Neptune Insurance Holdings Inc (NP) 2009 Q3 法說會逐字稿

Good morning. My name is Rebecca and I will be your conference operator today.

At this time, I would like to welcome everyone to the third quarter 2009 Neenah Paper, Incorporated earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions).

I would like to remind everyone that the presentation today contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect Management's belief 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 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 security laws, Neenah Paper undertakes no obligation to update or publicly revise any of these 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 will be posted on the Company's website, www.Neenah.com.

I would now like to turn the call over to Bill McCarthy, Vice President of Financial Analysis and Investor Relations.

Thank you and good morning everyone. Welcome to Neenah Paper's conference call and third quarter results.

With me today are Sean Erwin, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. Our earnings were released yesterday afternoon and our 10Q was filed as well. I'll recap a few items before turning things over to Sean and Bonnie to review financial performance and business results and details. Afterwards, we'll be happy to answer any questions.

We were pleased to report adjusted earnings per share of $0.29 for the quarter. This was significantly higher than both adjusted earnings of $0.21per share reported in the second quarter, and $0.18 per share reported in the third quarter of last year prior to the economic downturn. As a reminder, adjusted earnings is a non-GAAP measure and a reconciliation to GAAP was included in our earnings release, which is posted on our website. Adjustments were made to exclude additional tax expense of $1 million this quarter, primarily for interest arising from audits of prior year tax returns, $3.5 million in the third quarter of last year for pre-tax gains on Fine Paper asset sales, and a pre-tax charge of of $18 million last quarter when we closed our Fine Paper mill in Ripon, California.

With that I'll turn things over to our CEO Sean Erwin. Sean?

Thank you, Bill. And good morning everyone.

As you saw last night with our release, third quarter results were very good and showed the success of our efforts to reduce costs, improve margins, generate significant cash flows and pay down debt. At the same time we maintained our focus on increasing share with key customers. These actions will further benefit us as market conditions continue to improve.

Let me touch on a few highlights and then discuss each of our segments. Third quarter consolidated sales of $150 million increased 11% versus the second quarter. Markets began to stabilize mid-year and we no longer see impacts from destocking at customers. Therefore, as end-use demand began to pick up, it flowed through the supply chain, although customers continue to control inventory levels tightly. Adjusted EBIT of over $10 million in the quarter grew 37% from the second quarter and was also up 17% from the prior year. Improvements were realized in both business segments, and reflected the hard work and success of our teams in reducing costs as well as the benefits of lower input prices and higher volumes. Operating margins continued to improve. Fine Paper was above 15%, and technical products increased to 6% of sales, the highest level since first quarter of 2008.

Finally, we generated significant cash flow which we continue to use to delever. Debt was reduced $15 million in the quarter, bringing our year-to-date debt reduction to $42 million. As a reminder, none of this has come from black liquor credits. We generated cash and paid down our debt the old-fashioned way. So, overall, third quarter results showed the success of our actions, especially when coupled with a modest recovery in market demand.

Let me talk about each of our segments for a minute. Printing and writing markets remain hard hit this year. However, demand grew 4% quarter on quarter and our Fine Paper business showed similar growth. A number of activities were completed which will further strengthen our market-leading position and brand portfolio going forward. In mid-September we reached an agreement with Crane, the country's most recognized cotton writing paper brand, to be the exclusive marketer for their business correspondence papers. We had been manufacturing their paper the past few years, and this was a natural extension of our relationship. This consolidation will leverage our strong customer and channel presence and adds to both our top and bottom line.

Recognizing the market's continuing search for value-oriented and environmentally responsible products, we recently repositioned our Sundance brand and added new product solutions in the growth areas of 100% post consumer and digital. We also introduced a new green brand, appropriately called Conservation, that combines product line simplicity and exclusive representation in regional markets to capitalize on one of the clearer growth opportunities in our category. These market moves provide consumer-preferred products that compliment and protect the strong premium positioning of our well-known classic and environment brands.

Our Fine Paper team has also made great progress in continuing to adjust our cost structure and to improve operating performance. The benefits of these moves were apparent in the third quarter. As with the efficiencies from the Ripon mill closure and other cost reductions, we were able to generate higher profits and margins despite rising pulp prices.

