Neptune Insurance Holdings Inc (NP) 2011 Q2 法說會逐字稿

Good morning, my name is Mishay, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2011 Neenah Paper earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remark, there will be a question-and-answer session. (Operator Instructions). Thank you, Mr. Bill McCarthy, Vice President Financial Analysis and Investor Relations, you may begin your call.

Okay, thank you. Good morning, everyone, and thank you for joining Neenah Paper's call and webcast discussing second quarter earnings and business results. With me today are John O'Donnell, our Chief Executive Officer, and Bonnie Lind, Chief Financial Officer. We released earnings yesterday afternoon, and I'll recap a few headlines before turning things over to John and Bonnie to cover results in detail.

Consolidated net sales were $183 million, up 8%, while operating income of $16 million grew 15% in the quarter. These results reflected strong top line growth in our technical products business, along with higher selling prices and an improved mix in both segments. Our strong top line along with ongoing cost control efforts also allowed us to offset more than $6 million of higher input costs in the quarter.

Earnings per share were $0.49, up 20% from $0.41 per share last year. The higher growth rate for net income and earnings per share reflected lower interest costs resulting from a capital structure with significantly less debt. The current quarter also included a one-time charge of $300,000 or around $0.02 per share to tax expense following a recent change in Michigan tax laws.

Before turning things over to John, I'd like to remind everyone that this conference call may include forward-looking statements subject to risks and uncertainties more fully described in our SEC filings and explained in the Safe Harbor disclaimer found in the Investor Relations section of our website. John?

Thank you, Bill, and good morning, everyone. Through the first half of the year and into the second quarter, our businesses performed well.

While market demand for North American printing and writing papers is down about 4% versus last year, our premium fine paper business has held their top line and offset much of the domestic market decline. We have done this by finding new revenue streams and areas of opportunity, such as direct sales of envelopes and growth in packaging labels and international sales. In addition, as a clear leader in our category, we expect to continue to benefit as the market evolves consolidating brands and suppliers.

In technical products, our markets are growing. In the second quarter, sales for every one of our major product groups increased, reflecting our strong relationships with growing multinational customers and collaborative efforts to bring new products to market. In addition, our teams continue their focus on mix improvement by driving sales of higher value products. Investments like our new filtration meltblown line in Germany, which was completed earlier this year, provided added capacity and improved technical capabilities to support a higher value mix.

Finally and importantly, both of our business segments have pricing power, and over time are able to offset the impact of higher input costs. We're continually working with our customers to find ways to add value or mitigate cost increases, and these efforts have clearly been successful. As Bill mentioned, in the second quarter, we offset more than $6 million of higher input costs with improved selling prices, cost reduction, and mix enhancement.

I'll talk about expectations for the second half of the year at the end of the call, but for now, let me turn to second quarter results starting with technical products. Sales of $114 million grew 15% with about half of this increase resulting from higher volumes, selling prices, and improved mix. The remainder was a result of currency translation due do a weaker dollar relative to the Euro in 2011.

Revenue for transportation filtration, our largest product group, grew more than 20% on volume growth of 8%. In addition to good results in our European base where we are the market leaders, we continue to grow our international presence with export sales us 15% this year, reflecting growth in Asia, South America, and North America. Key drivers include growing demand for specialized products like flame retardant air filters and long-life media for cars and heavy duty vehicles.

Many of these products require advance meltblown combination technology and our second meltblown line continues to operate on an efficient five-day schedule. In addition to filtration, sales grew strongly for labels, medical packaging, wall cover, and tape. In total, our technical products business continues to benefit from a diversified and global product base with major supply positions at market leading customers who are growing share and expanding globally.

We're partnering with key customers to bring innovative new products to market and optimizing designs of current products like abrasives and labels to meet the specific needs of faster growing developing markets. We're also finding ways to use our existing capabilities to expand into profitable adjacent markets. We're pleased with our top line performance this quarter, our growing market positions, and how we're positioned for the future.

