Ladies and gentlemen, thank you for standing by and welcome to the Neenah Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to your speaker today, Bill McCarthy. You may begin..

Thank you and welcome to Neenah's third quarter 2020 earnings call. With me today are Chief Executive Officer, Julie Schertell; and Paul DeSantis, our Chief Financial Officer.

Julie and Paul will cover activities and financial results for the third quarter in detail, provide a few comments on our outlook and then Julie will wrap up with a discussion about key initiatives underway that will create substantial long-term value. Following these prepared remarks, we'll open up the call for questions.

We released earnings yesterday afternoon, though I understand there was some other news last night. So in case you missed it, let me recap a few headlines. Sales in the third quarter were $191 million and up almost 20% from the second quarter, but below 2019, due to the continued impact of COVID on demand.

Operating income followed this pattern as well, with a significant rebound from second quarter, but not yet catching up to last year. Non-routine items of $2 million for restructuring and other costs, compared to $2.5 million last year. On an adjusted basis, third quarter operating income of $16 million in 2020, compared to $21.5 million in 2019.

GAAP EPS of $0.46 compared to $0.84 last year. Excluding adjusting items, adjusted EPS was $0.55 this year, up from a small loss in quarter two, but below $0.95 in 2019. Complete details of non-GAAP items, along with a reconciliation to comparable GAAP figures, can be found in our press release.

Lastly, I'll note that our comments typically include forward-looking statements and actual results could differ from these statements, due to risks outlined on our website and in our SEC filings. With that, I'd like to turn things over to Julie..

Thank you, Bill, and good morning, everyone. Our third quarter performance was very encouraging, as we saw sequential monthly improvements in sales that led to significantly improved profits in both business segments.

As expected, Technical Products recovered more quickly, led by strong filtration performance and operating income for this segment increased by more than 30% versus last year.

I'd also note, both business segments returned to double-digit EBIT margins and we generated our highest ever third quarter free cash flow, with disciplined management of working capital and capital spending.

These results reflect the great job our teams have done, maintaining the health and safety of our employees, supporting our customers, reducing costs across all areas and preserving our strong liquidity position.

I'll comment on each of these and then later in the call, we'll talk about progress on initiatives that will create value by accelerating our growth and increasing our margins. As always, our top priority is the health and safety of our employees. To address COVID, we've implemented numerous changes to the way we operate this year.

Our employees quickly adapted to these changes, while continuing to place safety above all. We have a number of manufacturing facilities in the Midwest.

And while this region has experienced a recent surge in cases, our teams have worked successfully to prioritize health and safety, while maintaining operating efficiencies and avoiding disruption to our customers.

It's a real credit to our teams that despite these many changes and challenges we reduced injuries by over 25% this year, as we work toward our expectation of no one getting hurt while working at Neenah. Next, as I mentioned, we worked very closely with customers to ensure their needs are met in this unusual year.

It's during times like these that I believe we build deep long-term relationships with increased levels of collaboration and interdependency. We've launched innovative new products and customers have continued to grow share with us.

Our global footprint, local supply chain and agile flexible asset base provide us an advantage to respond to changing needs and our financial strength is also valued, as customers want to know their supply chain is secure and that we are well positioned to grow with them in the future. Third, we've aggressively reduced cost across all of Neenah.

In the third quarter, we removed almost $15 million of manufacturing costs and $4 million of SG&A, through actions to optimize capacity, restructure parts of our organization and deferred or eliminated spending in multiple areas.

As noted previously, these initiatives result in $7 million of permanent savings split between SG&A and cost of manufacturing. Finally, our actions have helped us maintain a very strong liquidity position. Liquidity increased in the third quarter, driven by our impressive cash generation and we remain well ahead of our initial plans.

I'm very pleased with how our teams have continued to unlock and increase cash flow this year. With over $180 million of available liquidity, we have significant financial strength and flexibility as we exit 2020. And I think I can speak for all of this, when I say, we can't exit soon enough.

