Neptune Insurance Holdings Inc (NP) 2005 Q4 法說會逐字稿

Good morning, my name is Latricia, and I will be your conference facilitator. At this time I would to welcome everyone to the Neenah Paper fourth quarter 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 managements' belief and assumptions regarding future events based on currently available information. Listeners are therefore cautioned not to put undo reliance on forward-looking as they are not a guarantee of the future performance, and remain subject to a number of uncertainties and other factors that could cause actual results to differ materially from forecasts. A more detailed description of these uncertainties and risk factors is provided in the 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 the 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 the 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 website at www.neenah.com. I would now like to turn the call over to Mr. 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 Neenah Paper’s financial results for the fourth quarter, and then turn things over to Sean and Bonnie. We’ll do things a bit differently this morning, with Sean speaking first on progress against 2005 priorities and our strategic direction going forward. Bonnie will then cover business results, and we will conclude with an update on the situation on Terrace Bay.

Earnings were released yesterday afternoon, and hopefully everyone has had a chance to read through the announcement. Since this is the last quarter we will be comparing results to pre-spin off periods, I suspect we’re all glad that this will be the final time you’ll hear my caveats that resulted following the November 30, 2004 spin off. But for old time’s sake, here are the major items. First discounts on pulp sales to Kimberly-Clark increased following the spin off, lowering both sales and pre-tax profits. The impact was $6 million for the fourth quarter, and $27 million for the full year.

Second, we began incurring higher stand alone corporate expenses; for the year we estimate the increase was close to $13 million. Third, we began incurring interest and amortization expense of $19 million per year on our $225 million of ten year notes.

In the fourth quarter of 2005 we also booked an additional non-cash impairment charge for our Terrace Bay assets. You may recall we booked a similar charge in 2004. The additional impairment in 2005 resulted from an updated assessment of probabilities and cash flows for various alternatives to Terrace Bay, following sustained losses in 2005 and increasing wood costs. Following the 2005 charge, the value of long lived assets on the books of Terrace Bay is now zero. The impact of the impairment charges was $54 million pre-tax in 2005, versus $113 million pre-tax in 2004. On an after tax basis, the amounts in 2005 was $33 million or $2.25 per share, versus $72 million or $4.89 per share in 2004.

Bonnie will cover the financial results in detail, so let me just briefly summarize a high level review of the fourth quarter. consolidated net sales were $180 million, up slightly compared to $177 million in the fourth quarter 2004. External pulp sales, net of intracompany amounts, increased for the quarter. Fine paper sales were about equal to the prior year, while technical paper also increased.

At the operating earnings level, we reported a consolidated loss of $56 million for the quarter, including the $54 million non-cash charge for impairment. In 2004 the fourth quarter operating loss was $109 million, including $113 million Terrace Bay impairment charge.

Excluding impairment charges in both years, operating results for the quarter fell by about $6 million, primarily due to higher pulp discounts, increased raw material and energy related costs, and additional costs due to the timing and length of the Pictou maintenance down. Partially offsetting these factors were increased paper selling prices, cost savings, gains on currency hedges, and somewhat lower administrative costs.

For the quarter we reported a net loss of $38 million or $2.56 per diluted common share in 2005, versus a net loss of $70 million or $4.73 per share in 2004. These figures included the impairment charges. Excluding impairment, earnings per share would have been a loss of $0.31 in the fourth quarter of 2005 versus earnings of $0.16 in the same quarter 2004, including the two months during which we were part of Kimberly-Clark. I’d like now to turn things over to Sean.

Thank you, and good morning everyone. As Bill said, I’d like to cover the progress we made against our short term objectives over the past year in addition to sharing our strategic priorities moving forward. As we’ve said, our first year focus was on the following; one, restoring growth in our core paper businesses, including reinvigorating R&D in support of technical papers. Two, assessing Terrace Bay’s competitive position and developing alternatives to create shareholder value from both of our pulp operations. Three, controlling costs, both capital and operating, and delivering savings to offset increased raw materials and energy prices; and finally, implementing the infrastructure required as a separate public company.

I feel good about the progress we’ve made in many of these areas, and it is reflective of the hard work by our teams throughout the company. Let me touch on each of these objectives briefly. Let’s start with our objective of reestablishing growth in the paper segment. In the uncoated free sheet segment, AF&PA figures indicate the market declines were about 3% last year, and even more in some of the segments in which we compete. However, our fine paper business grew sales 1% in 2005 on top of a 5% increase in 2004.

We continue to outperform the market due to the strength of our brands and our capabilities in the marketplace. In 2005 we launched our first major new brand in over 10 years with the Eames Collection, and these new products have helped keep Neenah Paper in the forefront with designers and graphic artists, while helping to generate volume and interest in premium papers. We are also pleased with what our people have achieved on pricing, which we were able to increase slightly in a very competitive market.

Our technical products business volume in 2005 increased by almost 3%, driven by growth in our tape, masking and abrasive lines. However after growing 10% in 2004, net sales fell 1% in 2005, primarily as a result of lower sales of certain specialty grades, including our high value heat transfer papers, which alone accounted for our entire decline in net sales. as mentioned last quarter, we began transitioning to a new sales model where we work directly with the large OEM customers. We’re in the process of introducing the next generation of this advanced product, and our teams are pushing to accelerate the transition. But the reality is that the development trials with large customers do take a bit of time.

