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Neenah Paper, Inc. (NYSE:NP)

Q1 2014 Earnings Conference Call

May 8, 2014 11:00 AM ET

Executives

Bill McCarthy - VP, Financial Analysis and IR

John O'Donnell - CEO

Bonnie Lind - CFO

Analysts

Evan Wingren - D.A. Davidson & Co

Jon Tanwanteng - CJS Securities

Operator

Good morning, my name is Kimmie [ph], and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper First Quarter 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s prepared remarks there will be a question and answer period. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, May 8, 2014. Thank you.

I will now turn the call over to Mr. Bill McCarthy, Vice President, Financial Analysis and Investor Relations. Please go ahead, Mr. McCarthy.

Bill McCarthy

Okay. Thank you. Good morning everyone, and welcome to Neenah's 2014 First Quarter Earnings Call. With me on the call today are John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. We reported earnings yesterday afternoon so everyone should have had a chance to get familiar with our results. I'll recap a few headlines and then turn things over to John and Bonnie will review business activities and financial performance in detail. Following our prepared remarks, we'll open up the call for questions.

Net sales were a record $225 million, up 6% from a year ago and reflecting growth in both of our segments. Operating income was up similarly. as very strong performance in typical products more than offset fine paper earnings that were lower due to an unusual spike in natural gas prices that increased cost by more than $3 million or $0.12 per share. Nonetheless, consolidated operating income grew 5% and earnings per share increased 7% from $0.74 last year to $0.79 on an adjusted basis. Adjustments for a penny per share in both years, last year as we integrated acquired fine paper brands and this year as we restructured to improve cost in technical products. Adjusted earnings are in non-GAAP measures and reconcile to GAAP figure is in our press release.

Finally, I would like to remind you that our call will contain forward-looking statements, risks and uncertainties that could cause actual results to differ materially from these statements are outlined in our SEC filings and in the Safe Harbor disclaimer on our web site.

And with that, I'll like to turn things over to John

John O'Donnell

Good morning everyone. 2014 is off to a very good start building up the momentum that we reported in February. In the first quarter, our technical products business led the way with record sales and profits behind a strong volume growth in each of our major product categories. We also executed well in fine paper with could topline results and improved manufacturing operations. Nonetheless this good performance could not overcome the impact of almost $5 million of higher input costs in that segment, primarily foreign energy prices that were even higher than we have foreshadowed on our last call.

In addition to the good topline in earnings our teams continue to do a nice job managing capital. Helped by improved working capital efficiencies in the quarter, we generated almost $13 million more free cash flow than last year. With increased earnings and capital efficiencies, return on invested capital improved and continues to be at a very attractive level of more than 12%. These results confirm that we are successfully executing against our strategic priorities. First, we are continuing to develop and grow meaningful positions in our core profitable niche markets. Filtration media sales grew 11%, led by transportation filtration growth in Europe, which is by far is the biggest market.

We are leading with innovative high-performance products and are leveraging these technologies to grow with existing customers and expand both in international and adjacent filtration markets. New customer qualifications leverage filter materials, execution of announced price increases and our commitment to continue building presence in share position in North America and China, all supported our strong topline growth. In addition we recently entered into a relationship with a small nonwovens manufacturer in India as a responsible way to increase our understanding and presence in this growing market for supporting our customers’ global needs.

We’re also excited about the opportunities we see in premium packaging. In the first quarter, sales of these products grew by more than 30%. Our focus is on end-use premium vertical markets like spirits, jewelry, electronics and cosmetics. We are significantly increasing our presence in these markets, in a capital efficient manner, as we expand our offerings and allocate existing resources towards these growth opportunities. With an estimated market size of about 300 million, premium packaging has a long-term potential to develop into a much more meaningful part of our fine paper segment in the future. Other core markets like premium fine papers and packing, comprised of specialty tape and abrasives, also performed well and will be covered later in the call.

Our second strategic priorities to increase or company growth rate and portfolio diversification in an efficient manner as we gain scale. You can expect continued investments behind faster growing markets like filtration, premium packaging and other performance oriented technical products. Our recent melt blow expansion is one example but many products in these markets also utilize wet-laid nonwovens technology, where different levels and types of synthetic fibers are used in manufacturing instead of wood pulp. We currently make wet-laid nonwovens in two of Germany facilities and recognize opportunities to expand this technology globally through organic investments and complementary acquisition.

