Neptune Insurance Holdings Inc (NP) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Neenah Paper earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of today's call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

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 belief and assumptions regarding future events based on currently available information. Listeners are therefore cautioned not to put unduly 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 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 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 presentation over to your host for today's call, Mr. Bill McCarthy, Vice President of Investor Relations and Financial Analysis. Please proceed, sir.

Thank you. Good morning and welcome. With me today are Sean Erwin, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. I will briefly review consolidated results and then turn things over to Sean and Bonnie to discuss business performance and plans in more detail. Hopefully, you have all had a chance to review our earnings release from yesterday afternoon and our 10-Q was also filed this morning.

Consolidated net sales in the third quarter were US$252 million, up almost 80% versus last year, and operating earnings of US$16 million were up 55% versus the third quarter of last year. Income from continuing operations for the quarter was US$16.5 million or US$1.08 per diluted common share. This compared with US$4.6 million or US$0.31 per share last year. The current quarter included a US$8.9 million reduction in income tax expense equal to US$0.59 per share as a result of the decrease in deferred tax liabilities following a reduction in German corporate statutory tax rates. Excluding this impact and approximately US$1.5 million of pre-tax gains in both years for amortization and deferred gains on last year's Timberland sale, adjusted earnings from continuing operations increased over 70% from US$0.25 to US$0.43 per share. With sales in earnings up 70% to 80% versus prior year, and almost 80% of our revenues now paper-based, we are quite a different company that we were a year ago.

Discontinued operations, which include results of Terrace Bay pulp operations, which were divested in August of last year, generated losses of US$1.1 million in the third quarter, primarily for pension and other ongoing obligations for former Terrace Bay employees. This compared to a loss of US$19 million in the third quarter of 2006, which included costs for the curtailment and partial settlement of the Ontario pension plan.

I'd like now to turn things over to Sean.

Thanks, Bill, and good morning. As usual, let me start with a quick comment on safety, and then I'll provide an overview of business activities in the quarter before turning things over to Bonnie to review performance in more detail.

Year-to-date, our mills have a combined reportable incident rate of 2; up from 1.5 last year. In large part the change is due to the addition of acquired locations. While rates at these new sites are at or better than industry averages, they are not at the world-class levels that we are targeting and that some mills have achieved. Safety programs and initiatives are active in all of our locations and are a part of our ongoing jobs, part of our integration efforts, and part of our hourly and salary compensation programs. Working safely will always be a top priority and an indicator of our success as a Company.

Turning to financial results, paper markets this year continue to be challenged by softer demand and historically high input prices. As most of you know, in our paper businesses, the third quarter tends to be low compared with other quarters since we schedule mill down time and incur higher costs for maintenance and other expenses. Customer demand in the second half is also somewhat slower than the first half. Nonetheless, we saw no major surprises in the quarter and I am pleased with the progress we continue to make with many of our key initiatives.

In Fine Paper, it's all about maintaining and increasing the value of our brands and delivering synergies from the Fox River purchase. We said 2007 was going to be a transitional year and results would include one-time costs to integrate Fox River. Our integration efforts are on or ahead of plan, and we have a lot of the heavy lifting behind us and expect to pick up momentum as we head into 2008.

As part of the integration, we have spent a significant amount of time working through customer and distribution changes. This has not been easy, but I am confident that we are emerging as a larger company with a solid foundation and that as clear leaders in the premium Fine Paper market, we will be able to build from this to provide our expanded customer base with the quality and service which Neenah Paper has always been known for.

On a related note, the full suite of Oracle has now been live for six months and we are seeing benefits from the system with more timely and better visibility of data related to customer orders, manufacturing and supply chain, and grade in customer profitability. It has taken a lot of hard work and a sizable investment, but we now have a competitive tool that will help us enhance both service to our customers and our financial returns.

As included in our integration plan, we recently shut down paper manufacturing at the Fox River mill in Urbana, Ohio, and transferred a large majority of Urbana's output to our other mills. Between fixed cost reductions and other efficiencies, this should deliver savings of about US$4 million to US$5 million annually. A small amount of savings will start to phase-in in this quarter, but the savings will fully kick in during the second half of 2008 when converting and distribution at Urbana cease. At that point, we will also have Fox sites on Oracle and will start to realize full G&A synergies. As indicated in the last call, these are worth more than US$6 million per year.

