Neptune Insurance Holdings Inc (NP) 2013 Q1 法說會逐字稿

Good morning. My name is Tishonna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper first quarter 2013 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 period. (Operator Instructions). As a reminder ladies and gentlemen, this conference is being recorded today, May 9, 2013. Thank you.

I will now turn the call over to Mr. Bill McCarthy, President of Financial Analysis and Investor Relations. Please go ahead, Mr. McCarthy.

Okay, good morning, everyone. And thank you for your interest in Neenah. With me on the call today are John O'Donnell, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. I will provide a few overview comments and then turn things over to John and Bonnie to review business activities and financial results in detail. As usual, we released earnings yesterday afternoon, so I hope everyone has had a chance to get acquainted with these results.

Consolidated sales for the first quarter were $213 million, up 8% from a year ago. Revenues grew in both segments, with fine paper boosted by acquisitions, both through an added month of sales from brands acquired in January of 2012, and from two months of sales from brands purchased from Southworth in January of this year. Adjusted earnings per share were $0.74 in the quarter and this included a $0.07 per share reduction versus last year, due to our higher 2013 effective tax rate. This increase in tax has more than offset benefits from higher operating income and lower interest expense. In 2012, adjusted earnings were $0.77 per share.

As a reminder we record adjusted numbers when there are items that materially distort ongoing business results. In the first quarter, this included acquisition-related costs in both years and a pension settlement charge in 2012. Excluding these items, GAAP earnings were $0.54 per share last year and $0.73 in the current quarter. Adjusted earnings are a non-GAAP measure, and are reconciled to GAAP figures in our press release.

Finally, I will remind everyone that this call includes forward-looking statements subject to risks and uncertainties. These risks are fully described in our SEC filings and in our Safe Harbor disclaimer found in the Investor Relations section of our website.

And with that, let me turn things over to John.

Thank you, Bill. Good morning, everyone. I'll start with a few comments on our strategic direction before turning things over to Bonnie to cover first quarter financial results.

As I have shared before, there are three broad principles guiding our strategic activities. First, we focus on profitable specialty niche markets where we can have a meaningful share position and a right to win through improving performance or image of a product. Second, we expect to increase our portfolio growth rate and diversification as we gain scale and expand in higher-value products in growth markets. And third, we will operate in a disciplined financial matter that continues to deliver consistent and attractive returns to our shareholders.

Let me talk first about our progress in building our leadership in profitable niche markets. As I have said, these are markets that value our competencies in performance and image, have barriers to entry, and provide attractive financial returns. Some of these more sizable markets for us today include transportation filtration, luxury packaging, premium labels, and our core commercial print brands.

In filtration, we hold the leading share of transportation filtration media in Europe, and are growing from this base both internationally and through entry into new filtration end markets. While economic and competitive conditions in Europe remain challenging and this certainly includes the auto industry, our businesses continued to perform well. In this quarter, we grew sales in Europe, complemented by international growth of over 20%. Our customers, many of whom are global, look to us for innovative and specialized products and we are working with them on next-generation needs for global engine platforms. At the same time, demand for our highest performance filtration media is growing at a double-digit pace, and we'll start up our third non-woven meltblown line late in the third quarter to support this need.

Next, with annual sales of around $75 million, the labels and luxury packaging are also growing nicely. These products cross both of our business segments with labels and packaging for premium image products that use our fine papers, and performance-oriented labels that are developed in technical products. These markets are growing and we are outpacing them as we introduce new products like paper-based gift cards that provide an environmentally friendly solution, new customized performance labels in unique textures and colors for customers that value premium labels or luxury packaging.

In fine paper, we identified the retail challenge as a strategic growth opportunity. Our brand acquisition in 2012 brought us entry into this channel, with the purchase of brands from Southworth earlier this year, we now have achieved a leading market share of 60%, consistent with our strong share in commercial print. The addition of Wal-Mart as a customer this year strengthened our position in the general merchandise channel and reinforced our commitment to future growth in retail.

The majority of our fine paper business remains in commercial print, where we have leading brands and strong market position. We continue to outperform the market as our teams have found new ways to grow through supply chain innovation, in partnerships with others, and expanded international distribution. There's no doubt that it takes lot of work to generate growth in this market, and I'm especially pleased with how our fine paper team continues to be the value adding exception.