Our acquisition bias remains in markets that value these types of performance technologies and we are well-positioned financial aid to pursue value adding opportunities that are a good strategic fit and provide a meaningful platform for future growth. Last, but not least we expect to deliver attractive returns to shareholders and are committed to making cash returns of meaningful component. As we grow our earnings and cash flow in addition to investing in high returning organic opportunities that help support a rising share price, we’re returning more cash directly to shareholders. We have doubled or dividend in the past three years and expect utilize our growing cash flows to increase it further as we move towards an attractive yield of over 3%.

At the same time we expect to maintain the share buyback program to take advantage of buying opportunities. In summary, our teams of executing well and this continues to translate into solid financial returns and attractive returns for our shareholders. With strong balance sheet and cash flow generation we are in an enviable position and able to pursue multiple avenue to create value.

With that I’ll turn things over the Bonnie to review financial results for the quarter.

Bonnie Lind

Thanks John. As you heard or good start to the year was led by strong technical product segment performance. So I’m going to start there. First quarter technical product sales were a record 118 million, up 10% compared with last year. Higher volumes accounted for 8% of the growth with the remainder due to favorable currency translations, up 3% from a stronger Euro partially offset by lower price mix. Impressive growth were seen across all categories as filtration sales grew 11%, specialties also gained 11% driven by growth in labels and packings revenues were up 7%. While an improving economic environment in Europe certainly helped, we had good performance globally with increased sales in U.S. and in Asia. Selling price increases on many products also started to kick in during the quarter.

Operating income of almost $14 million was up more than 40% from just under $10 million in the first quarter of 2013. Input costs were mixed with increased cost for energy and fiber offset by lower cost for other materials. Higher profits this year resulted from strong topline growth, bolstered by improved manufacturing efficiencies and lower administrative costs. In 2013, you may remember John discussing the operational challenges we experienced early in the year, these items have now been addressed.

Bill mentioned, we had a small amount of restructuring costs in the quarter, about 300,000, as we implemented changes to our organization to reduce cost. As we complete these programs we expect additional charges of around 400,000 in each of the second and third quarters. These programs have less than a two-year payback with returns starting late in the year.

Moving to find paper, quarterly sales were 102 million, up 2% versus last year. With the man in unquoted freesheets down 3%, we continue to outperform the market as or shipments were down only 1%. We demonstrated good performance in our core brands and impressive growth in premium packaging while also benefiting from an added amount of sales of the Southworth brands acquired in late January last year. Our higher sales value, sales mix and increased selling prices offset volume impacts and continue to allow us to deliver topline growth.

Operating income was $13.3 million, down $3 million from the prior year. The reason for the decline was almost $5 million of higher input cost primarily for natural gas but also for pulp. Both gas prices end usage increased due to severe winter weather in United States. Our teams were able to offset almost half of this impact with better manufacturing efficiencies and a higher value makes and selling prices. As John will cover later, energy prices have now moderated but we are expected to remain above last year’s levels.

In our other segments, sales were 6.1 million, compared with 6.8 million last year, and operating results were around breakeven in both periods. As a reminder these nonpremium grades came as part of the Wausau brand acquisition in 2012 and continue to be valued by our customers. While less profitable than our core brands, they help cover fixed costs in our expectedly close to breakeven on the bottom line. Unallocated corporate cost of $3.8 million in the quarter, we are in line with the last year’s spending of 4.1. Total SG&A of $19.9 million, was down from $21 million in 2013; but in line with our historical and projected spending levels. With record sales in our cost, SG&A efficiencies improved significantly versus last year.

We will moves now to a few corporate items. Net interest expense of $2.8 million was up slightly compared with $2.6 million last year as or debt increased following the issuance of our very attractive 5.25% notes last May, since most of our debt is not repayable, we expect annual interest expense of around $11 million this year. The effective tax rate in the first quarter was 35%, lower than last year’s rate of 38%, but equal to the 2013 full-year rate. For 2014 we expect to remain at this level. With the remaining net operating loss is more than $30 million, we do expect to pay U.S. cash taxes this year.

