Neptune Insurance Holdings Inc. (NP) Q2 2016 Earnings Report, Transcript and Summary

Good morning. My name is Kayla and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper Second Quarter 2016 Earnings 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 call is being recorded August 4, 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.

Thank you. Good morning and thanks for joining us on Neenah's 2016 second quarter earnings call. With me today are John O'Donnell, our Chief Executive Officer and Bonnie Lind, our Chief Financial Officer. John and Bonnie will discuss business activities and financial results and following these prepared remarks, we will open up the call for questions. But first, we would like to start off with a few summary comments and reminders. Yesterday afternoon, we reported earnings with consolidated sales of $246 million up 16% operating income of $34 million up 22% and earnings per share of $1.21 up 26%. On an adjusted basis, EPS of $1.26 increased by more than 30%. These results include the acquisition of FiberMark which occurred on August 1 of last year. FiberMark results including associated synergies and integration costs have been reported within each of our segments. Integration and restructuring costs, primarily related to the acquisition, were $1.4 million or $0.05 per share in the second quarter. These costs have been shown as an adjustment to earnings to aid in understanding and improve comparability between periods. There were no adjusted items in the prior year. Adjusted earnings are a non-GAAP measure and have been reconciled to corresponding GAAP figures in our press release. Also, on October 31 of last year, we divested our wallcovering mill in Germany and results for this business are shown as discontinued operations. In the second quarter, we recorded a net charge of $400,000 to discontinued operations to reflect final settlement of closing down [indiscernible]. Finally, as a reminder, our comments today may include forward-looking statements. Risks and uncertainties that could cause results to differ from these statements are noted in our SEC filings and on our Web site. With that, I will turn things over to John.

Thank you, Bill. In the second quarter, our teams again delivered record results, with double-digit top- and bottom-line growth, strong cash flows and improving margins and returns. Like last quarter, results were positively influenced by the FiberMark acquisition, as well as very good performance in our heritage businesses. Operating margin, excluding one-time costs, topped 16% in each of our segments. Margins were held by lower input costs, operating efficiencies and synergies from the acquisition. Our strong earnings, coupled with working capital improvement generated cash from operations of more than $40 million which we used to invest in our U.S. filtration capital project, to reduce debt and returned to shareholders. As always, we are mindful of deploying capital in ways that will maintain our attractive return on invested capital which remains over 12% and has increased modestly even with the acquisition and higher organic capital spending. I will comment on our progress of a few key initiatives before turning things over to Bonnie. Technical products continues to be an important growth engine for Neenah, supported by growing filtration and performance material businesses. In our filtration business, we are increasing our global presence and market share in transportation filtration. Our capital project to repurpose a fine paper asset and add advanced solvent saturating capabilities is on track to start up as planned in early 2017. This will provide needed capacity to support growing demand for our products not only in the U.S., but also in Europe and Asia. Customers remain very supportive of our expansion and we're working with them on initial qualification plans, as well as future projects. As with most defensible technical businesses, qualification periods can sometimes be lengthy, so while the project facilitates our continued strong top-line growth in filtration, bottom-line growth will be reduced due to the low machine utilization and start-up costs in 2017. We will talk about this in our call in November. Going forward, we expect asset utilization to ramp up in a disciplined fashion, fully consuming the added capacity within five years. Looking more broadly, this investment establishes Neenah more firmly as a global filtration player. It provides an attractive financial return. We are excited about the long-term growth prospects we see in transportation filtration as a result of increasing demand for high-performing filters and opportunities to grow our global share, focusing first in North America and then in Asia. As you may have read, we recently added Bill Cook to our Board of Directors. Bill was previously Chairman and CEO at Donaldson Company, a leading global manufacturer of technology-driven filtration systems. We welcome Bill to the Board as his broad business experience and industry knowledge will be invaluable as we continue to grow our filtration business. Technical products results were bolstered by performance materials, and in particular, tape, which enjoyed double-digit organic growth and is our biggest backings market. As I mentioned in our last call, we are managing our backings capacity more globally, continuing to leverage our R&D investments and the unique manufacturing capabilities of our global footprint. This is helping us to grow share in Europe and Asia, as well as with our customers here in the United States. Turning to fine paper and packaging, this business continues to deliver consistent earnings and cash flows. Our teams have outperformed the market in commercial print and retail, adding new products and distribution. Premium packaging is a key growth category, and the FiberMark acquisition expanded our packaging presence by 50%, with new capabilities in premium folding cartons and box wrap complementing our strong base in high-image labels. With a target addressable market of $450 million in beauty, alcohol, and retail verticals, we see attractive opportunities to grow and ultimately expect premium packaging to transform fine paper and packaging into a larger growing business. Let me finish with a brief update on the FiberMark acquisition. Our teams have done a great job integrating this business. As a result, we expect to achieve planned end-of-curve synergies of $6 million this year, one year early, offsetting a softer top-line than initial anticipated and helping us deliver the financial returns we are committed to. Through the first six months of this year, we have delivered over $3 million of synergies, with integration costs of just under $2 million. Additional costs of $1.5 million are expected in the second half to complete our plan and our teams continue to look for opportunities to deliver even more value. With that, I will turn things over to Bonnie to review quarterly financial results.

