Neptune Insurance Holdings Inc (NP) 2012 Q3 法說會逐字稿

Good morning, my name is Holly and I'll be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper, Inc., third quarter conference call. (Operator Instructions).

As a reminder, ladies and gentlemen, this conference being recorded today, November 7th , 2012. Thank you. I will now turn the call over to Mr. Bill McCarthy, VP Financial Analysis, and IR. Please go ahead, Mr. McCarthy.

Good morning, and thank you for joining the Neenah Paper 2012 third quarter earnings call. Along with me this morning are John O'Donnell, our CEO, and Bonnie Lind, CFO. Our press release, covering results, went out yesterday afternoon, so I'll briefly summarize a few items before turning things over to John and Bonnie to cover results in detail.

Third quarter consolidated net sales of $206 million were up 18%, or almost $30 million from last year. This growth resulted from fine paper where we continued to benefit from sales of brands acquired from Wausau paper in January, as well as gains in targeted technical products markets that helped to mitigate declines due to currency translation.

Operating income of over $16 million was up 30% versus last year with double-digit increases in each of our business segments. Diluted earnings-per-share also rose by more than 30%, from $0.42 to $0.55 cents per share.

We report adjusted numbers when there are items that materially distort ongoing business results. This year, that's included integration costs for acquired brands. While these costs were only $300,000, or a penny per share in the third quarter, year to date charges are $0.18 cents per share, or approximately $5 million.

We expect to complete these integration activities in the fourth quarter. Adjusted earnings figures are non-GAAP, and are reconciled to GAAP earnings in our press release.

I would also 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 and the our Safe Harbor disclaimer, found in the Investor Relations section of our website. With that, let me introduce John O'Donnell, our CEO.

Good morning, everyone. Our business continued to grow in the third quarter with strong earnings growth and record cash flow, despite the challenging economic environment. Before getting into quarterly results in detail, let me comment on progress against three of the strategic objectives that we have outlined in the past.

Building technical products into a larger, and more profitable growth platform. Second, capturing incremental growth opportunities in fine paper, while maintaining a very attractive financial return. And finally, increasing return on capital to sustainable double-digit rates, while ensuring that those returns translate into increased value for our shareholders.

First, in technical products. The technologies and product categories in this business represent an important growth platform for Neenah.

We are continuing to increase sales over of our higher value offerings, and as a result, improving EBITDA and margin performance. Filtration, which is approximately 1/3 of the sales, is cornerstone of our growth expectations.

Sales are up 5% through September, and have grown to 8% annually over the last ten years. Also importantly, the market is demanding more of our specialized high performance filtration grades, which contributes to an improving mix.

We continue to expand our presence in targeted international geographies, and our innovation efforts are yielding promising new products in adjacent filtration markets, such as beverage, and industrial applications. As I mentioned on our last call, we're adding a third (inaudible) line that will start up in late 2013 to support this growth.

We're finding success in other technical product categories as well. In labels, we're bringing new performance products to market,and have grown sales this year by 7% with notable increases in image transfer and durable print products.

In non-woven wall coverings, we continue to grow our higher margins offerings, that provide excellent print ability. In abrasive backings, we're growing with customers internationally and exploring product innovations that enhance our portfolio.

Our technical know how is base media, combined with expertise in coating and saturating, and touches many markets. As we expand in technical products, we'll continue to drive organic growth of high value products, and pursue additional growth through value adding acquisitions that build on our capabilities.

Turning to fine paper, we expect this business to unlock incremental growth opportunities, while continuing to deliver very attractive returns. The share focus has been on delivering value by successfully integrating the acquired brands.

Externally, customers have responded positively to the transaction and we continue to grow share. Internally, I couldn't be happier with the way our teams have executed against our plans.

We've internalized manufacturing capabilities more quickly than anticipated, capped by the start up of a new color system in our Whiting mill in August.

Our assets are now fully utilized and our focus has moved from integration to optimization. With this, we are beginning to set new productivity records at our mills.

In addition to improving our position in the merchant channel, we see growth opportunities in the retail channel. For example, we currently sell to large customers like Staples, Michaels, Office Depot, and others. These customers also carry other premium products that we could potentially provide for them.

International sales represents another growth opportunity as there are very few companies that make the high quality, environmentally friendly premium papers that we do. We are finding ways to grow outside of the US, either in collaboration with other companies, or through our distribution partners.

Last but not least, we are focused on growing image driven categories outside of the traditional premium, printing and writing, such as luxury packaging, and premium labels. Sales in these categories are up significantly this year as we have expanded geographies and end markets.