As we have communicated previously, our pension plan as well funded and we expect to reduce contribution in 2015 when our cash tax payment will increase. There were four we don’t expect a material net change to our consolidated cash flows and attractive returns as a result of these items. In the first quarter, cash from ops was $15 million compared to $2 million in the prior year. Improvement is notable, as cash flow in the first quarter are typically more historically low as we rebuild inventories and receivables from lower year-end levels. However, this year, increase working capital efficiencies helped deliver higher operational cash flows. Capital spending was $4.3 million in the quarter compared to $4.7 million last year, for the full year we still expect spending to be near $30 million. Debt was $205 million at quarter end down 7 million from yearend but up from 187 million a year ago. Most of the debt consists of 175 million of senior notes issued last May, cash and equivalents were 77 million up almost 4 million compared to yearend and up nearly 75 million versus March 2013.

As John mentioned with strong stable cash flows substantial borrowing capacity and significant cash on hand were well positioned add on opportunities that will add value. With that I’ll turn things back to you John.

John O'Donnell

Thank you Bonnie. We had a solid start to 2014 with very good performance in our technical products businesses and what has been historically the best quarter of the year. The global economic environment appears to be trending upward in Europe despite showing signs of caution and still improve from where it was a year ago. Although markets remain competitive and the secular challenges in fine paper have not gone away our market position remains strong we’re continuing to grow share in key categories and expand in probable adjacent markets and geographies.

I’ll start the call with a recap of a few strategic priorities interaction. But before I talk about our outlook I’d like to comment on what our employees are doing each day to drive value and activate those strategies. First, we ensure that we continue to be aligned with leading blue-chip customers who are wining in their markets, our joint development efforts with many technical products customers are helping us to share and grow in our share.

Next, we’re working closely with our customers to provide them with supply chain solutions and support their growth efforts, this includes designing flexible programs that ensure that our product is there when they need it. We continue to invest in brands and capabilities. Our fine paper brands are known for their high quality and when image matters like at the recent Oscar ceremony when the envelope was opened we were inside. This year we re-launched our environment brand well known as a leader in green premium papers and in technical products we continue to invest in assets or capabilities that meet the unique specification and needs of our customers.

Cost reduction and efficiency improvements is never ending and our teams are focused on relentlessly pursuing ways to enhance our competitive position. We have incentive programs where all employees focused on maintaining quality or significantly improving productivity waste and cost efficiencies. Finally, we’re growing through an expanded global presence, many of our customers are global and we’re looking for ways to increase our participation with them as we expand the Neenah home base that expansion may come through organic investments, M&A or new market relationships like the one I mentioned early with a small company in India. While these may not always seem glamorous or exciting except for the Oscars. It is relentless commitment of our team day in and day out that delivers the consistent good results that you are seeing each quarter.

Let me take a moment and comment on a few items impacting the rest of the year. As we noted a few times in this call input costs were large headwind in the quarter notably for natural gas prices in the upper Midwest where our U.S. fine paper mills are located. As the weather in the U.S. has moderated natural gas prices have declined but they’ll be down by more than $1 million versus the first quarter. Second quarter prices will still be $1 million more than last year.

Pulp price increases moderating are still lynching up in the quarter as well. For the full year we expect input costs to be up by approximately $5 million across all our businesses. Energy costs will remain higher every quarter this year both for natural gas in the U.S. and for electricity in Germany following a new green energy tax. Pulp prices are forecasted to decline later in the year that help to offset increased energy cost if this occurs. Regardless as we said before our businesses have demonstrated that they can offset input cost increases over time to selling prices and other actions.

Where the price increases we’ve implemented this year in both segments the shifts continue to be the case. Bonnie mentioned we expect to spend up the $30 million for capital projects. As we invest behind attractive growth and cost savings opportunities our capital spending have increased each of the past four years to support our growth by remainder very manageable 3% to 4% of sales and in line with depreciation. The bulk of our spending goes to investments with high returns and we continue to look at organic capital as one of best choices for deploying cash.

As I mentioned in February, a key investment this year will be to increase capacity in one of our filtration machines in Germany. This will occur in the fourth quarter, in addition to the capital costs we’ll incur up to $1 million of higher cost due to added down time to complete the project. We’re also moving our annual maintenance down in the middle to the fourth quarter which will shift an additional million of cost from the third quarter to the fourth. Annual maintenance down at most of our other facilities will remain in the third quarter. By executing this high returning investment we’ll support our ongoing efforts in filtration and we’ll have optimized and balance saturation and media capacity in the mill. Plans are in place and show no disruption to sales or customer service levels this year as a result of the project.