In addition to these three larger markets, we are focused on growing in profitable technical niches like specialty tapes, and premium abrasives, and medical packaging and filtration adjacencies. While these are not large pieces of business today, our unique capabilities and defensible market positions are providing opportunities to grow. We have started commercialized products in beverage and industrial filtration, and in abrasives. We currently participate only in a small part of this market and believe that our saturated paper solutions may be an attractive alternative to certain film- and cloth-based products.

Next we intend to increase Neenah's growth rate and portfolio diversification as we gain scale as a company. We expect to do there through organic efforts as well as with acquisitions that meet our financial return requirements. Organically, our invasion efforts are focused on higher-value offerings in markets that are defensible, growing, and aligned with our unique strengths in performance media and coating and saturation.

As I mentioned, we are commercializing new markets in beverage and industrial filtration, expanding our label and packaging offerings, and developing specialized abrasive backings. Our organic efforts are likely to be supplemented by acquisitions. Our process to identify and evaluate targets is active. However, we are focused and disciplined, so before we spend any money, we will ensure that the acquisition will add value and is a strategic fit. Our criteria focuses on four adjacency areas that can provide synergies and barriers to entry through technology, products, customers, or geographies.

Finally, our expectation is to deliver consistent attractive returns to shareholders through disciplined financial management. Our starting point is from a position of strength, with businesses that are profitable and generate sizable cash flows. We have a number of internal processes to drive good decisions to grow and deploy cash to deliver attractive returns.

We have structured many of our raw material and customer pricing contracts to allow us to manage input cost variability and protect margins. Both of our businesses have demonstrated the ability to offset changes in input costs over time. We are focused on driving efficiencies throughout the organization, and expect improving performance as we grow and leverage our infrastructure. We have a disciplined capital spending process that carefully controls sustaining capital to around $10 million, and then prioritizes higher return growth and cost reduction product. We are able to keep overall spending within a prudent $25 million to $30 million range below depreciation and amortization, while ensuring attractive returns on our spending.

As a reminder, our compensation is tied directly to the key performance metrics of increasing return on invested capital, top line growth, cash flow generation, and comparative returns to shareholders. This pay for performance philosophy is extended throughout our company, including our hourly employees. In 2012, you saw the results from this as we grew top line, while also increasing margins and return on invested capital. We were pleased that our shareholders benefited from that performance and the higher stock price.

In addition to reinvesting capital wisely in the business, returning cash to shareholders is an important part of our strategy. We have increased our dividend in each of the past three years as our company has grown, and as a reminder, today's level still represents a relatively small part of our free cash flow.

So in summary, we are encouraged by our ability to deliver on our strategic initiatives, act on attractive opportunities, and to reward our shareholders for their investments. I will talk more about priorities in 2013 later in the call, but now I would like to turn things other to Bonnie to discuss first quarter results. Bonnie.

Thanks, John. Today I will cover our business segments first, starting with technical products.

Sales of $107 million increased 1% versus last year. We had strong volume growth in filtration and tape, in addition to a higher-value mix in both of these areas. We also had modest translation benefits. Offsetting this were challenging conditions in Europe that extended to some of our other product lines. Technical products operating income of just under $10 million was down from an all-time quarterly record of $12.5 million last year. In addition to impacts from conditions in Europe, margins this year reflected higher manufacturing costs due to increased input costs and less efficient mill operating performance.

Moving next to fine paper, sales of almost $100 million were up 15% versus last year. In addition to growth from acquired brands, sales benefited from an improved mix and double digit increases in targeted areas such as luxury packaging and premium labels. Operating income was $16.3 million, compared to $10.8 million last year.

After excluding acquisition costs in both years, adjusted income grew by $3 million or 23%. This higher operating income resulted from increased volume, a higher value sales mix, record manufacturing performance, and lower input costs. These items more than offset increased selling, marketing, and distribution costs associated with the higher sales.

Turning next to unallocated corporate and other results. Sales of acquired non-premium brands in the first quarter were $6.8 million with operating income of $300,000. In 2012, sales were $5.8 million with profit of $700,000. These grades are not considered strategic to us, and margins will vary with mix and market conditions. Unallocated corporate cost was $4.1 million, compared to $7.8 million last year, which included $3.5 million for a one-time pension settlement charge. Excluding this charge, costs in 2013 were slightly below last year. Costs this year are expected to remain around $4 million per quarter about where they have been for the past three years, as we continue to leverage our corporate infrastructure as we grow.

