Neptune Insurance Holdings Inc (NP) 2011 Q1 法說會逐字稿

Good morning. My name is Danielle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper first quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

I would now like to turn the call over to Mr. Bill McCarthy, Vice President Financial Analysis and Investor Relations. Sir, you may begin your conference.

Okay, thank you.

Good morning, and thank you, everyone, for joining Neenah Paper's call and webcast to discuss first quarter earnings and business results. With me today are John O'Donnell, our Chief Operating Officer, and Bonnie Lind, our Chief Financial Officer. As most of you know, John will become Chief Executive Officer next week at our annual shareholders' meeting, when Sean Erwin will retire as CEO and continue as Non-Executive Chairman of the Board.

We released earnings yesterday afternoon, and hopefully most of you have had a chance to read through this. I will recap a few headlines, and then turn things over to John and Bonnie to cover results in detail. For the quarter, consolidated net sales of $173 million grew 3% compared with last year, while adjusted operating income increased at a double-digit pace. Benefits from a higher value mix, increased selling prices, and cost improvements in 2011 helped to offset rising input costs. During the quarter, we took advantage of available cash and low-cost borrowing availability to call about 30% of our bonds. This had a one-time, pre-tax cost of $2.4 million, or $0.09 per share; and will save us over $5 million a year of interest expense.

GAAP earnings per share, including costs for the bond call, were $0.45 in the first quarter. Excluding these costs, adjusted earnings per share of $0.54 grew 13%, compared to $0.45 in 2010. Finally, my lawyers wanted to make sure I remind everyone that this conference call may include forward-looking statements subject to certain risks and uncertainties more fully described in our SEC filings and also explained in our Safe Harbor disclaimer, which can be found in the Investor Relations section of our website at www.neenah.com.

With that, let me turn things over to John.

Thank you, Bill, and good morning, everyone.

While there's been a change in lead-off this morning, what hasn't changed is our strategic direction and key objectives. As a reminder, they include -- growth in profitable specialty markets, sustainable double-digit margins in technical products, consistent and attractive fine paper returns, meaningful cash flows deployed to create value, and finally, increasing return on invested capital as a key measure of success. We will touch on these as we go through the call, but first I'd like to provide some comments on economic and market conditions. As we said in the last call, we've seen orders return to typical seasonal patterns, and in general, economies continue to grow in the quarter, although perhaps slowing a bit from last year when markets were still recovering. Industries like auto manufacturing, an important end market for our technical products business, were strong; while printing and writing markets remain challenging, with uncoated freesheet down almost 4% in the quarter. Prices for commodities continue to be volatile, and have been rising with global economic growth. Prices, after falling slightly from peaks last July, are now back at all-time highs. Especially latex, used in the technical products, has also experienced significant increases following higher oil and oil-based derivative prices.

In the first quarter, both of our businesses were able to overcome higher input costs, which combined, were more than $9 million. I will talk about expectations for the remainder of the year at the end of the call, but with this as background, let me turn to the segment results. Technical Products sales of $105 million grew 8%, driven by a higher value mix of products and increased selling prices. Growth was led by gains in filtration, label, abrasives, and wall covering. While volumes in total were flat, sales increased as a result of strong growth in higher value products. As a reminder, mix improvement is one of the ways that we expect to expand margins and return on invested capital in this segment. In the first quarter, volume growth in higher value grades offset reductions in lower value tape products that we shipped to Asia in the first half of 2010. We will continue to look for ways to optimize mix and utilize our capacity to make and sell the most profitable combination of products.

Filtration, our largest product group, had a strong quarter, with sales up 14%, and sales of advanced meltblown products up 24%. This growth was enabled by our second meltblown line, which started up, as planned, in late February, and as of today is operating on a five-day schedule. This project, along with recent investments in R&D in Germany help support the growing demand for higher value products, and also eliminates any requirement to supplement our capacity with purchased meltblown. Overall, Technical Products' performance continues to reflect the major supply positions we have with customers who are market leaders in our growing share and expanding globally.

In abrasives, sales of our highest performing waterproofed backing grades grew 22% in the quarter, helped by the introduction of these products in the Asian market by our global customers. In addition, we are seeing sales of new products resulting from our joint development and R&D work. At Avery Dennison, for example, we launched a successful new name badge label with them late last year, and recently received their Growth and Innovation Excellence Supplier Award from the office products division for a second consecutive year.

