Neptune Insurance Holdings Inc (NP) 2013 Q4 法說會逐字稿

Good morning. My name is Bridget and I will be your conference operator today. At this time I would like to welcome everyone to the Neenah Paper fourth-quarter and year-end earnings conference call. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, February 19, 2014.

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

Okay, thank you. Good morning and thanks to everyone for joining Neenah's fourth-quarter earnings call. With me today are John O'Donnell, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer.

I will recap a few items, and then John and Bonnie will review business activities and financial results in detail, as well as provide comments relative to 2014 expectations. Following our prepared remarks, we will open up the call for questions.

We released results yesterday afternoon and reported earnings per share from continuing operations of $0.78. This was up 30% compared with adjusted earnings of $0.60 per share in the fourth quarter of 2012 and marked our strongest fourth quarter ever.

For the full year, adjusted earnings per share were $2.93, compared to $2.78 per share in 2012. Increased operating income and reduced interest expense in 2013 more than offset an $0.18 per share impact from a higher tax rate.

With lower integration costs in 2013, GAAP earnings increased even more, growing from $2.41 to $2.96 per share. Adjusted earnings are a non-GAAP measure and are reconciled to these comparable GAAP figures in our press release.

Finally, as a reminder, our press release and call today contains forward-looking statements, and actual results could differ materially from these statements due to risks and uncertainties described in detail in our SEC filings and in the Safe Harbor disclaimer contained on our website.

With that I will turn things over to Bonnie to discuss fourth-quarter results.

Thanks, Bill. In addition to reviewing the fourth quarter, I will also provide some comments on our outlook for certain corporate items in 2014.

As Bill mentioned, our businesses delivered a very strong fourth quarter, with volume-driven top-line growth of 6% and improved operational and cost performance that helped boost earnings by 30%. Each of our business segments contributed to these results, and I will start our review this morning with Technical Products.

Sales of $99 million in the quarter were up 4% compared with last year. Filtration continues to be a key driver of results and delivered double-digit growth in units and in sales dollars. In addition to share gains and growth in Europe with an improving economy, international revenues grew 24% and sales of our advanced filter media increased by 17%.

In other product categories, sales of abrasives and industrial products also grew strongly in the quarter and helped offset some slowing in labels and tape.

Of our total sales increase of 4%, volumes accounted for 3%; and the balance reflected favorable currency translation from a stronger euro, partly offset by lower average selling prices. Prices fell for certain products with contractual price adjusters that move with input costs, as well as due to some competitive conditions in some of our markets.

Operating income topped $10 million in the quarter, up more than 60% from $6 million in 2012. Income grew as a result of higher sales, but more so due to improved cost and manufacturing efficiencies.

In addition to very good operational performance, manufacturing costs were helped by increased production schedules in Germany, where economic conditions were on an upswing at year-end, compared to a more cautious environment in 2012.

Input costs were mixed, but lower overall, with higher pulp prices being offset by lower cost for latex and chemicals.

Moving to Fine Paper, quarterly sales were $100 million and increased 10% versus 2012. Volumes were up 6%, and this included acquired Southworth brands as well as growth in targeted categories such as premium packaging, digital papers, and in international markets.

In addition to higher volume, sales grew as a result of increased selling prices and higher-value mix. Our mix reflected good performance in our core premium brands as well as growth in targeted higher-value products.

Operating income was $14.7 million, up 12% compared to $13.1 million in 2012. After adjusting for integration costs of $1.1 million in 2012, income grew by 4% due to the higher sales and lower selling and administrative costs. These benefits offset higher manufacturing costs, which included over $1 million of increased costs for pulp and energy.

Looking next to unallocated corporate and other results, sales of nonstrategic rights in the fourth quarter were $6.2 million and compared to $6.7 million last year. Operating income was $1.2 million and benefited from unusually favorable machine loadings and good operating performance. In general, we expect profit contribution from these grades to be modest.

