Neptune Insurance Holdings Inc (NP) 2005 Q3 法說會逐字稿

Good morning. My name is Lori and I will be your conference facilitator. At this time, I would like to welcome everyone to the Neenah Paper quarter three 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (OPERATOR INSTRUCTIONS).

I would like to remind everyone that the presentation today contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect management's beliefs and assumptions regarding future events based on currently available information. Listeners are therefore cautioned not to put undue reliance on forward-looking statements as they are not a guarantee of future performance and remain subject to a number of uncertainties and other risk factors that could cause actual results to differ materially from forecast.

A more detailed description of these uncertainties and risk factors is provided in Neenah Paper's earnings release and filings with the Securities and Exchange Commission, which you are encouraged to review. Except to the extent required by applicable securities laws, Neenah Paper undertakes no obligation to update or publicly revise any of the forward-looking statements that you may hear today.

In addition, the Company may make certain statements during the course of this presentation that include references to non-GAAP financial measures as defined by SEC regulations. As required by those regulations, if that were to happen, a reconciliation of these measures to what management believes are the most directly comparable GAAP measures would be posted on the Company's w website at www.Neenah.com. I would now like to turn the call over to Bill McCarthy, Vice President of Financial Analysis and Investor Relations. Please go ahead, sir.

Thank you and good morning, everyone. With me this morning are Sean Erwin, our Chief Executive Officer and Bonnie Lind, our Chief Financial Officer. I will briefly summarize financial results for the third quarter and then turn things over to Bonnie and Sean to cover business and financial performance in more detail.

Earnings were released yesterday afternoon and hopefully everyone has had a chance to read through the announcement. Third-quarter consolidated net sales for Neenah Paper were 168 million compared to 189 million in the third quarter 2004. Of the 21 million decline, 16 million was due to lower pulp sales resulting from reduced volumes following the No. 1 mill shutdown and lower selling prices. The remainder of the shortfall was primarily from our technical paper business.

Operating income for the quarter was 1.5 million compared to 7.8 million in the same period of 2004. Principal causes of the decline in profits versus 2004 were lower pulp prices of approximately $9 million, including the impact of higher discounts on sales to Kimberly-Clark following the spin-off and cost increases of over $10 million resulting from a stronger Canadian dollar, higher prices for raw materials and energy and added corporate expenses as a standalone company. Partly offsetting these factors were lower manufacturing costs of approximately $12 million primarily of the pulp mills as a result of reduced spending and improved operations at Terrace Bay during their annual maintenance shutdown and signing (ph) differences versus 2004 for the Pictou down.

For the third quarter, we reported a net loss of 1.5 million or $0.10 per diluted common share. This reflects operating income of 1.5 million, less 4.5 million for quarterly interest expense, both net of associated tax impacts. I would also note that cash balances during the quarter increased by more than 8 million and there were again no borrowings against our revolving credit facility. I'd like now to turn things over to Bonnie to more fully discuss business results.

Good morning. I will start off reviewing each of our business segments and then provide an update on various corporate items. Net sales for the fine paper segment in the third quarter were 52.2 million, down 1% versus the same period of 2004. Quarterly volumes were down 5% driven by lower sales of unbranded special orders, which generally carry lower price points. Consequently compared to the same quarter last year, average prices were up 4% reflecting both the improved mix and the price increases implemented in late 2004 and more recently on selected brands.

Year-to-date, both net sales and volumes for the fine paper business are up 1% with unit growth in both branded and unbranded products. Operating income for our fine paper business in the third quarter was 12.3 million compared with 14.2 million in 2004. Benefits of the higher net selling prices offset the impact of lower volumes for the quarter. However, profits continue to reflect increased costs for hardwood fiber and energy as well as additional allocated corporate expenses in 2005.

We have undertaken specific initiatives to mitigate rising energy prices. One example is an expansion in our hedging coverage financial gap (ph). In the third quarter, we were slightly less than 50% hedged at an average rate of just below $6 per MMBtu. This saved us approximately $250,000 in the quarter. For the next two quarters, we are over 60% hedged at rates of approximately $7 per MMBtu, rates that are significantly below both current market rates and peak rates expected during the coming winter months.

In addition, we recently entered into an arrangement for our Neenah mill to purchase steam at significantly lower prices. Lastly, I'd like to point out that, during the third quarter, annual maintenance downs were taken at each of our mills in Wisconsin similar to last year's timing.

Turning to the technical paper segment, we had a challenging quarter. Net sales were 28.7 million, 4 million below last year, primarily as a result of lower volume. Volumes declined 9% versus third quarter 2004 with about two-thirds of the decrease resulting from tape where we exited certain low margin supply agreements. In addition, we saw a weaker demand for selected other products and lower sales of heat transfer, which Sean will discuss later. Both of these factors also negatively impacted mix.

During the quarter, installation and start up of a new headbox on one of our paper machines at Munising resulted in downtime and changes in production and customer order patterns and sales were also reduced by a onetime termination fee for an exclusive distributor of our heat transfer products. This fee was recorded as a price allowance against sales to this distributor.

Selling prices in the quarter were above the prior year reflecting increases that took effect late in 2004 as well as the surcharge for latex that we implemented during the third quarter. Although prices for specific brands and grades were up, average prices were lower than 2004 due to mix and the termination fee. The price impact of the surcharge was $600,000 in the third quarter and in the fourth quarter we expect to realize approximately a million.

Operating income in the third quarter for the technical paper business was 0.2 million compared to 4.1 million last year. Lower sales, including the impact of the termination fee, contributed to about a third of this decline with the other drivers being higher costs for raw materials, particularly latex, which increased 1.2 million for the quarter and then additional allocated overhead.

