Neptune Insurance Holdings Inc (NP) 2016 Q4 法說會逐字稿

Good morning. My name is Crystal, and I will be your conference operator today. At this time I would like to welcome everyone to Neenah Paper 2016 fourth quarter and full year earnings call. All lines have within placed on mute to prevent any background noise. After the speaker's prepared remarks there will be a question and answer period. (Operator Instructions). As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, February 16th, 2017. Thank you. I would now like to turn the call over to Bill McCarthy, Vice President, Financial Analysis, and Investor Relations. Please go ahead, Mr. McCarthy.

Good morning. And thank you for joining Neenah's 2016 fourth quarter earnings call. With me today are John O'Donnell, our Chief Executive Officer, and Bonnie Lind, our Chief Financial Officer. I will start off with a few summary comments, and then John and Bonnie will review financial results and progress against key initiatives, as well as thoughts on our 2017 outlook. Following our prepared remarks, we'll open up the call for questions. We released earnings yesterday afternoon, and reported record profits for the quarter and full year. Quarterly operating income of $22 million was up 5%, and earnings per share of $0.95 grew 12%, helped by a lower tax rate.

Revenues in the fourth quarter of $221 million fell 4%, although more than half of this was related to a surge in the 2015 sales in our other segment, prior to exiting parts of this business in December 2015. On an adjusted basis, fourth quarter earnings of $1.10 per share increased 21%, compared with $0.91 per share in 2015. We report adjusted earnings to aid in understanding and comparability of results, and reconcile these to corresponding GAAP figures in our press release.

In the fourth quarter of 2016 adjusted earnings excluded costs of $4.1 million, or $0.15 per share, primarily for our FiberMark facility closure, pre-operating expenses for the US filtration project, and a pension settlement charge. In 2015, fourth quarter earnings were adjusted $0.06 per share to exclude integration and restructuring costs of $3.6 million, and $1.1 million of tax credits related to prior year periods. Finally I'll note that our comments today include forward-looking statements, risks and uncertainties, that could cause actual results to differ in these statements, are noted in our SEC filings and on our website. With that, I would like to turn things over to John.

Thank you. Good morning. As Bill noted the fourth quarter marked another strong quarter of earnings, closing out a year where we grew top line by 6%, adjusted operating income by 13%, and adjusted earnings per share by 23%. While inclusive of an acquisition at a lower tax rate, our organic businesses also continued to perform well, maintaining their leading market positions, as our teams work closely with our customers, and carefully managed costs. During the quarter we completed a number of important strategic initiatives that will help us further add value.

Our capital project to add transportation filtration capacity in North America was completed as planned in December. We are now manufacturing samples and beginning the 6 to 12-month qualification timelines of our key customers. In addition, the FiberMark integration was completed with implementation of our ERP system at their sites, and the refinement of our expanded asset footprint. As part of this, we rebalanced production and closed a small converting facility in Reading, Pennsylvania. These actions in addition to enabling future growth have delivered acquisition synergies earlier than planned, helped generate record cash from operations, and maintained our very attractive return on invested capital.

As you should expect, we continue to deploy capital in accordance with our stated priorities. First, investing in high returning organic investments, like adding filtration capacity in North America. Second, pursuing acquisitions that add value. Next, supporting our shareholders with attractive returns through an increasing dividend, and opportunistic share repurchase. In fact, in November we announced our seventh double-digit dividend increase in the past five years. Finally, using remaining available cash to reduce debt. I'll talk more about our 2017 activities and expectations later in the call. But first, Bonnie will cover 2016 financial results in more detail. Bonnie.

Good morning. As you'll hear the fourth quarter, and for that matter the full year, were both very positive for Neenah. Starting with technical products, sales were $104 million, down 3% versus the prior year. We continued to see solid volume growth in categories like transportation, filtration, and backings, although these were offset by growing currency headwinds and reduced shipments in label, water filtration, and other specialties. Sales in these other categories were down in the quarter, in part due to the timing of customer orders.

Turning to the bottom line, Technical Products, operating income of $12 million, and adjusted operating income of $13 million were both equal to last year. Adjustments to income in 2016 were largely for the FiberMark facility closure, a portion of which also went to Fine Paper. Fourth quarter results benefited from lower input costs in SG&A spending, that were offset by the lower revenues and less favorable mix. Adjusted operating margins in the quarter continued to improve, and for the full year exceeded 14%, up from 13% in 2015.

