NewMarket Corp (NEU) 2005 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NewMarket Corporation Second Quarter 2005 Financial Results Earning Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. [OPERATOR INSTRUCTIONS]

It is now my pleasure to introduce your host, Mr. David Fiorenza, Vice President, Treasurer, and Principal Financial Officer of NewMarket Corporation. Thank you, sir. You may now begin.

Thank you for joining us to discuss our second quarter performance. With me today is Teddy Gottwald, our CEO and President. I have a few planned comments, after which we’ll open the line for any questions.

As a reminder, some of the comments we will make today are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We believe our statements are based on reasonable expectations and assumptions within the bounds of what we know about our business and operations. However, we offer no assurance that actual results will not differ materially from our expectations due to uncertainties and factors that are difficult to predict and beyond our control. A full discussion of these factors can be found in our most recently filed 10-K.

I’m going to focus the majority of my comments on the segment presentation that’s included in the press release. You may note that the second quarter of 2004 segment operating profit is different from what was within last year’s 10-Q. This is to reflect the current charging of certain costs that we now operate as a holding company. The adjustment had no effect on net income.

Second quarter 2005 net income was 13.1 million or $0.77 a share compared to net income of 11.4 million or $0.67 a share for second quarter of ‘04. This year's results include the benefit of 2.5 million or $0.15 per share from an insurance settlement. Excluding this benefit, second quarter 2005 results would have been earnings of 10.6 million or $0.62 a share.

Net income for the first half of the year, which also included the benefit of the insurance settlement, was 17.8 million or $1.05 a share, while net income for the same period last year was 17.2 million or $1.02 a share. Excluding the benefit of the insurance settlement, earnings for the first half of 2005 would have been 15.3 million or $0.90 per share.

As you know, we report on our business in two segments. The contract manufacturing and other classification in our segment operating profit presentation primarily represents certain manufacturing operation that Ethyl provides to Afton. Those charges did not exist prior to the formation of the holding company. So to get the best view of petroleum additive performance, that should be taken into consideration.

The following comments pertain to petroleum additives. Net sales in the second quarter of this year were 269 million, which were up 51 million or about 23% from 218 million in the second quarter of ‘04. Shipments for the second quarter increased about 13% in this comparison. The increase in shipments was the result of significantly higher shipments in the engine oil additive product line. Shipments in the other product lines were generally unchanged in this comparison.

Selling prices, which were higher in the second quarter of ‘05 than the same ’04 period, as well as favorable foreign currency impact, resulted in higher net sales between the two quarters. The six month comparison, petroleum additives had sales of 506 million, which was 73 million or 17% higher than the comparable period last year. Total shipments increased 6% when comparing these periods. Again, higher shipments from increased engine oil additives was the major contributor. Shipments in the other product lines were about even.

Similar to the second quarter, higher selling prices and favorable foreign currency also resulted in higher net sales. Petroleum additives’ second quarter 2005 operating profit was $17 million, compared to 17.3 for the second quarter of last year or about flat. While net sales were higher, unrecovered rising raw material costs, as well as small increases in selling, generally administrative expenses, resulted in the operating profits being generally unchanged. Raw material costs have continued to increase since June 30 of this year and we’re currently attempting to recover the most recent price increases in the marketplace.

Petroleum additives’ six month 2005 operating profit was 26.8 million, compared to 30.2 million for the first half of last year. Continuing the trend from the first three months, net sales were approximately 17% higher, in shipments, about 6% higher. Despite the favorable trend in net sales, operating profit for six months was lower due to unrecovered raw material costs as well as increases in SG&A and R&D. We have been successful in increasing prices during the first six months, but the rising cost of raw materials has outpaced our [southern] price increases.

Turning to TEL, as you know, most of the marketing activity is done through marketing agreements with Octel where we do not record the revenue. So the revenues we record are those that Ethyl Corporation makes in areas not covered by the marketing agreement. TEL sales for the second quarter in six months were lower than the same periods of last year. These changes were caused substantially by variation in quarter-to-quarter timing.

