Neptune Insurance Holdings Inc. (NP) Q1 2015 Earnings Report, Transcript and Summary

[Call Starts Abruptly] All lines have been placed on mute to prevent any background noise. After the speakers' prepared remarks, there will be a question-and-answer period. [Operator Instructions] As a reminder ladies and gentlemen, this conference is being recorded today, May 7, 2015. Thank you. I will now turn the call over to Mr. Bill McCarthy, Vice President Financial Analyst and Investor Relations. Please go ahead, Mr. McCarthy.

Thank you. Good morning everyone and thank you for your interest in Neenah. Our press release covering first quarter earnings went out yesterday afternoon, so hopefully you’ve had a chance to read through it. In our call today, John O'Donnell, our Chief Executive Officer and Bonnie Lind, our Chief Financial Officer will discuss activities and financial results for the quarter in more detail. And as usual, following our prepared remarks, we'll open up the call for questions. I’ll first provide a few high level comments before turning things over to John and Bonnie. Consolidated sales for the first quarter were $228 million, up 1% from a year ago, although on a constant currency basis, sales increased 8%. As we indicated in our February call, translation impacts due to the rapid strengthening of the dollar versus the euro would materially impact our top-line, but through careful cost control and benefits of lower input costs, we would mitigate any bottom-line impacts. These efforts were successful and we in fact delivered our best ever quarter with EBITDA of $29 million and EPS of $0.95 per share. At times we use adjusted figures to aid and comparability between periods, and these non-GAAP measures are reconciled to corresponding GAAP figures in our press release. In 2015, there were no adjusting items, but the first quarter of last year included an adjustment to exclude restructuring costs of approximately $300,000 or $0.01 per share in our technical products business. Also let me remind everyone that our comments today may include forward-looking statements, actual results could differ from these statements and risks and uncertainties that could cause these differences are outlined in our SEC filings and in the Safe Harbor disclaimer on our website. With that, I'll turn things over to John.

Thanks, Bill. Our businesses performed very well in the first quarter with both segments delivering strong bottom-line growth, improving margins and operational efficiencies. Historically, the first quarter tends to be our strongest, though still with plenty of challenges that our teams were clearly able to over come. This consistent business performance reflects the success of our strategies to grow a defensible profitable niches as we continue to evolve into a larger, more diversified specialty materials company. Let me start as usual with a recap of some of our key strategies and initiatives. First we’ll continue to expand our leading positions in premium niche categories that are core to Neenah. These categories include, transportation filtration, performance packings and premium fine papers. I’ll talk about each of these briefly, starting with transportation filtration. This business continues to demonstrate impressive growth. In the first quarter, local currency sales rose 6%, while still highly concentrated in Europe, we sell globally and have been growing exports at a double-digit pace. We expect to consume available capacity in Germany within the next two years and, as announced in February, we are adding manufacturing and advanced saturating capabilities in the United States to meet this growing global demand. As a reminder, we’ll do this in a capital-efficient manner by repurposing one of our fine paper machines in Wisconsin. Following our February announcement our sales team met with a number of US customers and the response has been very positive. The US markets evolve into more demanding engine platforms that require the type of high performance innovative filter media for which Neenah is known. These customers, many of whom are global and with whom we built successful long-term relationships, also confirm the opportunity we see to increase our presence in the Americas in a disciplined and responsible manner. From a technical standpoint, the project remains on track for a start-up in early 2017. Initial paces of permitting are well underway. Our past investments and capabilities in fine paper, along with significant increases in productivity as we've achieved over the past two years, will allow us to support future fine paper and packaging growth with one less machine. Work is already underway on optimizing and rebalancing operations to ensure a seamless transition for our customers. So to summarize, our filtration, international growth plans are on track and have been met with excitement by both customers and employees. I’ll turn next to backings, which are a key component of specialty tape and abrasive end products where we add value through saturating and coding expertise. Backing is a global business today with customers serve out of our mills in the United States and Germany. These markets are growing in line with global GDP and sales and constant currency for the first quarter were up approximately 3%. We are looking at ways to take further advantage of our footprint as it’s more global than a number of competitors. Our products are focused on meeting specialized needs such as high temperature resistance, fine paint lines, and UV protection. And we continue to look for opportunities to expand in adjacent markets that will further grow the business and enhance profitability. The last core category is premium fine paper, a business that continues to deliver outstanding financial returns. In the first quarter, sales of approximately $100 million were in line with last year. We benefited from new distribution at a major retail customer, and sales were also boosted by shelf resets at other retailers in the first quarter of this year that occurred in the second quarter of last year. These positives were offset in part by reduced sales of non-branded business with declining pulp prices, we expect more aggressive competitive pricing for the lower value business to continue, and while this could reduce our top-line, it should have a minimal effect on our bottom-line. Overall, fine paper continues to deliver steady results despite challenging market conditions. And the strength of this business remains in our leading brands. We are leveraging our brand awareness and expertise as we expand in premium packaging and for all of our high-end fine paper and packaging products, we continue to outperform the broader market as customers look for the distinctive solutions that can convey a premium image. If you want to check out our latest packaging progress, you can visit our recently launched website at neenahpackaging.com. A second strategic priority is to increase our size, growth rate and portfolio diversification by expanding our presence in profitable and defensible segments of growing markets that value our capabilities. As we’ve mentioned before, we are looking to expand in categories like filtration media, premium packaging, and performance-oriented technical products. We’ve allocated internal resources to support growing markets like premium packaging and filtration, and remain very excited about the business we acquired last year and the new technologies now available to us to drive future organic growth. Same time, our acquisition process remains very active as we pursue companies that fit or complement our capabilities and can deliver meaningful value for our shareholders. Filtration continues to be a target market. We are also open to opportunities in other defensible markets that are strong fit and improve our growth profile. With our disciplined process, you can be assured we are not simply looking to buy growth, and that any acquisition will provide the necessary financial returns. I am very pleased with the attractive acquisitions we’ve been able to deliver in each of the past three years, and expect that M&A will continue to support our future growth aspirations as well. And finally, our priority is to continue to deliver attractive returns to shareholders including a meaningful cash component. We believe that combining our strong execution culture with our commitment to delivering attractive return on capital as we grow our company will reward our shareholders with an increasing stock. Price In addition, the strong cash flows our businesses generate allow us to supplement these returns with an attractive dividend. In March, we paid our first dividend of this year at a new quarterly rate of $0.30 per share representing the fifth double-digit increase over the past 10 quarters. Before turning things over to Bonnie, I will reiterate how pleased I am with how our teams are executing our strategies and how these results translate into good financial performance and returns for our shareholders. Bonnie?

