Neptune Insurance Holdings Inc (NP) 2010 Q4 法說會逐字稿

Good morning. My name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the Neenah Paper 2010 fourth quarter and full year earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer session. (Operator Instructions).

Thank you, I would now like to turn the conference over to Mr. Bill McCarthy, Vice President Financial Analysis and Investor Relations. Sir, you may begin your conference.

Okay. Good morning and thank you for participating in Neenah Paper's fourth quarter earnings call. With me today are Sean Erwin, our Chief Executive Officer, John O'Donnell, Chief Operating Officer and Bonnie Lind, our Chief Financial Officer. We released earnings yesterday afternoon and hopefully most of you have had a chance to read through this. I will recap a few headlines and then turn things over to Sean, John and Bonnie to discuss the results in detail.

For the quarter, net sales were $160 million, up a solid 4% despite currency headwinds and in comparison to a very strong fourth quarter in 2009 when economies were still recovering. Earnings per share were $0.43 compared to $0.28 a year ago. After excluding a $0.13 gain on the sale of the Ripon Mill in 2010 and a $0.05 charge in 2009 primarily related to refinancing our North American credit facility, adjusted earnings per share were $0.30 in 2010 and $0.33 in 2009.

Terms like adjusted earnings are non-GAAP and have been reconciled to GAAP in the press release which is also available on our website. I would also remind everyone that this conference call may include forward-looking statements subject to certain risks and uncertainties that are fully described in our SEC filings and also described in our Safe Harbor disclaimer which can be found on the Investor Relations page of our website at www.neenah.com.

With that, let me turn things over to Sean.

Thank you, Bill, and good morning everyone. As it said in our press release the fourth quarter capped what was a very successful year for Neenah Paper. Our teams were able to deliver on the five objectives we have talked about this year. One, driving top line growth, expanding margins in Technical Products, maintaining consistent and attractive returns in Fine Paper, generating strong cash flows and improving our return on invested capital.

Let me review each of these briefly and then I'll turn things over to John and Bonnie to cover the fourth quarter in detail.

In 2010 full-year consolidated net sales were $658 million, up 15% from 2009. Each of our businesses did well, with Technical Products increasing 21% and Fine Paper up 7%. The growth was largely volume driven, aided by improved market conditions but also reflecting the success of our teams in capturing market share, pursing growth in new or adjacent markets and commercializing innovation-driven new products.

At the same time, we continued to improve our mix as we focused efforts on selling higher value products like our advanced meltblown filter grades, image transfer and premium fine papers. We also increased selling prices in both businesses in response to the higher input costs in 2010.

In Technical Products we have indicated our midterm goal for this business is to achieve sustainable double-digit margins. In 2010, EBIT margins were 8%, up from 5% in 2009. Improvements resulted from higher volumes, an improved sales mix, increased prices and cost efficiencies. Notably, 2010 profit was an all-time record for this segment and our teams were able to do this despite having to overcome more than $20 million of higher costs for materials like pulp and latex.

In Fine Paper we again delivered the attractive returns this business is known for and it continues to be an important platform to support Neenah's growth. Our Fine Paper team outperformed the market as a result of good core business performance, supplemented by double-digit growth in areas such as labels, packaging and international sales. Operating margins remained solidly in the mid-teens despite more than $15 million of higher input costs. Cash flow from this business also continues to be very strong, as our good operating performance was coupled with working capital reductions and an efficient asset base requirement minimal capital.

Consolidated cash from operations was an impressive $55 million in 2010 and we had $17 million of capital spending. We also realized almost $90 million from sales of non-core assets like the timberlands and the Ripon Mill despite a challenging market for selling these assets. Cash flows were used to de-lever, as Bonnie will talk about later, and we are very pleased with where our capital structure is today.

Finally, return on invested capital this year was 8%, up 200 basis points from a 6% return in 2009. Our teams continue to manage both the numerator, with margin improvement and top and bottom line growth, and the denominator, with working capital efficiencies and controlled capital spending.