In Fine Paper and Packaging, our team closed the year with impressive results. Revenues were $112 million, just short of last year's record quarter, and driven by 3% growth in shipments. We saw strong growth in non-branded grades sold direct to customers, increased sales at key brands like ENVIRONMENT and ROYAL SUNDANCE, and consistent growth in premium packaging.

Our consumer business also had a solid quarter, with continued strength at customers like Amazon and Wal-Mart. Volume growth in the quarter was offset by a lower price but value-adding mix, mostly due to increased non-branded sales. Operating income in the fourth quarter was a record $18 million. This was up 16% versus last year, as the benefits of higher volumes, lower input costs, and reduced SG&A more than offset the lower value mix. Adjusted operating margins were 16%, both for the quarter and for the year. As noted in both segments, SG&A spending was lower in the fourth quarter, and consolidated spending of $20.4 million compared with $24.9 million in 2015.

The lower spending in 2016 included benefits from synergies, but was more impacted by timing differences for items like advertising and incentive accruals. On average we expect SG&A spending to be around the $24 million per quarter we previously communicated. Unallocated corporate costs were $6.6 million compared to $4.8 million last year. Results included higher non-capitalized costs, as we completed our project transition to Fine Paper machine to filtration, as well as an $800,000 non-cash pension settlement charge, as we cost effectively eliminated about $9 million of pension liabilities through a lump sum buy out at deferred divested purchases.

Excluding one-time costs in both years, unallocated expense was about $4.6 million in both 2016 and 2015. Going forward, we expect unallocated costs to average $4.5 million to $5 million per quarter. As Bill noted, net sales of our other segments declined significantly from $10 million in 2015, to $4.5 million in the fourth quarter of 2016. Just as a reminder, the other segment includes products which are dissimilar in nature from those that are reflected in our primary two segments.

The decline was due to higher sales in advance of the December 2015 Fitchburg mill closure, and our exit from certain product lines that were produced there. Excluding integration costs in both periods, an adjusted operating loss of $600,000 in 2016, compared to operating income of $200,000 in 2015, with the decline primarily as a result of lower net sales in 2016. For the full year, EBIT was breakeven, and we expect to continue to operate at that breakeven level next year. This business does provide positive variable profit contribution, and helps us absorb fixed costs.

Fourth quarter net interest expense of $2.8 million was equal to last year's. Year-end debt was $221 million, down $8 million compared with prior year. The majority of our debt is at a fixed rate of 5.25%. However, with rising interest rates, we expect interest expense on short-term debt to increase modestly in 2017. Tax rates were low in the fourth quarters of both 2016 and 2015 at 14% and 20% respectively. In 2015 the lower tax rate was due to recognition of a full year of R&D tax credits after this credit was permanently approved by Congress in December of 2015. In 2016, these credits were recognized throughout the year. The low rate in 2016 reflected both reductions in reserves for uncertain tax positions, and excess tax benefits related to stock compensation that under ASU 2016-09 are now deducted from tax expense and recognized in the period that they are incurred.

Under this new accounting standard, quarterly rates will be impacted positively or negatively, based on two types of stock compensation events. Vesting of performance stock units that occurs in the fourth quarter of each year. And the second one is exercises of stock options at the time that they occur. The amount of any gain or loss will be influenced by the difference in the stock price when these awards are vested or exercised, compared to the value when they were granted. Understandably, our ability to predict the magnitude of any impacts by quarter is pretty difficult.

In 2017, we expect our average tax rate to be 32%, including the effects of stock compensation events. This is up from the 29% rate in 2016, largely due to changes in income mix. Our cash tax rate should remain around 20% for the next couple of years, as we consume our remaining R&D credits. Cash from operations in the fourth quarter was $18 million. This is down from $32 million in 2015. This was primarily due to increased cash contributions to post retirement plans, and differences in working capital.

So starting with the post-retirement plans, with expectations late last year of changes in discount rates that could lead to higher expense in 2017, we increased pension plan contributions in the fourth quarter to mitigate this impact, and maintain our funding levels. For the full year cash contributions and payments into these plans were $23 million, with about half of that occurring in the fourth quarter. In 2017 we expect to reduce cash contributions and payments significantly to $16 million, with any changes in expense to be minimal.

In addition to higher 2016 retirement plan contributions, cash flows in the fourth quarter were impacted by working capital differences. In 2015 we had a large decrease in Accounts Receivable in the fourth quarter, partly due to sales and collections from the Fitchburg business that we exited. Consequently, cash flows from Accounts Receivable changes was about $10 million lower in 2016.