Thank you, John. Let me begin with technical products. First quarter sales were $120 million up from $117 million last year. As expected, with more than half of our technical product sales in Europe the translation impact of a stronger dollar had a large impact on our top-line, reducing sales by $14 million or 7%. The average exchange rate in the quarter declined by almost $0.25 from $1.37 to $1.13. As we me mentioned on our last call, every $0.10 change reduces sales by about $35 million annually or over $6 million per quarter with a corresponding impact equal to around 10% of that amount on the bottom-line. On a constant currency basis, our businesses did really well, growing 4% organically and increasing 8%, including sales from last year’s acquisition. In addition to volume growth, net sales benefited from a higher value mix and higher selling prices. Operating income was a $16 million, up 17% compared to income of $14 million last year. In addition to higher volumes and improvement in selling prices, profits also benefited from lower input costs. In total, these items more than offset the currency translation impact on the bottom-line. Turning to fine paper and packaging, sales in the quarter were $101 million, and, in line with the prior year. As John mentioned we had an unusually strong quarter in the retail channel, primarily due to the shelf resets that occurred in the second quarter of last year. Sales of core premium brands also did well growing 2%. These results were partly offset by timing of premium packaging orders and volume declines in the non-branded business. Overall, benefits from our higher value mix and increased selling prices we’re able to offset a 3% volume decline in volume. Fine paper and packaging operating income of $17 million increased from $13 million last year. The majority of the increase is due to lower energy costs, which had spiked in the first quarter of 2014 due to high winter demand. Profits also increased in 2015 as a result of benefits from the improved mix and pricing. Unallocated corporate costs of $4.8 million compared with $3.8 million last year, these costs generally average around $4 million per quarter, but were higher in the first quarter of this year primarily due to the timing of certain expenses. Consolidated SG&A was $21.9 million, up from $19.9 million in 2014. About half of the increase was due to timing of unallocated corporate expense and the other half reflected SG&A associated with our 2014 acquisitions. Going forward, we expect SG&A to continue to average around $21 million to $22 million per quarter. Net interest expense of $3 million increased from $2.8 million last year as a result of a year-end borrowing in Germany on our new global lending facility. These funds were used to repatriate cash to the United States in a tax-efficient manner. And in the first quarter we began paying down this added debt in Germany with local cash flows. Our effective tax rate in quarter was 37%, equal to the guidance we provided in February, but higher than the rate of 35% last year, due to changes in the mix of income between our tax jurisdictions. As a reminder, if Congress renews R&D tax credits for 2015, as it has in the past years, this would lower our overall full year rate to about 35%. However, we can't record this until the law has passed, which was in December of last year. Our cash tax position remains favorable, while we no longer have any US federal net operating losses and we now have almost $30 million in R&D credits. Even with these credits, we are subject to minimum US tax payments of approximately $10 million in 2015 and expect our consolidated cash tax rate to be about 20%. As a result of the actions we've taken to fund our US pensions, we are able to reduce pension contributions significantly this year as planned, and offset the impact of the higher cash taxes. In addition, our actions and the good returns on our investments will keep pension and OPEB expense similar to last year despite changes in mortality tables and lower actuarial discount rates in 2015. Let me finish up with a few comments on cash flow and deployment. In the first quarter, cash from operations was $5 million down from $15 million last year. The first quarter is always seasonally low as sales increase and we rebuild accounts receivable from low year-end levels. The comparison with last year also reflects a favorable one-time benefit in the first quarter of 2014, resulting from changes in accounts payable terms. While the first quarter was seasonally low due to timing of working capital, our cash generating capabilities remains strong. Capital spending of $6 million was up from $4 million last year as we’ve stated full year spending will be in the upper-end of our targeted range of 3% to 5% of sales or around $45 million to $50 million. This includes $25 million for the North American filtration expansion. Our balance sheet is strong with low leverage. We deploy cash in a disciplined and balanced manner in line with our priorities of attractive organic investments value-adding M&A, increasing dividends, and share repurchases. Our actions and cash deployment strategies have delivered attractive returns on capital and returns for shareholders and this remains a priority in the future. With that, I'll turn it back to you John to provide summary comments.