Finally, last week we were pleased to announce that John O'Donnell joined Neenah Paper as President of Fine Paper. John was -- most recently worked for Georgia-Pacific as President of their North American retail business. His knowledge of the industry and background in consumer and branded products and supply chain make him the ideal person to lead this business.

Let me turn next to Technical Products. Our focus has been on improving and optimizing our mix and returns by investing in our more profitable businesses in faster growing markets, improving margins in other core businesses, and reducing our position in areas that may not provide adequate returns. Filtration, wallcovering, and certain specialty niche businesses, such as veneer backer durable print media and image transfer are all examples of priority markets for us. We will also continue to invest and support our position as leaders in specialty tapes and abrasives, two of our larger categories.

As Bonnie will talk about later, third quarter results showed good growth in these core markets and success in executing our strategy to improve mix. I am pleased with how our teams in the U.S. and Germany are continuing to work together to find ways to learn from each other and optimize operations and efficiencies.

As mentioned, we are investing to grow in selected markets. This year we are spending capital in Germany for capacity in wallcovering and filtration. The new headbox at our Lahnstein mill started up on time and successfully in September, allowing us to increase throughput of wallcovering and provide customers with an even better product. The new saturator line for filtration is also on track and will start up in January, providing us needed capacity to grow in this important market.

To wrap up Technical Products, while the third quarter reflected expected impacts from maintenance downs and seasonality, our businesses are tracking to deliver growth for the full year in top line and bottom line, and that is what we expect from this segment.

Let me next provide some perspective on our pulp business. While demand and pricing remain strong, the recent run-up in the Canadian dollar and current significant weakness in lumber markets make this a challenging time for pulp producers in Canada. Our teams have responded to these challenges and are delivering results. The Pictou mill is running well, with productivity up 4% year-to-date. We are carefully controlling spending and are working to ensure adequate availability of chips at the lowest price possible. We remain focused on ways to deliver value from our pulp operations, but in the interim, the mill is performing well and Pictou is contributing positively to corporate results.

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

This morning I'll start with a few overall comments. We've made a number of strategic moves over the past year and a much more balanced platform of businesses from which to grow. Our focus is now on optimizing results from these businesses.

As Sean mentioned, Fox River will deliver significant synergies in Fine Paper, and we are working to enhance our mix as we grow Technical Products. A measure of our success in these and other initiatives will be improvement in operating margin. We'll also continue to manage our assets and capital structure prudently. Returning capital remains a key measure for us and each of our businesses has clear objectives on what they need to deliver.

Next, I'd like to comment on performance for each of our segments. In Fine Paper, net sales were US$95 million in the third quarter versus US$54 million last year. The increase was essentially due to added volumes from Fox River. As Sean mentioned, we have implemented the changes in our customer distribution network included in our integration plan and we are now working as one unit. Recently we relaunched Fox Heritage Starwhite and Coronado brands as part of the Neenah portfolio.

Despite a challenging uncoated free sheet market this year, we are building upon our strength and focusing on growing niches. An example of this is in environmental papers. We are recognized as a leader in green premium papers and have expanded our eco-friendly offerings to our higher margin premium brands like Classic Crest and Starwhite, which are now produced with 100% green energy. We also recently added Carbon Neutral Classic brand offerings. Overall sales of our environmental papers have been a real success story, with volumes up more than 30% year-to-date.

Fine Paper operating income in the quarter was US$9 million versus just under US$13 million last year. We have indicated earnings in 2007 would be impacted by added costs associated with the Fox River integration. In the third quarter, these costs were close to US$2 million and primarily for expenses that are related to the Urbana shutdown. These costs will start to tail off in the fourth quarter, but we'd still expect another US$1 million to US$2 million to come.

In addition, escalating pulp prices and higher costs for transportation and other manufacturing inputs in 2007 could not be offset by higher selling prices. This represented an additional US$2.5 million of net higher costs in the quarter. To begin to recover these costs, we implemented price increases in October on many of our heritage brands. On average, the most recent increase was in the range of 2% to 3% on more than one-third of our business.

