Neptune Insurance Holdings Inc. (NP) Q1 2016 Earnings Report, Transcript and Summary

Good morning. My name is Nandi and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper First Quarter 2016 Earnings Conference Call. 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 12, 2016. 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 our first quarter earnings call. With me today is John O'Donnell, our Chief Executive Officer, I am sad to say that Bonnie Lind, our Chief Financial Officer, had a death in the family and he is unable to join us this morning. So I’ll do my best to finish it for her. As usual, following our prepared remarks, we will open up the call for questions. Let me start up with a few comments before turning things over to John. We completed a number of important strategic activities last year, including the acquisition of FiberMark on August 1st, and the divestiture of our wall covering mill in Germany at the end of October, results for this divested wall cover business for the first 10 months of last year are therefore shown as discontinued operations. FiberMark results have been incorporated into each of our segments and are no longer clearly separable as we have continued to integrate and realize efficiencies from combining operations. In the first quarter, integration and restructuring cost were $1.1 million or $0.04 per share and have been excluded from adjusted earnings. There were no adjusted items in Q1 2015, and these adjusted figures are a non-GAAP measure that we use to improve comparability between periods and are reconciled to corresponding GAAP figures in our press release. Finally as a remainder, our comments today may include forward-looking statements. Risks and uncertainties that could cause actual results to differ from these statements are outlined in our SEC filings and in the Safe Harbor disclaimer on our Web site. And with that, I will turn things over to John. John O’Donnell: Thank you, Bill, and good morning. Our business has began the year with record results and double-digit growth, in both the top and bottom-lines. In fact, this was the first time that Neenah’s quarterly earnings have exceeded $1 per share with adjusted earnings of $1.15, eclipsing prior high of $0.96 in the second quarter of last year. While results were boosted by the FiberMark acquisition and resulting synergies they also reflected performance in our heritage businesses. In addition to strong earnings growth, operating margins improved, cash generated from operations increased by more than $10 million, and our return on invested capital remained at very attractive level, over 12%. Results were both helped and hindered by the external environment, slower growth, the economic growth continues and while this dampens market demand, it also helps push down input cost. Overall for the quarter, our higher sales coupled with lower input costs, synergies and other improvement initiatives more than offset increased SG&A and helped deliver the increased profits. Growth was led by technical products where sales increased 15% due to the acquisition and organic volume growth in filtration and performance materials. Adjusted operating income grew faster by 25% reflecting benefits from higher sales and lower input costs, as well as our historically strong first half of the year. I would be remised if I didn’t also note the nice margin improvements our teams have achieved as we have grown the business and delivered manufacturing efficiencies and improvements in mix and price. A key technical products initiative this year is our investment to meet the growing global demand for our transportation filtration products. This capital efficient project to repurpose some existing fine paper machine and add advanced solid but saturating capabilities remains on track to start up as planned in early 2017. We continue to be very pleased with the excitement and support we are getting from our customers and qualification of our grades are already underway. Our plans are to responsibly match production output with market demand as we fully utilize this capacity over the next five years. This investment helps establish Neenah more firmly as a global filtration player and will support continued profitable growth in this business. In addition to filtration good-good quarter in our global backings category which is included as part of our performance materials business. Backings’ volumes was up 6% in the quarter, led by strong performance in tape. Over the past year we have managed our capacity in this category more globally while continuing to provide strong support to our customers. Our recent example of success is our high performance ultrathin tape which gained regional distribution at a major DIY retailer to one of our customers. We earned this new growth opportunity by leveraging our global organization, developing and producing this consumer advantaged solution in Germany and using our strong customer relationships in the U.S. to secure distribution care. Turning to fine paper and packaging, sales grew 5% and adjusted profits were up 1%. Revenue growth was driven by the acquisition as organic sales were impacted by declines in some price sensitive business as well as a slower start in commercial and consumer channels. Accelerating growth in premium packaging is a key initiative in this segment and with the acquisition we greatly expanded our capabilities and presence in the category. This has provided a more relevant and broader portfolio for an expanded customer base. Packaging sales including acquired grades were up significantly versus last year. We grew more than 10% compared to the run rate of the past two quarters. With an initial target market of 450 million, pushing an attractive run rate for growth and remain confident in our ability to capture share. The FiberMark integration remains on track to deliver the return we anticipated. Last year we moved quickly to implement a new right sized organization and negotiate supply chain and procurement savings. In addition we began optimizing our manufacturing footprint and have accelerated the in sourcing of products that had been previously purchased. We expect to spend around 2 million through the end of next year to complete the integration activities. As a result of these efforts, synergies are being realized faster than recently projected and has helped to offset a top-line that was developed more slowly than anticipated. Some of you may have heard me saying that I believe the two primary rules of a CEO are talent management and capital allocation. Our results over the past few years are a great illustration of the strong team we have at Neenah. So I’ll wrap up with a comment on capital deployment. Our sizable cash flows give us the flexibility to execute our growth strategy and reward shareholders. We are balancing deployment among attractive organic investments, like the filtration expansion and value adding acquisitions. You can expect us to continue to invest and deploy capital in these high returning opportunities while also recognizing the importance of providing a consistent and meaningful return of cash directly to shareholders through an attractive dividend and share repurchases. With that I’ll turn things over ton Bill to discuss quarterly financial results in more detail.