Turning to technical products, customer inventory destocking was largely completed by the end of the second quarter, and as a result, our volumes rebounded to reflect end user demand across most product lines. Filtration and abrasives delivered the largest volume gains and EBIT and profit margins improved overall in both our US and German businesses. We are addressing challenges in Germany in wall cover and tape where new competitive wall cover capacity, the negative impact on exports from a strengthening Euro, and lower economic activity, have affected sales.

The fourth quarter is historically a light season, but we have ramped up a number of initiatives, including a short term tape supply contract that will help improve capacity utilization and restore volume. So while market demand has not returned to pre-downturn levels, our cost reductions have made us more profitable at today's volume levels, and our mill teams have capitalized on the recent increases in through-puts to further reduce costs and more than offset increasing prices for raw material. In addition, our R&D efforts are providing a sound basis for continued innovation and growth in filtration and across other products and applications.

So to conclude, each of our businesses delivered notable improvements in results this quarter, and are on a good footing going forward. We have increased margins and combined with our success in managing working capital, and controlling capital spending, Neenah's well-positioned to continue to generate good cash flow and returns.

I'll now turn things over to Bonnie to discuss the financial results in more detail. Bonnie?

Thank you.

As Sean indicated, we were pleased with the results in the third quarter in all of our businesses. Volumes began to recover and our cost initiatives delivered year-on-year savings of over $6 million. Input costs, while up from last quarter, remained significantly below prior-year and along with our cost savings helped to offset the impact of lower year-on-year volumes and operating schedules. The end result was growth in profits over both the prior year and previous quarter.

Turning to segment results, I'll start with Fine Paper today. Sales of $63 million were up from $61 million in the second quarter, but below $82 million last year which was prior to economic downturn. Selling prices on branded products remained unchanged, helped by our strong brand equity and support. While volumes have stabilized this year, the decline versus last year reflects the decreased market demand following the economic downturn versus the second quarter operating rates increased by about 20% and should further benefit if economic conditions continue to improve and print advertising begins to recover.

Adjusted operating income of almost $10 million was the highest level since the first quarter of 2008, as we have aggressively worked to resize our cost structure at today's lower volume levels. Combined benefits of $2 million from the closure of the Ripon mill, operational efficiency gains and other reductions in spending, coupled with input cost reductions of $3 million helped to offset a $4 million impact of lower volume. Technical products quarterly sales were $87 million, up from $74 million the second quarter, but down from $104 million in the third quarter of last year. Filtration, abrasives and saturated label volumes recovered nicely, while medical packaging remained strong and is up versus last year both for the quarter and year-to-date. Operating income was $5 million, up significantly from both second quarter and last year. Cost reduction initiatives of $4 million, along with lower input costs of $5 million, more than offset the impact of reduced volumes, lower mill utilizations and lower prices in Europe for certain products.

Turning to corporate items, selling, general, and administrative expense of $18.1 million compares compares it an unusually low $16.6 million last year. 2009 costs increased due to timing and amounts of certain employee benefits, while 2008 expense was reduced following a change in our vacation policy. Year-to-date SG&A is down about 7% or $4 million. Similarly, unallocated corporate expense of $4.2 million compared to an unusual low $2.2 million last year. As we've said, unallocated costs generally are expected to be in the range of $3.5 to $4 million per quarter. Net interest expense was $5.4 million, down from $6.3 million last year due to lower borrowings, as well as a drop in interest rates.

In the third quarter, tax expense included an additional additional $1 million, primarily for interest arising from IRS audits of prior year tax returns. While booked tax expense has been correctly reported, recently completed audits identify additional cash taxes due mostly as a result of differences and the timing of depletion and silviculture allowances related to Timberland operations. This amount totaling $7 million will be paid in the next two quarters, however with the recent tax law change now allowing a five-year carry-back of operating losses, we expect to recover most of this in 2010. Excluding the effects of the tax audit, our blended tax rate was 17% and compared to a prior-year rate of 17%. Our book tax rate continues to be highly sensitive to changes in the mix of income between tax jurisdictions, but regardless of the rate we do not expect to pay US federal income taxes in the next several years, as a result of tax operating losses available following disposal of our pulp operations.

Free cash flow, which we define as cash from operations plus capital spending, was over $17 million in the quarter and almost $50 million year-to-date as both businesses continue to generate significant operating cash flows. Capital spending remains tightly controlled and was $2 million in the quarter and is $6 million year-to-date. As we've indicated, we expect to send end the year with spending of less than $10 million.