Third quarter results in both years reflect scheduled annual maintenance downs at our paper mills. And while not nearly as material as the pulp mill downs, there is higher spending and costs as a result of these downs. The impact is dependent on the length of the down and the scope of planned maintenance work, but it's not unusual for the total to be in the range of up to US$1 million per mill.

Turning to Technical Products, quarterly net sales were US$100 million; triple last year's levels. Although the largest reason for the increase was the addition of Neenah Germany, sales in our domestic business also increased due to improvements in mix and higher pricing. In fact, this was the fifth consecutive quarterly increase. The mix during the most recent quarter reflected higher sales of decorative components, image transfer, and tape. Our filtration and wallcovering businesses also had very good performance.

Operating income for Technical Products was approximately US$3 million for the quarter compared to US$1 million last year. Profits were impacted by scheduled mill maintenance downs as well as increased costs for pulp, transportation and energy that were not fully offset by improved prices and mix. In addition, there were higher expenses in the quarter as a result of a steam turbine failure at our Munising mill.

Similar to Fine Paper, we are implementing selling price increases on many of our Technical Products over the next few months. These increases average about 3% on products representing more than half of our business. Our teams have also found ways to offset rising latex costs by optimizing the levels of coating added and by working on vendor sourcing strategies.

In pulp, net sales of US$57 million were up about 5% versus last year as a result of higher prices and the absence of pulp hedge losses, which were recorded as a reduction in net sales in 2006. Shipments of pulp in the third quarter were a relatively normal 67,000 tons, but this was below the 75,000 tons we shipped last year when we were sourcing key customers out of Pictou due to Terrace Bay being down. In the fourth quarter, this will reverse, as 2007 shipments are expected to significantly exceed lower shipment levels that we saw in 2006. Also, as a reminder, our annual maintenance down was taken in October of last year and in May of this year.

Market prices for softwood continue to rise in the quarter, averaging just under US$840 per metric ton, which is up US$100 per ton or 14% from a year ago. They continue to be subject to a price cap for the remainder of this year for sales to Kimberly Clark's North American mills. The impact of the price cap was approximately $1.2 million in the quarter and US$2.5 million year-to-date. Fourth quarter impact is likely to be in the range of US$1.5 million, bringing the full year impact to around US$4 million.

In the third quarter, operating income for pulp was US$7 million. This compared to a slight loss in 2006. Both periods include about US$1.5 million for amortization of deferred gains on last year's Timberland sale, which will stop at the end of this year.

Improved profits in 2007 were due to higher selling prices, improved mill performance, and the absence of US$4 million of pulp hedging losses. These were able to offset unfavorable impacts from a stronger Canadian dollar and increased fiber costs. Year-on-year impact of fiber was about US$2 million in the quarter, reflecting both higher costs for wood following the sale of our Timberlands last year and higher prices for chips as a result of poor lumber markets and sawmill down time in 2007.

The Canadian dollar averaged US$0.96 in the third quarter versus US$0.88 a year ago. This resulted in over US$3 million of unfavorable cost translation. We had C$25 million hedged in the third quarter, representing about 50% of our exposure. These hedges were at an average rate of US$0.88 and generated a gain of approximately US$2 million in the quarter, similar to the amount of gain recorded in the third quarter of 2006.

As of September 30, we had C$17 million hedges remaining at an average rate of approximately US$0.86. The fair value or unrecognized gains on these hedges was US$2.4 million and most of those hedges will expire in the fourth quarter.

Let me turn next to some general financial items. Selling, general and administrative expense for the third quarter were just over US$20 million, which is up from US$13 million last year. The increase primarily was for additional expenses of the German and Fox River acquisitions. As a percent of net sales, SG&A continues to track around 8%, down from over 9% last year as a result of synergies and economies of scale following the acquisitions. Unallocated corporate SG&A expense was US$2.9 million, the same level of the prior year.

Quarterly net interest expense of US$6.4 million increased from US$2.8 million last year due to added borrowings to finance acquisitions and because the third quarter of last year was unusually low, due to interest income on proceeds from the Timberland sale. In the most recent quarter, we averaged approximately US$105 million of variable floating rate debt at an average interest rate of just over 7%.