Thanks Bonnie. As usual, I’ll start with a few comments on external influences that may impact us in the quarters ahead. As we stated in February, currency translation due to a stronger dollar was expected to materially impact our top-line. But we would work to fund ways to mitigate bottom-line impacts. In 2014, the remained above 113 for most of the year. Therefore, if the euro stays around the current levels of 113, translation impacts will continue to reduce quarterly sales by around $15 million or so before easing a bit in the fourth quarter. But the euro has traded between 105 and 115 so far this year, so, don’t hold me to any predictions please. In addition to translations, a weaker euro could enhance the competitiveness of the lower-priced imports into the United States. However, the majority of our businesses are in defensible niche markets where performance, brands, and other factors account more than just landed cost. On the positive note, many economies in Europe appear to be gaining momentum, although projected growth is still not robust. Fortunately for us, Germany continues to be among the best performing countries. And transportation filtration is one of our more resilient categories. Turning next to input costs. As in the past, commodity prices like oil and pulp have moved inversely with the US dollar, although hardwood pulp prices appear to have strengthened more recently, while prices for many of our inputs don’t move as quickly due to their specialized nature and we also have selling price adjusters on some products. Overall, we still expect the lower input cost to be a benefit and help offset impacts from currency. So with that, I’ll wrap up. First quarter results were very good. As I said earlier, this historically has been our strongest quarter, particularly for technical products. Looking forward, our businesses are well positioned competitively in defensible niche markets and our teams are executing on their initiatives. Key efforts include support of growth in global transportation and specialty filtration markets with capital-efficient investments in North America. Allocation of resources towards premium packaging to expand our share, development of new products that combine our global capabilities, pursuit of acquisition targets that deliver attractive returns, and return of cash directly to shareholders through an attractive dividend. Given the quality and the depth of our teams, I am confident in our ability to execute these initiatives and create value as we build a leading global specialty materials company. Thanks for your attention and at this point, I’d be happy to open up the call for any questions.

[Operator Instructions] Your first question comes from the line of Jon Tanwanteng of CJS Securities.

Good morning, guys. Very nice quarter.

Thanks, John.