We continue to focus on reinvigorating our R&D capabilities, our relationships with customers, and have begun to see new joint development agreements with customers in other indications of progress, such as the launch of new advanced Kimdura label products, a new line of multitask abrasive papers, and new Prevail fiber reinforced products. We intend to focus our assets on manufacturing these higher value products and will outsource the manufacturing of lower margin business where it makes sense.

Lastly I would mention that we successfully implemented price increases in both paper businesses in 2005 and 2006, hoping to defray increased costs of raw material and energy. Looking back over the past year, while it is clear that paper markets and external conditions have been challenging, we have had a number of successes and remain confident in the unique strengths and future of these businesses.

A second priority we set was to assess Terrace Bay’s competitive cost position and then develop and implement plans to deliver shareholder value from our pulp operations. As most of you are aware, it has been an extremely difficult year for the Canadian forest products industry, and for pulp mills in particular. We were not immune to these factors. The combination of a Canadian dollar at a 14 year high, rising costs for energy and materials, including wood in Ontario, and weak selling prices for much of the year, resulted in industry wide losses and the closure of multiple assets.

At Terrace Bay the mill teams completed a number of major initiatives. We closed the older, number one mill in May, took a totally different approach to conducting the annual maintenance down, and focused on operating more efficiently following the number one mill closure. We were able to achieve a number of new production records. As I’m sure most of you are aware, our woodlands workers went on strike on January 30, due to what we felt were necessary contract changes, and the operations at the mill had to be suspended in mid-February. I will cover more of the status of Terrace Bay later in the call.

In addition to our internal efforts, we have held discussions throughout the year with other forest products companies in the region, and with the Ontario government, to try to develop opportunities for joint relationships to improve costs and optimize wood flow. While recent initiatives by the provincial government provide some support, many of the fundamental challenges related to cost and availability of wood remain, and there are no easy answers. In the interim, we remain open to all options that could provide value to our shareholders and the recent amendment to the Kimberly-Clark pulp supply agreement provides us with additional flexibility.

At Pictou I indicated in the last call that we are focused on our analysis of selling a portion of our 1 million acres of timberland holdings in Nova Scotia, and developing plans that would, over time, mitigate the higher wood costs expected from a sale. We are in the process of determining the market value of these woodlands as well as potential terms for a sale. We will continue to communicate more as we finalize our plans.

Like the entire industry, our pulp operations lost a lot of money in the current difficult environment, but our teams did not sit still, and were able to complete a number of steps to address our long term objective of creating value from these operations.

Turning to cost savings, our teams generated over $25 million of year-on-year savings, greatly helping to offset higher prices for raw materials and energy. As I indicated earlier, the Terrace Bay mill teams in particular did a solid job in delivering a large part of these savings through productivity improvements and changes in operations. At the same time we closely controlled capital spending in 2005, especially at our pulp operations. Total spending was $26 million, well below initial projections of $40 million, and included $8 million for our new Oracle ERP project.

I’d like to briefly touch on progress made on establishing our infrastructure this past year. Overall our approach is to operate as a lean organization, outsource non-core tasks, and stretch our people to take on multiple assignments. Our teams have risen to this challenge. In January 2006 we started up the first phase of our Oracle ERP system. Not only does this provide us improved detail and timeliness of information in a consistent manner, but it will save us more than $3 million per year as we no longer have to pay Kimberly-Clark for their legacy systems and services.

The start up is progressing well and as the transition of many of these services to outsource providers. We’re starting our work on Phase II this year, which will cover supply chain and expect this to provide additional savings through improved planning, customer service and control of working capital, both internally and in support of our customers.

Now let me briefly cover some of our strategic priorities. There are three primary goals [replay gap] business mix, from Holton Paper to Principally a Premium Paper and Technical Products company; two deliver top and bottom line growth and three, providing investors with attractive and more consistent returns.

2006 is likely to be a year where we initiate a number of different actions supporting these priorities, and you can expect our teams to continue to foster a culture of making things happen. First, let’s talk about our business mix.

At the time Neenah Paper was spun in November of 2004, it was comprised of three separate business units; a very well known, branded premium fine paper business, a technical paper business and pulp operations. Half of our sales were from pulp; however all of the value and cash flows were derived from paper. As we evolve, the future of Neenah Paper will be in increasing the size and proportion of our paper businesses through organic growth and also, potentially, through acquisitions. We’ve begun to develop an acquisition strategy and criteria to help us execute this in a disciplined fashion.

A second strategic focus area will continue to be delivering organic growth in our existing paper businesses. We own some of the strongest, most admired brands in the fine paper industry, giving us a solid foundation upon which to build. We plan to drive growth through new product opportunities and expanded distribution channels, such as retail in Internet sales. We continue to work with our customers and others to help them understand the benefits of using premium papers in order to build usage in the entire segment.

Our technical paper business centers on producing a wide range of synthetic and paper-based products. Our research and development activities are now leading us in new directions, where our processes and proprietary capabilities can create values for customers and shareholders.

In fact, with the wide variety of directions available to us with our expertise in coating and saturating, you may have noticed that we have renamed the technical paper segment Technical Products. We believe the engine of growth in this segment will be our R&D capabilities and a close relationship with our customers, working with them to provide innovative new products in expertise and product supply, and supply chain management.

Prior to the spin off, these businesses were, to some extent, in a harvest mode. We can now choose where and how we invest in order to manage these businesses for profitable growth and it will then be all about executing these initiatives.

Finally, we expect to deliver attractive returns for our shareholders. We use return on capital as a key metric in our company, and this is also integral to our compensation plan. We will continue to carefully control capital spending and the ERP investment will give us a tool to better manage supply chain and drive efficiencies in this area. We’ll supplement these returns with a stable dividend. And finally, we’ll install best practices and high levels of standards of corporate governance, risk management and other areas.

