Neenah, Inc.
Q4 2020 Earnings Call Transcript

Published: 18 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Neenah Q4 2020 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Bill McCarthy, Vice President, Investor Relations. Thank you. Please go ahead, sir.

[Bill McCarthy:]

Thank you and welcome to Neenah’s fourth quarter 2020 earnings call. A press release covering our financial results was issued yesterday afternoon. So hopefully, many of you have had a chance to review that information. On the call today, you will be hearing from Julie Schertell, our Chief Executive Officer and Paul DeSantis, our Chief Financial Officer. Julie and Paul will discuss recent activities and financial results and comment on our outlook as we look ahead in 2021. We will finish up with a recap of key strategies and initiatives underway to drive long-term value. Following these prepared remarks, we will open up the call for questions.

[Julie Schertell:]

Thanks, Bill and good morning, everyone. The fourth quarter marked the end to an unprecedented and challenging year for everyone. While there was no escaping the impact of the pandemic, I am pleased with the actions we took to prioritize the health and safety of our employees, maintain substantial liquidity, aggressively reduce cost and drive demand recovery. This was evidenced in our strong performance as we exited the year with both segments again delivering sequential improvement in quarterly revenues, operating income and margins. In the fourth quarter, adjusted operating income of $21 million and corresponding earnings per share of $0.87, both equaled the prior year. Performance was led by our Technical Products segment. With the combination of a strong market demand, new product launches and efficient manufacturing, Technical Products sales increased an impressive 11% versus 2019 and adjusted operating income of $18 million reached the highest quarterly level in recent history. Market demand in Fine Paper & Packaging, as expected, has a more extended recovery curve and we remain on track for this business to recover 90% of its pre-COVID quarterly run-rate of $90 million this year. Before we talk about 2021 later in the call, I would be remiss if I didn’t note some of the key accomplishments our teams achieved in 2020. Most importantly, with new health and safety protocols put in place, we were able to protect our employees and avoid disruptions to our operations and to our customers. We began to implement a Neenah operating system at our two largest facilities. Utilizing lean principles, this system will improve safety, quality, customer deliveries, and will reduce our cost structure with improved productivity and unlocked capacity. We aggressively reduced cost and working capital, resulting in free cash flow of $75 million, one of our highest years ever. We quickly developed and commercialized high-performance media for face mask to support COVID release efforts and meet our customers’ needs.

[Paul DeSantis:]

Thank you, Julie. As you heard, both business segments delivered another sequential quarter of improved sales, profits and margins. Versus the third quarter, sales increased 8%, adjusted operating income was up by more than 30% and adjusted earnings per share jumped almost 60%. These results were led by our Technical Products segment, which now makes up almost 65% of our total revenue. So, let me start there. Sales of $137 million in the quarter were up from quarter three and more impressively, grew 11% versus last year. The increase was driven primarily by volume growth and helped by currency translation as the stronger euro increased the top line by about $5 million. These favorable results were partially offset by lower pricing in a few categories such as backings that have price adjusters tied to raw material input costs. Our filtration business has continued to perform extremely well and fourth quarter revenues were up almost 30% to a record $66 million. Transportation filtration media sales grew strongly in Europe and the U.S. and sales of industrial filters increased by more than 20%. Industrial filtration growth was led by gains in products used for evaporative cooling and other similar applications.

[Julie Schertell:]

Thanks, Paul. Our recent results are demonstrating the success of our strategy and ultimately will make Neenah a faster growing, more profitable company. Each of our businesses is on track or ahead of the top line recovery expectations we have communicated. Technical Products exceeded pre-COVID levels in the most recent quarter and Fine Paper & Packaging is tracking with its targeted pace of recovery. Going forward, we will drive profitable organic growth as we build on three core competencies

[Operator:]

Your first question comes from the line of Jon Tanwanteng from CJS. Your line is open.

[Jon Tanwanteng:]

Hey, good morning. Thank you for taking my questions and very nice quarter.

[Paul DeSantis:]

Thank you.

[Julie Schertell:]

Good morning.

[Jon Tanwanteng:]

The first one – good morning. The first one I wanted to ask, I think one of your maybe follows, you mentioned that you’re expecting to see sequential quarterly gains throughout 2021. Does that include Q1 over Q4 or is that – are you going to see the seasonal downtick as we head into the first quarter and maybe just talk about trends you are seeing today?

[Julie Schertell:]

Yes. What I would say, Jon is I wouldn’t take Q4 and annualize it, for sure, one of our best quarters ever in Technical Products, so I would be cautious, and that will be a little bit overly ambitious. I’m really pleased with the margin improvement we had in Q4, particularly in Tech Products at 13% and Fine Paper, not far behind it, with a lot of momentum as we enter 2021. We also know as input costs rise and we will feel some pressure from that as well as just normal seasonality and machine downtime. So over time, we’re going to continue to see improving margins and improving profitability. It just may not always be linear because of some of those moving pieces, but I expect both segments to see mid-teen margins over time. And Q4 was a nice, solid step in that direction.