Switching to our pulp segment, net sales were 89.6 million in the quarter versus 110.4 million last year. The 19% decline in sales was due primarily to 15% lower volumes following the closure of the No. 1 mill on May 1st. Net selling prices were also lower due both to higher discount to Kimberly-Clark versus 2004 and local market prices. These items were somewhat offset by improved mix with a higher proportion of softwood and byproduct sales.

During the quarter, our sales mix was over 90% softwood, which is in line with our strategy to focus on this type of pulp. Market list prices for pulp in the third quarter were approximately $620 per metric ton for northern softwood kraft. That's 7% below last year's price of 670. Prices did begin to firm up in October and increased 10 to $20 a metric ton. But as a reminder, our selling prices to Kimberly-Clark under terms of the pulp supply agreement reflect a one month lag versus market pricing.

Our pulp business generated an operating loss of 9.3 million in the third quarter versus a loss of 8.6 million in the same quarter last year. Net selling prices reduced profits 9 million primarily due to the change in KC discounts and a stronger Canadian dollar caused profits to fall by another 6 million, excluding gains from our hedging activities.

In the third quarter of 2005, the Canadian dollar strengthened 11% to an average of $0.83, which compared with $0.75 a year ago. In addition, prices for raw materials and energy were 2 million higher year-on-year. Largely offsetting these items was a $13 million improvement in pulp manufacturing costs during the quarter. We had three major items that drove the improvement. The first, as we mentioned in the last call, we reduced the scope of our maintenance activities at Terrace Bay during their annual down and further controlled all spending during this period. This saved us more than $5 million year-on-year.

Second item, our startup at Terrace Bay went extremely well and savings, including benefits of the No. 1 mill closure, were more than $2 million.

Finally, the third item, in 2004, half of the Pictou down was in the third quarter. Whereas this year, all of the Pictou down occurred in the fourth quarter or October. This year-on-year reduction in costs for the third quarter was approximately 4 million.

So in total, we were pleased with the change in approach in execution of the down at Terrace Bay this year as it helped to offset cost impacts from a stronger currency, rising energy and rising material prices.

Now let me cover a couple of corporate items that we usually talk about. Selling, general and administrative expense increased from 11 million in the third quarter 2004 to 13.4 million this past quarter. The primary driver of the increase is administrative expenses, which continues to reflect a significant level of spending for external audits accounting services, including Sarbanes-Oxley compliance as well as the ongoing costs of operating as a standalone company.

To give you an update on our hedging program, during the third quarter, we recognized gains of approximately 3 million from currency and pulp hedges. We have continued to replace and layer in currency hedges and had over 80 million Canadian of hedges in place during the third quarter with coverage over the net six months of approximately 90 million for the fourth quarter and 60 million in the first quarter of 2006. The hedged rate for all of these periods is approximately $0.81.

We did not add to our pulp hedging position and have about 15,000 metric tons per month hedged at a price of 651 for the fourth quarter and 12,000 metric tons per month in 2006 at a price of $631. As of September 30th, the balance sheet reflected a fair value of $14 million for our hedges indicating that our future hedged rates are favorable compared with projected future rates. Currency hedges were valued at 13.8 million and our pulp hedges were valued at 300,000.

Our liquidity position continued to improve during the quarter and cash provided from ops totaled 17 million, which included a $12 million reduction in working capital. Much of this change related to timing of the pulp mill down at the end of the quarter and we would expect this to reverse in the fourth quarter. Cash and equivalents on the balance sheet grew from 37 million to 45 million and debt remained essentially unchanged with no draws against our revolving credit facility at any point this year.

Capital spending in the quarter was 7 million and for the first nine months of this year, totaled 18 million. This compared to year-to-date depreciation and amortization of 22 million. We still expect to spend close to 30 million in 2005 with the fourth quarter, including spending for the Pictou down, some ERP implementation and then smaller projects at the mills. In 2006, we are projecting spending at 40 million.

Now I would like to turn things over to Sean to cover progress against some of our key objectives and some of the other business activities.

Thank you, Bonnie and good morning, everyone. I will briefly cover businesses segment results and progress against our key objectives of growth in our paper businesses, addressing Terrace Bay's competitive position and delivering shareholder value from our pulp operations and three achieving cost savings in all areas of the Company to offset the increased raw materials and energy prices that we're seeing. I will finish up with some thoughts on our outlook for the remainder of the year and into 2006 and then we will open up the call to questions.

Before getting into the business segments, I would like to spend a moment and recognize our progress in creating a world-class safety environment within Neenah Paper. I am pleased to say that our Whiting and Neenah Paper mills have both now gone well over a year without incurring a single reportable safety incident. These are the same mills that historically had among the highest safety incident rates within Kimberly-Clark. The involvement of all employees observing our processes and making the changes necessary before problems arise has been tremendous and I would like to thank them.

Now onto our businesses. Let's start with our objective of re-establishing growth in the paper segment, which had been in decline. Clearly the third quarter was challenging on a number of fronts for companies in the pulp and paper industry. In the paper markets, AF&PA figures indicate uncoated freesheet demand declined about 6% in the quarter. Although third-quarter net sales for our fine paper segment declined a little over 1% versus last year, Neenah Paper continued to outperform the market due to the quality and position of our products and the strength of our brand.

As Bonnie mentioned, lower volumes in the quarter resulted in part from reduced sales of unbranded products, which typically are special orders with lower price points. Consequently, the improved mix helped increase average selling prices 4% over the prior year. We remain confident in the strength and the potential of our brand. The success of initiatives like the new Eames portfolio has shown that it is possible to add excitement and drive incremental volume into the premium segment.

