Neptune Insurance Holdings Inc (NP) 2012 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Neenah Paper second quarter 2012 earnings conference call. (Operator Instructions).

I will now turn the call over to Mr. Bill McCarthy. Please, go ahead, Mr. McCarthy.

Okay. Thank you, and welcome everyone, to the Neenah Paper 2012 second quarter earnings call. Speaking this morning will be John O'Donnell, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. We issued a press release covering the results yesterday afternoon, and I will briefly comment on a few items before turning things over to John and Bonnie, to cover results in detail.

In the second quarter we reported consolidated sales of $212 million, adjusted operating income of $24 million, and adjusted net income of $14 million. These numbers were all-time records, and reflected benefits from our expanded fine paper business, as well as, improved margins and double digit profit growth in Technical Products. On a percentage basis, we grew top line 16%, while operating income and net income increased 52% and 78% respectively.

In addition to sales growth, margin improvements and lower interest and tax rates, benefited the bottom line. Adjusted earnings per share of $0.85, compared to $0.49 per share in the second quarter of last year. We report adjusted numbers, when there are items that would materially distort ongoing business results. In the second quarter, adjusted results excluded costs of about $2 million pre tax, or $0.08 per share, for integration of acquired Fine Paper brands. There were no adjusting items in the second quarter of last year.

Finally, I would like to remind everyone that this call includes forward-looking statements that are subject to risks and uncertainties, described in our SEC filings and explained in the Safe Harbor disclaimer, found in the Investor Relations section of our website. With that, I will turn things over to our Chief Executive Officer, John O'Donnell.

Thank you, Bill, and good morning, everyone. Our second quarter financial results speak for themselves. Our businesses delivered record sales and earnings, and reflect the success of our teams, in executing against three broad strategic objectives that we outlined in the past. Building Technical Products into a larger and more profitable growth platform, capturing incremental growth opportunities in Fine Paper, while maintaining its very attractive financial returns, and increasing return on capital delivering sustainable double digit rates.

Before getting into the quarterly results, I will comment on our progress against each of these objectives. First, Technical Products is continuing to develop as an important growth platform for Neenah. Filtration, our largest product group, has continued to perform very well, with significantly increased sales in higher value transportation filtration grades, and an expanding presence in shared targeted international geographies. Innovation efforts focused on entry into adjacent filtration markets, are delivering tangible benefits, and we are seeing strong growth in areas like single serve coffee capsules. Growth in new markets, along with continued success in core transportation filtration grades, has resulted in the need for additional meltblown capacity. Last week, our board approved $15 million for a third meltblown line, to start up in late 2013.

As you may recall, we started up our second line in early 2011, and we are ahead of our original expectations as it is now approaching full capacity. The financial returns of these organic growth projects are very attractive, and support our continued expansion in high value filtration products. As you know, there are a number of product categories represented within the Technical Product segment. In addition to filtration, our labels and non-woven wall covering businesses are also finding success in growing markets, and we are enthused about the opportunities we see for growth and geographical expansion. Balancing some of the higher growth categories, are the challenges we are beginning to see in more mature markets, like tape. In these areas, we remain focused on growing with innovative niche product solutions, while protecting our high quality based business.

Turning to Fine Paper, we expect this business to unlock incremental growth opportunities, while we continue to deliver very attractive returns. The share focuses on delivering the value, by successfully integrating brands we acquired at the end of January. Since these efforts touched every facility, it was clear that the value of this transaction would be enhanced or diminished, by the quality of our execution. I couldn't be happier with the way that our teams have delivered. We were able to qualify and begin to manufacture grades on our assets, ahead of our plans, and have now reached a 90% utilization rate. Which we would consider close to a full operating system.

At the same time, we've maintained high customer service levels, even with increased order complexity and new customers and channels. With over 800 new grades and 2,500 new products, this has been a big accomplishment. The markets reacted positively to the transaction, and as a result, we are well on the way to meeting or exceeding the $100 million of additional sales initially communicated. We're realizing benefits from higher utilization and productivity rates, and continued to identify ways to leverage our even stronger position in our traditional markets, and our new presence in retail channel, to tap into incremental pockets of growth.

