy brand names. Additionally with respect to the acquisition of Conwed in early 2017, we may not be able to achieve anticipated cost savings or commercial or growth synergies, for a number of reasons, including contractual constraints and obligations or an inability to take advantage of expected commercial opportunities, inability to achieve increased operating efficiencies or commercial expansion of key technologies. In the second half of 2015, we formed our AMS business unit comprised of these operations and certain other SWM resources. The future success of AMS depends, in part, on our ability to attract additional management, retain key employees, integrate new personnel, operating and reporting systems as well as execute AMS’ growth strategy. Failure to successfully integrate acquired companies into AMS may have an adverse effect on our business, financial condition, results of operations, and cash flows.


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Our restructuring activities are time-consuming and expensive and could significantly disrupt our business.
We have initiated significant restructuring activities in recent years, including restructurings in 2014, 2015, 2016 and 2017 in France and the U.S., during 2014 in Brazil and during 2012 in the Philippines, that have become part of an overall effort to improve an imbalance between demand for our products and our production capacity as well as improve our profitability and the quality of our products. We expect to continue these restructuring efforts from time to time. Restructuring of our existing operations, or as a result of acquisitions, involves issues that are complex, time-consuming and expensive and could significantly disrupt our business as well as garner review from regulatory authorities which could result in financial impacts to the Company. The challenges involved in executing the actions that are part of our ongoing and, potentially future, restructuring plans include:

demonstrating to customers that the restructuring activities will not result in adverse changes in service standards or business focus;

consolidating administrative infrastructure and manufacturing operations while maintaining adequate controls throughout the execution of the restructuring;

preserving distribution, sales and other important relationships and resolving potential conflicts that may arise;

estimating, managing and minimizing the cost of the restructuring activities;

minimizing the diversion of management attention from ongoing business activities;

maintaining employee morale, retaining key employees, maintaining reasonable collective bargaining agreements and avoiding strikes, work stoppages or other forms of labor unrest while implementing restructuring programs that often include reductions in the workforce;

securing government approval of such plans, where necessary, and managing the litigation and associated liabilities that often are associated with restructuring actions;

incurring costs associated with delays in restructuring activities caused by labor negotiations and/or governmental approvals;

coordinating and combining operations, which may be subject to additional constraints imposed by collective bargaining agreements and local laws and regulations; and

achieving the anticipated levels of net cost savings and efficiency as a result of the restructuring activities.

If we do not achieve future and continued expected benefits as a result of our legal entity realignment, the ability to achieve our financial guidance for operating results and our financial condition, results of operations and cash-flow could be adversely affected.

In 2014, 2016 and again in 2017, we re-examined and re-aligned certain internal business operations and our legal entity structure in order to improve our cash-flows, have easier access to our foreign cash, centralize, enhance the management of our intellectual property and streamline certain internal business activities. Steps to accomplish these objectives have been taken and additional steps may be taken later as we continue to grow certain of our operations, diversify our business and continue our business analyses. We anticipate that there could be further realignment activities in the future.

Realignments can present significant risks of events occurring that could delay, halt or adversely affect the success of a project, including delays encountered in finalizing the scope of, and implementing, the realignment, the failure to achieve targeted benefits or savings, the failure to follow appropriate regulatory requirements or internal processes and procedures and a potential decrease in employee morale. Further, there can be no assurance that the taxing authorities of the jurisdictions in which we operate, or to which we are otherwise deemed to have sufficient tax activity, will not

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challenge our interpretation of tax laws and regulations or the tax benefits that we expect to realize as a result of the realignment. Any such challenges (including our response thereto) can be time consuming or expensive with potentially uncertain outcomes, including as to additional interest, penalties or increase in back taxes that could be payable by us. In addition, changes to U.S. or non-U.S. tax laws and regulations may materially impact the anticipated benefits of our legal entity structure and any potential future realignments. Any future impact to our effective tax rate will also depend on our ability to operate our business in a manner consistent with the regulatory requirements for such a realignment including applicable taxing provisions and realization of our anticipated profits as well as the countries in which such profits are realized. Further, we have incurred certain costs in connection with the realignment and we may incur additional costs, including ones that are not currently expected to be incurred. There also can be significant costs and complexities around meeting the necessary tax accounting rules as required by our realignment structure and regulations applicable to us and it is possible that the authorities might disagree with our accounting treatment or that there may be a disagreement or dispute regarding our calculations. It is also possible that the authorities might change, either prospectively or retrospectively, certain complex tax rulings that would have potentially significant impacts to our financial results. Additionally, due to the complex nature of some of the accounting and taxation calculations, the Company may incur significant costs in defending its interpretation of positions in regards to certain tax legislation, rulings and inquiries.

To the extent these risks or circumstances occur, we may fail to achieve the future financial and business benefits that we anticipate as a result of the realignments, our tax rate may increase and our future operating results, financial condition and cash flows may be negatively impacted. Thus, there can also be no assurance that we will realize the expected future benefits of the realignments.

Our financial performance can be significantly impacted by the cost and availability of raw materials and energy and we may have limited ability to pass through increases in costs to our customers.

Raw materials are a significant component of the cost of the products that we manufacture. The cost of wood pulp, which is the largest component of the raw materials that we use in our EP segment, and some resins used by our AMS segment are highly cyclical and can be more volatile than general consumer or producer inflationary changes in the general economy. For instance, during the period from January 2013 through December 2018, the U.S. list price of northern bleached softwood kraft pulp ("NBSK") a representative pulp grade that we purchase, increased by 61%. Also, in that same time period, the cost of polypropylene has fluctuated significantly based on a number of factors, including changes in global oil markets. As we periodically enter into agreements with customers under which we agree to supply products at fixed prices, unanticipated increases in the costs of raw materials, or the lack of availability of such raw materials (due to force majeure or other reasons), can significantly impact our financial performance. Even where we do not have fixed-price agreements, we generally cannot pass through increases in raw material costs in a timely manner and in many instances are not able to pass through the entire increase to our customers. Further, some of the resins we use in our AMS segment are only available from a single supplier, or a limited number of suppliers. Consequently, such supplier(s) can control the availability and thus the cost of the resins we use, notwithstanding any changes in the cost of oil. It can be time consuming and costly, and occasionally impractical, to find replacement resins where such suppliers limit the availability or increase the cost of resins we use.

Paper manufacturing is energy-intensive. In France, Poland, China and in the U.S., availability of energy generally is reliable, although prices can fluctuate significantly based on variations in overall demand. Western Europe is becoming significantly dependent on energy supplies from the Commonwealth of Independent States, which in the past has demonstrated a willingness to restrict or cut off supplies of energy to certain customers. The volume of oil or gas flowing through pipeline systems that ultimately connect to Western Europe also has been cut off or restricted in the past, and such actions can adversely impact the supply of energy to Western Europe and, consequently, the cost and availability of electricity to our European operations. In Brazil, because production of electricity is heavily reliant upon hydroelectric plants, availability of electricity can be, and has been in the past, affected by rain variations. Electricity in Brazil is also heavily taxed. Due to the competitive pricing for most of our products, we typically are unable to fully pass through higher energy costs to our customers. Periodically, when we believe it is advantageous to do so, we enter into agreements to procure a portion of our energy for future periods in order to reduce the uncertainty of future energy costs. However, in recent years this has only marginally slowed the increase in energy costs due to the volatile changes in energy prices we have experienced.

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A failure of, or a security breach in, a key information technology system or process or other unusual events could compromise our information and expose us to liability, which could adversely affect our business; IT project delays and overruns are possible.

We rely extensively on information technology systems, some of which are managed by third-party service providers, to analyze, process and manage transactions and sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our employees. The secure processing and maintenance of this information is critical to our operations and business strategy and we rely heavily on the integrity of this data in managing our business. Insider or employee cyber and security threats are increasingly a concern for all companies, including ours. In addition, social engineering and phishing are a particular concern. We are continuously working to install new, and to upgrade our existing, information technology systems and to provide employee awareness training around phishing, malware and other cyber risks to ensure that we are protected, to the greatest extent possible, against cyber risks and security breaches.

Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or be breached due to employee or third party error, malfeasance or other disruptions. To date, we have not had a significant cyber breach or attack that has had a material impact on our business. However, any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims, proceedings, or regulatory penalties, including penalties under EU privacy laws, and could disrupt our operations.

There are further risks associated with the information systems of companies we acquire, both in terms of systems compatibility, level of security and functionality. It may cost us significant money and resources to address these risks and we may fail to address them successfully, adversely impacting our financial condition, results of operations and cash flows.

From time to time, we undertake significant information technology systems projects, including enterprise resource planning updates, modifications and roll-outs. These projects are subject to cost overruns and delays. Not only could these cost overruns and delays impact our financial statements but a delay in the completion of a needed IT project could adversely impact our ability to run our business and make fully informed decisions.

We rely on a limited number of key employees, have had significant personnel turnover and have had difficulty in attracting and hiring qualified new personnel in some areas of our business.

The loss of any of our key employees, including our CEO and his direct reports, due to retirement, difference in culture with acquired businesses, the demands of our business, our tobacco-related operations or otherwise could adversely affect our business and thus our financial condition, results of operations and cash flows. Because a large part of our business is tied to the tobacco industry, we may also experience difficulty in retaining and hiring qualified executives and other personnel in our AMS segment, at corporate and/or in EP. This may be caused by the health and social issues associated with the tobacco industry. We not only compete for talent with consumer products and other companies that enjoy greater social acceptance but also with larger, more established companies within the tobacco industry.

As we diversify through acquisitions outside our tobacco-related operations, we run the risk of turnover of key personnel within the businesses we acquire as well as difficulty in finding and attracting first class talent in industry segments that are new to us. This could slow the growth of these businesses and impede our ability to find and complete synergistic acquisitions.

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Our business is subject to seasonal or cyclical market and industry fluctuations which may result in reduced net sales and operating profits during certain periods.
Sales of our EP products in the U.S., Europe, China and Brazil are subject to seasonal fluctuations. In the U.S. and Europe, customer shutdowns typically occur in August and December and historically have resulted in reduced net sales and operating profit during those two months. Likewise, the production of cigarettes in China for the Chinese market slows significantly before and during Chinese New Year, with a corresponding reduction in demand for our EP products. Additionally, our facilities occasionally shut down equipment to perform additional maintenance during these months or as a result of slow demand, resulting in higher product costs, higher maintenance expenses and reduced operating profit. In Brazil, customer orders are typically lower in December due to a holiday season during much of January and February. The oil & gas, mining and automotive industries are important to sales in our AMS segment and these and other industries tend to be cyclical, which could adversely impact our business, financial condition, results of operations and cash flows during the duration of their down cycles.