Going forward, base capital spending is expected to be about $15 million annually, excluding major strategic investment. We expect to contribute up to $9 million this year to fund pension trusts. Funding levels of our plans continue to be in good shape, despite last year's challenging financial markets. In total, pension and other post retirement benefits expense of $15 million will be up about $3 million versus last year, due to lower returns on pension plan assets in 2008. For 2009, we continue to expect expense for pension and OPEBs to be about equal to cash payments.

We ended the quarter with debt of $323 million compared to debt of $374 million a year ago. In addition to our $224 million of tenure bonds, we had $69 million drawn against our North American senior secured credit facility. We announced last week that we renewed this facility, extending the term from November, 2010 to November, 2013. We will recognize one-time added interest charges of about $1.7 million in the fourth quarter for non-cash accelerated amortization costs as a result of this. We're really pleased with the terms of the renewed facility, which reflected the improved profile of Neenah Paper following our transformation by divesting pulp and growing the size of our specialty paper businesses. The facility continues to provide adequate borrowing capacity and gives us future financing flexibility with a high quality group of banks including JP Morgan Chase, Bank of America, UBS, and Goldman sacks.

So to recap, in the third quarter our businesses grew, margins improved and we again delivered sizable cash flow. Our liquidity position and financing flexibility are now stronger and axles we've taken to improve our cost structure will continue to benefit us as the economy recovers. Our cash flow and cash flow yields are very attractive, and we are committed to maintaining a meaningful dividend.

With that, I'll turn things back over to you, Sean.

Thank you, Bonnie.

Let me wrap up with a few comments, including some thoughts on the fourth quarter. As usual, I'll start with safety, as we believe safety of our employees is always paramount. Our Neenah-based operations have now gone more than 500 days without a reportable incident. And this year, as a Company, we have reduced our reportable incident rate by 20% from 1.8 to 1.4. We're pleased with this improvement and progress towards the world-class objective of 1.0 that we set a few years ago.

Third quarter financial results were encouraging and began to show our business can perform with a leaner structure as volumes recover. While other -- while order books at the end of the quarter were still firm, the fourth quarter and particularly December, has traditionally been seasonally weaker and customers remain cautious in their planning horizons. So we are optimistic, but by no means are expecting to ease up on the cost programs implemented over the past year as we finish up this year. Input costs for items such as pulp and latex are continuing to right, though partly offsettling this will be benefits of lower energy prices in technical products as new annual contracts for both natural gas and coal are at lower prices. So while the fourth quarter has many moving parts, one thing I am willing to bet, we don't give guidance, but I am willing to bet is the results in the quarter will be a heck of a lot the better than they were fourth quarter of last year.

Looking beyond the quarter, we remain optimistic about Neenah's prospects going forward. Our teams have made and executed some tough decisions, but these actions have resulted in us operating more efficiently, not just due to changes in cost structure, but with lower working capital and capital spending levels as well. We are focused on growing technical products through innovation and expansion, while continuing to improve margins in that business. In Fine Paper, we'll protect our attractive margins, while pursuing growth opportunities we've identified in profitable niches. We will maintain our discipline in capital spending. And we will continue to strengthen our capital structure and provide returns and assurance to our stakeholders by generating strong cash flows and maintaining an attractive dividend.

Potential proceeds from the sale of our timber lands and the mill site in Ripon, California obviously represent an additional and substantial source of cash and liquidity that we expect to realize. Our initial transformation from a premium specialty paper company has been successful. Our focus is now on driving sustainable profitable growth in our paper businesses. We believe we have the market leadership, products, brands, and people to succeed and will build on the momentum we achieved in the third quarter. So thank you for your time and interest this morning.

I would now like to open up the call to any questions you may have.

(Operator Instructions). Your first question comes from the line of Fred Buonocore with CJS Securities.

Good morning, Fred.

Yes, good morning Sean, Bonnie, Mike -- I mean Bill, sorry. Very good, detailed review. We appreciate that.

Thank you.

And I just wanted to see if you can get a little bit more granular or detailed about the demand trends you're seeing in your different end-markets, both on the Fine Paper and the technical product side? Thank you.

