Neptune Insurance Holdings Inc (NP) 2016 Q1 法說會逐字稿

Good morning. My name is Namdi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper first-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, ladies and gentlemen, this conference is being recorded today, May 12, 2016. Thank you. I'll now turn the call over to Mr. Bill McCarthy, Vice President, Financial Analysis and Investor Relations. Please go ahead, Mr. McCarthy.

Okay. Good morning, and thank you for joining us on our first-quarter earnings call. With me today is John O'Donnell, our Chief Executive Officer. I'm sad to say that Bonnie Lind, our Chief Financial Officer, had a death in the family and is unable to join us this morning. So I'll do my best to pinch hit for her. As usual, following our prepared remarks, we will open the call for questions. Let me start off with a few comments before turning things over to John.

We completed a number of important strategic activities last year, including the acquisition of FiberMark on August 1 and the divestiture of a wall covering mill in Germany at the end of October. Results for this divested wall cover business for the first 10 months of last year are therefore shown as discontinued operations. FiberMark results have been incorporated into each of our segments, and are no longer clearly separable as we've continued to integrate and realize efficiencies from combining operations.

In the first quarter, integration and restructuring costs were $1.1 million, or $0.04 a share, and have been excluded from adjusted earnings. There were no adjusted items in Q1 2015, and these adjusted figures are a non-GAAP measure that we use to improve comparability between periods, and are reconciled to corresponding GAAP figures in our press release. Finally, as a reminder, our comments today may include forward-looking statements. Risks and uncertainties that could cause actual results to differ from these statements are outlined in our SEC filings and in the Safe Harbor disclaimer on our website.

With that, I'll turn things over to John.

Thank you, Bill, and good morning. Our businesses began the year with record results and double-digit growth in both the top and bottom lines. In fact, this was the first time that Neenah's quarterly earnings have exceeded $1, with adjusted earnings of $1.15 eclipsing the prior high of $0.96 in the second quarter of last year. While results were boosted by the FiberMark acquisition and resulting synergies, they also reflect good performance in our heritage businesses.

In addition to strong earnings growth, operating margins improved, cash generated from operations increased by more than $10 million, and our return on invested capital remained a very attractive level, over 12%. Results were helped by -- both helped and hindered by the external environment. Slower growth -- economic growth continues, and while this dampens the market demand, it also helps push down input costs. Overall for the quarter, our higher sales, coupled with lower input costs, synergies and other improvement initiatives, more than offset increased SG&A and helped deliver the increased profits.

Growth was led by technical products, where sales increased 15% due to the acquisition and organic volume growth in filtration and performance materials. Adjusted operating income grew faster, at 25%, reflecting benefits from higher sales and lower input costs, as well as our historically strong first half of the year. I would be remiss if I didn't also note the nice margin improvements our teams have achieved, as we've grown the business and delivered manufacturing efficiencies and improvements in mix and price.

A key technical products initiative this year is our investment to meet the growing global demand for our transportation filtration products. This capital efficient project to re-purpose an existing fine paper machine, and add advanced solvent saturating capabilities, remains on track to start up as planned in early 2017. We continue to be very pleased with the excitement and support we're getting from our customers, and qualification of our grades are already underway. Our plans are to responsibly match production output with market demand, as we fully utilize this capacity over the next five years. This investment helps establish Neenah more firmly as a global filtration player, and will support continued profitable growth in this business.

In addition to filtration, we had a good quarter in our global backings category, which is included as part of our performance materials business. Backings volume was up 6% in the quarter, led by strong performance in tape. Over the past year, we've managed our capacity in this category more globally, while continuing to provide strong support to our customers. A recent example of success is our high-performance ultra-thin tape, which gained regional distribution at a major DIY retailer through one of our customers. We earned this new growth opportunity by leveraging our global organization, developing and producing this consumer advantage solution in Germany and using our strong customer relationships in the US to secure distribution here.