Thanks John. I’ll start with technical products. Quarterly sales of 122 million grew 15% due both through acquired sales and growth in our heritage business that was led by higher shipments of filtration and backings. Partly offsetting this was a lower average selling price due to mix and pricing on grades with adjustors based on input costs. Currency had a relatively small impact in the quarter, reducing sales 1% as a result of a 3% decline in the value of the euro relative to the dollar. Operating income after excluding integration cost was 300,000 was 19.5 million up 25% from just under 16 million last year. Higher profits resulted primarily from increased revenues and lower input costs that more than offset higher SG&A and currency impacts. Turning to Fine Paper & Packaging, first quarter sales were 114 million. This was consistent with the last two quarters and is up 5% from year ago levels, as additional acquired revenues more than offset lower sales in our heritage business. As John mentioned, this resulted from reduced sales of lower value grades as well as a slower start in commercial and consumer sales. In total Fine Paper continues to deliver great returns and cash flows. EBIT margins continue in the mid-teens and adjusted operating income which excludes 300,000 of integration costs was 17.8 million, up slightly from last year as benefits from lower input costs, higher sales and manufacturing efficiencies were partly offset by a less favorable mix and higher SG&A. The SG&A increase reflected both what was acquired and also about $1 million of higher spending due to timing of advertising and research trials that will moderate in the second half. Total consolidated SG&A expense was 26.4 million, up from 20.8 million last year. About two-thirds of the increase reflected incremental SG&A from the acquisition with most of the remaining increase due to timing. For the full year we still expect to average around the 24 million per quarter we previously communicated. Unallocated corporate costs which are part of SG&A were 5.3 million compared to 4.8 million last year. Cost this year included 300,000 related to transitioning the Wisconsin fine paper machine to a filtration asset. As mentioned in February, we expect to incur $3 million of expenses this year related to the project with the majority of cost in the second half of the year. Net interest expense was 2.9 million and equal to last year as slightly higher debt levels were offset by lower interest rates. Debt was $239 million at the end of the quarter and we continue to have plenty of financial flexibility with a debt to EBITDA ratio around 1.5 million and over 100 million of borrowing capacity available on existing credit facilities. Our effective tax rate was 33% in the quarter in line with last year’s average rate of 34% but below 37% reported in the first quarter of last year. Our lower rate in 2016 is largely due to differences and timing of R&D credits which were recognized all at once in the fourth quarter of last year but are now being recognized in each quarter following Congress permanently approving this credit last December. We expect our book rate this year to remain in the low to mid-30s and our cash tax rate to be around 20% through 2018 as we consume more than $25 million of prior year R&D credits. Turning to pension, our defined benefit pension plan remains in good shape. Combined pension and other post retirement obligations expenses are expected to increase $2 million this year and cash payments for these plans are projected to be $14 million or about 2 million more than expense. Cash from operations was $16 million in the first quarter up significantly from 5 million last year due to higher earnings