We are also continuing to gain momentum in image driven categories, such as luxury packaging and premium labels, as well as, in select international markets. These areas are key to the future, as we expand in markets that provide a stronger ongoing platform for growth. While representing less than 20% of Fine Paper sales today, our sales in these markets have been growing at double digit rates. Our third objective is to increase return on invested capital. We have improved this metric, both by delivering higher profits off of our existing asset base, and through disciplined management of our capital investments.

Higher profits have resulted from growth and increased utilization of our assets, expanded margins in Technical Products and realization of SG&A and operating economies of scale. Consolidated operating margins topped 10% in the second quarter, and as Bonnie will cover later, this is contributing to increasing our return to on capital. As I mentioned, our process to manage capital remains disciplined. With the recently approved meltblown expansion, we've re-prioritized spending to insure that the highest returning projects are resourced, as we remain committed to ongoing capital spending level of $25 million to $30 million per year. The Fine Paper acquisition is another great example of how we can deploy capital effectively and create value. While working capital increased, as expected in the first half, we intend to reduce this towards target to the levels in the second half of the year.

So with that recap of key strategic objectives, let's move to the financial results for the second quarter, starting with Technical Products. Sales of $107 million were up versus the first quarter, but down versus a record of $114 million last year. The largest reason for the decline was currency, as the Euro depreciated by more than 10%. Excluding currency impacts, our sales in the second quarter increased 1%. Drivers for this growth were higher value sales mix, increases in filtration, label and wall covering volumes, and improved selling prices. These items were partly offset by lower sales of tape. Filtration sales and local currency were up significantly in the quarter, reflecting modest growth in Europe, coupled with stronger sales into international markets and improved mix of higher value meltblown products.

Increases in labels and wall cover, were helped by sales of new products and growth in Asia. As mentioned in our last call, tape shipments have been down versus last year. In addition to challenges of excess industry capacity, sales were up compared to a prior year, that benefited from a national roll-out and customer stocking for our new product. Looking at the bottom line, Technical Products delivered impressive growth. Operating income of $12.3 million, was up 26% over last year, with margins meeting our double digit expectations. While there were higher input costs, primarily for latex, we more than offset this with a profitable mix, improved operating performance and increased selling prices.

Turning to Fine Paper, sales in the second quarter were $96 million, up 41% from last year. While the large majority of the sales increase this year is volume driven, due to the acquired brands, we're demonstrating success in other areas as well. Our core premium brands continue to outperform the market. And in the retail channel, while we are still fairly new, the transition has gone well and customers have been very receptive and supportive of Neenah. In addition, sales to targeted areas like international, packaging and label, were up by more than 20%. We focused resources in these growing markets, and we are continuing to capture new business with consumer products companies that value image, and appreciate an environmentally responsive premium label or package. Typically a very small part of the final product cost.

Operating income was $13 million, and included $2 million of integration costs, to support the transition of acquired brands. We expect to incur around $2 million of remaining integration costs, mostly in the third quarter, and for the full year, we will be in line with the $7 million previously communicated. Excluding these costs, adjusted operating income in the second quarter was $15.2 million, representing an operating margin of almost 16%. Results reflected the increased top line and associated manufacturing efficiencies, as well as, lower input costs primarily for pulp. Combined, these favorable items more than offset higher SG&A and distribution expense to support the increased sales.

So in summary, our business teams are executing well, and delivered strong results in the first half of the year. I will add a few comments on our outlook for the second half, later in the call, but we will now turn things over to Bonnie, to review corporate and financial items. Bonnie?

Thanks, John. Our businesses are performing well, and we are also seeing value from our corporate actions. Results continue to benefit from lower interest expense. In the second quarter, net interest expense was $3.5 million, down from $3.7 million last year. We've reduced our interest rates by shifting our debt composition to include more variable rate debt, following our $65 million bond call in March of last year, and an additional $10 million purchase in April of this year. These moves have allowed us to replace debt at 7.375%, with borrowings below 3%. Debt was $203 million at the end of June, virtually unchanged from March, but up from $186 million at year end, as we borrowed to finance the Fine Paper brand purchase.

Our debt is currently comprised of $148 million of long-term bonds, $43 million outstanding on our revolver and a balance of $12 million in Germany. Capital structure leverage metrics remain well within our target range. We have no significant short-term liquidity or refinancing requirements. Consolidated selling, general and administrative expense was $19.1 million in the quarter, and compared to $18 million last year. Spending increased for selling and marketing costs, to support the new business, and second quarter spending levels were in line with our expected average quarterly run rate.

