Neptune Insurance Holdings Inc. (NP) Q4 2012 Earnings Report, Transcript and Summary

Good morning. My name is Holly, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper Fourth Quarter and Full Year 2012 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, February 21, 2013. 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. Good morning, and thank you for joining us on Neenah Paper's Fourth Quarter Earnings Call. Along with me this morning are John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. I'll cover a few consolidated headlines first and then turn things over to John and Bonnie, who will review key accomplishments and financial results. We released earnings yesterday afternoon, and hopefully everyone's had a chance to review this. For the full year, net sales topped $800 million, an increase of 16% over 2011. Growth resulted from added sales from acquired Fine Paper brands, as well as benefits of a higher-value sales mix and increased selling prices in each of our businesses. Earnings increased even more significantly, as adjusted operating income grew 36%, while adjusted earnings per share of $2.78 was up by almost 50% as we realized added benefits from lower interest costs. In the fourth quarter, we saw similar results with sales growing 16% and adjusted earnings per share of $0.60, up 28% versus 2011. As a reminder, we report adjusted numbers when there are items that materially distort ongoing business results. This year, we excluded one-time costs of $0.05 per share in the fourth quarter, and $0.37 for the full year. About 2/3 of this was for costs to integrate our acquired brands, which ended in the fourth quarter. The remainder was for a first quarter SERP settlement charge and a small amount related to repurchasing our bonds in the fourth quarter. Adjusted earnings are a non-GAAP measure and have been reconciled to GAAP in our press release. Finally, let me remind everyone that this call includes forward-looking statements subject to risks and uncertainties described in our SEC filings, and also explained in the 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, and good morning, everyone. As I hope you've seen from our results throughout the year, 2012 was a successful one for Neenah, and our consistent performance extended through year end despite somewhat weaker economic conditions. Bonnie will cover results for the fourth quarter in detail later in the call, so I'd like to start by reminding you of our strategic direction and progress this year. There are 3 broad principles underlying our strategic direction. First, we will continue to focus in profitable, specialty niche markets, where we have a right to win that translates into meaningful share positions by improving the performance or image of the product. Second, over time, we will continue to increase our size and our organic growth rate by further diversifying our portfolio into attractive growth markets. And third, we'll do this in a disciplined financial manner that delivers consistent returns to our shareholders. Let me talk first about our progress this year in building our leadership in profitable niche markets. Key markets for us today include transportation filtration, premium packaging and labels and Fine Paper. In transportation filtration, we continue to hold a leading share in Europe, while growing our presence with new and existing customers around the world. Transportation filtration sales grew 6% this year in local currency, with export sales up 16%. Our customers look to us for innovative and specialized products like flame-retardant filters and high-efficiency meltblown combination grades. Consequently, our sales and research team remain in close contact with customers working on next-generation needs for new engine platforms. We've focused resources to grow our label in luxury packaging business. In total, this category currently represents sales of approximately $75 million, and our top line grew nearly 20% in 2012. Labels include both premium quality products for wines and beverages, where a distinctive label can