So overall our teams did an excellent job executing against these objectives and I like the momentum we have going into 2011. With that I'll turn things over to John to discuss the fourth quarter results. John?

Thanks Sean. Before going through each of our segments I would like to provide some comments on the economic and market environments. Fourth quarter economic news was encouraging with US GDP growth of over 3%, Euro Zone growth of 2% and higher growth rates in emerging markets.

Industries like auto manufacturing, which is an important end market for our Technical Products business, appeared particularly strong, although U.S. printing and writing markets were less than robust with uncoated free sheet falling 3% in the quarter. So while the recent quarter reflected more typical conditions it still resulted in a challenging comparison versus 2009. As a reminder, in Q4 of 2009 the economy was still recovering and we delivered our highest quarterly sales for the entire year.

In 2010, we saw a return to normal seasonal demand with customers reducing their year-end inventory levels. However, as is typical, this was temporary and we are seeing orders in the first quarter back to usual seasonal patterns.

Another item to note is the increased demand and higher prices for commodities resulting from the global economic growth. Oil prices, while down slightly from all-time peaks in July, remain stubbornly high. Versus the third quarter, market list prices fell modestly but, with lags in many of our contracts, we didn't realize much benefit in the fourth quarter. At the same time, prices for energy and other fibers and chemicals including latex, a key material in many of our Technical Products, have been rising.

Most of our businesses have demonstrated pricing power and we expect to continue to offset increases in input costs with operational efficiencies, reduced costs and higher selling prices over future months.

So with that as background, let's turn to the segment results starting with Technical Products. Despite the challenging comparative period and currency translation headwinds, sales of $92 million were up 5% in the quarter. On a constant currency basis sales grew 11% and were led by gains in filtration, graphics and identification, and wall coverings. In fact, our filtration business had a record fourth quarter and our Technical Products segment in total is now back to pre-recession levels.

Our performance reflects the major supply position we have with market leaders in many of our product categories, customers who are growing share and expanding in developing economies and, we are seeing sales of new products resulting from joint development and R&D work with many of these same customers.

With sales in over 70 countries, Technical Products is clearly a global business and we continue to see opportunities to increase our global presence. As an example, this year we benefited from volume growth as we expanded and grew our graphic image transfer business in developing markets.

In addition to higher volumes, an improved mix and increased selling prices contributed significantly to the fourth quarter results. The mix reflected the growth in filtration and graphics and identification, both of which use some of our more technologically complex and highest value products. So overall we were pleased with the increase in top line performance in 2010.

Operating income of $4.4 million was down from all-time record fourth quarter EBIT of $6.5 million in 2009. The lower income in 2010 resulted from higher costs for materials and energy, as well as increased operational costs, including the costs of additional downtime in 2010 due to more normal seasonality. Higher input costs totaled $7 million in the quarter and increases in other costs were about $1 million. We were able to offset approximately 75% of these costs through higher selling prices and improved mix and volume growth.

Turning to Fine Paper, sales of $68 million grew 3% with an improved mix and higher selling prices offsetting a 5% decline in volume. The volume comparison was against a prior-year when the fourth quarter was by far the largest and included sales of non-branded business that did not repeat in 2010. Targeted growth areas like international, packaging and labels all continue to deliver double-digit growth rates with sales of these products increasing 11% in the quarter and 18% for the full-year. We have focused resources to support and maintain momentum in these growth areas.

We see Digital Products as an area we can grow by providing unique market solutions. An example of our success has been our LETTRA brand, which is used by Apple as cover stock for their growing online photo printing application. And we are delighted with the market's reaction to the recent launch of additional digital and color copy solutions targeted to drive future growth.