Our business depends upon good relations with our employees; work stoppages, slowdowns or legal action by our unionized employees may have a material adverse effect on our business, financial condition, results of operations and cash flows.
We employ approximately 3,500 employees, including manufacturing employees represented by unions. Although we believe that employee and union relations are generally positive, there is no assurance that this will continue in the future. We may experience difficulties in maintaining appropriate relations with unions and employees in certain locations. Problems or changes affecting employees in certain locations may affect relations with our employees at other locations. The risk of labor disputes, work stoppages or other disruptions in production could adversely affect us, especially in conjunction with potential restructuring activities. If we cannot successfully negotiate or renegotiate collective bargaining agreements, or if negotiations take an excessive amount of time, there may be a heightened risk of work stoppages and we may be unable to achieve planned operational efficiencies. Work stoppages may be caused by the inability of national unions and the governments of countries in which we operate from reaching agreement, and are outside of our control. Any work stoppage or failure to reach agreements with our unions could have a material adverse effect on our customer relations, our productivity, the profitability of a manufacturing facility, our ability to develop new products and on our operations as a whole, resulting in an adverse impact on our business, financial condition, results of operations and cash flows.

Our business is subject to various environmental laws, regulations and related litigation that could impose substantial costs or other liabilities on us.

Our facilities are subject to significant federal, state, local and foreign environmental protection laws with respect to air, water and emissions as well as the disposal of solid waste. We believe that we are operating in substantial compliance with these laws and regularly incur capital and operating expenditures in order to achieve future compliance. However, these laws may change, which could require changes in our practices, additional capital expenditures or loss of carbon credits, and we may discover aspects of our business that are not in compliance. Violation of these laws can result in the imposition of significant fines and remediation costs. In France, we presently have sufficient authorized capacity for our emissions of carbon dioxide through 2020.  However, this authorization must be renewed periodically. We cannot predict whether we will have sufficient authorized capacity to conduct our operations in France as presently conducted or to do so without having to make substantial capital expenditures in future years.

We are a member of a potentially responsible party group ("Global PRP Group") that entered into a settlement with the State of New Jersey in 1993 concerning the remediation of a landfill site in Middlesex County, New Jersey. The landfill remediation has been completed. We have established a reserve of approximately $0.4 million that we believe is adequate to cover our ongoing liability, but we remain exposed to post-closure operating costs over an extended period of years that cannot be fully known or estimated at this time.

Additionally, in recent years, assessments of the potential impacts of climate change have begun to influence governmental authorities, consumer behavior patterns and the general business environment of the European Union

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and the United States. The implementation of these policies may require us to invest additional capital in our properties or it may restrict the availability of land we are able to develop. These changes, or other changes in other environmental laws or the interpretation thereof, new enforcement of laws, the identification of new facts or the failure of other parties to perform remediation at our current or former facilities could lead to new or greater liabilities that could materially adversely affect our business, results of operations, cash flows or financial condition.

Although we are not aware of any environmental conditions at any of our facilities that could have a material adverse effect on our financial condition, results of operations and cash flows, we own facilities in France, the U.S. and elsewhere that have been operated over the course of many decades. Should the Company make material changes in the operations at a facility it is possible such changes could generate environmental obligations that might require remediation or other action, the nature, extent and cost of which are not presently known. We may also face higher disposal and clean-up costs to replace equipment or facilities containing materials that were compliant when installed, but are now considered contaminants. Additionally, as we sell closed or other facilities or materially alter operations at a facility, we may be required to perform additional environmental evaluations that could identify items that might require remediation or other action, the nature, extent and cost of which are not presently known. We may also incur environmental liabilities in connection with assets or businesses we may purchase in the future.

Increases in costs of pension benefits may reduce our profitability.
Our results of operations may be negatively affected by expenses we record for our defined benefit pension plans. Generally accepted accounting principles in the U.S., ("GAAP"), require that we calculate income or expense for the plans using actuarial valuations. These valuations reflect assumptions about financial markets, longevity of our current and former employees and other economic conditions, which may change based on changes in key economic indicators and mortality tables. We are required to make an annual measurement of plan assets and liabilities, which may result in increased funding obligations or negative changes in our stockholder equity. At the end of 2018, the combined projected benefit obligation of our U.S. and French pension and other postretirement healthcare plans had a net underfunding of $27.8 million. For a discussion regarding our pension obligations, see Note 18. Postretirement and Other Benefits of the Notes to Consolidated Financial Statements in Part II, Item 8 and "Other Factors Affecting Liquidity and Capital Resources" in Part II, Item 7. Although expense and pension funding contributions are not directly related, key economic factors that affect expense would also likely affect the amount of cash we would contribute to pension plans as required under the Employee Retirement Income Security Act ("ERISA") for U.S. plans. Failure to achieve expected returns on plan assets driven by various factors, which could include a continued environment of low interest rates or sustained market volatility, could also result in an increase to the amount of cash we would be required to contribute to pension plans.

We are subject to various legal actions and other claims.

We regularly are involved in legal actions and other claims arising in the ordinary course of business and otherwise. We are also subject to many laws and regulations around the world. Despite our efforts, we cannot guarantee that we are in compliance with every such law or regulation. Because of the complexity of Brazilian tax laws and court systems, legal actions are a particular risk that affects our Brazilian operations.  Although we believe that our positions in pending disputes about state and federal taxes are correct and will ultimately be upheld by Brazilian courts, the outcome of legal proceedings is difficult to predict. An adverse result in one or more of these tax disputes could have a material adverse impact on our financial condition, results of operations and cash flows. We are also subject to other litigation in Brazil, including labor and workplace safety claims. Although we do not believe that any of the currently pending actions or claims against us will have a material adverse impact on our financial condition, results of operations and cash flows, we cannot provide any assurances in this regard. Information concerning some of these actions that currently are pending is contained in Note 20. Commitments and Contingencies, of the Notes to Consolidated Financial Statements and in Part I, Item 3, “Legal Proceedings” of this report. We also cannot give any assurances as to any litigation that might be filed against us in the future, including any claims relating to the alleged harmful effect of tobacco use on human health.


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Significant impairment charges could result from our evaluation of the Philippines RTL manufacturing site.

We suspended construction of our Philippines RTL manufacturing site during 2011. During 2015, as a result of management's intent and ability to dispose of these assets, the amounts were reclassified from property, plant and equipment to assets held for sale in our balance sheet. The carrying value of these assets is based on estimated fair value less cost to sell. During 2017, we compared the estimated fair value less cost to sell to the net book value of the assets which resulted in our recording of an impairment charge of $4.0 million.

In years prior to 2015, the carrying value of the assets was evaluated for impairment at each reporting period by assessing the recoverability of the costs based on the undiscounted cash flows of the operation, the likelihood of its reactivation and any alternative uses for the equipment. This evaluation, along with declines in our RTL volumes, resulted in 2013 in an impairment of $37.2 million. Further declines in the estimated fair value of these assets could result in a decision to record a further impairment of some or a substantial portion of the remaining outstanding balance of these assets, which was $12.0 million at December 31, 2018.

One portion of our business is dependent upon a single plant; further, we have limited cross redundancy across our facilities.

Sales of RTL products represent a substantial portion of our revenues and profits. We presently produce RTL at only one facility located in France and wrapper and binder products at only one facility located in Ancram, New York. In our AMS business, in order to enhance the protection of our trade secrets, critical proprietary dies used in a significant portion of our extruding operations are made with very limited personnel trained to manufacture them and very strict access to the equipment. Further, in order to achieve operational efficiencies, among other reasons, we have limited ability to shift production across our various facilities, thus the loss of production at one facility may not be able to be mitigated by increased production at another. Consequently, natural disasters, pandemics and other unusual events could cause the loss of, or interruption of operations for a significant length of time at, one or more of our facilities in six different countries, which could have a material adverse effect on our financial condition, results of operations and cash flows.

Any loss or interruption of the operations of our facilities may harm our operating performance.

Our revenues depend on the effective operation of our manufacturing facilities. The operation of our facilities involves risks, including the breakdown, failure, or substandard performance of equipment, power outages, the improper installation or operation of equipment, explosions, fires, natural disasters, failure to achieve or maintain safety or quality standards, work stoppages, supply or logistical outages, and the need to comply with environmental and other directives of governmental agencies. The occurrence of material operational problems, including, but not limited to, the above events, could cause the loss of, or interruption of, operations for a significant length of time, which could have a material adverse effect on our financial condition, results of operations and cash flows.

Fluctuations in construction and infrastructure spending can impact demand for certain of our products.

Demand for certain of our products depends on spending in the construction industry, both residential and non-residential, as well as infrastructure sectors. Spending in those sectors is impacted by numerous circumstances beyond our control including, but not limited to, interest rates, availability of financing, housing inventory, capital spending, corporate investment, local, federal and state regulations, as well as availability and commitment of public funds for municipal spending, capacity utilization and general economic conditions. Decreased spending in any of these sectors could have an adverse impact on our financial condition, results of operations, and cash flows during the duration of their down cycle.

Historically, we have experienced significant cost savings and productivity benefits relating to our ongoing operational excellence program; however, these benefits may not continue indefinitely or at the same levels.

Historically, we have experienced significant cost savings and productivity benefits relating to our ongoing operational excellence program as it relates to our tobacco operations that have supported our margins during periods of significant

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attrition in the tobacco industry. We expect to continue to achieve significant savings and benefits from this program; however, in light of continued industry attrition, execution risks and other factors, we may be unable to continue in the future to obtain savings and benefits in line with historical achievements, and our profitability and financial results could be adversely affected.

Similarly, though we have initiated implementation of this program in our AMS business operations in order to achieve margin improvements, due to the different company cultures of the acquisitions that make up a significant part of AMS and our continuing integration of these acquisitions, we may not be able to achieve the desired margin improvements through our operational excellence program at AMS.

Item 1B. Unresolved Staff Comments

None.

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Item 2. Properties

As of December 31, 2018, we operated a total of 22 production facilities on four continents and owned one non-production facility which is marketed for sale.