We see these as growing areas in which we will continue to invest as they represent exciting premium niche opportunities that clearly align with our capabilities and strengths.

Our third objective is to increase return on invested capital and deliver attractive returns to share holders. With operating margins that are nearing 10% on a trailing 12 month basis, combined with our disciplined capital management process, I'm pleased to note that our return on invested capital has now surpassed our double-digit threshold. Return on capital will remain front and center as we look at ways to deploy cash, to generate value for our shareholders.

So with that brief overview, let's move to the financial results for the third quarter.

Starting with technical products. Sales of $99 million were down 8% versus prior year, essentially all due to currency. Excluding currency, impacts are sales in the third quarter were flat, as an improved mix was offset by 2% average decline in volume.

The bulk of the volume decline in the third quarter was overseas, and industrially sensitive product markets like tape, abrasive backings. In other categories, transportation filtration sales and Euros were stable despite the market weakness in sales of labels grew almost 10%.

Countering the modest overall volume decline was an improved mix of products, which reflected gains in label, abrasive's, and filtration, three of our targeted growth areas.

Turning to the bottom line, technical products again delivered double digit profit growth, and increased operating margins. Operating income grew 14% in 2012 to $6.4 million. In addition to the more profitable mix, earnings benefited from lower pricing for some raw materials.

Moving next to fine paper, sales in the third quarter were $99 million, up more than $30 million from last year, where the large majority of sales increase was volume driven, due to the acquired brands. We're growing in other strategic areas as well. Sales of luxury packaging in premium label were up by over 50%.

We're capturing share both domestically and internationally, by introducing new products and aligning with key end users who value high image and performance. These categories provide Neenah with the opportunity to become part of the brand identity for our customers.

Premium category such as jewelry, cosmetics, and high end apparel are key target segments for our products.

Operating income was $12.8 million, an improvement of 35%, or more than $3 million from last year.

Growth resulted from higher sales volume, as well as manufacturing efficiencies and lower poll prices. In total, these more than offset higher selling, marketing, and distribution costs associated with the increased sales.

As I mentioned earlier, our integration activities have gone extremely well. We incurred $300,000 of related costs for this in the third quarter, and the remaining fourth quarter costs are expected to be approximately $700,000.

This will result in full year costs of around $5.5 million, well below our initial estimate of $7 million, mostly as a result of more efficient manufacturing grade transition.

So in summary, both of our businesses delivered double digit bottom line growth this quarter, and in technical products, we were able to accomplish this despite a challenging external environment. I'll talk about our current outlook later in the call, but will now turn things over to Bonnie to discuss corporate initiatives and results.

Given our strong cash flow in the quarter, let me start with that. Cash from operations was $32 million,a third quarter record, and $7 million above last year.

This performance reflected substantial growth in earnings, as well as expected reductions in working capital. While much of the working capital increase this year was in line with our higher sales and earnings, we built fine paper inventories in the first half to support a smooth customer transition.

As we mentioned in the last call, these higher inventory levels would be reduced in the second half of the year. Capital spending was $6.5 million in the quarter, slightly above last year. Our capital spending process is disciplined and predictable.

We maintain an efficient sustaining capital level of around $10 million per year, and then allocate additional capital based on strategic priorities and financial returns. Each year we expect to spend between $25 million and $30 million, barring unusual circumstances.

Even after normalizing for the large working capital reduction this quarter, you can clearly see Neenah's cash generating capabilities and the added value from our acquisition.

As we have shared in presentations, our free cash flow per share represents a pretty attractive yield today as well as an ongoing source of funds for future value creating investment.

Let me talk next about what we did with our cash this quarter. That was $183 million at the end of September. This was down $20 million from June, as we used most of our free cash flow to pay down debt as well as to fund dividend payments, and modestly increase our cash balance.

Our debt is comprised of $148 million on long term bond, $28 million outstanding on our revolver, and a balance of $7 million in Germany.

While our capital structure and leverage metrics remain well within our target range, with today's low interest rates, it continues to make sense for us to move from higher cost fixed rates to lower cost floating rate debt.

In mid-October, we announced that we would call $58 million of our bonds on November 15th, and that this would financed through a new $30 million term loan, and capacity available on our existing revolving credit line.

At current interest rates, this change will save us $2 million per year in interest expense, and helps us maintain a strong balance sheet with flexibility to support growth initiatives going forward.

Our earnings this year benefit from the changes we have already made in our capital structure, and in the third quarter, net interest expense was $3.3 million, down from $3.6 million last year.

