Neptune Insurance Holdings Inc (NP) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by and welcome to the 2007 second quarter Neenah Paper earnings conference call. (Operator instructions)

I would like to remind everyone that the presentation today contains statements that are forward-looking within the meaning of the Private Security 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 factors that could cause actual results to differ materially from forecasts. 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 law, 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 website at www.neenah.com.

(Operator instructions)

With that, I would now like to turn the presentation over to your host for today's conference, Mr. Bill McCarthy, Vice President of Investor Relations and Finance Analysis. Please proceed, sir.

Thank you. Good morning. With me today are Sean Erwin, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. I'll briefly review consolidated results and then turn things over to Sean and Bonnie to discuss business performance and plans in more detail.

As our results show, we are quite a different company that we were a year ago, both in scale and in business composition. Net sales in the second quarter were $258 million, up more than 80% versus last year, and for the first time it reached a $1 billion annual run rate.

After adjusting to exclude gains from the sale of timberlands, operating income was $10 million in the second quarter of this year, versus approximately $16 million last year; however, this decline was essentially due to the timing and scope of our annual maintenance down at Pictou which cost approximately $10 million and occurred in May of this year versus October last year. Despite this impact, year to date earnings, excluding timberlands gains, are up almost 40%.

Net income from continuing operations for the quarter was $3.3 million, or $0.22 per diluted common share, including $0.06 per share for gains on the timberland sale being amortized through the end of this year. Our acquisitions of Neenah Germany in October 2006 and Fox River in 2007 in March have been included in results of the technical products and signed paper segments respectively.

Terrace Bay Pulp operations, which were divested in August 2006 are separately classified as discontinued operations. Losses from discontinued operations were $700,000 for the second quarter of 2007, primarily for pension obligations of former Terrace Bay employees; this compared to a loss of $10.9 million in the second quarter 2006.

Let me now turn things over to Sean.

Thanks, Bill, and good morning. I'll provide an update on strategic progress and then Bonnie will cover business and financial performance for the quarter in detail.

As usual, let me start with a quick comment on our safety performance. Year to date our mills had a combined reportable incident rate of 1.6, which is up slightly from 1.5 in 2006. These rates compare very favorably to industry averages but are not yet at the world class levels we expect. Working safely is a top priority at all of our locations and part of integration of our new sites. I'm pleased with the response to our efforts at our recently acquired sites and this will remain an area of focus at all of our locations.

Just as we stand out versus our industry in safety performance, we expect Neenah Paper to stand out compared to our industry in many areas, including quality, service, and financial returns. We are starting from a strong base and what will allow us to continue to stand out is successful execution of a strategy that delivers value-creating growth for our investors. Initially we have focused on transforming our company, building on an outstanding premium fine paper business which delivers great returns on capital and cash flow, and a technical products portfolio that has leading positions in profitable niches of growing markets. Our paper businesses remain the core of our future and I am pleased with the steps we have taken to strengthen each of them.

With the Fox River purchase, we are now the clear market leader in premium fine papers and are taking action that will allow us to deliver what we expect to be very attractive returns from this investment. The transition to a more cost efficient manufacturing footprint is well underway with a shutdown of the Housatonic, MA mill in May, and plans to stop production on the paper machines in Urbana, OH by the end of the third quarter. In addition, we are consolidating finishing operations in Wisconsin and moving ahead with our plans to outsource warehousing. Converting and distribution activities in Urbana will stop in 2008, after the finishing center changes in Wisconsin are complete.

As discussed in the last call, we already acted to combine the sales force and integrate back office functions. These steps, while not easy, are absolutely necessary to secure a strong base going forward and to deliver synergy. We are executing well, but it has taken a lot of hard work by our teams to make it happen.