Yes. It varies both by business, between buying and technical and -- and then within technical in terms of segments. Taking technical first, as I mentioned in the comments, our order books are in pretty good shape. Backlogs are significantly higher than they were earlier this year. So we feel good about that. And working individually with customers, what we are seeing is -- is customers are being cautious. They are ordering in terms of weeks or months ahead, instead of giving us full-year projections or six-month projections with estimates by month. So we are seeing the build there. But we also realize that customers are taking things a month at a time, if you will. And so I think as we see the economies globally, and we are seeing nice movement there, but globally and in North America improve, we expect to go up with that.

In Fine Paper, we did see volume growth in the quarter. We, as I mentioned in some of the comments, we've made a significant number of market moves to further strengthen our position. We're in great shape with our customers. We have the supply chain programs that we've talked about in past calls are in place and building. And we expect that business to recover as the economy improves and print advertising levels in areas such as automobiles and travel begin to come back. I'm not going to tell you that we're planning on that business jumping to a high level of sustainable growth, because I do think there are some secular issues, but our position in that market is getting stronger. And we expect to continue to do very, very well in it, as the margins in this quarter reflect.

Got it. So with those items in mind, thinking about, assuming that we continue just to see volume improvement, stronger demand and then your internal cost reduction actions, the things that you have under your control, as we look into Q4, the reminder of Q4, there was a helpful comment that you expect the results for Q4 to be a heck of a lot better than Q4 last year.

A hard statement.

That really works well into my model. But using that as a framework, is it possible that some of these, broader, cyclical improvement trends as well as the things that you have under control could dampen or mitigate some of seasonal effects to where Q4 could look something like Q3 of this year, realizing that you don't give guidance?

We don't give guidance and if I've learned anything, the month of December is a difficult month to predict.

Yes.

But, what I can say very strongly is, across all of our businesses and in all of the markets we compete, nobody is sitting on their hands saying that, well, fourth quarter is going to be a dog and there's nothing we can do about it. We're working very hard to continue to push hard. The cost control measures that have been underway continue to intensify. So, we, by no means, are throwing in the towel on the fourth quarter.

Got it. And then finally, Bonnie, could you just review what you were talking about with the tax item? You said that you expect, relative to the audit on the prior year's cash taxes paid, to pay out about, I think you said $7 million over the balance of the year? Could you just review that with me once more, please?

Yes. Fred, as a result of our IRS audit of the period 2004 through 2006.

Yes.

There were identified adjustments of $8 million, of $8 million, $7 million of those will be paid in cash, $1 million of them would be covered by NOL's. We expect six of the seven to go out in the fourth quarter and then the other million go out in the first quarter of next year for state tax adjustments, related to the exact same issues. I also said in there that recently, and I think it was last week, there was a new law enacted that allows companies to carry back their NOL's for five years versus the two years, so we will very quickly be filing amended returns to get the -- our losses to carry back to cover that tax, that tax payment. We'll still pay it. But we expect to recover it.

Got it. And so what would the P&L impact look like in Q4 then?

There won't be a P&L impact related to this. The P&L impact that was related to this was the $1 million that we adjusted tax expense for and that's really the interest expense on these items that I was talking about.

Right.

And so we don't expect any further interest expense. So no P&L.

Got it. Thank you very much.

You're welcome.

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

Good morning, Mark.

Thank you, good morning Sean. Three questions, first, are there any pricing initiatives in any of your product lines?

Yes, some are contractual. We have for a portion of our technical products business, it's embedded in there both in terms of pulp and latex. From just a market standpoint, we have, this quarter, taken some other actions, increasing prices in certain technical product segments. Fine Paper, where we took some heady increases at the end of 2008, we haven't adjusted our branded prices upwards. We have adjusted and will adjust our -- any non-branded products upwards as pulp moves. And, so not general price increases, but we are active both in non-branded Fine and in areas within tech products.

And can you give us a sense on the tech products side how much of the pulp gets offset by contractual adjustments that get made on the pricing side?

I would have to guess it's half. The other thing is in filtration business, the German business. A high percentage of that fiber was a mercerized pulp that is a contract price that had gone up actually quite a bit. This year on that we're seeing some relief on pricing so that we would expect to go against the market. And on the -- as I said in the other areas of tech, probably half are tied to pricing and contract.

Right. Helpful. And is that a pretty much immediate pass through or does this tend to be a quarter lag or something to that effect?

We lag a quarter both ways but it's typically -- we lag a quarter to a risking price.