Thank you, John. I will start with technical products today. Quarterly sales of $127 million were up 19%, due to acquired sales and strong organic volume growth, led by filtration and tape. Partly offsetting these higher volumes were lower average selling prices, primarily due to mix, but also due to decreases for grades with price adjusters that are tied to input costs. Currency had a small positive impact in the quarter as a result of a slightly stronger euro this year. Operating income was a record $20 million, up more than 30% from just over $15 million last year. Higher profits resulted from increased sales and lower input costs that more than offset impact of price adjusters and higher SG&A, the latter mostly related to the acquisition. Results in the second quarter also included $200,000 for integration costs. Turning to fine paper and packaging, second quarter sales were $114 million, consistent with the pace of prior quarters and up 8% from 2015 due to acquired volume and organic growth in packaging. In the second quarter, we continued to gain momentum in packaging. Our growing pipeline of sales helped increase second-quarter sales 10% above the run rate of the past two quarters. In our premium print categories, list prices were maintained, though average selling price was lower due to an increased proportion of non-branded volume and more competitive pricing on these grades. Operating income was almost $19 million after excluding integration costs of $500,000. This was also a record and up 9% from the prior year. Higher income resulted from lower input costs, manufacturing efficiencies and volume growth that more than offset increased SG&A and lower net selling prices. As we mentioned in May, about half of the SG&A increase is related to the acquisition and the remainder is due to timing of spending that is expected to moderate in the second half of this year. I'd also note that we have now successfully transitioned all fine paper grades off the planned filtration asset with no loss of business or impact to the customers and with minimal added cost. Total consolidated SG&A spending was $24.4 million, down $2 million from the first quarter, but still up from $20 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 continue to expect to average around the $24 million per quarter that we have previously communicated. Unallocated corporate costs, which are part of SG&A, were $4.6 million compared to $4.9 million last year. Results in 2016 include non-capitalized costs of $300,000 related to transitioning the fine paper machine to a filtration asset. We continue to expect to incur approximately $3 million of these non-capitalized costs this year with most of the expense occurring in the second half of the year. Net interest expense of $2.7 million decreased slightly from $2.9 million last year. Debt was $219 million at the end of the quarter, down $20 million compared with March. Our balance sheet remains really strong with a debt to EBITDA ratio of less than 1.5 times and over $125 million of borrowing capacity on our credit lines. Our effective tax rate was 34% in the quarter, in line with last year's second quarter rate. As a reminder, we are recognizing benefits from R&D credits in each quarter of this year following the permanent approval of this credit by Congress last December. We expect our book tax rate to remain in the low 30s, with a cash tax rate of around 20% through 2018 as we consume R&D credits of more than $25 million. Turning to pension items. Our U.S. defined benefit pension plan remains in great shape, so over 90% funded on a PBO basis. Cash payments for all postemployment benefit plans are projected to be $14 million this year or about $2 million more than expense. While up from last year, cash contributions in 2016 are well below previous years, as we have offset higher cash tax payments with lower pension contribution. Cash from operations was a record $40 million, reflecting our strong operating earnings and a decline in working capital. Capital spending was $17 million in the quarter and just under $30 million for the first six months. We expect full-year capital spending of up to $75 million. That's up from our prior $65 million estimate, as we have moved forward timing of spending related to the filtration project. In 2017 and beyond, we expect capital spending to be back in our 3% to 5% of sales range. In addition to spending on this important organic project, we used cash in the quarter to pay down $20 million of debt and return almost $6 million to shareholders. Our capital deployment priorities remain unchanged. We look first for attractive organic investments and value-adding M&A that can provide the highest returns, while also ensuring we continue to provide a consistent, meaningful return of cash directly to shareholders through an attractive dividend and share repurchases. With that, John, you want to take it back?