The following are the locations of our principal production facilities as of December 31, 2018. Except as otherwise noted, we own the facilities listed below:
Advanced Materials & Structures Segment Production Locations
 
Approximate Square Footage of Buildings
 
Engineered Papers
Segment Production Locations
 
Approximate Square Footage of Buildings
Middletown Manufacturing Site
 
 
 
Spotswood Plant
 
 
Middletown, Delaware
 
142,000

 
Spotswood, New Jersey
 
399,000

 
 
 
 
 
 
 
Tubing Operations*
 
 
 
Papeteries de Saint-Girons Plant
 
 
Richland, Pennsylvania
 
35,000

 
Saint-Girons, France
 
214,000

 
 
 
 
 
 
 
Tubing Operations*
 
 
 
PDM Industries Plant
 
 
El Cajon, California
 
22,000

 
Quimperlé, France
 
592,000

 
 
 
 
 
 
 
Suzhou Manufacturing Site*
 
 
 
Pirahy Plant
 
 
Suzhou, China
 
108,000

 
Piraí, Brazil
 
1,098,000

 
 
 
 
 
 
 
Poland Manufacturing Site*
 
 
 
Poland Plant*
 
 
Strykow, Poland
 
42,000

 
Strykow, Poland
 
125,000

 
 
 
 
 
 
 
Gilberdyke Manufacturing Site
 
 
 
Newberry Operation
 
 
Gilberdyke, United Kingdom
 
67,000

 
Prosperity, South Carolina
 
50,000

 
 
 
 
 
 
 
Wilson Manufacturing Site*
 
 
 
Fiber Operation
 
 
Wilson, North Carolina
 
108,000

 
Manitoba, Canada
 
16,000

 
 
 
 
 
 
 
Argotec Manufacturing Operations*
 
 
 
LTR Industries Plant
 
 
Greenfield, Massachusetts
 
182,000

 
Spay, France
 
736,000

 
 
 
 
 
 
 
Minneapolis Manufacturing Site*
 
 
 
Ancram Plant
 
 
Minneapolis, Minnesota
 
144,000

 
Ancram, New York
 
116,000

 
 
 
 
 
 
 
Athens Manufacturing Site
 
 
 
RTL Philippines Plant (currently marketed for sale)
 
 
Athens, Georgia
 
200,000

 
Sto. Tomas, Philippines
 
283,000

 
 
 
 
 
 
 
Roanoke Manufacturing Site
 
 
 
 
 
 
Roanoke, Virginia
 
40,000

 
 
 
 
 
 
 
 
 
 
 
Chicago Manufacturing Site*
 
 
 
 
 
 
Chicago, Illinois
 
66,000

 
 
 
 
 
 
 
 
 
 
 
European Manufacturing Site
 
 
 
 
 
 
Genk, Belgium
 
90,000

 
 
 
 
 
 
 
 
 
 
 
* Leased properties
 
 
 
 
 
 

During 2017 we acquired five production locations in conjunction with our acquisition of Conwed.

29



As of December 31, 2018, AMS product manufacturing lines operated at approximately 58% capacity compared to 63% capacity as of December 31, 2017. We had approximately 188,000 metric tons of annual paper production capacity, dependent upon the production mix. Capacity utilization decreased in 2018 to 80% for EP products compared with 82% in 2017. We also operate flax fiber processing operations in Canada and printing operations in France, Poland and the U.S.

We maintain administrative and/or sales offices in Alpharetta, Georgia; Quimperlé, France; Spay, France; Shanghai, China; Piraí, Brazil; Moscow, Russia; Strykow, Poland; Middletown, Delaware; Greenfield, Massachusetts; Luxembourg City, Luxembourg; and Minneapolis, Minnesota. Our world headquarters are located in Alpharetta, Georgia. All of these offices are owned except for those located in Alpharetta, Shanghai, Moscow, Strykow, Greenfield, Minneapolis, and Luxembourg City which are leased.

We consider all of our facilities to be well-maintained, suitable for conducting our operations and business, and adequately insured. Our RTL Philippines facility in Sto. Tomas, Philippines, is currently being marketed for sale. This property is classified as Assets held for sale in the Company's Consolidated Balance Sheets as of December 31, 2018 and 2017.

Item 3. Legal Proceedings
 
General

We are involved in various legal proceedings relating to contracts, commercial disputes, taxes, environmental issues, employment and workers' compensation claims, product liability and other matters. We periodically review the status of these proceedings with both inside and outside counsel. We believe that the ultimate disposition of these matters will not have a material effect on the results of operations in a given quarter or year, but no assurances can be given in this regard. Below is a summary of major outstanding litigation.

Litigation
 
Brazil

Imposto sobre Circulação de Mercadorias e Serviços ("ICMS") a form of value-added tax in Brazil, was assessed to our Brazilian subsidiary, Schweitzer-Mauduit do Brasil Indústria e Comércio de Papel Ltda. ("SWM-B"), in December of 2000. SWM-B received two assessments from the tax authorities of the State of Rio de Janeiro (the "State") for unpaid ICMS taxes on certain raw materials from January 1995 through November 2000 (collectively, the "Raw Materials Assessments").
 
The Raw Materials Assessments concerned the accrual and use by SWM-B of ICMS tax credits generated from the production and sale of certain non-tobacco related grades of paper sold domestically. SWM-B has contested the Raw Materials Assessments based on Article 150, VI of the Brazilian Federal Constitution of 1988, which grants immunity from ICMS taxes to papers intended for printing books, newspapers and periodicals, or immune papers, and thus to the raw material inputs used to produce immune papers. The Federal Supreme Court decided the first Raw Materials Assessment in favor of SWM-B.  SWM-B's appeal on the merits concerning Assessment 2 in the amount of approximately $11 million was denied by a single justice in a different chamber of the Federal Supreme Court of Brazil on April 9, 2018, and SWM-B appealed his decision to the full chamber of the Federal Supreme Court on May 11, 2018.
 
SWM-B received assessments from the tax authorities of the State for unpaid ICMS and Fundo Estadual de Combate à Pobreza ("FECP," a value-added tax similar to ICMS) taxes on interstate purchases of electricity.  The state issued four sets of assessments against SWM-B, one for May 2006 - November 2007, a second for January 2008 - December 2010, a third for September 2011 - September 2013, which was replaced by a smaller assessment for January - June 2013, and a fourth for July 2013 - December 2017 (collectively the "Electricity Assessments").  SWM-B challenged all Electricity Assessments in administrative proceedings before the State tax council (in the first-level court Junta de

30


Revisão Fiscal and the appellate court (the "Conselho de Contribuintes")) based on Resolution 1.610/89, which defers these taxes on electricity purchased by an "electricity-intensive consumer."  In 2014, a majority of the Conselho de Contribuintes sitting en banc ruled against SWM-B in each of the first and second electricity assessments ($5 million and $8 million, respectively, based on the foreign currency exchange rate at December 31, 2018), and SWM-B is now pursuing challenges to these assessments in the State judicial system. Different chambers of the judicial court granted SWM-B preliminary injunctions against enforcement of these two assessments in the State judicial system. The Conselho de Contribuintes unanimously upheld SWMB's challenge to the third Electricity Assessment and dismissed this Electricity Assessment on technical grounds after the State admitted the tax did not apply as it had asserted. Instead, in August 2018, the State filed a revised Electricity Assessment in the amount of $1 million for ICMS on electricity purchased during part of 2013. In August 2018, the State filed a fourth Electricity Assessment in the amount of $9 million pertaining to ICMS and FECP on electricity purchased from July 2013 to December 2017. SWM-B filed challenges to these recent assessments in the first-level administrative court on the same grounds as the older cases. On December 19, 2018, the Junta de Revisão Fiscal ruled against SWM-B in the last two Electricity Assessments. SWM-B will appeal these rulings to the Conselho de Contribuintes.  The State issued a new regulation effective January 1, 2018 that only specific industries are “electricity-intensive consumers,” a list that excludes paper manufacturers. SWM-B contends this regulation shows that paper manufacturers were electricity-intensive consumers eligible to defer ICMS before 2018.
 
SWM-B believes that both the remaining Raw Materials Assessment and the Electricity Assessments will ultimately be resolved in its favor. No liability has been recorded in our consolidated financial statements for these assessments based on our evaluation of these matters under the facts and law as presently understood. The Company can give no assurance as to the ultimate outcome of such proceedings.

France

In December 2016, the Conseil de Prud’hommes d’Orange (a French court dealing with labor matters) rendered a decision by which the Company’s wholly owned subsidiary, Schweitzer Mauduit France (“SWM France”), was ordered to pay approximately €1.3 million to 18 former employees of Malaucène Industries, another wholly owned subsidiary, on the grounds, among other things, that SWM France was a “co-employer” of the plaintiffs, and, as a result, liable for certain obligations of Malaucène Industries with respect to such employees.  Malaucène Industries stopped production in 2009.  The Company believes that SWM France, which is a corporate holding company and indirect corporate parent of Malaucène Industries, is not a “co-employer” of any person and that the other claims are also without merit.  The Company has no liability recorded in the consolidated financial statements for this matter, believing that the chances of SWM France to reverse the decision on appeal are sufficient that no such reserve is warranted.  There can be no assurance, however, that the court of appeals will decide in favor of SWM France on any of the questions pending before the court.

Germany

In January 2015, the Company initiated patent infringement proceedings in Germany against Glatz under multiple LIP-related patents. In December, 2017, the Dusseldorf Appeal Court affirmed the German District Court judgment on infringement of EP 1482815 against Glatz. Glatz has filed an action in the German Patent Court to invalidate the German part of EP1482815. The trial on this invalidity action has not yet been scheduled. The cost, timing and outcome of intellectual property litigation can be unpredictable and thus no assurances can be given as to the outcome or impact on us of such litigation.

Environmental Matters
 
Our operations are subject to various federal, state and local laws, regulations and ordinances in various nations relating to environmental matters. The nature of our operations exposes us to the risk of claims with respect to various environmental matters, and there can be no assurance that material costs or liabilities will not be incurred in connection with such claims. While we have incurred in the past several years, and will continue to incur, capital and operating expenditures in order to comply with environmental laws and regulations, we believe that the future cost of compliance with environmental laws, regulations and ordinances, our exposure to liability for environmental claims, and our

31


obligation to participate in the remediation and monitoring of certain hazardous waste disposal sites, will not have a material effect on our financial condition or results of operations. However, future events, such as changes in existing laws and regulations, or unknown contamination or costs of remediation of sites owned, operated or used for waste disposal by us (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 effect on our financial condition or results of operations.