We sought out a strong board of very qualified, independent directors at the spin off. While it was with regret that we accepted Jim Grosklaus’ resignation from our board last November due to personal reasons, we are very pleased that Jack McGovern agreed to join our board as Jim’s replacement. Jack’s experience as CFO at Georgia Pacific, in addition to his experience on Wall Street and in the capital markets, makes him a valuable addition.

Lastly, I would like to note that, in spite of the new processes, systems and changes we implemented to establish our infrastructure, we expect to be in very good shape with Sarbanes-Oxley in this, our very first year.

This is a relatively short summary of some of the things we’re focusing on. We expect to be a very different company in the future than we have been in the past and as a spin off and we believe this transformation can generate value for our shareholders. 2006 will be a year when things start accelerating and we expect to talk to you about our accomplishments, not our plans.

So, let me end there and turn things over to Bonnie to review how we ended the year in 2005. Bonnie?

Thank you Sean and good morning everyone. I’ll review the performance for each of our business segments and then cover a few corporate items and thoughts on 2006. Then Sean will end with an update on our situation at Terrace Bay.

Net sales for the Fine Paper segment in the fourth quarter were $55 million, essentially even vs. the same period of 2004. Quarterly volumes were down 3%; however average prices increased 3%, reflecting an improved mix and effective selling price increases implemented during the year. For the full year, sales were up 1% as volumes were maintained, despite declines in the uncoated free sheet market and average selling prices rose 1%.

Operating income for our Fine Paper business in the fourth quarter was $13 million, compared to $16 million last year. Half of the decline was due to increased costs for hardwood fiber and energy with the balance resulting primarily from lower manufacturing volumes and increased corporate expenses. For the full year, operating income was $58 million, vs. $67 million in 2004. Almost $6 million of the change was due to higher raw material and energy related costs, with the rest mainly due to increased stand-alone allocated corporate expenses.

In our Technical Products business, fourth quarter results also rebounded from the very challenging third quarter. Net sales were $32 million, up 3% from the fourth quarter of 2004. The increase was due to volumes, which were 14% ahead of prior year, driven by higher sales of Tape, Pre-Mask and Abrasive papers. These gains were partly offset by lower sales in some of our higher value products, in particular, Heat Transfer as Sean has already discussed.

For the full year, Technical Products volumes grew 3%, but sales were down 1%, reflecting a mix that included lower sales in Heat Transfer papers. Operating income in the fourth quarter for the Technical Products business was $2.5 million, compared to $4.6 million in 2004. Reasons for the decline include the less profitable sales mix, higher raw material and energy costs and increased corporate expenses in R&D. For the year, Technical Products’ operating income was $11 million. The decline of $11 million, vs. 2004, was due to higher raw material and energy related costs of $7 million, increased corporate and non-manufacturing costs of over $3 million and a less favorable sales mix. We were able to recover some of this through higher selling prices and cost reductions.

Switching to our Pulp segment, net sales were at $97 million in the quarter, vs. $99 million last year. The decrease in sales was due primarily to lower volumes following closure of the Terrace Bay #1 mill and lower net selling price as the result of higher discounts to Kimberly-Clark.

Market prices began to firm in the fourth quarter, with softwood up $10 per metric ton, vs. 2004. Softwood still carries higher prices and margins than hardwood and about 90% of our mix is now softwood. Market prices for softwood averaged near $640.00 per metric tons in the quarter, but because of the one-month lag on K-C pricing, our prices were $10 per metric ton lower.

For the year, Pulp sales declined 11% with the lower volumes, higher discounts again being the principle reasons. Our Pulp business incurred an operating loss of $70 million in the fourth quarter. This compares with a loss of $125 million in the same quarter of last year. Both of these periods included Terrace Bay asset impairment charges. Excluding impairment in both years, fourth quarter operating losses increased by $5 million, primarily due to additional maintenance costs at Pictou, where our annual shutdown was taken entirely in October this year, vs. over the September-October month in 2004, as well as higher energy costs. These factors were partly offset by hedging gains of $4 million.

For the full year, excluding impairment and restructuring costs, our Pulp segment incurred an operating loss of $33 million in 2005, vs. a loss of $8 million in 2004. Terrace Bay operating results accounted for most of the loss in 2005. Reasons for the year-on-year decline included higher discounts on the sales to Kimberly-Clark, the impact of a higher Canadian dollar, worth about $20 million, [including] hedging impact, and higher costs for raw materials and energy of about $14 million. Partly offsetting these factors were cost savings improvements, with the majority at Terrace Bay due to reduced spending for the annual down and other productivity gains.

In the fourth quarter of 2005, the Canadian dollar strengthened to an average of $0.85, as compared with $0.82 in the fourth quarter of 2004 and $0.83 in the third quarter of 2005. As most of you know, the Canadian dollar recently has reached $0.88 and each penny change impacts our pre-tax profits by over $5 million and you don’t factor in hedging gains or losses. For the full year, the Canadian dollar averaged $0.83, vs. $0.77 in 2004.

Next, I’d like to cover a couple of corporate items. Selling, General and Administrative expense was $13.6 million, compared to $16.1 million in the fourth quarter of 2004. 2004 included $3 million of transaction costs that were related to the spin off. For the full year, SG&A increased from $46 million in 2004, to $53 million in 2005. After adjusting for one-time transaction costs in 2004 and other higher spending in anticipation of the spin off, corporate expenses were up about $13 million.

