Neptune Insurance Holdings Inc. (NP) Q3 2013 Earnings Report, Transcript and Summary

Good morning. My name is Kyrlie, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Neenah Paper Third Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, November 7, 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, thank you. Good morning, and thanks for joining Neenah's 2013 third quarter earnings call. As usual, with me today are John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. I'll start with a few brief comments and then turn things over to John and Bonnie to review business activities and financial results in detail. Following our prepared remarks, we'll open up the call for questions. As noted in our press release yesterday afternoon, adjusted earnings per share were $0.61 in the quarter, up 9% from the prior year. These adjusted earnings excluded $0.07 per share primarily for a special R&D tax credit. Including this credit, earnings on a GAAP basis were $0.68 per share in 2013 and $0.55 per share in 2012. A reconciliation of these GAAP earnings to adjusted amounts is included in our press release. Finally, as a reminder, our call today may contain forward-looking statements. Actual results could differ materially from these statements due to risks and uncertainties that are described in detail in our SEC filings and in the Safe Harbor disclaimer contained on our website. With that, I'll turn things over to John O'Donnell, our Chief Executive Officer.

Good morning. The recently published results mark Neenah's highest third quarter performance in sales, adjusted EBIT and adjusted earnings per share, driven primarily by the good performance in each of our business segments. Operating results, combined with continued improvements in working capital efficiencies, delivered very strong cash flows, with cash from operations of $35 million. This performance reflects our team's execution against a few key strategic priorities. We've developed meaningful positions in profitable niche markets. Filtration is our largest Technical Products business and currently represents almost 40% of the segment. In the third quarter, sales and profits for this business grew by double digits. In addition to growth in Europe, international sales increased by over 20% as we've focused resources in this area. We continue to see good opportunities to support our global customers and meet the needs of local filter manufacturers as we expand in geographies that complement our strong European share base. Developing new product solutions with our customers becomes ever more important as Indian platforms become more demanding, and we're meeting these needs by supplying high-performance filter media and composite products made from a combination of nonwoven meltblown and saturated cellulose fibers. These products are higher in value, and demand is growing faster than the overall market. I guess our team has the technical abilities, coupled with a reputation for innovative and specialized products and high service levels that has earned us the opportunity to continue to grow in this area. Specialty backings, comprised of tape and abrasive products, are another important market for us, and they represent about 30% of technical product sales. In general, this is a GDP growth business, yet sales and profits grew 3% and 8%, respectively, this quarter. Tape has been a primary driver for performance this year as we have recovered share and increased sales of innovative products with unique surface characteristics like water repellency and ultraviolet resistance. As a result, sales of specialty grades are up 20% this year. Finally, even with the growth challenges that can accompany our paper segment, our premium Fine Paper business continues to deliver solid top and bottom line growth. Revenues are benefiting from acquired Southworth brands, success in our envelope go-to-market strategy and higher-value price and mix. Margins remained strong despite a sharp rise in pulp prices and reflected improved manufacturing efficiencies as we've increased productivity and gained experience across a larger base. While performance in this core business is always a priority, increasing our growth rate and portfolio diversification in an efficient manner is important to our future success. Filtration is a platform we intend to build upon. While our base today is largely focused in transportation filtration, our ability to make unique composite filter media materials provides the opportunity to explore complementary markets as well. The capacity addition of our third nonwovens meltblown line will support continued growth in advanced transportation filtration products and will also support growth in broader filtration applications. We'll continue to invest in opportunities to grow in defensible markets that require unique media performance that can satisfy a variety of technical solutions. Luxury packaging and premium labels are also growth markets where we see opportunities to expand. Sales were up 2% in the quarter with very strong growth in luxury packaging. In September, we launched an expanded collection of design and packaging papers that showcased our access to unique product solutions as a result of our distribution agreement with Italian premium paper manufacturer, Gruppo Cordenons. We're also expanding in luxury packaging with a broader portfolio of premium folding cartons that are image driven and environmentally friendly. In labels, our premium image products for beverage and other uses continue to do well. We're also addressing needs in the performance label market through new offerings like vinyl-free name badge for consumer use and inkjet printable labels for high-durability industrial applications. Our strategy is to maximize our organic efforts to grow in these markets and, if the opportunity is right for Neenah, to supplement this growth through acquisitions. With a strong balance sheet and cash flow generation and disciplined internal process, I'm confident in our ability to find value-adding opportunities that are a good strategic fit and a platform for future growth. Lastly, we expect our actions and performance to result in attractive returns to shareholders, and cash returns will be a meaningful component of those -- these returns. In May, we stated a commitment to increase our dividend to provide, ultimately, a yield of 3% to 4%. We are committed to this strategy, as evidenced by our 2 increases in dividends that we've announced this year. So to wrap up, we're pleased with the results in the quarter. Each of our segments drove both top and bottom line improvements and continue to make progress in key strategic areas. I'll provide a few more comments later in the call, but now Bonnie will review financial results for the quarter in more detail.

