Neptune Insurance Holdings Inc. (NP) Q4 2016 Earnings Report, Transcript and Summary

Good morning. My name is Crystal, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper 2016 Fourth Quarter and Full Year 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 conference is being recorded today, Thursday, February 16, 2017. Thank you. I would now like to turn the call over to Bill McCarthy, Vice President, Financial Analysis and Investor Relations. Please go ahead, Mr. McCarthy.

Good morning, and thank you for joining Neenah's 2016 fourth quarter earnings call. With me today are John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer. I’ll start up with a few summary comments, and then John and Bonnie will review financial results and progress against key initiatives as well as thoughts on our 2017 outlook. Following our prepared remarks, we will open up the call for questions. We released earnings yesterday afternoon, and reported record profits for the quarter and full year. Quarterly operating income of $22 million was up 5% earnings per share of $0.95 grew 12% helped by a lower tax rate. Revenues in the fourth quarter of $221 million fell 4% although more than half of this was related to a surge in 2015 sales in our other segments prior to exiting parts of this business in December 2015. On an adjusted basis fourth quarter earnings of $1.10 per share increased 21% compared with $0.91 per share in 2015. We reported adjusted earnings to aid in understanding and comparability of results and reconcile these to corresponding GAAP figures in our press release. In the fourth quarter of 2016, adjusted earnings excluded cost of $4.1 million or $0.15 per share primarily for a FiberMark facility closure, pre-operating expenses for the U.S. Filtration project and a pension settlement charge. In 2015, fourth quarter earnings were adjusted $0.06 per share to exclude integration and restructuring cost of $3.6 million and $1.1 million of tax credits related to prior year periods. Finally, I’ll note that our comments today 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, good morning. As Bill noted, the fourth quarter marked another strong quarter of earnings closing out the year where we grew topline by 6% and adjusted operating income by 13% and adjusted earnings per share by 23%. While inclusive of an acquisition and a lower tax rate, our organic businesses also continue to perform well, maintaining their leading market positions as the teams work closely with our customers and carefully managed costs. During the quarter, we completed a number of important strategic initiatives that will help us further add value. Our capital project to add transportation, filtration capacity in North America was completed as planned in December. We are now manufacturing samples and beginning the six to 12 month qualification time lines of our key customers. In addition, the FiberMark integration was completed with implementation of our ERP system at their sites and the refinement of our expanded asset footprint. As part of this we rebalanced production and closed a small converting facility in Reading, Pennsylvania. These actions in addition to enabling future growth have delivered acquisition synergies earlier than planned how to generate record cash from operations and maintain their attractive return on invested capital. As you should expect we continue to deploy capital in accordance with our stated priorities. First, investing in high returning organic investments like adding filtration capacity in North America. Second, pursuing acquisitions that add value. Next, supporting our shareholders with attractive returns, through increasing dividend and opportunistic share repurchase. In fact, in November, we announced our seventh double-digit dividend increase in the past five years. Finally, using remaining available cash to reduce debt. I’ll talk more about our 2017 activities and expectations later in the call, but first Bonnie will cover 2016 financial results in more detail. Bonnie.