Year-to-date, both unit volumes and net sales are ahead of last year and we are moving forward with plans in 2006 to expand into new channels and regions to continue this growth. Our technical paper business, while quarterly results were extremely disappointing, I remain positive on the prospects for this business. The investment in startup of a new headbox on one of our paper machines takes our product quality and machine capability to new levels.

Our R&D activities are accelerating and beginning to result in commercialization of sales with new products in synthetic label, medical packaging and heat transfer paper. During the quarter, we concluded negotiations with a distributor who essentially had exclusive rights to sell our heat transfer products and we now have the flexibility to work directly with large OEM customers previously handled by our distributor, which we believe will accelerate growth for these advanced products.

While the future prospects remain exciting, as I mentioned, third-quarter results clearly were not. Bonnie indicated volumes were down 9% with tape accounting for about two-thirds of the decline as we chose not to continue a certain lower price and margin order. Our strategy is to outsource the manufacturing of this type of lower margin business where we can and focus internal manufacturing on our value-added products. While the lower price tape had a big impact on volume declines in the quarter, the decrease in sales was not due just to this but also as a result of a lower price mix reflecting weaker demand in some categories as customers worked down inventories and also the previously mentioned impact from the heat transfer sales.

On a year-to-date basis, volumes are down less than 1% versus 2004 and net sales are approximately 2.5% lower, of which 80% is due to heat transfer, which we addressed earlier in this call. From a profit standpoint, the escalation in material and energy costs this year has been more challenging. Latex, which is our largest single cost component in technical paper, represents 25% of manufacturing costs and was $1.2 million higher than the prior year in the third quarter alone.

The selling price surcharge on our products, which I mentioned in the last call, has now been implemented and should deliver around $1 million in the fourth quarter to offset the cost increases. With additional rises in oil prices, latex suppliers have announced further price increases. We are working with our key suppliers to delay or minimize any increases and in addition, we announced to customers earlier this week a general selling price increase that will be effective beginning in January.

In summary, while it is clear paper markets and external conditions have been challenging this year, we remain confident both in our strategy and in our team's ability to execute it and to achieve our goal of growth in our core paper business.

A second key priority we set this year was addressing Terrace Bay's competitive cost position and developing plans to deliver shareholder value from our pulp operation. Let's start with Terrace Bay. As I'm sure many of you are aware, it's been a difficult year for the Canadian forest products industry and a terrible time for pulp mills in particular. The combination of the Canadian dollar at a 14 year high and rising cost for energy and wood, especially in Ontario, has exacerbated a situation that was not good to begin with.

At Terrace Bay, the mill team is focused on operating more efficiently following the No. 1 mill closure earlier this year and the savings they committed to are being realized. At the same time, we have intentionally been delaying wherever possible initiatives that require capital investment until we're confident that the site has an assured supply of softwood fiber at a competitive price.

In addition to internal actions, we have looked outward and held multiple discussions with other forest products companies in the region and with the Ontario government to try to develop opportunities for joint relationships that can improve costs and optimize wood flow. Suffice it to say, there are no easy answers. The situation has been complicated by the ongoing trade dispute over lumber between Canada and the U.S., which has severely impacted the liquidity of many of these Canadian lumber companies.

As I mentioned in the last call, wood cost and availability had become critical at Terrace Bay over the summer. During the quarter, we took steps to address this and we shut the mill with a lay off for two weeks prior to the scheduled maintenance down to allow wood inventories to increase to an acceptable level. We also curtailed the extent of maintenance work performed during the down. The down and reduced operations during the quarter were successful in restoring wood and fiber inventories to normal levels.

At the same time, by controlling maintenance activities and other spending during the down and with the mill starting up much better than last year, we were able to improve costs by over $7 million in the quarter. These actions were important in offsetting some of the other adverse factors in the quarter.

At Pictou, I previously indicated we were analyzing the impact if we were to sell a portion of our one million acres of timberland holdings in Nova Scotia. During the quarter, we have completed this analysis, which indicated that if we were to sell a portion of our current landholdings, we believe we could operate the mill competitively by making changes in operations to help offset the expected cost increase. We are currently finalizing these plans and we will continue to communicate with you on our progress.

I would also like to address our cost savings efforts. During the quarter, these programs were able to deliver over $10 million in savings, including those improvements from the Terrace Bay down. This is more than double the $4 million impact of higher prices for raw materials and energies during the quarter. We continue to look for and implement new ideas and, as Bonnie mentioned, we entered into an arrangement in October that will provide our fine paper mill in Neenah about 90% of the mill's required steam from a waste to energy supplier. This firm uses manufacturing wastewater solids to generate energy and will replace steam previously produced from our natural fired boilers.

So at a time when natural gas prices are increasing, we will be dramatically reducing our gas consumption and generating annual cost savings of almost $2 million with these savings starting this month.

Next, I would like to add just a few comments on our outlook. In the fourth quarter, results will include spending and other costs associated with the annual Pictou maintenance down. As we have said, these costs historically have been approximately $8 million. In addition, while there appears to be some strength -- modest strengthening in pulp prices, we have a one month contractual lag in the KC agreement and the recent C dollar rates are about at the highest level of the year and will result in higher translated pulp costs.

In 2006, raw material and energy prices are expected to increase further with energy being the biggest driver. Energy represents about 10% of our manufacturing costs and prices for most fuels are projected to increase by double digits next year. At Terrace Bay, our current electricity rate agreement will expire and costs will increase at that mill by about $4 million. While natural gas hedges in the new Neenah steam arrangement will help to offset these increases, the net effect will still be higher costs next year.