Thank you, John. I'll start with Technical Products. Sales of $104 million were up 6% compared with last year. While this was aided by favorable currency translation from a stronger euro, results also reflected 3% volume growth and a higher value mix. As John mentioned, filtration and tape both grew strongly and offset declines in building and industrial products, which are smaller categories in more competitive markets. In accordance with contracts for products that have selling price adjusters that move with input costs, as well as more competitive conditions in certain markets, prices were lower in the quarter. Operating income was just under $7 million in the quarter and up 5% from last year. In addition to the higher volumes, income grew as a result of improved manufacturing efficiencies and lower input prices that more than offset the selling price adjustments on some grades. Moving to Fine Paper. Quarterly sales of $103 million increased 4% versus last year. While volumes benefited from acquired Southworth brands and luxury packaging growth, they were down overall as we shed lower-value products, a natural outcome of full operating system. The change in volume was more than offset by benefits from an improved mix and higher selling prices. Our higher value mix reflected growth in areas like envelopes, luxury packaging and retail, which included the acquired Southworth brands. Operating income was $13.3 million, up 4% compared to $12.8 million in 2012. Increased income resulted from improved manufacturing efficiencies as well as higher average selling prices. Versus last year, input costs were up over $1 million in the quarter primarily due to increased hardwood pulp prices. Hardwood prices in the third quarter increased significantly over the second quarter. As in the past, we expect to offset changes in input costs over time and have announced price increases in December for our consumer business and continue to take action in other areas to maintain our margins. Turning next to unallocated corporate and other results. Sales of non-strategic grades in the third quarter were $7.1 million compared with $8.5 million last year. Operating income also declined and was down $200,000. As a reminder, these grades came with our ASTROBRIGHTS brand acquisition, and we plan to reduce some of this volume following the purchase. Our quarterly run rate this year has remained at around $6 million to $7 million of sales. Unallocated corporate costs were $3.9 million in the quarter, in line with our expectations and historical run rate. In 2012, spending of $3.4 million was lower than normal due to the timing of certain expenses. Consolidated SG&A of $19.8 million was up from $18.5 million in 2012 due to the previously mentioned timing of corporate expenses as well as increased costs related to sales growth. We continue to expect ongoing quarterly spending of $19 million to $20 million and to become more efficient by leveraging our existing infrastructure as we grow. Let's move now to a few corporate financial items. Our effective tax rate was -- has increased in 2013 primarily due to repatriation of cash from Germany. In the third quarter, the rate was 17% and included onetime benefits from an R&D tax credit related to work done in 2012 to qualify and produce the acquired grades. The tax credit was $1.4 million or $0.08 a share. Excluding the credit, we currently expect a full year rate of 35%. Our cash tax rate remains below 15% as we used net operating losses to offset cash tax payments on North American income. As of September, we had $35 million of NOLs remaining that we expect to use by the end of 2014. Cash flow from operations was $35 million and reflected strong cash generation in our businesses, including improvements in working capital efficiencies. Working capital improved notably in Fine Paper where we continued to reduce inventory levels that were built to support strong customer service and a smooth transition following our brand acquisitions. Quarterly capital spending was $11 million. That's up from $7 million last year mostly as a result of spending for the added nonwoven meltblown capacity that John mentioned. Year-to-date, we have spent $20 million and expect full year spending to be within our $25 million to $30 million targeted range, which is comprised of $10 million for sustaining capital and the remainder for projects that deliver attractive financial returns. Cash payments for defined benefit pension plans in 2013 are expected to be $18 million, in line with the last few years and about $10 million more than expensed. Our US pension plans are well funded, and we'd expect funding levels to drop in the next 12 to 18 months. This timing is in line with expected increases in U.S. cash tax payment as our NOLs are consumed, minimizing any net impact on ongoing company cash flow. Turning to capital structure. We ended the quarter with debt of $193 million. This consisted of $175 million of bonds at an interest rate of 5.25% and $18 million of long-term debt in Germany. Interest expense of $2.6 million in the quarter reflected the new attractive lower rate on our bond, and expense was down 20% compared to $3.3 million last year. We built cash during the quarter, ending with a balance of $48 million. Our ongoing priorities for cash deployment have not changed. These priorities are reinvesting in attractive organic projects while keeping total capital spending within a prudent range, pursue value-adding acquisitions and return cash to shareholders through an increasing dividend and opportunistic share buybacks. Annualized cash outflows at our current dividend rate of $0.80 per share are $13 million, and we have ample flexibility to increase as we move to our planned yield. With that, I'll turn things back over to you, John.