In the second quarter we continue to implement changes in our business composition, brand portfolio, and merchant and distribution relationships. The transition out of the Housatonic Art Papers business has gone very well. We're moving ahead with revisions and improvements to key brands and are continuing to work with merchants and customers to educate them on the broader fine paper portfolio we now have available. For some merchants, this would include access to brands they might not have had previously.

Another area we continue to see success has been our sales of environmentally friendly products. Brands like ENVIRONMENT EverGreen are delivering impressive year on year volume growth, and our premium brands like CLASSIC Crest and STARWHITE can now also be produced with 100% green energy. Neenah is recognized as a leader in the environmentally responsible fine papers, not only by our customers but by independent entities like the Forest Stewardship Council and the U.S. Environmental Protection Agency. In May we joined the Chicago Climate Exchange and became one of a select number of companies in our industry willing to take this step, further underscoring our commitment to act in an environmentally responsible manner by reducing our carbon emissions. In all, our actions in this area are increasingly important to our customers and the design community who specify and purchase premium papers.

We also continued to dramatically move up the learning curve with our new Oracle ERP system. While the startup of any ERP system is not without some short-term pain, we are starting to see the power of the system and the data now available to us. We have begun to focus resources to strengthen our abilities in supply chain management and customer service, and expect Oracle to provide us with an important competitive advantage.

Overall, for fine paper we remain very pleased with the prospects for the combined business, are successfully executing our integration plan and confident of the value that will be created.

In technical products, increased innovation and development efforts have led to a number of new products, which in turn have also helped renewed joint development relationships with key global customers. With Neenah Germany, our opportunities are even greater due to the breadth of technologies and expertise now available. I just got back from meetings in Germany and can assure you there's no shortage of ideas, initiatives, and enthusiasm about ways to grow our combined technical products business.

As we look at second quarter and year to date results, it is gratifying to see that our strategy to grow higher value products is working and generating substantial mix improvement.

Let me add a few comments about pulp. Without Terrace Bay, our pulp segment is on solid footing and the Pictou team has successfully implemented changes that have improved operations and cost competitiveness. In fact, year to date productivity is up 5%. We continue to control our cost in local currency, and while the strengthening of the fee dollar has had an unfavorable translation impact on cost, this has been more than offset by the continued rise in selling prices.

While the mill and the remaining woodlands are important and profitable assets, pulp does not represent a growth opportunity for Neenah Paper and we will continue to look for alternative ways to deliver value to our shareholders from this segment. In June we executed our right to exit our supply obligations to Kimberly-Clark as it pertains to the Terrace Bay portion of the pulp supply contract. This will take effect starting in July of 2008. The termination does not have any impact on our financial results, but further reduces our exposure to the segment.

We recently held our strategic planning session. I think it was one of the better sessions we've had as we were able to build upon the added experiences, products, and technologies that the German team and Fox River bring us. We see a variety of opportunities for Neenah Paper to expand in premium niche markets that are both profitable and growing. This can be achieved organically, or in some cases through acquisition. I look forward to sharing more about where we go from here in the future, but our focus for now remains on delivering value by successfully completing our transformation and the integration of Fox River and Neenah Germany.

Next, Bonnie will cover business and financial results for the quarter in detail. Bonnie?

I'll start this morning with a few overall comments. As Bill mentioned, our top line continues to reflect the new Neenah Paper. Net sales nearly doubled versus the prior year, and with 80% of our revenues coming from paper.

Operating earnings for paper were solid despite the effect of purchase accounting and high pulp prices, and our pulp business is also profitable notwithstanding the timing of maintenance downs in any one quarter.

Cash from operations in the quarter was a strong $21 million. Year to date, EBIT for the first six months of this year was $39 million, and depreciation and amortization added almost $26 million more. In total, we are a company able to deliver strong cash flows and financial returns.

Next I'd like to turn to each of our segments. In fine paper, net sales were $104 million in the second quarter versus $57 million last year. The increase was due to Fox River, which was included for the full quarter. Industry conditions have been more challenging this year than in recent years, with weaker uncoated free sheet demand and a continued run-up in pulp prices. Our volumes and mix reflect these market conditions and the additional Fox River grade at lower average prices and margins.

