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Neenah, Inc. (NYSE:NP)
Q3 2019 Earnings Call
Nov 6, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Neenah Q3 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Bill McCarthy. Please go ahead.

Bill McCarthy -- Vice President-Investor Relations

Okay. Thank you, and good morning, everyone.

On the call with me today are John O'Donnell, Chief Executive Officer, and Bonnie Lind, Chief Financial Officer. John and Bonnie will provide comments on business and financial results for the most recent quarter, along with thoughts on the remainder of the year. After these prepared remarks, we'll open up the call for questions.

I'll start with a few headlines. Excluding impacts from currency and the divestiture of our operation in Vermont last December, quarterly sales of $232 million were down 6% compared to last year. Adjusted earnings per share were $0.95, up 25% from $0.76 last year. GAAP earnings were $0.84 per share and also up from $0.75 a year ago. Details on adjusting items and a reconciliation to comparable GAAP figures are included in the press release.

Finally, I'll note that our comments today may include forward-looking statements. Actual results could differ from these statements due to uncertainties and risks outlined both on our website and in our SEC filings.

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

John O'Donnell -- President and Chief Executive Officer

Thank you, and good morning, everyone.

As a result of the many actions our teams have under way Q3 results versus prior year, again, demonstrates significant progress in a number of areas. Operating margins increased by over 250 basis points and are returning to more normalized levels, earnings grew 25% and operating cash flow was a very solid $33 million, up $10 million as we were relentlessly focused on capital efficiencies.

While our bottom line increased significantly as we closely manage costs and pricing initiatives, revenues reflected weaker market conditions in both segments. In addition, short-term results were negatively impacted by two strategic actions we've taken. As you should expect from our teams, we are working aggressively across the businesses to address short-term issues and position us for long-term success.

In Fine Paper and Packaging, commercial print volumes remain under secular pressure and higher value products like ours are even more pressured when prices are elevated. In addition, short-term results were negatively impacted by two significant strategic actions taken to strengthen our long-term position. First was the 2018 divestiture of our Vermont mill, reducing sales but improving our bottom line. And second was a more recent change to our market representation, which I'll talk about next.

Our strategy has been to selectively maintain the very best distribution in each market we serve. Neenah is the market leader and we believe limited distribution of our well-known brands help support the value of these products and rewards the loyalty of our customers. However, one of our historically larger distributors radically changed their strategic focus, choosing to no longer actively promote premium fine papers. As a result, over the past few quarters we've seen accelerating declines in sales through this distributor. While we recaptured some of this business through other customers, we recognize the need for more proactive approach. To address this, in the third quarter we formally terminated our support for their market representation in all of our US markets and have worked actively with our strategically aligned distributors to ensure maximum retention of our branded sales volume.

In addition to the focus on preserving volume, our team has done a terrific job executing plans to minimize freight and distribution expense by keeping the majority of our inventory resident in the market with value distribution. Although we anticipate these actions to negatively impact fine paper sales by an added 1% to 2% in the near term, we clearly believe this is the right action to support the health of our fine paper brands and overtly demonstrate that we are committed to a selective distribution strategy. While any change of this magnitude is difficult to make, our plans show that by actively transitioning relations with printers and designers we'll have significantly better results in the long run.

In tandem with this change, we continued to keep our capacity aligned with our strong market share and consolidated our footprint with the recent idling of the highest cost fine paper asset, rationalizing unproductive SKUs and transitioning production to paper machines in Wisconsin with available capacity. As mentioned on the last call, this asset rationalization is expected to generate operational savings of up to $1 million annually starting in the fourth quarter.

Turning to Technical Products. Almost 60% [Phonetic] of our sales are outside of the United States. And with Germany nearing a recession, Europe is clearly struggling. Nonetheless, in our targeted growth markets digital transfer volumes grew at our long-term expectation of 7%. And filtration rose 2% in constant currency.

The biggest top line challenge in Technical Products this year has been in backings, our most global and economically sensitive category. Backings comprise more than 70% of the third quarter decline in segment sales, mostly due to lower sales in Asia, where volumes continue to be pressured by rising nationalism, a strong US dollar and tariff concerns. With $15 million to $20 million of annual sales in this region, they're still exposure if the competitive environment deteriorates further. My belief, however, is that since the fall-off in sales began at the start of this year, we'll lap this decline as we enter 2020.

Our teams are also actively executing long-term strategies to drive meaningful growth as we work with customers to satisfy their needs for new or enhanced product solutions. This continues to be an important strategy for Technical Products, as our innovation efforts have resulted in more than 20% of sales coming from products developed and commercialized in the last five years.