Bottom line results in technical products were also very good. Operating income of $9.8 million grew 15% from last year, reflecting benefits from higher volumes and improved mix and selling prices, as well as cost efficiencies. Combined, these offset over $4 million of higher input costs in the quarter, primarily due to increases in latex prices.

Turning to fine paper, sales in the second quarter were $69 million, flat with last year. As I mentioned earlier, the North American printing and writing market has remained soft this year, while our volume was in line with the market, we were able to offset this and maintain revenues with a higher value product mix and improved selling prices. Our fine paper team is tirelessly pursuing ways to overcome a secular market decline, yet at the same time deliver to their financial commitments. With those challenges in mind, we focused on three primary strategies to drive revenue.

First, growth share in existing markets by leveraging our leading brands and working with customers to optimize their supply chain, making it easier for them to do business with Neenah. Second, seek out new revenue streams. This has included the addition of [inaudible] branded papers in 2010 and, most recently, the ramp-up of direct envelope sales. Finally, we expect to grow sales in targeted markets, such as international, digital, packaging and labels, where we believe we can disproportionately grow as a result of our value proposition.

In the second quarter, sales in these markets grew 4%, led by strong growth and packaging and digital grades. Bottom line results in fine paper remain very good, with operating income of $10 million and EBIT margins in the mid-teens. An attractive mix and increased selling prices helped to overcome almost $2 million in higher input costs, the impact of lower volumes and planned downtime to control inventories.

So to recap, both of our businesses performed well this quarter and continue to show that they can overcome the impact of higher input costs. At the same time, our teams are delivering, again, strategic growth initiatives, such as expanding filtration internationally, finding new market opportunities like direct envelope sales and new label markets, and improving our mix through increase sales of higher value products. These actions are heaping Neenah to deliver results in the short-term, while continuing to build our position for the future.

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

Thank you, John. As we said at the start of the call, good business unit performance in the quarter was further boosted by lower interest expense related to lower debt levels following our bond call in March. I'll get to that shortly, but first let me start with a recap of SG&A.

Consolidated selling, general and administrative expense of $18 million compared with $18.7 million in the second quarter of last year. The decrease in SG&A compared to last year was in part due to an increase in fine paper bad debt reserve taken in 2010. At $18 million, spending this past quarter was higher than our average run rate. This was due to translation of our Euro based SG&A cost, as well as timing of certain spending.

In general, we still expect SG&A to average a little over $17 million per quarter for the year, although the timing between quarters will vary. In the third quarter, in the spirit of supporting a higher value mix, we'll invest up to an additional $1 million for promotional support of Classic, our leading fine paper brand. John will cover this in more detail later in the call.

While total promotional costs of the year are not increasing, this is an example of how timing and spending can vary by quarter. Finally, looking at unallocated corporate costs, there was $4.1 million in the second quarter, which was virtually flat with last year.

Net interest expense was $3.7 million, down 26% from $5 million of expense last year. The decrease was primarily due to lower debt levels, including the impact from the early redemption of $65 million of bonds in March. Interest expense in the quarter was consistent with guidance in the May call.

Debt at the end of June was $206 million, comprised of $158 million of bonds, $19 million drawn against our US revolving credit facility, and the balance of $29 million in Germany. Interest rates remain low on our debt and we continue to have significant borrowing capacity. Turning next to taxes, our effective rate was 35% in the quarter. This was up from 28% last year and 32% in the first quarter.

The higher rate in the second quarter included a one-time charge of $300,000 or $0.02 per share to write-off a deferred tax asset following a change in the Michigan tax law that eliminated the use of NOLs there. Without this, our consolidated rate would have been inline with our current expectations of approximately 33%. The consolidated rate will also continue to vary based on the amount of income between segments.