and also improved working capital efficiencies. Capital spending was 11 million up from 6 million last year as a result of the filtration project. In addition, we returned over 10 million to shareholders in the quarter, slip between share repurchases and our growing dividends. And with that humble attempt to fill in for Bonnie, I’ll send it back to John to wrap up. John O’Donnell: As I hope you’ve heard, we’re encouraged with our start to the year, excited about initiatives currently underway and confident about the future. In the near-term, market demand will likely continue to reflect today’s more tepid economic environment, foreign exchange headwinds, also have lessened although forecasts are for further weakening in the euro in the remainder of the year. We start to see some upticks in input cost this year and the first quarter likely represents the largest year-on-year favorability. However, we expect cost increases to be modest and addressed by our market activities and sourcing initiatives. We hold leading market positions in key categories and are implementing initiatives to help us grow and outperform the market, especially in categories like transportation, filtration and premium packaging. Our teams are working to increase sales of higher value products while delivering cost efficiencies and optimizing prices. Their ability to remain focused on these priorities has delivered the good results we reported each quarter. Going forward, our strategies and priorities remain unchanged. Utilizing our expanded manufacturing capabilities to accelerate top-line growth and deliver the synergies we’ve come to expect from value adding acquisitions, investing in product innovation and in our brands knowing these organic investments deliver the highest returns, and finally growing in profitable niche markets where we can own a leading market position. M&A continues to be an important part of our growth strategy and a priority use of cash. My desire is to find the right additions that can enhance our specialty material niche businesses with a bias towards filtration and performance oriented markets that are defensible as a result of technological differentiation. As has been the case over the past five years, we’ve dedicated resources and continue to seek companies that can add value and are a right fit for Neenah. As a reminder, our intent is to improve the growth rate of the Company, so future M&A investments will likely be more growth oriented although we will still evaluate attractive consolidating opportunities. As always we’ll be selective in our approach and recognize that the size and timing of acquisitions are difficult to predict. Our strong balance sheet and sizable cash flow provides us flexibility to act not only on M&A but on multiple fronts to drive additional value for Neenah's shareholders. Looking back over the past five years, you can really see the strength of our businesses. During that time we generated over 400 million of cash from operations and invested 225 million in acquisitions, over 100 million in value adding capital spending and returned 75 million directly to shareholders. During that same time, we delivered double-digit earnings growth and accomplished all this while increasing return on capital and maintaining our low debt and strong balance sheet, consequently we remained very well positioned to move forward and execute our growth strategy. The first quarter was a steady as you go start to the year and our dedicated and extremely talented employees’ expanded capabilities and meaningful market positions. We look forward to updating you on our future progress. Thank you for your interest. And at this point I would like to open up the call to questions.