I'd also like to recognize the Appleton facility for achieving ISO 14001 certification, a designation that demonstrates our commitment to environmental stewardship, and it's very important to our global filtration customers.

Looking ahead, I'm extremely encouraged by the number of projects currently under development, specifically in product categories like advanced air filtration and digital transfer media. For example, at a recent trade show in Europe we exhibited a new product branded Texcol that uses proprietary technology enabling the transfer of digital images onto natural fibers, a breakthrough that we believe could double the addressable market of this category.

In both businesses, these longer-term growth initiatives are balanced with near-term actions to improve results. Our teams are working aggressively to increase volume and improve utilization of our assets. These efforts have included customization of product solutions and relentless pursuit of additional business with key customers through our greater supply chain capabilities.

In addition, our teams remain very focused on managing costs and optimizing cash flows. As you would expect with near-term volume weakness, fixed cost absorption is a larger challenge. As a result, we're working to drive out excess costs and improve operational efficiencies at every manufacturing location. We saw evidence of this with improved cost during our annual maintenance downs in the third quarter. In addition, we're actively managing freight and SG&A costs, and delivered improvements in both areas this quarter.

Finally, I commented earlier, we generated substantial cash flow and, for a second consecutive quarter, reduced debt by approximately $20 million, further strengthening our balance sheet. These strong cash flows reflected increased operating earnings and careful management of inventories and capital spending. For the record, we expect to retain this working capital improvement going forward and keep our near-term annual capital spending within the range of $30 million to $40 million.

As we all know, the most resilient improvement comes from a very focused and aligned team that demonstrates the ability to make improvement a daily objective. I'm very pleased with the progress our teams are making, especially with the balanced perspective of long and short term actions to ensure our future success.

I'll talk more about our outlook later in the call, but I'll now turn things over to Bonnie to cover third quarter financial results in detail.

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Thank you, John. Hello, everyone.

As you heard, we delivered good bottom line results that translated into strong cash flows in the quarter. I will review financial results for each of our business segments and then finish with a few comments on corporate items.

Starting with Technical Products. Quarterly sales were $132 million compared to $142 million last year. Currency impacts from a weaker euro generated about a third of the shortfall. Excluding this, sales were down 5%. As John mentioned, lower backings in Asia accounted for most of the decline, though this was partly offset by growth in filtration and digital transfer media as well as benefits from increased selling prices and a higher value mix.

Operating income of $9.5 million in 2019 increased 15% from adjusted income of $8.3 million last year. Adjusted income in 2018 excluded $2.6 million of net favorable items. Higher profits in 2019 resulted from lower input costs, higher selling prices and a higher value mix that more than offset negative impacts from reduced sales and production volumes and higher SG&A.

Moving to Fine Paper and Packaging. Sales of $100 million were down from $113 million last year. About half of the decline resulted from the Vermont mill divestiture, with the rest due to lower commercial print volumes, including impacts from the distributor change that John discussed and a less favorable mix. In addition, sales benefited from increased selling prices. Premium packaging sales were down slightly in the quarter, reflecting timing of orders as well as the slowdown in overseas markets, though this was partly countered by increased sales in our retail channel as a result of excellent performance during the back-to-school season.

Operating income included about $2 million in non-routine costs in both periods. In 2019, this was mostly for accelerated depreciation on the machine we idled in the third quarter, while in 2018 we recognized additional expense related to the Vermont mill divestiture. Excluding these items, adjusted operating income of $15.5 million in 2019 increased 17% from $13.2 million last year. This was a result of lower input costs and higher selling prices that more than offset lower volumes and a less favorable mix. I'd also like to note that operating margins in this segment are now back in line with their historical mid-teen levels.

Moving on to corporate items. Consolidated SG&A of $23 million was down $0.5 million from the prior year. Year-to-date spending was about $75 million in both years, in line with our projected average of $25 million per quarter. Unallocated corporate SG&A was $3.7 million compared with $5.1 million last year. Excluding non-routine costs, adjusted corporate expense was $3.5 million this year, down from $4.3 million a year ago. Quarterly interest expense of $2.8 million declined from $3.2 million in the prior year due to lower outstanding debt and lower average interest rates this year.

Debt at the end of September was $205 million, down $19 million in the quarter. Our debt is all pre-payable without penalties or fees, with the majority comprised of a $175 million unsecured note that's due in May of 2021.