To wrap up, our teams have done an exceptional job working safely, during this most challenging of times, supporting customers in new ways and with new products, aggressively managing costs and maintaining our strong financial position.

Their success driving results this year along with initiatives I'll talk about later position us very well for the future. But now I'd like to turn things over to Paul to cover third quarter financial results in more detail..

Thank you and good morning, everyone. As you heard from Julie, our business delivered meaningful improvements in sales, profit and cash generation in the quarter.

While demand for some categories remains below pre-COVID levels, our teams have worked to mitigate this by pursuing top line growth opportunities and aggressively managing costs to improve margins and protect liquidity. As a result, we're continuing to make progress in both segments. Let me start with Technical Products.

Sales in the quarter of $124 million were up 16% versus last quarter, though down 6% from last year because of reduced demand due to COVID. The year-on-year impact was seen most acutely in some of our industrial categories like labels and security, products that tend to be more economically sensitive.

Digital transfer and backings fared better and filtration performed very well, growing 9% over last year. Transportation filtration volumes grew 7% overall, including double-digit growth in North America, and we also added sales from face mask media launched earlier this year.

Net selling prices were slightly lower, primarily because of price adjusters related to lower raw material costs. This was partly offset by favorable currency translation due to a stronger euro. Adjusted operating income was up an impressive $8 million from last quarter and also up $3 million from the third quarter of 2019.

This improved performance reflected cost reduction efforts, a more profitable mix and a modest benefit from lower input costs, net of selling price changes, which offset impacts of lower sales volume.

In Fine Paper and Packaging, net sales of $67 million were up more than 20% versus the second quarter but down from a strong third quarter last year with the biggest impact in lower commercial print volume. Net selling prices were modestly lower in the quarter mostly related to reduced raw material costs.

We've implemented a number of initiatives in commercial print, consumer products and premium packaging that will help restore demand as we work with customers to accelerate their COVID recovery. Adjusted operating profit bounced back strongly from the second quarter but still fell short of last year, primarily due to lower sales.

These items were partially offset by spending reductions and modest benefits from lower input costs, net of selling prices. Our actions have positioned Fine Paper and Packaging to respond quickly to further improvements in end markets.

Earlier this year, we curtailed production on one of our paper machines, restructured parts of the business and dramatically reduced inventory.

While these actions disproportionately impacted fixed cost absorption, we're now at a more balanced inventory level and capacity utilization, which should ultimately help accelerate our return to historical mid-teen operating margins. Looking next at a few corporate items. Consolidated SG&A of $19 million was down $4 million from last year.

Unallocated corporate costs on an adjusted basis were $3.4 million and in line with last year. We've acted aggressively to take out costs this year and the quarter was also helped by certain temporary benefits from credit under the CARES Tax Act, further cuts in selling and marketing and other one-time items.

As our business continues to recover, we expect the variable costs in SG&A and unallocated corporate expense to begin to approach pre-pandemic levels, once we're able to start traveling and meeting with our customers again.

We then expect to grow SG&A at a rate lower than our ultimate sales growth, while investing disproportionately in areas that will drive growth and margins like innovation.

Quarterly net interest expense was $3.6 million in line with what we had communicated, but up from $2.8 million in 2019, approximately $400,000 of the increase was due to an overlap in July prior to the redemption of our bond.

Going forward, quarterly interest expense should be around $3.3 million, primarily for our $200 million Term Loan B, which has an interest rate of approximately 5%. Our tax rate for the quarter was 23% in line with our projected ongoing rate of 22%, but higher than last year's 11% rate.

While the third quarter rate in both 2020 and 2019 benefited from the reversal of reserves for tax audit after statutes of limitation expired, in 2020 this benefit was offset by increased expense due to a change in our projected mix of income by jurisdiction. Turning to a few balance sheet and cash flow items.