Good morning. As you will hear the fourth quarter and for that matter the full year were both very positive for Neenah. Starting with technical products, sales were $104 million, down 3% versus the prior year. We continued to see solid volume growth in categories like transportation, filtration and backings although these were offset by growing currency headwinds and reduce shipments and label, water filtration and other specialities. Sales and these other categories were down in the quarter, in part due to the timing of customer orders. Turning to the bottom line, technical products, operating income of $12 million and adjusted operating income of $13 million were both equal to last year. Adjustments to income in 2016 were largely for FiberMark facility closer, a portion of which also went to Fine paper. Fourth quarter results benefited from lower input cost in SG&A spending that were offset by the lower revenues and less favorable mix. Adjusted operating margins in the quarter continued to improve and for the full year exceeded 14% up from 13% in 2015. In Fine Paper and Packaging our team closed the year with impressive results. Revenues were $112 million, just short of last year’s record quarter and driven by 3% growth in shipments. We saw a strong growth in non-branded grades sold direct to customers, increase sales with key brands like Environment and ROYAL SUNDANCE and consistent growth in premium packaging. Our consumer business also had a solid quarter with continued strength in customers like Amazon and Walmart. Volume growth in the quarter was offset by a lower price but value adding mix, mostly due to increased non-branded sales. Operating in the fourth quarter was a record $18 million. This was up 16% versus last year as benefits of higher volumes, lower input costs and reduced SG&A more than offset the lower value mix. Adjusted operating margins were 16% both for the quarter and for the year. As noted in both segments SG&A spending was lower in the fourth quarter and consolidated spending of $20.4 million compared with $24.9 million in 2015. The lower spending in 2016 included benefits from synergies but was more impacted by timing differences for items like advertising and incentive accruals. On average, we expect SG&A spending to be around the $24 million per quarter we previously communicated. Unallocated corporate costs were $6.6 million compared $4.8 million last year, results included higher and non-capitalized costs as we completed our project transition to fine paper machine to filtration as well as an $800,000 non-cash pension settlement charge as we cost effectively eliminated about $9 million of pension liabilities through a lump sum buyout of deferred – purchases. Excluding onetime cost in both years, unallocated expense went [Indiscernible] $4.6 million in both 2016 and 2015. Going forward, we expect unallocated cost average $4.5 million to $5 million per quarter. As Bill noted, net sales of our other segments declined significantly from $10 million in 2015 to $4.5 million in the fourth quarter of 2016. Just as a reminder, the other segment includes products which are dissimilar in nature from these or those that are reflected in our primary two segments. The decline was due to higher sales in advance of the December 2015 Fitchburg mill closure and exit from certain product lines that were produced there. Excluding integration cost in both period and adjusted operating loss of $600,000 in 2016 compared to operating income of $200,000 in 2015 with the decline primarily as a result of lower net sales in 2016. For the full year EBIT was breakeven and we expect to continue to operate at that breakeven level next year. This business does provide positive variable profit contribution and helps us absorb fixed costs. Fourth quarter net interest expense of $2.8 million was equal to last year. Year end debt was $221 million down $8 million compared with prior year. The majority of our debt is at a fixed rate of 5/4%. However, with rising interest rates we expect interest expense on short-term debt to increase modestly in 2017. Tax rates were low in the fourth quarter in both 2016 and 2015 at 14% and 20% respectively. In 2015 the lower tax rate was due to recognition of a full year of R&D tax credit after this credit was permanently approved by Congress in December of 2015. In 2016 these credits were recognized throughout the year. The low rate in 2016 reflected both reductions in reserves for uncertain tax positions and excess tax benefits related to stock compensation that’s under ASU 2016 - 09 are now deducted from tax expense and recognized in the periods they are incurred. Under this new accounting standard, quarterly rates will be impacted positively or negatively based on two types of stock compensation events. Vesting of performance stock units that occurred in the fourth quarter of each year, and the second one is exercises of stock option at the time that they occur. The amount of any gain or loss will be influenced by the difference in the stock price when these awards are tested or exercised compared to the value when they were granted. Understandably, our ability to predict a magnitude of any impact by quarter is pretty difficult. In 2017, we expect our average tax rate to be 32%, including the effects of stock compensation events. This is up from the 29% rate in 2016, largely due to changes in income mix. Our cash tax rate should remain around 20% for the next couple of years as we consume our remaining R&D credits. Cash from operations in the fourth quarter was $18 million, this is down from $32 million in 2015. This was primarily due to increased cash contribution to past retirement plan and differences in working capital. So starting with the post retirement plans, with expectations late last year of changes in discount rates that could lead to higher expense in 2017, we increased pension plan contributions in the fourth quarter to mitigate this impact and maintain our funding levels. For the full year cash contributions in payment into these plans were $23 million but with about half of that occurring in the fourth quarter. In 2017, we expect to reduce cash contributions and payments significantly to $16 million with any changes in expense getting minimal. In addition to higher 2016 retirement plan contributions, cash flows in the fourth quarter were impacted by working capital differences. In 2015, we had a large decrease in accounts receivables in the fourth quarter, partly due to sales in collections from the Fitchburg business that we exited, consequently cash flows from accounts receivable changes was about $10 million lower in 2016. In summary, 2015 was another great year for Neenah. We had record sales, adjusted EPS and operating cash flows. We completed integrating an acquisition that enhanced our capabilities and growth potential and delivered end of curve synergy a full year ahead of plan. We were disciplined and balanced as we deployed cash to generate the best returns for our shareholders and maintain an attractive return on invested capital. In 2016, we returned almost $40 million of cash to shareholders through our dividend and share repurchases, a 35% increase compared with 2015 and we also improved our [Indiscernible]. With that, I’d like to shift to our outlook as we look forward to 2017. I’ll start with comments on the general economy and then move on to financial items and then John will cover the business afterwards. Our two largest markets are the U.S. and Europe. GDP growth in both of these regions was subdued in the fourth quarter and there really are no indications that this will change significantly in 2017. What has changed is that the U.S. dollar projections are -- $0.05 to $0.10 lower in 2017. In our press release we dimension the impact from currency changes prior to any actions we may have available to help mitigate these impacts. Input prices have also moved up recently with increases in fiber, energy, latex and other materials. This could be a headwind especially in the first half of the year as this is typically a lag as we adjust prices. However, all of our businesses have demonstrated the ability to overcome changes in input cost overtime and that hasn’t changed. Finishing up with a few other financial items here’s a quick recap. SG&A averaging $24 million per quarter, including $4.5 million to $5 million of unallocated corporate expense. Annual interest expense increasing from $11 million to $12 million retirement plan contribution and payments lower by $7 million above tax rate of 32% and a cash tax rate of around 20% significantly reduced spending as we return to levels normal for us in this 3% to 5% range, roughly $40 million. And last but not the least, another year of increased dividends. So with that, I’ll hand things back to you, John to talk about other business items.