We are benefiting from higher selling prices, with increase implemented early in the quarter both for heritage business and for Fox River branded business, and we're continually monitoring pricing for our direct and made-to-order businesses. Now as Sean previously indicated, we are also implementing a number of initiatives in our brand portfolio that will further strengthen our position in the marketplace.

Fine paper operating income was $13.2 million. That's up about $1 million from the first quarter, still short of the $15.5 million we had a year ago. Second quarter results were negatively impacted by $1.2 million due to the effect of revaluing beginning inventories for Fox River that's required under purchase accounting standards. In addition, significantly higher pulp and freight costs this year of around $2 million could be only partly offset by the higher selling prices.

Turning to technical products, quarterly net sales were $103 million, which is triple last year's level. Although the largest reason was the addition of Neenah Germany, sales in our domestic business also increased by mid to high single digits, reflecting an improved mix with increased sales of decorative components in the transfer papers and other high value products. This marks the fourth consecutive quarter of year on year sales growth for our U.S. business. In Germany, our business was also up, with gains in wall covering, tape, and transportation filtration.

Operating income for technical products was approximately $9 million for the quarter, compared to $3 million last year. Results reflected the addition of Neenah Germany and sound performance in our existing business as the improved mix in pricing were able to offset increased manufacturing costs due in part to higher pulp costs. Sean will discuss this later, but the first half is seasonally our strongest part of the year for technical products.

Finally in pulp, net sales of $52 million matched last year's level, as lower shipments in 2007 were offset by higher selling prices. Shipments of pulp in the second quarter were 66,000 tonnes. This was a relatively normal level but below the 75,000 tonnes shipped in the second and third quarters of last year when we were sourcing key customers out of Pictou due to Terrace Bay being down.

Market prices for softwood were up approximately 17%, and the average just over $800 per metric tonne for Northern softwood kraft; however, we continue to be subject to a price gap for the remainder of this year for sales to Kimberly Clark's North American mills. The impact of the price gap was approximately $800,000 in the quarter and $1.2 million year to date. There are approximately 75,000 tons in 2007 that are subject to this price gap.

In the second quarter, reported pulp operating losses were $6 million. This compared with breakeven operating results in 2006, after excluding the gain on the timberland sale. The less favorable results in 2007 were due to timing and scope of the annual maintenance down which occurred in May 2007 versus October 2006. The estimated impact of the down in second quarter results was over $10 million, which is about $3 million higher than normal, as the scope of the down was expanded to include maintenance spending originally planned for later in the year. So while our second quarter results were negatively impacted, we will see lower costs than originally planned for the remainder of the year.

Excluding the impact of the down, higher selling prices were worth about $6 million year on year, and we're able to offset the unfavorable impact of increased wood costs and a stronger Canadian dollar. Reduced losses on pulp hedges also contributed to improved profits year on year.

First, in the first quarter, in addition to the maintenance down, pulp results were also affected negatively by higher wood costs, in large part due to the depressed lumber market, and stronger Canadian dollar, which ended the quarter at $0.95. The Canadian dollar averaged $0.91 in the second quarter versus $0.89 a year ago. It is around $0.95 today.

We had $34 million Canadian dollars hedged in the second quarter, representing close to 70% of our exposure. These hedges were at an average rate of $0.85 and generated a gain of approximately $2 million in the quarter. As of June 30 we had $42 million Canadian dollar hedges remaining at an average rate of approximately $0.88. Fair value or unrecognized gain on these hedges was $2.9 million, and most of these hedges will expire in the third and fourth quarters of this year.