Thank you, Bonnie. I should have said at the start of the call that although economic conditions remained sluggish, they are improving, and I'm encouraged by the progress of our Technical Products business. Turning to our Fine Paper business. As a reminder, we're in an industry that's challenged for growth and undergoing a healthy amount of consolidation, both with customers and suppliers. We've experienced the value of consolidation. And while it may at times create a short-term change in orders and supply chain as consolidated to rightsize their inventory levels, ultimately it does not fundamentally change the demand for our products. Looking at the short term, we expect the fourth quarter to return to normal seasonality with year-end holiday downtime at many large customers that can translate into lower sales and operating schedules for us. Year-on-year, this may be more noticeable in our Technical Products business, especially versus last year when sales picked up as economic conditions began to improve. Bonnie mentioned that pulp prices, especially hardwood using fine paper, rose significantly in the third quarter. Well, we expect additional modest increases in the fourth quarter of this year, while last year pulp prices declined. As we have demonstrated historically, both businesses are able to offset input cost variations over time through market pricing and cost reduction activities. Speaking of cost reductions, this remains a priority across all of our businesses. As I mentioned in our last call, results have been negatively impacted this year by poor cost performance in our Technical Products business early in the year. Our teams remained focused on improvements at all our mills, and that commitment is reinforced by incentive compensation for our manufacturing employees that's directly aligned with improving our cost position. To close, the third quarter marked another period where we did what we said we would. And while to some it may not seem exciting, we were pleased to deliver consistent, profitable results and provide shareholders with attractive returns. Our financial position remained strong and will allow us to continue to deliver on our strategic initiatives, act on attractive opportunities and, most importantly, reward our shareholders. Thank you for your interest. 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 with Buckingham Research.

Two quick questions. One, could you give us a little bit more detail perhaps on the pricing initiatives in your various product lines which are in place to offset some of the cost pressures you were talking about?

Sure. I'll start with the Fine Paper business. The Fine Paper group, 2 major segments: consumer and commercial. Commercial had an increase earlier in the year and is pulling that through. We also increased on the consumer side when we acquired the Southworth brands. And then, as I mentioned in the transcript, in this quarter we'll have another increase. So as a reminder, the Fine Paper portion of the business, it's more or list price oriented, so that price increase goes right through. On the technical product side of the business, it's more customer-by-customer negotiations. So those are ongoing as we go through the year. I would estimate about 1/3, Mark, of our Technical Products business is -- participates in adjusters. So those will be systemically raised while the others are negotiated with customers. Filtration tends to be a more of an annual negotiation and has the longest lead time.

Is 2% to 3% a reasonable estimate on the Fine Paper side or...

Yes. Yes, that's a very reasonable -- and I think also, I should remind that those prices tend to be fairly sticky, too, as -- so we try not to move up with large percentages or the frequency you might hear in commodity papers.

Right. And I'm sure it's much more complicated on the Technical Products side to put a number, so I won't even try. But more -- on the Technical Products side, you did note that besides delivering on your commitment to increase cash returns to shareholders, you will continue to pursue value-adding growth investments in Technical Products. Now I think you've talked about filtration in particular as being a potential area of focus in the past. Is that still a priority? Or could you maybe expand a little bit more on what types of opportunities might be out there?