Sure, thanks. Three months ago, I described the first quarter as a steady as you go start to the year and we continued this solid performance through the first half. While the economic environment and market demand hasn't been particularly robust, our competitive positions are strong and we're executing in the areas that can provide added growth for many years. These include building, literally, our U.S. transportation filtration presence, expanding in premium packaging, and strengthening our global position in performance materials. At the same time, our teams are delivering on our acquisition commitment while maintaining focus on the basics, maximizing top-line growth opportunities while managing costs and asset returns. Looking at the second half of the year, our annual maintenance downs will occur, as usual, in the third quarter and we anticipate an incremental cost impact of up to $4 million. As a reminder, we experience seasonality in technical products, with typically 10% lower sales in the back half of the year. Input prices are projected to trend modestly upward and, as mentioned earlier, non-capitalized expenses for the filtration project will also increase as we anticipate $2 million of spending in the second half and we will complete spending on integration with $1.5 million in the back half. These items will be partly offset by up to $4 million of lower SG&A spending. In addition to organic initiatives, M&A will continue to be part of our long-term growth strategy. Our bias is finding and growing defensible performance-oriented businesses. And we will continue to be selective and disciplined in our approach. We recognize that the size and timing of acquisitions are difficult to predict, but to save you the question, our efforts remain active with dedicated resources and our pipeline remains solid. As always, we will communicate any progress or change in status when it is appropriate. In the meantime, our strong balance sheet and sizable cash flow provide us the flexibility to act not only on M&A, but on a variety of actions that can provide value for Neenah shareholders. Neenah has become a specialty materials company focused on profitable niche markets, and we remain very excited about our future. We have a sound strategy with leading positions in our core categories, a wide array of capabilities, and a strong financial position. Most importantly, we have dedicated and talented employees that have proven they can execute again strategic initiatives that drive value. I believe our consistent results over the past consecutive quarters are the best illustration of the improvement in value our teams can deliver. Thank you for your interest this morning, and at this point, I would like to open up the call to questions.

[Operator Instructions] Your first question comes from Dan Jacome of Sidoti.

Yes. Appreciate the time. So just trying to get this, put my arms around this. So the incremental cost for this Appleton project, is this all, everything you're telling us, is this in line with what you guys had planned six months ago or 12 months ago or was there some incremental creep-up in planned start-up costs?

No, Dan, this $3 million is the same that we have guided every time we have guided. There is no change in Appleton. The spending, the capital spending is more this year, but in total we have always communicated that we expected to spend between $70 million and $80 million and so our total spending is consistent with that, too. We are just spending it sooner.

Okay, got you. Okay. And then, lastly, the new Board of Directors member, that looks very encouraging. Does Mr. Cook have transaction experience? I don't know if you can elaborate on that. M&A transaction experience?

Yes, if you look back through Donaldson's history of growth, you will see a very impressive track record there. So while his pedigree is very impressive, you should talk to him in person. He is even more charming.

Yes, I would love to. Okay, fair enough.

[Operator Instructions] The next question comes from Frank Duplak of Prudential.

Good morning. As you think about the ramp of the transportation filtration capacity, should we think it is a relatively straight line over five years or do you think you fill up a decent-sized chunk of it right away and then gradually from there? I am just trying to figure out what might the impact be on cost as we think about the out years.

Frank, that's a great question and this might come across as a little flip, but it will be zero at the beginning and full in five years. The market is going to determine a lot of it. I can tell you 2017, because of the long qualification, typically up to a year in qualification six months to a year, 2017 is going to be a slow start if you're looking at the revenue generating capacity that comes off of there. Our expectation is that we will have a nice slope after that. The initial bump, we are going to capacity balance our global system, so we will be moving some of the demand that has been satisfied from Bavaria to the U.S. in 2017, most likely beginning in 2018 as well. That will free up capacity in Bavaria to support the continued growth with our key customers in Europe. As a reminder, we have a 42 share there, so we want to make sure that we continue to outperform the market in Europe. So there will be bumps and what we will try to do as we go through this process is keep everyone up to date on that loading. What I am encouraged by is the customers' enthusiasm. What I want to be able to see is their approval of the qualification of our products and of the orders coming in, then I will feel a lot more confident, but I am optimistic. How about that?

And would you think it would just be, as we roughly think about it, would it be a breakeven to the EBITDA? Do you think it will be a little accretive or could it actually be a slight headwind on the cost upfront?

In 2016, or 2017, rather, because of the start-up costs and the extended qualification period, we expect there to be a loss on the start-up. So what we have done is we've basically looked at the financials. This is a good returning project over its lifetime, but we need about 30% capacity utilization to break even. We don't expect to be at 30% in the first year.

There are no further questions in queue. I will now turn the call back over to Bill McCarthy.

Okay, thank you. I feel like I should ask a few more questions since we are out here, but I won't. But I will note that for those listening that may attend conferences that in the second half of the year we will be presenting at the Jefferies Industrials Conference in New York next week, at KeyBanc in Boston in September, and finally at Baird's Industrial Conference in New York in November. So that concludes our call today and we will look forward to updating you in November. Thank you.

Thank you. You may now disconnect.