Neenah Paper, Inc. (NP): Neenah Paper Management Discusses Q2 2013 … – Seeking Alpha

Neenah Paper (NP) Q2 2013 Earnings Call August 8, 2013 11:00 AM ET

Operator

Good morning. My name is LaShanta, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, August 8, 2013. 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.

William B. McCarthy

Great. Good morning, and thank you for joining Neenah’s 2013 Second Quarter Earnings Call. With me today are John O’Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. I’ll start with a few brief comments and then turn things over to John and Bonnie to review business activities and financial results in detail.

As noted in our press release yesterday afternoon, adjusted earnings per share where $0.80 in the second quarter. Earnings were adjusted by $0.03, primarily for a noncash write-off related to refinancing our senior notes. Last year, adjusted earnings were $0.85 per share and excluded cost of $0.08 for integration of acquired Fine Paper brands. Earnings on a GAAP basis were $0.77 per share in both periods, and a reconciliation of adjusted earnings to corresponding GAAP figures is included in our press release.

Finally, as a reminder, this call will contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from these statements. These risks and uncertainties are described in detail in our SEC filings and in the Safe Harbor disclaimer contained on our website.

And with that, I’ll turn things over to John O’Donnell, our Chief Executive Officer.

John P. O’Donnell

Good morning. As Bill mentioned, adjusted earnings in the second quarter were $0.80 per share. That’s not only exceeded our expectations but was our second highest income level ever, only better by the second quarter of last year. Technical Products operating income increased significantly versus the first quarter and was equal to last year’s very strong results, despite a somewhat weaker but improving business environment in Europe.

And our Fine Paper business continues to deliver mid-teen operating margins, supported by market-leading brands and a more efficient operating platform. Coupled with working capital improvements in the quarter, earnings translated into cash from operations of almost $28 million.

Results also reflect the continuing progress against 3 strategic priorities. As I’ve shared before, at first, to build businesses in profitable specialty niche markets where we have a meaningful share position and right to win through improving the performance or the image of a product; second, to increase our growth rate and portfolio diversification as we invest and expand with high-value products and growing markets; and third, to operate in a disciplined financial manner that will deliver consistent and attractive returns for our shareholders. Let me update you briefly on our progress in each of these areas.

We’re continuing to build on our meaningful positions in profitable niche markets. Some of these more sizable markets include transportation filtration, premium labels, specialized backings and branded fine papers.

Transportation filtration is our largest Technical Products business, and the majority of this business is in Europe, where we hold a leading share.

While economic conditions in Europe remains soft, our filtration business has continued to perform well, and volumes grew 5% this quarter.

With 70% of filters going through the aftermarket, this provides a solid foundation in consistency and demand. Growth is being supplemented by an increasing international presence as we expand with existing global customers and increase sales to local filter manufacturers. In addition, the need for our highest-performing filtration media continues to grow at a pace greater than the market as consumer climates become more demanding. We are known and valued by customers for providing innovative and specialized products with high service levels, and we expect this positioning to provide us growth opportunities in the future.

Premium labels is another attractive market. Here, our products span both business segments, with premium image levels delivered to our high-quality fine papers and with performance-oriented labels using our Technical Products capabilities. Sales of performance labels were especially good in the quarter, growing 8%, and led by increases in image transfer and durable papers.

We also continue to find success in image labels with distinctive color and texture labels for craft beers, wines and other food and beverage applications, where the label can influence trial or improve the perceived value of the product. Labels are a large and growing market. We are exploring solutions where our core capabilities allow us to successfully differentiate.

Our third market is specialty backings, which is comprised of tape and abrasive products. In tape, sales were up more than 50% as we recovered share and continue to commercialize innovative new products with features such as water repellency, ultraviolet resistance and unique service characteristics. Partly offsetting this growth was lower abrasive sales in the quarter as customers, especially in Asia, reduced orders as economies slowed and inventories were managed.

Finally, premium fine paper, where we are a clear market leader. Sales grew 4% this quarter as we integrated Southworth brands, further implementing our envelope go-to-market strategy and continue to support core premium brands like CLASSIC. Margins remain strong and are benefiting from manufacturing efficiencies, including production output records set in the quarter.