become part of the selling attraction and brand image, as well as labels that satisfy rigorous customer performance needs in terms of durability and other functionality. In Fine Paper, the acquisition in 2012 solidified our position as the clear leader in premium papers, and gave us the leading brand in the category new to us, BRIGHTS. It also provided an additional platform for growth by selling through the retail channel. The focus this past year was clearly on successful integration of these brands. Our organization completed this brilliantly and I could not be more pleased with the value they achieved. With our larger scale, it enabled us to completely utilize our asset base, realized added manufacturing and administrative efficiencies, and delivered the very attractive financial returns that we expected. At the same time, our team never lost focus of our flagship CLASSIC brand, which continued to outperform the market. We grew in specialized higher end products across our mix, and witnessed success with nonwoven wall covering and specialty tape grades. In general, our focus on image and performance in specialized markets that value our core competencies has allowed us to build leading positions and deliver attractive financial returns. Second, we intend to continue to increase Neenah's size, growth rate and portfolio diversification. We expect to do this through organic efforts, as well as through acquisitions that meet our financial return requirements. We made good progress in 2012 with the development of new products in growing categories such as beverage and industrial filtration, media, unique new label grades and development of a stored value card that can replace plastic cards through a more environmentally friendly product. While initial sales of these products were just a small percentage of the total, they represent attractive future growth opportunities. As I mentioned in the past, we're likely to pursue acquisitions in profitable growing markets that align with our capabilities in high-performance media, as well as coding and saturating. We will continue to look first at technical specialty markets for acquisitions, but when other compelling value-creation opportunities arise, we will not let them pass. Finally, let me talk about our expectation to deliver consistent and attractive returns with disciplined financial management. While we can't control the economy, you can expect us to make adjustments in response to external conditions. Our businesses have demonstrated the ability to offset input cost increases over time, and we carefully manage our spending and costs every day. Success in 2012 was evidenced by adjusted operating margins increasing from 8.5% to almost 10%, and by the double-digit EBIT growth at each of our business segments. We continue to manage our balance sheet as well, prioritizing high-return capital projects, while keeping annual spending within a prudent range of $25 million to $30 million. These actions helped us increase return on invested capital for the fourth straight year, as we grew more than 200 basis points to more than 11% in 2012. Finally, we completed a number of corporate initiatives to support attractive shareholder returns. We restructured debt to reduce interest expense by $2 million, and increased our dividend for 2013 by 25%. In addition, our board approved a share repurchase plan, and we acquired $4 million worth of shares under this plan, mostly in the fourth quarter, at an average price below $26 per share. Our strong business unit performance, coupled with effective capital deployment in highly accretive acquisitions and other corporate initiatives, allowed our shareholders to participate in the success. In fact, last year Neenah's stock provided a total return of over 30%. Our teams accomplished a lot last year, and we're excited about our positioning, strategic direction and opportunities we see going forward. I'll talk more specifically about 2013 outlook later in the call, but we'll now turn things over to Bonnie to cover fourth quarter financial results. Bonnie?