As Julie noted, our liquidity is in great shape and we grew during the quarter to more than $180 million. This was comprised of over $40 million of cash and $140 million of unused available borrowing capacity. We ended the quarter with debt of $196 million, primarily our Term Loan B and had no borrowings against our $175 million credit facility.

Cash generated from operations was a very strong $36 million and included around $20 million from working capital management. In the fourth quarter there are initiatives we are pursuing that will have a temporary negative cash impact.

For example, we're accelerating $6 million of 2021 retirement planned cash contribution in order to generate a significant cash tax benefit. Working capital needs are also expected to increase, however, overall will deliver sizable cash flow in 2020 as a result of the many initiatives our team successfully completed.

We're also carefully managing capital spending. Third quarter spending was $4 million. And year-to-date we've spent $12 million with full year spending expected to be around $17 million.

This is about half our normal level as we cut or deferred noncritical items but continue to fund projects that deliver meaningful cost savings or our key to long-term growth. Next year, we expect capital spending to return to a more normal level of around $30 million to $35 million. I'll wrap up with a few comments on our near-term outlook.

In general, demand should continue to recover with global economies and we've been encouraged by what we've seen so far in the quarter. However, as a reminder, the fourth quarter is seasonally our slowest. And consequently while year-on-year percentage comparisons should continue to improve, overall sales may be similar to the third quarter.

While we've seen limited impact at this point, the recent resurgence of COVID makes forecasting a challenge. And hopefully we've all learned how to manage more effectively in this environment to minimize impacts. Fiber costs should remain fairly stable in the fourth quarter.

While there have been some recent price increases, most of our contracts have a one quarter lag to market, providing us time to implement selling price changes if warranted. Other input costs are projected to rise modestly in the fourth quarter with increases in certain chemicals and energy.

Fourth quarter results will also include $1.5 million to $2 million of incremental cost for annual maintenance balance, primarily at our filtration operation in Germany. In summary, third quarter results were very encouraging. Revenues, profits and margins improved significantly in both segments as markets recovered.

Technical product profits surpassed last year led by impressive filtration performance. Our teams have been successfully managing working capital and cash flow and our financial position is strong.

This gives existing customers reassurance that Neenah can grow with them and provides us flexibility to act on new opportunities that can drive our business to higher levels. With that I'll turn it back to Julie..

disciplined capital deployment; a relentless focus on return on capital; maintaining a prudent balance sheet and returning cash to shareholders through an attractive dividend. Success is not possible without a talented and dedicated group of employees and I appreciate all that our teams have done and continue to do.

I'm excited about our future and appreciate your interest today. I'd like to now open the call for questions. .

[Operator Instructions] Your first question comes from the line of Steven Chercover from D.A. Davidson. Your line is open..

Thanks. Good morning everyone. So you've answered many of my questions partially. In the global manufacturing -- or now the Neenah....

Neenah Operating System? Yes. .

Neenah Operator System, I'm going to write that down.

So $20 million over five years so what should we kind of be plugging in for 2021? We're assuming that you're just getting going now?.

Sure. We're launching now in our two largest facilities. And as a reminder the Neenah Operating System, it encompasses safety and cost and quality and delivery. We're really focused on safety and cost and we're ramping up through the next year.

And as you're probably aware the lean principles create a high level of sustainability and execution, but they don't happen overnight.

So while it's $20 million over that 5-year period of time, it will see benefits next year but there are some start-up costs some upfront cost in 2021 from a personnel and training standpoint that will offset some of the initial cost reductions in year one.

I wouldn't want to leave you with the impression though that we're managing cost and reducing costs every single day. As a manufacturing company it has to be part of our DNA to be successful. So what the Neenah Operating System does is, it really accelerates amplifies those efforts and make them sustainable.

And then at the end of curve our expectation is clearly the $20 million annually that we should be seeing. .

Okay. So it's going to be maybe a little back-end loaded or a couple of years before we start to see it.