So while this month remains challenging, our teams continue to find creative ways to grow in a capital-efficient manner through supply chain innovations, partnerships with others and expanded consumer and international distribution.

In fact, an example is the recently announced distribution agreement with Gruppo Cordenons. This Italian company manufactures a number of uniquely differentiated brands that will enhance our portfolio of colored and textured papers and support our growth in luxury packaging. In the third quarter, we’ll begin to offer our new design collection line to customers in North America, and we’re excited about how nicely this edition reinforces and complements our existing offerings. In real forms, Neenah is a clear innovative leader in premium papers.

While performance in core businesses is a priority, increasing our growth rate and portfolio diversification as we scale as a company follows right behind. We expect to do this both organically with high-value offerings and growing markets, as well as through thoughtful and value-adding acquisitions.

Organic areas we are finding success include adjacent filtration markets, expansion of our luxury packaging and growth in our retail fine papers.

In filtration adjacencies, we continue to grow sales of beverage filter media and more recently, began commercializing new industrial filtration products. While revenues from these new areas are still relatively small, they are in growing markets, and they utilize our existing filtration technologies.

Luxury packaging also continues to demonstrate strong growth with both new products and new customers. Recent successes include packaging for some of the most popular smartphones as well as prestigious jewelry and cosmetic brands. As of premium labels, we sell our customers with valuable brands, and our papers complement their image while validating the consumers’ purchase choice.

Finally, retail fine papers continue to grow with customers like Michaels and Staples and Target and more recently, Walmart. We’re the share leader in our existing categories and are pursuing opportunities for growth in new channels like, drug, crafting and club, as well as by expanding our offerings with our existing customer base.

These organic efforts are helping us to accelerate growth through high-value products with attractive returns. We expect to supplement this growth with acquisitions. We’ve dedicated resources to that end, and our process to identify and evaluate target remains very active. While we clearly have the financial strength to execute, we’re very disciplined in our approach and will not invest unless an acquisition provides us the good strategic fit and platform for future growth that we’re looking for.

Finally, our expectation is to deliver consistent attractive returns to shareholders through disciplined financial management. Our businesses are profitable and well positioned, with pricing in both segments that has allowed us to offset input cost changes over time. Our teams are focused on achieving growth in a financially responsible manner, with active internal processes to drive good decision-making and return on invested capital as the prominent financial metric.

Dividends are an important part of how we will deploy cash. In May, we stated our intent to grow our dividend yield to 3% to 4% and announced a dividend increase of 33%, our second increase of the year. We’re committed to an attractive dividend as a way to provide our shareholders with a consistent and meaningful total return.

As a measure of success and for incentive purposes, we compare ourselves to some of the best-performing companies in the Russell 2000 Index and expect to redeploy our strong cash flows in ways that continue to deliver against our high expectations.

So in summary, we’re pleased with the progress we’ve made in key strategic areas, how our businesses continue to deliver consistent and attractive returns. I will provide a few more comments later in the call, but now I’ll turn things over to Bonnie to review financial results in more detail.

Bonnie J. Cruickshank-Lind

Thanks, John. As usual, I’ll cover our business segments first, starting with Technical Products. Sales of $106 million were in line with last year despite the challenging global conditions in Europe and slowdowns in Asia. We were able to do this with growth in filtration, labels and tape that helped to counter declines in the more economically sensitive industrial and other product groups. Our mix improved in the quarter with growth in higher-value products, and we also benefited from translation gains due to a slightly stronger euro.

Operating income of just under $12 million was similar to last year’s pretty strong level and up significantly from $10 million in the first quarter. While operational performance is improving, it continues to be below last year, and plans are in place for further improvements in the second half.

In the second quarter, the impact of higher manufacturing costs was largely offset by a more profitable mix and decreased selling, administrative and other expenses.