The Company incurs spending necessary to meet legal requirements and otherwise relating to the protection of the environment at its facilities in the U.S., France, Poland, Brazil, China, the United Kingdom and Canada. For these purposes, the Company incurred total capital expenditures of $1.0 million in 2018, and expects to incur less than $1.0 million in each of 2019 and 2020, of which no material amount is the result of environmental fines or settlements. Should the Company make material changes in the operations at a facility it is possible such changes could generate environmental obligations that might require remediation or other action, the nature, extent and cost of which are not presently known. The foregoing capital expenditures are not expected to reduce the Company's ability to invest in other appropriate and necessary capital projects and are not expected to have a material adverse effect on its financial condition or results of operations.

Indemnification Matters

In connection with our spin-off from Kimberly-Clark in 1995, we undertook to indemnify and hold Kimberly-Clark harmless from claims and liabilities related to the businesses transferred to us that were not identified as excluded liabilities in the related agreements. As of December 31, 2018, there are no material claims pending under this indemnification.

Item 4. Mine Safety Disclosures

Not applicable.


32


PART II.

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information. Since November 30, 1995, our common stock, $0.10 par value per share ("Common Stock") has been listed on the New York Stock Exchange, trading under the symbol "SWM." On February 28, 2019, our stock closed at $38.56 per share.

Performance Graph. The following graph compares the total cumulative stockholder return on our Common Stock during the period from December 31, 2013 through December 31, 2018, with the comparable cumulative total returns of the Russell 2000 Index and the S&P SmallCap 600 Capped Materials Index, both of which we consider to be reflective of the performance of the industries in which we operate.

The graph assumes that the value of the investments in the Common Stock and each index were $100 on December 31, 2013 and that all dividends were reinvested. The stock price performance shown on the graph below is not necessarily indicative of future price performance.

Comparison of Cumulative Five Year Return
chart-907191b8c598541e9eb.jpg
Holders. As of March 1, 2019, there were 1,684 stockholders of record.

Dividends. We have declared and paid cash dividends on our Common Stock every fiscal quarter since the second quarter of 1996. In 2018, 2017 and 2016, we declared and paid cash dividends totaling $1.73 per share, $1.69 per share and $1.62 per share, respectively. On February 21, 2019, we announced a cash dividend of $0.44 per share payable on March 22, 2019 to stockholders of record as of the close of business on March 4, 2019. Our credit agreement covenants require that we maintain certain financial ratios, as disclosed in Note 14. Debt, of the Notes to Consolidated Financial Statements, none of which under normal business conditions materially limit our ability to pay such dividends. We will continue to assess our dividend policy in light of our overall strategy, cash generation, debt levels and ongoing requirements for cash to fund operations and to pursue possible strategic opportunities.


33


Recent Sales of Unregistered Securities. We had no unregistered sales of equity securities during the fiscal year ended December 31, 2018.

Repurchases of Equity Securities. The following table indicates the cost of and number of shares of our Common Stock we have repurchased during 2018 and the remaining amount of share repurchases currently authorized by our Board of Directors as of December 31, 2018:

Issuer Purchases of Equity Securities
Period
 
Total
Number of
Shares
Purchased
 
Average
Price
Paid per
Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Programs
 
Approximate Dollar Value of Shares that May Yet be Purchased Under the Programs
 
 
 
 
 
 
(# shares)
 
($ in millions)
 
($ in millions)
January 1-March 31, 2018
 
62,634

 
$
40.57

 

 
$

 
$

April 1-June 30, 2018
 
4,703

 
40.27

 

 

 

July 1-September 30, 2018
 
2,421

 
40.73

 

 

 

October 1-October 31, 2018
 
1,609

 
36.53

 

 

 

November 1-November 30, 2018
 
1,771

 
33.23

 

 

 

December 1-December 31, 2017
 
2,257

 
25.83

 

 

 

Total 2018
 
75,395

 
$
39.86

 

 
$

 
$


We sometimes use corporate 10b5-1 plans to allow for share repurchases to be made at predetermined stock price levels, without restricting such repurchases to specific windows of time.  Any future common stock repurchases will be dependent upon various factors, including the stock price of our Common Stock, strategic opportunities, strategic outlook and cash availability. From time-to-time, certain of our officers and directors may sell shares pursuant to personal 10b5-1 plans.


34


Item 6. Selected Financial Data
 
The following selected financial data should be read in conjunction with Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the consolidated financial statements and related notes within this Annual Report on Form 10-K. The results of our San Pedro, Philippines and Medan, Indonesia plants have been retrospectively presented as discontinued operations for all periods, both of which were sold in 2013. The results for 2017 and 2015 include results of operations of Conwed and Argotec from the date of their acquisitions of January 20, 2017 and October 28, 2015, respectively. All dollar amounts are in millions except per share amounts, statistical data and ratios.
 
For the Years Ended December 31,
 
2018
 
2017 (1)
 
2016 (1)
 
2015 (1)
 
2014 (1)
Results of Operations
 
 
 
 
 
 
 
 
 
Net sales
$
1,041.3

 
$
982.1

 
$
839.9

 
$
764.1

 
$
794.3

Cost of products sold
762.8

 
698.7

 
582.0

 
538.3

 
575.3

Gross profit
278.5

 
283.4

 
257.9

 
225.8

 
219.0

Nonmanufacturing expenses
141.8

 
147.0

 
122.3

 
104.8

 
99.3

Restructuring & impairment expense
1.7

 
8.1

 
25.6

 
14.6

 
13.1

Operating profit
135.0

 
128.3

 
110.0

 
106.4

 
106.6

Income from continuing operations
94.8

 
34.4

 
82.8

 
90.5

 
89.7

Income (loss) from discontinued operations
(0.3
)
 
0.1

 

 
(0.8
)
 

Net income
$
94.5

 
$
34.5

 
$
82.8

 
$
89.7

 
$
89.7

 
 
 
 
 
 
 
 
 
 
Net income (loss) per share - basic:
 
 
 
 
 
 
 
 
 
Income from continuing operations
$
3.08

 
$
1.12

 
$
2.71

 
$
2.97

 
$
2.94

(Loss) income from discontinued operations
(0.01
)
 

 

 
(0.02
)
 

Net income per share - basic
$
3.07

 
$
1.12

 
$
2.71

 
$
2.95

 
$
2.94

 
 
 
 
 
 
 
 
 
 
Net income (loss) per share - diluted:
 
 
 
 
 
 
 
 
 
Income from continuing operations
$
3.07

 
$
1.12

 
$
2.70

 
$
2.96

 
$
2.93

(Loss) income from discontinued operations
(0.01
)
 

 

 
(0.02
)
 

Net income per share - diluted
$
3.06

 
$
1.12

 
$
2.70

 
$
2.94

 
$
2.93

 
 
 
 
 
 
 
 
 
 
Cash dividends declared and paid per share
$
1.73

 
$
1.69

 
$
1.62

 
$
1.54

 
$
1.46

EBITDA from continuing operations(2) 
$
193.9

 
$
192.4

 
$
157.6

 
$
162.8

 
$
162.5

Adjusted EBITDA from continuing operations (2) 
$
196.9

 
$
197.9

 
$
178.4

 
$
162.0

 
$
164.8

Percent of Net Sales
 
 
 
 
 
 
 
 
 
Gross profit
26.7
%
 
28.9
%
 
30.7
%
 
29.6
%
 
27.6
%
Nonmanufacturing expenses
13.6
%
 
15.0
%
 
14.6
%
 
13.7
%
 
12.5
%
Financial Position
 
 
 
 
 
 
 
 
 
Capital spending
$
27.0

 
$
37.2

 
$
27.8

 
$
24.2

 
$
35.1

Depreciation and amortization
61.6

 
59.5

 
44.5

 
41.0

 
45.1

Total assets
1,466.5

 
1,542.5

 
1,173.7

 
1,290.0

 
1,185.0

Total debt
622.1

 
684.2

 
440.4

 
571.5

 
437.9

Total debt to capital ratio
52.7
%
 
55.6
%
 
46.4
%
 
55.0
%
 
47.2
%

(1)
In March 2017, the FASB issued ASU 2017-07, "Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." The amendment

35


requires an employer to report the service cost component in the same line item or line items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal from operations. The Company adopted this ASU effective January 1, 2018, utilizing the retrospective transition approach upon adoption. The adoption of this guidance resulted in a reclassification of the components of net periodic pension cost, other than service cost, from Cost of products sold and General expense to Other income (expense), net, in the Consolidated Statements of Income. The reclassification of these costs affects only the EP segment, as there are no pension costs associated with the AMS segment. For the years ended December 31, 2017, 2016, 2015 and 2014, respectively, $3.6 million, $3.9 million, $3.4 million and $0.5 million in pension expense were reclassified from Operating profit to Other expense in the condensed consolidated statement of income for the 2017, 2016, 2015 and 2014 comparative periods. The adoption of this guidance had no effect on Net income in the Consolidated Statements of Income and no effect on the other consolidated financial statements.

(2)
Earnings before interest, taxes, depreciation and amortization ("EBITDA") from Continuing Operations is a non-GAAP financial measure that is calculated by adding interest expense, income tax provision and depreciation and amortization expense to income from continuing operations. Adjusted EBITDA from Continuing Operations is a non-GAAP financial measure that is calculated by adding restructuring and impairment expense, Loss (income) from equity affiliates and Other (income) expense, net to EBITDA from continuing operations. We caution investors that amounts presented in accordance with our definitions of EBITDA from Continuing Operations and Adjusted EBITDA from Continuing Operations may not be comparable to similar measures disclosed by our competitors, because not all companies and analysts calculate EBITDA from Continuing Operations and Adjusted EBITDA from Continuing Operations in the same manner. We present EBITDA from Continuing Operations and Adjusted EBITDA from Continuing Operations because we consider them to be important supplemental measures of our performance and believe they are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Reconciliations to income from continuing operations are as follows ($ in millions):

 
For the Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
Income from continuing operations
$
94.8

 
$
34.4

 
$
82.8

 
$
90.5

 
$
89.7

Plus: Interest expense
28.2

 
26.9

 
16.6

 
9.7

 
7.2

Plus: Income tax provision
10.7

 
69.6

 
15.4

 
21.6

 
20.5

Plus: Depreciation and amortization
60.2

 
61.5

 
42.8

 
41.0

 
45.1

EBITDA from continuing operations
193.9

 
192.4

 
157.6

 
162.8

 
162.5

Plus: Restructuring and impairment expense
1.7

 
8.1

 
25.6

 
14.6

 
13.1

Plus: Loss (income) from equity affiliates
11.3

 
(2.5
)
 
(4.8
)
 
(6.6
)
 
(2.0
)
Plus: Other (income) expense, net
(10.0
)
 
(0.1
)
 

 
(8.8
)
 
(8.8
)
Adjusted EBITDA from continuing operations
$
196.9

 
$
197.9

 
$
178.4

 
$
162.0

 
$
164.8




36


Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The following is a discussion of our financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K and the selected financial data included in Part II, Item 6, "Selected Financial Data" of this Annual Report on Form 10-K. The discussion of our financial condition and results of operations includes various forward-looking statements about our markets, the demand for our products and our future prospects. These statements are based on certain assumptions that we consider reasonable. For information about risks and exposures relating to us and our business, you should read the sections entitled "Factors That May Affect Future Results," in Part I, Item 1A of this Annual Report on Form 10-K and "Forward Looking Statements" at the end of this Item 7. Unless the context indicates otherwise, references to "SWM," the "Company," "we," "us," "our," or similar terms include Schweitzer-Mauduit International, Inc. and our consolidated subsidiaries.

