Neptune Insurance Holdings Inc. (NP) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Tonie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper Third 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, November 9, 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 welcome to Neenah's 2016 third quarter earnings call. With me today are John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. As usual, John and Bonnie will discuss business activities and financial results in detail, and following these prepared remarks, we will open up the call for questions. But first, I’d like to start off with a few summary comments and reminders. We released earnings yesterday afternoon, reporting record third quarter revenues and profits. Sales of $233 million were up 1%, while operating income of $27 million increased 10%. GAAP earnings per share of $0.95 increased 22%, and after excluding integration and restructuring costs, adjusted earnings per share was $0.99, up 11% and also a third quarter record. Integration and restructuring costs totaled $1.2 million, or $0.04 per share, and were primarily related to last year's FiberMark acquisition and non-capitalized costs for our U.S. filtration investment. This was down from similar cost of $2.9 million, or $0.11 per share, last year. These costs are adjusted from earnings to aid in understanding results and improved comparability between periods. As a non-GAAP measure, we reconcile these to corresponding GAAP figures in our press release. Finally, our comments today may include forward-looking statements, risks and uncertainties that could cause actual results to differ from these statements, are noted in our SEC filings and on our website. With that, I'd like to turn things over to John.

Thank you, Bill. The third quarter was another solid quarter, as we continue to support our customers and maintain our leading market positions. Our managing cost to deliver consistently improving bottom line results. Top line growth rates moderated as we lapped last year's acquisition and we continue to invest in future growth, including U.S. transportation filtration capacity and value-adding premium packaging capabilities. Operating income grew 10% in the quarter with higher sales. Operating efficiencies and lower input and integration costs, excluding integration and restructuring costs, adjusted operating income grew 3% with higher margins in each of our segments. Growth continues to be led by technical products with increased demand from backings and filtration. Higher profits, coupled with improved management of working capital, resulted in operating cash flow of over $40 million, up 16% or $6 million versus last year. We continued to deploy cash in accordance with our priorities, with spending on organic investment to expand filtration, increased cash returns to shareholders and reduce debt. As always, we are mindful of deploying capital in a manner that continues to deliver an attractive double-digit return on invested capital. Our balance sheet is very strong with plenty of available financing capacity and we continue to pursue strategic investments that will strengthen our businesses and provide attractive returns. I'll comment on progress against a few of our major initiatives later. But first, Bonnie will review our quarterly financial results in more detail.

