Neenah Paper Management Discusses Q1 2013 Results – Earnings Call Transcript – Seeking Alpha

Neenah Paper (NP) Q1 2013 Earnings Call May 9, 2013 11:00 AM ET

Operator

Good morning. My name is Tashauna, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper First Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, May 9, 2013. Thank you.

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

William B. McCarthy

Okay. Good morning, everyone, and thank you for your interest in Neenah. With me on the call today are John O’Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. I’ll provide a few overview comments, and then turn things over to John and Bonnie to review business activities and financial results in detail.

As usual, we released earnings yesterday afternoon, so I hope everyone’s had a chance to get acquainted with these results.

Consolidated sales for the first quarter were $213 million, up 8% from a year ago. Revenues grew in both segments, with Fine Paper boosted by acquisitions, both through an added month of sales from brands acquired in January of 2012 and from 2 months of sales from brands purchased from Southworth in January this year.

Adjusted earnings per share were $0.74 in the quarter, and this included a $0.07 per share reduction versus last year due to our higher 2013 effective tax rate. This increase in taxes more than offset benefits those from higher operating income and lower interest expense. In 2012, adjusted earnings were $0.77 per share.

As a reminder, we report adjusted numbers when there are items that materially distort ongoing business results. In the first quarter, this included acquisition-related costs in both years and a pension settlement charge in 2012. Excluding these items, GAAP earnings were $0.54 per share last year and $0.73 in the current quarter. Adjusted earnings are a non-GAAP measure and are reconciled to GAAP figures in our press release.

Finally, I’ll remind everyone that this call includes forward-looking statements subject to risks and uncertainties. These risks are fully described in our SEC filings and in the Safe Harbor disclaimer found in the Investor Relations section of our website.

And with that, let me turn things over to John.

John P. O’Donnell

Thank you, Bill, and good morning, everyone. I’ll start with a few comments on our strategic direction before turning things over to Bonnie to cover first quarter financial results.

As I’ve shared before, there are 3 broad principles guiding our strategic activities: First, we focus on profitable specialty niched markets, where we can have a meaningful share position and a right to win through improving performance or image of a product. Second, we expect to increase our portfolio growth rate and diversification as we gain scale and expand in higher value products and growth markets. And third, we’ll operate in a disciplined financial matter that continues to deliver consistent and attractive returns to our shareholders.

Let me talk first about our progress in building our leadership in profitable niche markets. As I’ve said, these are markets that value our competencies and performance and image, have various entry and provide attractive financial returns. Some of these more sizable markets for us today include transportation filtration, luxury packaging, premium labels and our core commercial print brands.

In filtration, we hold a leading share of transportation filtration media in Europe and are growing from this base, both internationally and through entry into new filtration end markets. While economic and competitive conditions in Europe remains challenging, and this certainly includes the auto industry, our business continue to perform well. In this quarter, we grew sales in Europe, complimented by international growth of over 20%.

Our customers, many of whom are global, look to us for innovative and specialized products, and we’re working with them on next-generation needs for global engine platforms. At same time, demand for our highest-performance filtration media is growing at a double-digit pace, and we’ll start up our third nonwoven meltblown line in the third quarter to support this need.

Next, with annual sales of around $75 million, labels and luxury packaging are also growing nicely. These products cross both of our business segments, with labels and packaging for premium image products that use our fine papers and performance-oriented labels that are developed in Technical Products. These markets are growing, and we’re outpacing them as we introduce new products, like paper-based gift cards that provide an environmentally friendly solution; new customized performance labels in unique textures and colors for customers that value premium labels or luxury packaging.

In Fine Paper, we identify the retail channel as a strategic growth opportunity. Our brand acquisition in 2012 brought us entry into this channel with the purchase of brands from Southwood earlier this year. We now have achieved a leading market share of 60%, consistent with our strong share and commercial print. The addition of Walmart as a customer this year strengthened our position in the general merchandise channel and reinforced our commitment to future growth in retail.

The majority of our Fine Paper business remains in commercial print, where we have leading brands and a strong market position. We continue to outperform the market as our teams have found new ways to grow through supply chain innovations, partnerships with others and expanded international distribution. There’s no doubt that it takes a lot of work to generate growth in this market, and I’m especially pleased with our Fine Paper team continues to be of value-adding exception.

In addition to these 3 larger markets, we’re focused on growing in profitable technical niches, like special tapes and premium abrasives, medical packaging and filtration adjacencies. While these are not large pieces of business today, our unique capabilities and defensible market positions are providing opportunities to grow.

We’ve started to commercialized products in beverage and industrial filtration and in abrasives. We currently participate only in a small part of this market and believe that our saturated paper solutions may be an attractive alternative to certain film and clock-based products.

Next, we intend to increase Neenah’s growth rate in portfolio diversification as we gain scale as a company. We expect to do this through organic efforts, as well as with acquisitions that meet our financial return requirements. Organically, our innovation efforts are focused on higher-value offerings in markets that are defensible, growing and aligned with our unique strengths in performance media, in coating and saturation. As I mentioned, we’re commercializing new products in beverage and industrial filtration, expanding our label and packaging offerings and developing specialized abrasive backings.