This Management's Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of our financial statements with an understanding of our recent performance, our financial condition and our prospects. The following will be discussed and analyzed:

    SUMMARY;
    CRITICAL ACCOUNTING POLICIES AND ESTIMATES;
    RECENT ACCOUNTING PRONOUNCEMENTS;
    RESULTS OF OPERATIONS;
    LIQUIDITY AND CAPITAL RESOURCES;
    OTHER FACTORS AFFECTING LIQUIDITY AND CAPITAL RESOURCES;
OUTLOOK; and
    FORWARD-LOOKING STATEMENTS.

SUMMARY
 
In 2018, SWM reported net income of $94.5 million on total net sales of $1,041.3 million. Compared to the prior year, net sales increased $59.2 million due primarily to an increase in organic sales in both AMS and EP as well as incremental net sales from the acquired Conwed business and favorable net foreign currency impacts.

Net income increased to $94.5 million in 2018 compared to $34.5 million in 2017. Outside of typical business drivers, several large one-time items affect the year-over-year comparison. In 2018, these items included a $15.0 million (after-tax) impairment of the Company’s interest in one of its joint ventures in China, a $7.7 million (after-tax) favorable revaluation of a contingent consideration liability related to the Conwed acquisition, and a favorable $13.0 million tax adjustment related to the Tax Act. 2017 Net income included net expenses of $39.6 million related to the Tax Act and other tax valuation allowances and one-time expenses. Business trends that were key drivers of year-over-year financial performance included sales growth in both segments, which was offset by higher raw material costs for both wood pulp for EP and resin for AMS, as well as manufacturing inefficiencies and expenses associated with an AMS site closure.

Cash provided by operations was $139.1 million in 2018 compared to $131.0 million in 2017. Uses of cash during 2018 included $61.1 million in net debt repayments, $53.2 million in cash dividends paid to SWM stockholders and $27.0 million of capital spending.



37


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We disclose those accounting policies that we consider to be significant in determining the amounts to be utilized for communicating our consolidated financial position, results of operations and cash flows in the first note to our consolidated financial statements included elsewhere herein. Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S., which require management to make estimates that affect the amounts of revenues, expenses, assets and liabilities reported and disclosure of contingencies. Changes in these estimates could have a significant impact on our financial position, results of operations, and cash flows. We discussed with the Audit Committee of the Board of Directors the estimates and judgments made for each of the following items and our accounting for and presentation of these items in the accompanying financial statements:

Accounting for Income Taxes

Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best estimate of current and future taxes to be paid. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in the determination of the consolidated income tax expense.

Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets in the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and incorporate assumptions about the amount of future state, federal, and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require the use of significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income (loss).

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Accounting Standards Codification Topic No. 740, Income Taxes ("ASC 740"), states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. We (1) record unrecognized tax benefits as liabilities in accordance with ASC 740 and (2) adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available.

On December 22, 2017, the Tax Cut and Jobs Act (the “Tax Act”) was enacted into law effective January 1, 2018. The new legislation contains several key tax provisions that affected the Company, and include but are not limited to a one-time deemed repatriation tax on post-1986 accumulated earnings and profits of the foreign subsidiary undistributed earnings (“transition tax”), a reduction of the federal corporate income tax rate from 35% to 21%, and a new provision designed to tax Global Intangible Low Taxed Income (“GILTI”) of foreign subsidiaries effective January 1, 2018. As a result of the GILTI provision, the FASB issued Staff Q&A Topic 740, No. 5 “Accounting for Global Intangible Low-Taxed Income” requiring an entity to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or to provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. We have elected to account for GILTI as a current period expense when incurred.

In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), which allowed us to record provisional amounts during the measurement

38


period, not to extend beyond one year of the enactment date. We recognized the effect of the tax law changes in the period of enactment; reported the transition tax, re-measured the U.S. deferred tax assets and liabilities and reassessed the ability to realize our net deferred tax assets and liabilities. As of December 31, 2018, we have completed our accounting for the tax effects of the Tax Act.

Revenue Recognition

We have two main sources of revenue: product sales and materials conversion. We recognize product sales revenues when control of a product is transferred to the customer. For the majority of product sales, transfer of control occurs when the products are shipped from one of our manufacturing facilities to the customer. The cost of delivering finished goods to our customers is recorded as a component of cost of products sold. Those costs include the amounts paid to a third party to deliver the finished goods. Any freight costs billed to and paid by a customer are included in net sales. We also provide services to customers through the conversion of customer-owned raw materials into processed finished goods. In these transactions, we generally recognize revenue as processing is completed.

Revenue is recognized when performance obligations under the terms of a contract with a customer are satisfied, which generally occurs when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Generally, we consider collectability of amounts due under a contract to be probable upon inception of a sale based on an evaluation of the credit worthiness of each customer. If collectability is not considered to be probable, we defer recognition of revenue on satisfied performance obligations until the uncertainty is resolved. Any variable consideration, such as discounts or price concessions, is set forth in the terms of the contract at inception, and is included in the assessment of the transaction price at the outset of the arrangement. The transaction price is allocated to the individual performance obligations due under the contract based on the relative stand-alone fair value of the performance obligations identified in the contract. We typically use an observable price to determine the stand-alone selling price for separate performance obligations.

We do not typically include extended payment terms or significant financing components in our contracts with customers. Certain product sales contracts may include cash-based incentives (volume rebates or credits), which are accounted for as variable consideration.  We estimate these amounts at least quarterly based on the expected forecast quantities to be provided to customers and reduce revenues recognized accordingly. Incidental items that are immaterial in the context of the contract are recognized as expense in the period incurred. We generally expense sales commissions when incurred because the amortization period is one year or less. These costs are recorded within sales and marketing expenses. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. As a practical expedient, we treat shipping and handling activities that occur after control of the good transfers as fulfillment activities, and therefore, does not account for shipping and handling costs as a separate performance obligation.

Accounting for Contingencies

We accrue an estimated loss by taking a charge to income when the likelihood that a future event, such as a legal proceeding, will result in a loss or the incurrence of a liability is probable and the amount of loss can be reasonably estimated. We disclose material contingencies if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued, we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial condition, results of operations, and our cash flows.

For further information, please see "Litigation" in Part I, Item 3, "Legal Proceedings" and Note 20. Commitments and Contingencies, of the Notes to Consolidated Financial Statements.


39


Property, Plant and Equipment Valuation

Our manufacturing processes are capital intensive; as a result, we make substantial investments in property, plant and equipment which are recorded at cost. Net property, plant and equipment comprised 23% of our total assets as of December 31, 2018. Property, plant and equipment is depreciated on the straight-line method over the estimated useful lives of the assets. Production machines and related equipment are not subject to substantial technological changes rendering them obsolete and are generally depreciated over estimated useful lives of 10 to 20 years. When indications of impairment exist, we assess the likelihood of recovering the cost of long-lived assets based on our expectation of future profitability and undiscounted cash flow of the related asset group. These factors, along with management's plans with respect to the operations, are considered in assessing the recoverability of property, plant and equipment. Changes in management's estimates and plans could significantly impact our financial condition, results of operations and cash flows.

As a result of excess capacity in the tobacco-related papers industry and increased purchased material and operating costs experienced in the last several years, competitive selling prices for certain of our products are not sufficient to cover our costs with a reasonable margin. Such competitive pressures have resulted in downtime of certain paper machines and, in some cases, accelerated depreciation or impairment of certain equipment. We have also incurred restructuring costs in our AMS segment in pursuit of synergies from integrating our acquisitions. Over the past six years, we have restructured our operations to improve our competitiveness and profitability. As a result, we incurred significant charges related to asset impairments, accelerated depreciation and employee severances.

In 2011, the Company revised its plans for RTL expansion in Asia and suspended the construction of the Philippine greenfield site. In 2015, the Company made the decision to dispose of the facility and related equipment. Based on an updated estimate of the fair value of the equipment in 2015, the Company recorded an additional impairment charge of $5.2 million. During 2015, the net book value of the RTL Philippines property, plant and equipment was reclassified as Assets held for sale in the Company's Consolidated Balance Sheets. The Company reviews these assets at each reporting period and would recognize an impairment charge for the excess of carrying value of the assets over the fair value less any costs to sell. The Company did not record any additional impairment charges during 2016. During 2017, the Company recognized additional impairment charges of $4.0 million related to the RTL Philippines assets. The Company did not record any additional impairment charges during 2018. The net book value of the RTL Philippines property, plant and equipment was $12.0 million as of December 31, 2018.

Management continues to evaluate how to operate our production facilities more effectively. Further restructuring actions are possible that might require additional impairments or accelerated depreciation of some equipment.

Business Combinations

Accounting for business combinations requires us to recognize, separately from goodwill, the assets acquired and the liabilities assumed ("net assets") at their acquisition date fair values. Goodwill is measured as the excess of consideration transferred over the net assets acquired at their respective fair values as of the acquisition date. The estimated fair values are based upon quoted market prices and widely accepted valuation techniques, which require significant estimates and assumptions including, but not limited to, estimating future cash flows and developing appropriate discount rates. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding adjustment to goodwill, based on new information obtained about the facts and circumstances that existed as of the acquisition date. Upon the conclusion of the measurement period or final determination of the values of net assets acquired, whichever comes first, any subsequent adjustments are recorded to our consolidated financial statements. See Note 4. Business Acquisitions, of the Notes to Consolidated Financial Statements for additional information.