With the added sales and associated spending efficiencies, SG&A as a percent of sales, was down 80 basis points in the second quarter, to just over 9%. Unallocated corporate costs were $4.2 million, very close to last year's level of $4.1 million. We expect our run rate to remain around that $4 million per quarter. Results for our other segment, include non premium grades we obtained as part of the Wausau transaction. In the second quarter sales of these papers were $8.5 million, with operating income of $0.6 million. Our effective tax rate was 31% in the second quarter. This was lower than the 35% in the second quarter of last year, but in line with the 2011 full year rate of 29%.

We continue to use our net operating losses or NOLs, to offset cash tax payments due on North American income. During the first half of this year, we used around $15 million of NOLs, and at the end of June there were just over $80 million still remaining. Next, I will cover cash flow. On a year-to-date basis, cash flow is perhaps the only area not yet showing the benefits from our larger scale and higher earnings. Principally due to increases in working capital and the impact of unusual items. As I explained in the first quarter, cash from operations declined $22 million, as a result of items that were either one-time in nature or represented unusual accounting classifications.

In addition, we intentionally built working capital in the first half of the year, to ensure a smooth transition and strong customer service levels during the initial integration of the acquired brand. As John mentioned earlier, we expect to reduce working capital and return to a more normal level of around, say, 15% of sales, with significant progress throughout the remainder of this year. In the second quarter we generated cash from ops of $3.4 million, down from $13 million in the same quarter of last year. While quarterly EBITDA of $33 million grew $8 million versus 2011, this higher income was offset by increased investments in working capital.

Working capital increased as a result of receivables growth from higher sales levels, temporary increases in inventory in advance of our third quarter mill shutdown, and reduced payables due to timing. Capital spending was $5.8 million in the quarter, and just over $9 million for the first six months. As John mentioned, we expect full year spending of $25 million to $30 million, with higher spending in the second half as we complete planned projects during our annual mill shutdown, add color capabilities at one of our Fine Paper mills and begin spending on the new meltblown expansion. I would note, that the Fine Paper color system gives us capability redundancy, it will lower operating costs and it supports our ability to minimize investments in working capital going forward.

Let me close with a comment on return on invested capital. We consider this to be one of our most important financial metrics, and our objective is to find ways to increase it each year. With improving operating margins, disciplined capital management and the added benefit from the acquired brands, our trailing 12 month return on capital is now over 11%. We've increased this significantly in each of the past three years, and achieved the double digit threshold we originally targeted. While we are pleased with our progress, our teams continue to look for ways to further improve capital efficiency, and we believe our higher ongoing return on capital should also translate into increased returns for our shareholders. With that, I will turn things back to you, John.

Thank you, Bonnie. Let me start with safety, which as always, is our top priority. I'm pleased to say our teams have continued to make their work environment safer, with fewer injuries and notable improvement in our recordable incident rate. Hourly and salaried employees across all of our facilities, remain committed to safety. I would especially like to recognize our Appleton Mill employees, who have exceeded one year incident free in early July. As I have mentioned in the past, while our performance has improved and remains better than the industry average, we won't be satisfied until we are injury free.

Next, I'll provide a few comments on items expected to impact the second half of the year. Europe remains top of mind for many companies, and as a reminder, approximately 66% of our technical product sales are in Europe. In the second quarter, sales to European customers grew 2%. Our operations and a significant portion of our sales are in Germany, which continues to be the strongest country in the Euro zone. In summary, we see a more cautious, but still fairly stable market. While exchange rates in the third quarter may not differ greatly from the second quarter, we will continue to see a year-on-year impact from currency. Current Euro rates are about $0.20 below last year.

On a quarterly basis, this impact represents year-on-year around $10 million of sales, and $2.5 million of EBIT. We saw a similar impact in the second quarter results, when the exchange rate differential was about $0.15. Next, let me touch on input costs. Since both of our businesses have demonstrated capability to offset impacts of higher input costs over time, these comments are really directed to those interested in short-term variations. Our pulp costs will rise by $20 per ton to $50 per ton in the third quarter. While market prices for pulp have softened in recent months, we will not see the benefit until the fourth quarter, due to the lags in our North American contracts.