Turning to fine paper and packaging, sales grew 5% and adjusted profits were up 1%. Revenue growth was driven by the acquisition, as organic sales were impacted by declines in some price sensitive business, as well as the slower starting commercial and consumer channels. Accelerating growth in premium packaging is a key initiative in this segment, and with the acquisition, we've greatly expanded our capabilities and presence in the category. This has provided a more relevant and broader portfolio for an expanded customer base. Packaging sales, including [the acquired] grades, were up significantly versus last year. We grew more than 10% compared to the run rate of the past two quarters. With an initial target market of $450 million, we see an attractive run rate for growth, and remain confident in our ability to capture share.

The FiberMark integration remains on track to deliver the returns we anticipated. Last year, we moved quickly to implement a new right sized organization, and negotiate supply chain and procurement savings. In addition, we've begun optimizing our manufacturing footprint, and have accelerated the in-sourcing of products that had been previously purchased. We expect to spend around $2 million, through the end of next year, to complete the integration activities. As a result of these efforts, synergies are being realized faster than originally projected, and has helped to offset a top line that was developed more slowly than anticipated.

Some of you may have heard me say that I believe the two primary roles of a CEO are talent management and capital allocation. Our results over the past few years are a great illustration of the strong team we have at Neenah, so I'll wrap up with a comment on capital deployment. Our sizable cash flows give us the flexibility to execute our growth strategy and reward shareholders. We're balancing deployment among attractive organic investments, like the filtration expansion, and value adding acquisitions.

You can expect us to continue to invest and deploy capital in these high returning opportunities, while also recognizing the importance of providing a consistent and meaningful return of cash directly to shareholders through an attractive dividend and share repurchases. With that, I'll turn things over to Bill to discuss quarterly financial results in more detail.

Thanks, John. I'll start with technical products. Quarterly sales of $122 million grew 15%, due both to acquired sales and growth in our heritage business that was led by higher shipments of filtration and backings. Partly offsetting this was a lower average selling price, due to mix and pricing on grades with adjustors based on input costs. Currency had a relatively small impact in the quarter, reducing sales 1% as a result of a 3% decline in the value of the euro relative to the dollar. Operating income, after excluding integration costs of $300,000, was $19.5 million, up 25% from just under $16 million last year. Higher profits resulted primarily from increased revenues and lower input costs that more than offset higher SG&A and currency impacts.

Turning to fine paper and packaging, first-quarter sales were $114 million. This was consistent with the last two quarters, and is up 5% from year-ago levels, as additional acquired revenues more than offset lower sales in our heritage business. As John mentioned, this resulted from reduced sales of lower value grades, as well as a slower start in commercial and consumer sales. In total, fine paper continues to deliver great returns and cash flows.

EBIT margins continue in the mid-teens, and adjusted operating income, which excludes $300,000 of integration costs, was $17.8 million, up slightly from last year, as benefits from lower input costs, higher sales and manufacturing efficiencies were partly offset by a less favorable mix and a higher SG&A. The SG&A increase reflected both what was acquired, and also about $1 million of higher spending due to timing of advertising and research trials that will moderate in the second half.

Total consolidated SG&A expense was $26.4 million, up from $20.8 million last year. About two-thirds of the increase reflected incremental SG&A from the acquisition, with most of the remaining increase due to timing. For the full year, we still expect to average around the $24 million per quarter we previously communicated.

Unallocated corporate costs, which are part of SG&A, were $5.3 million compared to $4.8 million last year. Costs this year included $300,000 related to transitioning the Wisconsin fine paper machine to a filtration asset. As mentioned in February, we expect to incur $3 million of expenses this year related to the project, with the majority of costs in the second half of the year.

Net interest expense was $2.9 million and equal to last year, as slightly higher debt levels were offset by lower interest rates. Debt was $239 million at the end of the quarter, and we continue to have plenty of financial flexibility, with a debt to EBITDA ratio around 1.5, and over $100 million of borrowing capacity available on existing credit facilities.