40


Investments in Equity Affiliates

Investments in companies which we do not control but over which we have the ability to exercise significant influence and that, in general, are at least 20 percent-owned by us, are stated at cost plus equity in undistributed net income. These investments are evaluated for impairment when warranted. An impairment loss would be recorded whenever a decline in value of an equity investment below its carrying amount is determined to be other than temporary. In judging "other than temporary," we would consider the length of time and extent to which the fair value of the equity company investment has been less than the carrying amount, the near-term and longer-term operating and financial prospects of the equity company, and our longer-term intent of retaining the investment in the equity company. See Note 9. Joint Ventures, of the Notes to Consolidated Financial Statements for additional information.

Goodwill and Unamortized Intangible Assets

Goodwill is not subject to amortization and is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill is measured as the excess of consideration transferred over the net assets acquired at their respective fair values as of the acquisition date. Goodwill is tested for impairment at the reporting unit level. Fair value of a reporting unit is typically based upon estimated future cash flows discounted at a rate commensurate with the risk involved or market-based comparables. If the carrying amount of the reporting unit’s net assets exceeds its fair value, then an analysis will be performed to compare the implied fair value of goodwill with the carrying amount of goodwill. An impairment loss will be recognized in an amount equal to the excess of the carrying amount over its implied fair value. After an impairment loss is recognized, the adjusted carrying amount of goodwill is its new accounting basis. The annual impairment tests performed on October 1, 2018 and 2017 did not indicate any impairment of goodwill.

Intangible assets with finite lives are amortized over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss would be indicated when estimated undiscounted future cash flows from the use of the asset are less than its carrying amount. An impairment loss would be measured as the difference between the fair value (based on discounted future cash flows) and the carrying amount of the asset. Estimated useful lives range from 10 to 23 years for customer relationships and 4 to 20 years for developed technology, patents and other intangible assets. Certain trade names are estimated to have indefinite useful lives and as such are not amortized. Intangible assets with indefinite lives are reviewed for impairment following a method similar to the impairment testing for Goodwill.  Testing of these assets is performed annually and whenever events and circumstances indicate that impairment may have occurred.

RECENT ACCOUNTING PRONOUNCEMENTS

For a discussion regarding recent accounting pronouncements, see "Recent Accounting Pronouncements" included in Note 2. Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements.


41



RESULTS OF OPERATIONS
 
For the Years Ended December 31,
 
2018
 
2017(1)
 
2016
 
($ in millions, except per share amounts)
Net sales
$
1,041.3

 
$
982.1

 
$
839.9

Cost of products sold
762.8

 
698.7

 
582.0

Gross profit
278.5

 
283.4

 
257.9

Selling expense
35.7

 
33.3

 
25.3

Research expense
15.2

 
17.8

 
17.5

General expense
90.9

 
95.9

 
79.5

Total nonmanufacturing expenses
141.8

 
147.0

 
122.3

Restructuring and impairment expense
1.7

 
8.1

 
25.6

Operating profit
135.0

 
128.3

 
110.0

Interest expense
28.2

 
26.9

 
16.6

Other income, net
10.0

 
0.1

 

Income from continuing operations before income taxes and income from equity affiliates
116.8

 
101.5

 
93.4

Provision for income taxes
10.7

 
69.6

 
15.4

(Loss) income from equity affiliates, net of income taxes
(11.3
)
 
2.5

 
4.8

Income from continuing operations
94.8

 
34.4

 
82.8

(Loss) gain from discontinued operations
(0.3
)
 
0.1

 

Net income
$
94.5

 
$
34.5

 
$
82.8

 
 
 
 
 
 
Net income (loss) per share - basic:
 
 
 
 
 
Income per share from continuing operations
$
3.08

 
$
1.12

 
$
2.71

Loss per share from discontinued operations
(0.01
)
 

 

Net income per share - basic
$
3.07

 
$
1.12

 
$
2.71

 
 
 
 
 
 
Net income (loss) per share - diluted:
 
 
 
 
 
Income per share from continuing operations
$
3.07

 
$
1.12

 
$
2.70

Loss per share from discontinued operations
(0.01
)
 

 

Net income per share - diluted
$
3.06

 
$
1.12

 
$
2.70

(1) Results during the year ended December 31, 2017 include Conwed from the January 20, 2017 acquisition date to December 31, 2017.



42


Year Ended December 31, 2018 Compared with the Year Ended December 31, 2017
 
Net Sales
(dollars in millions)
 
2018
 
2017
 
Change
 
Percent Change
Advanced Materials & Structures
$
467.9

 
$
433.2

 
$
34.7

 
8.0
%
Engineered Papers
573.4

 
548.9

 
24.5

 
4.5

Total
$
1,041.3

 
$
982.1

 
$
59.2

 
6.0
%
 
Net sales were $1,041.3 million in 2018 compared with $982.1 million in 2017. The increase in net sales consisted of the following (dollars in millions):

 
Amount
 
Percent
Changes in product mix, selling prices and sales volumes
$
41.7

 
4.2
%
Changes in currency exchange rates
17.6

 
1.8

Changes in royalties
(0.1
)
 

Total
$
59.2

 
6.0
%

AMS segment net sales were $467.9 million for 2018 compared to $433.2 million during 2017. The increase of $34.7 million or 8.0% was due primarily to an increase in organic sales of $27.0 million (or 6.2%), led by strong growth in filtration, particularly for RO water filtration products. The Company’s sales in transportation, driven by surface protection films, and medical were also key growth drivers. Infrastructure and construction and industrial sales were generally flat with prior year. The Company had a $7.7 million partial period benefit from net sales generated by the operations of our Conwed business.

The EP segment net sales during the year ended December 31, 2018 of $573.4 million increased by $24.5 million, or 4.5%, versus net sales of $548.9 million in the prior year.  The increase in net sales was primarily the result of the favorable net foreign currency impacts of $14.9 million, mainly from a stronger euro and the $9.9 million combined net favorable impact of changes in volumes, mix of products sold and average selling prices, in each case compared to the prior year. The company benefited from a more favorable mix of products sold as a result strong performance of LIP and other cigarette papers as well as specialty battery papers, and de-emphasizing and/or exiting significant volumes of certain low-margin non-tobacco papers.
 
Gross Profit
(dollars in millions)
 
 
 
 

 
Percent Change
 
Percent of Net Sales
 
2018
 
2017
 
Change
 
 
2018
 
2017
Net sales
$
1,041.3

 
$
982.1

 
$
59.2

 
6.0
 %
 
100.0
%
 
100.0
%
Cost of products sold
762.8

 
698.7

 
64.1

 
9.2

 
73.3

 
71.1

Gross profit
$
278.5

 
$
283.4

 
$
(4.9
)
 
(1.7
)%
 
26.7
%
 
28.9
%
 
Gross profit for the year ended December 31, 2018 decreased by $4.9 million, or 1.7%, to $278.5 million from $283.4 million in the prior year. AMS gross profit decreased by $1.1 million, primarily due higher input costs, particularly resin, and manufacturing inefficiencies and expenses associated with the closure of one site and the transition of those volumes to the Company’s other facilities, which combined to offset sales growth. In the EP segment, gross profit decreased by $3.8 million, primarily due to higher raw materials costs, particularly wood pulp and energy, which offset

43


sales growth, improved manufacturing efficiencies compared to the prior year period, and favorable currency movements.

Nonmanufacturing Expenses
(dollars in millions)
 
 
 
 

 
Percent Change
 
Percent of Net Sales
 
2018
 
2017
 
Change
 
 
2018
 
2017
Selling expense
$
35.7

 
$
33.3

 
$
2.4

 
7.2
 %
 
3.4
%
 
3.4
%
Research expense
15.2

 
17.8

 
(2.6
)
 
(14.6
)
 
1.5

 
1.8

General expense
90.9

 
95.9

 
(5.0
)
 
(5.2
)
 
8.7

 
9.8

Nonmanufacturing expenses
$
141.8

 
$
147.0

 
$
(5.2
)
 
(3.5
)%
 
13.6
%
 
15.0
%
 
Nonmanufacturing expenses in the year ended December 31, 2018 decreased by $5.2 million, or 3.5%, to $141.8 million from $147.0 million in the prior year due primarily to lower professional service fees and certain general expenses.

Restructuring and Impairment Expense
(dollars in millions)
 
 
 
 

 
Percent Change
 
Percent of Net Sales
 
2018
 
2017
 
Change
 
 
2018
 
2017
Advanced Materials & Structures
$
1.5

 
$
2.7

 
$
(1.2
)
 
(44.4
)%
 
0.3
%
 
0.6
%
Engineered Papers
0.2

 
5.3

 
(5.1
)
 
(96.2
)
 

 
1.0

Unallocated expenses

 
0.1

 
(0.1
)
 
(100.0
)
 
 
 
 
Total
$
1.7

 
$
8.1

 
$
(6.4
)
 
(79.0
)%
 
0.2
%
 
0.8
%

The Company incurred total restructuring and impairment expense of $1.7 million in the year ended December 31, 2018, compared to $8.1 million in the year ended December 31, 2017, a decrease of $6.4 million or 79.0%. In the year ended December 31, 2018, restructuring and impairment expenses consisted of $1.3 million in severance accruals for employees at our U.S. and French manufacturing operations, as well as $0.4 million in impairment charges at our U.S. manufacturing facilities.

In the year ended December 31, 2017, restructuring and impairment expenses consisted of $3.5 million related to severance expenses in the French, Belgian and U.S. operations for ongoing accruals over the remaining service lives of affected employees related to previously announced actions as well as $4.0 million of impairment charges to certain of our RTL Philippines physical assets and $0.6 million in impairment charges for manufacturing equipment at our French and U.S. manufacturing facilities.

44


Operating Profit
(dollars in millions)
 
 
 
 
 
Percent Change
 
Return on Net Sales
 
2018
 
2017
 
Change
 
 
2018
 
2017
Advanced Materials & Structures
$
49.5

 
$
48.5

 
$
1.0

 
2.1
%
 
10.6
%
 
11.2
%
Engineered Papers
121.8

 
119.7

 
2.1

 
1.8

 
21.2

 
21.8

Unallocated expenses
(36.3
)
 
(39.9
)
 
3.6

 
9.0

 
 
 
 
Total
$
135.0

 
$
128.3

 
$
6.7

 
5.2
%
 
13.0
%
 
13.1
%

Operating profit was $135.0 million in the year ended December 31, 2018 compared with $128.3 million during the prior year.
 