In other areas, energy costs are flat, up slightly, and latex prices have begun to fall. Overall input costs in the third quarter are expected to rise modestly versus the second quarter, with the largest impact in Fine Paper, but overall, will remain below prior year levels. As a reminder, our Technical Product business tends to be seasonally slower in the second half of the year, and we will also take all of our Fine Paper and Technical Product mills down in the third quarter, for annual maintenance work. The incremental spending and impact of fixed costs under absorption, typically represents $3 million to $5 million of higher costs. We expect to be on the high end of that range this year, due to the timing and planned projects, with the majority of the costs incurred by our Technical Products mills.

Let me close this morning, by reinforcing my messages from the start of the call. I'm very pleased with how each of our businesses has improved what they can control and executed against their key objectives. The success of their efforts is clearly reflected in the financial results in the second quarter. In Technical Products, we are expanding margins, and driving growth in higher value products. Our innovation efforts are leading commercialization and growth in adjacencies like beverage filtration. At the same time, we're expanding in core products like transportation filtration, labels and abrasives.

In Fine Paper, we are clearly delivering the value expected from our brand acquisition earlier this year. We are completing integration activities ahead our plans and we see long-term potential for added benefits through expansion in the retail channel, growth in premium niche markets and further operating efficiencies. At Neenah, we set high expectations for ourselves, and our teams are living up to them. With an expanded Fine Paper portfolio and improvements in Technical Products, our Company metrics and financial performance are at a different level than they were just one year ago. Like any company, we will face challenges if economic conditions deteriorate.

However, our leading market positions, relentless focus on driving operational efficiencies, growth in high value products with expansion in new adjacencies and disciplined capital management, will serve us well in any economic environment. Thank you for your interest in Neenah. At this point, we will open up the call to questions.

(Operator Instructions). Your first question comes from Mark Weintraub, of Buckingham Research.

Thank you. First, I caught your indication that your utilization rates in the Fine Papers business, are I believe, approaching 90%. Is this a business where when you have these types of high utilization rates, you can potentially have pricing power? Even in a mediocre demand macro environment or do you need that to be working for you as well?

Mark, by the way, good morning. I would say that I think we have demonstrated in the Fine Paper side of the business, through the consolidation, that they have demonstrated pricing power over the years in that regards. I think genuinely, movement in price from this point forward, really is driven more by some of the input costs and where we are at. But I would tell you, we are down to a few players this in this market. They demonstrated they can continue to preserve their brand premiums. The operating efficiencies obviously enable us to enjoy the fixed costs absorption, and where we say we are at 90% today, what I would also want to make sure that I suggest, is that as we continue to learn these new grades -- and we are going continue to improve our overall operating efficiency. So I would expect throughput, but still be able to go up in the future, even at what we would consider to be a 90% utilization rate.

Thank you. On the input costs, in particular pulp, I'm a little bit surprised that you would expect that you are looking for $20 per ton to $50 per ton increase 3Q v 2Q. I thought that much of your pricing was a one month lag, and if I look at published prices and I throw in the one month lag, it would look more like flat. Can you explain a little bit what is going on? Obviously -- presumably there's going to be a fairly significant decline in 4Q. I don't know if you can elaborate on if prices were to stay where they are in August let's say what would be the expected decline in 4Q?

That is probably -- I'm probably guilty of not being able to explain that very well in the past. It is actually a three quarter -- three month or full quarter lag, Mark, from that standpoint. Hardwood is going to be moving up greater than soft wood from that standpoint, and that obviously impacts the Fine Paper business to a greater degree. So it's a three month lag, okay? And impacting hardwood, which would impact Fine Paper to a little greater degree.

Okay. Obviously for 4Q, it would then be a three month lag.

Right.

I'm doing this on the fly, but that would suggest maybe about a $40 decline for 4Q versus 3Q?

Yes, I think what we were trying to suggest is what you may expect in third quarter, without lags, for pulp to be declining. We expect a small tick up in the third, which we sized for you there, and probably more returning to existent levels in Q2, back into the fourth.

Okay. It was a $20 to $50 increase 3Q v 2Q?

Yes.