Our organic efforts are likely to be supplemented by acquisitions. Our process to identify and evaluate targets is active. However, we are focused and disciplined. So before we spend any money, we will assure that the acquisition will add value and is a strategic fit. Our criteria focus on 4 adjacency areas that can provide synergies and barriers to entry through technology, products, customers or geographies.

Finally, our expectation is to deliver consistent attractive returns to shareholders through a disciplined financial management. Our starting point is from a position of strength, with businesses that are profitable and generate sizable cash flows. We have a number of internal processes, derive good decisions to grow and deploy cash to deliver attractive returns.

We’ve structured many of our raw material and customer pricing contracts to allow us to manage input cost variability and protect margins. Both of our businesses have demonstrated the ability to offset changes in input cost over time. We’re focused on driving efficiencies throughout the organization, and expect improving performance as we grow and leverage our infrastructure.

We have a disciplined capital spending process that carefully controls sustaining capital to around $10 million and then prioritizes higher-return growth and cost-reduction products. We’re able to keep overall spending within a prudent $25 million to $30 million range, below depreciation and amortization, while ensuring attractive returns on our spending.

As a reminder, our compensation is tied directly to key performance metrics of increasing return on investment capital, top line growth, cash flow generation and comparative returns to shareholders. This paper-for-performance philosophy is extended throughout our company, including our hourly employees.

In 2012, you saw the results from this as we grew top line while also increasing in return on investment capital. We were pleased that our shareholders benefited from that performance and a higher stock price. In addition to reinvesting capital wisely in the business, returning cash to shareholders is an important part of our strategy. We’ve increased our dividend in each of the past 3 years as our company has grown. And as a reminder, today’s level still represents a relatively small part of our free cash flow.

So in summary, we’re encouraged by our ability to deliver on our strategic initiatives, act on attractive opportunities and reward our shareholders for their investments.

I’ll talk more about priorities in 2013 later in the call, but now I’d like to turn things over to Bonnie to discuss first quarter results. Bonnie?

Bonnie J. Cruickshank-Lind

Thanks, John. Today, I’ll cover our business segments first, starting with Technical Products. Sales of $107 million increased 1% versus last year. We had strong volume growth in filtration and tape, in addition to higher value mix in both of these areas. We also had modest translation benefits. Offsetting this were challenging conditions in Europe that extended to some of our other product lines.

Technical Products operating income of just under $10 million was down from an all-time quarterly record of $12.5 million last year. In addition to impacts from conditions in Europe, margins this year reflect a higher manufacturing cost due to increased input costs and less efficient mill operating performance.

Moving next to Fine Paper. Sales of almost $100 million were up 15% versus last year. In addition to growth from acquired brands, sales benefited from an improved mix and double increases in targeted areas, such as luxury packaging and premium labels.

Operating income was $16.3 million and compared to $10.8 million last year. After excluding acquisition costs in both years, adjusted income grew by $3 million or 23%. This higher operating income resulted from increased volume, a higher value sales mix, record manufacturing performance and lower input costs. These items more than offset increased selling, marketing and distribution costs associated with the higher sales.

Turning next to unallocated corporate and other results. Sales of acquired non-premium brands in the first quarter were $6.8 million, with operating income of $300,000. In 2012, sales were $5.8 million, with profit of $700,000. These grades are not considered strategic to us, and margins will vary with mix and market conditions.

Unallocated corporate cost was $4.1 million and compared to $7.8 million last year, which included $3.5 million for a onetime pension settlement charge. Excluding this charge, costs in 2013 were slightly below last year. Costs this year are expected to remain around $4 million per quarter, about where they’ve been for the past 3 years, as we continue to leverage our corporate infrastructure as we grow.

Consolidated selling, general and administrative expenses was $21 million, up from $19.5 million last year. As you would, most of the increase was in Fine Paper, where we incurred additional costs related to the higher sales levels. As a percentage of sales, SG&A for the quarter held constant at 9.8%. As we grow, we expect SG&A as a percent of sales to decrease as we use existing resources to grow efficiently. Spending for the remainder of the year is likely to be between $19 million and $20 million per quarter.

Now let’s move to corporate financial items.

Taxes. Our effective tax rate was 38% in the first quarter, significantly higher than last year’s 29%, As we indicated in the February call, we expected a higher rate this year due to increased repatriation of capital from Germany. We said that the rate could go as high as 40% depending upon proposed changes in German tax law. Following the February call, these changes were enacted and resulted in the 8% rate. We expect this to decline next year to around 35%, which should be more indicative of our long-term run rate.

Neenah’s cash tax rate is below 15%, significantly less than the book rate as we use our net operating losses to offset cash tax payments due on North American income. Currently, we have approximately $50 million of NOLs remaining and expect to use these by the end of 2014.

Cash flow from operations was $2 million in the first quarter. This included a $23 million increase in working capital, mostly as a result of higher receivables. Sales growth and seasonality tend to drive working capital increases in the first quarter as we come off of year-end lows. The positive cash generation in the current quarter, compared to a $13 million cash deficit last year, and we also had unusual and higher outflows for item, like pension settlement, taxes on stock compensation and acquisition-related inventory.