The AMS segment's operating profit in the year ended December 31, 2018 was $49.5 million compared to $48.5 million in the prior year period. The increase of $1.0 million in the AMS segment's operating profit during the year ended December 31, 2018 compared to the prior-year period was positively impacted by sales growth, $1.2 million of lower restructuring and impairment expenses and SG&A cost reductions, partially offset by lower gross profits due to higher input costs and certain manufacturing inefficiencies.

The EP segment's operating profit in the year ended December 31, 2018 was $121.8 million, an increase of $2.1 million, or 1.8%, from $119.7 million in the prior year.  The increase was primarily due to sales growth, positive currency movements and $5.1 million of lower restructuring and impairment expenses, partially offset by higher input costs.

Unallocated expenses in the year ended December 31, 2018 were $36.3 million, down $3.6 million, or 9.0%, from the $39.9 million in the prior year period. The decrease was primarily due to lower professional service fees and deferred compensation expense, which decreased due to stock price volatility during the fourth quarter of 2018.

Non-Operating Expenses, Net
 
Interest expense was $28.2 million in the year ended December 31, 2018, an increase of $1.3 million from $26.9 million in the year ended December 31, 2017.  The increase in interest expense is primarily due to a higher average interest rate compared to the prior year as a result of increases in market rates and the addition of the senior secured notes, partially offset by a lower total debt balance as of December 31, 2018 compared to the prior year. The weighted average effective interest rate on our debt facilities was approximately 4.20% and 3.45% for the years ended December 31, 2018 and 2017, respectively.
 
Other income, net was $10.0 million during the year ended December 31, 2018 compared to $0.1 million during the year ended December 31, 2017. The $9.9 million increase in other income, net, was due primarily to the $10.2 million decrease in the fair value of the contingent consideration liability related to the Conwed acquisition, as discussed in Note 4. Business Acquisitions.
 
Income Taxes
 
A $10.7 million and $69.6 million provision for income taxes in the years ended December 31, 2018 and 2017, respectively, resulted in an effective tax rate of 9.2% compared with 68.6% in the prior year.  The Company’s effective tax rates differ from the statutory federal income tax rate of 21% due to varying tax rates in foreign jurisdictions, the relative amounts of income we earn in those jurisdictions and year over year adjustments due to U.S. tax reform, including a $13 million reduction to the one-time transition tax netted against discrete tax adjustments and the revaluation of the deferred taxes to reflect lower federal corporate tax rates.

45


(Loss) Income from Equity Affiliates
 
Loss from equity affiliates, net of income taxes, was $11.3 million in the year ended December 31, 2018 compared with income of $2.5 million during the prior year and reflected the results of operations of CTM and CTS. The decrease in earnings was driven primarily by the $15.0 million impairment of the CTS equity method investment, as discussed further in Note 9. Joint Ventures.
  
Discontinued Operations
 
Because we closed our Philippines plant as previously reported, the results of this plant were reported as discontinued operations for all periods presented. Consequently, this plant's results have been removed from each line of the statements of income and the operating activities section of the statements of cash flow. In each case, a separate line has been added for the net results of the discontinued operation. Loss from discontinued operations was $0.3 million versus income of $0.1 million for the years ended December 31, 2018 and 2017, respectively. These amounts are primarily the result of the Company's efforts to dispose of the remaining assets and liabilities of the discontinued operations.

Net Income and Income per Share
 
Net income in the year ended December 31, 2018 was $94.5 million, or $3.06 per diluted share, compared with $34.5 million, or $1.12 per diluted share, during the prior year period.  The increase in net income was primarily due to the benefit of higher organic sales in our AMS segment, a lower income tax provision in 2018, primarily related to the enactment of the Tax Act on December 22, 2017, and higher Other income from the revaluation of a contingent consideration liability related to the Conwed acquisition, partially offset by a loss from equity affiliates due to the impairment of our CTS equity method investment and higher input costs.

46


Year Ended December 31, 2017 Compared with the Year Ended December 31, 2016
 
Net Sales
(dollars in millions)
 
2017
 
2016
 
Change
 
Percent Change
Advanced Materials & Structures
$
433.2

 
$
280.6

 
$
152.6

 
54.4
 %
Engineered Papers
548.9

 
559.3

 
(10.4
)
 
(1.9
)
Total
$
982.1

 
$
839.9

 
$
142.2

 
16.9
 %

Net sales were $982.1 million in 2017 compared with $839.9 million in 2016. The increase in net sales consisted of the following (dollars in millions):

 
Amount
 
Percent
Incremental AMS segment revenue from acquisitions
$
141.3

 
16.8
 %
Changes in currency exchange rates
8.6

 
1.0

Changes in royalties
(4.6
)
 
(0.5
)
Changes in product mix, selling prices and sales volumes
(3.1
)
 
(0.4
)
Total
$
142.2

 
16.9
 %

AMS segment net sales were $433.2 million for 2017 compared to $280.6 million during 2016. The increase of $152.6 million or 54.4% was due primarily to $141.3 million in incremental net sales generated by the operations of our Conwed business and an increase in organic sales of $11.4 million, led by strong growth in transportation, mainly from surface protection films, as well as gains in industrial and medical sales; this growth was partially offset by softness in filtration sales.

The EP segment net sales during the year ended December 31, 2017 of $548.9 million decreased by $10.4 million, or 1.9%, versus net sales of $559.3 million in the prior year.  The decrease in net sales was primarily the result of the $14.5 million net combined unfavorable impact of changes in volumes, mix of products sold and average selling prices, and $4.6 million of lower royalty income, partially offset by favorable net foreign currency impacts of $8.7 million, mainly from a stronger euro, in each case compared to the prior year.
 
Gross Profit
(dollars in millions)
 
 
 
 
 
Percent Change
 
Percent of Net Sales
 
2017
 
2016
 
Change
 
 
2017
 
2016
Net sales
$
982.1

 
$
839.9

 
$
142.2

 
16.9
%
 
100.0
%
 
100.0
%
Cost of products sold
698.7

 
582.0

 
116.7

 
20.1

 
71.1

 
69.3

Gross profit
$
283.4

 
$
257.9

 
$
25.5

 
9.9
%
 
28.9
%
 
30.7
%
 
Gross profit for the year ended December 31, 2017 increased by $25.5 million, or 9.9% to $283.4 million from $257.9 million in the prior year. AMS gross profit increased by $46.8 million, primarily due to the incremental gross profit associated with the operations of our newly acquired Conwed business, along with organic sales growth and a favorable mix of products sold, partially offset by certain manufacturing inefficiencies and higher input costs. In the EP segment, gross profit decreased by $21.3 million, primarily due to the unfavorable impact of lower sales combined with the lower sales volume's associated impact on manufacturing efficiencies and overhead absorption compared to the prior-year period.

47


Nonmanufacturing Expenses
(dollars in millions)
 
 
 
 
 
Percent Change
 
Percent of Net Sales
 
2017
 
2016
 
Change
 
 
2017
 
2016
Selling expense
$
33.3

 
$
25.3

 
$
8.0

 
31.6
%
 
3.4
%
 
3.0
%
Research expense
17.8

 
17.5

 
0.3

 
1.7

 
1.8

 
2.1

General expense
95.9

 
79.5

 
16.4

 
20.6

 
9.8

 
9.5

Nonmanufacturing expenses
$
147.0

 
$
122.3

 
$
24.7

 
20.2
%
 
15.0
%
 
14.6
%
 
Nonmanufacturing expenses in the year ended December 31, 2017 increased by $24.7 million, or 20.2%, to $147.0 million from $122.3 million in the prior year due primarily to incremental costs from the operations of our acquired Conwed business.

Restructuring and Impairment Expense
(dollars in millions)
 
 
 
 

 
Percent Change
 
Percent of Net Sales
 
2017
 
2016
 
Change
 
 
2017
 
2016
Advanced Materials & Structures
$
2.7

 
$
21.3

 
$
(18.6
)
 
(87.3
)%
 
0.6
%
 
7.6
%
Engineered Papers
5.3

 
4.0

 
1.3

 
32.5

 
1.0

 
0.7

Unallocated expenses
0.1

 
0.3

 
(0.2
)
 
(66.7
)
 
 
 
 
Total
$
8.1

 
$
25.6

 
$
(17.5
)
 
(68.4
)%
 
0.8
%
 
3.0
%

The Company incurred total restructuring and impairment expense of $8.1 million in the year ended December 31, 2017, compared to $25.6 million in the year ended December 31, 2016, a decrease of $17.5 million or 68.4%. In the year ended December 31, 2017, restructuring and impairment expenses consisted of $3.5 million related to severance expenses in the French, Belgian and U.S. operations for ongoing accruals over the remaining service lives of affected employees related to previously announced actions as well as $4.0 million of impairment charges to certain of our RTL Philippines physical assets and $0.6 million in impairment charges for manufacturing equipment at our French and U.S. manufacturing facilities.

In the year ended December 31, 2016, restructuring and impairment expenses consisted of $4.3 million related to severance expenses in the French, Brazilian and U.S. operations for ongoing accruals over the remaining service lives of affected employees related to previously announced actions as well as $0.6 million of impairment charges to certain of our Polish manufacturing equipment. Additionally, in the fourth quarter of 2016, in line with the Company's rebranding strategy, it was determined that use of the DelStar trade name would be discontinued in 2017. As a result, a $20.7 million impairment charge was recognized to adjust the carrying value of the DelStar trade name intangible asset to its estimated fair value as of December 31, 2016, based on expected future cash flows to be realized from the use of the trade name. The remaining value of this intangible was amortized in the first six months of 2017.


48


Operating Profit
(dollars in millions)
 
 
 
 
 
Percent Change
 
Return on Net Sales
 
2017
 
2016
 
Change
 
 
2017
 
2016
Advanced Materials & Structures
$
48.5

 
$
9.0

 
$
39.5

 
N.M.

 
11.2
%
 
3.2
%
Engineered Papers
119.7

 
141.9

 
(22.2
)
 
(15.6
)
 
21.8

 
25.4

Unallocated expenses
(39.9
)
 
(40.9
)
 
1.0

 
(2.4
)
 
 
 
 
Total
$
128.3

 
$
110.0

 
$
18.3

 
16.6
 %
 
13.1
%
 
13.1
%
N.M. - Not Meaningful

Operating profit was $128.3 million in the year ended December 31, 2017 compared with $110.0 million during the prior year.
 
The AMS segment's operating profit in the year ended December 31, 2017 was $48.5 million compared to $9.0 million in the prior year period. The increase of $39.5 million in the AMS segment's operating profit during the year ended December 31, 2017 compared to the prior-year period was positively impacted by $18.6 million in decreased restructuring and impairment expenses due primarily to the prior-year's tradename impairment and $19.5 million in incremental operating profit associated with our newly acquired Conwed business and organic net sales growth and associated gross profits.