Finally, we are also growing by extending our technical capabilities into adjacent markets. An example of these efforts is coffee filter pods, for which we recently completed the qualification process, and are now a supplier in this small, but profitable, growing niche market. Overall, we are pleased with the top line performance in Technical Products, with growth coming from market demand, mix improvements, global share expansion, and innovative new products. Technical Products' bottom line was excellent, with operating income of $10.5 million, up 13% from last year. Performance reflected benefits from the improved mix of higher selling prices, as well as our underlining focus on driving cost efficiencies. As a result, we offset more than $7 million of higher input costs and improved margins in the quarter.

Turning to Fine Paper, sales were $67 million, down 3% versus last year, as benefits from a higher value mix and increased selling prices were not able to fully offset the impact of lower volumes. While the uncoated market was down almost 4% in the quarter, our volumes declined 10%. With today's elevated pulp prices, returns on certain lower value non-branded business are less attractive to us, and we've reduced shipments of these products in 2011. We'll continue to measure success in premium paper segment by our ability to offset top line pressures from secular demand, while delivering the financial commitments of the business. We focused on three clear strategies to do this. First, we will grow share in our existing markets. Leveraging our market-leading brands and working with customers to optimize supply chain, we'll continue to earn this share growth. In fact, last year, customers reported we successfully grew a full share point with them. Second, we will seek out new revenue streams, like the addition of the Crane brand which was fully rolled out last year, and the ramp-up of direct envelope sales this year, which I will talk about a little more shortly. Finally, as previously discussed, we've increased focus and resources in our target markets of international, digital, packaging, and labels, where we believe we can disproportionately grow as a result of our value proposition.

Each of these strategies has demonstrated the potential to help us offset some of the top line challenges in the writing, text, and cover market that we face every day, and the first quarter has continued to help us. Higher pricing, strong mix in the quarter were supported by growth in direct sales of our envelopes. We introduced this offering late in 2010, leveraging the convenience of our existing service platform. In addition, we grew in all of our targeted growth markets, with the exception of international, which was in line with recent run rates, but below a strong first quarter 2010. We remain committed to our long-term participation in all these areas, as illustrated by our recent qualification of new packaging grades, which have opened additional opportunities for us. Bottom line results in Fine Paper were good, and operating income of $10.5 million increasing 11% over last year. Benefits from the higher value mix and increased selling prices, as well as improvements in costs, helped us to overcome more than $2 million in higher input costs and maintain an attractive margin in this business.

In summary, the first quarter is typically a strong quarter for us, and this year was no exception. With both business segments delivering sound, bottom-line results that included improved margins, and double-digit increases despite headwinds from rising input costs.

With that, I will turn things over to Bonnie to review corporate and financial items.

Thank you, John.

We started the year on strong financial footing, and during the quarter, we completed important initiatives that further improved our capital structure. I'll talk about that shortly, but first let me go through a few corporate numbers, starting with SG&A. Consolidated selling, general, and administrative expense of $17 million compared with $16.3 million in the same quarter last year. Spending this year is consistent with last year's average run rate, and in line with expectations. Unallocated corporate costs were $6.2 million, significantly higher than an unusually low $2.4 million last year. In 2011, unallocated corporate costs included $2.4 million for the early redemption of our bonds, and this expense is shown separately on the income statement. Without this, unallocated cost would've been just under $4 million, which is a more typical level. In 2010, both SG&A and unallocated corporate costs benefited from a litigation settlement credit and the timing of other spending.

Net interest expense was $4.5 million in the quarter, down more than 20% from $5.7 million last year. Reduced interest expense in 2011 is primarily due to lower debt levels. Following the early redemption of $65 million of our bonds, which was completed on March 10, quarterly interest expense is expected to fall to around $3.8 million. That's based on debt levels at the end of March. As mentioned previously, this will reduce interest expense by $5 million annually. The bond call was financed with $34 million of available cash, and the balance was borrowed against our North American revolving credit facility. We renegotiated this facility in the first quarter, extending the term through November 2015, and incorporating other favorable pricing changes that were reflective of the current credit environment. As of the end of March, we had $28 million drawn against the revolver.