Cash from operations in the quarter was $13 million, compared to $14 million last year. While income increased versus last year, this was offset by higher working capital needs in 2011. Increased working capital resulted from sales growth and a higher mix of value added products sold in 2011. As we mentioned in May, inventories increased in the first quarter in part due to increases in certain raw materials to enhance the security of supply. While we reduced inventory slightly in the second quarter, we see further opportunities to return to more optimal levels in the second half.

Capital spending in the first quarter was $4.7 million, compared to $2.8 million last year. Spending in 2011 is on track with the $20 million to $25 million range previously communicated. A little less than half of this is the maintain assets with the balance for projects that add value by supporting sales growth or delivering significant cost savings. Our pension and employee benefit plans are in great shape with funding levels in our US-defined benefit plan above 90% on the PBO basis.

In 2011, we expect to contribute around $13 million to qualified defined benefit pension plans, and that's about $1 million below last year. Combined expense for pension and OPEB plans in 2011 is expected to be approximately $6 million less than cash contributions. So to wrap-up, our businesses generate strong cash flows and our capital structure provides us with great flexibility.

We are in position to explore new growth opportunities, but remain disciplined and committed to point cash in ways that create value for our shareholders. Return on investment capital will continue to be a key metric we use to evaluate our investments and to measure our success.

So with that, I'll turn things back to you, John.

Thank you, Bonnie. I would like to start with a comment on safety. Safety is always a top priority for us and our bottom line is the same. People should not go home hurt. Our goal is to maintain a top (inaudible) safety record, and we've made significant progress towards establishing both a world-class safety environment and record over the past six years. Unfortunately, in 2011, our safety performance has slipped from the top (inaudible).

Historically, when we focused our organization on an issue worth attending to, we've demonstrated we can dramatically improve our performance. Confident that we can refocus efforts, that our teams across all of our facilities will find the incentive to meet our high performance expectations. Let's move next to some thoughts on the remainder of the year.

As is typical, results in the third quarter will reflect a seasonal slowdown in sales, especially in Europe. In addition, both business segments will take scheduled maintenance downs, resulting in higher costs. While there are a lot of speculation about the direction of global economics, as of this point, we have not seen any unexpected or significant variation in our order books.

As Bonnie referenced earlier, we'll re-launch our four Classic fine paper brands in the third quarter. Classic is the market leader and most recognized brand in the premium fine papers category. With this initiative, we're tailoring our offerings to meet market and customer needs, while providing new supply chain solutions and creating excitement by adding new textures and consolidating colors. These investments will keep Classic, our most valued brand, strong for years to come. Looking at input costs, we anticipate cost increase in the third quarter.

While market prices for pulp have dropped from June high, with lags in some of our contracts, we'll see a $30 to $50 per ton increase versus second quarter pricing. Prices for latex, a key material for many of our technical product grades, are expected to rise more than 10% in the third quarter, and will be 30% higher than last year. As a reminder, we consume about 170,000 tons of fiber annually and spend approximately $40 million for latex formulations.

With like in some of our raw material contracts, we're better positioned to anticipate cost increases and take appropriate actions. We increased selling prices for many of products during the second quarter and other price increases will go into effect in the third quarter. So while in the short-term, our results are sensitive to variability and input costs. Our businesses have demonstrated the ability to preserve margins by offsetting these costs over time.

I'll end our call this morning with a brief strategic reminder. Our strategy is to focus on speciality businesses where we have clear leadership and performance advantages. Our technical products business will continue to grow, and today represents over 60%of our revenue and half our business unit profits. As mentioned in prior calls, key objectives supporting our strategy include growing in profitable specialty markets, increasing technical product margins to sustainable double-digit levels, delivering consistent and attractive fine paper returns, generating and deploying meaningful cash flows to create value and increasing return on invested capital.

Our four businesses are performing well and we're excited about the many activities going on in Neenah. Partnerships with key customers are bringing innovative new products to market, and we're finding ways to use existing capabilities to expand into adjacent markets. Our capital structure is in good shape, and as a company, we're well-positioned for the long run, able to pursue opportunities that are a good strategic fit, meet our disciplined financial return metrics, and create value.