The operating profit from our marketing agreement for the second quarter was 6.8 million, which was 3.9 million lower than the second quarter last year. Similarly, six months marketing agreement results of 13.3 million were 4.8 million lower than six months of last year. Both period comparisons reflect improved pricing but volumes were 40% lower for the second quarter and 31% lower for the six months. The decrease in operating profit from the marketing agreements is primarily due to lower shipments. During the second quarter, Octel advised us that one of the major TEL customers under our marketing agreements has indicated that it has discontinued the use of TEL earlier than we previously expected. As a reminder, the TEL market will continue to decline as other customers discontinue the use of this product.

Other TEL operations not included in the marketing agreements were 4.3 million favorable when comparing the second quarter of this year to the second quarter of last year and 3.1 million favorable when comparing six month periods. Both the second quarter and six months include a special item of $3.9 million before income taxes for insurance settlement gain related to our premises asbestos liability. The other TEL operations for both the second and six months also reflect lower expenses for premises asbestos charges relating favorably impact of the change in the expected future expenditures in this area.

During the second quarter, we entered into an agreement with the Travelers Indemnity Company resolving certain long-standing issues regarding our coverage for certain premises asbestos claims. Our previously-filed lawsuit against Travelers in the Southern District of Texas was dismissed. In addition, we settled our outstanding receivable from [Albermoral] Corporation for premises asbestos liability obligations. As a result of the insurance settlement described above, the outstanding amount owed to us by Albermoral is now 1.4 million, compared to $4 million at year end. The 1.4 million is scheduled to be paid to us by Albermoral during the third quarter of this year. These settlements resulted in a gain of 3.9 million or 2.5 million after taxes, which is included as a special item this quarter.

Both the second quarter of this year and last year we had interest expense of 4.5 million, which was basically unchanged. Income taxes were 5.7 million for both the second quarter of this year and last year. The effective tax rate this year was 30.4% and last year’s effective rate was 33.4. R&D tax credits were the predominant reason for the change in the effective tax rate.

Taking a look at cash flows, cash at the end of June was 30.5 million, which was an increase of 2.7 million from year end and included a 3.4 million negative impact for foreign currencies. Cash flows from operating activities for six months were $8 million. Included in the ’05 cash flows from operating activities were collections of 3.7 million related to the 2004 environmental insurance settlement, as well as 6 million from the 2005 insurance settlement I just discussed. Cash flows from operating activities for this period also included higher working capital requirements, predominantly accounts receivables.

At the end of June, our debt was at a 188.1 million, which was an increase or is an increase of 3.7 million since the end of ’04. We funded 7.1 million of capital expenditures through the first six months and we estimate our spending for the year will be in the $20 million range. We had working capital at the end of June of $253 million, compared to 220 million at year end. The major portion of this increase is in accounts receivables. Our past dues and DSOs have improved slightly. So this increase is due to increased business activity and price increases.

Looking out, petroleum additives, the segment performed well in the marketplace in the first half of this year as evidenced by a significant revenue and volume gains when compared to the first half of ’04. Unfortunately, when the profits for the two six month periods are compared, the negative impact of rising raw material costs and the lag associated with recovering those increases in the marketplace continue to obscure those favorable accomplishments. Since the end of the second quarter, there has been another round of raw material price increases and once again, we are in the marketplace attempting to recover those increases. As you know, this business cycle results in higher working capital and has reduced the amount of cash we have available for debt reduction. We continue to expect that the operating profit for petroleum additives will be higher in ’05 than in ’04 for the total year.

Looking at TEL, the segment had relatively good performance in the first half of ’05. We believe profits in the second half of this year will be significantly lower than the first half of this year. The anticipated decline in profitability is volume driven and we expect that TEL will earn less in ’05 than in ’04 for the total year.

And lastly on cash flows, as I’ve talked about before, as our revenue grows from both business gains and price increases, working capital needs have increased significantly, mainly in accounts receivable. While our cash generated from earnings remained strong, the working capital increases have lower our free cash flow. We now expect that our debt reduction capacity from our operations will be in the 25 to $30 million range for the year.

That concludes my planned comments. I’d like to open the line for questions, please.

Ladies and gentlemen, at this time, we will be conducting a question and answer session. [CALLER INSTRUCTIONS.] Our first question is coming from [Alex Goldman] from Morgan Stanley. Please proceed with your question.