As I mentioned, the decrease in volume was more than offset by an 8% gain in our average selling price, reflecting both the higher value mix and the increased prices for our brands. The mix was helped by continued growth in our premium Crane papers and a very successful launch of another supply chain initiative that allows customers to purchase envelopes directly from our mills.

Fine Paper operating income was $13.1 million in the quarter. Excluding the $3.3 million gain on the sale of Ripon, income of $9.8 million increased 11% from the prior year. With operating margins remaining in the mid-teens, input costs moderated only slightly versus the third quarter and we are up more than $3 million from the prior year.

On a positive note, benefits from the higher price and mix and operating efficiencies more than offset these higher input costs. With that, I will turn things over to Bonnie to review corporate and financial highlights.

Thank you, John. The strong operating performance in Asset Management John and Sean described this year has allowed us to continue to reduce our net debt and puts us on very solid financial footing. I will talk about that shortly but first let me go through some of the corporate numbers starting with SG&A.

Consolidated selling, general and administrative expense of $17.7 million was down slightly from $18.1 million last year. Unallocated corporate costs, which are part of SG&A, were $4.2 million and also below last year. For the full-year SG&A was $69 million or about $17 million per quarter and flat with 2009.

Our net interest expense was $4.8 million in the quarter, down 11% compared to $5.4 million after excluding last year's $1.4 million charge related to the renewal of our revolving credit facility. Reduced interest expense in 2010 is primarily due to our lower debt levels. Interest expense continues to include approximately $500,000 per quarter for non-cash amortization expense and commitment fees related to our North American credit facility.

Our effective tax rate in the fourth quarter was 21% and the rate for the full-year was 28%. The rate will vary based on the mix of income between jurisdictions. Looking ahead to 2011, we expect the rate to be in the low 30s. We continue to use available net operating losses to offset taxes that are due on income in the US and consequently our consolidated cash tax rate is lower than our (inaudible) rate.

Continuing on with cash flow items, capital spending was $6.5 million in the quarter and $17.4 million for the full-year. We spent more in the second half of the year, coincident with timing of scheduled maintenance and holiday downtime and also due to spending on the German meltblown line. We continue to carefully prioritize and manage capital spending, and in 2011 spending is expected to be between $20 million and $25 million. About a little less than half of this is for maintaining assets with the balance for value-added projects that support sales growth and cost efficiencies.

Contributions to defined benefit pension plans in 2010 were approximately $16 million and while final actuarial figures are not yet available, we currently expect 2011 contributions to be approximately $1 million lower as a result of strong asset returns and funding of our plans in 2010.

As of year-end our plans were in good shape, reasonably well funded. In 2011 total expense for Pension and OPEB plans is expected to be approximately $12 million which is $6 million less than cash contributions.

Consolidated cash flow from operations in the fourth quarter was $12 million and included our semi-annual bond payment of over $8 million. For the full-year cash from operations was $55 million and continues to reflect our good operating results and effective management of capital.

In 2010 we kept working capital relatively flat despite a $75 million increase in sales. Consequently, as a percent of sales, working capital averaged less than 14% compared to more than 16% in 2009. This not only helped cash flow but also contributed to our improved return on capital. Our strong cash flows have allowed us to make significant improvements in our capital structure. During the quarter net debt declined $11 million as we built cash balances and we ended the year with less than $200 million of net debt. In addition, we continue to have nothing drawn against our North American credit facility and have borrowing capacity of approximately $85 million, based on normal working capital levels.

We have now reached a point where our capital structure is at a very comfortable level. With almost $50 million of cash available we decided to call $65 million of our 2014 notes. Since cash earns very little in today's environment, this will allow us to offset the 7.375% interest on the notes and reduce interest expense by $3 million in 2011 and by $5 million on an ongoing basis. The transaction will be completed by mid-March at which time we will book approximately $2.4 million of costs to recognize the 2.5% call premium and then to write off on unamortized debt issuance costs.