Okay. And then on the mill downtime, was there anything exceptional in the third quarter and/or to be expected in the fourth quarter?

No. In the third quarter, I think the the first two quarters, Mark, they were averaging about $10 million a quarter. And the third quarter was a little over $2 million, so we had less of it. We do have some holiday downs in the fourth quarter. But those are normal. So year-on-year, that part will be less.

And we don't -- if you remember, especially in the month of December last year, we took tremendous downtime across the whole system and which was especially expensive in Germany before the short time work payment program of the government kicked in. We don't expect to experience any of that this year. So year-on-year, the operating rates will be substantially higher.

Okay. So somewhat -- there will be some pickup in downtime costs seasonally related to third quarter but less than 4Q? Is that fair?

Yeah. I think maybe a way to put it, Mark, is you are going to trade some holiday time for maintenance time. We'll take less maintenance and costly downtime but we will have some holiday downs.

Okay. And then lastly, I think there have been some changes in Nova Scotia on the political scene. Are you seeing any -- are you closer to the end of the tunnel on the timber land side?

You are as plugged in as I am. There have been some dramatic changes up there. And, saying things that are public, I think that the government has come out and said that they are interested in buying land, both for set-aside purposes, but also in ways that could support industry because it is an important part of the economic program up in Nova Scotia. And as I said in the prepared comments, we're active in the process, we're very plugged in to what's going on both politically there as well as through economic development and DNR, and hopefully that does not hurt the process. I think it helps; obviously, it helps us.

Okay. Terrific. Thank you very much.

Okay. Thank you.

(Operator Instructions). Your next question comes from line of Robert Howard with Prospector Partners.

Good morning, Robert.

Just wanted to ask about exchange rates. You mentioned that that was providing some pressures on the German operations. And I was wondering if things continue on the -- on the path that they have been, the Euro getting stronger versus the dollar, can it continue for a while before you have to make a major change? How do you respond, if things were to continue to progress?

Yes. It's a mixed bag for us in terms of our filtration business, which is the most important business out of Neenah Germany. Most of that is European-based. And so in some ways the strong Euro helps us from that standpoint because we'll be translating higher profit levels and a lot of the raw materials are still dollar-based. So there's a double benefit to them. Where it does hurt us is in exporting more of the commodity end of tape out of a mill in Germany, and for instance into Asia, and that does impact margins.

Conversely, our US tape business does very well in this market. And, we are looking for some alternative products to fill that capacity if the exchange rates continue on this path for a while. We have a new organization in the mill focused on innovation. I was there a week before last and they are making good progress on that. So the exchange rates in Europe are really a mixed bag for us. It helps filtration and really just hurts tape.

Okay. Great. That's it for me. Thanks, guys.

Thank you.

Okay, thank you.

(Operator Instructions).

Well, if --

Your next --

-- if -- if there are no more questions, once again I with like to thank you you for -- oh there is a question. Fred?

Your next question comes from Fred Buonocore with CJS Securities.

Sorry, Fred, I did not mean to cut you off almost.

Not a problem. I was slow on the trigger there. Just wanted to see if you had any thoughts or comments the outlook for strategic expansion, either through M&A or geographic expansion opportunities or other relationships like with Crane in terms of getting in with other brands? Can you talk a little bit about those opportunities, please?

Yes. We are active in evaluating opportunities and I think we're also open to different structures. These don't have to be all-cash deals because in our current situation, we're very committed to our capital structure and our debt-to-capital. We know our debt-to-EBITDA range, our targets that we said we will get to. And by the way, in that regard, I'll sure be glad when the fourth quarter of last year rolls off of our debt to EBITDA.

But -- so within the constraints that we want to operate the company, we do see opportunities, especially where we have strategic advantages. In filtration, we're the innovation leader and as that -- products, our customers globalize and engine platforms globalize, it does create opportunities for us where our technology and innovation and market position gives us an advantage for an opportunity and we expect to capitalize on that. So we are looking forward. But, we're also looking at it in terms of we're going to keep things within the range that we think is appropriate that our capital structure can support.

Very good. Thank you.

At this time you have no further questions.

All right. Well, I want to thank you again for joining the call. And I look forward to our next call in the first quarter of next year, when we sum up the fourth quarter. So thank you. And have a good holiday season.

Thank you for participating. You may disconnect at this time.