Moving on to Fine Paper. Quarterly sales topped $100 million and were up 4% versus last year. Increased revenues reflected growth from acquired brands and increases in luxury packaging, retail and the international market. Net prices were also higher, reflecting price increases and an improved mix of higher-value branded products like our business papers, envelopes and other specialty grades.

Operating income was $15.5 million compared to $13.3 million last year. After excluding integration costs in both years, adjusted income grew from $15.2 million to $15.6 million.

Increased income resulted from higher average net prizes and improved manufacturing efficiencies, partly offset by almost $2 million of higher input costs and added selling, marketing and distribution costs associated with the increased sales.

Advertising expenditures were also higher in the quarter due to timing of launches and promotions, and this should decline in the second half of this year. Our Southworth brand integration is ahead of plan, and integration costs in the quarter were less than $150,000.

We expect to incur $350,000 in the third quarter, at which point we’re done. With total costs of around $600,000, we’ll end up well under original estimates as our team has found ways to optimize integration activities and reduce costs.

Turning next to unallocated corporate and other results. Sales of non-premium grades in the second quarter were $6.5 million compared with $8.5 million last year. As a reminder, these grades of companies are ASTROBRIGHTS brand acquisition and included grades that were important to some of our customers for a smooth transition. We expect to lose some of this business following the purchase, and our run rate over the past few quarters has been $6 million to $7 million.

As you would expect, profits have declined with lower volumes in the second quarter, included additional costs associated with the disposal of obsolete products. However, this nonstrategic business will continue to provide incremental variable profit contribution and positive cash flow, and at current volume expectations, EBIT is projected to be around breakeven.

Unallocated corporate costs were $4.2 million, both this year and last year. After excluding costs related to early debt retirement and pension settlement charges, costs were approximately $0.5 million lower this year. Even with a growing top line, we have maintained a run rate of around $4 million per quarter, about where it’s been for the past 3 years as we leverage our infrastructure and gain efficiencies.

These efficiencies can also be seen in SG&A, which as a percent of sales, is 9.4% so far this year. That compares to 9.6% in 2012. In dollar terms, consolidated SG&A of $19.2 million was almost identical to last year. Increased spending in Fine Paper related to the higher sales was offset by reductions in other areas.

We expect ongoing spending of $19 million to $20 million per quarter.

Let’s move now to a few corporate financial items. Our effective tax rate increased earlier this year due to additional repatriation of cash and a change in German tax law. We work to respond to changes in the law and now expect a full year rate of around 36%, down from 38% in the first quarter, though still above last year’s rate of 30%.

In the second quarter, the rate was 34% as we trued up expenses to reflect the new projected full year rate. Our cash tax rate remains below 15% as we used net operating losses to offset cash tax payment due on North American income. As of June, we had $39 million of federal NOLs remaining that we expect to use by the end of 2014.

Cash flow from operations was $28 million in the second quarter, primarily due to earnings but also included a $3 million decline in working capital. Cash flow was up significantly from last year when we increased working capital to support acquired Fine Paper sales.

Capital spending was $5 million in the quarter compared to $5.8 million last year. For the full year, we expect to be within our $25 million to $30 million targeted range. And the second half of the year will reflect the planned increase in spending, in part due to the timing of our annual maintenance down in the third quarter.

Cash payments for defined benefit pension plans are expected to be $18 million this year, about the same level as the last few years’ and about $10 million more than expense.

Based on these contribution levels and projected discount rates, we expect our U.S. pension plans to be fully funded by the end of 2014. This timing is in line with when our NOLs will be consumed, minimizing the net impact on overall cash flow.

Turning to capital structure. A significant accomplishment during the quarter was the refinancing of our long-term notes. In May, we issued $175 million of 8-year bonds with an interest rate of 5.25%. Proceeds were used to retire the remaining $90 million of notes due in 2014 that carried an interest rate of 7 3/8 and were also used to pay up all other U.S. borrowings.

In addition to locking in a fantastic rate, we were able to derisk our balance sheet by refinancing with new long-term debt and secured terms that gave us added flexibilities for the plans to grow and provide increasing cash returns to shareholders.