Next, I would like to cover taxes.

Our effective tax rate was 29% in the third quarter, in line with the second quarter rate, but well above a rate of 24% in 2011. In 2011, the rate was lower due to changes in the projected mix of income between tax jurisdiction.

Year-to-date, our tax rate is 30%, approximately equal to the 2011 full year rate. In 2013, we plan to repatriate additional cash from Germany and expect our rate to increase to around 35%. This year, cash generated in Germany has been used to reduce debt in our German operations.

We continue it use net operating losses to offset [cash-tex] payments due on North American income. As of the end of September, we had approximately 70 million of NOLs remaining, and we expect to use these by the end of 2014.

I'll comment next on SG&A. Consolidating SG&A expense was $18.5 million dollars, compared it $15.1 million last year. Spending in 2012 has increased for selling and marketing support of the additional fine paper sales. However, as a percent of sales, SG&A spending has been, and will continue to be, more efficient as we grow.

Unallocated corporate costs, were $3.4 million, and compared to $2.6 million in 2011. The third quarter of last year was unusually low due to reduced spending and timing of certain items, and our ongoing run rate is expected to remain closer to $4 million per quarter.

Also, included in our other segment, are results from non-premium rates obtained as part of the Wausau transaction, and third quarter sales of these papers were $8.5 million with operating income of $0.5 million. Let me close with a comment on capital allocation.

As you saw this quarter, we're a company that generates significant cash flow and our cash generating ability has increased this year with the acquired brands. We expect to reinvest, redeploy, or return these cash flows to generate attractive returns. Re-investing, either through organic projects or through value adding acquisition, is our first choice.

Return on invested capital is a key metric we'll continue use in making these investment decisions. If attractive investment opportunities are not available in the short-term, we may redeploy capital, as we have in recent years, to pay down debt and thus preserve our financial flexibility. At the same time, we believe returning cash to share holders is important.

We expect to maintain a meaningful dividend and have the flexibility to buy back shares if the opportunity is compelling. Summary, we're ending the third quarter with a strong balance sheet and cash flow generation. This puts us in a great position to be able to continue to drive incremental value for our shareholders. With that, I'll turn it back to you, John.

Let me start as I usually do with safety, which is always a top priority at Neenah. Our philosophy on safety is grounded on the premise that every employee be personally involved and focused on activities that identify and eliminate potential hazards.

Our expectation that every employee is engaged in ongoing safety activities that will contribute to a safer workplace. The level of employee engagement continues to increase, and we're pleased to see the success of our programs this year resulting in a safer work environment and an important reduction in the number of injuries at our facilities.

Before I wrap up,let me comment on our current outlook as we extend our horizon into 2013. Europe remains on the mind of many companies, and we're no different. As a reminder, one-third of our sales are in Europe, most of which are from technical products business.

Third quarter is typically a slow quarter in Europe and we continue to see customers carefully controlling their inventories in line with a softer demand. As is typical, fourth quarter sales and operating schedules will be impacted as customers manage through the holidays and bring down year end inventories.

While the Euro is strengthened from it's summertime low, it's still almost 5% below where it was in the fourth quarter of last year. As a reminder, every $0.05 of exchange rate differential has a quarterly impact of about $2.5 million of sales and $600,000 of EBIT.

Next, let me touch on input costs. These comments are primarily directed to those who monitor short term variations since both of our businesses have demonstrated the ability to offset impacts of changing input costs over time. Changes in pulp prices in the fourth quarter vary by business and in general are expected to decline in North America and increase slightly in Germany.

With weakened global demand, prices for most other raw materials are expected to stay in line with the third quarter, while energy prices are increasing in both North America and Europe for natural gas.

In total, there may be a benefit of no more than $0.5 million versus the third quarter from lower input prices. Looking ahead into 2013, expectations are for modest increases in most input costs.

I'll close with a few thoughts on the year to date. There has been a lot of progress, and I'm very pleased with what our teams have accomplished.

We began the year with an acquisition of selected fine paper brands, as a result, of a disciplined process on the front end, and excellence in integration afterwards. This transaction created substantial value for our shareholders, and provides a platform to create future value.

We're also delivering, in our targeted growth categories. Premium transportation filtration products, continue to demonstrate impressive growth. Our teams in Germany, are commercializing filtration products in new markets including beverage and industrial uses.

We're also expanding in profitable niche markets like and premium labels, luxury packaging, and specialty wall coverings. Each of these represent continued opportunities for future growth.

Ultimately, the numbers tell the story. This year, we have delivered meaningful top and bottom line growth, improved margins in technical products, strengthened our balance sheet, and achieved a record high return on invested capital.