Can you go into a little more detail on the strength in the retail in the quarter? What's the relative size of that new customer opportunity there, is that still ramping? And for next quarter, do you expect a decline given the change in the timing of that reshelving you mentioned?

Yes, we are always looking for new distribution in retail and their shelf sets are typically an annual event. From that standpoint, the impact of that overall, new distribution maybe a couple million dollars if I try to size it from that piece. I would expect that to be a continual annual event we have. But what I wanted to make sure I called out in the call, was that last year, we saw a big part of those shelf resets and distribution activity happening in the second quarter. So really happening in the first quarter and I expect that to be a regular annual event. And just as a reminder too, our retail business represents about a quarter of our fine paper business.

Right, okay got it. Can you quantify the size of that shelf reset at all?

Well, shelf resets, it’s an annual process with many of the major retailers, so to look at Office People OfficeMax, Staples and then new distributions with customers. So, when you are doing a shelf reset you may gain SKUs. You may lose SKUs. In this first quarter, we saw a $3 million to $5 million opportunity if you will gaining incremental shelf space with our retailers.

Got it. That's helpful. And then, on the export side, you mentioned FX helping you a little bit, selling to the US from Germany. I am just wondering what percent of your revenues that might be?

Well, in reality, I did say, the US from a transportation filtration had improved, I didn’t connect it to FX. Our success in the United States, we’ve been growing at double-digit pace in the United States from transportation filtration as we’ve been moving into this market. In fact, I think I mentioned naphtha was up 15% in that overall quarter. Of all of the categories, transportation filtration has a long qualification cycle and so timing of currency isn’t going to affect dramatic changes in new distribution. I would say that our backings items, the ones that are more global GDP-ish and might have higher opportunities for switching would be the categories that would potentially be exposed with changes in currencies. And good news for us we have a facility in Germany as well as one in the United States.

Okay, thanks. And then finally, just an update on what you are saying in the M&A space, valuations or potential targets. How active exactly are you there?

Well, we’ve been very busy. As we said in the past, we’ve got dedicated resources and that’s a key part of continuing to reshape the growth profile of our business and configure the diversification for our specialty materials company. So, well, I can’t really communicate on any specific event. I will communicate it when they happen. I hope that our track record at least speaks for that, A, we are active and B, that we are not out just to acquire revenue but we are really very disciplined in the investments we are going to make. But I do expect it to be a part of the change in our growth trajectory.

Okay, thank you very much.

Thanks, Jon.

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

Hi, good morning. Thank you for the time.

Hi, Dan.

Hi, Dan.

Hey. So just back to the shelf reset, was that - can you talk a little bit more about that? Was that incremental, was that the customer displacing someone else for adding all into their paper offering?

So think about shelf resets as an annual event refreshing. So, retailers are actually, they are selling space and they are constantly looking each and every year to make sure that they have the best opportunity and best put up and mix of products there. So they are going to look at your brand awareness if you will as well as your put up and the meaningfulness for the consumers. We have the two strongest brands in retail. Our expectation is that, we will continue to gain market shelf space as we gone forward. The big piece of it was a Wal-Mart, we picked up an incremental SKUs in Wal-Mart as well as the shelf sets at Office People and Staples. So, this is an annual event. I would hate for you to think if it was a huge changing, it’s really a timing, first quarter, second quarter and probably the first time I’ve talked about shelf resets. So, I got to understand why the questions if you will, but, I think it’s more of a timing and new distribution in Wal-Mart are probably going to be the biggest drivers.

Okay. Well, Wal-Mart is a nice customer to have, it sounds like.

Yes, they are great customers by the way.

Okay.

In case anybody is on from Wal-Mart, I didn’t call them nice, I call them great.

Okay, I'll make a note of that.

You have to be.

So it sounds like you took space from someone else. All right, great. And then, was that kind of like the Astrobrights type of papers?

Yes, it really wasn’t – specifically, they had a private-label in there and what we were – we compared our brand and the lift of our brands versus the private-label performance and the team did a fabulous job ensuring they had the right put ups, the right mix and right assortments and net-net into that, our products drew a greater lift and greater revenue for Wal-Mart, that’s why they made a change.

Okay, great. And then on the premium packaging side, nice job on the website, by the way, I had a chance to look at that yesterday.

Perfect.

Yes, nice. What I was wondering is, I know, I have asked this before, but I am just curious, because there is not a lot of information out there, who will you guys be taking share from? I get this question a lot.