While payments to K-C for transition services will be largely eliminated in 2006, we will incur our own costs to replace many of these services. Also, as a reminder, SG&A expense will increase by approximately $5 million in 2006 as a result of amortization of our ERP investment and to expense stock options. Both of these, of course, are non-cash.

Turning to our hedging program during the fourth quarter, we recognized gains of approximately $4 million from currency and [inaudible] hedges. We have continued to replace and layer in some currency hedges, although the absolute amount of hedges required is now lower due to the shutdown at Terrace Bay. For 2006, we currently had a little than C$70 million of hedges in place for quarter one and around C$55 million in the second quarter.

Third and fourth quarters each have outstanding hedges of around C$25 million. Average hedge rates for all periods are between $0.82 and $0.83. As of December 31, the fair value of these hedges was reflected as an asset on our balance sheet of over $9 million. As for Pulp, during the fourth quarter, we had an average 10,000 tons per month hedged at a rate of $650 per ton. As of December 31, we also had Pulp hedging positions in 2006, for between 12,000 and 13,000 tons a month, at an average rate of about $630 per metric ton.

As of year-end, the fair value of outstanding pulp hedges was reflected as a liability on our balance sheets of 1.2 million, reflecting higher current pulp price expectations vs. our hedged rate.

Let me next briefly cover cash flow and liquidity. As I indicated in the third quarter earnings call, we expected cash to decrease during this quarter, due to the timing of the pulp mill downs, frozen receivables following a lower third quarter and payment of semi-annual interest on our bond. Consequently our cash balance declined to around $13 million by year-end. Working capital, which increased $24 million in the quarter, was the principle driver. We did not draw against our revolving credit facility during the quarter and, as expected, our cash has again started to grow in the first quarter of 2006 from this low year-end level.

As Sean mentioned, capital spending was $26 million for the year, well below our projections that started the year at around $40 million, as we closely controlled spending, especially at Terrace Bay. 2006 projected capital spending is likely to be in the $30 million to $35 million range, also below prior estimates, in part due to the current situation at Terrace Bay. Both 2005 and 2006 include about $8 million for our ERP implementation.

Let me close with some brief comments on the 2006 outlook. Forecasts are for the Canadian dollar to stay around today’s elevated levels of $0.86 to $0.88. While pulp prices have picked up a bit recently with softwood currently at $660.00 per metric ton, most market forecasts do not indicate sustained increases, primarily due to Latin American capacity coming on line later this year. Also as a reminder, as of December 31, we have up to 13,000 tons per month hedged in 2006 at $630.00 per metric ton.

Other raw material and energy prices are expected to stay near today’s elevated levels, although it’s no longer apparent that they will increase much further. January’s selling price increases of 2% to 3% in the Fine Paper segment, and 4% to 5% for Technical Products should further help offset the energy and material impacts. And, although the lower priced end of the uncoated pre-sheet market appears to have tightened a bit recently, it is not apparent that this translated into higher Premium Segment demands.

Finally I’ll again mention that in 2006 we’ll begin booking added non-cash expenses of $5 million for ERP amortization and stock option expensing. Now I’ll turn it back to you, Sean, for an update on Terrace Bay.

Thank you Bonnie. Since our last call we have successfully settled labor contracts [replay gap] in paper mills. However, we are not able to reach agreement with our Terrace Bay woodlands workers. The woodlands workers are part of the steelworkers union, and are the employees that harvest the trees and deliver the wood to the Terrace Bay mill. In a smaller stand alone company the high losses being generated at Terrace Bay both at the mill and in the woodlands operations, have a significant impact on our company and had to be addressed. We believe that all areas need to be part of any potential solution, including our wage and benefits agreement. The union position was that we needed to accept a pattern agreement, which would have resulted in additional cost increases over the life of the contract.

As a result of this impasse, and our supplement implementation of wage and benefit reductions, the woodland workers went on strike on January 30 and the mill was shut down during the week of February 20, due to a lack of wood. We have taken an aggressive approach to controlling costs during this period following the strike, with extensive cuts in personnel and spending. Of the roughly 400 people at the mill, close to 90% received temporary layoff notices in February, and of the remaining group, most will be laid off before the end of June if the mill remains closed.

During the colder months of March and April we will continue to run a boiler and heat the mill to insure the equipment remains in operable condition. However, all other spending, including capital, has been suspended. Shipments to Kimberly-Clark will continue from inventory for the next few months. If at some point we are no longer able to meet our commitments under the pulp supply agreement, we will give appropriate notice, and this will not result in any penalties to Neenah Paper. We will continue to supply Kimberly-Clark with available volumes from Pictou and also do not expect the situation to result in any negative impact on Pictou’s operations.

In the event of an extended strike, we expect mill operating costs or ongoing costs to continue to decline as a result of lower heating, operations and maintenance needs. As a result of the significant cutbacks in spending, we do not expect these ongoing costs during the strike to have a negative impact compared to what we would have incurred by operating in the current environment. Certain one time costs will occur however in the event of a lengthy shutdown. By law and contract employees are entitled to severance, even due to a temporary layoff. If the shutdown continues an initial $8 million payment would be due in the second quarter, and additional payments of one to three times this amount may be needed to be paid later in the year. Terrace Bay’s working capital is also being depleted, and would provide a source of funding for severance and other items.