Thanks John. As noted earlier, our results were a third quarter record, helped by the acquisition and related synergies, as well as continued growth in technical products and cost management across all of our businesses. As a reminder, in the third quarter of both years, we had scheduled annual maintenance downs at most of the mills. I'll start today with Technical Products, which continues to perform well and deliver good results, with 5% top line and 17% bottom line growth versus last year. Sales were $114 million, split between performance materials and filtration. Growth was led by increased volumes for transportation filtration and for tape and abrasive backings. Backings growth reflects our success in growing share as we manage this business more globally. And transportation filtration growth in the quarter was led by double-digit increases in North America and Asia, but partly offset by weaker demand in Western Europe. Overall we saw strong volume growth in Technical Products. In addition, average selling prices were lower, mostly due to mix, but also due to price decreases for grades with adjusters that are tied to input costs. Currency also had a small negative impact for the quarter. Technical Products’ operating income of $14 million was up 28% from $11 million last year. After adjusting for integration and restructuring costs in both periods, operating income grew 17%. Higher income resulted from volume growth and lower manufacturing costs, the latter due to material prices, acquisition synergies and operational efficiencies. Combined, these more than offset the lower net selling prices and added SG&A from acquired operations. Finally on that, operating margins also continued to improve in this segment and were up versus last year by more than 100 basis points in the third quarter. Turning to Fine Paper and Packaging. This business delivered strong and consistent earnings, while continuing to face secular pressures in some of its markets. Third quarter sales were $113 million, which was 3% below the last year's all-time record. Mix presented a significant headwind in the quarter, as customer inventory management decisions reduced sales of branded commercial print products. However quarterly volumes were the highest of the year as sales of premium packaging and non-branded grades grew. Operating income was $17 million, slightly ahead of last year. After excluding integration costs in both periods, adjusted operating income was down 3% as impacts from the lower sales and mix cannot be totally offset by improved manufacturing costs and reduced SG&A. Consolidated SG&A spending of $21 million was similar to last year, reflecting timing differences of certain expenses. In the fourth quarter, and on average, we continue to expect to spend around $24 million per quarter and we previously indicated that number. Unallocated corporate costs were $4.6 million compared to $3.6 million last year. Results include non-capitalized costs related to transitioning of the fine paper machine to a filtration asset. These include things like training, trials, grade transfers and other one-time expenses. As we've indicated, these costs will total around $3 million this year. In the third quarter, costs were $800,000, and fourth quarter costs are expected to be around $1.5 million. Net interest expense of $2.7 million decreased from $2.9 million last year as a result of lower debt. That was $211 million at the end of the quarter, down $8 million from June and down $30 million from September of last year. Turning to taxes. Our effective tax rate was 32% in the quarter, well below the 37% rate we had in the third quarter of last year. Two things impacted this comparison. First, last year's rate was unusually high due to an adjustment made to estimated tax credit. Second, a rate in 2016 was reduced by approximately 1.7 percentage points with the adoption of ASU 2016-09, which requires excess tax benefits from share-based payments to be reported as reduction in tax expense. We also recast our year-to-date results for this, which increased previously reported earnings per share for the first six months by $0.04 due to the lower tax rate. Cash from operations was a very strong $41 million, reflecting good business results and improved working capital management, partly offset by higher contributions for post-employment benefit plans, while planned contributions are expected to be higher than last year. They remain well below previous years, as we've been able to offset increased cash taxes with lower pension contributions. Our U.S. defined benefit pension plans remained in very good shape and are over 90% funded. Cash payments for all post-retirement plans are projected to be $14 million this year, which is about $2 million more than expense. So as John mentioned earlier, we are deploying cash in a balanced manner, and in ways that can generate the best returns for our shareholders and maintain an attractive return on capital. In 2016, our largest use of cash has been for organic capital to expand transportation filtration capacity to meet growing global demand for our products. Spending begin in 2015 and also represents the majority of the $75 million of capital we expect to spend this year. Third quarter capital spending was $21 million and we're projecting $25 million in the fourth quarter. After this, we expect to return to a normal annual spending range of 3% to 5% of sales. In addition to organic capital, we used cash flows in the quarter to pay down debt and to increase returns to shareholders. Dividends and share repurchases combined were over $8 million, up 14% from the prior year. In addition to being thoughtful with our spending, we continue to maintain a very strong balance sheet. Our debt to EBITDA ratio is below 1.5x and we are well over $125 million of borrowing capacity on our existing credit lines. I'm pleased to note that S&P recently updated our outlook from stable to positive. I believe this revised outlook reflects the progress we've made through the years in diversifying our portfolio in growth areas like filtration, performance materials and packaging, while also increasing the size of our company. With that, I'll turn it back to you John to wrap up.