Thank you, Bonnie. Looking at our businesses, in technical products our performance materials should be poised for a solid year. We’ll continue to leverage our global footprint to serve our backings customers building on our 7% topline growth in 2016. In addition, we’re excited about new label products that we've got in the pipeline for launch in 2017. Overall, performance materials is positioned to grow at or ahead of our GDP plus growth rate expectations for these markets. Transportation filtration which is our single largest technical products category and Neenah’s fastest growing category is at the start of our very important year. In the fourth quarter, we successfully completed a highly technical but capital efficient project to convert on existing fine paper machine into a state-of-the-art transportation filtration asset and added a world-class solid saturating facility at our site in Appleton, Wisconsin. As previously mentioned, qualification periods are lengthy and with most defensible technical businesses and we expect the majority of time in the first half of this year to be spend on non-sellable qualification runs and trials. Initial results have been very promising and we’re now beginning to send samples customer for testing. On our last call we communicated and expected operating loss of $4 million, half being non-cash. That will be front-end loaded the first half of the year. We also noted added sales in 2017 will be $10 million to $15 million and should start to ramp up in the second quarter. Since the increased market demand for our products has now consumed our existing capacity in Germany, our teams are working to optimize the use of this new U.S. capacity. Plans include shifting production to Appleton of less technically oriented products with short qualification periods to free up capacity in Germany that can support the continued growth of our valuable European customers. And as always they will continue to pursue opportunities to minimize costs. The outlook for transportation filtration is very bright. Customers remain extremely supportive as product performance, quality and cost of the new line is anticipated to be best-in-class. In addition to supporting the growth of our customers, the investment provides us our shareholder with an attractive double-digit return. As mentioned in past calls we expect to fully consume this added capacity within the next five years within curve sales of 80 million to 90 million and current expectation that the business will turn profitable in the back half of 2018. Importantly, this investment further solidifies Neenah’s position with our customers as a premium global transportation filtration player and paves the way for continued growth of this profitable business for years to come. In fine paper, while secular market pressures are likely to persists, our teams work hard each year to find ways to offset business declines and 2017 will not be an exception. In the first quarter our commercial team will be refreshing CLASSIC, our largest and most recognized premium brand, customer enthused about the new colors and textures that will be available. We also working to expand distribution for consumer brands at key retailers. [A category] we are focused on is premium packaging, which expanded by more than 30% in 2016. That’s market is growing and is a key catalyst for this business helping to offset secular pressures in other areas. We continue to develop and expand our portfolio and see other attractive opportunities that can help us increase our shares at our planned double-digit pace. While organic initiatives remain our highest priority, M&A is also expected to play an important role in our growth strategy. Our teams have shown the ability to acquire a disciplined manner and integrate effectively to deliver promised financial returns. Our process and pipeline remain active as we continue to pursue growing in defensible performance oriented businesses, however timing is always unpredictable. In summary, I'm extremely pleased with how our teams have delivered value for our shareholders by consistently producing meaningful results. 2016 marked another very good year, and while 2017 like most years will certainly have its challenges; our leading market positions, broad array of customer value capabilities and very strong financial position lead Neenah well-positioned and stronger than ever to build upon our track record. Thank you for your interest this morning. And now I like to open up the call for questions.