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

(Operator Instructions). And we'll pause for a moment to compile the Q&A roster. And your first question comes from the line of Mark Weintraub with Buckingham Research.

Thanks for the insights on some of the items moving into the third quarter. On the cost side, I guess if my math is right, it sounds like pulp and latex will be roughly a $2 million negative variance 3Q versus 2Q. Are there any other cost elements that we should be thinking about as we go into the third quarter?

Good morning, Mark. I will tell that you you're definitely in the range around the overall cost. Obviously, we have the maintenance that I mentioned before, and that typically happens in the third quarter, so not a dramatic change. Bonnie mentioned and I mentioned, as well, the Classic re-launch, which, while our overall advertising and promotion spending will not be going up this year, the timing of $1 million in the third quarter will definitely impact the quarterly splits.

Okay, and I just got the input costs is what I was referring to on the $2 million and so that's a good point. So the maintenance, can you kind of ballpark for us -- was there any maintenance in the second quarter? I'm sorry, I missed that, if you eluded to that, it what likely will it run in the third and fourth quarters.

We have maintenance in every quarter, but we have more seasonal downs in the third quarter. And the impact in the third, $2 million to $3 million from an overall maintenance standpoint of fixed cost absorption impact in the third quarter.

So that's three versus two, but very similar to what we had in the third quarter of last year.

Perfect. And then does it fall off -- fourth quarter is more like the second quarter? Or is it more --

Yes.

Okay, great. And then if you could, just two more questions, and then I'll pass it along, if I could. First, you mentioned you had increased prices in the second quarter, and you announced price increases for some products in the third quarter. If you could give a quick overview on those actions, that would be real helpful.

Sure. First, on the fine paper side, because it's prominently branded, they're list price increases that go out and take effect more immediately. As we have talked in past calls, the technical products is a customer-by-customer announcements, the majority or more than half of the price increase announcements were executed or implemented in the first half for technical products, but there are some that will roll into the second part for technical products. Most of the fine paper increases have already been implemented.

Okay. And were they implemented such that the average realizations in the third quarter will be higher then the second quarter or were they implemented earlier so that we saw most of it in the second quarter?

I think you're going to see third quarter did very similar to the second quarter from a pricing standpoint. They executed the majority of them early in that quarter.

And then lastly, you talked about new growth opportunities, and obviously, you focused on -- later comments on specialty products. Can you help us understand a little bit better, would these be adjacencies, would these be in product lines that you already have, maybe a little more help in understanding --

Sure. And I know you don't want to answer all of the above, but that's probably where I would go. First, there are certain product categories inside a portfolio that are growing or that are demonstrating growth; we've talked about those before, labels and from a fine paper standpoint, packaging, digital, and others. There's geographic expansion and I mentioned when we were on the call that our international sales up 15% from a filtration standpoint, so following our key converting customers into markets where they find value in our supply. So there's that growth in that, as well.

And then as we look at adjacency, whether it's around filtration, these are further out ones, but looking for opportunities that we can use our current technology and bridge other products in, you know, we are looking heavily at adjacencies, as well. Likely where if we have future growth opportunities, we'll likely be more in adjacent than in existing product categories with the exception of geographic expansion.

And I realize you don't have anything to announce today, but are you finding this is an environment that is presenting a decent number of opportunities to look at?

I think make sure that we have a business proposition where we can genuinely add significant value as a result of our capabilities is the primary filter for us, more than it is how many people are knocking at the door or are available. So I think it's that discipline that is probably setting the speed of our cadence, if you will, more than anything else.

Okay, thank you.

You're welcome, Mark. Good talking to you.

And the next question comes from the line of Fred (inaudible) from CJS Securities.

Hi, Fred.

Hi, Fred.

Hey, this is Andrew Galvin in for Fred.

Hi Andrew.

I wanted to follow up on the fine paper growth initiatives. Can you talk a little bit about the target mix for this segment going forward?