Unallocated corporate costs were $3.6 million in the quarter, compared with $4.2 million last year. In 2012, costs included $400,000 related to early redemption of our bonds. Excluding this, unallocated cost in both years was in line with our historic levels.

Consolidated SG&A of $19.4 million was down from $20.3 million in 2012, primarily due to timing of expenses. Ongoing quarterly spending is typically between $19 million and $20 million; and we expect to leverage our existing infrastructure in cost as we grow.

Let's move now to a few corporate financial items. Net interest expense of $2.7 million reflects the attractive lower rate on our bonds issued last May and was down 10% compared with the $3 million of expense we had last year. As a reminder, most of our debt is not prepayable; so in the short term we expect to continue to incur annual interest expense of around $11 million.

Our effective tax rate in the fourth quarter was 34%. This was similar to our full-year rate after excluding a one-time R&D credit booked in the third quarter.

The rate increased from 30% in 2012 primarily due to higher levels of cash repatriation from Germany. Going forward, we expect our rate in 2014 to be around 35%, in line with 2013.

We have used net operating losses to offset cash tax payments due on North American income. As of December, we had $33 million of federal NOLs remaining. We expect to use all of these NOLs in 2014, which will result in US quarterly tax payments.

Offsetting this use of cash will be lower pension plan contributions, which I will talk about in a minute.

But first, to wrap up on earnings, in the fourth quarter each of our businesses delivered higher sales, higher profits; that, coupled with our lower interest expense, more than offset impacts of the higher tax rates and generated impressive growth in consolidated earnings. We also continue to maintain very strong balance sheet and generated significant cash flows; and I will cover these items next.

We ended the year with debt of $212 million and cash of $73 million. Our debt consisted of $175 million of notes that are due in 2021 with a coupon rate of 5.25%, and the remainder largely in Germany to finance asset expansion and for other general purposes.

Debt and cash each increased by approximately $20 million in the fourth quarter as we took on additional borrowings in Germany in accordance with our repatriation strategy. Our net debt position of $139 million was down $6 million in the quarter, and $36 million below year-end 2012. At 1.2 times 2013 EBITDA, this represents a very conservative debt level and gives us significant flexibility to pursue attractive organic projects, value-adding acquisitions, and increase cash returns to shareholders.

Cash flow from operations was $19 million in the fourth quarter and $84 million for the full year. Net of capital spending, which was $8 million in the quarter and $29 million for the year, our free cash flow for the year was $55 million, which was more than 6% of our sales.

As a reminder, our targeted capital spending is around $30 million, and we expect to remain at this level again in 2014. Of that total, only $10 million is required for maintenance CapEx, with the remainder of the spending going to projects that deliver attractive financial returns.

I mentioned earlier that we will offset higher cash tax payments this year with lower cash contributions for defined benefit retirement plans. Our US pension plans are well funded, and contributions to these plans are expected to decline by $4 million in 2014.

Expense is expected to stay largely unchanged as benefits from increases in the discount rates are offset by changes in assumptions for plan returns and other factors such as mortality tables. Total cash requirements for benefit plans are likely to exceed expense by approximately $8 million in 2014, down from $11 million differential in 2013.

With that, I will turn things over to John to discuss full-year results and progress against strategic objectives.

Thank you, Bonnie, and good morning, everyone. As Bonnie described, we ended the year on a strong note, helped by recovering economic environment. But our success was ultimately due to solid execution of top-line initiatives that improved operational performance.

For the full year, sales of $845 million increased 4%, while adjusted EBIT was up 6% and adjusted earnings per share grew 5%. Each of our businesses contributed to the success, with volume-driven top-line growth and improvements in manufacturing operations that offset higher input costs.

In fact, our teams were able to grow our top line while improving both operating margins and return on invested capital, which is not always an easy task. At around 12%, our return on invested capital remains well above our cost of capital, and we continue to use this as a key criterion in our business decisions.