Yes, I would say that -- I'll give you a couple of devices. We -- I can't talk or we're not ready to talk about any potential acquisition now, but I can tell you about my biases. And it would be that from a growth and a performance-oriented media manufacturer, U.S. based would be made bias, okay, because we have such a strong share position in Europe from that standpoint. As we talked about, filtration is a bias because products are built and uniquely developed for customers. And there's a longer runway, but they're, again, fairly stable. The majority of our filtration markets today are in transportation, and the majority of the growth that I've talked to you about has been in composites, where we've added moldable medias together to solve -- to provide solutions. But we also have business in beverage filtration. We also have business in health or medical and industrial. So our expectation is to stay in niche filtration markets as a bias. Packaging and label, I also mentioned on the call, are areas that are very attractive to us. When we find the right opportunity that fits Neenah, we would act as well.

And is it fair to say that the size of likely targets at this point could largely be financed by cash on hand -- or be financed by cash on hand plus perhaps some additional debt financing? So they're not really big acquisitions you're looking at? Is that fair?

Yes.

Mark, I would say that they were probably -- the smallest size would start with our cash on hand here at about $48 million. But yes, we would say that we can support an acquisition with our cash and our debt capacity within our targeted 2 to 3x debt-to-EBITDA.

Your next question comes from John Tanwanteng, CJS Securities.

X benefit, taxes were still about 27%, which is still pretty low. What went into that?

I apologize, John, but you were cut off at the beginning. I'd like to make up the beginning of the question, but it wouldn't probably be appropriate. What -- could you restate it for me, please?

Yes, x the R&D benefit you had of $1.4 million, taxes were still at 27%, which is still pretty low. What went into that?

Yes, so -- and your math was really good because I have had 28%. But yes, we had our normal -- book-to-tax return true-ups that would typically occur in this quarter that were favorable. And then also, we're very sensitive to the mix of income. So that's the rest of that difference.

Okay, got it. And then that $500,000 of other expense, that's just integration and acquisition costs, right?

The onetime adjustment?

The $500,000 of other expense you had?

Yes.

Yes. On our income statement for the 3 months, we show a 0.4 as a onetime adjustment. That is for integration costs.

Okay. What's the other expense then?

It's probably things like currency, just odds and ends.

Okay. Okay. And then just a little bit more on the M&A pipeline. Do you currently have active candidates you're looking at? And what are the multiples maybe you're looking to pay depending on the sectors of businesses?

We'd -- we have a pretty robust process. We have the full-time resources dedicated to the process of -- and a radar screen that's -- again, has a number of candidates that we are looking at. We really would -- when we look at an acquisition, we tend to look at it from an NPV standpoint. And for -- our commitment is not overpay for a company. Finding the right strategic fit is the most important thing for us. So I don't want to limit where we would pay for a company if it's the right strategic fit for Neenah, it'd be the right thing for the shareholders.

Okay. And then finally, just for the Fine Paper business, do you have an organic year-over-year growth rate for the quarter?

Yes. The Fine Paper business since 1997 has declined by about 3% overall. But the expectation for our business as they continue to gain share -- they performed at kind of a flat to a 1% decline.

Okay. And just quickly on the dividend. Obviously, you had the 3% or 4% target yield on there. What's the pace of increase you expect to get there? Is it going to be steady? Or do you plan to get there, I don't know, ramping quicker or slower?

I don't think we could commit to that. All we would say is that we would expect to be there in 2 to 3 years.

Your next question comes from Lawrence Stavitski with Sidoti.

A lot of my questions were all answered already.

Perfect.

But if you could -- I guess kind of stepping back away from the acquisition front, are there any plans to kind of retreat from some of the declining markets in Fine Paper, areas that have been declining more rapidly than others?

Sure. Yes, I think a couple of things. One, especially, for example, in the Fine Paper business when our -- with our assets that are full, we're constantly evaluating the marginal products and which businesses have the best opportunities for the asset base that we have. When we look at our technical businesses, and they're kind of more one-off, we take a very hard screen at, do we have a long-term reason to win in this category? And we're evaluating those all the time. So I would absolutely say we're paying as much attention as why we should keep a business for the long term as we are on why we should acquire one for the future.

Okay, got you. And you mentioned U.S.-based targets for Technical Products. I guess down the road, any interest in looking into emerging markets, Latin America or Asia? Or there's -- you guys kind of have little exposure there. Is that also on your radar or get more U.S.?

Yes. First of all, those are very important markets for us and very important markets for our growth. We tend to play at kind of the higher end of some of the performance oriented. So the ability to put an asset in, lots of times, in some of those markets, why you're building the market need might be a little more difficult. Also, some of the technology, I think we definitely ship into those markets. We definitely enjoy the growth. I think we mentioned on the call a growth of 20% internationally in our filtration products overall. So yes, those are important to us. If an acquisition brought us an entrée into those markets, that would be very exciting as well.