[Operating Instructions] Your first question comes from the line of Dan Jacome from Sidoti.

Just a couple of quick questions here, I guess first on cost structure, just wondering kind of the benefit or tailwind you are getting from lower pull cost in energy, do you guys think they are sustainable and how are you thinking about them through the balance of the year, I think you said they were correlated to kind of micro but just wanted to get a little bit more on that? John O’Donnell: Sure. So we saw input costs beginning to decline last year, and throughout last year actually we had decline in input cost. So that’s why when I mentioned that the first quarter is probably going to have the largest year-over-year comparative impact. So going forward and obviously they are going to be moderated this is probably going to be our largest quarter of benefit if you will from that standpoint. And yes we did say that when economic conditions are bit tepid you get input cost declining and helps to offset, if the economic conditions pick up a bit, which I would prefer like capitalizing on getting that happened through input costs. But from our standpoint, now especially when you think about our fine paper businesses those have been fairly sticky and we enjoy some of the margins during that time period but in our performance material business we have got a lot of contractual business that’s tied to input costs.

Okay got it, thanks for that. And then I wanted to turn to technical products and sorry if I missed it, can you just elaborate on what is happening with pricing there, if I am not mistaking, I think it was the headwind this quarter? John O’Donnell: No, I think our technical products business it delivered a margin of about 16% both of our businesses performance materials and filtration demonstrated low single-digit volume growth.

Okay. John O’Donnell: And there maybe mix issues as you are working through that. But if I say headwinds Dan might have been not in the room I don’t know.

I think we continue to get price in most of our businesses but as I mentioned a small portion of our business does have price adjustors and technical products and maybe that’s what you are referring to, but that counter get reflective of the lower input costs. John O’Donnell: Yes I think that would be protective of margins and I think they have done a just a heroic job of improving margins, maybe into the mid-teen margins we have been talking about so.

Okay, so did, staying on that, did filtration media grow in the quarter ex-acquisitions volumes? John O’Donnell: Yes, we didn’t acquire anything in the filtration business.

Okay, just checking just a thought okay. John O’Donnell: Yes, yes.

Okay.

And then on the paper side, last question, you mentioned there was some softness on the heritage side, I just want to -- can you remind us again what is in there and does that include ASTROBRIGHTS? John O’Donnell: Yes it would be inclusive of ASTROBRIGHTS but really I think the headwind and I might used it there is on our more historical branded print products from that standpoint. As a remainder, we moved all those products, a majority of those products through wholesale distributors and so from an inventory movement standpoint, we had a weaker first quarter than we did fourth quarter, which is kind of opposite of what we normally would expect as people manage inventories in the fourth quarter. I fully expect that that will come back as we move forward it's still a business that has pressure of 2% to 3% decline secular decline. But it looks like it is a little greater dip in the quarter.

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

This is actually Robert Majek filling in for Jon today. John O’Donnell: Hi Robert.

You touched on it, but can you just give us a little more color on what you are seeing in terms of end market demand in input pricing trends half way to Q2 perhaps maybe touch on any surprising areas of strength or weakness? John O’Donnell: As far as moving into Q2 for end used demand?

Right. John O’Donnell: Our filtration business and our technical business have been very steady. Again our performance material tends for ride more with global GDP filtration, because of the spread between 20% going to OEM and 80% aftermarket in transportation filtration it continues to tick along. After market grows at 4%, we have historically grown about 8%, I haven't seen those changing from a technical side of the business it is very solid. I mentioned in the previous question that our fine paper business is typically out of inventory so there is inventory movement. In that business the commercial print was a little weak in the first quarter and we expect that to pick up in the -- as we move through more normalized through the rest of the year. The premium packaging we have expectations much like this quarter in double-digit growth which I think will offset some of that historical pressure that was held on the print paper side. Does that help?

Yes that was helpful. And do you expect any impact from the dissolution of the Office Depot, Staples merger? John O’Donnell: No, we don’t anticipate that that will have any meaningful impact to us at all.

Okay. And just lastly from me, any update on the acquisition pipeline? And if you feel more or less urgent to do deals this year, kind of given the significant investment in the Wisconsin plant? John O’Donnell: Well, I rarely let my organization say well we’re too busy. So I won’t use that as a rationale. But you’re right the market has been very quiet I think Q1 has been from a volume standpoint one of the lowest quarters of volume since 2009, and whether that’s regarding the economic conditions in China and the strong U.S. dollar or even on the pending election here I don’t know from that standpoint. From ours it's hard to predict the timing we are just as energetic in this quarter as we will be in the next quarter in looking for the right opportunity. So M&A is not the sole solution as we talked about the different pockets of growth we have. But it will part of our growth expectations going forward. And so hope that addresses it.