Thanks, Bonnie. I'll start with a few comments on the current business environment and then provide an update on a few key initiatives. Global economic growth remains subdued and input prices are expected to remain fairly consistent, likely drifting up as we head through 2017. As a reminder, the fourth quarters are seasonally slowest period as customers take downtime for holidays and control year-ending inventory levels, as they approach their fiscal year end. In Technical Products, for example, sales are typically 10% lower than the back half of the year versus the first half. Turning to our acquisition of FiberMark. This is now been successfully integrated into our businesses. The last two major activities were adding them to our ERP platform, which we completed in early October, and initiating the planned consolidation and closure of a small converting facility in Reading, Pennsylvania by mid-2017. Both of these initiatives deliver attractive returns. And in the fourth quarter, we expect to book approximately $1.6 million of one-time charges related to these efforts. While the integration is now essentially complete, can expect us to continually look across our company for ways to further improve efficiencies and optimize our footprint. As I've mentioned before, one of the most attractive aspects of the acquisition was its growing premium packaging business. We not only expanded our existing packaging portfolio, but also quite significant new coating capacity, as well as finishing and prototyping expertise. We complemented these capabilities with a new design center based here in Atlanta, where we work directly with customers on ideation and execution of new product opportunities. Recent examples include a new holiday gift card offering and high-end spirits package, just in time for the holidays. Growing premium packaging is a key initiative for Neenah. To-date, we've build a share of around 15% narrowly focused in premium niche verticals of beauty, alcohol and retail products. Besides this addressable U.S. market at approximately $450 million and see attractive opportunities to grow annual at double-digit rates as we expand our market offerings and grow share. Our goal over time is to offset secular pressures in fine paper, ultimately transforming this segment into a growing business. As you’re well aware by now, a key initiative of Neenah is to expand our global presence in transportation filtration. This is our fastest growing business and we've earned a market leadership position in Europe with our innovative high-performance products, consequently with global customers looking for us to continue to support their growth efforts and the fact that we are nearing capacity at our manufacturing base in Southern Germany. We undertook a highly technical but capital efficient project to convert an existing fine paper machine into filtration. To support that conversion, we're replicating the advanced solid saturating manufacturing capabilities that we’ve refined in Europe to make the same winning products here in the United States. This project is nearing its scheduled completion and is expected to start up very early in 2017. With increasing market demand, our German transportation filtration capacity has now been fully consumed. Our investment will provide the necessary capacity to support future growth, not only in the U.S. but also in Europe and Asia. Customers continued to be extremely supportive of our investment commitment and we're working closely with them on both the initial qualification plans as well as future projects. All that activity explains why we remain confident and excited about our ability to grow our global share with them. As I mentioned in our last call, with most defensible technical businesses, qualification periods are lengthy. Consequently we expect a large majority of time in the first half of 2017 to be spent on non-salable qualification runs and production trials with our customers. Since our existing qualified capacity is now full, our teams are working relentlessly to overcome capacity constraints in the first half of the year, as well as minimize the anticipated cost impacts. With start-up trials and new U.S. support team and depreciation, we are currently projecting an operating loss on this investment of around $4 million next year, inclusive of approximately $2 million of non-cash depreciation expense. These upfront costs are typical with this type of investment, and as we've indicated, this project has an attractive double-digit return and is much more capital efficient than an acquisition or greenfield. We will ramp up in a disciplined fashion with added sales of approximately $10 million to $15 million next year, somewhat below our historical filtration growth rate due to near-term qualification requirements and capacity constraints. We fully expect to consume the added capacity over the next five years with the end-of-curve sales of $80 million to $90 million and the investment turning profitable in 2018. Importantly, this will further solidify Neenah’s position with our customers as a global transportation filtration player and pave to the runway for future growth of this very profitable business. While organic initiatives like these remain our highest priority, M&A continues to play an important role in our long-term growth strategy and we continue to pursue growing a defensible performance-oriented addition. Our pipeline remains very active, and as always, we’ll communicate our progress when it’s appropriate. In summary, I'm extremely pleased with the ability of our teams to consistently produce meaningful results from our businesses. Not only have they delivered value from recent acquisitions, but they simultaneously acted on the multiple initiatives and priorities that continue to enhance the value of Neenah. We are successfully executing our strategy to grow as specialty materials company, focused on profitable niche markets, with leading market positions, a broad array of customer value capabilities and a very strong financial position. Confident that our dedicated and talented employees will continue to deliver, added value for Neenah and their shareholders. Thank you for your interest this morning. And I'll now open up the call for questions.