There were a number of activities in the past year that supported our three strategic priorities, contributed to our results in 2013, and will benefit us going forward. Our first strategic cornerstone is to develop and grow meaningful positions in profitable niche markets. In filtration, we grew globally in core transportation filtration media, while at the same time expanded into market adjacencies that require advanced, high-performance materials.

To support this growth we successfully started up our third nonwovens melt-blown line early in the fourth quarter. This asset has the ability to handle and blend a variety of polymers to meet customers' needs. Our technical capabilities, coupled with a reputation for innovative products and high service levels, continue to earn us the opportunity to grow share in filtration.

Specialty backings, comprised of tape and abrasive products, are another key market for us. In 2013, tape revenues grew 8% as we successfully recovered share by increasing our importance to our key customers and growing sales of specialized products with unique service characteristics like water repellency and ultraviolet resistance. Sales of higher-value specialty grades were up almost 20% in 2013, and we continue to see steady growth potential.

Premium packaging and label is the third area where we see exciting growth opportunities. Our forecast is on end-use -- our focus is on end-use luxury markets such as spirits, jewelry, electronics, and cosmetics.

Our foundation has been labels, where we hold the leading share in North American uncoated wine label market, and have successfully extended our portfolio of distinctive textured and colored labels to areas like craft brews and other foods and spirits. We are also addressing needs in performance labels through unique products used in both consumer and industrial applications.

In premium packaging we have expanded our portfolio of image-driven and environmentally friendly offerings, both in folding cartons and in design papers, supported by a recent distribution agreement with Gruppo Cordenons, an Italian premium paper manufacturer. Recent successes have included packaging for a leading smartphone, well-known branded jewelry, and a variety of customers using our hangtags and new stored-value gift cards. These paper-based cards provide a more premium image and environmentally friendly alternative to plastic cards while still meeting durability and functionality requirements.

In total, we see the premium packaging and label as a global market of $2 billion, although the addressable market for us in the near term is about $300 million. The market is growing 3% to 5% annually, and we are pointing resources towards exciting opportunities we see for growth.

Finally, while we can't change the fact that secular pressures challenging traditional printing papers are likely to remain, our Fine Paper business has been resilient and continues to find ways to deliver top- and bottom-line growth. Last year was no exception.

While some of the growth in 2013 was due to our acquisition of the Southworth brand, even after excluding its impact sales and profits increased year-on-year as we captured new revenue streams and profit pools from expanded distribution channels, international growth, third-party relationships, and even a change in our envelope go-to-market approach.

I am proud that the team has optimistically and relentlessly found new ways to outperform the market and, even more impressive, grow their top line for the last four years.

Performance in our core businesses remain front and center, but a close second strategic priority is to efficiently increase our Company growth rate and portfolio diversification. To do this, we look to maximize organic growth opportunities available in our strategic markets, since these typically have the best returns.

Our third nonwovens melt-blown line is an example of a good, high-returning organic investment. While that investment was made in Germany, we continue to evaluate our global footprint, to examine markets where we can serve and best meet our customers' needs, while supporting our future growth plans and optimizing our asset base.

In addition to organic initiatives, we intend to supplement growth through acquisitions. On January 31 of last year, we completed a small acquisition to further consolidate the premium Fine Paper market with our purchase of the Southworth brand, the leading consumer resume paper brand.

Integration was completed ahead of schedule and at a cost well below our original estimates. In addition, sales and profits for this brand exceeded our projections and helped boost our overall presence in the retail channel.

This was an attractive investment. However, our acquisition bias is clearly towards performance-oriented Technical Products' markets. While I obviously can't discuss specific targets, I would reiterate that our focus is on growing defendable niche markets.

Ideally, we would like to balance our strong European presence with an acquisition that adds to our US Technical Products base. Our M&A process remains very active and disciplined; and with a strong balance sheet and cash flow generation, we are positioned to pursue value-adding opportunities that are a good strategic fit and provide a meaningful platform for growth.