Also in 2006, we expect added non-cash administrative expenses as we begin depreciating our ERP investment and complying with new accounting rules to expense stock option. The ERP costs will be $2 million per year and option expense will probably be $3 million.

Finally, let me briefly update you on the status of our labor negotiation. We currently are in the midst of talks at our Neenah, Whiting and Munising paper mill. The Terrace Bay woodlands contract expired in June and we have now begun negotiations there as well. As you know, getting wood at a competitive cost is a key element in our overall efforts to improve the competitiveness at Terrace Bay.

In summary, I would like to reiterate that despite a challenging environment, we remain focused on the initiatives that we feel will best create shareholder value. We recently updated our strategic plan and reviewed it with the Board to confirm the direction of the Company and the underlying plans to get us there. Key areas of our focus continue to be developing sustainable growth programs in each of our paper businesses, creating value from our pulp business and delivering ongoing cost savings and generating attractive returns for our shareholders.

So I would like to thank you for your interest and in many cases, continued investment in Neenah Paper and I would like to now open the call up to questions. So thank you.

(OPERATOR INSTRUCTIONS). Mark Weintraub, Buckingham Research.

Sean, first, you indicated that you concluded you can sell a portion of the Nova Scotia lands without undermining the competitiveness of the Pictou mill. Can you give us a sense of what proportion that is?

Good morning, Mark. We're not right now ready to announce how much of our timberlands we think we should sell. Our objective and strategy is to derive, as you know, the maximum value for our shareholders in the long run, taking into account both the financial returns possible from the mill and the timberlands and we have done in effect that matrix and fixed the spot where we think the numbers should be and we are moving forward and we will announce more details as soon as possible.

And on Terrace Bay, that too is an evolving situation. Do you have a timetable for when decisions as to whether or not you would start spending the capital to push forward the cost reductions or alternately chose another route? Do you have a timetable when that --?

I think, as in the past, Mark, we have said on the capital investments that we don't think it would be appropriate. Even though these savings are real from cogeneration and chip bit (ph) screening, distributive process controls. It doesn't make any sense to spend that money if we don't have an assured supply of low-cost wood, softwood, primarily and our preference is in an all chip form. So we're not going to spend the money until we take care of the wood flow situation and the wood cost situation.

And in terms of the timing, at this time, if we don't find an alternative, I have to say there is not a plan to shut the mill. If we do believe that Terrace Bay would be unable to generate the necessary returns, we are considering all options, including closing the mill, which, as we have talked about before, we do have some legal agreements, including tax sharing of pulp supply, that we would have to take into consideration.

And also I believe that you have an underfunded pension plan and I'm curious how that plays in to any potential decision-making and perhaps if you could explain how, if you were to elect to choose Terrace Bay, how you would have to approach the pension underfunding?

Let me have Bonnie answer that question if that's okay.

As we've said, we have no plans to close Terrace Bay. But we do have underfunded pensions in Canada of between 50 to $60 million and that is about what we have had over the last several years. We are funding at a rate of -- I'm looking at it -- full year, we expect around $17 million. We have not disclosed that split between Pictou or Terrace Bay. So I would just say that it would be our expectation that we would continue funding at that rate.

Just make sure I understand the dynamics. I understand you're not making a decision to close Terrace Bay at this point. If you were to go that route, you would, I assume, have to make whole the pension underfunding and then there would be severance costs and then there would be the negotiation on the Kimberly-Clark contract and are there any other particular issues? For instance, the status of the tax spin or any other factors that one should be thinking through when trying to figure out what is the best route?

Let me answer that and you are correct when you said, Mark, that right now there is no plan to close the mill. If that is a decision that is ever reached, the analysis of the situation would obviously be done. There are legal requirements in Canada that we would expect to comply with and that would be a very difficult decision that we would make with our eyes wide open. So there would be good analysis before any decision was made. And I really can't say anymore about it at this point.

Chip Dillon, Citigroup.

First question I had was -- I must have missed something. You were going through a series of numbers of -- I think you said 13 million in cost savings that you all had achieved, yes, in pulp and I got -- the Terrace Bay is 7. I guess 5 from less maintenance and two from not having to start up the No. 2 line and then I guess Pictou I saw was 4 million and that adds up to 11. So am I missing something else?

I'll let Bonnie address some of that but before she does, do you remember that the Terrace Bay numbers are real numbers. That is a real cash savings. The Pictou numbers that Bonnie mentioned, because of the timing of the down for last year was split between the third and the fourth quarters, that really is a timing savings where it's an $8 million down cost there. Last year, we split them. This year, it will all be fourth quarter. Do you want to address the other ones?

The only thing I would say -- the difference that Chip is talking about is primarily due to reduced depreciation this year versus last year due to the Terrace Bay impairment.

Impairment charge.

That makes perfect sense.

For pulp being such -- in a difficult situation, I think that we all realize with the C dollar being where it is and with energy cost and the results -- nobody on this end of the phone is saying we are proud of the results. What we are pleased with is the actions that the teams are taking to reduce the cost and reduce the impact of a significantly higher Canadian dollar and significantly higher exchange rates. They are thinking differently. They are operating well and it is not a good situation. But during the quarter, they didn't make a bad situation worse. They covered a lot of these other things. So I am pleased with their performance but not the overall results obviously.

Got you. Now on tech papers, there were two factors that were onetime-ish in the quarter; the headbox replacement and the termination fee. What were the impacts of those two things together?