[Operator Instructions] Your next question comes from the line of Steve Chercover from D.A. Davidson.

Just forgive me if these are a little bit housekeeping oriented but can you just remind us what your stretch level or comfort level would be on leverage? John O’Donnell: Yes I think what we said that we would want to operate normally in the two to three times debt to EBITDA range, but we would go up for the right acquisition to 4 or 4 plus and then our priority for cash usage would change and then we look to delever after that.

And you’re currently about 1.5, is that right? John O’Donnell: That’s correct.

Okay. So don’t need to believe or the fact that you’ve got plenty of dry powder. And what was the average price that you paid for the shares you repurchased in the quarter? John O’Donnell: Well in the first quarter it was in the low to mid-50s over the past four or five years it was in the mid-40s.

And then I mean clearly not only you have the dry powder but you’ve got the bench strength that you could look at acquisitions right now if sales was in your wheelhouse, correct? John O’Donnell: Yes we are looking at acquisitions right now. As I mentioned before it's an important component of our growth strategy. I think what’s critically important is not only being prepared to do one but finding the right one that has a right fit and makes the most sense for our shareholders. But you're exactly right that’s nothing from a financing standpoint that’s preventing us from adding to the growth of Neenah, that’s for sure.

So the market had its kind of swoon in January-February and I think typically you’re looking more at private opportunities. So, was there a similar dislocation in valuations in the private realm? John O’Donnell: Though we haven’t seen a significant drop in valuation, maybe it's pulled in by half a tonne sell through. I think for us while we fully expect that we will be paying a higher multiple for growth in that regards, we want to make sure again right fit and right timing for us.

And then my final question is we know the currency is less of the headwind and hopefully that’s because Europe is getting stronger as opposed to the U.S. weakening. But can you contrast on the two geographies for us? John O’Donnell: Yes and it is a reminder, the biggest portion of -- while we have strong sales in performance materials and in filtration, 70% of our filtration sales are in Europe. And so it tends to be a category that kind of works its way through all the economic conditions, I mean we continue to show Europe here I think we’re on our 11th of 8% CAGR. We don’t have a significant number of product categories that are ebbing and flowing with the currency over that. What we -- also what I mentioned during our prepared remarks is that we’ve combined or organized under performance materials segment to make sure that our tape and abrasives have a footprint in both of those markets so that we can balance and minimize the swing that currency had a tendency to inadvertently add to our growth issue. So, from my standpoint, I think a ambiguous study as she goes I see a fairly steady demand for the products that we’re providing over in Europe, and that is it. Is there another caller operator?

Yes, you have a question from the line of Mark Weintraub from Buckingham Research.

Hi, this is actually Brennan Munson filling in for Mark. Just a quick follow up on the M&A front, if you don’t come across any acquisitions that quite fit the bill is there a point in time that you shift your focus more heavily to additional organic investments, or perhaps even more to the dividend? John O’Donnell: Yes, I think what we have communicated in the past, our priorities for uses of cash is first organic in CapEx, so we will continue to use that as our highest priority and we have pretty significant efforts underway, and there I don’t want to out run my organization's capability for that. And then from that standpoint M&A is the second use, because we are very focused on changing the growth trajectory of the business. Dividends was our third share report purchases which we have authorization for being our fourth, as we don’t need to talk about reduction is better, anything like that because we know where we are at. So that will continue with that same consistency in the uses of cash. Where I am sitting today, my belief is that there are companies available that would continue to help Neenah on its path of growth and I am optimistic that we will find that over some severance of time. If not we won't. We will just move down the usage of cash and continue to find a best way to deploy it where it is meaningful for our shareholders.

And there are no further audio questions at this time. John O’Donnell: Okay, well then that concludes our call this morning. Thanks to everyone for your time and we look forward to updating you on our next in August.

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