Turning to taxes, our effective tax rate was 32% in both the first quarters of 2011 and of 2010, and is in line with our prior guidance. We continue to use available net operating losses to offset cash taxes due on income in the US. Cash from operations was a relatively low $1.4 million, primarily due to a $15 million increase in working capital. Working capital generally increases in the first quarter from seasonally low year-end levels, although in 2010 this didn't occur, as a result of the economic recovery and customer restocking that was underway at that time. So while an increase in working capital in the first quarter is typical, our increase this quarter was higher than usual. And there are two principal reasons for this. First, receivables grew $17 million and reflected particularly high sales in March, which will be collected in the second quarter. Second, inventories grew $10 million, reflecting our mix of higher value products, as well as temporary increases in certain raw materials to enhance security of supply. Our teams have shown they can do a great job managing inventories, and we expect working capital to return to more optimal levels as the year progresses. We will begin to see progress in the second quarter as we adjust operating schedules to meet this objective.

Capital spending was $8.2 million in the quarter, and included $3 million for the completion of the new meltblown line. While our capital spending will be a little front-end loaded, the full-year outlook remains in the same $20 million to $25 million range we previously communicated. A little less than half of this is to maintain the assets, and the balance is for projects that add value by supporting top line sales growth or delivering significant cost savings. Our pension and employee benefit plans remain in good shape, with funding levels on our US defined benefit pension plan above 90% on a PBO basis. In 2010, we contributed $15 million to defined benefit pension plans, and in 2011, we expect contributions to be $1 million lower. Combined expense for pension and [Ophip] plans in 2011 is expected to be approximately $6 million less than cash contributions.

We have reached a point where our capital structure is at a very comfortable level, and provides us great flexibility. We are a Company that generate strong cash flows, and we remain committed to deploying cash in ways that create value for our shareholders. As previously announced, we increased our dividend 10% in 2011 as a part of this. Finally, return on investment capital will continue to be a key internal metric that we use to measure our success. We have increased our return on capital in each of the past two years. In 2010, we reached 8%, which was over 200 basis points above 2009, and we are targeting to further improve from this level.

With that, I'll turn the call back to you, John.

Thank you, Bonnie.

I would like to comment first on safety. While we improved safety performance significantly in 2010, we are off to a challenging start this year. Safety is always a top priority, and our teams are redoubling efforts to insure a safe work environment and prevent injuries. I have confidence in their ability to succeed based on our past track record, but we won't ever be satisfied until no one goes home hurt. With the exception of safety, we are pleased with the start of the year, both in terms of bottom line results and with actions taken to drive future performance. We are benefiting from the strong relationships we have with global customers, and we are seeing tangible benefits from joint innovation and development efforts. We are pursuing adjacent markets where we can leverage our R&D and technical know-how and efficiently utilize our capacity, including the recent meltblown addition. In Fine Paper, we are continuing to grow in higher value products like envelopes, labels, and luxury packaging, and don't mind rationalizing marginal volume in exchange for targeted, higher value products that deliver a strong bottom line.

So, while performance in the first quarter was very good, we anticipate that we will be challenged by additional increases in input costs throughout the year. Prices for pulp have continued to rise with the recent price hikes totaling around $50 per ton. And we will see this impact in future quarters. As a reminder, pulp is our largest input cost, and we consume over 170,000 tons annually. In addition, prices for latex, a key material in technical products, have increased by double-digits starting in our second quarter. This is our second-largest raw material, with annual spending of approximately $30 million to $40 million.

As leaders in specialized markets, we expect to recover input cost increases over time, and our teams are responding through cost control and pricing actions. In Fine Paper, list price increases have been announced for our branded business. In Technical Products, increases are also being enacted. These increases are communicated customer by customer, and some have already occurred, while others will be addressed in coming periods. In both businesses, we will take appropriate actions to respond to balance escalating input costs with plans to grow profitably -- all in the context of a competitive external environment. Our strategy to focus on specialty businesses where we have a relationship and performance advantage is proving to be successful. Core businesses have continued to perform well, and this has been reflected over the past year by growth in key markets, improved margins, and strong cash generation. Our capital structure is in good shape, and we're well positioned to pursue additional investments that are a good strategic fit, generate high, sustainable growth rates, and meet our disciplined financial return metrics. We are excited about many things going on in our businesses, the potential of our people, and what it means for Neenah next.

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

(Operator Instructions) Your first question comes from the line of Fred Buonocore with CJS Securities.

Good morning, it's actually Larry Solow calling in for Fred.

Hi, Larry.

How are you? Couple quick questions. Curious just if you can maybe give us a little color on sequentially how the quarter ran out on a month-to-month basis? Or as the quarter progressed? And how this bodes as you look out into Q2?

I think as we said in the transcript, we had a very strong March, and that's really seen in the receivables -- a $17 million increase in the receivables. We definitely started off a little weaker in the quarter with more momentum at the end of the quarter from that standpoint. That ought to give you some color for the months.