Okay, okay. And then just finally, the other gentleman kind of answered my question with the dividends. I guess any plans for share repurchases? Or is that evaluated as you see it -- as it comes to you? Or I guess going forward, anything on that forefront?

Well, we do have an active share repurchase program that was authorized and reauthorized again by the board. But today, the way that we looked at it, as Bonnie walked through the priorities for our uses of cash, it's more on an opportunistic. We believe the organic investments and our opportunity in M&A and continuing to deliver on our commitment regarding the dividends are in front of that. But if the opportunity came to -- for us to opportunistically acquire shares, that we're absolutely [indiscernible].

Okay, okay. Did -- but there were no shares repurchased this past quarter? Is that...

No. Yes, that's what the opportunistic word meant.

Your next question comes from Stuart Benway, S&P IQ.

Many of my companies are saying that Europe is looking a little bit better these days. I mean, not great, but at least there's some optimism that it may improve next year. Do you share that view?

Yes, I do share that view. I like optimism better than the sluggish word I used earlier -- or actually, we are definitely seeing our businesses and -- if you start with the moods of our customers and expectations, I would say yes, it's definitely picking up and our view that '14 looks like it will be a better year in that regards.

And you say that especially, tape growth was strong in the quarter and was also strong in the second quarter, I believe.

Yes. Right.

What industries and regions are you selling that product into?

Well, we make specialty tapes in 2 parts of the world. we have a facility in Bavaria, Germany, and we have a facility in the U.S., in the upper peninsula. But we actually ship the product globally. We've had a great deal of success in Asia through our German facilities and will -- so it's really a global sale. The real challenge with that is, again, meeting the unique requirements. It's a smaller portion of the tape market, so -- but it's, well, one that's -- you tend to get a premium and also tends to be more stable.

So what types of industries does it go into?

Electronics, we've had a great deal of success. The water-proof products work great in automotive. So that -- those are 2 big ones. Obviously, the -- but people, they tend to think with -- well, tape is more building and construction. While we do make a product that, well, that's called FrogTape that has a wicking agent on top, it's more for DIY-type markets. Those have all been very successful launches.

And you say that operating efficiencies in -- have improved in Fine Paper. Is there more room for improvement there in coming quarters?

Well, just in case anybody in my organization is listening, you bet. My expectation would be, obviously, with an experiential curve, you'll optimize your asset base. As we look at marginal products, we look at what's run the best, which will give the maximum throughput. The commitment is not building new paper machines, we're constantly looking at how do you support growth or -- and margin enhancement with the existing assets that we have in place. So they're constantly looking for ways. I -- personally, I'm absolutely amazed what -- on the progress that they've been able to make and the opportunities they have going forward.

And you say that the fourth quarter is typically seasonally slower, and it has been slower on a sales basis than the last 2 years. But your margins have increased actually significantly the last 2 years in the fourth quarter. Do you expect that trend to hold this year?

Well, I would say that if you look across the whole company, our Fine Paper business, which has nice margins, is fairly stable quarter-to-quarter. And I think our technical business, which has more of a work-in-process product and more impacted by supply chain movements, is really what's impacted more in the back half. So as a result probably and the product mix you see in those margin changes, there's no fundamental significant price changes, cost reductions we've historically had. I did mention on the call that last year, pulp was way down in the fourth quarter, which also helps margin from that standpoint. But I would say what my expectation would be: the mix between the businesses is likely driving the margin improvements.

One last quick one. Any early thoughts on CapEx next year? Do you have any major projects planned?

Yes, we would suggest, as we guided on CapEx, $25 million to $30 million on an annual basis, $10 million of it for sustaining the rest. But we focus first on growth and then on cost reduction. We have a number of initiatives under way that continue to make sure that we have the capacity in the growth categories that our customers are looking for. Since filtration has disproportionately grown by comparison to others, we invest in that capacity as well. So we do have a number of products we're very excited about as well as a number of cost reduction that can only enhance our overall businesses.

At this time, there are no further questions. I would like to turn the call over to John O'Donnell for closing remarks.

Well, I'd like to thank everyone for your participation and interest in Neenah, and we look forward to the opportunity to talk to you again in February. Thank you now.

Thank you. This concludes today's conference. You may now disconnect.