Last, but not least, our strong cash flows continue to represent a very attractive double-digit cash flow yield on our stock and we remain committed to paying a meaningful dividend to our shareholders. In November we announced we were increasing our dividend starting in 2011 by 10%.

With that I will turn things back to you, Sean.

Thank you, Bonnie. Let me start with safety and then I will wrap up with some additional comments on our outlook for this year.

Our safety performance improved again in 2010 as our incident rate was 14% below last year. Our safety programs and employee involvement remain active and we continue to operate under the belief that all injuries can be prevented and it is our collective responsibility to do so. I am pleased with the progress we have made, as it would not have been a successful year for us if our financial performance was great but our safety record was not.

Turning to our businesses, 2010 was a year where global economies grew modestly following the severe recession that began in 2008. As we look at 2011, we expect this modest economic growth to continue. In Fine Paper, secular pressures in uncoated free sheet are likely to continue and we remain focused on opportunities that will allow us to gain share as the market continues to consolidate. And we will continue to pursue growth in international markets and label and packaging.

In Technical Products we will benefit from an increasing presence in developing markets and from our innovation in new business development efforts. Our $10 million investment in the new meltblown line in Germany is a recent example of how we are supporting growth. The project is on track to start up as planned this quarter and will allow us to support increased sales of higher value transportation filters and also enter into adjacent markets such as medical and beverage filtration.

If global economies grow was expected, input costs are likely to remain elevated. Forecast for pulp prices continues to be revised upwards and, at best, show average prices in 2011 about equal to 2010. At the same time, costs for energy, latex, cotton and chemicals have all risen and are expected to be higher in 2011. While forecasts remain volatile and unsettled, we would expect the impact of higher input costs in 2011 to be substantially less than the $30 million of higher costs we experienced in 2010. But like last year, we have worked to offset cost increases through volume growth, mix improvements, cost efficiencies and selling price increases.

As John mentioned, both of our businesses have pricing power and actions have already occurred with recently negotiated annual contracts in Germany and a reduction in early payment discounts in our Fine Paper business. Other actions will be taken as market conditions warrant.

Our strategy to transform Neenah Paper away from pulp and focus on premium specialty markets where we can compete effectively is proving to be successful. Our core businesses are performing well and this was also reflected by the markets and our stock price. Our capital structure is in good shape and we are well positioned to pursue investments that are a good strategic fit, generate higher sustainable growth rates, provide scale and meet our disciplined financial return metrics.

We're excited about our businesses and where we're headed. Thank you for your time and interest today and I'd now like to open up the call to your questions.

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

Good morning, Fred.

Yes, good morning all. How are you?

Good.

Great. My first question relates to the Fine Paper business and kind of trying to get a little bit more with respect to your 2011 outlook in a two-part question. I would ask, do you think that with the secular headwinds, can you offset those with the initiatives that you talked about and generate some growth in that business for 2011?

Then as a second part of that, you have been talking about International, Label and Packaging for a few quarters now and I'm just trying to get a sense if you can help us with the scale of that and how much of the overall Fine Paper segment those businesses can represent maybe by the end of 2011? Thank you.

Fred, this is John and I'll take a shot at answering that for you. First, I think the best way to look at the Fine Paper group's potential is to look at its past performance. This past year, uncoated free sheet, the industry was down about 2%. The fourth quarter I mentioned was down about 3%. The Fine Paper business was able to grow 5% in volume in this past year. So I will let their performance speak for their potential a little bit in that regard.

You asked specifically about International and Packaging and Label. In those three segments they represent obviously a growing portion, less than 20% of our overall business from that standpoint but the expectation is for them to grow at double-digit rates and they far surpassed that in this past year as we highlighted.

So I think those are clear pockets of growth opportunities for them. We also had significant growth, as we said before, with the Crane products which we almost doubled in this year as we grew our business with that. As well, as I mentioned, envelopes and other revenue streams. So I think that organization continues to find more and more ways that they can add value through supply chain, meet their customer's needs and not find themselves victim to a secular decline but I think overcoming it. So I'm pretty positive on it.