Okay, great. And then in terms of Fine Paper, and I realized volumes dropped a pretty good amount. Was some of that reflective -- I know there was a lot of inventory restocking in early 2010? So was it just a very difficult comp? Is that part of the reason for the year-over-year drop?

I don't think I could tie it to restocking in the previous year. I would say it was a tough year-over-year comp for a couple of reasons. We had a significant amount of lower value, non-branded items sold in the first quarter of last year when we were in a different [viable] position. We also had a product launch -- or brand launch in this past year -- the introduction in the first quarter. But we look at the overall uncoated market down about 3% to 5% overall. So it's a combination of the above. We are not overly concerned about being off-track in that regard.

Okay, and just finally, it looks like you did a phenomenal job at offsetting a lot of these rising input costs. And as you look out, do think that your mix can maintain these pretty solid year-over-year margin increases with your mix despite the rising input costs? Or is it becoming more difficult?

I would be naive to suggest it wasn't more and more difficult, but we do expect that we will continue to see rising input costs especially with latex. So I think the challenge will even be doubly hard in our technical products business. But there's no question that a big part of our strategy is making sure that we are growing the profitable volumes. That is our expectation. That's what would like to do, but there's clearly it's going to be -- we've got a number of quarters of rising costs ahead of us still in our perspective.

Got it. Great. Thanks a lot.

Next question comes from the line of Mark Weintraub with Buckingham Research.

Hi, Mark.

Hi, good morning. Still trying to understand the bridge again in the Fine Papers business, where as you mentioned, volumes were down. But you did an excellent job from a profitability standpoint. Would it be fair to say that some of the more commodity business that you didn't produce this year -- was that of minimal profit contribution last year?

That would be very fair to say. And I think that's why challenged versus integrated players for some of that commodity-oriented products in the first quarter of this year.

Is it possible to give a sense as to what happened to your volumes if we were to put aside the more commodity part of the business that was of minimal profitability?

Again, I think as I was mentioning on the previous one, we are not concerned that we're off the industry, Mark. So 3% to 5% is what we would say from the industry standpoint, and that would be the realm of where we would be here.

I see, okay. I understand now. Okay. The cover and text business -- is that also off 3% to 5%? Or was that -- that was an overall uncoated freesheet number?

We use the overall uncoated freesheet number to track our niche segment of writing text and cover from that. And that's been a pretty good gauge. I think that's what we've used in previous calls as well.

Okay, do you happen to have -- do know what the -- if we were to focus on to the writing text and cover for the industry, was that also down 3% to 5%? Or was that quite different?

I think there is more pressure on the higher end products, and I think that's the advantage you have from as those products receive pressure, our brands and some of the packaging and label focus in digital that we have been focused on trying to offset some of that.

Okay. And of the of 170,000 tons of pulp that you buy each year? Roughly how much of that goes to Technical Specialties versus the Fine Paper?

Probably half and half across the groups. Fine Paper would be heavier toward the hard wood, where the technical products business would be predominantly the soft wood.

Okay, great. And so the fiber -- so that makes sense. Pulp, I take it, was up about $100 or so year-over-year. So that's your $2 million in the Fine Paper business. So presumably, was it pricing, or was it more other costs that -- presumably, the other costs that you were able to get the profit improvement. Can you just help me a little bit more -- understand what those drivers were?

Yes, I would say all of the above, Mark. The price and mix -- the combination of the two was probably the largest driver for our ability to offset a lot of the input costs. We did have -- some of the cost reduction as we've worked through the past few years continue to retain though. So we've continued to see cost reduction activities, but the predominant [benefactor] really was announced pricing changes as well as enhanced mix.

Great. And then you mentioned adjusting operating schedules. In relation to the receivables, could you expand on that just a little bit?

We will -- we mentioned we drew our -- we increased our overall inventories. The expectation would be the impact of reducing inventories over the rest of the year would be less than $1 million overall. Just to give a bit of a perspective. But inventory grew in the first quarter as we insured that we had the service supply up of higher quality products, and we'll draw that down as we go through the year.

Okay, and when you say less than $1 million you're talking about in terms of a profit contribution?

That's correct.

Lastly, I don't want to get -- actually two more, if I could. On the interest expense, Bonnie, just trying to figure -- if you are at $4.5 million -- don't want to get too much in the [weeds] here. But you're $4.5 million in the first quarter, and you talked about savings of $5 million, annually. And yet the second quarter, you talked about $3.8 million which is only a 700,000 ton -- sorry, $700,000 decrement which is only $2.8 million. Can you just help me out understanding that nuance?