Hi. Good morning, guys. Just a quick question on your-- on the pricing in petroleum additives. When you look at some of the factors that inhibited your ability to catch up to raw materials, what would you say were some of the most important ones? Is it just timing or is it some market dynamics that are adding to that as well? And when do you expect to catch up to the raw materials curve in the market.

This is Teddy. I’d say that it’s certainly-- it’s mostly a timing issue. Raw materials have just continued to go up at a pace quicker than we’re able to pass those increases through. I think we’ll catch up when we see raw materials increases slow down and stabilize. Raw materials are still going up. I’d say they’re not going up at the rate that they’ve been going up, but we’re still seeing an increase. But it’s our view that we will catch up here in the second half.

Okay. And on a separate topic, when I tried to take out the settlement benefits from the income statement and just look at the operating performance, I get a tax rate of about 28 or so percent. First of all, I just want to confirm that that’s in effect correct and just to follow up on that, what should we see as a tax rate going forward?

I think you did the arithmetic right and we’re looking at probably 30% effective tax rate for the total year.

And what allowed you to lower you tax rate sequentially? I think it was about 31% in the first quarter.

It really bogged down to the calculation and the research credit as the main variable. As we spend and we qualify for more credits, we take advantage of them.

Okay, and one last question. Can you sort of update us on your acquisition strategy and progress in that respect?

Sure. Our strategy remains the same. We’re looking primarily at businesses or technology closest to what we do. Our willingness to lever up depends quite a bit on how much we know about the business. The closer it is to us, the more we’ll lever up to accomplish an acquisition. I don’t have anything new to report to you. We continued to look around. We continue to broaden our search beyond just a traditional fuel and lubricant additive arena, but our preference would be to stay close to home.

Great, thank you very much. I’ll get back in the queue.

Thank you.

[CALLER INSTRUCTIONS.] Our next question is coming Omar Jama of Merrill Lynch. Please proceed with your question.

Good morning. I want to try to understand your working capital position a little bit better. I mean, it seems like just a huge amount of cash has been tied up in working capital over the last few years. And just looking at your 10-Q, your payables actually declined from, I think, from the beginning of the year, but your receivables are up something on the order of 20 million. Can you talk about who-- what kinds of customers are the-- I assume it’s fairly large oil companies and other people? Can you talk about the mix of your payables and your receivables and why the performance has been so poor there in terms of not being able to keep cash flow-- flat cash situation?

Sure. This is David. If we just look at receivables or talk about receivables for a minute, we-- as most companies, all companies do-- we track past dues and days sales outstanding very closely. And compared to December, our past dues have improved and our days sales outstanding have improved. So what does that mean? That just means the volume of our revenues is what’s driving the receivables. We typically have 55 days of sales out. And as price increases go up and as we have to charge more for our products, that’s driving that 23 million round numbers of accounts receivables. We have no bad debts for all practical purposes and we deal with major customers who pay their bills and they pay them on time. So this is just the business volume.

Payables, it just comes and goes. It’s when we get the product, when the 30 days are up on that one. There’s no particular message on payables. We ran inventories up pretty high last year and when inventories go up, as you know, your payables go up. But we’re doing a good job of holding payables-- inventories flat to down this year so I would expect some use of cash from the payables come down associated with that.

Okay. Now, 55 days sales outstanding--

Right.

I mean, your customers have very deep pockets. Why is it necessary for them to take 55 days to pay you? And is there any kind of a benchmark in the industry for what’s an acceptable-- that seems like an extremely high level--?

No, it’s not high at all and there are a lot of benchmarks and we follow those. That’s a worldwide average. You get into some parts of the Far East, you might have 90, 120 days. No, I think this is typical for our business.

Are you making any efforts to reduce that or are you happy with that level.

We’re making efforts to reduce it, yes.

Okay. Okay, thank you.

You’re welcome.

[Bob Robatti], [Robatti and Company]

Hi. Sales in the quarter, the volumes, was there-- do you anticipate or do you think there was any inventory build so therefore, stealing from kind of future quarters?

I don’t think so. We don’t really see that in the pattern.

And what kind of volume outlook do you kind of see going forward through the balance of the year and then subsequent years also?

Well, you know, second quarter is generally a good quarter, Bob, from a volume standpoint. So something off of the second quarter is the kind of volumes that we’re looking at.