Neither organic investments nor acquisitions would be possible without a solid financial base, and in 2013 we derisked our capital structure when we financed our bonds and replaced notes due in 2014 with new 8-year notes due in 2021. We have plenty of additional debt capacity to fund growth while still maintaining a prudent capital structure.

Lastly, we will continue to ensure our actions and performance support attractive returns to shareholders, and we are committed to making cash returns a meaningful component of our efforts.

Execution of our business plans, coupled with disciplined management of capital, allows Neenah to generate sizable cash flows. In 2013, we generated free cash flow of $55 million.

By deploying these cash flows in investments with good returns, we will continue to drive value for our shareholders. Last year we committed to increasing the cash component of these returns; consequently, we have increased our dividend twice in the past 12 months and announced a third increase that will move our dividend up by another 20% and goes into effect in March.

The continued financial strength of our businesses should provide confidence in our ability to deliver our targeted yield of 3% or more.

Bonnie mentioned a number of items related to our 2014 expectations. I would like to add a few more comments.

The global economic environment appears to be improving, notably in Europe; and this should help support demand for many of our products. With that said, we still participate in competitive markets, and the unique secular challenges in Fine Paper have not gone away. However, our competitive position remains strong and we are focused on continuing to grow share and expand in adjacent markets.

As we said many times before, our businesses have demonstrated that they can offset input cost increases over time through selling prices and other actions, and we did this again in 2013. Against a backdrop of still rising input costs in 2014, we recently implemented selling price increases in Fine Paper and in a number of our Technical Products grades.

Consistent with our past performance, the value of our selling price increases is expected to fully offset anticipated higher input costs. However, with the cold winter in the US, the impact in the first quarter from higher energy usage and prices will be steep and, combined with higher pulp prices, represents an estimated cost increase of up to $4 million compared to the prior year. The majority of this impact will be felt in Fine Paper, where our mills consume natural gas at market rates.

Lastly, while third-quarter annual maintenance downs will continue at most facilities, we will move our Weidach, Germany, mill down to the fourth quarter of this year and take some additional downtime to increase capacity on one of our filtration machines. The overall added cost impact to the fourth quarter may be as high as $2 million, with half of this increase due to the added downtime, the remainder due to timing.

This is a high-return investment that supports our ongoing growth in filtration, especially higher-value grades. And we expect no disruption to our sales and customer service levels in 2014 as a result of the project.

So to summarize, 2013 was a solid year for Neenah and a good year for our shareholders. We sometimes refer to our consistency in operating performance as making the doughnuts: delivering good results with no surprises. You should continue to expect this from us today and as we move forward.

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

(Operator Instructions) Mark Weintraub, Buckingham Research.

Congratulations, by the way. Excellent quarter there.

Thank you.

The first question was on the M&A side. When you think about debt carrying capacity, what type of metrics should we consider?

Yes. Our targeted range, Mark, is 2 to 3. We have indicated that we would be willing to go as high as 4 but not hang out there for very long. So I think it is pretty safe to go in that 2 to 4 range.

Okay, so up to 4 times --

EBITDA.

Debt to EBITDA? Got it.

Debt to EBITDA.

Okay. Is it fair to say that given the borrowing capacity that you have, even if you were making an acquisition in some of the higher-multiple areas, which you are talking about, that it should likely be accretive from the get-go?

That would certainly be our expectation.

Okay, great. Then just shifting gears a little bit, there was a fair bit of capacity closure in the commodity side of the uncoated freesheet business. Obviously you don't in general compete directly there.

But is that having any positive knock-on impact for your business? Maybe provide a little color there if you could.

Yes, I would suggest that it is definitely following what probably in our segment has already been the consolidation and rationalization. But most and many of those products are sold through the same forms of distribution, whether they are in retail or they are in the merchant channel.

So I think if nothing else, it helps those channels of distribution pick who they want to line up with as they move through rationalization. So it has got a positive effect, I would suggest.