Moving on to taxes. Looking forward, we expect our book rate to be in the low 20s but cash tax rates well below this as we consume prior period R&D credits. However, our third quarter book rate was only 11% as we reversed a $1.2 million tax reserve following expiration of the statue of limitations for audit. This low rate contributed $0.07 per share to 2019 earnings. This rate was still higher than the 3% rate in the third quarter of 2018 which benefited from pension contributions, excess benefits from stock comp and a magnified impact from other tax credits.

Pension and retirement plans remain well funded. Cash contributions and payments for these plans were $3 million in the quarter which is down from last year when we accelerated payments to take advantage of a tax rate benefit. For the full year, cash reserves [Phonetic] are expected to be approximately $15 million as previously communicated. This is down from over $20 million last year and is about $6 million higher than projected 2019 post-retirement plan expense.

As already noted, cash from operations in the quarter was a very strong $33 million, up from $24 million last year. In addition to higher cash earnings, we realized benefits from improved working capital and lower pension plan contributions. Given today's uncertain economic environment, we're closely managing capital spending, prioritizing projects that deliver attractive cost savings and continuing to optimize maintenance CapEx. Capital spending was $5 million in third quarter and $14 million year-to-date, and we expect 2019 full year spending in the range of $25 million to $30 million.

I'll wrap up by reiterating our commitment to maintaining a strong balance sheet and disciplined capital deployment. We believe that our debt to EBITDA ratio at below 2 times and the significant borrowing capacity that we have available on our existing facilities provide ample flexibility to withstand economic disruption while also allowing us to act on compelling acquisition opportunities. Absent such opportunities, our near-term capital allocation priority will continue to be paying down debt, while returning cash to our shareholders through an attractive growing dividend and opportunistic share repurchases.

With that, I'm going to turn it back to you, John.

John O'Donnell -- President and Chief Executive Officer

Thank you, Bonnie.

I'll start off with a few thoughts as we look forward. As you might imagine, current global market and economic conditions make it difficult to predict future demand, and we've seen no indication that the situation will change significantly in the near term. Our teams are focused on what they can control, taking actions to drive added volume while prudently managing costs and capital.

Looking ahead, our annual filtration maintenance down in Germany will occur in the fourth quarter like it did last year and we expect normal top line seasonality. Fourth quarter sales are typically the weakest of the year as year-end demand softens and customers manage down their inventories. We expect this to influence demand in both businesses and Fine Paper and Packaging will also see a short-term impact from our change in market representation.

As we've mentioned in past calls, this year we expect to recover at a minimum the $10 million of input cost increases that we did not offset with selling prices last year. We're clearly on track to deliver against that forecast, which will allow us to enter 2020 on a much improved and more attractive margin profile.

So let me wrap up. In the third quarter our teams continued to demonstrate progress by increasing margins, delivering meaningful improvement in capital efficiencies and cash flows, strengthening our balance sheet by paying down debt and providing our shareholders with an attractive dividend. Our strategies remain sound and are being executed with the disciplined internal decision-making process and catalysts and capabilities for long-term growth are in place as we grow in filtration, both gaining share in transportation filtration and expanding in other filtration categories; increase our global presence and product portfolio in digital transfer media; grow in premium packaging to mitigate fine paper volume declines; and recover margins as we overcome last year's unprecedented run-up in input costs.

Our customer support and competitive standing remains strong and as the global demand recovers, we're well positioned to grow in a capital efficient manner. From a peace of mind standpoint, our conservative balance sheet and meaningful cash generation give us financial strength and flexibility to weather unforeseen economic impacts yet also allow us to act on strategic investment opportunities that can accelerate our growth rate and add value.

We appreciate the talent and dedication of employees, the strength of our customer relationships and the support of our shareholders as we continue to emerge from a challenging period and unlock the potential of our company.

Thank you for your time. I'll now open up the call for questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Steve Chercover with D.A. Davidson. Please go ahead.

Steven Chercover -- D.A. Davidson -- Analyst

Thanks. Let's get on the game show.

John O'Donnell -- President and Chief Executive Officer

Good morning, Steve.

Steven Chercover -- D.A. Davidson -- Analyst

Good morning. So, in fine papers, your sales were down sequentially $7 million, while EBIT was flat. So obviously margins were up. And I'm just wondering, we attribute that to better productivity or falling pulp? Because it doesn't sound like the machine closure really is a benefit till I guess Q4.