Target mix -- you know, we found -- the areas that I talked a little bit about that are demonstrating growth or will become a larger portion of the category are packaging and label, and we're -- as well as some of our standard products internationally, and we're looking at double-digit growth on those items. They're a small percentage of the portfolio today. When you take a look at the direct sales of envelopes, they represent less than 5% of the business today, but have significant growth and very attractive margins, so they will shape the color of the portfolio as we move forward.

And packaging and label, did you say what the current percent of revenue is right now?

It's a smaller percent of our over -- but I think using roughly 15% to 20%.

And I assume that the margins there are at least as good as the legacy business?

Yeah. That's one of the reasons that makes them attractive from that standpoint. Our intent is that as we not only protect the revenue line and the asset base that we have, but we continue to enhance the margin base. So they're as good, if not better from that standpoint. Remember, this is a business that's in secular decline, so a very profitable business in secular decline, so as it's pressured finding very good business to go back in at equal margins is a pretty good challenge.

And just to kind of follow up on the previous question about the balance sheet and I guess whether acquisitions are going to be part of your strategy going forward, can you talk a little about that? Or can you talk about any targets that you find most attractive?

I don't think that we will discuss that on the call today. I will say that I'm very pleased with the financial performance of the businesses, I'm very comfortable with their ability to have meaningful market positions that can drive the cash that we need, our balance sheet is in a very good place, and we have flexibility as we look for that, but you'll have no surprise when we talk in the future about our intent to grow in specialty markets that are growing and profitable as we move forward. So no specifics today, Andrew.

All right, thank you so much, guys.

You're welcome.

Your next question comes from the line of Stuart Benway with Standard.

Yes, Standard & Poor's, thank you. I just want to talk a little bit about the raw material costs. You said latex was very important, but could you give us an idea of let's say latex, pulp, and energy, how do they compare in your costs?

Sure. I would say, and I'm going to amalgamate all of the businesses and give you kind of a high-level Neenah perspective, but pulp is by far the -- fiber is the largest of those components. And I think we said that latex runs roughly $30 million to $40 million overall from an annual spend. Energy is the smaller much the three categories, about 10% of our overall cost to manufacture.

And I believe you said it takes about three to six months for the pulp pricing to show up in your margins because of contractual agreements? Is that correct?

Three months. Three months lag time on many of our pulp contracts.

I think the prices started coming down in June, so we're talking -- I guess fourth quarter then for any impact there?

I think that's what we're anticipating, yes, that's correct.

You talked a little bit about interest costs and your debt is down a lot. I believe last quarter, you said that your interest costs would be down $3 million for the year, but it's already down $2.5 million in the first half. So does that indicate that interest costs are going to be up in the second half versus the second quarter?

The $3 million was the bond call only, and we've been reducing debt versus prior periods all along that were unrelated to the bond call itself. So I would say the rate of interest savings in this quarter is an indication of what you would see next quarter.

Okay, so last year you had $20 million of interest expense, so we're talking $14 million, $15 million this year?

Yeah. That's pretty close.

Okay.

So in the quarter, we had especially compared to last year, like we talked about in the transcript, we had lower debt levels and a lower weighted average interest cost, and so our interest expense is about $1.3 million lower, and half of it is from lower debt and half of it is from lower interest rates.

Right, okay. You talked a little bit about digital markets in fine papers. Can you tell us a little bit more about that market and how big it is for you?

Sure. Digital really is more of a process, the printing process moving from offset to digital. We try to manufacture all of our products to be technology agnostic, but it's definitely the growing segment in printing papers. So as the technology changes, (inaudible) comfort level is that more and more of our products are moving towards digital solution, probably less than 5% right now is considered to be digital. It's a much larger area for more commodity. Our big strength is colors and textures from that standpoint. It's up double-digits, but it's not a big part of the component, the portfolio today.

Okay, thank you.

Thanks, Stuart.

And there are no questions at this time.

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

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