In summary, 2016 was another great year for Neenah. We had record sales, adjusted EPS, and operating cash flows. We completed integrating and acquisition that enhanced our capabilities and growth potential, and delivered end of curve synergies a full year ahead of plan. We were disciplined and balanced as we deployed cash to generate the best returns for our shareholders, and maintained an attractive return on invested capital. In 2016 we returned almost $40 million of cash to shareholders through our dividend and share repurchases, a 35% increase compared with 2015, and we also improved our ROIC. With that, I would like to shift to our outlook as we look forward to 2017.

I'll start with comments on the general economy, and then move on to financial items, and then John will cover the business afterwards. Our two largest markets are the US and Europe. GDP growth in both of these regions was subdued in the fourth quarter, and there really are no indications that this will change significantly in 2017. What has changed is that the US dollar strengthened, and projections are for the Euro to be $0.05 to $0.10 lower in 2017. In our press release we dimensioned the impacts from currency changes prior to any actions we may have available to help mitigate these impacts. Input prices have also moved up recently, with increases in fiber, energy, latex, and other materials. This could be a headwind, especially in the first half of the year, as there is typically a lag as we adjust prices. However, all of our businesses demonstrated the ability to overcome changes and input costs over time, and that hasn't changed.

Finishing up with a few other financial items, here is a quick recap. SG&A averaging $24 million per quarter, including $4.5 million to $5 million of unallocated corporate expense, annual interest expense increasing from $11 million to $12 million, retirement plan contributions and payments lower by $7 million, a booked tax rate of 32%, and a cash tax rate of around 20%, significantly reduced capital spending, as we return to levels normal for us in the 3% to 5% range, or roughly $40 million. And last but not least, another year of increased dividends. So with that, I'll hand things back to you, John, to talk about other business items.

Thank you Bonnie. Looking at our businesses, in Technical Products our performance materials should be poised for a solid year. We'll continue to leverage our global footprint to serve our backings customers, building on our 7% top line growth in 2016. In addition, we're excited about new label products that we've got in the pipeline for launch in 2017. Overall, Performance Materials is positioned to grow at or ahead of our GDP plus growth rate expectation for these markets.

Transportation Filtration, which is our single largest Technical Products category, and Neenah's fastest growing category, is at the start of a very important year. In the fourth quarter, we successfully completed the highly technical but capital efficient project, to convert an existing Fine Paper machine into a state-of-the-art transportation filtration asset, and added a world-class solvent saturating facility at our site in Appleton, Wisconsin. As previously mentioned, qualification periods are lengthy, and with most defensible technical businesses, and we expect the majority of time in the first half of this year to be spent on non-sellable qualification runs and trials. Initial results have been very promising, and we're now beginning to send samples to customers for testing.

On our last call we communicated an expected operating loss of $4 million, half being non-cash. That will be front-end loaded in the first half of the year. We also noted added sales in 2017 will be $10 million to $15 million, and should start to ramp up in the second quarter. Since increased market demand for our products has now consumed our existing capacity in Germany, our teams are working to optimize the use of this new US capacity. Plans include shifting production to Appleton of less technically oriented products, with shorter qualification periods, to free up capacity in Germany that can support the continued growth of our valuable European customers. And as always, they will continue to pursue opportunities to minimize costs.

The outlook for transportation filtration is very bright. Customers remain extremely supportive as product performance, quality, and cost off of the new line is anticipated to be Best-in-Class. In addition to supporting the growth of our customers, the investment provides our shareholders with an attractive double-digit return. As mentioned in past calls ,we expect to fully consume this added capacity within the next five years, with end of curve sales of $80 million to $90 million, and current expectation that the business will turn profitable in the back half of 2018.

Importantly, this investment further solidifies Neenah's position with our customers as a premium global transportation filtration player, and paves the way for continued growth of this profitable business for years to come. In Fine Paper, while secular market pressures are likely to persist, our teams work hard each year to find ways to offset business declines, and 2017 will not be an exception. In the first quarter, our commercial team will be refreshing Classic, our largest and most recognized premium brand. Customers are enthused about the new colors and textures that will be available. We also are working to expand distribution of our consumer brands at key retailers.