John O'Donnell -- President and Chief Executive Officer

That's correct. The idling of the paper machine won't have an impact until Q4. We saw improved cost positions clearly as pulp came down the stickiness of the pricing actions that we had in place before us. This is actually the first quarter where we've started to see an improvement over our pulp cost increases from the prior two years. So a lot of it has been that. And there was some mix enhancement as well. I don't want to leave out SG&A and distribution work because that's a lot of hard work activity. So there's a variety of areas that drove that. But we're now starting to see that the pricing overcome the pulp as a big part of the margin restoration.

Steven Chercover -- D.A. Davidson -- Analyst

Yes. Because it occurs to me that of your peers who also buy market pulp, the benefits really only just started to accrue and should accelerate. So is it fair to say that that would be consistent with your view and the way it should follow through?

John O'Donnell -- President and Chief Executive Officer

Yes. I think so. You would love to believe that as high as it goes up, it will come down. I don't know. A minute exercising isn't the same thing as a minute doing something you enjoy. So on the going-down side, I believe we're going to have continued improvement in overall pulp. I also think it's a very challenging volume period for most of the markets where we participate that in itself you rarely see a lot of holding on to price when volumes are challenged. So that's going to be one of the things that we are going to be very focused on as we move forward in the next six to 12 months.

Steven Chercover -- D.A. Davidson -- Analyst

Okay. And if I heard you correctly, John -- and you're pretty articulate guy -- you said in Technical Products, you should be lapping most of the headwinds that you encountered in 2020 [Phonetic]?

John O'Donnell -- President and Chief Executive Officer

Yes.

Steven Chercover -- D.A. Davidson -- Analyst

So does that mean we can start to see a modest revenue trajectory absent some kind of unforeseen currency move that I wouldn't be able to predict?

John O'Donnell -- President and Chief Executive Officer

Yes, that was my half full guy, and I've said I expect that from that standpoint because I think the impact that Asia had on us, the significant impact that the Asia volume had on us of this year, we're starting to see that being mitigated. So our expectation is that the impact that we've had from Asia will likely be completed. And we have growth categories there. As we talked about, our transportation filtration as we roll out the incremental capacity, and our digital transfer media is just doing very, very well there as well.

Steven Chercover -- D.A. Davidson -- Analyst

Okay. And just to try and parse out that $10 million tailwind. As you recover costs that weren't recouped last year, I mean, is that separate of pulp? And then can you -- I mean, it sounds like -- trying to sound like an analyst -- give us the cadence and the split between the two segments? I mean, how much was captured this year and how much is sort of yet to come?

John O'Donnell -- President and Chief Executive Officer

Yes. So my $10 million that I'm referencing is the difference between the increases and the difference in selling price. So, last year we had $32 million increase in pulp and we recovered $22 million in price. So then I gave you an IOU, this year we're going to come in with significant price movements to make sure that we address that. Q3 was the very first quarter that we saw that impact.

As a reminder, from a pricing strategy, Fine Paper has a lot of net pricing, so they tend to capture theirs earlier as they move it through, and that's why you saw a nice margin improvement in the last quarter and again in this quarter. Technical Products is a much longer recovery run, if you will, so should expect that, I would say, in this quarter, more disproportionately associated to Fine Paper than Tech going forward.

Steven Chercover -- D.A. Davidson -- Analyst

All right. And then finally, obviously, Q4 is seasonally weakest for Technical Products, coupled with the maintenance down in Germany. So stay tuned for 2020?

John O'Donnell -- President and Chief Executive Officer

That's correct. I mean, Q4 is -- we're not done yet. So we'll run all the way to the end of this one. It is definitely one of our weaker periods from that standpoint. And as a reminder, we always take our down in Germany in the fourth quarter. So it's just more of a reminder of the activity than anything else. We expect it to be similar to the prior year.

Steven Chercover -- D.A. Davidson -- Analyst

Okay. Thank you, John.

John O'Donnell -- President and Chief Executive Officer

Thanks, Steve.

Operator

Our next question comes from Jon Tanwanteng with CJS Securities. Please go ahead.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Good morning, guys. Thank you for taking my questions.

John O'Donnell -- President and Chief Executive Officer

Hey, Jon.

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Good morning, Jon.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Can you be a little bit more specific in terms of what your expectations for input costs are in Q4 and also your ability to hold prices? Given the prospect of further moderation, when is your next price change expected to be?

John O'Donnell -- President and Chief Executive Officer

Yes. So, Jon, we know you for a long time. So you know I hate pulp prognostication mode. But we are definitely on the decline. So if you look at -- actually if you look at this year, our pulp pricing actually this year and even go into next year will still be higher than we were in 2017. So I'm expecting pulp to continue to add to our margin restoration. So we said we're looking for double-digit margins in both of these businesses. Input costs -- come again?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Were down $5 million in the third quarter.