Consolidated selling, general, and administrative expenses are $21 million up from $19.5 million last year. As you would expect, most of the increase was in fine paper, where we incurred additional costs related to the higher sales levels. As a percentage of sales, SG&A for the quarter held constant at 9.8%. As we grow, we expect SG&A as a percent of sales to decrease as we use existing resources to grow efficiently. Spending for the remainder of the year is likely to be between $19 million and $20 million per quarter.

Now let's move to corporate financial items. Taxes -- our effective tax rate was 38% in the first quarter, significantly higher than last year's 29%. As we indicated in the February call, we expected a higher rate this year, due to increased repatriation of capital from Germany. We said that the rate could go as high as 40% depending upon proposed changes in German tax law. Following the February call, these changes were enacted and resulted in the 38% rate. We expect this to decline next year to around 35% which should be more indicative of our long term run rate.

Neenah's cash tax rate is below 15%, significantly less than the book rate, as we use our net operating losses to offset cash tax payments due on North American income. Currently have approximately $50 million of NOLs remaining and expect to use these by the end of 2014.

Cash flow from operations was $2 million in the first quarter. This included a $23 million increase in working capital, mostly as a result of higher receivables. Sales growth and seasonality tend to drive working capital increases in the first quarter as we come off of year-end lows. The positive cash generation in the current quarter compared to a $13 million cash deficit last year when we also had unusual and higher outflows for items like pension settlement, taxes on stock compensation, and acquisition related inventory.

Our US pension plans are in sound shape and are funded at just over 90%. Globally, pension plan contributions and payments in 2013 are expected to be around $17 million, which is consistent with where we were last year. Our desire is for the US plan to be fully funded by the end of 2014, at about the same time our NOLs expire, in this way minimizing the impact on our overall cash flow generation.

Capital spending was $4.7 million in the quarter compared to $3.5 million last year. For the full year, we expect to be near the top of our $25 million to $30 million range, with the non-woven meltblown line investment.

Let me talk next about our capital structure. Debt was $187 million, at quarter end, up from $182 million at year end. The increase in part reflected funding for the $7 million purchase of brands from Southworth. As of quarter end our debt was comprised of $90 million of long term bonds, $50 million drawn on our revolver, $29 million for our term loan, and then the balance was in Germany. Interest expense was $1 million below last year, largely due to lower debt levels, and a lower average interest rate following prior year redemptions of senior notes paying 7.375% that were replaced by short term borrowings of a rate of about half that level.

We noted in the release yesterday that we will redeem another $20 million of senior notes in the second quarter, further reducing interest expense. In today's low interest rate environment, we continue to monitor the credit markets for additional opportunities to take advantage of these conditions.

Let me close with a few thoughts on cash generation and allocation. As John said, our businesses generate significant cash flow. Reinvesting through organic growth projects is our first choice, and we actively prioritize growth and cost reduction capital. Our acquisitions screening process is active, and we are looking for opportunities that are a strategic fit and provide the returns we need.

In the past, we used excess cash to pay down debt. Our balance sheet is now very strong, with debt to EBITDA of around 1.5 times and at the low end of our targeted range. Therefore, paying down more debt is not a particularly attractive option. Returning cash directly to shareholders has been and continues to be an important part of our capital deployment strategy. We maintained our dividend throughout the great recession, and have grown it 50% in the past three years.

In addition, we have the ability to buy back shares if the opportunity is compelling. In 2012, we spent approximately $4 million on share buy backs and an average price of less than $26 per share.

So to summarize, with substantial cash flow generating ability, and a capital structure with ample borrowing capacity, we are in a great position to take advantage of opportunities to drive incremental value and provide returns to our shareholders. With that, I'll turn things back to you, John.

Thank you, Bonnie. As usual, let me start with a few comments about safety, which is always our top priority. Our safety philosophy is grounded in the premise that every employee should be personally involved and engaged in activities that will contribute to a safer workplace. In 2013, our safety results have been disappointing to last year's improved pace, but I know our teams remain focused in this area, and our commitment remains that no one be hurt in the workplace.

Next let me talk briefly about the current outlook. I said in February, that market conditions, at least in the first half of 2013, will be slower than the prior year, with challenges being especially acute in Europe. These weaker economic conditions have resulted in a more challenging competitive environment, where companies are chasing volume, and we don't expect this situation to change in the near term. While we can't control the environment, our teams are focused on what they can control -- like costs, and innovation, and commercializing new products, and growing our share in markets outside of Europe.