A category we are focused on is Premium Packaging, which expanded by more than 30% in 2016. This market is growing, and is a key catalyst for this business, helping to offset secular pressures in other areas. We continue to develop and expand our portfolio, and see other attractive opportunities that can help us increase our share, and grow at our planned double-digit pace. While organic initiatives remain our highest priority, M&A is also expected to play an important role in our growth strategy. Our teams have shown the ability to acquire in a disciplined manner, and integrate effectively to deliver promised financial returns. Our process and pipeline remains active, as we continue to pursue growing and defensible performance-oriented businesses. However, timing is always unpredictable.

In summary, I am extremely pleased with how our teams have delivered value for our shareholders, by consistently producing meaningful results. 2016 marked another very good year. And while 2017, like most years, will certainly have its challenges, our leading market positions, broad array of customer value capabilities, and very strong financial position, leave Neenah well-positioned and stronger than ever to build upon our track record. Thank you for our interest this morning, and now I would like to open up the call for questions.

Thank you. (Operator Instructions). And your first question comes from the line of Steve Chercover of Davidson.

Good morning everyone.

Good morning Steve.

Morning.

Hi, Bonnie. So just a couple of questions from me. I just wanted first of all, a little color on the decline on the label in water filtration, wondering if that's a timing issue, or whether they might have plateaued?

No, label, we're very excited about the growth opportunities for label. I tried to call that out. It's really innovation-driven and R&D-resourced, and we continue to expect that to be a good growth platform for us. So label, I am not too concerned with. The water filtration is tied really to the loss of a Chinese customer, which again, as our teams are working hard to make sure that we have the right quality and prices associated with recapturing that business, but that's probably a longer term run. As a reminder, our RO business, that was part of the $50 million in sales that we bought from Crane in 2014. It was roughly half of that business. So not a huge business.

Okay, thanks for that color. And then switching gears, pulp prices seem to be gaining a head of steam. So I just want to ensure that as you have incorporated that into the raw material inflation that you have mentioned, and you expect to more or less offset that with costing pricing. Is that right?

Yes, that's exactly right. As I mentioned in the past, all of our businesses are expected to offset the impacts to our margins of input costs over time. Fine Paper, which has a tendency to be more list price, has already announced price increases that will come into effect in the first quarter. The technical product businesses have market pricing at cost escalators, and then annual pricing programs with their customers. So they will be able to recoup that over time. And we are in fact seeing, we would view it at least $5 million to $6 million of input costs headwinds next year.

Got it. Finally, the obligatory question on M&A. We know full well that you're looking. I'm just wondering, are multiples a hurdle? Can they still be accretive, even if you pay a multiple above your own trading multiple? And then finally, just assure us that you guys haven't reached the size, where doing kind of needle-moving deals, you're not too big at this stage?

Too big? I didn't follow the question.

Neenah hasn't grown to the point where bolt-on acquisitions aren't still substantially accretive? I think the answer is you're still small enough?

You should hear the excitement in the building as we look at those. No, the bolt-on acquisition also clearly under our consideration. Absolutely. It adds technology, new geography, new products, or new customers to our base. So we're clearly looking in those avenues. And we have had a lot of activity, I can tell you that from that standpoint. It's an important part of our growth strategy, and one we'll continue to move forward.

As far as what we pay, I think what we've demonstrated historically is that we'll be able to communicate while this is a value-adding acquisition for Neenah, in any condition where we bring it to marketplace. But we're not going to have any big surprise of a third leg that doesn't have a fit, from that standpoint just to acquire to acquire. I think what's most important is that while we did four acquisitions in four years, and 2016 was the first year that we did not, I keep reminding my organization, it's not about making an acquisition every year. It's making a value-adding acquisition that's right for Neenah. We are committed to doing just that.

Very good. Thanks, John.

Thanks, Steve.

Your next question comes from the line of Jon Tanwanteng from CJS Securities.

Good morning. And thank you for taking my questions. Very nice quarter.

Good morning, Jon. Thank you.

You have mentioned a couple of times that you're currently at capacity in the Germany facility, and growth could be limited as you wait for new products to qualify and kind of get up to speed. Is that giving you any ability at all to increase your pricing at all for the stuff that is already coming out of there?

Let me clarify that a little bit. We have one facility in Bavaria where we make filtration, we are now going to have two facilities globally. So while we're limited in our capacity in Germany, we're going to really use the new US capacity where we can, and I mentioned in my prepared remarks to try to balance, giving us the opportunity to support growth in Europe, as well as in the US. As far as pricing, this team has done a phenomenal job, if you look at the margins of their business, making sure that they recognize what the market pricing is, and they're getting paid for the high end technical premium that we have overall.