John O'Donnell -- President and Chief Executive Officer

In the third quarter overall. Around pricing activities, input cost is the largest driver for pricing efforts into the marketplace. So, as they're coming down there won't be any announced price increases from that standpoint. And that we manage each of the -- our overall pricing in accordance with the competitive markets that we participate in. So there isn't any timing for when will it impact your overall pricing or your ability to retain pricing has to do with the competitive market we're in and those that we compete against.

We are committed to ensure that we are at market levels from a pricing standpoint. And our expectation going into 2020 is that we'll continue, both in the fourth quarter and as we enter into 2020, we'll continue to enhance and restore the margins that we've historically had in both of these businesses.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Got it. And just to expand on that, are you seeing that increased competitive pressure yet?

John O'Donnell -- President and Chief Executive Officer

There's competitors out there every day, Jon, from that standpoint. I think where we are today, we're holding on to pricing where it makes a great deal of sense. And in certain areas, yes, we've had significant pressure on pricing. But my expectations is net-net of all of that, margins will continue to enhance fourth quarter and going into next year and our pricing activity should outstrip any of the cost elements that we'll see.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. Thank you. Just in terms of freight costs -- I know there has been an issue for you over the past two years. As you look into 2020, I was just wondering how much do you pay out in marine freight every year and is there an expected impact from this roll-in of IMO 2020 and how that might impact shipping rates.

John O'Donnell -- President and Chief Executive Officer

I don't know the marine rates off the top of my head because -- which would you, right, that it must not be very much because otherwise I would have it sitting in front of me [Indecipherable] almost nonexistent in fine paper and very low from what we pay anyway going into 2020. So I don't expect that.

But as a reminder, because you mentioned that freight has been a big issue because of -- we were up $8 million with the regulatory changes. We offset $2 million of that with our policy changes, and we're seeing rates come more in line. While we still think there is a minimal headwind of $2 million or $3 million overall than where we were back in '17, before the regulations, the teams have done a nice job of really pressing on the optimization of that freight.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. And then, Bonnie, I think you mentioned a timing impact in premium packaging. Can you size that and if you're expecting that to rebound?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Well, Jon, we typically expect that we have mid to high single digit growth in packaging and yet we didn't have any growth in the third quarter. So I would just say we still have the same annual expectation for it.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. What was the year-to-date? Just if you have that.

John O'Donnell -- President and Chief Executive Officer

I think it's kind a low single digit [Speech Overlap] low single digit.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay.

John O'Donnell -- President and Chief Executive Officer

So this is a business that's very -- we've talked about in the past, used that real technical word, lumpy, as it follows orders from that standpoint. We're trying to make sure that as we communicate our expectations for the category that we take a long-term perspective on its growth. And for us, the high single digits is clearly where we see this business.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. And then Bonnie, one last one. What should the normalized depreciation and amortization look like as we go into Q4 and beyond? What you'll have at this accelerated pace [Phonetic]?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

So once they lap that? [Speech Overlap]

Jonathan Tanwanteng -- CJS Securities -- Analyst

Once you finish this idling.

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

[Speech Overlap] get that out, I'm thinking $30 mill [Phonetic].

Jonathan Tanwanteng -- CJS Securities -- Analyst

$30 million? I'm sorry?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

I'm thinking, $30 million.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. On an annual basis?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Well, that was just depreciation, not amortization.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. And the combined?

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

That would be another $8 million.

John O'Donnell -- President and Chief Executive Officer

Yes.

Jonathan Tanwanteng -- CJS Securities -- Analyst

Okay. Great. Thanks a lot, guys.

John O'Donnell -- President and Chief Executive Officer

Thanks, Jon.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Bill McCarthy for any closing remarks.

Bill McCarthy -- Vice President-Investor Relations

Okay. Once again, thank you for your time and interest in Neenah today. As a reminder, we'll be presenting tomorrow at Baird Global Industrial Conference in Chicago and hope to see some of you there. But as always, please reach out to me at any time, if you have questions. Thank you.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Bill McCarthy -- Vice President-Investor Relations

John O'Donnell -- President and Chief Executive Officer

Bonnie C. Lind -- Senior Vice President, Chief Financial Officer and Treasurer

Steven Chercover -- D.A. Davidson -- Analyst

Jonathan Tanwanteng -- CJS Securities -- Analyst

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