Debt was $192 million at quarter end, up $6 million from March, while cash balances increased by $23 million, reflecting our strong cash flow. Debt was comprised of $175 million from the new bonds and $18 million of debt in Germany.

Interest expense in the quarter was $3.1 million, down from $3.5 million last year. Due to timing of the refinancing, we had 1 month of added interest expense in the quarter equal to about $500,000. Based on June ending debt levels, quarterly interest expense should be approximately $2.6 million for quarters going forward or a little over $10 million a year.

I’ll close with a few comments on cash deployment. Reinvesting in attractive organic growth projects is always our first choice, and we actively prioritize capital for growth and cost savings with good returns while keeping total spending within a prudent range. We have a strong balance sheet with debt-to-EBITDA of 1.7x. This is at the low end of our targeted range, so further reductions are unlikely.

John spoke earlier about how an attractive dividend is an important part of our capital deployment strategy and the actions that we’ve taken this year. Current annual dividend of $0.80 per share represents about $13 million of our cash flow. This is a very manageable amount, and we have ample flexibility to increase our payout as we move toward targeted dividend yield over the next 3 years.

At the same time, we also have a program that allows us to buy back shares if the opportunity is compelling. With our current capital structure and cash flow generating ability, we’re in a great position to take advantage of opportunities that deliver incremental value while continuing to provide attractive returns to our shareholders.

With that, I’ll turn things back to you, John.

John P. O’Donnell

Thank you, Bonnie. Let me start with a few comments related to our employees as success doesn’t happen without their commitment, engagement and accountability. We recently finalized new 5-year labor agreements at all of our U.S. facilities and entered into new multiyear labor contracts in Germany. Relationships with our unions are productive, and with their support and ownership of results, we continue to work together on our common objective of safely providing the products and quality our customers value while never losing sight of the importance of continually managing our costs.

Safety is a top priority, and our performance remains substantially better than the industry average. Our teams throughout the company are focused on this area, and our goal remains that no one be hurt in the workplace. I’d like to recognize employees at our plant in Munising, Michigan, who’ve reduced their rate of injuries by 2/3 this year, and also at our Bruckmühl facility in Germany, which has now operated injury-free for the majority of 2013.

Next, let me briefly talk about expectations for the second half of the year. As a reminder, demand in the second half reflects normal seasonality with some holidays in Europe and year-end holiday downtime at many of our large customers.

In the third quarter, we take annual maintenance downs at most of our plants. Higher spending and other costs related to downs are typically $3 million to $4 million, and our teams are focused on managing those costs and working safely through the down periods.

With lags in our pulp contracts, we’re expecting book costs in the third quarter to increase by about $1 million from the second quarter levels. Most of this will be related to hardwood prices used in fine paper. For the full year, the largest increases have been in hardwood and in specialty pulps.

As we’ve demonstrated, both businesses are able to offset input cost variations over time through market pricing and cost reduction activities.

Moving to the economic outlook. While our global conditions are not robust, we are starting to see some optimism in Europe, and our teams continue to move ahead with initiatives across our businesses that drive future value. Investments to expand capacity to support filtration growth are on track to start up in the fourth quarter at are our [indiscernible] Germany facility and our technical products mill in Michigan. Our investment in a soft-nip calender supports our efforts to lower operating costs and provides capabilities for new products such as super smooth, abrasive backings and our entry into the growing market of stored value gift cards.

In Fine Paper, we’ll complete the transition of converting for Southworth grades this quarter, helping to deliver costs and supply chain efficiencies with integration costs well below plan.

Our teams is focused on what they could control with the improvements that will benefit us, regardless of external conditions. But with that said, I’m still encouraged that these conditions appear to be moving in the right direction.

Let me wrap up with how I began. We’re very pleased with how our businesses performed in the second quarter. We’re doing what we said we would, and our shareholders are benefiting from our actions. Our financial footing is strong, and we’re excited about what this allows us to do as we deliver on our strategic initiatives, act on attractive opportunities and reward our shareholders.

Thank you for your interest. And at this point, I’d like to open the call up to questions.