What's really important, and I'll share with the team, is not having a moment of pricing ecstasy, that we're in this business for a very long time, and we want to be a very solid supplying partner for our customers. So we do look at pricing activity. We have in the past few years continued to balance that. Where we're limited, our marginal products on those assets come under a great deal of scrutiny. Whether we remove those or move in pricing. But I think this category grows at 4% a year. We have grown at 8% for the last 12 or 13 years. I feel very comfortable we're going to be able to continue to grow, even in 2017, as we qualify at the market growth rates of 4%. So I don't want anybody to believe I am late to the party. We are definitely happy with the timing of when we put this asset in. A longer answer than you cared for, huh, Jon?

No, that's all very helpful. I appreciate the detail. And then Bonnie, could you clarify, I think you said something about $5 million to $6 million in additional input cost headwinds. Was that across the whole business, or just Fine Paper and Technical Products?

It was across the whole business. I said it, so I must not have said it eloquently.

I couldn't have answered that anyway.

But really we are saying $5 million to $6 million, and we would look at probably $3 million in each half, if you're doing it, or early loaded, if you will. That is across all of the businesses.

Great. Thank you very much.

You bet, Jon.

Your next question comes from the line of Dan Jacome with Sidoti & Company.

Good morning. How are you?

Hi, Dan.

All right, thanks for your time. Staying on the topic du jour, so the energy costs potential headwind, was that just natural gas for the mills, or was there something else there?

Yes, so natural gas is one for the energy side, and again, if you think about our costs, the largest category is wood fibers. The second would be in latex for us, which has had double-digit increases. And the third would be energy. But you're exactly right, the energy part would be natural gas, and latex having a significant input as well.

So would the fiber, okay, on the wood fiber, is it MBSK and hardwood, or you use both, right?

We use both. More MBSK and Technical Products, more hardwood in the Fine Paper.

Okay, but it's a soft wood,

they are headed. Yes.

Okay, all right. And the price lag, I mean, you're able to pass through the costs, I get it. But how long is that lag, again? Typically, is it just a quarter, right?

No, I think what you're remembering is that in our Fine Paper business they were able to negotiate their pricing lag of a quarter on their wood pulp, to ensure that they could get their branded or list price pricing announced and through the system. On the technical side of the business, that's not the case. And technical has three pricing strategies, and you can do them about a third each, because I am a simple man. A third of them are market announced. A third of them have lags with cost increases. And then a third of them are annual contracts, that are negotiated with each customer from that standpoint. But again, over time, our expectation is, and we've demonstrated the ability to protect our margins.

Yes, you have. And that is great. Lastly, just in terms of Fine Paper, does your kind of like internal assumptions assume that you will continue to have that, what's happening now with the non-branded and the ASP, is that going to continue? Is that kind of in your line of site? Your internal expectations?

Obviously we value the branded value, all of the business. But the branded, it's a much higher margin. I mentioned that we're relaunching our Classic, so again, with the branded business, as you typically have new news for the market people, marketplace, people can talk about it. As we grow packaging, packaging is typically not a branded product. It is a more customized product from that standpoint. It gets lumped into that non-branded category as well. Doesn't mean that they're not as valued. That's why I really want to make sure. Because Fine Paper, if you look at their trend of margins through input cost cycles, they have been staying at that mid-teen margin.

I was just trying to understand when we were going to see an end to this? So you're going to be introducing new Classic product this year. Is that what you're saying?

We are. In the first quarter they will be launching the Classic brand. And again it's the largest and most valuable brand that we have in our portfolio. And again, as we launch it to distribution, they will carry it out into the marketplace, create some energy. And usually you have an element of a lift that has some stickiness to it. So we have some high expectations for that investment in 2017.

That should be interesting. I think you guys, you and another are about, well, you're still at 70% of the US premium paper market. Right?

It's a very consolidated market, as you highlighted, from that standpoint. If you look at the US, I think the two of us have probably closer to 90%.

Is that 90%? Okay.

But I think 70% is pretty close to our share. About 65%, 66%, in that realm.

Okay. That's it from me. Thank you very much.

Thank you, Dan.

I am showing there are no further questions at this time.

Okay. Well, that concludes our call this morning. Thank you everyone, for your time and interest, and we'll look forward to updating you on our progress later this year.