There has been a lot of speculation that this represents a permanent shutdown of Terrace Bay. We are of course looking at all options, but want to reiterate that at this point there has been no decision to permanently shut the mill. The recent pulp supply amendment provides us flexibility and would not hinder such a decision, however this is a complex matter and also requires assurance that the tax free nature of the spin off is not jeopardized. As we have said, with minimized operational spending, no capital expenditures and working capital reductions, we do not believe that we will be negatively impacted by an extended shutdown given the current economic environment.

However, our employees, their families, and the communities in which we operate are coping with a very difficult situation and we continue to try to find a solution including the possibility of selling or otherwise transferring the operations to someone that may be in a better position to extract improvements in wood costs in conjunction with their existing operations. However the difficult conditions facing not just Terrace Bay, but the entire Canadian industry, have made this option a difficult one so far.

In summary I’d like to reiterate that despite a challenging environment, we are moving forward with initiatives that we feel will best create shareholder value and build our company in the long run. 2006 is likely to be a year of many changes at Neenah Paper as our story continues to unfold. I’d like to thank you for your interest, and in many cases investment, in Neenah Paper, and I’d now like to open the call up to questions.

[OPERATOR INSTRUCTIONS]

The first question comes from the line of Chip Dillon with Citigroup.

Yes, good morning. First question, I just wanted to ask you about the – you were mentioning how you were dividing the tech papers into sort of the low margin/high margin. I just want to make sure I understand that. The high margin again would be the heat transfer papers, and the low margin would be like the adhesive, masking and abrasive, is that a fair way to look at it?

It is, but we really refer for the most part Chip, to high value, with the price ranges in technical products we measure things typically in square yards, and it can go from $0.10 a square yard up to $2.00 a square yard. When you think of the curve, we can make margins throughout the curve, but typically the more advanced the product, the more proprietary the coating, the number of coatings, really the less commodity oriented it is the better the margins for us. So we’re really focused in areas such as jeans labels, heat transfer products, synthetic films, abrasive papers that bring both a higher sales value and correspondingly higher margins.

OK. Then I know that volume mix and the price change is I think 2% to 3% and 4% to 5% was that just to clarify in fine and tech products, were those first quarter ’06 versus first quarter ’05? Is that what you meant by that?

Yes, we implemented those effective January 1 of this year and it’s a little different, as you know the businesses, in fine paper where it’s a branded business you can come out with a price increase, in effect a general price increase; whereas in tech paper, because of the number of products and direct relationships with customers, in some cases it’s a one off negotiation. But we successfully implemented it in both business units.

But that would sound sequential like that was what it was from December to the first quarter. Is that actually the way we should look at it?

Yes.

OK, and then you mentioned Cap Ex would be $30 million to $35 million this year, how much in the budget is for Terrace Bay?

We don’t disclose spending by mill location. We do cover major projects at mill and as you’re aware, pulp mills tend to be more capital intensive than our paper mills, especially our fine paper mills where we have a very young asset base.

I guess I’ll ask it this way, if the strike were settled tomorrow and the mill ran for the rest of the year, would your Cap Ex go up from $30 million to $35 million?

Chip it would be more toward the higher end of the 35, so that 30 to 35, if you ran Terrace Bay longer would be closer to 35, and if you didn’t run it, it would be closer to 30.

OK. Then last question, how much did the Pictou downtime cost you this quarter?

It’s hard to really pin that down exactly, but we feel it cost us about $10 million.

So that was actually a little more, because I know on the third quarter call you said 8, was there something that – I mean how long was it down for?

The down was extended, and let me just be clear, it’s about $10 million in the income number, it’s about $7 million worse than what it cost us last year.

On the quarter a couple of things happened, Chip, one last year the down was split between the third and fourth quarter, this year it was all on the fourth. And two, they were doing the down when the hurricane hit along the east coast, and it made, very candidly, for somewhat less efficient down because you had to take the cranes away and other scaffolding equipment, and they had to bring pipes in and other items by hand and move them up to the mill, and it extended the down probably I think two to three days due to the weather.

So all in, how many days was the mill down?

I think it was about 12 this year rather than the planned for about nine.

Is there any indication, is it fair to say that if you take away the $10 million the segment loss was about 6.5, is it fair to say that the remainder of that loss was all Terrace Bay?

As I said, especially when you look at the year, most of the pulp loss was Terrace Bay.

Then that’s the year without the charges.

Including impairment.

OK, thank you.

Your next question comes from the line of Josh [Gress] with Gress Asset Management.

Good morning. Sean I guess this question is for you. You mentioned that you did about $25 million in savings, mostly from Terrace Bay, over the year. I’m just wondering is it fair to say that management really had to focus the lion’s share of its time on stemming losses from the pulp operations and that up until this date it’s been such a distraction that it’s really hampered efforts at growing and improving the paper segments.

I guess you could say that, but we have a lot of faith and respect for the business teams that we have in the paper businesses, and they’re very strong individuals. We had very clear objectives, we got together as a broad management group, about 30-35 of us a few times this year, and we know that we’ve got to grow those businesses. So I wouldn’t say that the issues that they’re facing is because a handful of us sitting here are not paying attention to them and that we’ll be a lot better once we resolve pulp. We’ve got a focus team and now it’s a matter of executing. They have very strong objectives for this year, and we expect that they’ll deliver on them.

But surely with Terrace Bay shut down it seems like it opens up some time on your side to – or it’s less of a distraction than it would have been last year, which would lead to just more focus on the other two segments.

As we talked about our strategy going forward, we do expect to change the mix from the 50/50 pulp and paper to predominantly a fine paper and technical products company. So to make that happen, yes, it will receive most of the focus.