Thank you. [Operator Instructions] And your first question comes from the line of Steve Chercover of Davidson.

Good morning, everyone.

Good morning, Steve.

Good morning.

Hi, Bonnie. So just a couple of questions from me. I just wanted first of all, little color on the decline on the label and water filtration, wondering if that's a timing issue or whether they might have plateaued?

Yes. Label, we’re very excited about the growth opportunity for label. I try to call that out. It’s really innovation revenue and R&D resourced and we expect that to continue to be a good growth platform for us. So label, I’m not too concerned with. The water filtration is tied really to a loss of a Chinese customer, which again as our teams are working hard to make sure that we have the right quality and prices associated with recapturing that business, but that’s probably a longer term. As a reminder, our RO business -- that was part of the $50 million in sales that we bought from cranium in 2014 and it was half -- roughly half of that business, not huge business.

Okay. Thanks for that color. And then switching gears, pulp prices seem to be gaining ahead of steam, so I just want to ensure that as you’ve incorporated that into the raw material inflation that you’ve mentioned and you expecting more or less offset that with cost and pricing, is that right?

Yes. That’s exactly right. As I’ve mentioned in the past, all of our business are expected to offset the impacts to our margins of input costs over time. Fine paper which has tendency being more list price, has already announced price increases that would come into effect in the first quarter. The technical products businesses have market pricing, cost escalators and then annual pricing programs with their customers, so they will be a recoup that over time and we are in fact see – we would be up at least $5 million to $6 million of input cost headwinds next year.

Got it. And then finally, the obligatory question on M&A. We know full well that you're looking, and then it won't be so. I’m just wondering are multiples are hurdle, can they still be accretive even if you pay multiple above your own trading multiple. And then finally just assure us that you guys haven't reached the size where getting, doing kind of needle-moving deals, you’re not too big at this stage?

Too big, I didn’t follow the first part.

Neenah hasn’t grown to the point where bolt on acquisitions aren't still substantially accretive? I think the answer is still said [Indiscernible].

You should hear the excitement in the building as we look at those. Now the bolt on acquisitions clearly are – under our considerations, absolutely whether its adds technology, new geography, new products or new customers to our base, so we’re clearly looking in those avenues, and we have a lot of activity that I can tell you from that standpoint. It’s important part of our growth strategy and one will continue to move forward. As far as what we pay, I think what we’ve demonstrated historically is that we’ll be able to communicate, while this is a value adding acquisition for Neenah in any condition where we bring it to marketplace. We’re not going to have any big surprise of a third leg [ph] that doesn't have a fit from that standpoint just required to acquire. I think what’s most important is that while we did four acquisitions of four years and 2016 was a first year that we did not. I keep reminding my organization it’s not about making an acquisition every years, its making a value adding acquisition that’s right for Neenah and we’re committed to doing just that.

Very good. Thanks John.

Thanks, Steve.

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

Good morning and thank you for taking my questions. Very nice quarter.

Thank you.

Hi, Jon. Thank you.

Hi, guys. John, you’ve mentioned a couple times you're currently add capacity in the Germany facility and growth could be limited as you wait for new products to qualify and kind of get up to speed. Is that giving you any ability to increase your pricing at all for the stuff that’s really coming out of that?