One more, and then I will get back in queue. Don't want to hog things here. But on the Technical Specialties business, despite the currency, you actually were up quite nicely year-over-year --

Right.

-- in that business. Is that something that is potentially achievable in the back half of the year? And recognizing that you maybe have a little bit more down time this year than you did last year. What would be the key dynamics to be focused on in making that assessment?

You are absolutely right. The third quarter down, would have an impact, especially in the back half the year. From a seasonality standpoint, as I said, typically we'd see less volume in the back half, than we would in the first half. I think what you are seeing driving a lot of the margin improvement is the high end in filtration, it might be the meltblown combination products from that standpoint, but each of the businesses driving mix. My expectation would be that as we continue to improve our overall mix, we retain that. That is not a moment of mix ecstasy, okay. So I would suspect some of that to carry into the future. But it will have a couple of those headwinds that we talked about, outside of even currency.

So as we he compare this year's second half in Technical versus last year's second half, is it conceivable you can be at the same earnings level, or because of the headwinds, is it going to be difficult for you to match last year's second half?

I gave you the head winds that I knew about, and I have got this big huge asterisk next to the economy, and the economic pressures, and the headwinds associated with that. What I would tell you, the things that our organizations can absolutely control are driving their mix. The operational efficiencies and where we are from an input standpoint, those obviously are enablers that help drive better performance. It could very well be offset in the back half by some of the other challenges from an economy standpoint.

Okay. So open-ended question.

I am trying to answer the stuff I know, and what I would tell you is, that the economic conditions in the back half of the year -- I'm not overly bullish on. What I want you to know is, that while it is a stable demand today, from that standpoint, and our groups' driving the mix for their overall products, I would expect improvement. Give me that little caveat on the economy if you will, that little asterisk.

Very fair. Appreciate it. Thank you.

(Operator Instructions). Your next question comes from the line of Stuart Benway, with S&P Capital IQ.

Good morning, Stuart.

Good morning.

Hi, Stuart.

Thank you. Hi. Again, on the Technical Products business, I'm a little confused here. You said that your volume in the first half was down. I mean, is that mostly in the tape business?

Yes. When we look at -- from the first half of the business, our overall Technical Products business in local currencies, was actually up 2%. Okay. Since you did the first half of the year. The largest deterrent from -- we saw strong growth in filtration, strong growth in wall covering and labels. And tape, which had a phenomenal year last year, in the second quarter for sure, was really up against a pretty hard year-on-year comparison. Actually, tape was up in the second quarter over the first quarter. So depending on the period you are looking at.

Okay. Just seems to me that you are saying pretty good growth in new product development there, but yet the volumes were actually down for the half. And I guess it is because of this --

It is really --

New product.

Tape category is a meaningful category. It is our second largest in the Technical Products business, and it did have a big comparison against a record quarter last year.

And does that -- is that mostly into automotive the tape business or?

That is one of the very large markets from that standpoint. Our focus is heavily on the high end specialized tape markets, but automotive clearly is a meaningful one.

Consumer as well. And that was last year, we had a launch of a consumer branded tape, so.

But you are saying that you have higher efficiencies in that business. It seems unusual to have higher efficiencies on lower volume. How were you able to achieve that?

Higher efficiencies on that business being up overall.

I mean the overall.

Technical Products business?

The whole segment, yes.

Because we are going in and out of different product segments, and also in and out of different facilities. I think we have been very pleased with the efficiencies of a very high infiltration meltblown items, and we've continue to grow some of those as well. When we talk about efficiencies, we're talking about waste reduction and cost reductions from that standpoint. While we are not down significant, as we said, local currency, we're up about 2%. Those efficiencies, if --- it has reduced in our Technical Products business, our operating level slightly, but not significantly.

Okay. And the favorable product mix is the same thing, more in the high infiltration and less in tape or?

Yes. Less in the raw crate tape, from that standpoint. So when we talk about tape we -- there is a high end specialty tape that is -- helps the and drives the mix, where more commodity oriented raw tape would diminish the mix. What you are seeing in the revenue side, is strong pricing and mix enhancement, more than volume driven.

Okay. In the automotive business, and I do believe that is mostly in Europe and I think it is high end filtration, right? So people seem to be cautious about that business overall. Are you seeing any indications of reduced order patterns over there?