Can you give me some color on what it takes for Pictou to be profitable, maybe sort of what Canadian dollar level, what pulp price, what natural gas price is required to see positive numbers from that mill?

We don’t typically disclose that, the Pictou mill is a competitive pulp mill and it always has been, I think as we’ve said publicly in the past that it tends to generate cash in almost any environment. Granted we had somewhat of a perfect storm scenario last year, no pun intended, with the hurricane, but it is a competitive operation. What the team there is doing a good job of is saying and determining what do we need to achieve in the mill to make it a strong viable operation even if we proceed with monetizing a significant portion of the woodlands to capture the value that’s intrinsic in that. And they’re looking inside the mill in terms of what do we need to do to improve our chemical costs, our maintenance costs.

One of the big steps last year is in the labor agreement that was negotiated and agreed upon earlier in the year. There were some significant steps taken in agreements in terms of maintenance flexibility that is improving the operation. As an example, the Pictou mill operated through the Christmas holiday last year, which is something that the mill had never done before. So, we’re seeing the sort of flexibility we think we really need to be successful, even if we monetize some of the trees.

Is there any way to do, like, a logging operation and to sell logs from those timberlands, in addition to using those logs for the pulp operation?

No, actually and it’s why the Pictou operation is in much better shape, in that, there are no logs that come to the Pictou pulp mill. One of the reasons that they’re lower cost is all of the work is harvested from our timberlands, which is done by contractors. Those go to saw mills and other higher value users and we exchange that wood for an equivalent amount of chips that are delivered to the mill. So, we start at the gate with the much lower costs than we have at Terrace Bay, where 50% of the fiber used in the mill is delivered in the tree-length form, which I believe is the highest cost or highest level within the industry in Canada.

Your next question comes from the line of Mark Weintraub, with Buckingham Research.

Good morning, Sean. First, I just want to follow up, you’d mentioned there were $8 million severance payment in the second quarter, related to Terrace Bay. And then, if I caught you correctly, you said one to three times that amount later, potentially, in the year. Is the high end, is that what the total severance outlays would be if the mill were to be shut permanently?

It most likely wouldn’t be above that. It depends on the length and other situations, there, Mark and we, as you could guess, we’ve looked at this from lots of different standpoints. We have a pretty good idea as to what the costs would be in various scenarios, but at this point, it’s probably appropriate just to say that we have our arms around it and to not disclose anything in detail. No permanent decision has been made at this point to close the Terrace Bay mill.

Totally understood. I guess, just from the perspective of understanding different scenarios, I guess it’s important for us to have an understanding of what the various costs entail, different routs with the [replay gap]. And, I guess, while I understand you probably don’t want to get specific either, could you help me understand - .

We can [dimension] that the numbers that we had in our transcript are pretty much the worst that we would expect, if Terrace Bay did not come back up.

OK, terrific. And then, would there also be any pension related issues that would need cash to resolve them? Or, would those be non-cash?

Those we’ve discussed in the past, our pension funding program in Canada, where it was under-funded at the spin off. And we would expect that to continue in the future, no matter what the situation is, but that’ll be extended, Mark, over a number of years, as opposed to one lump sum. So, it really is the same if we operate, or if we don’t.

Yes, and the only thing that I’d add to that is, as I previously said that in 2003, 2004, we were under funded by about $50 million to $55 million. In 2006, that number has increased to about $75 million, due to decreasing interest rates. And we’d say that a little less than half of that is associated with Terrace Bay.

OK, thank you. Shifting gears, Sean, you indicated that, I believe the terminology you used is a significant portion of the woodlands in Nova Scotia -.

Ah, I shouldn’t have said the word. I’m sorry. You know, before you asked the question, Mark, you know I’m not going to tell you how much. But, what the team has done, you know, the team was given the challenge, and I think, did a very good job of saying, “Where’s the sweet spot? How much do you really need to own?” And it’s obvious, or I think it’s obvious, that it’s not 100% integration. And, how do you use your scale and size to leverage that and still have an efficient operation? And, I apologize for using the word significant.

OK, and then, can you give us a timeframe, when decisions might likely be made? Or, is that still too open ended at this point?

Well, it’s open ended, but as I said in the comments, I know there’s strong interest in this from our shareholders and we’re trying to be as expeditious as possible.

OK, thank you, Sean.

Our next question comes from the line of Joe Stivaletti, with Goldman Sachs.

It’s actually Dave [Goupal] on the behalf of Joe Stivaletti. I just have a couple of questions for you. Going back to [Chip’s] question on the pulp operations, I mean is it safe to say that if we sort of looked at, if Terrace Bay was down for a while, that even if it was down for the strike in the full fourth quarter, and you take out the Pictou down time that they operated, they would not have had an operating loss in the quarter?

Would not have had an operating loss? I’m sorry; I think that one’s too much speculation for me.

Yes, and I guess I mean, is there any sort of more color on that? I mean, I guess it was asked previously about the timing. I mean, is this going to be a 2006 event on the sale of timberlands? Or is it, I mean, just some sort of general time span for us to kind of look for an announcement there.

We began the analysis last year, and I think we talked about it in the third quarter for the first time. And, we haven’t been specific as to the date and I’d rather not speculate on it, on the timing. But, we do know that there is a strong interest for us to be able to say what we’re going to do. And so, as soon as we can we will. I wish I could say more, but that’s all I’ve got right now.

I appreciate the comment though. Thank you.