Thank you, John. Let me begin today with business segment results, starting with Technical Products. Sales of $95 million increased 1% versus prior year but were up 4% after excluding currency effects. The increase in sales was led by volume growth in Filtration, tape and labels and growth in our higher value products. Filtration continues to show good growth in international sales and meltblown combination products. And in labels, products such as heat transfer and durable print media, grew at a double-digit pace. Turning to the bottom line, Technical Products' operating income of $6.4 million was down from a fourth quarter record $7.9 million last year. With a weaker global economic environment in the fourth quarter, customers reduced their year-end inventories and we took downtime to similarly control our inventory levels. We also had higher manufacturing, selling and administrative costs in the quarter that offset slightly lower input cost for pulp and other raw materials. Moving next to Fine Paper. Sales in the fourth quarter were $91 million up by approximately $20 million or 27% versus last year. While the majority of the increase was due to acquired brands, our mix also reflected a greater proportion of sales in core, higher-value products, and we also grew strongly in targeted areas such as luxury packaging and premium labels. Our product support high-quality image, and targeted markets include premium jewelry, cosmetics and apparel, as well as high-end beverage and food labels. We've been pleased with growth at existing customers as our products become part of the brand identity and also our success in attracting new pieces of business. In total, packaging and label sales were up 15% in the quarter. Operating income was $13.1 million and included $1.1 million for integration costs. Even with these one-time costs, profits grew 35%, or more than $3 million, compared to last year. Higher income resulted from sales growth, as well as manufacturing efficiency and lower pulp prices. In total, these benefits more than offset increased selling, marketing and distribution costs associated with the higher sales. Now as John mentioned, the integration of brands was executed very well by our Fine Paper team, and helped ensure we maximize the value from the acquisition. We were able to internalize manufacturing capabilities and increase efficiencies more quickly than we planned, leading to start up of a paper machine in Neenah that had previously been idle. Consequently, our asset base is now fully utilized. We no longer have any base paper outsourcing needs related to the acquisition. Integration is complete and full year costs of $5.8 million were better than our estimate of $7 million as we were able to transition the grades more efficiently, and capital required from new capabilities was also less than originally projected. Turning next to unallocated corporate and other results. Fourth quarter sales of acquired non-premium grades were $6.7 million, with operating income of $600,000. These grades are sold through existing distribution channels but require limited incremental support cost. Our unallocated corporate cost was $4.2 million, and it included $400,000 of expense related to retirement of bonds. In 2011, unallocated corporate costs were $4 million. We are leveraging our corporate infrastructure as we grow and costs in 2013 are likely to remain where they've been for the past 3 years, in the range of just under $4 million per quarter. Consolidated selling, general and administrative expense was $20.3 million, up from $18.1 million last year. For the full year, spending in 2012 was $77 million. While this was up from 2011, mostly due to selling and marketing support for the additional Fine Paper sales, SG&A as a percent of sales continued to decline. Spending in 2013 is likely to be around the same level and will continue to decrease as a percent of sales as we use existing resources to grow efficiently. Let's move now to corporate financial items. Our effective tax rate was 29% in the fourth quarter, consistent with where it's been all year, but above an unusually low quarterly rate of 24% in 2011. For the full year, our rate was 30% in 2012 and 29% in 2011. We mentioned in our last call that in 2013 we expected our rate to be approximately 35%, primarily as a result of increased cash repatriation in 2013. Recent proposed changes in German tax law may result in the elimination of certain deductions currently available to us in Germany, and could push our consolidated tax rate to near 40%. Our cash tax rate however, is significantly lower as we continue to use net operating losses to offset cash tax payments that are due on North American income. As of year end, we had approximately $66 million of our NOLs remaining, and expect to use these up by the end of 2014. Finally in the fourth quarter, we received notification that our position on issues related to an IRS audit was upheld. Subsequently, we reversed the tax liability on the balance sheet, and recognized $4.4 million in income as discontinued operations since this item was related to our former pulp operations. Cash flow from operations was $18 million in the fourth quarter, slightly above last year, as higher earnings and reductions in working capital were partly offset by the timing and amounts of benefit contributions. Pension plan contributions in 2012 were $15 million, and that's up from the $13 million we had in 2011. In 2013, funding is expected to be approximately the same level. Although with lower discount rates, pension expense will increase by about $1 million. Our pension plans remain in really strong shape and were funded at just under 90% at year end. Capital spending was $9.2 million in the quarter and included initial payments from the nonwoven meltblown line in Germany. For the full year, our capital spending was $25 million, at the lower end of our targeted range of $25 million to $30 million. In 2013, we expect to be closer to the upper end of this range. Let me next talk about our capital structure. Debt was $182 million at year end, down slightly from about where we were in September of this year and from December of last year. During the fourth quarter, we called $58 million of our bonds and we financed that transaction through a new $30 million term loan, and capacity that we had available on our revolving line of credit. We amended this line during the quarter, to extend the maturity to November 2017, and we were also able to reduce interest rates and fees. At year end, our debt was comprised of $90 million of long-term bonds, $56 million on our revolver, $30 million for the term loan and a balance of $6 million in Germany. Our balance sheet's strong with debt-to-EBITDA of around 1, 5x and provides us flexibility and borrowing capacity to support future growth initiatives. With the changes made to our capital structure to take advantage of today's low interest rates, we expect interest expense in 2013 to be approximately $11 million, down from over $13 million in 2012. Let me close with some thoughts on cash generation and allocation. Our businesses generate significant cash flows, and we will reinvest, redeploy or return these to provide attractive returns for the shareholders. Reinvesting through organic growth projects or value-added acquisitions is our first choice, and we actively prioritize organic growth capital while also looking for acquisitions that are a good strategic fit and provide necessary financial returns. If attractive investment opportunities are not available in the short term, we may redeploy capital to pay down debt and preserve financial flexibility. However, as noted, today we have more than adequate financial capacity. Returning cash to shareholders is also a part of our capital deployment strategy. This includes providing a meaningful and consistent dividend to our shareholders, and in 2013, we significantly boosted our dividend to reflect our higher cash flow generation. In addition, we can buy back shares if the opportunity is compelling. As John mentioned earlier, in 2012, we spent approximately $4 million on share buybacks. So in summary, we're starting 2013 on strong financial footing. With strong cash flows generated by our businesses and a capital structure with lots of capacity, we're in a great position and can take advantage of opportunities we see to drive incremental value for our shareholders going forward. 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 a top priority. Along with our other successes and despite the increased level of activity and complexity in 2012, I'm pleased to note that our employees worked more safely as well. Our safety philosophy is grounded in the premise that every employee be personally involved and engaged in activities that will contribute to a safer workplace. In 2012, employee engagement continued to increase and our incident rate declined by 25%. We're pleased with this progress, but our ultimate desire is that no one be hurt in the workplace. I'll wrap up with some thoughts on the current outlook for our businesses as we enter 2013. With downward revisions in fourth quarter GDP growth, both in the U.S. and Europe, momentum in the first part of 2013 may be slowed. However, as I said at the beginning of the call, our businesses are well-positioned in markets where they compete, and our teams are excited about the opportunities that they see. In Technical Products where 2/3 of our sales are in Europe, market demand may be more affected, although the headwinds from currency translations we experienced in 2012 should be diminished. We expect continued growth in international markets for Filtration, a recovery in demand for our higher-end tapes and continued good performance in labels. Input costs are forecasted to rise, with larger increases in Germany for specialized pulps and chemicals. We expect over time to offset this with pricing and cost management. In the second half of the year, we'll also benefit from investments, including a soft nip calendar in the U.S. and a third nonwoven meltblown line in Germany that give us new capabilities to support our growth strategies. In Fine Paper, we'll continue to see benefits and efficiencies in our operations as we move from integration to an optimization mode. Already this year, our machines have set multiple new productivity records. Our prospects to grow in targeted niche markets in luxury packaging and premium labels remain strong, and we're developing new products and new ways to go to market. With rising input costs, we recently announced a 2% list price increase for most grades. That will take effect in early March. Last but not least, 2013 will include our recent acquisition of brands from Southworth. Southworth is a leading retail business paper brand, and on January 31, we acquired this business with annual sales of approximately $20 million for a price of $7.5 million. The purchase price includes finished goods inventory and converting equipment, and the transaction structure is very similar to the Wausau brand purchase, but on a much smaller scale. We expect costs of approximately $2 million in the first year to integrate the business and we'll source base paper from Southworth during the transition period to ensure the highest level of customer satisfaction. Expansion in retail represented a growth opportunity for us. This acquisition allowed us to enter the channel by leveraging our existing presence and without disrupting the market or requiring significant additional costs. In addition to increasing our business at existing retail customers, we also gained distribution at Walmart. Overall, this acquisition represented a logical extension of our Fine Paper business, and, like our prior acquisition, should provide attractive financial returns and will not dilute our Fine Paper margins. So in closing, our teams have accomplished a lot in 2012. We delivered meaningful top and bottom line growth, especially in key markets like Filtration, labels and Fine Paper. Our efficiencies and operating margins improved and return on invested capital grew to record levels. In addition, we improved our capital structure, increased dividends and repurchased shares. Our businesses are strong, and we will start the year well-positioned to pursue opportunities that can create value growth going forward. Our employees are the ones that will make it happen, and they're engaged, focused and excited about growing our company. Thank you for your time and interest this morning, and at this point I'd like to open the call up to questions.