We haven't disclosed the individual amounts. In terms of the termination fee, it if it was a material amount, we would have disclosed it, had to disclose it separately and we tend to use $1 million as a threshold for that. And you are correct. It is a onetime impact on that business. Having the exclusive relationship with a distributor, it has kept us away from some of the major OEM customers and now we have the flexibility with our R&D teams to work directly with them and we continue to believe that heat transfer paper, which is our most advanced product and technical paper represents a good growth opportunity for the business and in effect, in the quarter, we cleared the deck to go get it.

And then on the headbox.

The headbox, as you know, you do have a startup curve and they went through that. The mill had a -- on that machine, it was about a 60-year-old headbox. This improves our capability. It improves our quality and the operations team has done a good job of getting through that. These are machines though, Chip, that make lots of different products and in that switch, and these are products unique to a customer, quite a few of them wanted to prequalify. They had us build some inventories just in case and so we went through a lot on that machine in the quarter. But now that is behind us. We've made the investment in Munising that was necessary and we're ready, as I said, with heat transfer. We're going to go get the business.

So is it fair to say that the impact of that was also less than a million but maybe if you added both the distributor and the headbox, it's over million?

I will let you do the math yourself but together they had a sizable impact on the quarter.

Okay. And then as we look at the fourth quarter, just to make sure we think about this the right way. As I look at pulp, you are sort of saying you're going to get a little bit of price for the lag of course because of the contract. But offsetting that, you will have, before we deal with Pictou being down, you're going to have somewhat higher I guess synergy costs. So if those hypothetically offset each other, the slightly higher price and the slightly higher cost, should we just take what you earned in the third quarter and then add 8 million to the loss due to the downtime and Pictou or is that not the right way to think about it?

No, remember we had the Terrace Bay down in the third quarter that won't happen in the fourth. So you get some of the Pictou down. You get the full cost for the Pictou down in the quarter but Terrace Bay will be running. Mills tend to run very well after they are shutdown and then you'll have to look at your estimates for the average of the C dollar versus the fourth quarter versus the third, which could be one of the single biggest impacts in the quarter.

Right. But you would probably, not to say dance and cartwheels, but you would probably be very pleased if your loss narrowed in the fourth quarter based on what we know today?

Yes.

We don't provide guidance.

We don't give guidance and I'm also not very good at cartwheels but I don't like losing money.

Got you. Now last question is -- back to the pension, you were -- it was great. You guys disclosed what your contributions are. How does that relate to what you are expensing at this point?

Chip, just for pension expense, we are expensing about $13 million or projecting that we will expense 13 million for the year.

So maybe 4 million in addition.

Just on pensions. But in the sense of full disclosure here, you've got to add pensions and OPEBs for us. So for 2005, we don't really have any contributions in excess of expense.

I see. Okay. You've got to be pretty happy with, at least as I measure it, your net debt has come down $40 million since the end of '04 and I know maybe a fourth of that alone will go the other way when you rebuild working capital in the first quarter. But that's certainly a lot more than I would have thought given what you've earned. That is basically $2.50 or so dollars, maybe even $3.00 a share when you include the dividend going out. How did you do that? Is there anything I'm missing besides the normal stuff, earnings CapEx and depreciation?

I hope a little of it is the way the management team throughout the whole Company is responding. We came up with a leadership development program early this year and have trained all of our leaders, including the operations leaders, purchasing, marketing sales, on ROIC or working capital because we've felt in the past that there are some great financial guys that knew the impact of all those guys but they are not the ones out there negotiating with customers, working with suppliers and so we have everybody focused on it. We're measuring our people based on it and they are responding. There is nothing weird or unusual in those numbers. It is people focused on this as a key priority make it happen and they are doing a good job.

It is a combination of discipline and spending. So it's discipline in not only working capital but in capital spending and our latest estimate is 30 million versus what -- we said 50 to start with. So we're pretty serious about having disciplined spending.

And last question, you mentioned your underfundedness in Canada was 50 to 60 million. Is that U.S. or Canadian?

That's U.S.

And at the rate you're funding right now, this year, are you making a dent into that underfundedness?

Chip, we were making a dent. Our asset returns have been extremely good this year. But with what is happening with interest rates, you know on the long end, they keep coming down. It just doesn't seem to make sense. So that is having an overall effect on our funded levels. So we're not making us much headway as we would expect. At the next conference call, we'll be in a position because we will know what our pension expense and pension contributions are after 12/31 of this year. So I would say at the next call we will be in a position to tell you where we think they're going to be. I don't think they're coming down.

Got you. Thanks.

Joe Stivaletti, Goldman Sachs.

I was just -- one little follow-up on the whole question on the pulp side. Earlier this year, when you closed some capacity, I believe if I understood it right, you were able to basically stop selling. You stopped having a requirement to sell some capacity to Kimberly.

Right.

As it relates to any of the current capacity that you're operating in the pulp business, is there any ability under any scenario where if you were to decide to close any of that capacity where you could walk away from supplying Kimberly or would you have to enter into a negotiation of some sort to make them whole or supply them some other way?

Our pulp supply agreement is a matter of public record and it is available through our 10-K and proxy last year at the spin-off time. The pulp situation you are referring to earlier this year is our pulp supply agreement. It has different terms for hardwood and softwood pulp. In terms of hardwood, we had the right with 90 days notice to stop supplying hardwood pulp. We discontinued it from Terrace Bay. We're still producing some hardwood, not significant quantities at our Pictou, Nova Scotia mill and we would have the option to discontinue that.