Your next question comes from the line Frank Dunau, with Engage Capital.

I have just one more question on Terrace Bay. You know, in theory, if it shuts down permanently, are there any environmental costs associated with that? Do you have to clean up anything or that?

We did, prior to the spin off, there were [replay gap] Phase I environmental assessments done at Terrace Bay. And, it is a mill site that’s been operating in Canada for a number of years. However, as I think you know, and Kimberly-Clark has a well-deserved reputation for environmental stewardship and operated it in best-in-class status for a number of years. We continued that with a commitment last year, so there may be, but I think we would have our arms around what that would be prior to any permanent decision.

Right. And one last question on Terrace Bay, if the woodworking, woodland workers decided to stop the strike, what happens?

We, as we’ve said repeatedly, we don’t talk about our bargaining and next steps publicly, or in the press. So, I’d rather not speculate on that.

All right, let me word it differently. If there’s an agreement – they’re not your workers, right?

No, they are.

All right, they’re not bargaining with you?

Yes they are.

They are? [Inaudible].

They’re represented by the steelworkers union, but they are our employees, and we pay them directly.

So they are your employees?

Unlike Pictou, where it’s contractors and has been for a number of years.

So these are your employees?

Yes.

So, if you were to reach – all right. I guess you can’t talk, never mind.

Your next question comes from the line of Chip Dillon, with Citigroup.

Hi, what was the Pulp; you probably said this, Bonnie. I’m sorry. What were the Pulp volumes for the full year percentage change, sales?

Oh, let’s see. My volumes for the quarter were down 4% in Pulp and down 11% for the full year.

For the full year, OK. And then, on the pension, you mentioned that, I think the question was the under funded, is that right, that were, well you mentioned – I’ll let you tell me. What was that, $75 million, and was that C-dollars or U.S. dollars?

They were U.S. dollars. It was $75 million; it was on a PBO basis. And on an ABO basis, our pension plans are funded, but on a projected benefit obligation basis, they’re under funded. And so the under funded level I gave you, of about $75 million, puts you in the low 80% as a percent funded to the PBO obligation. And so what I had on that was a little under half of that is related to Terrace Bay.

So, I’m just going to make up a number. Let’s say a little under half of that is, like, $30 million, or $35 million, U.S., or for any – well, I’ll [inaudible] more generically. If some of that PBO is tied to an operation that you shut down, you’re not necessarily on the hook for that full amount, day one? Is that fair?

Chip, we’re not on the hook for it, day one, but we’re on the hook for it over a period of time.

And is it possible – let’s say that, you know, you have to pay out this $8 million and then another $24 million. Could some of that be paid out of your pension fund? Or, would it have to come out of the company’s cash?

It would have to come out of the company’s cash.

OK, but would that -.

Pension funding, though, would come out of, ultimately, it would come out of the pension fund. But, inasmuch as we’re under funded, the company would need to contribute.

Well OK, I’m not sure if I understand you; let’s just say that the ultimate payments of $32 million, would all of that come out of the company’s accounts? And, if it did, would it reduce your PBO?

I’m not sure I understood your question, but are you saying, would the company have to fund the pension plan for the amount of the under funded-ness in the event Terrace Bay did not start back up?

Yes.

Yes.

But I guess what I’m asking is, so you’d have to pay – let’s say you’re under funded by $30 million. You’d have to pay that plus this $8 million, plus one to three times that?

Yes, except the pension under funded-ness, you would not be paying immediately. That could take up to five years.

OK, OK. So maybe a way of looking at it, just so we’re clear, is that – you know, if the mill doesn’t, hypothetically, you know. Anything can happen, but if hypothetically it didn’t come back up, you could possibly be needing to pay $32 million out of your pockets this year, let’s say, and then another whatever, a little less than half of this $75 million, is over the next, following five years?

Yes, if you took the severance times the three times, then you would get up to that number, and then, yes, you would have to fund the pension plan over time by that amount.

Would there be a tax – I mean would you be able to deduct that on your corporate tax return?

It would hurt [replay gap] certainly hope so.

OK. Thank you very much.

Your next question comes from Matthew Armis, Goldman Sachs Asset Management.

Good morning, just a couple quick questions. You’d mentioned, mentioned in the release, an intent to go on the acquisition trail. If you could talk generally, and strategically, as to what you would like to acquire, what grades, what markets and if you have anything in the pipeline?

Obviously, we wouldn’t speculate if we did have anything in the pipeline. But we would expect to focus on leveraging our existing strengths in the premium paper markets and in the technical products areas. We have unique strengths in each of them and we also know where there are growth opportunities in each and we’d build on that.

We’ve defined a strategy and criteria and would move forward in a disciplined fashion. I would say that, you know, with the number of mill closures that have occurred in North America and elsewhere, we’re not going to jump in, opportunistically, just because some assets are inexpensive because a mill is closed. In the long run, we don’t think that that’s how you will generate shareholder value. So, we expect to build on our strengths strategically.

If you were to make acquisitions in the fine paper segment, for example, would that be focused on buying brands? Or, is it more of buying mills?

I’ll tell you what; as soon as we move down the road and if we make some decisions in that regard, we’ll be very pleased to talk about the rationale, when we make that decision. But, you know, I don’t want to speculate at this time.

Great, and could you talk briefly as to your target capital structure, especially since you have potential for land monetization? Is that – proceeds would that be a share of debt reduction as well as funding into acquisition? Or, are you primarily doing that capital to be redeployed in new assets?

Bonnie, do you want to address that please?