But we don't see -- as you highlighted, we really don't compete with those commodity markets from that standpoint. But we do share customers.

Okay. Just one last one if I could. The technical specialty business did a fair bit better profit-wise than I had anticipated. Can you maybe provide a little bit more color as to -- were there any surprises there, and what were those surprises?

And/or if there were no surprises, what were you delivering on that you had anticipated?

Yes, I would say couple things on the Technical Products side. Early in the year when we talked about operational challenges, that really was the Technical Products business. So I think an element of it is not only restoring to where they have historically been; they ran very, very well across all of our facilities.

I also mentioned, especially in our German facility, where we are going to add capacity next year in our filtration business, they continued to operate even more full than we probably historically would have in the fourth quarter to ensure there will be no customer interruption or challenges as we moved into 2014. I think those are probably larger drivers. So good operating performance.

Okay, thank you.

Jon Tanwanteng, CJS Securities.

Morning, guys. Very nice quarter. Just a little bit more on the margin side.

Obviously you closed out the year on a very high note just on gross and operating margins. How sustainable is that? And is there more low-hanging fruit for you guys heading into Q1 and 2014?

Boy, as hard as it felt, I don't believe low-hanging fruit is the way I would describe. But I do have expectation that for each of our businesses that they would have double-digit margins.

Because we participate really in defensible performance niches from that standpoint. So our margins have remained in the mid-teens in our Fine Paper business. And I will tell you I am as giddy, if that is an appropriate word to use, on their ability to not only grow yet maintain those mid-teen margins.

Our expectation for the Technical Products business is double digit will continue. We believe that will provide the great returns to continue to invest behind that business going forward.

Okay, great. Then maybe just a little bit more color on the M&A side. Can you just give us a little more color on the pipeline and maybe the general size of the opportunities and valuations that you are pursuing? Are they reasonable at all?

Yes, I think that we -- I might have mentioned in the transcript, I believe I did, that the process, besides being disciplined, it's fairly robust. So there is -- we have a number of candidates; and I will communicate and talk about M&A opportunities as we come to opportunities for announcement.

In the last call we talked about the size of our risk appetite as to how big they may be. We are seeing opportunities. It is probably more difficult finding the right acquisition than finding an acquisition.

So I think what we have demonstrated, and I am hoping you view it as patience, is that we are committed to ensuring that -- you cannot make up for overpaying for a company, and we are going to make sure that we find the right long-term solution for us. I am not discouraged at all by any means and feel that we are in a really good place to find the right opportunity.

Okay. Then finally, in the past year you added the new melt-blown line. Heading into 2014, your CapEx is going to be roughly the same.

Is there a specific project that you can point to that is accounting for the similar level of spend? I know you talked about the German filtration expansion.

Yes, that's fair. As we have said in the past, really up to $30 million in capital spending, that is really -- $25 million to $30 million is where we have historically talked about our capital spending.

Bonnie mentioned $10 million of it is in sustaining. So the rest really are cost reduction and growth.

The growth projects continue to get our priority. And then the cost reduction have to -- the highest-returning project moves to the top of the line.

So it is important for us as we look; we look out five years and we make sure we space these more major projects where we can feed those into consistent CapEx spending. So the melt-blown that we did really in 2012 and 2013; this filtration project that you've talked about, which is a rebuild of one of our paper machines will be the more major project in 2014; in addition to strong cost-reduction activities that we have in Fine Paper now that we have integrated the last two acquisitions that we made there.

Okay. Thank you very much.

Steve Chercover, D.A. Davidson.

Good morning, everyone. I, too, was interested in margins. These EBITDA margins in the upper teens, sounds like they are certainly sustainable. But from an aspiration standpoint, do you think you can get a 2 handle in front of those at some stage?

I am probably famous for my silly sayings but -- up and to the right is one of them. I am not going to commit to any 2 handle on this call, but what I would suggest is that I continue to be impressed both with the organization's understanding of what activities really drive meaningful value and their ability to continue to improve the margins. And it sounds like others are pleased with that as well.

