News; Feb 23, 2005 CET

An eventful year

Operations developed favorably during 2004 and sales increased by 3 percent in local currencies. Volumes increased, particularly for cigars, as well as snus. Operating income increased and was affected by several items of a nonrecurring nature. The settlement with UST at the beginning of the year resulted in an income item of 1.5 billion SEK before tax, while write-downs, allocations to reserve and costs for rationalization measures were charged against earnings. Earnings per share rose to 5.61 SEK (4.68), and the Board of Directors has decided to propose that the dividend for the year be increased to 1.90 SEK (1.70).

“On the whole, operations in 2004 performed well and showed a favorable trend,” notes Lars Dahlgren, CFO of the Swedish Match Group. Sales in SEK declined slightly to 13,007 MSEK (13,036), but increased by 3 percent in local currencies. Operating income increased to 3,370 MSEK (2,224).

2004 was a unique year due to the major settlement with UST, which brought in revenue of 1.5 billion SEK before tax. In other areas, the company experienced certain setbacks on the legal front during the year. In December, the European Court of Justice ruled that the ban on the sale of Swedish snus in the EU is not unlawful.

“It is regrettable that the European Court reached that conclusion, and it invites speculation as to what the real grounds were on which the ruling was based,” says Lars Dahlgren. “Experience gained in Sweden suggests that many thousands of lives could be saved if cigarette smokers who have not managed to quit could be offered a smokeless product - such as Swedish snus - as an alternative. The irony is that chewing tobacco is legal, so that if snus were intended solely for chewing, it would be legally permissible” notes Lars Dahlgren.

In India, the Supreme Court ruled against Swedish Match and ordered the company to acquire 20 of the 26 percent of the shares outstanding in Wimco Ltd. An amount of 90 MSEK was charged against earnings and has been set aside for completion of the acquisition in accordance with the Supreme Court’s ruling.

A write-down of 150 MSEK relating to fixed assets in the match operations was also charged against operating income. As a result of a weak earnings trend for matches in certain markets, the company revised the balance sheet figures.

“Extensive rationalization measures were also undertaken during 2004, since we have decided to take firm control of operations and enhance efficiency to lay the foundation for favorable development in the future,” says Lars Dahlgren. During 2004, these measures were charged against operating income in a total amount of 235 MSEK.

The measures in question are aimed at dealing with overcapacity in the match operations in Europe, reorganization within the Continental Europe division and rationalizations, primarily among administrative personnel, in the North Europe division.

“We also took a carefully weighed decision to reposition the Timber Wolf snus brand in North America to put a halt to the negative trend observed during the year,” says Lars Dahlgren.

The repositioning of Timber Wolf involved steering the brand toward the low-price segment. While this is expected to lead to improved volumes in the future, it had a negative impact on sales in the fourth quarter, resulting in a decline of 50 MSEK in operating income.

Operating income for the year, excluding the revenue from the settlement with UST, the provision for the acquisition of shares in Wimco and the write-down in match operations, declined by 6 percent to 2,089 MSEK (2,224). The entire decline - and additional expenses - resulted from the restructuring measures taken in Europe, which led to costs of 235 MSEK, as well as the nonrecurring amount resulting from the repositioning of Timber Wolf and negative currency effects amounting to 94 MSEK arising from the translation of foreign subsidiaries’ earnings, primarily due to the lower exchange rate for the USD.

“While it is true that costs for rationalization measures are a recurring item that should be taken into consideration when analyzing a company’s results, these costs were a particularly major factor during 2004,” says Lars Dahlgren. “We also incurred rationalization costs in 2003, but to a lesser extent, and if we make adjustments for the repositioning of Timber Wolf and the costs of major rationalization measures for both years, we see that the underlying operating income for 2004 rose by 4 percent, or 8 percent calculated in local currencies.”

IN SNUFF OPERATIONS, sales increased during 2004 by 3 percent to 3,081 MSEK (2,995). In local currencies, sales increased by 6 percent. In Scandinavia as a whole, the rate of increase slowed down to 1 percent in terms of volume. The explanation is that the total market in Sweden is growing more slowly than has historically been the case, and that competition intensified in the Swedish market during the year. The Norwegian market continued to grow strongly, however, with a volume increase of nearly 20 percent for Swedish Match.

In the US, volumes increased by 3 percent in terms of the number of cans sold, primarily due to the success of the new low-price brand Longhorn. During the year as a whole, Swedish Match’s market share in the US market amounted to 8.9 percent, according to Nielsen data, compared with 9.1 percent for the preceding year.

Operating income declined to 1,373 MSEK (1,386). In local currencies, operating income rose by 1 percent. The operating margin was 44.6 percent (46.3).