[Jon Tanwanteng:]

Got it. Thank you for that color. And then just on the margin. As you look at the year, $20 million and increased input costs, I know you guys have had a great history of passing them through. But is it possible to increase margin year-over-year given that amount of headwind as you’re looking at it now or how should we think about the ability to grow your operating income and gross margins as we look to the next three or four quarters?

[Julie Schertell:]

Sure. We expect to recover raw material inflation, just like you said, over time, it does vary by business depending on just normal market pricing norm. So in some parts of our business, that happens more quickly than others. We have announced price increases in Fine Paper & Packaging and in Industrial. In filtration, we negotiate contracts and commitments annually so we typically get more of a lag. We get that with inflation and with deflation. We also have some nice fiber pricing lags in our fiber contracts so that we have a little bit more time to accelerate and offset with pricing that helps us manage timing. And probably most importantly, outside of pricing, we’re taking a number of other actions to offset input costs to accelerate our operating system, drive continuous cost improvement, pre-build raw material inventory. So all that said, we estimate we will offset raw material inflation this year, while at the same time, continue to make progress in our growth strategy and initiatives.

[Jon Tanwanteng:]

Okay, great. And just one more and I will jump back in queue. But just given how strongly Tech Products performed in the quarter. Can we see some more of that strength going to Q1, especially as we look at the auto guys, inventories are still low or is there more of a hangover coming that you are seeing? Just give us a sense of maybe compared to 3 months ago, that market is going to be stronger or maybe the same as maybe you thought when you last reported?

[Julie Schertell:]

I would say right now, we are seeing – continue to see nice demand and growth, both in Europe and in North America. And as a reminder, we have about 30% of our filtration business that is not transportation filtration. It’s more industrial filtration. Within transportation filtration, about 75% of our business goes to the aftermarket and about half of our business goes to heavy duty vehicles. So we are really more influenced by the economy than we are by new car sales or car inventories. It’s really that aftermarket. So as long as the economy stays strong, we are expecting to see nice continued demand.

[Jon Tanwanteng:]

Great. Thanks for the reminder. And I will jump back in queue.

[Operator:]

Your next question comes from the line of Chris McGinnis from Sidoti & Company. Your line is open.

[Chris McGinnis:]

Good morning. Can you hear me?

[Paul DeSantis:]

Yes. Good morning.

[Julie Schertell:]

Yes. Good morning.

[Chris McGinnis:]

Perfect. Thanks for taking my questions and nice quarter. Sorry I am on a cell phone, I apologize. I just wanted to ask, I guess, just with the improvement around Technical Products, can you just give an update on where Appleton is and maybe the expectations for the year ahead from that facility? Thanks.

[Julie Schertell:]

Sure. Chris, I’d be disappointed if you didn’t ask about Appleton so that’s what I would say. We had really strong performance in global filtration, as you saw in Q4. And as a reminder, Appleton and North American filtration is a part of that. We also have another filtration facility in North America that helps drive filtration as well. We just haven’t probably talked about as overtly. And we really manage this business as a system, just like our other businesses. So we optimize profits and utilization for our lowest cost assets first. And in the last year or so, we have unlocked additional capacity in our filtration facility in Germany with an environmental investment as well as with the Neenah operating system implementation. So we are still on a journey is how I would think about it in filtration. I’m pleased with our recovery from a global filtration standpoint and our innovation launches and our margins have got good momentum. But I would be remiss if I didn’t say the qualification process out of Appleton has been lengthy. And it has taken more time than we originally anticipated and we are still experiencing that to a fair degree. So it’s a journey.

[Chris McGinnis:]

I apologize for I know I am harping that out. Just wondering, just as really strong quarter…

[Julie Schertell:]

No, no, we know it’s coming.

[Chris McGinnis:]

Yes, it was a really good quarter. So, congrats on that.

[Julie Schertell:]

Thank you.

[Chris McGinnis:]

I guess just in thinking about ‘21 on the top line, especially or I guess just in Fine Paper, how much of the expected recovery of that 90% is maybe the legacy business coming back versus new product introductions. Can you just help us understand that maybe a little bit better? Thanks.

[Julie Schertell:]

Sure. It’s more heavily the legacy business coming back, but it’s supplemented by new product introductions. We expected, and we are still expecting about a 10% permit demand destruction in Fine Paper. So that means we would get to about $80 million a quarter on average. And we expect to return to that this year, over the course of this year. But the majority of that is our historical business coming back. And the other nice part about Fine Paper that we didn’t have always in the past is the diversity of the portfolio. So the fact that half of Fine Paper is commercial print, which has the greatest pressure on it. The other half is consumer products and its premium packaging, which has some nice growth dynamics. And the team has done a great job of extending beyond traditional paper products with new products like teacher tools and planners and journals and plastic alternatives, like gift cards and signings and floor graphics. So I’m encouraged by where we are in fine paper, and it’s a strong business. It generates a lot of nice cash for us.