The mix, as you move more into the premium packaging and gift cards, would that see -- would that come at the expense of other Fine Papers? Or is there actually going to be some capacity creep?

Yes, what I would suggest on -- what we are trying to do is we want to obviously have our portfolio filled with the highest-returning. So if Fine Paper is in decline, then it is really not the expense of it, because it wasn't available.

From our standpoint, we believe the packaging market has a lot of growth opportunities -- opportunities for us to repurpose those assets, from that standpoint. I wouldn't view it as at the expense of it, as we are just stepping into that market, really understanding where can we have lasting value.

There is always room for managing our marginal business, and we do that across our entire asset base.

Okay. Then staying on margins but switching to Technical specialties, you said double-digit margins are the objective. Again, can they approach the mid-teens where Paper has been the last few years?

Yes. I take great resistance of comparing the kids. I think the Fine Paper business, which is consolidated and is really predominantly branded -- and I think that is really key -- in that mid-teens is, it's best compared to other paper alternatives. That is, I think, the easiest one from that standpoint.

It's nice having that aspirational target right here in the building for that business to continue to look at and to understand where they can go. But I would be hard pressed to say that because Fine Paper is in double digit that Technical Products would be.

In fact, I would be happy to double my Technical Products business at its current margin if that gave me the opp. So double digit is really what I look for; and then up and to the right in regards to managing marginal businesses on our asset base.

Understood. Two more quickies and then I will turn it over. The new melt-blown line, can you give us a sense of what kind of utilization rate it's currently running at, or your expectations for 2014?

We try to bridge in at least half-full from that standpoint, from the overall capacity. But that has got a little difficulty to understanding that, because the newest line that you put in is also the most cost-effective and most productive.

So we have two other melt-blown lines, and naturally we will be optimizing the full asset base for melt-blown. So if you wanted to view it as a stand-alone asset, it is over 50% full.

We have actually qualified new customers on it recently, so very excited about the progress they have made. But in reality since it is the lowest-cost asset, we are running it more full at the expense of a higher-cost melt-blown line.

Makes sense. Okay. It is encouraging to hear that Europe is getting better. Can you give us maybe a little color?

Is that in automotive filtration? Or what markets are perking up there?

Sure. Our largest business in Europe is in our automotive filtration. Just as a reminder, the demand for that is typically driven by miles, as 30% of our consumption is driven by OEM or original equipment manufacturers and 70% by the aftermarket. As the markets pick up, people drive more miles, that helps that business in itself.

We also have a couple of other businesses over there. I talked about our backings business, and we have seen that pick up as well.

So with the pickup of those markets it is disproportionately going to help transportation filtration, solely because it is the largest business in our European assets.

Great. Thank you for taking my questions.

Frank Duplak, Prudential.

Morning. Just had a question on the debt that you guys drew down in the period. Was that on the German revolver, was there another term loan done? Just where was that?

I am trying to get at just on total revolver availability as of the end of the year.

Yes, we drew that on our German revolver. So what we had is an opportunity to be able to bring cash back from Germany in the month of December very tax efficiently. So we drew their lines, pretty much all of their lines, and then repatriated the cash to the US.

And then we will be repaying that line in the first six months of 2014.

Okay. Then do you have just a look at just the GAAP underfunding for the pension as of the end of 2013?

Yes, so we have pension plans, defined-benefit pension plans in Germany that are not required to be funded. So they don't have any assets, so I won't include them.

But if you look at the US pension plan, we are about 98%, 97% funded at the end of the year.

Thank you.

That is on a PBO basis.

On PBO; okay. Thank you.

Thank you. There are no further questions at this time. I would like to turn the call back over to John O'Donnell.

Thank you very much. I would like to thank everyone for your participation and interest in Neenah. We look forward to updating you on our progress and results again in May. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect your line.