Okay, that sounds really good. Then my follow-up, on the Technical Product side, in the face of the commodity-related headwinds that you may not even be able to determine with the type of precision that you can forecast pulp prices, given the volatility and what is happening with oil prices and such, do you think that you get stalled on your way to a double-digit margin this year for that segment? Or are the pricing actions and mix enough to help you continue to expand operating margin for the year in Technical Products? Thank you.

I think first of all I have to tell you thank you for appreciating the complexity in trying to anticipate what is going to happen to pulp and with oil. So you are exactly right. We won't have it and I think your word for precision recognition, you are exactly right. We wouldn't be able to do that.

I also appreciate the fact that you said "on your way to double-digit" because definitely that is the direction we have clearly said that our Technical Products business can clearly have double-digit margins. In fact, we see nice pockets of that with some of our businesses. Pricing is one way, in addition to the mix that we talked about as we are moving forward, and that pricing is going to take a bit of time. As you know, that doesn't happen as quickly sometimes as the input costs happen.

But I am confident with, as I mentioned earlier, with the pricing power, the relationships we have with the customers and the ability for that group to find unique and innovative products that our customers value and we will meet that need. Very pleased with the progress that we made this year in that.

Okay, thank you very much. I'll get back in line.

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

Good morning, Mark.

Thank you. I just wanted, this is kind of a bit of a follow-up I guess. Specifically in the press release when you talk about higher material input costs, especially for pulp in the first half of the year, you describe your selling price increases and cost control initiatives as partly offsetting those material input costs.

When I listened to the dialogue on the call here it sounded like maybe you were hopeful that you could fully offset or even more than offset and I just wanted to understand the, again recognizing the forecasting is difficult, but what exactly are you trying to convey?

Some of it Mark is obviously timing. Pulp, as you know, the run up was for the most part let's say the middle half of last year is where it really surged and we were taking price actions. For instance, if you look when the K is out the fourth quarter, we're seeing more price relative to fiber so there is a lagging effect and you'll see the benefits of that this year.

So some of it is timing and our teams will continue to take actions. As we mentioned in the transcript both already this year the German team has implemented some new contracts, Fine Paper has implemented changes in terms. So it is an ongoing process and we feel good about what they accomplished last year, covered some big numbers and we are confident that they will take the appropriate actions this year.

So, to ask the question concisely and perhaps a little bit differently, so I shouldn't read the statement "higher material input costs partly offset by selling prices, increases and cost control initiatives" to suggest you are expecting any margin compression in 2011 overall versus 2010?

The keyword there is overall, no. Over the full-year we're very comfortable the actions we're taking. We'll have some leads and lags in certain cases but we do rolling forecasts, and so over the course of a year we think we will have appropriate actions to cover any changes in input costs that may occur. I think we're all watching the market right now. There's a lot of short-term volatility both up and down and we'll respond.

Okay, that is helpful. So basically first half there could be some pressures but you'll be taking action the second half and you get to hopefully see the expansion. Is that fair?

That is very fair.

Then, just curious obviously we had lots of wintry weather in the first couple of months here. Has that been having any impact? Are you seeing any impact on your business because of that or is it fairly negligible?

I would say on the wintery weather, from an energy consumption standpoint, colder, greater energy usage in the quarter and I think I mentioned that during the call as well. Challenges from the wintery weather in regards to timing of demand and so on but I don't know that has a significant negative impact from the overall demand. Nothing that we would call out and use for an excuse anyway.

Okay. Thank you.

At this time there are no further questions. I will turn the conference back over to Sean Erwin for closing remarks.

Well thank you very much for your interest in the call and Neenah Paper. We look forward to talking to you again coming up in the near future on our next call. Have a good day.

Ladies and gentlemen this does conclude today's conference. Thank you all for participating and you may now disconnect.