So I trust you'll give us road map marks over the course of time?.

Yes. We'll give you as much road map as possible. And like I said, we'll see benefits next year. There will just be some upfront costs that may offset some of those benefits next year. So I wouldn't call it completely back-end loaded but it won't be a light switch for sure. .

Yes. And -- I write-down my questions and then you answer them before I ask so paper. Well that's good. So you're anticipating what we need. But in paper, I expect that -- at least talking to some of the commodity guys there's going to be a permanent step function down.

And I was going to say 10% and that -- if you're going to return to 90% of previous sales in paper is that about right? And then do you think that your end markets will have the same kind of secular headwinds that the commodity guys have or basically will offset it through growth in packaging?.

So, a couple of things. I think, you got it exactly, right. We're expecting to return to about 90% of our pre-COVID quarterly pace, which was about $90 million, and we're expecting to do that in 2021. So a couple of things, I will tell you that's different.

As we looked at the last recession, and our performance in Fine Paper and Packaging, we saw a step down somewhat of a recovery, but not entirely, like we expect at this time. And then, the market leveled off for a couple of years. So there was less secular pressure for a couple of years. That's what I would expect.

Now, obviously there's a lot of moving pieces and this is a different time with COVID. But the other thing that's very different about Neenah from the last recession and different from the more commodity players is the diversity of our portfolio, and the end markets that we serve.

About 50% of our portfolio in Fine Paper and Packaging is consumer products and premium packaging, and where the greatest secular pressure and ongoing pressure is in that other 50% of commercial print.

Our commercial print is really not driven by office usage as much it is driven by advertising so there's just different influencers in the end markets from our competitors and from our last recession, but we feel good about the pipeline we've built particularly in consumer products and in packaging.

The other thing that, I would just tell you that's not different is I think Neenah has done a really good job managing this business over the long term. We know how to run this business. It's been in secular pressure – under secular pressure since the mid-1990s.

But our expectation is to return to mid-teen margins, continue to generate strong cash and then we invest that cash for growth in our growth platforms..

And do you think you'll be back to that $90 million revenue rate by Q1 of 2020 – sorry, 2021?.

Well, I think there's a lot of uncertainty right now with the resurgence. And so forecasting is more challenging right now than it's been in some time, but it will be a ramp-up. But we're seeing nice sequential improvement in Fine Paper and Packaging across all of the categories in which we compete..

But it might be more from a modeling perspective to assume that's an exit rate that is opposed to your $360 million in sales next year..

Yeah. I would assume it ramps up over the year. .

Okay. Last question on paper, which has to do with the market pulp that you guys purchased.

Can you tell us – can you remind us how much pulp you buy? And I wouldn't call it a competitor, but another company that buys market pulp is incorporating about a $50 a ton increase – is that about – so what kind of magnitude increase are you thinking? What's the tonnage that you buy? And will you be able to offset at your pricing?.

Yeah. So, this is Paul. So, a couple of things on that pricing. So I think as, you know, we – as the market pricing tends to hit us we have a bit of a lag both in terms of when we get that pricing, and then how that gets passed on.

And so, if you – in our comments that we talked about now, we talked about – our selling price came down a bit, but our raw material cost came down as well. So we were able to match that up. And so as long as the movement isn't too dramatic, our expectation is that, we're going to recoup that change one way or the other fairly soon in the process.

And so we're not expecting dramatic increases. We're expecting pretty modest increases. And so from our point of view, we think that, the bottom line impact will be minimal on those assuming that our set of assumptions is correct..

Okay. And last question, I promise. I'm not a very fast writer. I'm just not very quick. So the growth platforms, the four that you mentioned is it industrial air and water, face mask, media? And what were the other two? Is it –.

Let me go through them, because I think you're on one of them. And so the four growth platforms the first one is filtration and so industrial air and water fit into that particular growth platform as does the others I think you mentioned. The second one is specialty coating.