You know we’d like to see our capital structure get a little stronger, but all of our debt is, when we issue it in any way, 10 year fixed. So our first choice for our proceeds from Pictou would be to redeploy it, either in our operation or into an acquisition.

And last question, to the extent that you can, can you talk to the relative magnitude of the Pictou operating loss for the year? Is it slightly negative, is it very negative, is it break even?

We don’t break those out separately, but I did say in my commentary that substantially all of the loss for the year in pulp was Terrace Bay.

Great, thank you very much.

Paul Quinn with Salmon Partners.

Thanks. Can you just walk us through the changes to your pulp supply agreement with Kimberly-Clark?

The agreement by the way is a matter of public record, and if you can’t access it let us know and we’ll lead you to it so you can see it in detail. But there were several changes to it, one is Kimberly-Clark gets the right, has one time relief, this is prior to the mill shutdown, they get about 50,000 tons of annual commitment in relief because they felt a need to have some flexibility from sourcing. For that, from our standpoint, the contract now includes a termination clause, which it didn’t have before, so we can give notice to Kimberly-Clark that we would intend not to operate the Terrace Bay mill. Those are the two major changes.

The other change would be if we do give Kimberly-Clark a [inaudible] notice, if the mill subsequently starts up they get some flexibility and they don’t immediately need to take the output from the mill. But the key ones are we have a termination notice and for that we gave them some one time relief up front of 50,000 tons, which is, candidly, one of the reasons why we have some inventory at Terrace Bay and we’re continuing to ship it. But from a financial standpoint that really isn’t a negative for us, because we’re selling into, at least into the short run, a rising pulp market.

OK, is there a cost for that termination clause?

No.

OK and just going over, just Pictou here, you described it as competitive. Would it be competitive without the benefit of the surrounding woodlands?

Good question and it’s the study that the mill team went through last year and they question I gave them was, “If we monetize a portion of the woodlands what do you have to do to remain a competitive viable operation?” And the team came back with a program that we’re embarking upon. Part of it is, as I think we’ve said before, we may take a portion of the proceeds, it wouldn’t be a major portion of it, and use that to upgrade the process within the mill to reducing things such as the chemical cost in the mill, and a combination of process changes and some of the flexibility that we mentioned a little earlier, we believe that it can be a very viable operation.

All right, and just lastly on a potential shutdown at Terrace Bay, you mentioned this $30 million to $35 million total severance bill, and you talked about the Phase I environmental assessment. Just to try to get a range of those environmental cleanup costs, is that approximately what severance would be?

Bonnie gave some good numbers and fairly clear ones, let me repeat. There is no decision at this point to permanently close the Terrace Bay mill, and when we do reach a decision, and I mentioned earlier some of the caveats as to when we can and what we wouldn’t do, when we reach a decision we will follow our typical practice of being as transparent as possible in providing you the information. But at this point I’d rather not speculate any more. I hope you don’t mind.

Your next question comes from Josh Gress with Gress Asset Management.

I think there’s a lot of questions because there’s a lot going one. Just one more question, you said that you would use some working capital from Terrace Bay to pay severance payments, and just curious as to what type of assets you could sell to sort of create some cash for those payments.

You know it’s interesting when you look at a pulp mill, a significant amount of spending in any large pulp mill is always looking forward, you’re building roads that you may not use for a couple of years; you’re doing certain long term major maintenance, and with the lack of progress on the negotiations we felt it was prudent to be prepared for a potential work stoppage and the potential resulting mill closure due to a lack of fiber. Our teams here and at Terrace Bay I thought did a lot of good appropriate work and were prepared to quickly take action to minimize the impact on the company. It’s areas like as we began depleting all of our raw materials, the fuel oil, the chemicals, so on and so forth.

The big driver is our accounts receivable. We’ll collect all the accounts receivable and our finished good pulp inventory rather than fixed asset sales.

OK thank you.

The last question comes from the line of Mark Weintraub with Buckingham Research.

Last question Mark, I’m sure it will be a good one.

On the corporate expense Bonnie, can you give us what the total number for ’06 might come out to relative to the $6.5 million that ran through the statements last year?

Normally we really don’t guide but for 2006 the one thing I’d say is we have increased costs that are going to be related to stock option expensing that we didn’t have before, and we’re going to have the increased costs related to ERP amortization, that’s $5 million. We’ve said that our transition service cost was around $7 million, and we expect about half of that to go away and the other half of that we’re going to have to just use outside service providers for like our IT.

OK so it goes up a couple of million, but cash actually goes down a couple of million, that’s the way to think of it?

That pretty much sounded like the math would work that way.

OK, great. And just on the deductibility of the severance and the pension, in the scenario that there was a shutdown, would that reduce your cash tax outlays or would that go against deferred taxes, and just affect the book taxes?

Severance would go against our cash taxes.

OK. And that does it, thank you.

Good. Well I’d like to thank you again for your time and your questions; they were good ones as usual. As we’ve said, 2006 is going to be a busy year, but it’s also going to be an exciting one for Neenah Paper, as we expect to complete actions in support of our strategic priorities, which if you recall, were transitioning from a pulp and paper company to a company with a portfolio of highly oriented premium paper and technical products; delivering top and bottom line growth in our core paper businesses, and providing our shareholders with attractive returns through careful management of capital, a reasonable dividend and other initiatives.

So I look forward to communicating to you as we progress on these plans and our initiatives during the year. So thank you very much.

This concludes today’s Neenah Paper fourth quarter 2005 earnings conference call. You may now disconnect.