We recently received approval from the Ontario Pension Authority to proceed with windup of the Terrace Bay pension plan. As previously indicated, this is expected to result in a final non-cash charge to discontinued operations of approximately $40 million pre-tax when the plan is settled. Any final cash funding will be made this year and is expected to be less than $6 million, with the final amount based on a number of actuarial assumptions.

I'd like to next turn to a couple of general financial items that we look at. SG&A expense for the second quarter was $22 million, which is up from $12 million last year. The increase primarily was for additional expenses of the German and Fox River acquisitions, as well as approximately $1 million in the current quarter for acceleration of costs associated with an executive retirement. As a percent of net sales, SG&A is expected to track around the year to date level of 8%, which is down from 10% last year as a result of synergies and economies that scale following our acquisitions.

Unallocated corporate SG&A expense in the second quarter was $4.4 million, versus $2.6 million last year. The increase was due to the executive retirement as previously mentioned, as well as higher non-cash costs for ERP amortization and amortization of stock-based compensation.

Looking at interest expense, quarterly net interest expense increased from $4.1 million last year to $6.5 million this year due to the added borrowings to finance acquisitions. In addition to our bonds we averaged approximately $125 million of variable rate debt at an average interest rate of just over 7%.

Our effective tax rate was 33% in the second quarter versus 38% last year. Year to date our rate remains around 30%.

Cash from operations was approximately $21 million in the second quarter, including $7 million from a decrease in working capital as a result of increased payables and lower inventories. As expected, this offset some of the $25.4 million increase in working capital in the first quarter.

Other items impacting cash flow in the second quarter were depreciation/amortization of $11 million, capital spending of $17 million, our semi-annual bond interest payment of $8 million, and pension funding of $2 million. As a reminder, during the first six months of last year we were depleting over $40 million of working capital at Terrace Bay, so year on year comparisons are not completely apples-to-apples.

Capital spending for the year is projected to be approximately $55 million, including $25 million for strategic investments in Germany. Projects are proceeding on track and year to date capital spending was $24 million.

At the time of the Fox River acquisition we recorded as a liability on our balance sheet $10 million for expected costs associated with the exit and closure of certain operations, including the shutdown of Housatonic and the Urbana mill and sales and administrative head count reduction. In the second quarter we paid $1.6 million for these. In the second quarter we also received cash from the sale of the Housatonic Rising Art paper brand and we expect to receive additional proceeds related to sale of assets as we consolidate our business.

Total debt decreased from $360 million at the end of March to $347 million at the end of June as we used available cash flow to pay down debt. I remain very comfortable with our existing capital structure, and the recent downturns in the debt market have had minimal impact on us. Our cash flow generation capabilities and credit metrics remain strong and we continue to have adequate flexibility and borrowing capacity to finance our operations.

Sean, I'd like to now turn things back over to you.

Thanks, Bonnie. I'd like to share a few thoughts about the second half of the year, if I could. As you may recall, the third quarter is when we take our paper mills down for their annual maintenance work, and this will impact both fine paper and technical products, although the impacts are not as dramatic as a pulp mill down.

In fine paper, our focus remains on generating value through the successful integration of Fox River. In the second half of the year we will incur costs to transition grades from Urbana to other mills, which will position us to benefit from our footprint consolidation going forward. Overall, we are on track with integration activities and our outlook is unchanged, minimal net earnings impact this year but substantial value creation going forward.

In technical products we will continue to benefit from our increased scale and improved sales mix; however, with the mill maintenance downs and seasonality, particularly in Europe the second half will be weaker than the first half.

Finally, in pulp, the impact of today's higher $0.95 Canadian dollar should be offset by the recent increases in selling prices to $830 per metric tonne. So, of course, the higher prices will negatively impact on our paper segment.

In summary, we continue to ask a lot of our people and are doing the things we said we would to deliver value to our investors. Once again our teams have shown that they are up to the challenge and I'd like to thank them again and recognize their efforts. Our focus has been on successfully integrating our recent acquisitions to deliver value and this is happening, but at the same time we're keeping an eye to the future and see numerous opportunities for us to grow profitably and evolve as a company.