So today, Neenah – at Neenah, we coat and saturate, a lot of our products particularly in Technical Products. And we have the ability to extend that into adjacent markets as well. It could be things like more performance in image labels, it could be things like silicone release labels that type of advanced coating technology. That's the second one.

The third one is custom engineered materials. So this – that what is all about manipulating fibers to get a better or different end-use characteristics for our customers. So, composites might be an example of that and we do that today. We manipulate and mix fibers whether they're glass or non-woven or cellulose fibers.

And then the last one is premium packaging. And that's one that we'll continue to lean into in advance. And that runs on the same assets as our print -- our paper business. And so it's a really nice utilization over time of that asset base to ensure that we remain competitive from a cost position as well..

Got it. Thanks for taking my questions..

Sure. Thank you..

Jon Tanwanteng from CJS. Your line is open..

Hi. Good morning everybody. Thanks for taking my questions. Very, very nice quarter..

Good morning..

The first one you gave us some color on the expected revenue heading into Q4 which was helpful. Thank you. But I think if I heard you correctly, you're going to see additional drags from inputs maintenance down to maybe some expenses rolling back in and the CARES benefit I guess expiring.

Putting it together, is it fair to say you expect a pretty big sequential downtick in the margins there, or are there offsets or savings that we should be thinking about?.

Yes. I wouldn't say a pretty big downtick in margin. So what we wanted to highlight was that we have some items that we are expecting like the maintenance. The maintenance downs are going to be a little incremental. At the same time, we're driving our mix. We are still focused on cost control.

And so even though we had some savings from the Cares Act and from the equivalent around the world showing up in SG&A and even though we have some permanent headcount reduction in there, we don't expect SG&A to bounce back up to historical levels next quarter. It might be a little bit higher on a run rate basis than it was this quarter.

So I think there will be pressure on margin in the fourth quarter from those items, but I wouldn't expect it to be a dramatic impact..

Okay. Thank you. That helps. And then Julie, just to clarify, the $20 million of expected savings over the next 5 years, that doesn't include the $7 million permanent savings you already realized, right? And maybe as a follow-on to that, does the savings need to -- right.

And do those -- do you need to realize any certain volumes or revenue levels to realize this maybe?.

The $20 million savings those are really based on our current expectation of recovery. So as -- of course as volume continues to recover that helps our margins. And as we continue to accelerate our ramp-up in North American filtration that helps our margins.

So there's definitely other things that will drive margins in addition to the Neenah Operating System, but it's incremental to the $7 million. It is not dependent on getting to a -- significantly larger volume numbers based on our current short-term forecast based on the businesses we're in today.

And it's really focused in those areas that are mostly variable in nature..

Okay. Great. And then the last one for me. Julie, you've drawn a line in the sand I guess for the paper revenue with I guess the $90 million run rate at some point next year. You've listed a lot of growth initiatives on top of that whether it's fine packaging or on the other side in technical which do sound great.

When do you see yourself, I guess with the rebound in the economy and these growth initiatives returning to 2019 revenue levels? And maybe what kind of long-term growth rates are you targeting for both those segments and inclusive of all of these things that you have going on?.

Well that was a couple of questions in there, so let me try and get them all. First, I just want to make sure the $90 million run rate what we're trying to message as our expectation is we get to about 90% of our previous COVID -- pre-COVID run rate which was $90 million.

So that's -- as you've asked about demand destruction in the past that's the 10% we're expecting just to clarify from a Fine Paper and Packaging standpoint. Your second question I think was a lot around growth in 2019 and when we get back.

And what I would tell you is -- and again, I want to start with barring any significant impact from the resurgence because we know we're seeing some lockdowns happen in Europe and other areas. But based on what we're seeing today, recovery in all categories is happening. It differs by pace and there's some expected normal seasonality that we'll feel.

It's led by filtration both transportation filtration, our core business as well as the incremental business in face mask that we've penetrated this year. There is stability in our large industrial categories things like backings.