In terms of softwood pulp, that is a taker pay or supplier pay agreement. If we did not supply the pulp, there are damage clauses, a penalty of 10% of the incremental costs that Kimberly-Clark would pay to replace that pulp. So it is really based on if they can't find pulp at our price or a lower-price, there would be a penalty. But obviously it is something that we would want to negotiate with and talk to Kimberly-Clark about before anything would happen as they are our largest customer.

That's very helpful. And I just wondered if you -- net of -- or reflective of hedges and whatnot, could you give us a little bit of guidance on what we should be thinking about, your total energy bill for the fourth quarter relative to the third, what the delta would be roughly?

Costs are going up but when you look at the fourth quarter you will see the benefits of the new steam supply agreement at the Neenah mill kicking in. The Terrace Bay mill is still under an existing electrical contract that stays in effect through the end of the year. So the big delta there kicks in in January and we won't see quarter-on-quarter dramatic increases partly also due to the hedges that Bonnie talked about on natural gases. So quarter-on-quarter, I wouldn't expect a major shift and then some of it, more of it will kick in next year.

That's helpful. Thank you.

Matthew Armis (ph), Goldman Sachs Asset Management.

Just a couple quick questions trying to understand. First, if you could step through the volume decline in technical papers. How much of that was due to the headbox work or is that not really a meaningful impact on volumes this quarter?

It is hard for me to put my thumb on the headbox and say an exact number. When you are dealing with a business like technical paper, unlike let's say a tissue mill where you are running a half a dozen different grades on a paper machine or on a tissue machine, the machines that Munising may have 60 to 90 different grade changes a month and when you take out a machine and go through a rebuild and a requalification of it, it does have a fairly significant impact. When we look at net sales though for the quarter in technical paper, in total, they were down $4 million dollars. A volume of it was $3 million. Price was -- or mix was $1 million and we were positive on price by $1 million, most of which is from the latex surcharge that we discussed in the last call.

Right. Is it possible now that you have changed your distribution arrangements to talk about your order book as you headed into October? Was that firming? Did you find -- was there a lot of inquiries relative to your capacity and potentially new R&D work?

We -- obviously we don't give guidance, including start stating what our actual backlogs are but the mail is scheduled to run full. We have launched the new products. The marketing teams with working with customers have made the commitments to deliver on these and we wouldn't be working on outsourcing strategies within technical paper if we expected to have capacity-related issues. So it is what we believe is a business that we will grow and we are committed to do that.

Great. And on your fine paper segment, can you say what percentage of your production is the unbranded?

We have said publicly that, in the past, our branded business -- and this is the strength of our fine paper business, we are about 80% branded. We have superb quality and there is a lot of business out there that is below where we are. We are, as you know, pricing wise, we are in the premium segment and the sales and marketing team does a very good job of targeting that we are not going to let the unbranded outgrow and we do measure the business on average selling prices and we want to see that stable to increasing rather than jumping into more of the commodity end of the market.

Can you say whether or not Pictou is cash flow positive?

I don't think we have disclosed individual results for the pulp mills. Pictou is in much better financial shape than Terrace Bay obviously because of the wood situation that Terrace Bay faces and the fact that we only generate 50% of our energy at the mill.

Right. And talking about what could be a fairly sizable investment at Terrace Bay, is really the only major hurdle rate at this point fiber supply in Ontario or is it fiber supply and energy given the electrical rate change?

Yes. Clearly, I mean Terrace Bay, as I mentioned just a second ago, generates about 50% of its energy needs through cogeneration, which on a major mail is probably the lowest you're going to find in Canada. We have worked on alternatives for cogeneration, significant cost savings with the new programs that the Ontario government announced last month to help support the industry. We had a meeting, I think it was two weeks ago, with the Minister of Natural Resources as to the support of the government to help us with the cogeneration project. So we can deal with that but, as I said in the comments earlier, it does not make sense for us to proceed down the capital side of the path to improving Terrace Bay unless we correct a fiber situation.

We identified actually earlier in the year when we worked on it, there was really four main things we had to deal with in Terrace Bay. We had to take care of our wood situation, both the cost and the supply. We needed to improve the operations in both the mill and the woodlands and the practices that we had. We needed to -- we knew what to do capital wise and the improvements we had to make in the mill and the fourth is working with the government to get the support in areas such as allocation of wood and other regulatory involvement from them. We really need to succeed on all of them if Terrace Bay is going to hit the objectives it needs to. But we believe it is more prudent that you have to go slow on the capital side until we have confidence that we can make it on the other three.

Just two last questions. First of, the restricted payments basket, do you happen to know how big that is as of the end of the quarter?

I'm sorry. I don't understand the question.

The restricted payments basket under your bond indentures.

No. It's negligible.

And I take it that the woodlands are captured within that collateral package?

We can get back to you on that. We don't think it is significant but Bonnie why don't you get back to him on that.

Great. And lastly what would the potential use of proceeds be from a woodland sale? Is creating shareholder value paying down debt or is creating shareholder value investing in new assets?

We are not at a position to talk about that. When we announce the program, that may be an issue. We will be prepared to talk about it at that time.

Mark Weintraub, Buckingham Research.

Just the technical paper price increase in January, can you give us a sense of the magnitude?

No. We don't disclose price increases. It is unlike ones in the past where it has been customer by customer. This is an across the board price increase really with standard increases by product category. They are not all the same and that went out this week and, as I mentioned, it will take effect in January and then next call, we will be able to, once things are implemented, we will give you the percentages.

In terms of the thought process, was it largely to recover cost pressures or is there some of it also to take advantage -- for instance, looking for new business in the heat transfer paper, etc. The thought process perhaps?