[Chris McGinnis:]

Great. And just in terms of – you mentioned some sustainable products. Are you going to market a little bit differently given there seems to be a greater focus following the pandemic around sustainability. Can you just maybe talk about how maybe the – that’s changed, if at all, given the pandemic? Thanks.

[Julie Schertell:]

Sure. I think the go-to-market approach hasn’t necessarily changed as far as our path to market. I think what has changed is our acceleration and focus on innovation. We expect our business to grow at GDP plus, and innovation is a key part of that. And we have achieved that in places like packaging and filtration and backing. But that means that our innovation process has to be robust enough to offset some parts of our portfolio that are under secular decline pressures or that are towards the latter part of their life cycle by introducing new margin accretive products early in their life cycle. So we have really focused on biasing our resources to do so as part of our strategy is to increase our organic growth rate as we view innovation as a catalyst for that. And I’m pleased that we – I said in my prepared remarks, we recently hired a new global innovation leader that will help us do that as well. So I think where we are seeing it more from the acceleration of sustainability is around our innovation efforts and new product introductions.

[Chris McGinnis:]

Great. And just on the new hire. I guess can you just maybe the biggest areas of focus the new person coming in? I apologize, I am trying to jump between two calls, so if I missed any detail earlier.

[Julie Schertell:]

No. Yes, our new gentleman has about 15 years of global industry experience at 3M and Honeywell, leading innovation teams and new business development teams as well as ramp. So as he comes and transitions into Neenah, he just started a little over a week ago. His primary focus is going to be on how we accelerate a global innovation process and really utilize the skills and know-how and knowledge of our technology team across Neenah. So historically, we’ve been more aligned by category, which can work well, but it can also sub optimize across Neenah. So we might have great technology knowledge around coatings in a particular category, but we need that in another category like we might have it in Tech Products, but we needed to Fine Paper as we drive new innovative products, and he’s really going to help us ensure we’re making the right decisions and accelerating growth across all of Neenah.

[Chris McGinnis:]

Great. I appreciate. Thanks for taking my questions and good luck in Q1.

[Julie Schertell:]

Thank you.

[Paul DeSantis:]

Thanks, Chris.

[Operator:]

Your next question comes from the line of Jon Tanwanteng from CJS. Your line is open.

[Jon Tanwanteng:]

Hi, yes. I just wanted to revisit the SG&A commentary for the year. I think you said $25 million on average per quarter, but I assume just like everyone else what we’re still on this term of COVID restrictions and budget control. Does that ramp through the year and it comes out to an average of 25%? How should we think about it on a quarterly cadence perspective?

[Paul DeSantis:]

Yes. No, Jon, that’s good. I think not all the costs are going to resume immediately. So things like travel and the like. But some of the other costs are going to be a little bit more front-end loaded. So there may not be tons of volatility between quarter, but yes, but certainly on a ramp up I think would make sense. But I want to do – I do want to be clear. Within this SG&A guidance that we’re giving, we are investing behind some of our highest growth potential initiatives. And Julie just talked about innovation. We’ve got some IT automation going and those are really to support a lot of our margin driving – and top line driving initiatives like the Neenah operating system. So within that, bounce back of SG&A, you are going to see some focus on really driving value in the organization.

[Jon Tanwanteng:]

Got it. Thank you. And then there was a due diligence line in the quarter. Just wondering if that’s foreshadowing any movement in M&A? And just tell us about what’s out there in terms of the pipeline and valuations and attractive end markets?

[Julie Schertell:]

Sure. I’ll take that one, Jon. We have a very active M&A process, and we maintained an active pipeline and process throughout 2020. So we’re always evaluating opportunities. Sometimes those work out and sometimes they don’t. It’s an important part of our strategy. We’re focused on the four growth platforms I’ve mentioned a little bit in the past. So that is filtration, it’s custom engineered materials like composites would be an example, it’s specialty coding. Something like silicone release where we have an organic investment, and our capital plan would be an area of focused at opportunity and then premium packaging. So those will be the areas we’re focusing on where we can accelerate our growth trajectory, where it’s a strong strategic fit, it’s accretive and we get compelling returns.

[Jon Tanwanteng:]

Great. Thanks, Julie. Just one more thing, if I could ask. Do you have a number for how much the premium packaging business grew either sequentially or year-over-year?

[Paul DeSantis:]

Yes. I think that the premium packaging business was in the mid single-digit in the quarter in the fourth quarter when we look at growth.

[Jon Tanwanteng:]

Got it. Thank you.

[Julie Schertell:]

Sure.

[Operator:]

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

[Bill McCarthy:]

Great. Well, I’d like to thank everyone for your time and interest today. And as always, please feel free to reach out to me if you have any further questions. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.