Of course, the last two fiscal years and so far this year volumes have grown year-- on a year-over-year basis. Do you see that-- I would imagine that trend of growth is going to slow down because that’s one of the issues also that’s consuming all the cash, as you, right, have the benefits. But the working capital [quorums] associated with that, there’s a little bit of a drag currently.

Well, it’s hard for me to tell the business guys to slow down and draw on their volume because accounts receivable didn’t run up. But Teddy’s got a comment [inaudible].

Yes, I think for the year we do expect volumes to be up in the double-digit range. Going forward, I don’t expect that to continue. I don’t expect to see the same kind of growth we’ve had over the last couple of years. We do have growth ambition but it’s targeted and it’s not as great as what we’ve seen. And from a practical standpoint, we don’t have the capacity to keep growing at that rate.

Could you actually speak to that issue? I guess, of course, Lubrizol in their comments did make mention of some sale volume increase they got from a competitor having problem with its capacity. I’m assuming since your volumes were up, that obviously was not you but some other competitor. And then they also made the comment that they were operating what they think is the operating [inaudible, audio issue] capacity of their business. How do you see industry capacity? It seems to me as if it must be kind of favorable and, as you say, that’s given some constraints. And what’s the outlook? Is there anyone who is talking about adding capacity, therefore, put that at risk on a go-forward basis?

I think that the capacity utilization in the industry is higher than it’s been in a number of years, certainly higher than it’s been since the last major plant was added back in the ’98 timeframe. So that’s good news for the industry. I don’t see us being short on capacity as an industry. There’s some short-term issues right now that’ll work themselves out. And then I think I would expect that most of the players have an ability to debottleneck selectively to handle industry growth. Keep in mind, too, that one of the big variables in this industry on capacity utilization, unlike a lot of industries, is what’s happening with technology. And as we continue to develop new products, we’re all trying to do better with less. We’re all trying to meet specs with better chemistry that requires less of it and when that happens, you effectively get a boost in capacity.

So I don’t expect that we’re going to tighten up to the point of seeing major expansions, but I know we have-- we’re looking a lot more at debottlenecking than we have in some time.

And lastly, people was asking about the receivables and the working capital buildup. On the inventory side, I guess David made reference to, of course, that at the end of last year, you actually built inventories kind of in anticipation of potentially raw material increases and maybe other factors, operating factors, too, and I guess maybe the switch from engine oil. But where does-- it seems though you’ve done a great job in the inventory side that you haven’t needed to increase working capital this year with higher raw material cost, therefore, clearly you must be doing something positive there. Is that temporary and for the balance of the year is there a risk that really that inventory starts to go up, too, and is going to consume some capital or do you think that you’ll be able to fight that battle and win it and keep that as is?

Well, there’s a couple of elements to that-- probably two key elements. One, one of the big drivers in us building inventory at the end of last year was the end of a long supply relationship on the BI improvers side where we had to build inventory to affect a switch of supply there. That’s a one-time issue. The other thing is we are and have been for some time actively working on improving our internal processes to control inventory, to plan better, and we’re applying the same efforts to receivables, too. We’ve got some internal room to get better at what we do to improve our working capital.

And lastly, is there-- on product pricing is there some metric you use because I guess I’m kind of looking at, of course, the operating profit on EBITDA basis to sales and, you know, is up slightly this quarter. It’s still, I imagine, low historically; definitely it is low historically. Is there a goal that you mange to when you change prices that is kind of the EBITDA margin number? And if so, what do you think the business, you know, looking out a year from now, what’s the right profitability margin on sales? Because you’ve clearly done a great job in growing volumes and that the top line is growing and capturing that benefit is one that-- a moving target. But I imagine at some point you would anticipate things stabilize, as we say that, of course, it takes longer and longer, but what’s your views on that?

Well, primarily we’re trying our best to recover raw material increases in the marketplace. Those are quantifiable and we are raising prices accordingly to capture those increased costs. That’s the main driver and our margins vary tremendously from one product line to another. We do have general targets in each product line of where we like to see the profitability and they do vary quite a bit. And so I can’t tell you what our overall margin goal is because the mix is just going to have such a big impact on it. It’s not a number we can manage to.