None of this could happen without employees who are engaged and focus on improving performance while working safely. Our teams have done very well,and we continue to develop bench strength and develop stronger internal capabilities.

I'm confident that you can see we are a much stronger company this year. Our market positions continue to improve, as our cash flow generation and we're well positioned to pursue opportunities that can create value going forward.

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

Thank you, ladies and gentlemen. Mark Weintraub, Buckingham Research Group.

Good morning. You gave us indications on the cost side, of what you're expecting. What's happening in terms of pricing?Do you have any initiatives in the market? What's the sense of supply and demand and the tone of your various markets?

We have talked about pricing in the past,and we said that we have got very different pricing strategy across our businesses. Our fine paper business is more of a list price, and as of today, there are no list prices increases given where we are in the overall input costs.

As a reminder, our technical product business goes from annual contracts, to quarterly contracts, and some with escalators. So there's a variety of activity. As we go into the new year, there's always those discussions about the upcoming year. So that effort is underway as it would normally be going into 2013.

Okay, and in terms of your allocation of cash flow, I assume you're looking hard at acquisitions, et cetera. At what point in time do you say, okay, we haven't found anything that has quite works yet, so perhaps move to the dividend?You noted you wanted to be meaningful, and I guess that's a judgment call. How would you define meaningful?

Mark, we look at dividend on a yield basis, and what we consider meaningful is being near the top of the peer group, and certainly consistent with the broader market. For the broader market, we look at the Russell 2000 and the S&P.

So on both of those metrics, based on a reasonable stock price for us, we're slightly low at the moment. We do say we look at it over time,but while we do prioritize the growth, expenditures like organic growth, and acquisitions, maintaining that meaningful dividend is important to us.

Okay, thank you.

Your next question comes from the line of Stuart Menway, Standard and Poor's.

Can you give us more details on the favorable mix in technical? What categories are strong for you there?

On the filtration side, the (inaudible) products in our filtration, which represents about 30% of the filtration categories. We have seen double-digit growth rates year to date on those products, and that has been real positive. Labels, also, we have seen nice success in labels. Those are probably the two biggest categories where we have enjoyed an above market growth rate.

And in the fine papers area, you said that you had double-digit gains in luxury packaging labels, and international markets.

Right.

So what's happening there in terms of luxury packaging and labels? Do you have like a new customer, is it new products or just gains?

Yes, all of the above. Especially in the luxury packaging, and I think I said luxury packaging and premium label were up 50%, so that's double digit, but that's worth repeating. I think there are a couple of things.

One, the expansion geographically. I think you see from an SG&A standpoint, we've invested in selling resources focused on both of those categories to ensure that we are representing them in the market on a geographic expansion.

But we have also got new products, significant new products, and again, we talked a little bit about the cosmetics and jewelry. Our positioning, which we find to be very well received in the market, is the environmental strength.

Because our packaging, we have 100% post-consumer waste product,which is a hard one for others to replicate, and we have found a tremendous amount of success there. So that's a product that geography, and the selling resources applied are probably the three biggest drivers.

And in paper, you say the cost efficiencies help margin. Is that primarily due to the new volume from the required brands?

I think two fold. One, obviously filling up the asset base, we get the benefit of longer runs and more amalgamation of products on the machines, and that's a more natural one, and we have also invested in capabilities. In the third quarter, we put in a new color system in Whiting.

Those investments, combined with that experiential curve are driving our efficiencies. It gives us a better opportunity to optimize which machines can best run which products. We're at the beginning of that, I think the group is going to continue to see improvements from that experience over time. But that's predominantly what the drivers are.

You talked about Europe in general, but how would you classify it now versus either a year ago or second quarter? Is it the same, better, worse?

Well the economic environment versus a year ago is dramatically different. From our standpoint, our share position hasn't been diminished, so that would be very much the same from that standpoint, our growth strategy in our filtration business, which is one of the larger ones in our European markets, (multiple speakers)

That's primarily on motive, right?

Yes. Transportation, filtration hasn't changed dramatically. We're still focused on the very high end performance. So probably, by our focus being more on the high-end, we're probably less impacted by the more commodity oriented products.

That's what I mentioned in the call, that the products like tape and abrasive backing is going to be more impacted. I would be remiss if I didn't tell you how much happier I am that our facilities are in Germany, and there's an element of strength there as well.

And one last one. Given the events of yesterday, have you evaluated at all what the impact could be in the future on your healthcare costs?