I mentioned that we grew our business in Europe by 2% in the second quarter. That was down slightly from the first quarter, from that standpoint. Going forward, and I mentioned that when I was talking to Mark a moment ago, going forward there is definitely concern. I think it is shared across a lot of industries in that overall region. There is some caution, but I am going to go with stable because that is -- I think what we have been seeing from our overall order patterns.

That is better than a lot of people are saying.

Yes.

You said the Wausau brands initially would generate about $100 million of sales, but it seems like you are having pretty good success there with integration. Do you think you can get maybe more than that on an annualized basis, I don't know next year?

What I would suggest is that -- and the $100 million is absolutely the right number to stay focused on. We said $100 million non-dilutive of our margins. While we are encouraged by the reception we are getting from the customers and the channels and we are still so early inside of that. I don't want to promise significant upside. I also feel obligated to remind, this is still a secular decline market.

Right, more about margin than about volume.

Right, and getting access to new customers, like the retail channel, we see that as a big upside potential. We have got to let that shake out, before I commit that business to significantly enhancing the $100 million.

In the third quarter, I think as you said is your typically heaviest maintenance quarter, how do you expect that to compare this year versus last year?

As I mentioned, $3 million to $5 million and I would say if you took a multiple year average, we might have been closer to the $3 million. We expect to be more on the higher end of that $3 million to $5 million range this year.

Millions you're talking about.

Millions, yes, I'm sorry. Millions. And that is really the timing related to some of the Technical Products efforts we have underway at our facilities.

Okay. Thank you.

Thank you.

Your next question comes from Mark Weintraub, with Buckingham Research.

Thank you.

Hi again, Mark.

Hi again. Cap spending for 2013, with the German facility expansion, should we be adding another $15 million or what do you expect the 2013 CapEx to be roughly?

$25 million to $30 million, Mark. We are absolutely committed to a cadence of meaningful capital spend by -- as you can imagine, that naturally forces you to invest in the highest returning projects. We have re-prioritized that and we will fit that very nice returning project inside of our $25 million to $30 million CapEx spend next year.

Okay. Then I guess the question is, given the types of earnings that you are generating and given the NOLs that you still have in place. There is a lot of free cash that you are generating above and beyond your capital needs. What can we expect to be the priorities and are you considering a significant acceleration of a return of capital to shareholders? And maybe an update on your share repurchase, as well as dividends?

So Mark, as we had said and as you saw with the approval of the meltblown project, our first priority for cash is organic investment. And then I would say so that is R&D -- if we increase our R&D spend, if we can increase our value added capital spending, that is where our money will go. We should have extra beyond that. What we would really like to do and what we are hunting for, as we continue to look along adjacencies, is a value adding acquisition. So that would be our next priority.

We remain committed to a dividend. As we've stated before, our dividend policy is to have a dividend that's consistent with the market and towards the upper end of our peers. We have recently announced that our board approved a $10 million share buyback program. Not a huge use of cash, but at least another lever that we can use. That would be our order of priority.

Okay. And on the share -- you haven't done any share repurchase yet, though?

Yes, we did two of them in the second quarter, about 47,000 shares. $1.2 million of the $10 million authorization.

Okay. Okay. Very good. On the dividend, can you just explain that a little bit more? How do you --when you say commensurate with your peers in what -- is that as a percentage of your -- the cash that you are generating or how are you --

We really look at it on yield. We kind of size it, and we look at our cash generating capability, but we are interested in having a dividend in that 2% to 3% yield. However, we say that it is a 2% to 3% yield over time, and we also size it based on our available cash. So we kind of do a combination of payout and yield.

All right. I guess one of the questions is, do you think your stock should be at $28 or do you think your stock should be higher? If you think your stock should be higher, then do you factor that into the thought process?

We do. Obviously we think our stock price should be higher, and that is why I always give you the caveat over time. We are not going to go and do a dividend increase if the stock price is $38 and instantly get to 2%. We work at it over time.

Okay. Thank you.

There are no further questions at this time. I will turn the call over to John O'Donnell, for closing remarks.

Once you again, thank you for your interest and participation today. We are excited about all that is happening at Neenah, and look forward to the opportunity to talk to you again in our next call in November. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.