Our effective tax rate was 33% in the quarter, in line with last year's average rate of 34% but below the 37% recorded in the first quarter of last year. Our lower rate in 2016 is largely due to differences in timing of R&D credits, which were recognized all at once in the fourth quarter of last year, but are now being recognized in each quarter following Congress permanently approving this credit last December. We expect our book rate this year to remain in the low to mid 30%s, and our cash tax rate to be around 20% through 2018, as we consume more than $25 million of prior-year R&D credits.

Turning to pension, our defined benefit pension plan remains in good shape. Combined pension and other post retirement obligation expenses are expected to increase $2 million this year, and cash payments for these plans are projected to be $14 million, or about $2 million more than expense.

Cash from operations was $16 million in the first quarter, up significantly from $5 million last year, due to higher earnings and also improved working capital efficiencies. Capital spending was $11 million, up from $6 million last year, as a result of the filtration project. In addition, we returned over $10 million to shareholders in the quarter, split between share repurchases and our growing dividends. And with that humble attempt to fill in for Bonnie, I'll send it back to John to wrap up

As I hope you've heard, we're encouraged with our start to the year, excited about initiatives currently underway, and confident about the future. In the near-term, market demand will likely continue to reflect today's more tepid economic environment. Foreign exchange headwinds also have lessened, although forecasts are for further weakening in the euro in the remainder of the year. We've started to see some up-ticks in input costs this year, and the first quarter likely represents the largest year-on-year favorability. However, we expect cost increases to be modest and addressed by our market activities and sourcing initiatives.

We hold leading market positions in key categories, and are implementing initiatives to help us grow and outperform the market, especially in categories like transportation filtration and premium packaging. Our teams are working to increase sales of higher value products while delivering cost efficiencies and optimizing pricing. Their ability to remain focused on these priorities has delivered the good results we've reported each quarter.

Going forward, our strategies and priorities remain unchanged. Utilizing our expanded manufacturing capabilities to accelerate top line growth and deliver the synergies we've come to expect from value adding acquisitions. Investing in product innovation and in our brands, knowing these organic investments deliver the highest returns. And finally, growing in profitable niche markets where we can own a leading market position.

M&A continues to be an important part of our growth strategy and a priority use of cash. My desire is to find the right additions that can enhance our specialty material niche businesses, with a bias towards filtration and performance-oriented markets that are defensible as a result of technological differentiation. As has been the case over the past 5 years, we've dedicated resources and continue to seek companies that can add value and are a right fit for Neenah. As a reminder, our intent is to improve the growth rate of the Company, so future M&A investments will likely be more growth oriented, although we'll still evaluate attractive consolidating opportunities. As always, we will be selective in our approach, and recognize that the size and timing of acquisitions are difficult to predict.

Our strong balance sheet and sizable cash flow provides us flexibility to act not only on M&A, but on multiple fronts, to drive additional value for Neenah shareholders. Looking back over the past 5 years, you can really see the strength of our businesses. During that time, we generated over $400 million of cash from operations and invested $225 million in acquisitions. Over $100 million in value adding capital spending, and returned $75 million directly to shareholders. During that same time, we delivered double-digit earnings growth, and accomplished all of this while increasing return on capital and maintaining our low debt and strong balance sheet. Consequently, we remain very well positioned to move forward and execute on our growth strategy.

The first quarter was a steady as you go start to the year, and our dedicated and extremely talented employees expanded capabilities and meaningful market positions. We look forward to updating you on our future progress. Thanks for interest, and at this point, I'd like to open up the call to questions.

(Operator Instructions)

Dan Jacome, Fidelity.

Good morning, Dan.

Good morning. Excellent. Just a couple quick questions here. I guess first, on a cost structure, just wondering benefit or tailwind you're getting from lower pull costs and energy? Do you guys think they're sustainable? And how are you thinking about them through the balance of the year? I think you said they were correlated to macro, but just wanted to hear a little bit more on that?

Sure. We saw input costs beginning to decline last year. And throughout last year actually, we had decline in input costs. So that's why, when I mentioned that the first quarter is probably going to have the largest year-over-year comparative impact. So going forward, obviously going to be moderated. This is probably going to be our largest quarter of benefit, if you will, from that standpoint.