Fourth-quarter sales fell by 6 percent compared with the year-earlier period, amounting to 725 MSEK (772), while operating income declined by 20 percent to 286 MSEK (359). In Sweden and Norway combined, volumes declined slightly during the fourth quarter, compared with Q4 2003. Volumes and operating income were also lower in North America due to the repositioning of Timber Wolf.

FOR CIGAR OPERATIONS, 2004 was a strong year, despite the fact that a large proportion of sales were generated in North America, resulting in a negative impact from the weak USD.

Sales during the year rose by 5 percent to 3,171 MSEK (3,008). In local currencies, sales increased by 13 percent.

“Both premium cigars and machine-made cigars performed well in the US. Flavored machine-made cigars showed strong growth on a full-year basis, but volumes diminished slightly during the fourth quarter compared with a strong fourth quarter in 2003. However, sales in local currencies rose as a result of price increases,” notes Lars Dahlgren.

In the European market, the volume trend varies between different countries, while the total volume was slightly higher than in 2003. The French market developed particularly well, however.

Operating income improved by 73 MSEK to 466 MSEK (393), a 19-percent increase, but was adversely affected by restructuring costs of 36 MSEK and the weaker USD.

Sales of cigars during the fourth quarter were on par with the year-earlier period and amounted to 790 MSEK (787). Operating income declined 14 percent to 83 MSEK (97).

LIGHTERS AND MATCHES had a difficult year, although some improvement was discernible for matches toward the end of the year as a result of increased export volumes and a strong trend in a few selected local markets.

Match sales during the year totaled 1,378 MSEK (1,395), a 1-percent decline. Sales volumes fell in all significant markets. An operating loss of 57 MSEK was reported (income: 83). The operating loss includes restructuring costs of 125 MSEK (30).

Sales of lighters during 2004 declined by 3 percent to 582 MSEK (599). Sales increased slightly in local currencies. Operating income declined to 7 MSEK (14) as a result of a lower average price, costs for reducing the number of employees in the European production operations and currency effects when the earnings of foreign subsidiaries were translated.

PIPE TOBACCO AND ACCESSORIES had a strong year despite falling sales volumes. The favorable result was attributable to a combination of price increases, efficiency gains and the strength of the South African rand.

Sales amounted to 901 MSEK (909). Operating income rose by 9 percent to 220 MSEK (201). During the fourth quarter, sales declined by 4 percent to 242 MSEK and operating income rose by 14 percent, compared with the year-earlier period, to 64 MSEK (56).

CHEWING TOBACCO reported an 8-percent decline in sales to 1,058 MSEK (1,146). Operating income fell 10 percent to 304 MSEK (336) and includes costs related to the launch of Firebreak in Japan. Chewing tobacco in the US reported an increase in both sales and operating income in local currency.

The Group’s cash flow from operations increased to 3,626 MSEK, compared with 2,638 MSEK for the preceding year.

“This is an exceptionally strong result, which is of course attributable to the settlement with UST,” says Lars Dahlgren. “At the same time it is satisfying to note that the company has reduced working capital to a record-low proportion of sales, and this change helped to increase cash flow by 338 MSEK.

“It is also pleasing to note that the consolidated balance sheet is stronger than ever. At year-end, we had a net debt of 527 MSEK, which is a reduction of nearly 2.2 billion SEK compared with 2003.”

The total tax cost for 2004 amounted to 1,314 MSEK (572), which corresponds to a combined tax rate of 41 percent. The tax rate increased temporarily, partly as a result of the 42-percent effective tax rate on the settlement revenue from UST. Shares with a value of 658 MSEK (959) were repurchased during the period.

THE GROUP FINANCE DEPARTMENT had several new requirements to handle during the year. Work is currently in full swing to document the Group’s internal controls. The internal controls have to be evaluated through a special testing procedure and also examined by the Group’s external auditors. The work involves adapting financial controls to conform with the regulations set forth in the Sarbanes-Oxley Act. It is necessary as a result of Swedish Match’s registration with the Securities and Exchange Commission (SEC) in the US.

“The task of fulfilling these requirements is enormous. As CFO, I can see the benefits of having more rigorous controls, but at the same time, meeting the requirements involves substantial costs, and the regulations are in many respects adapted to work methods in the US. For foreign companies, major changes to procedures are required - particularly to how they are documented,” says Lars Dahlgren.

The other major change is the transition to the new reporting standard, IFRS, adopted by the EU. This change was implemented during the year.

“As far as Swedish Match is concerned, it is mainly the new rules for handling goodwill that will be noticed in the income statements and balance sheets,” says Lars Dahlgren. “For 2004, the new rules mean that operating income reported in accordance with the transition rules to IFRS would have been 191 MSEK higher and income after tax 160 MSEK higher.”