I'd like to again thank those shareholders that have continued to support us and have shown confidence in us with their investment, and we'd now like to open up the call to your questions. Thank you.

Thank you, sir. (Operator instructions) Your first question will come from the line of Joe Stivaletti of Goldman Sachs. Please proceed.

Good morning, Joe.

Good morning. I was just wondering, you mentioned continuing to look at options for your remaining pulp mill and the timberlands and we're aware there's a lot of value there. Was just wondering if you could expand on that at all, or possibly at least give us some timeframe? Is it something where you're actively looking to do something, or is this much -- a longer term initiative?

Yes. And as you can imagine, I'd be careful how to answer that. We do actively evaluate strategic options in that business. Timing is an important matter. I think you saw from some of the recent transactions announced this week from a comp standpoint there's still significant activity in timberlands. The pulp market remains strong and we will look at our strategic options.

Okay. And then on the technical papers side I just wondered if you could maybe dig into that a little bit just to -- I know from Q1 to Q2 we saw a little bit of decline in operating income in that business and you're saying that the second half will be a little softer because of the downtime. Maybe you could explain a little bit more about Q1 to Q2 trend, and also maybe give us some feel for when we might be able to see more momentum in that business.

Sure. Momentum in terms of the revenue growth is continuing. As Bonnie highlighted, it was up three times the prior year, and year on year the earnings are up substantially. But as you indicated, it is below the first quarter. Really saw two things. One is obviously the input costs in the business are higher both in terms of pulp here in North America and in Europe. The second item, really the key factor, is the sales mix. Even though the sales are fairly consistent quarter to quarter, we had a higher concentration of tape sales in the second quarter and less of the transportation filter media in Germany, which is on track for the year but has -- they had forecasted the first quarter would be a stronger quarter for them in terms of volume.

Yes. And I would only add that we're still up year on year fairly significantly in that business and it's not all Germany. We're seeing strong improvements in our heritage business.

Yes, the mix -- we talked a year ago about the focus in product development in areas such as heat transfer paper, and we're -- the teams are delivering on the promise and commitments that they made in those regards. So we're very pleased with where we see it heading.

So it's reasonable for us to assume that even though you might see some falloff in the second half that you talked about, that '08 we might to really start to see some of the benefits and see some good momentum on the operating income line based on what you're now seeing?

Yes, I think year on year you're seeing improvement and we continue to see significant opportunities as we integrate the German business and globalize the product categories in areas such as tape that's now being managed by a global team, as is abrasives. We're making strategic investments in Germany, as Bonnie highlighted, which will be completed at the end of the year which will support further growth in both the automotive, or transportation filter media, and the non-wovens wall covering business, both that are attractive margin businesses.

Okay. And just one final numbers questions on the pension side. Bonnie, including wrapping up things relating to Terrace Bay, what are you expecting to shell out for the full year '07 in terms of pension above and beyond whatever you're expensing on an ongoing basis in your income statement?

We expect -- did you say, Joe, including the Terrace Bay payment?

Yes.

We expect that excluding the Terrace Bay pension that our expense is going to be well above our contribution, and that even with the Terrace Bay pension that our expense should be reasonably close to what our total contributions are. And I give you the two different breakdowns because we said up the $6 million; I'd be hopeful that it would be less than that.

Okay. Great, thank you.

And your next question will come from the line of Chip Dillon of Citigroup.

Good morning, Chip.

Yes, good morning. How are you all?

Pretty good.

Okay. My first question is as we look at the second half of the year, are you going to still be shipping out of Pictou at about the 65,000 tonne rate? And secondly, could you just give us an idea of how much the wood costs are higher as a result of the timber sale last year? Like, what the run rate of that is.