We expect $3 million for the rest of the year. And the $5 million was the annualized rate, and our bonds have gone down. And our ABL has gone up. I don't know if that's answering your question?

Okay, so there are some offsetting factors with the ABLs going on.

There are, but net/net, we expected a $3 million improvement in interest expense for the full year, this year.

Okay.

From where we were last year.

Okay, and then lastly, on the Technical Specialties business. Can you -- I apologize I had a little technical difficulty so maybe you did talk to this. But what impact, if any, did currency have? And also the meltblown capacity, where are you in process there? And what impact did it have in 1Q and might it have for the balance of the year?

Okay, I'm the -- if you want to take the currency? You can.

Yes, Mark, we you just talking about the impact of currency in the first quarter?

Yes.

Currency had a $1 million impact on the top line, and virtually no impact on the bottom line.

Okay.

From a meltblown standpoint as we mentioned in the call, we had minimal start-up costs. We are operating about roughly 5 days, and expectation is that we will be at that level through the rest of the year. So the benefit we'll enjoy will be those higher meltblown combination products in filtration.

And have you given any guesstimate as to what type of financial impact that can have?

Don't provide guidance around that, but we are very pleased with that whole project itself. Both the start-up, and we're ahead of the appropriation expectations.

Just helping us [guide], was it about a $10 million investment?

That's correct. It's was a $10 million.

Okay, thank you very much.

You're welcome. Thanks, Mark.

(Operator Instructions) Your next question comes from the line of Stuart Benway with Standard & Poor's.

Hello, thank you. You said that the auto manufacturing business was strong. I'm assuming that's talking about Europe, is that correct?

That's correct. We have one of the leading shares in Europe for our transportation and filtration business.

And is that broad across the industry? Or is it more high performance vehicles? Or trucks? What kind of vehicles are we talking about?

I think it's across the board. Our real advantage is in the high performance engine platforms, but the intent was -- our demand was strong with our European partners. We've also had good shipments into Asia and South America as well.

And how much of that overall filtration business is auto versus other types of categories like vacuum bags or something like that?

A very small percentage is vacuum bag, and that's diminishing as we continue to grow our transportation filtration. About 20% of the transportation filtration goes to original equipment manufacturers and about 80% is in the after-market. For various vehicles.

And so the meltblown is primarily going into the auto sector?

That's correct.

Okay. It seems like you are also focusing on the label area. What has changed in labels? Has something change there? Is it the RFID labels or other things that are unique that give you an advantage there?

There are things that give us an advantage. First of all, it's a very large market, and we focus on the niche portions of it. In our Fine Paper business in the area where there is opportunity to enhance image, color and texture really is our advantage. So many products, as we know, are often sold just by how the image of the product from the label itself. And that would be the Fine Paper advantage.

On the Technical Products side, we participate through some of our key customers -- strategic key customers like through Avery and others. But really, their strength, durability, unique performance characteristics that we can provide to the label. But it isn't, at least today, it isn't centered solely around RFID by any means. Although that's one we -- everyone is very interested in.

Just one more thing on the overall costs, you said there were $9 million of input costs escalation in the first quarter. Can you give us any idea of how you expect that overall to be in the second quarter versus the first quarter?

I don't provide the guidance around that, but I will tell you that our pulp is going to -- the announced increases in our pulp will peak. And at least what we see is they're going up in the next quarter. Pulp will continue to rise. We're just beginning to receive latex increases, but we are seeing double-digit latex increases. Our expectation is that we will continue to feel the input cost headwinds in the upcoming quarters. I couldn't speculate on how long or where it will peak.

And your price increases are going in now generally?

We've got a tale of two cities here. First from a Fine Paper business, we announced an overall list price on our branded business. That represents about 75% of the volume in Fine Paper. And those increases have been announced and are being implemented 2% to 4%.

On the Technical Products side of our business, it's customer by customer. We have various contract lengths, and those are individual customer negotiations. Some have been enacted, and many of them are being enacted as we go forward. The commitment that we have, as I've mentioned in the call today, is that in these businesses we are committed to insure that we, over time, recoup the input cost pressures that we are feeling to make sure that we protect the margins that we enjoy in those businesses.

Okay, thank you.

Sure thing.

At this time, there are no further questions. I would now like to turn the call back over to Mr. John O'Donnell.

All right. Thank you for your interest and participation today. We look forward to the opportunity to talk with you again on our next call. Thanks very much.

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