[Operator Instructions]. We'll pause for just a moment to compile the Q&A roster. And our first question comes from the line of Dan Jacome from Sidoti & Company.

Good morning. John O’Donnell: Good morning, Dan.

Sidoti is here. Just a couple of questions. First, John I appreciate all the color on the Appleton project, and it sounds like well expected maybe near-term speed bumps with the qualification process and production trials. Is everything you say kind of still assumed that you'll be at a 30% kind of capacity utilization rate in year one, or has that changed at all? John O’Donnell: Yes. So I think what we've said in the past, 30% is a right number. That's really where we say the project in some terms is profitable. And our expectation on 30% was really - it certainly moved into 2018, but you're right that 30% is that magic number.

Okay, so 2018, 30% operating rate. And then on the Fine Paper, I know you mentioned some of the mixed pressures. Can you just give us a little bit more detail on that? It sounds like - if I'm correct that might be the same thing you’ve seen in the last couple of quarters? John O’Donnell: Yes. Now I consider this quarter - and we had one of the highest volumes that we’ve had on this year overall. So it really became a very much a mix. Our most profitable portion of our mix in Fine Paper is our in-the-stock item. So we had significant inventory reductions, if you will, as a couple of key customers and I would consider to be more a quarterly timing not necessarily an annual issue or something that I would look at as being systemic. So I think the revenue demand for the Fine Paper business has been fairly consistent. I was just trying to explain the color for the quarter but not cause any alarm or concern.

Got you. Okay, great. Appreciate that. And then lastly, liquidity is in great shape. The FiberMark has been fully integrated. Have you guys seen anything change? Just kind of very high level thoughts on the M&A landscape, maybe conversations or what the pipeline looked for you guys, as after - I know in your terms focus to the Appleton, but just kind of thinking longer term, has anything changed on your views there and just on the landscape or so? Thank you. John O’Donnell: Yes. And Dan, I would be disappointed if you didn't ask me that each time. But yes, that you're exactly right. It's an important part of our growth. As we've said in the past, that dedicated resources, we continue to - and we are not driven by timing. We are driven by the right fit for the company. So what hasn't change is M&A is going to be important part of our growth strategy. We are biased towards technical specialty materials businesses, filtration specialty in that regards. And then I’ll communicate as quickly and as robustly as I do when we find something that I want to share. But no, it hasn't changed. It's very important. Okay?

Yes, thank you. John O’Donnell: Thank you, Dan.

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

Good morning, guys. Thank you for taking my questions. I jumped in a little bit late. I was just wondering if you could give us an update on the planned conversion of Wisconsin, and if the slowdown in North American auto sales has impacted on your planned there at all? John O’Donnell: Yes, I think the largest impact that's going to be on our Wisconsin are our U.S. addition of capacity is going to be what the customer qualifications, not any near-term consumption issues. Still see a great deal of support by our customers. 2017 has gone to be that transition year. But what we communicated in our prepared remarks was it's a very good project, one better than a greenfield or an acquisition, but in technical businesses there is customer qualification period. So you should expect to see next year we communicated roughly $4 million impact with $2 million of it non-cash depreciation expense. And the first half of the year - if I were giving color, I would say the cost implications of 75% are going to be the first half of the year and the revenue that we communicated which 10 to 15, 75% of that is going to be in the back half of the year as you would surmise as we work with customers to get qualified.

Great. Thank you very much. John O’Donnell: So I hope that gives you a color.

You bet. It does. That’s helpful. Thanks. John O’Donnell: Yes.

And there are no further questions.

Good. Okay. I'd like to thank everyone again for their time and interest in Neenah. And one note and one final forward-looking statement that John, Bonnie and I will be in Chicago tomorrow presenting at the Baird Global Industrials Conference. That concludes our call today and we look forward to updating you again in February.