We recorded a US$9 million credit to tax expense in the third quarter as a result of a reduction in German statutory tax rates from 37% to 28%. This credit reflected a reduction in our deferred tax liabilities. The expected ongoing consolidated tax rate for 2007 remains around 30% versus 37% for the full year 2006. Lower rates in 2007 result from changes in corporate structure in connection with the German acquisition and the mix of income between the different tax jurisdictions. The lower German rate will reduce both tax expense and cash payments when it goes into effect in January. Overall, we expect ongoing annual savings of approximately US$2 million to US$2.5 million. Because our income mix in 2008 is likely to change versus what we have in 2007, it's difficult to say at this point what impact this will have on our effective tax rate.

Cash from operations was approximately US$23 million in the third quarter and US$45 million year-to-date. Depreciation and amortization track in just over US$11 million per quarter, not including the US$1.6 million for amortization and stock-based comp expense. In total, these non-cash expenses will exceed US$50 million for the full year.

Capital spending was US$14 million in the third quarter and we are on track with our forecast of up to US$55 million for the full year. Similar to last quarter, we used available cash flow to pay down debt. Net debt reflecting debt less cash balances decreased US$13 million in the third quarter. We also upsized our asset-based facility to give us added flexibility for the future.

As I said in the last call, I am very comfortable with our capital structure, and the recent turmoil in the debt market has had minimal to no impact on us. Our cash flow generation capabilities and credit metrics remain strong. And we continue to have adequate flexibility in borrowing capacity to finance our operations.

Looking ahead to 2008, capital spending levels will decline as we won't have the German expansion projects. However, we will spend US$5 million to US$10 million related to the Fox River integration for Oracle implementation primarily and a couple of other smaller items. At this point, I would expect total capital spending of around US$45 million comprised of US$20 million to US$25 million of sustaining or maintaining types of capital expenditures; US$5 million to US$10 million for the Fox River integration; and the balance for projects that have been identified that will deliver cost savings, product improvements or incremental capacity.

We have been challenging our teams to deliver cost savings in all areas and they've done a nice job in identifying types of projects that can drive long-term improvement supporting our growth.

Sean, I will now turn things back to you.

Thanks, Bonnie. I'd like to close with a couple of comments about our businesses as we head into 2008.

The paper industry has had a challenging year with continued increases in pulp and energy prices, and U.S. markets that have not been particularly robust. The overall uncoated freesheet market is down more than 3% this year -- a much steeper decline than in prior years -- and while domestic Technical Products markets held up in the first part of the year, the U.S. economy, as we know, is showing some signs of slowing.

Nonetheless, we continue to make changes that will position us better for the future. Recently enacted selling price increases will help offset some of the impact of rising input costs starting next quarter. And we will continue to reduce costs through controlled spending and productivity gains. More important are some of the strategic initiatives that we are implementing that will improve margins and our competitive position.

In Fine Paper, we are executing our plan for the Fox River integration both internally, with organizational and manufacturing footprint changes and externally, with our customer distribution network. We are now the clear leader in our market and are emerging with brands, assets, and tools that will strengthen our competitive position and our financial results.

In Technical Products, we are launching new and improved products in abrasives, filtration and image transfer. Our focus on mix improvement is also yielding results. While these top line improvements are encouraging, we are just as focused on driving down cost and improving efficiencies to get margins into double digits.

In pulp, results will continue to be challenged by the strength of the Canadian dollar and the higher cost of fiber, particularly if the lumber markets remain weak. Reducing costs will be key, and our team at Pictou has shown that they have been able to do this with gains in productivity and reductions in non-fiber related costs. We will continue to look for ways to deliver value from pulp.

Last week, we had our Board of Directors meetings in Munising, Michigan, during which we reviewed our strategic plan and initiatives. We see many opportunities ahead of us as a Company and have touched on some of these this morning. We remain focused on delivering value and returns to our shareholders. Neenah Paper is a Company that generates strong cash flows, allowing us to maintain a reasonably conservative capital structure and pay a secured dividend while having plenty of financial flexibility to meet business needs and opportunities.