We were talking about that before the call started,and I said I don't think they have swept up the confetti yet. We haven't quite gone through that yet. Most important for our organization to remember that no matter what happens from a political standpoint, it doesn't change our chances for success and growth in the marketplace.

That doesn't change our overall strategy. As we have demonstrated in the past, we'll continue to be nimble, and do the right thing for shareholders as we move forward living inside the change we have experienced in the upcoming months and years.

Thank you.

Thank you, Stuart.

Your next question comes from the line of Lawrence Stavitski, Sidoti & Company.

Hi, Larry.

Good morning. Could you talk about the fine paper segment? If you crossed out the Wausau brands, how should we look at that in terms of growth there, if you backed out the newly acquired brands?

Larry, that's going to be a hard one. Because we worked so hard to integrate them. First, I'd start with the market. Clearly, printing and writing, you see the pressure it has been under each quarter this year. So it's clearly a declining market. If I look at the last three years, we continued to make share gains. I would say the last three years, because the Wausau wasn't here until this year.

So we continue to make share gains inside of that. Some of the Wausau brands are performing really well, and some of them are not. Now, I think what's key, is the change. With the Wausau brands, we were able to grow in our international market even at a greater pace. They also brought us an entree into retail. Which I think is critically important.

The groups worked hard outside of the new brands, at growing our envelope business, which has become a significant business for us. So it's hard in me to tease it apart. I would tell you, it's a challenging market. I can't tell you how hard that group works every day to ensure that.

If they end this year with growth, this would be their third year in a row of growth. Our expectation is that if they eliminate any brackets, any decline in year-over-year basis. All of those efforts were with underway before brands. The brands helped us fill up the asset base and provide us more meaningfulness to our customers, and opened the new channel in retail as well as the brights category.

And you also mentioned the environmentally preferable brands, and what makes it environmentally preferable? Is it the process of making the paper? The parent rolls?

The claim that is made is 100% post-consumer waste. So to have that in a packaging or a board, it enables the manufacturer, or consumer products company, then to make a claim about their environmentally responsible packaging.

What's different than everyone else is we have the ability to do that in a very bright, so it looks like a very attractive package, and then it has superior printing performance capability. So it's a combination of 100% post-consumer, the ability to put great graphics on that, and the ability for it to be an attractive sheet. It's the combination of all of those.

Okay, and also, can you just provide a little more color on the progress of the (inaudible) line, in terms of that extra capacity? Do you have commitments for that?

Sure, I would be happy to. As I said before, it's our third line, so we have been very planful, as ensuring that we're consistently bridging our additional capacity. So we have utilized where we could any outsourcing, as well as working with customers on contractual commitments going forward.

It was recently approved and planned to be up in the fourth quarter of next year. So and in regards to that, our expectation will be much like the one we approved two years ago, and I think it came up in the first quarter of 2010. We fully utilized it, and utilized it ahead of schedule. We have a nice bridging strategy that built into that capacity addition.

Just one last question, can you guys just remind us of your criteria for your investment opportunities? What are you looking for, or what you may be looking for?

Okay. First of all, we talked about the investment, organic being the priority. From an organic standpoint, we do it from an IRR basis. I think our cost reduction has been over 20% IRR, to give you an idea of investments and where we are. Larry, I want to make sure that I'm addressing your question.

Yeah, Larry, are you asking what we find attractive in an acquisition candidate?

Yes, in terms of sales and I guess size, and things of that nature.

We have probably been more limited historically for what we're looking for for size, and what we would say today, while we're open to all sizes, we're very much focused on an acquisition, and that gives us the opportunity to have a transformational addition to our overall portfolio, and our financial flexibility can easily get that done.

As we demonstrated with the Wausau brand acquisition, if there's something that has compelling value, in that case, $20 million, we'll move down that path. We're looking really towards technologies, performance oriented technologies, in our technical products businesses.

As I said on the call, really, expertise and coating and saturating is where we live. Obviously we're looking for growth. I think that's key for us to continue to change the growth profile of that category. Okay?

Yeah, the only other thing that I would add to that, Larry, we really look at these in terms of adjacencies, because we think that we have an increased chance of extracting synergies from them so the adjacencies that we would like to look in would be customer, product, technology or geography.

Okay.

I hope that's helpful.

Thank you, you guys.

You bet.

At this time, there are no further questions.

Well, once again, thank you for your interest and participation today. and I hope you share excitement about the changes and results that our teams are accomplishing this year. and we look forward to the opportunity of talking with you again in February. Thank you.

Thank you, this does include today's conference call, you may now disconnect.