Yes. If you think you get a lot, I guess how often I get it. Okay, this is, premium packaging, first of all packaging is such a large market, $42 billion. We’ve sized $300 million of addressable market. So as you could imagine, there is no single customer out there that to have done a phenomenal job in capturing the biggest share of it. There are some other players out there, especially in high-end spirits, like, I believe FiberMark is in that business.

Yes.

But we focus in spirits, cosmetics, retail, and

Electronics.

Electronics, yes, thank you Bonnie, in electronics. So those categories where you have expensive things in small boxes is where we believe we have the greatest opportunity. Any time a customer is looking to enhance an image through the packaging, not just protect the product, that’s where we believe we have the greatest chance for success. So, there isn't a set player out there. A number of players that are doing it more of a hobby.

Okay and in this niche, is this still growing like 20%, I think you said in the past?

Yes, double-digit is a good thing for you to have in your mind, I am excited when it’s 20%, but it is definitely a growing market for us and as we garner share and focus in those key markets, our expectations will continue to demonstrate meaningful growth going forward. The markets growing as well. So I sized it a 300, but as a reminder, it’s a high-end image luxury goods are continuing to grow and that’s the place we want to be in.

Okay. I hate to hammer you on this, but is this high double-digit or low double-digit? Where are you close to?

Yes, so, well, we’ve we both agreed on double-digits. So I'm going to split the difference and call it mid.

Okay.

On that.

I would take that.

All right.

Thanks.

Your next audio question comes from the line of Steven Chercover of D.A. Davidson.

Thank you. Good morning everyone.

Hi, Steve.

I got on a wee bit late, so forgive me if I’ve missed something. But both segments did really well, and I am just wondering, is the margin in technical products, do you think, sustainable, because it certainly seems a little bit better than we've seen previously?

So, our aspiration has always been for both of our businesses to be in that double-digit margins and tech products made tremendous progress over the last four years. As we continue to look actually in the filtration and with our filtration acquisition, as we look at those higher-end mix opportunities are going to continue to drive that up. So, we had good cost performance in – especially in some of our US technical businesses as well. Our view is that, it’s not a one-off margin opportunity.

Okay, and then so to kind of continue along that line of thinking, John, you said that Q1 tends to be the strongest.

Yes.

And I am just wondering, does that – is that a statement that's related to, if that doesn't seem to be the case, at least as far as earnings go in the last three years, so, was that a comment on fine papers due to the shelf situation or earnings as a whole?

Yes, right, and that’s a great question. And, you’ve talked with me before, so you know sometimes I can confuse people. I would say, when I talk about the strongest, I am really talking about top-line. So, technical book products business that the largest quarter is the first, then the second, then the third and then the fourth historically where we are at. As a reminder, the majority of our maintenance downs and outages are in the third quarter. So that quarter is up and pressured on overall margins. Since our first quarter typically is a highest revenue opportunity and it follows our weakest fourth quarter that’s why Bonnie was talking about the cash piece. We are in good shape on that. But, it looks like it lows a little bit at the beginning because we had strong sales and – but we are in great shape from a collection standpoint. The business that’s the most predictable is the fine paper business, I would say, it’s typically 50%, 50%, top-line and almost bottom-line to that end. So, pretty stable between the two. I think our technical business has been 52% in the first half and 48% in the second half. So, I don’t want to suggest there are dramatic swings, but we clearly, I was talking about the top-line piece of our business and from a bottom-line, remember, third quarter outages will definitely impact the bottom-line performance.

And fourth quarter in the technical products business is especially in Germany with a lot of…

We have a lot of customers who manage our inventories towards a year end and then restock at the beginning in January, hence the seasonality impact that we talked about. I hope that clears that up.

Yes, you guys are great. The way you go back and forth is almost like a married couples classic.

Oh, no, don’t’ say that, Steve.

But are happily married couple.

Oh.

Steve, I am happily married and I work with Bonnie, exactly.

Okay, I'll just leave it there. I am going to touch with… Thanks a lot guys.

That’s right. Thank you, Steve.

There are no further questions in queue.

Okay. Well, everyone, thank you for joining us. On behalf of the team here at Neenah, we appreciate your time and interest and look forward to updating you on our progress next August.

Thank you, ladies and gentlemen. That does conclude today’s conference call. You may now disconnect.