The EP segment's operating profit in the year ended December 31, 2017 was $119.7 million, a decrease of $22.2 million, or 15.6%, from $141.9 million in the prior year.  The decrease was primarily due to overall sales volume decline. Lower RTL and overall cigarette paper volumes were partially offset by growth of non-tobacco paper, and positive currency movements offset anticipated lower LIP royalties.

Unallocated expenses in the year ended December 31, 2017 were $39.9 million, down $1.0 million, or 2.4%, from the $40.9 million in the prior year period. The decrease was primarily due to lower professional fees.

Non-Operating Expenses
 
Interest expense was $26.9 million in the year ended December 31, 2017, an increase of $10.3 million from $16.6 million in the year ended December 31, 2016.  The increase in interest expense is primarily due to higher average debt balances outstanding compared to the prior year in connection with the Conwed acquisition as well as the effect of the higher effective interest rate applied to borrowings under our amended credit agreement executed in January 2017 when compared to our previous credit agreement.  The weighted average effective interest rate on our debt facilities was approximately 3.45% and 2.42% for the year ended December 31, 2017 and 2016, respectively.
 
Other income, net was $0.1 million during the year ended December 31, 2017 compared to $0.0 million during the year ended December 31, 2016. The $0.1 million decrease in other income, net, was due primarily to higher net currency losses in the current year, partially offset by lower transactional taxes incurred in Brazil in 2017 and lower losses incurred on the sale of assets at our Philippines site.
 
Income Taxes
 
A $69.6 million and $15.4 million provision for income taxes in the years ended December 31, 2017 and 2016, respectively, resulted in an effective tax rate of 68.6% compared with 16.5% in the prior year.  The Company’s effective tax rates differ from the statutory federal income tax rate of 35% due to varying tax rates in foreign jurisdictions, the relative amounts of income we earn in those jurisdictions, and additional taxes due to earnings intended to be indefinitely reinvested outside the U.S. On December 22, 2017, the Tax Act was enacted into law and the new legislation contains several key tax provisions that affected the Company, which include, but are not limited to, a one-time mandatory

49


transition tax of $48.7 million on accumulated foreign earnings and a reduction of the corporate income tax rate from 35% to 21% effective January 1, 2018.

Income from Equity Affiliates
 
Income from equity affiliates, net of income taxes, was $2.5 million in the year ended December 31, 2017 compared with $4.8 million during the prior year and reflected the results of operations of CTM and CTS. The decrease in earnings was driven primarily by lower sales volumes at CTS in 2017 compared to the prior-year period.
  
Discontinued Operations
 
Because we closed our Philippines plant as previously reported, the results of this plant were reported as discontinued operations for all periods presented. Consequently, this plant's results have been removed from each line of the statements of income and the operating activities section of the statements of cash flow. In each case, a separate line has been added for the net results of the discontinued operation.

Net Income and Income per Share
 
Net income in the year ended December 31, 2017 was $34.5 million, or $1.12 per diluted share, compared with $82.8 million, or $2.70 per diluted share, during the prior year period.  The decrease in net income was primarily due to the unfavorable impact of the new tax legislation, the unfavorable impact of lower sales and associated gross profits in our EP segment, higher intangible asset amortization in our AMS segment as a result of the Conwed acquisition and higher interest expense. These factors were partially offset by the incremental operating profits from the Conwed acquisition, the favorable impact of higher organic sales and associated gross profits in our AMS segment and lower restructuring and impairment charges in 2017.


50


LIQUIDITY AND CAPITAL RESOURCES
 
A major factor in our liquidity and capital resource planning is our generation of cash flow from operations, which is sensitive to changes in the mix of products sold, volume and pricing of our products, as well as changes in our production volumes, costs and working capital. Our liquidity is supplemented by funds available under our revolving credit facility with a syndicate of banks that is used as either operating conditions or strategic opportunities warrant.

As of December 31, 2018, $49.6 million of our $93.8 million of cash and cash equivalents was held by foreign subsidiaries. Cash paid for income taxes (net of refunds) was $23.2 million for the year ended December 31, 2018. On December 22, 2017, the Tax Act was enacted into law. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates U.S. taxes on foreign subsidiary distributions. At December 31, 2017, we recorded a provisional tax liability of $48.7 million relating to the one-time mandatory transition tax on our accumulated foreign earnings, which we intend to pay over an eight-year payment schedule, as prescribed by the Tax Act. In the quarter ended September 30, 2018, we reduced the provisional tax liability by $13.0 million. We do not expect the payment of the transition taxes over the next eight years to adversely affect our liquidity and resource planning. Additionally, the Tax Act is not expected to adversely impact our debt covenant compliance. We believe that our sources of liquidity and capital, including cash on-hand, cash generated from operations and our existing credit facilities, will be sufficient to finance our continued operations and growth strategy.
 
Capital spending for 2019 is projected to be approximately $35.0 million to $40.0 million. We generally fund our capital projects using cash on-hand, cash generated from operations and our existing credit facilities, including the New Credit Agreement, as defined below in "Debt Instruments and Related Covenants."

Cash Requirements
 
As of December 31, 2018, we had net operating working capital of $195.2 million and cash and cash equivalents of $93.8 million, compared with net operating working capital of $184.2 million and cash and cash equivalents of $106.9 million as of December 31, 2017.  The 2018 year-over-year increase in net operating working capital is primarily due to increases in Accounts receivable and Income taxes receivable outstanding at December 31, 2018 compared to 2017, and decreases in Accrued expenses and Income taxes payable. These factors were partially offset by a decrease in Inventories and an increase in Accounts payable outstanding at December 31, 2018. Changes in the amounts that make up these balances also reflect the impacts of changes in currency exchange rates which are included in the changes in operating working capital presented on the Consolidated Statements of Cash Flow.


51


Cash Flows from Operations ($ in millions)
For the Years Ended December 31,
2018

2017

2016
Net income
$
94.5

 
$
34.5

 
$
82.8

Less: (Loss) gain from discontinued operations
(0.3
)
 
0.1

 

Income from continuing operations
94.8

 
34.4

 
82.8

Non-cash items included in net income:
 
 
 
 
 
Depreciation and amortization
61.6

 
59.5

 
44.5

Impairments
0.2

 
4.6

 
21.3

Deferred income tax provision (benefit)
7.5

 
1.6

 
(13.5
)
Pension and other postretirement benefits
2.8

 
3.8

 
3.8

Stock-based compensation
4.8

 
7.1

 
5.8

Loss (income) from equity affiliates
11.3

 
(2.5
)
 
(4.8
)
Gain on sale of intangible assets

 

 
(1.8
)
Gain on sale of assets

 
(4.9
)
 

Long-term income tax payable
(12.0
)
 
36.7

 

Change in fair value of contingent consideration
(10.2
)
 

 

Excess tax benefits of stock-based awards

 

 
0.2

Cash dividends received from equity affiliates
2.0

 
1.8

 
3.0

Other items
0.4

 
0.7

 
(0.6
)
Net changes in operating working capital
(24.3
)
 
(11.9
)
 
(11.0
)
Net cash provided by operating activities of:
 
 
 
 
 
Continuing operations
138.9

 
130.9

 
129.7

Discontinued operations
0.2

 
0.1

 

Cash provided by operations
$
139.1

 
$
131.0

 
$
129.7

 
Net cash provided by operations was $139.1 million in the year ended December 31, 2018 compared with $131.0 million in the prior year. Our net cash provided by operations increased primarily due to higher net income from continuing operations of $20.5 million, adjusted for non-cash items which related primarily to the Loss from equity affiliate, Long-term income tax payable and the Change in fair value of contingent consideration. This was partially offset by a $12.4 million unfavorable year-over-year impact of net changes in operating working capital.

Net cash provided by operations was $131.0 million in the year ended December 31, 2017 compared with $129.7 million in the prior year.  Our net cash provided by operations increased primarily due to higher net income from continuing operations of $2.2 million, adjusted for non-cash items which related primarily to the Long-term income tax payable. This was partially offset by a $0.9 million unfavorable year-over-year impact of net changes in operating working capital.

Net cash provided by operations was $129.7 million in the year ended December 31, 2016 compared with $144.7 million in the prior year.  Our net cash provided by operations decreased primarily due to a $23.8 million unfavorable year-over-year impact of net changes in operating working capital, partially offset by higher net income from continuing operations of $9.8 million, adjusted for non-cash items which related primarily to Impairment expense.


52



Operating Working Capital ($ in millions)
For the Years Ended December 31,
2018

2017

2016
Changes in operating working capital
 
 
 
 
 
Accounts receivable
$
(18.3
)
 
$
(0.9
)
 
$
3.1

Inventories
(4.9
)
 
(6.4
)
 
(6.9
)
Prepaid expenses
(0.1
)
 
0.8

 
(0.5
)
Accounts payable
8.0

 
4.7

 
(3.7
)
Accrued expenses
(1.0
)
 
(3.0
)
 
0.8

Accrued income taxes
(8.0
)
 
(7.1
)
 
(3.8
)
Net changes in operating working capital
$
(24.3
)
 
$
(11.9
)
 
$
(11.0
)

In 2018, net changes in operating working capital decreased cash flow by $24.3 million compared with an $11.9 million decrease in cash flow in the prior year. The 2018 reduction in cash flow from the net change in working capital was driven primarily by higher accounts receivables associated with sales growth.

In 2017, net changes in operating working capital decreased cash flow by $11.9 million compared with an $11.0 million decrease in cash flow in the prior year.

In 2016, net changes in operating working capital decreased cash flow by $11.0 million compared with $12.8 million increase in cash flow in the prior year. The 2016 reduction in cash flow from the net change in working capital was driven by increases in inventory and decreases in accounts payable and accrued income taxes, partially offset by decreases in accounts receivable.

Cash Flows from Investing ($ in millions)
For the Years Ended December 31,
2018

2017

2016
Capital spending
$
(27.0
)
 
$
(37.2
)
 
$
(27.8
)
Capitalized software costs
(2.7
)
 
(3.5
)
 
(2.8
)
Acquisitions, net of cash acquired

 
(291.7
)
 

Proceeds from sale of assets

 
7.0

 

Other
2.2

 
6.9

 
8.2

Cash used for investing
$
(27.5
)
 
$
(318.5
)
 
$
(22.4
)