As anticipated, input costs are rising this year, with the largest increases in specialized pulp used in Germany, and in hardwood pulp, used in our fine paper. Let me remind you that our businesses have demonstrated that they can offset cost variations over time. Costs did increase in the first quarter, and additional increases in pulp and energy are expected in the second quarter, with commodity pulp increases of $30 to $50 a ton and specialty pulp pricing even more. Our teams are managing this with a selling price increase in the fine paper implemented in early March, and pricing discussions with customers and technical products that don't participate in automatic price adjustors.

Finally let me share a few of our priority areas for this year. First, we'll deliver the returns we committed to with organic growth capital. This includes a startup of a third meltblown line in Germany, and a soft nip calendar in Munising, Michigan. These investments provide cost efficiencies, but more importantly, they support our growth plans in adjacent filtration and abrasive markets.

Second, we will continue to prioritize capital for value-adding acquisitions that can deliver on our strategy to diversify into growing a profitable niche markets, most likely in technical products. Our acquisition of brands from Southworth in January is on track, and we're integrating and optimizing our operations to capture this value. We're also finding ways to minimize integration costs, which add $1.3 million, which is projected to be below of our original estimate.

Next we will deliver on our innovation and growth plans in both businesses. Initiatives this year include commercialization of new label products, expansion of our envelope go to market approach, and increased commercialization of new products in filtration and luxury packaging and the retail channel.

Finally, we will continue to optimize our financial position, through a lower-cost capital structure, addressing our high tax rate, investing our cash efficiently, and providing attractive returns to shareholders. As I hope you can see, we had a sound start to the year, and continue to find unique and creative ways to drive additional value in our businesses. We have a number of activities underway and our teams are very active, and that's okay. We enjoy the energetic pace because winning is fun.

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

(Operator Instructions). Your first question comes from the line of Jon Tanwanteng of CJS Securities.

Good morning, Jon.

What was the impact of -- and I apologize, I jumped on a bit late, so if these are answered already, I'm sorry. What was the impact of increased pricing on your results in the quarter? And did that completely offset input pricing increases?

Yeah, just a quick reminder, input costs are going up in the quarter and going up and plan to go up in the next quarter. We have announced price increases in the fine paper business that took effect early March. The magnitude of it is that it will offset it, but in the first quarter costs were greater than the overall price improvements in that very first quarter.

Okay, got it. And then the Southworth integration costs were a bit lower than we expected? Is that going to be the run rate going forward as well?

Yeah. Our -- from our expectation.

You mean the amount that was in the quarter, the $0.1 million?

Yes.

No. We are expecting them to be closer to $1.3 million for the full year, with more of them coming in the back half of the year than in the first half.

Correct.

Okay, got it. And then what kind of progress have you made actually in selling your core fine paper products into their retail channels?

I mentioned on the call because I think -- I'm very pleased with their role, 60% share in the retail channel, we size the retail market at about $150 million for the categories where we have opportunity. We've got significant positions in the big box, and as I also mentioned, with the addition of Wal-Mart, continue to see other growth opportunities, so 60% share in our categories I'm very pleased with and continue to see improvements.

Okay, great. And then finally, luxury packaging what was the bright spot for you guys? Can you talk about the opportunity there and how you plan to continue that share gain?

Sure. In luxury packaging is one that we continue for quite some time now, growing at double-digit rates. It is hard to size the luxury packaging category, but we would size it at roughly $250 million, if you will. And with us having a roughly 15% inside of it.

So we think there's a lot of room to run on the luxury packaging. Again, our biggest sweet spot is when we have an opportunity to change the perception of the value of the product in the end market. And we think there's a lot of upside to that.

Great, thank you very much.

You bet. Thank you, Jon.

Your next question comes from the line of Stuart Benway of S&P Capital IQ.

Hi, Stuart.

Hey.

Good morning.

Can you tell me how much of this 15% sales gain of fine papers was due to acquisitions?

The bulk of it was really due to the acquisition. I think as we have said in the past, our core business which clearly outperformed the market, still met with some of the overall pressures. So -- I would suggest that, with the envelopes that offset, those are probably the two biggest growth areas in addition to luxury packaging. But most of it as a result of the acquisition.

Okay, and back on the price increase a little bit. So do you expect the price increase you put through in March obviously would be effective for the full quarter, full second quarter. Would that be enough, do you think, to offset cost increases?

Yes. It is -- again, it's important for us to both protect those margins from the long term -- we don't announce a lot of increases in the fine paper business from that standpoint. But projecting out -- it will cover the cost increases that we have almost equal to it, for the full year, what we are projecting anyway.