We have got a real sharp marketing team and they went through it, everything from elasticity to the -- what do we want to be producing on the machines, where do we want to make our money and they came with a pretty solid proposal, including covering cost increases and we approved it and they have gone forward. And hopefully you'll see good results of it next year.

And then you mentioned that you had taken downtime at all of the fine paper mills. Should we also assume that was less than one million because it wasn't specifically identified or can you give us a sense of the magnitude of the --?

There was nothing abnormal year-on-year in terms of that downtime. And keep in mind, those mills are running on a five-day schedule as opposed to Munising or Terrace Bay that are running on, and Pictou, seven-day schedules. And so they are doing maintenance on a routine basis during the year and as much vacation period to shut the mill down for that week than it is anything else. So it is not material.

Emanuel Weintraub, Integra (ph) Advisors.

In terms of the corporate service agreement with Kimberly-Clark, does that expense there go away to offset the ERP depreciation expense that comes on?

Yes. The transition service agreement will essentially be over at the end of January 2006. Most of it at the end of December, the accounting services part at the end of January. Yes, we would expect that that is going to offset the increases, 3 million for stock option expensing and then 2 million for ERP amortization.

So it could offset both?

Yes.

Sherman Chao, Impala Asset Management.

I also wanted to ask about general capital allocation. In the CapEx numbers for '06, did you budget anything for Terrace Bay, the $40 million?

Yes. There is about 8 million, a little under 8 million of the 40 was for Terrace Bay and that is budgeted and then we will make a decision next year how much of that to spend.

So from the standpoint of the progress you would like to make, the four points you mentioned for Terrace Bay longer-term plans, did you assume that you would have progress on all four that would allow you to see the 8 million in '06?

No. There is really nothing strategic in the significant and strategic in the Terrace Bay P&E budget for next year. Keep in mind, some of that -- next year, the maintenance down will probably be a little more extensive. So there would be some capital during the maintenance down that we didn't spend this year.

But all of the Terrace Bay is what we would call sustaining.

Understood. Then that ties in -- I can't answer the same question about -- ask the same question about the proceeds.

You can. I will give you the same answer.

Well consistency counts. The final question then. There have been a lot of questions about pensions. How does OPEB fit into the equation?

I'll let Bonnie address that.

That was kind of where I was answering Chip's question that when you look at us for pension and OPEB added together, our expense and our contributions equal. But our OPEB expense is about $5 million. This year we're expected to be about $5 million this year and our payments are expected to be a little over one million.

Are the nature of the benefits under your retirement plans for OPEB, are they -- I don't know how to ask this question -- are they like the auto industry where they need to be adjusted in a meaningful way and so that the OPEB liability potential could come down significantly or are they sort of fairly standard business practice?

The one thing to keep in mind with the spin-off company -- in the U.S., in both the fine paper and the technical paper businesses and these are mills that have been in existence for, in two out of three cases, 100 years, we assume no responsibility for the retirees in either fine paper or technical paper. So we only deal with current employees who retire in the future, which is important. So we do have more retirees in Canada. The liability that we have is predominantly in Canada as opposed to the U.S. Figure three-quarters of it is in Canada.

And then going back to the discussions about -- if the decision -- the considerations over a potential closing of Terrace Bay, recognizing you haven't made that decision, how does one account for the OPEB liability? Would we treat it similar to the pension or is it not?

It's something, as I said, we don't have a plan. We haven't announced a plan to shut the mill. If it ever gets to that point, that is something that we will deal. We are well aware of what any liabilities would be and we would deal with it at that time and would hopefully discuss it.

I guess the difference is that pension is a legal liability whereas OPEB, I've always thought of that as being a discretionary liability so that I guess the --

That is a bridge that we will cross when we get to it if we get there. Right now, we are focused on trying to make some things happen.

And then just to follow-on on the previous question about the transition service costs that you had for Kimberly. The payments you're making this year is also the same amount that you are expensing this year. Was it about $8 million or so?

About 7.5 million.

So for next year, the expense will go down along with the cash payments.

Yes.

(OPERATOR INSTRUCTIONS). Brad Turpack (ph), Sigma (ph)

I think we have gone through most of the expenses. Everybody has hit you on them pretty well but I just wanted to get clear on that last year you had Q3 -- you divided the maintenance in Q3 and Q4 and the total is $8 million when it is divided evenly between those two quarters.

Pretty close, yes. This is only on the Pictou mill, yes.

On the Pictou, so it will be an incremental 4 million?

Theoretically, you are right.

So an incremental 4 million in Q4 of this year.

Right.

And then the hedges, you had a 3 million gain this quarter in the pulp business. Will that be the same next quarter assuming the Canadian dollar stays where it is? Or do those hedges go down, the hedge gains go down?

I can't say what the hedge gains will be, only you can I guess if you're going to project what you think the Canadian dollar will be. I can say that we have got about the same amount hedged in the fourth quarter as what we had hedged in the third quarter.

That rate is higher or lower?

At the same rate, $0.81.

And then that would roll off in Q1.

We are hedged -- we have a systematic hedging program where we hedge up to 75% in the shorter periods and that gradually decreases over time.

But eventually it becomes a headwind. I'm just trying to figure out when.

We are more hedged in the short months than we are in the longer months.

So next year, that could become a $12 million headwind?

I'm not sure I understand the question.

Well if you took a $3 million gain.

Again, it depends on what the Canadian dollar is but we are hedged about -- right now, the hedges that we have in place are about one-third of our exposure and we're hedged at $0.81 for next year.

Hedged at $0.81?

Yes.

Great. What was the hedge for? Where were you hedged this year for most of the year?