Our U.S. pension plans are in sound shape and are funded at just over 90%. Globally, pension plan contributions and payments in 2013 are expected to be around $17 million, which was consistent with where we were last year. Our desire is for the U.S. plan to be fully funded by the end of 2014 at about the same time our NOLs expire, in this way, minimizing the impact on our overall cash flow generation.

Capital spending was $4.7 million in the quarter, compared to $3.5 million last year. For the full year, we expect to be near the top of our $25 million to $30 million range with the nonwoven meltblown line investment.

Let me talk next about our capital structure. Debt was $187 million at quarter end, up from $182 million at year end. The increase, in part, reflected funding for the $7 million purchase of brands from Southworth. As of quarter end, our debt was comprised of $90 million of long-term bonds, $50 million drawn on our revolver, $29 million for a term loan and then the balance was in Germany.

Interest expense was $1 million below last year, largely due to lower debt levels and a lower average interest rate, following prior year redemptions of senior notes paying 7.375% that were replaced by short-term borrowings at a rate of about half that level. We noted in the release yesterday that we will redeem another $20 million of senior notes in the second quarter, further reducing interest expense.

In today’s low interest rate environment, we continue to monitor the credit markets for additional opportunities to take advantage of these conditions.

Let me close with a few thoughts on cash generation and allocation. As John said, our businesses generate significant cash flow. Reinvesting through organic growth rate project is our first choice, and we actively prioritize growth and cost-reduction capital. Our acquisition screening process is active, and we’re looking for opportunities that are a strategic fit and provide the returns we need.

In the past, we used excess cash to pay down debt. Our balance sheet is now very strong, with debt to EBITDA of around 1.5x and at the low end of our targeted range. Therefore, paying down more debt is not a particularly attractive option. Returning cash directly to shareholders has been and continues to be an important part of our capital deployment strategy. We maintained our dividend throughout the great recession and have grown at 50% in the past 3 years.

In addition, we have the ability to buy back shares if the opportunity is compelling. In 2012, we spent approximately $4 million on share buybacks at an average price of less than $26 per share.

To summarize, with substantial cash flow generating ability and capital structure with ample borrowing capacity, we’re in a great position to take advantage of opportunities to drive incremental value and provide returns to our shareholders.

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

John P. O’Donnell

Thank you, Bonnie. As usual, let me start with a few comments about safety, which is always our top priority. Our safety philosophy is ground in the premise that every employee should be personally involved and engaged in activities that will contribute to a safer workplace. In 2013, our safety results have been disappointing compared to last year’s improved pace. But I know our teams remain focused in this area, and our commitment remains that no one be hurt in the workplace.

Next, let me talk briefly about the current outlook. I said in February that market conditions, at least in the first half of 2013, will be slower than the prior year, with challenges being especially acute in Europe. This weaker economic conditions have resulted in a more challenging competitive environment where companies are chasing volume, and we don’t expect this situation to change in the near term. While we can’t control the environment, our teams are focused on what they can control, like costs and innovation and commercializing new products and growing our share in markets outside of Europe. As anticipated, input cost are rising this year, with the largest increases in specialized pulp used in Germany and in hardwood pulp used in our Fine Paper.

Let me remind you that our businesses have demonstrated that they can offset cost variations over time. Cost did increase in the first quarter, and additional increases in pulp and energy are expected in the second quarter, with commodity pulp increases of $30 to $50 a ton and specialty pulp rising even more. Our teams are managing this with a selling price increase in the Fine Paper implemented in early March and pricing discussions with customers in Technical Products that don’t participate in automatic price adjusters.

Finally, let me share a few of our priority areas for this year. First, we’ll deliver the returns we committed to with organic growth capital. This includes the start-up of a third meltblown line in Germany and a soft-nip calender in Munising, Michigan. These investments provide cost efficiencies. But more importantly, they support our growth plans in adjacent filtration and abrasive markets.

Second, we’ll continue to prioritize capital for value-adding acquisitions that can deliver on our strategy to diversify into growing at profitable niche markets, most likely in Technical Products. Our acquisition of brands from Southworth in January is on track, and we’re integrating and optimizing our operations to capture this value. We’re also finding ways to minimize integration costs, which $1.3 million is projected to be below our original estimate.

Next, we’ll deliver on our innovation and growth plans in both businesses. Initiatives this year include commercialization of new label products, expansion of our envelope go-to-market approach and increase commercialization of new products in filtration, luxury packaging and the retail channel.

Finally, we’ll continue to optimize our financial position through a lower cost capital structure, addressing our high tax rate, investing our cash efficiently and providing attractive returns to shareholders.

As I hope you can see, we had a sound start to the year and continue to find unique and creative ways to drive additional value in our businesses. We have a number of activities under way and our teams are very active, and that’s okay. We enjoy the energetic pace because winning is fun.

Thank you for your time and interest this morning. At this point, I’d like to open up the call to any questions.