And yes, we did say that when economic conditions are a bit tepid, you get input costs declining that helps to offset if the economic conditions pick up a bit. Which I would prefer, quite candidly, than getting to heaven through input costs. But from our standpoint, especially when you think about our fine paper businesses, those have been fairly sticky, and we enjoy some of the margins during that time period. But in our performance material business, we've got a lot of contractual business that's tied to input costs.

Okay. Got it. Thanks for that. And then I wanted to turn to technical products. And sorry if I missed it. Can you just elaborate on what is happening with pricing there? If I'm not mistaken, I think it was a headwind this quarter?

No. I think our technical products business, when you -- they delivered a margin of about 16%. Both of our businesses, performance materials and filtration, demonstrated low-single-digit volume growth. And there may be mix issues as you're working through there, but if I said headwinds, the fan might have been on in the room. I don't know.

Yes, I think that it's -- we continued to get price in most of our businesses. But as I mentioned, a small portion of our business does have price adjustors in technical products, and maybe that's what you're referring to. But that's countered and reflective of the lower input costs.

Yes. I think that would be protective of margins. And I think they're done just a heroic job of improving margins, getting to the mid-teen margin we've been talking about.

Okay. So did -- staying on that, did filtration media grow in the quarter, ex acquisition volumes?

Yes. We didn't acquire anything in the filtration business.

Okay. Just checking. That's what I thought.

Yes.

And then on the paper side -- last question -- you mentioned there was some softness on the heritage side. I just want to -- can you remind us again, what is in there? And does that include ASTROBRIGHTS?

Yes. It would be inclusive of ASTROBRIGHTS, but the really -- I think the headwind, and I might have used it there, is on our more historical branded print products, from that standpoint. As a reminder, we move all those products, a majority those products, through wholesale distributors.

And so from an inventory movement standpoint, we had a weaker first quarter than we did fourth quarter, which is opposite of what we normally would expect, as people manage inventories in the fourth quarter. I fully expect that will come back, as we move forward. It's still a business that has pressure of 2% to 3% secular decline. But it experienced a little greater dip in the quarter.

Okay. All right. Thanks a lot. I'll get back in the queue.

Thanks, Dan.

Jon Tanwanteng, CJS Securities.

Hi, John.

This is actually Robert Majek filling in for John today.

Hi, Robert.

You touched on it, but can you just give us a little more color on what you're seeing, in terms of end market demand and input pricing trends halfway into Q2? Perhaps maybe touch on any surprising areas of strength or weakness?

As far as moving into Q2 for brand use demand?

Right.

Our filtration business and our technical business have been very steady. Again, our performance material tends to ride more with global GDP. Filtration, because of the spread between 20% going to OEM and 80% after market in transportation filtration, it continues to tick along. As the market grows at 4%, we've historically grown about 8%. I don't see those changing. From the technical side of the business, it's fairly solid.

I mentioned in the previous question that our fine paper business is typically out of inventory, so there's inventory movement. In that business, the commercial print was a little weak in the first quarter, and we expect that to pick up in the -- as we move through the -- more normalized through the rest of the year. The premium packaging, we have expectations much like this quarter, in double-digit growth, which I think will offset some of that historical pressure that was felt on the printing paper side. Does that help?

Yes, that was helpful. And do you expect any impact from the dissolution of the Office Depot/Staples merger?

No. We don't anticipate that will have any meaningful impact to us at all.

Okay. And just lastly from me. Any update on the acquisition pipeline? And if you feel more or less urgent to do deals this year, given the significant investment in the Wisconsin plant?

I rarely let my organization say we're too busy, so we'll use that as a rationale. But you're right, the market has been very quiet. And I think Q1 has been a -- from a buying standpoint, one of the lowest quarters of volumes since 2009 and whether that's regarding the economic conditions in China and the strong US dollar, or even an impending election year, I don't know from that standpoint.

From ours, it's hard to protect the timing. We're just as energetic in this quarter as we will be in the next quarter in looking for the right opportunity. So M&A is not the sole solution, as we've talked about the different pockets of growth we have. But it will be part of our growth expectations, going forward.