$0.81.

At $0.81 also?

Yes.

Just to be clear on the pulp downs, we took all of Terrace Bay in the third quarter and we will take all of Pictou in the fourth. So year-on-year, as you had said, you will see $4 million extra at Pictou this year versus last year if the historical costs are consistent and for quarter-on-quarter, you are going to see a full Pictou cost in the fourth quarter but you won't see any Terrace Bay costs in the fourth quarter. So quarter-on-quarter, it won't be that much greater.

And Terrace Bay last year in Q3 and Q4 was about how much? Was it 8 million also?

We disclosed it last year. I don't have the 2004 -- Pictou will be a full down. So what they will incur in the fourth quarter is more than what Terrace Bay incurred in more their curtailed down this year but we'll get through it in this quarter and then year-on-year next year, everything in gets to be much more normal when we do our comparison.

I just want to add when we were talking about hedging, that 3 million hedge gain isn't all currency.

Some of it's pulp also?

Right. It's about half and half.

Half and half. That makes more sense to me then. Okay. My final question was -- technical papers had been very consistent for the past two years and it looked to me like it fell off a cliff going from 30, 34, $35 million to 28 million. Is that going to come back in the fourth quarter or losing that business? Is that gone forever and this is now a breakeven business?

Good question. Tough question. The third quarter's traditionally and this goes back a number of years the weakest quarter they have revenue wise. They take their maintenance down and unlike the fine paper business, it does impact business because they run typically seven days a week. You always see a dip in revenue in the third quarter. They also sell much more internationally than fine paper and so their customers are a bit weaker in the third quarter and we expect the business to come back. We have invested in R&D. We have invested in the capabilities and we have reviewed the programs and plans that the teams have to have profitable growth in that business and now it is up to them to execute. So I have confidence that they will.

Thanks, guys. Have a good afternoon.

Frank Dunau, Adage Capital.

I got confused by the last answer. On Pictou, you spent 4 million in the third quarter and you're going to spend another 4 million in the fourth quarter on the maintenance. Is that how it works?

No.

No.

Last year --

Oh, last year.

Last year, the down straddled the quarters. This year the down is entirely in the fourth quarter.

Now I understand. When you say 5 million in maintenance expense at Terrace Bay, was that from doing it better or was that from just not doing stuff that you might have to do next year?

I think it is doing it better and also curtailing how much we did.

You made a comment about and how like the maintenance down next year at Terrace Bay would be more expensive than this year, are they related or is that just the normal cycle?

Theoretically you could say that but one of the things that I know the operations team is digging in and taking a hard look at that while the mill is running, we do have some infrastructure from the closure of the No. 1 Mill, we have access recovery capacity. We have some other infrastructure and they are working very hard from an operations and an engineering standpoint to say why do we have to take these big mega downs. Why can't we take smaller downs during the year and use some of the other infrastructure to fundamentally change the cost structure? So that will be an impact. Two, we are evaluating -- the mill always took its downs in May. Historically if you go back through the years and it was only switched to September, the third quarter, beginning -- Kimberly-Clark switched it in 2004 and we are evaluating -- do we do it again in May because, keep in mind, that is when the ground is thawing in Canada. You can't deliver the wood to the mill anyways and it is a perfect time not to be running a pulp mill in Ontario. So if we do take it in May, that is only eight months. The amount of spending would be less because the mill is in better shape after 8 months than 12.

One last question, you said you took two weeks worth of downtime at Terrace Bay before the maintenance down.

Yes.

Because of the low fiber wood coming in. After that, do you have an adequate finished goods --?

We had been hand to mouth in terms of fiber supplies and so last year. We took the mill down for two weeks, continued to get wood deliveries during that period. Ontario had a really tough situation this summer in terms of fires and which impacted a lot of the folks up there in terms of wood supply. So we took the mill down, built the inventory and regrettably everyone went on layoff during that period. Now we have an adequate wood supply at least to let us run through the winter period and right now the wet time up there where sometimes deliveries are curtailed. We're in pretty good shape.

I'm trying to figure out the impact on your finished pulp supply. The inventory of that, which you carry at the mill, did that go down or what happened --?

We worked out -- our biggest customer is Kimberly-Clark and before anything was done, we made arrangements with them. We shifted some supply to them from our other pulp mill and there was good coordination on that.

Matthew Armis, Goldman Sachs Asset Management.

Just two quick follow-ups. One is the transitional service agreement at 7.5 million a year. This quarter, did you have up and running the similar services and is it fair to say that when that duplicative cost rolls off in the first quarter of '06 that that basically accretes back?

If you mean does the whole 7.5 million accrete back --.

Yes.

I would say no because the payment that we are giving to Kimberly-Clark has slowly but surely been decreasing as we have been adding our own capability. So it is not going to be 1 for 1 but it is going to be -- we do have some added costs to replace what they were doing for us.

And the last question is the electric repricing at Terrace Bay that happens in the first quarter, did you say that was 4 million a quarter or 4 million a year incremental?

Full year.

At this time, there are no further questions. Are there any closing remarks?

Let me just make a real, real brief one. I would like to obviously thank you for your time and the questions, including the tough ones. They were good. While the current environment in the pulp and paper industry is very challenging, which we have talked about. Neenah Paper, we still believe, has many unique strengths and opportunities and I can assure you that our teams are focused on the initiatives that we believe can position the Company for the future and create shareholder value for the long term. And as always, we look forward to keeping you informed on our progress. So thank you very much.

Thank you. This concludes today's Neenah Paper quarter three 2005 earnings conference call. You may now disconnect.