Driving margin enhancement in core businesses while executing our strategic initiatives will generate attractive returns to our shareholders. We did not do this in the third quarter, as our stock price declined along with other paper and forest products and small cap stocks. Our goal is to exceed these benchmarks and our long-term compensation is tied to this.

I'd like to thank those shareholders that have continued to support us and show confidence in us with their investments, and our employees who continue to have a lot on their plates but find ways to deliver on their commitments.

I'd now like to open up the call to questions. Thank you.

(OPERATOR INSTRUCTIONS). Chip Dillon, Citigroup.

I had a question regarding the Fine Papers area. Could you just review for us -- you might have mentioned these numbers and they just, they all didn't stick -- how much would you say the integration costs that you incurred hurt you in the third quarter? And how do you see the interplay between those costs trailing down over the next two to three quarters and the benefits starting to kick in?

For the integration costs, we had about US$2 million of integration costs in the second quarter, US$2 million in the third quarter, and we are expecting about US$2 million in the fourth quarter. At which point we expect to be essentially done with the integration type costs. We don't see those carrying forward into 2008. With the synergy realization, we've now communicated close to US$15 million worth of synergies. We don't see a lot of them being realized in our results yet. We have seen some of them, but the bulk of them are going to come in the first quarter and second quarters of next year. So I would say, we would be at that run rate, that US$15 million run rate type of synergies in the second half of next year.

Okay. And again, I guess that that would be US$5 million from shutting down, I think, Housatonic, and then US$5 million, I think you mentioned roughly from Oracle, and US$5 million -- what was the other US$5 million?

Yes, I did -- US$5 million from Housatonic, US$6 million from the SG&A and then US$4 million from Urbana.

Got you. Okay. And then when you look at the Tech Products, I know seasonally it's obviously a down quarter in the third. Could you tell us, was it possible that -- or was it likely that you lost money in the U.S. and made money in Germany in that product in that segment during the quarter?

No. Both businesses remain profitable, Chip.

Okay. And you mentioned (multiple speakers) --

What you're going to see -- you know, it's interesting, one of the synergies we're seeing from the acquisition -- and you'll see more of that next year -- is we're moving production back and fourth between the U.S. and Germany to one, serve customers better and two, to take advantage of the capabilities. And so we're now looking at the businesses in terms of the business units, the five business units we broke Tech Products up into. But we still get domestic and German P&L's and they're both solidly profitable.

Okay. And then I think you mentioned in the third quarter with the headbox project, et cetera. Was there anything dragging you down in the third that won't continue in the fourth in that segment in Germany?

Germany in the third quarter, as you know, tends to slow with some of the vacation holidays that take place and the maintenance we did in the third quarter. Europe in general tends to be stronger the first half of the year than the second half. December in many markets isn't the strongest month of the year in Europe. But no, Germany should not have the significant down time other than normal holiday shots, which, you know, you're not doing the maintenance costs then that they had in the third quarter. The headbox in Lahnstein started up like a champ. They're running through the grades now in the mill. But we're very pleased with the throughput improvements we're seeing.

And then lastly, when you look at the Pulp segment, I know that as these hedges come off after the fourth quarter, you're going to in effect see a substantial net increase in what your costs look like, given where the currency is. But I would also expect there would be some -- is there some benefit from the way your contracts with Kimberly Clark works? Will you start to be able to get a little bit higher pricing relative to the market?

Yes, the pricing has always been based on receipt, with a one month lag but as you may be aware, we had both a floor and a cap in the price when we had that agreement, which was really set up to protect the Corporation while we still had Terrace Bay. And which is why the floor went in. That cap comes off with shipments at the end of December. And as was said during the comments, that will be about US$1.5 million this quarter that -- so if pricing holds in January, you'll see about US$1.5 million improvement. So the price cap won't quite offset the hedges, but it's a nice offset.

Got you. Thank you.

(OPERATOR INSTRUCTIONS). Sir, it appears we have no additional questions at this time.

This may be the best transcript we've ever had. I'd just like to thank people for your participation in this call. And we look forward to talking to you at the end of -- or during the first quarter, as we talk about our progress the fourth quarter of this year. So, we appreciate your participation. Thank you.

Ladies and gentlemen, this concludes today's presentation and you may now disconnect. Good day.