Then, of course, leads me to when you address the mix issue, I guess it seems to me as if you probably has improved over the last couple of years. So maybe more than volume trends, it’s mixed trends. Do you anticipate that continuing to be the case that you have newer products that have better margins in them, that have better growth prospects to them and therefore, does that change the margin over time?

We’ve been successful in some of the more specialty product lines and growing volumes, but we’ve been successful across the board. It’s really our goal to attack the margins in each product line, the good margins, the bad margins. And we’ve got a big multiplier in terms of volume and revenue on our engine oil business where the margins are not particularly attractive and we’ve got a lot of effort underway to improve those.

Okay, great. Thanks.

Thank you.

Alex Goldman, Morgan Stanley

Thank you. I just want to follow up on the pricing issue. If I sort of do a rough estimate and sort of break down the sales growth in the [polymer] additives business, it appears that prices were up probably about 9 or 10% in a year-over-year basis. Can you sort of tell me whether or not that’s sort of in the ballpark and can you give us some indication in terms of how much the prices change sequentially versus the first quarter?

You’re 9 or 10% is right. I don’t have the answer to over the first quarter at my fingertip, but I know where we’re at in the marketplace in the second quarter with another price increase. But I don’t have that.

Okay. And can you give us dollar value in terms of how far you are behind the raw materials curve?

Before the last round of price increases, I was looking at 200 basis points behind, in that ballpark. So on 200 million of sales, 4 million, but I was comparing that to the first quarter of ’04. You know, obviously it matters what you pick as your peg point.

Sure.

And then we had another set of increases, so.

It’s a moving target.

Right.

So do you think now it’s more like 300 basis points or is it bigger than that?

We’re not going to know until we get through the marketplace, so.

Okay.

It’s a bigger number, yes.

Okay, thank you very much.

[CALLER INSTRUCTIONS.] Our next question is coming from [William Blackenburn], a private investor. Please proceed with your question.

I had heard the head of Corning mention that their research has invented a process that greatly reduces diesel emissions. If diesel fuels were much more widely used someway down the road because this invention proved successful, would there be a considerable pickup in additive sales by a company such as yourself?

There’s a lot going on around the world in terms of regulation on emissions. We in America hear a lot more about the gasoline side but there’s a lot-- the diesel side is getting a lot of attention as well. General rule of thumb, the tighter the regulations are on emissions, the greater the opportunity for the additive industry to provide the solutions to those problems. So yes, I do see growth ahead in the fuel additives area and a lot of that is being driven by tighter regulation.

Let me go on and ask this. I’m from Connecticut and I notice when I pump gas that right on the pump it says that we have an ethanol blend. The energy bill boosts the use of ethanol nationally by 2012. If the petroleum is a lesser percentage of my gallon of gasoline-- that’s not the right way to say it. Well, if--

Sure.

Yes, I think maybe that is the way to say it. If ethanol becomes a greater percentage of a gallon of gasoline, is there room for more additives to be sold for corrosion purposes, rust purposes, the octane purposes or do you lose the opportunity to add to your additive sales?

I think there maybe a net increase there but it’s nominal. But the bigger issue is ethanol fuels, other alternative fuels, generally they have their own set of problems and in general they still require additives to help solve those problems. So we have products today that work in high-ethanol fuels. We’re constantly watching the future trends in automobiles and in fuels to be prepared as the market changes.

Thank you.

Thank you.

[Tom Ferguson], [KDP Advisors]

Hi guys. I’m wondering if you could give me a quick education on your raw materials cost profile. I’m assuming that oil is the biggest variable? What others should I be looking out for and tracking and how do you guys hedge them?

Well, most of our large raw materials are petrochemical-based. We don’t buy crude; we buy a particular refined cut called [grace oil]. There’s no available direct hedge for our basket of raw materials and that’s true for us as well as our competitors in this industry. Our larger purchases are base oil, polybutine, maleic anhydride, and some anti-oxidants and a range of others.

Okay, thank you.

Thank you.

[CALLER INSTRUCTIONS.] There are no further questions at this time. I would like to turn the floor back over the management for any additional or closing comments.

Well, thank you for your questions today and have a good day. Bye-bye.

Ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.