Let me close with what I said earlier, we’re in an amiable position; our good business performance and strong balance sheet allow us to pursue a number of ways to deliver value to shareholders. As a reminder our priorities for uses of cash remained; first, making attractive organic capital investments; second, value adding M&A and third supporting meaningful direct cash returns to our shareholders. Success in business comes from making good choices and our current position enables us to choose from these alternatives with an and, and not an or, as we look at value adding ways to utilize our financial capacity. I am encouraged and excited by all that’s going on at Neenah and I hope you are as well. Thank you for your interest this morning, at this point I’d like to open up the call to any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Evan Wingren with D.A. Davidson.

Evan Wingren - D.A. Davidson & Co

Relative to our expectations, I think technical products outperformed us by quite a bit. I was hoping to get some granularity on the margin improvement year over year. And maybe is that a function of that melt-blown line that you started up? Just some commentary on that would be appreciated.

John O'Donnell

Couple of things, first I mentioned in the transcript that we had less than exciting performance in the last quarter, so I think we got a year-over-year comp change because of performance is poor. We’ve corrected all those and I think that’s really a positive. Filtration is the major driver of the change in the quarter, very strong volumes and as we talked before this is a category that’s grown 9% over the last 10 years on an annual basis. As Europe starts to recover and optimism of our customers continues to grow, we start to see the pipeline refill from that standpoint.

It would be short sighted of me not to give them credit for all the cost production efforts that they have put in place, so we see strong utilization of the assets with the volumes, strong cost reduction activities as well. In regards to melt-blown, the melt-blown drives the enhanced mix, so melt-blown combined with our historical paper products gives us the opportunity to sell up a mix into more premium mix, especially in products like cabin air and we’ve continued to see those grow as well. So I think to give it all to a recent capital investment when it’s really of strong volume performance in our filtration business year-over-year comps and the relentless pursuit of cost reduction.

Evan Wingren - D.A. Davidson & Co.

Sure. Thank you for that. And then maybe on filtration a little further, can you just kind of maybe give us a high-level update on the competitive environment in your current filtration markets, which I think primarily is transportation, and then maybe those that you're trying to enter as well?

John O'Donnell

Well I think really focusing from a competitive standpoint transportation filtration is probably the one that we spend the most time on. In Europe we’ve got a leading market share, there is three major players in transportation filtration, Ahlstrom, H.B. predominantly in the United States and our strongest position by far is in Europe which is great because that’s where our existing current existing capacity resides.

Two other very large markets the U.S. and China are opportunities for growth, we represent about 15% share globally but 42% or so in Europe. So that opportunity for us to continue to follow and pursue those strong customers as they grow in those markets is what we see as the long-term opportunity for us in transportation filtration. Maybe other markets like beverage filtration some of the others, we’re really focused on entering into nice markets. So there is a variety of competitors in each of those and I think I probably caused more confusion than I would cause clarity. We’re looking sort of where the high value nice mix is and where we can bring unique capabilities from that standpoint.

So predominantly I would think transportation filtration from a competitive position and then opportunistic mix enhancements in those other categories.

Evan Wingren - D.A. Davidson & Co.

Okay. And maybe moving to paper, the 5 million in the first quarter. Is there a way that we could think about how much of that should be recovered maybe sequentially? I know you said $5 million higher input costs across the remainder of the year, but shouldn't you see the majority of that come back in the next quarter relative to the first?

John O'Donnell

The big spike in natural gas, we’re going to see that mitigate. So three of the five was natural gas. So from that standpoint we still expect that to be elevated all year. We’ve had and we’ll have to overcome that with pricing activity that was announced early on in the year. Pricing activity, really we can -- we see pulp and can act on pulp despite from natural gas, we couldn’t influence the pricing activity, we’re already taken by that. What our expectation is that all the businesses have been in the marketplace with price increases will carry those through as we move through the year. Pulp our expectation is not in the first half because we’re still going to see elevated costs in the first half but in the back half we do believe that it will be mitigated, so that more sticky pricing in our paper side, we should see our margins recover.

So I would expect margin to recover significantly in the second quarter just as a result of the non-spike in natural gas but full year before we’re able to overcome the input cost that we talked about.

Evan Wingren - D.A. Davidson & Co.

Alright, thanks for that. Just a couple more here, I tried to follow your maintenance commentary. I think in the paper, you usually take maintenance in Q3. Is that still the case and do you have an estimate for us for that you can share?