And then Fine Paper and Packaging is recovering as well and as expected, it's just at a little bit slower pace which is what we expect. We're working really closely with customers and we've seen opportunities to grow share during this time. We've launched innovative new products that has driven incremental revenue.

So, we're really working to proactively manage the recovery with some growth catalysts and with some margin catalysts in place..

Okay. Thank you very much..

Sure..

Chris McGinnis from Sidoti & Company. Your line is open..

Good morning. Thanks for taking my questions. Nice quarter..

Thank you. Good morning..

Thank you..

I was wondering just on the comments around the mid-teen margin profile in Fine Paper, is that at that 90% run rate, or is that at current levels and would that improve? Just wondering about that comment you made earlier..

Sure. Well, the first step Chris was to get to double-digit EBIT margin, which we did in Q3 in both segments. And as volume continues to recover, those will continue to ramp up. As our innovation pipeline continues to become more and more accretive, those will ramp up. As our Neenah Operating System begins to get implemented, those will ramp up.

So I'm expecting continuous sequential improvement in our margins, again, barring any significant impact in resurgence. And then, of course, we have normal shutdowns and some seasonality that impact those as well. But at a high level, I would expect continuous margin improvement and we saw that in Q3.

We also saw it pre-COVID really nice margins in Fine Paper and Packaging as well as technical product improvements. So, I feel like our strategies were working in Q1. And as we exit -- start to emerge in Q3 from a recovery standpoint, we're seeing them work as well with some nice margin recovery this quarter..

Sure. No, I definitely, I have it in my numbers, so congrats on that.

And I guess just around packaging, was last year just a really strong quarter for packaging or just impacted, or was there growth actually in the period for the packaging product?.

Last -- you're asking if there was a growth this year in packaging?.

Yeah. Sorry. Yeah, yeah, for this year. Yeah..

This year packaging currently it's been impacted by the virus as well. So from a year-over-year standpoint, we're not seeing packaging up versus last year, yeah. But it's recovering at a much faster pace than some other parts of our category like commercial print. .

Okay. Okay. I apologize. I thought last quarter was up a little bit. So I was wondering if that was a step down or just a….

No, it's continuing to grow sequentially. And I will tell you I'm encouraged by the innovation pipeline that the team has developed around packaging and some of the sustainable solutions that we're launching, I think, right now when health is so top of mind for everyone.

And it quickly turns to the health of our environment as well, and the team has done a really nice job developing some products like floor graphics that you see everywhere if you're out all.

And their cellulose space and recyclable and an alternative to some of the less environmentally friendly options, as well as styrene alternatives in some of those areas. So, I'm encouraged by what we're seeing from a new product standpoint..

Great. And that was the answer to my next question, but I'll jump to my next question after that.

Can you just talk about maybe your appetite for M&A in the current position? Would you want to wait for a little bit more clarity on the economy to recover before you kind of pick your fit?.

Well, I'm really pleased with our current cash position and liquidity position and that is an important part in our -- M&A remains an important part of our strategy and we're seeing solid deal flow right now.

We'll continue to be cautious, because we're in uncertain times we may take smaller bites, but having strong cash generation and liquidity gives us the opportunity to capture the targets that we see that are a right strategic fit for Neenah and accretive.

So we'll just be more cautious but still participating from an M&A standpoint is our continuing path..

Great. Thanks for taking my question. And good luck in Q4..

Thank you..

There are no further questions at this time. I'll turn the call back over to Bill for closing remarks..

Okay. Thank you. As you've heard we're successfully addressing the challenges this year, have a clear pathway to accelerate top line growth and catalysts to improve margins. Thank you for your time and interest today. And as always please feel free to reach out to me if you have questions.

We hope to have the opportunity to talk to many of you at the upcoming virtual conference hosted by Baird next Thursday, November 12. Thank you..

This concludes today's conference call. You may now disconnect..