We don't see an impact to the margins as a result of the input costs.

Okay. In technical products, can you tell us what categories have been challenging, as you put it?

Yes. I think that's a great question. The simple -- or the shorthand is the more technically differentiated the product, the less challenging it is. So you have to go to some of the categories like wall cover, where a lot of people are -- have focused on that as a market. It doesn't take a significant technical differentiation to participate in that. We also saw some pressures on maybe more of the non-differentiated abrasives might be another area where we have seen some overarching pressure. Again, the more differentiated which is why I'm so incredibly pleased with the performance of our transportation filtration business. It just has proven to be very resilient.

Yes, a little surprising, I think, in the current situation over there.

Yes, I don't want to sound surprised. I am supposed to not sound surprised.

Can you tell us the nature of the manufacturing inefficiency? Was that a one-time thing? Is that resolved now?

Yes. There's no way that I can run from it. We are a manufacturing company. So I mean -- while we try to make the donuts every day from that standpoint, you have good quarters and you have bad quarters. While we were pleased with the acquisitions and the filling up the asset base in our fine paper business, we were challenged in a number of our technical products businesses. It's not a systemic issue, it is a one time -- but it was meaningful enough I believed I needed to call it out.

Your typical seasonal earnings pattern is for stronger results in the first half of the year, I guess, second quarter the current quarter is probably strongest. I mean do you expect that pattern to hold this year?

I don't see anything that says we should buck historical trends from that standpoint. I would just remind you that the fourth quarter is also the more challenging, and the middle part of the year tends to be good quarters from that standpoint. So I don't see anything that we are doing, or that we would expect that would change our historical trend.

Okay, one quick last one -- do you expect a tax rate to remain high for the balance of the year?

Yes, at this point, we would expect 38% for this year, and then 35% for next year.

Okay, thank you.

You bet.

And your next question comes from the line of Eric [Badio] of [LKF Capital].

Good morning, nice quarter.

Hi.

Thank you.

Just quickly, the discontinued operations, I assume that was still the tax liability reversal, is that correct?

No. In the discontinued ops, we had a big pension fund in our Canadian operations that we sold years ago, and one of the things we had is a pension fund that was overfunded. And what happened in this quarter is we were able to get all of the excess amount of cash that was sitting in that pension fund to come back into our US operations.

Got you.

So that was the pick-up.

Okay, and on the German meltblown facility and the Michigan facility, you have coming on later on this year, should we expect any kind of change or build up in working capital ahead of that?

Not a significant bump from that standpoint. It is really what you should expect is there is a runway to continued growth in those key areas. But I wouldn't expect a significant buildup in the working capital.

And then when they do come on line and start hitting the income statement, is that going to be a weight on margins? How much until they become either margin-neutral or accretive? How long, or what sales level?

Just a reminder, our meltblown line comes up with our very highest-quality items. So from that standpoint, the greater we can move those -- the greater we can improve the overall mix in our filtration business, the better our margins are. Both of the assets we are talking about here are cost reduction, or cost-saving, so you're going to see -- you will continue to see efficiencies again to offset some of the other cost pressures that we feel. So they will both be low cost assets and both of them, again, driving the higher end of the mix, from our standpoint. Obviously, with any asset that comes on, and we will manage it in a cost efficient way, but it will take us like the meltblown maybe three years for us to fill that asset completely.

And then lastly, your fine paper margins are doing very, very well despite the headwinds that you saw there. Is it a sustainable level, these increases, or was there other factors that really were very positive that may not be so positive later on in the year?

No, I think that business has continued to demonstrate over the last three years not only growth on the top line, but an ability even to enhance margins. So we felt input cost pressures over the past couple of years. The mid-teen margin that you see in that business, you know, I don't see anything that -- when we talk about luxury packaging and premium labels, those are businesses that continue to play in that profitable range.

I would just add that in the first quarter we did have record operating performance in all of our fine paper mills, which contributed to -- I would say a more favorable cost variance environment than what we would expect to see going forward.

But mid-teens is --

Mid-teens is good.

Not out of bounds at all.

Great, thank you so much.

You are very welcome.

I would now like to turn the call back over to Mr. John O'Donnell for closing remarks.

Once again, thank you all for your interest and participation today. We look forward to the opportunity to talk to you again in August. Thank you, now.

This concludes today's conference, you may now disconnect.