John O'Donnell

Yes, first of all no need to apologies, people have hard time following me all the time. I would say, yes, the majority of our maintenance happens historically in the third quarter and that’s still going to be the case this year and it typically is a $2 to $3 million impact for the downtime in that third quarter. What we see different this year is that we have a significant capacity adding capital project and the best opportunity for us is to move that into the fourth quarter. So, rather than have a maintenance down and then come to had take another down later, we combine the two to be more efficient. So, really what I was trying to suggest is that fourth quarter will have a 1 million of incremental cost to achieve that and you should see a million of our historical 2 to 3 move from the third quarter to the fourth quarter, that’s really it. And I am sure than in future years, you will see more of a third quarter maintenance activity for us seems to be the best time.

Evan Wingren - D.A. Davidson & Co

Okay. And then just the final one for me. Just maybe an update in general terms on your acquisition pipeline and sort of what you're seeing out there in the markets I think would be helpful.

John O'Donnell

Sure. Evan, I mentioned in the past and now it may sound redundant but learning comes from reputation. We got a very disciplined process and we have dedicated resources to that and continue to be very, very active. Our bias is towards asset in United States but open to the all opportunities in that regards and our bias is towards performance oriented technical products but would love to continue to grow our filtration portfolio as that’s where we believe we have the most unique value from that. And then finally, I mentioned in the call around packaging, it’s a large market we are early in it and those are the opportunities that we would want to continue to see what capabilities make sense for us to continue to invest behind it. So, active process, I am not discouraged in that regards. I think it’s really important to balance why is it right that Nina owns this company and what’s the long-term value with our desire to utilize some of the cash that we built on the balance sheet. And that’s kind of the tension I live in everyday.

Evan Wingren - D.A. Davidson & Co

Okay. Well, thank you for that given all the after commentary and the script, I think go hop off before I get played off. So..

Operator

Your next question comes from Jon Tanwanteng with CJS Securities.

John O'Donnell

Hi, Jon.

Jon Tanwanteng - CJS Securities

You did a very nice job on the technical products. My question is has the momentum in that segment carried into Q2 or should we view that Q1 has the seasonal high-water mark for both revenues and margins this year?

John O'Donnell

Yes, I did mention that Q1 is typically a strong quarter for technical products and there is some seasonality that happens as customers replenish inventories that they might have pull down. But I was hoping you could hear it in the tender of my voice, I am excited about the technical products opportunities and I don’t view it as a one-off, I believe that area, we’re going to continue to invest and have a meaningful point of difference. So our expectation is that is a great opportunity and a great area for us to continue to see growth.

Jon Tanwanteng - CJS Securities

Okay, great. And then aside from increased energy costs, was there any other impact from the poor weather in Q1, just from a demand side?

John O'Donnell

Great question, we turned over everything we could to try to really look hard to say what could I quantify as a result to the weather. This is a time I have got to have a shout out for my team, I am incredibly impressed with what they were able to overcome. For us I would say no I can’t suggest any revenue was lost as a result of cold weather. Remember we’re in business that often times have either longer lead times and so the weather was cold weather and it caused interruption in timing. In the quarter our team was able to act and react in a way that ensured that we protected all the revenue opportunities that we had in the quarter. So I am very pleased with their performance.

Jon Tanwanteng - CJS Securities

Okay, that's helpful. And then you mentioned 30% year-over-year growth in premium packaging. Can you update us as to what percent of the fine paper segment that is, and do you envision an inflection point where the growth there could kind of accelerate the overall segment growth?

John O'Donnell

That segment is pressured as we talked about with the secular decline, so the group has done a fabulous job over the last four years offsetting any pressures in top line. So remind we’ve growth that business over the last four years. The premium packaging, we said that it represents about $300 million addressable market in the segments we’re in. Today it represents about 10% of the Fine Paper businesses probably where I would look. As far as what kind of step change, today what we’ve done is we continue to point resources to it to learn more about it and to make sure that we’re meeting the needs of the customers, likely step changes will come with capacity additions or capability additions and we’ll talk about those more as we go forward. It won’t be a linear improvement from that standpoint but today with where we’re at we see lots of nice upside in that regard.

Operator

At this time there are no further questions. I'd like to turn the call back to John O'Donnell for closing remarks.

John O'Donnell

Thank you and I'd like to thank everyone for your participation and interest in Neenah today. We look forward to updating you on our progress and results in the future. Thank you again.

Operator

And thank you. This does conclude today's conference. You may now disconnect.

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