Yes. Let me clarify that little bit. We have one facility in Bavaria we made transportation filtration. We’re now going to have two facilities globally. So while we’re limited in our capacity in Germany we’re going to really use the new U.S. capacity where we can and I’ve mentioned in my prepared remarks to try to balance give us the opportunity to support growth in Europe as well as in the U.S. As far as pricing, this team has done a phenomenal job if you look at the margins of their business, making sure that they recognize what the market pricing is and they're getting paid for the for the high-end technical premium that we have overall. What’s really important and I want to share with the team is not having a moment of pricing accesses that we’re in this business for a very long time and we want to be a very solid supplying partner for our customers. So, we do look at pricing activity we have in the past few years continue to balance that. Where we’re limited our marginal products on those assets come under great deal of scrutiny whether we remove those or for move in pricing. But I think this category grows at 4% a year. We’ve grown at eight for the last 12 or 13 years. I feel very comfortable, we’re going to be able to continue to grow even in 2017 as we qualify at the market growth rate of 4%, so I don’t want anybody believe I’m late to the party. We are definitely happy with the timing of when we put this asset in. A longer answer than you [Indiscernible], Jon.

No, no. That’s all very helpful. I appreciate the detail. And then Bonnie just, could you clarify, I think you said something about $5 million to $6 million an additional input cost headwinds, was that across the whole business or just fine paper and technical products?

It was across the whole business and I said –

Answer that, but anyway.

But really we’re saying 5 million to 6 million and we’d look at probably 3 million in each half if you’re doing it or early loaded. And that’s across all the businesses.

Great. Thank you very much.

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

Good morning. How are you?

Hi, Dan.

All right. So, thanks for your time. Just staying on the topic, I guess, so the energy cost potential headwind, was that just natural gas for the mills or there’s something else there?

Yes. So natural gas is one for the energy side, and again if you think about our costs, the largest categories wood fibers. Second would be in latex for us which has had double-digit increases. And then third would be energy. But you're exactly right, the energy probably be natural gas, latex is having significant input.

So wood fiber – okay, on wood fibers did NBSK and hardwood use both, right?

We use both. More NBSK and technical products, more hardwood in the fine paper.

Okay.

It’s a soft wood.

Okay. All right. And then the price lag, I mean you get the – you’re able to pass through the cost, I get it. But how long is that lag against, particularly is it like or is it just a quarter, right?

No. I think what you’re remembering is that in our fine paper business, they were able to negotiate their pricing lag of a quarter on their wood pulp to ensure that they could get their branded or less pricing announced and through the system. On the technical side of the business that’s not the case. And technical has three pricing strategies and we can do about a third each because I’m a simple man. Third of them are market announced. Third of them have lags with cost increases. And then third of them are annual contracts that are negotiated with each customer in that standpoint. But again over time our expectation is and we demonstrated the ability to protect their markets.

That’s great. And then lastly, just in terms of fine paper, did you’re kind of like internal assumptions assumed that you will continue to have that – what’s happening now with the non-branded and the ASP, is that going to continue, is that kind of in your line of site or internal expectations?

Obviously, we value the branded.

Yes.

Value all of business, but value the branded and it’s a much higher margin, so I’d mentioned that we’re relaunching our CLASSIC, so yes, again with the branded business as you typically have new news from the market people, place, people can talk about it. As we grow packaging, packaging is typically not a branded product, its more customized product from that standpoint. So, it gets lumped into that non-branded category as well. Doesn't mean that they're not as valued and that's why we really want to make sure because the fine paper if you look at their trend of margin through input costs cycles, they’ve been staying at that mid-teen margin.

Yes. Now I just want to understand when we’re going to see kind of end to this, so you’re going to be introducing new CLASSIC product this year? Is that what you’re saying?

Yes. In the first quarter we’re launching the CLASSIC brand and again its largest and most valuable brand that we have in our portfolio. As again as we launch it to new and to distribution, they’ll carried out in the marketplace, create some energy, and usually have an element of a lift that had some stickiness to it. So we have some high expectations for that investment 2017.

Yes. That should be interesting, I think you guys, you and another are about – or you’re still at 70% of the U.S. premium paper market, right?

So it’s a very consolidated market as you highlighted from that standpoint and if you look at the U.S. I think two of us have probably closer to 90.

90, okay. All right.

I think 70 is pretty close to our share, about 65, 60.

Okay. All right. That’s it from me. Thank you very much.

Thank you, Dan.

Showing there are no further questions at this time.

Okay. Well, that concludes our calls this morning. Thank you everyone for your time and interest and we look forward to updating you on our progress later this year.