Okay.

So I hope that addresses it.

Yes, I appreciate it. I'll jump back in the queue. Thank you.

(Operator Instructions)

Steve Chercover, D.A. Davidson.

Good morning.

Good morning, Steve.

Forgive me if these are little bit housekeeping oriented. But can you just remind us what your stretch level or comfort level would be on leverage?

Yes. I think what we said that we would like to operate normally in the 2 to 3 times debt to EBITDA range, but we would go up for the right acquisition to 4, 4 plus. And then our priority for cash usage would change, and then we'd look to de-lever after that.

And you're currently about 1.5 times, you said, right?

That is correct. Yes.

Okay. So we don't need to belabor the fact that you've got plenty of dry powder. And what was the average price that you paid for the shares you repurchased in the quarter?

In the first quarter, it was in the low to mid $50s. Over the past 4 or 5 years, it was in the mid-$40s.

Got it. And then clearly, not only do you have the dry powder, but you've got the bench strength that you could look at acquisitions right now, if you -- (inaudible) was in your wheelhouse, correct?

Yes. We are looking at acquisitions right now. As I mentioned before, it's an important component of our growth strategy. I think what's critically important is not only being prepared to do one, but finding the right one that has the right fit, and makes the most sense for our shareholders. But you're exactly right. There's nothing from a financing standpoint that's preventing us from adding to the growth of Neenah. That's for sure.

So the market had its swoon in January, February. And I think typically, you're looking more at private opportunities. So was there a similar dislocation in evaluations in the private realm?

We haven't seen a significant drop in evaluation. Maybe it's pulled in by half a turn or so. I think for us, while we fully expect that we will be paying a higher multiple for growth in that regard, so we want to make sure, again, right fit and then the right timing for us.

Great. And my final question is, we know that currency is less of a headwind, and hopefully that's because Europe is getting stronger, as opposed to the US weakening. But can you contrast the two geographies for us?

Yes. As a reminder, the biggest portion of -- while we have strong sales in performance materials and in filtration, 70% of our filtration sales are in Europe. And since it tends to be a category that works its way through all economic conditions, we continue show, year after year, I think we're on our 11th year of 8% CAGR. We don't have a significant number of product categories that are ebbing and flowing with the currency over there.

What we -- also, what I mentioned during our prepared remarks is that we've combined or organized under performance materials segment, to make sure that our tape and abrasives have a footprint in both of those markets so that we can balance and minimize the swing that currency has a tendency to inadvertently add to our growth issue. So from my standpoint, I see very -- and I think I ended with steady as she goes. I see a fairly steady demand for the products that we're providing over in Europe, from that standpoint.

Great. Thanks, John.

You bet. Good talking to you, Steve. Is there another caller operator?

Yes. Mark Weintraub, Buckingham Research.

Hi, this is actually Brendan Munson filling in for Mark. Just a quick follow-up on the M&A front. If you don't come across any acquisition that quite fit the bill, is there a point in time that you shift your focus more heavily to additional organic investments? Or perhaps even more to the dividend?

Yes. I think what we've communicated in the past, that our priorities for uses of cash is first organic CapEx. So we will continue to use that as our highest priority. We have pretty significant efforts underway, and there, I don't want to outrun my organization's capability for that.

And then from that standpoint, M&A is a second use, because we're very focused on changing the growth trajectory of the business. Dividends was our third, share repurchases, which we have authorization for, being our fourth. We don't need to talk about reduction in debt or anything like that, because we know where we're at.

So that will continue with that same consistency in the uses of cash. Where I am sitting today, my belief is that there are companies available that would continue to help Neenah on its path of growth, and I'm optimistic that we will find that over some semblance of time. If not, or won't, we'll just move down the uses of cash, and continue to find a best way to deploy it where it's meaningful for our shareholders.

Okay. Great. That's very helpful. Thanks.

Thank you.

And there are no further audio questions at this time.

Okay, then that concludes our call this morning. Thanks, everyone, for your time, and we'll look forward to updating you on our next call in August.

That does conclude today's conference call. You may now disconnect.