Yes. I think the second half the shipping rate should be consistent. We highlighted last year when we sold the first half of the woodlands that the incremental cost would be about $6 million a year. The team is doing a good job delivering on that up there. Chip, they have seen your -- probably is plugged in or more plugged in than I am into this. We have seen some increases in the second quarter over and above the $6 million with the weakness in the lumber market.

Sawmills have -- well, combination of lumber market and the C$. Some of the sawmills in the maritime provinces have slowed down so there aren't as many residual chips available to us so we have, especially in the second quarter, had to do some of our own chipping to wood the mill. It's an impact. It's not like what you're seeing out in British Columbia and it really shows some of the strengths of the wood market in the maritime provinces. So the Pictou mill -- let's push the down aside for a moment and look at normalized operations with the current wood prices, even if we have to do more chipping; a high Canadian dollar; and with the current pulp market, the Pictou operation remains profitable.

Okay.

Even with that $6 million of incremental costs from selling the timberland.

Got you. Now looking at fine papers, I know with Fox River there was supposed to be -- we should be counting on roughly a $5 million, I guess, benefit relative to what it would have been with the shutdown of one of the mills, I think, right when you bought it, the one in Massachusetts.

Yes, Housatonic.

Yes, Housatonic. And then we also should see some benefit from the overhead reductions. However, you mentioned that there might be some transition costs moving product from Urbana. And can you just give us a feeling for how you see all those issues changing in the third quarter and the fourth quarter? I would imagine the fourth quarter you ought to see less pain and more benefit.

I think -- I totally agree with you. In the fourth quarter we should see the benefits because you're not going to flip a switch January 1 and have dramatic savings, so it has to begin to ramp up. We haven't had significant transition costs from a grade standpoint year to date. We experienced some in the second quarter. We'll see more of it in the third quarter. We had planned for this in the business plan.

Year-to-date, the teams are over-performing on what they thought the cost would be to qualify the grades. And these aren't technical grades that the customers have to approve. These are fine paper grades that we know how to make and so the transitions are pretty smooth. They have to match some colors the first run, but these are not dramatic changes. We should see -- you highlighted the savings from Housatonic from a fixed cost. You highlighted the benefits from the back office integration.

We will begin to see the benefits from Urbana with those fixed costs as the year progresses once we shut the machines down. So we'll begin to see the benefits. We won't get the full benefits of Urbana, as we said in the transcript, until early next year when we close the converting and distribution operations there.

Okay. All right, thank you.

You're welcome.

(Operator instructions) Your next question will come from the line of Brian Doyle of RBC Capital Markets.

Good morning, Brian.

Good morning. Can you just ballpark what we're talking about for dollars in the maintenance expense by group and by quarter for the next -- for the remainder of the year?

We haven't disclosed those costs in the past. We highlight the pulp mill down because it's a one-off once a year, but we haven't disclosed individual paper mill maintenance costs. It's -- when we take the downs in a paper mill it's not nearly as traumatic as a pulp mill because quite a bit of that down is when the hourly employees and salaried employees take vacation. And so what you really have is a cost of unobserved fixed cost during the down because we do maintenance on a routine ongoing basis in the paper mills, whereas the pulp mills will run 24/7 entire operation so you do it all at once. So we haven't disclosed it in the paper mills, but it's not a significant change in cost.

I mean, could you characterize it as what would be typical, rather than pinning it down? I mean, is the order of magnitude $2 million for --

If you take an individual mill, that may be a fair number, but it really depends on are you replacing a roof in a year? Are you replacing a major pipeline? So we manage it in the budgeting process every year and we know it's a reasonable expense for the mill and we hold them to their budgets and manage it during the course every year.

Okay. Just one other -- when do you expect the Q will be filed?

It's already filed.

Okay. Thank you.

And there are no further questions at this time. I would like to turn the call over to management for closing comments.

Okay. Well once again, thank you for your time. We're excited about where Neenah Paper is headed and we look forward to sharing our progress with you on future calls. So thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.