[Operator Instructions] Your first question comes from the line of Mark Weintraub, Buckingham Research.

I heard the comment on the acquisition not likely to dilute your operating margins, the Southworth. And then your operating margins in Fine Papers have been roughly about 15%. So is that a reasonable starting point in terms of an expectation? So if you got $20 million in sales, is it a reasonable starting point to think that it can generate $3 million or maybe even better than that in operating profits?

Yes, that is a reasonable assumption. I think it's important. We've talked about $2 million of integration costs and as we transition -- so it won't be in year 1, but that's a very fair assumption overall.

Yes, and the $3 million, your calculation would be annualized.

Yes, end of January, that's a good point.

Right. And I guess, my sense was, from your comments, was that maybe the first half of the year might be a little bit more difficult than what we've been seeing, but that by the second half of the year, some of your pricing initiatives, as well as some of the benefits from your investments should start kicking in and make the second half better. Was that a reasonable top down interpretation?

Yes, Mark, that's a good characterization of how we see the year, that's for sure.

Okay. And I don't know if this is a fair question, but you've had several years of upward performances there. Any reason -- are there any bigger hurdles to jump this year than in the prior years? Or is there every reason to believe that 2013 can be better than 2012.

Yes, our expectation, obviously, are continue to improve on our businesses year-over-year. One thing I want to make sure that we fully understand, it's not going to be easy and, as we've said, this is the third in a row for the Fine Paper business to continue to improve. Bonnie also mentioned on the transcript there, the tax rate changed and that will be...

Yes, we have -- that's a kind of a headwind, we have on that.

But otherwise, from the business standpoint, our expectation is, we've had 9 years of continued growth in the Filtration, another nice year. And this year we've demonstrated that we can unlock some real niche growth opportunities, whether it's international sales or in luxury packaging and premium labels, and our expectations going into 2013 is that we'll improve on our businesses.

Your next question comes from the line of Stuart Benway, S&P CapitalIQ.

So when you bought the brands from Wausau, there was a supply agreement, I think, that sort of phased out throughout the year and -- so when did that end?

Well, actually, it had a multiple year component. We were able to internalize it much quicker, just right about December by the time we fully got it integrated into our systems. It was much quicker than we had anticipated because of the productivity benefits that we've been able to see across our entire system. So that is fully satisfied and the products are all in-house.

Okay. And so, I mean, I would assume that the margins that you're generating now are higher than they were on supplied product, is that true?

There's definitely a benefit from filling the system from that standpoint, but I'd -- that's probably a bigger stretch. I'd say they're similar margins to what we had before through the supply agreement. It was a beneficial supply agreement.

Yes.

Okay. I mean, so did that involve hiring people when you started up the new machine?

We have hired about 150 people, I want to say, for in this year. The majority of them in the facilities where we both started up the machines and added additional shifts because we are running completely full.

Okay. So if you're running full, where is the new Southworth output going to come from?

Yes, A couple of places. The new machine -- or not new machine, but #3, started up in the fourth quarter. So that's one piece of it. Second, I mentioned productivity improvements. So we've seen at least a 5% improvement in our overall productivity, but internally, so that's going to be organic improvement. Continue to manage our marginal businesses but we also have a supply agreement with Southworth to ensure that there's a very smooth transition.

It seems that you have a new affinity for acquiring brands without any production assets. Do you think that there's more opportunity for that?

Oh, what isn't new is our commitment to continue to improve our return on invested capital. We think that's one of our most important metrics. From a brand standpoint, the Wausau brought us into a brand new category in BRIGHTS. Our commitment to ensure that we have a meaningful position as a market leader in every channel was why we wanted to enter the retail. I think we're very well-positioned and, never say never, but I would tell you, I think people were very satisfied with the brand portfolio we had in the heritage Neenah business in addition to the 2 brands that we recently acquired.

And your paper volume was up 36%, largely due to the acquisitions here, but your sales dollars were only up 27% in the quarter. Was that due to lower prices or mix or a combination?

Yes, I'd go heavier on the mix side of it, because we mentioned when we acquired those brands that the category of BRIGHTS was a lower value business from that standpoint. By it was a unique category, 100 million in size, where we could enjoy 70% share. So it did bring the mix that down from that standpoint, but we've actually continued to demonstrate that we can capture price in the marketplace.

Okay. And one last one on the -- I'm hearing that the automotive business in Europe is really quite weak right now and yet you're saying that your Filtration business is seeing gains. I mean, can you explain the difference there?

Well, just, I'd like to start with we're not average, but I would suggest that we said our overall business was up 6% for the year. Our international business for Filtration was up 16%. So we've done a nice job of growing outside of Europe as well. There's no question that it's a very seasonal business, our Technical Products business is a seasonal business and the fourth quarter might have been somewhat of a challenge. As a reminder, 30% of ours go in new cars, 70% in the aftermarket. So we've been -- just, we've been able to have that steady growth CAGR year-over-year. I'll also mention the additional meltblown capacity that we're putting in. So our R&D and our high-end Filtration products continue to be met with a great deal of success in the marketplace. The last meltblown line that we had, we were able to actually fill it even quicker than we had originally anticipated. That's where our success is.

At this time, there are no further questions. I'd like to turn the conference back over to management for closing remarks.

Okay, once again, thank you for your interest and participation today. We look forward to the opportunity to talk to you again in May.

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