NewMarket Corp (NEU) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the NewMarket Corporation fourth-quarter 2005 and year-end financial results 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)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Fiorenza, Vice President and Principal Financial Officer of NewMarket Corporation.

Thank you for joining us to discuss our fourth quarter and total-year 2005 performance. With me today are Teddy Gottwald, our CEO, and Warren Huang, the President of Afton Chemical Corporation, our Petroleum Additive Company. We each have a few planned comments, after which we will open the lines 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 balance 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.

For an overview, the year 2005 was a good year for NewMarket Corporation, and included many achievements and continuing challenges. Petroleum Additives' net sales surpassed the billion dollar mark, while achieving improved earnings in a very competitive market.

We paid off all of our bank debt and have begun building cash for future opportunities. Our TEL segment had good results within its declining market, and our credit rating was upgraded during the year by Standard & Poor's.

I will now turn to a discussion of our two segments, starting with tetraethyl lead, or TEL. Most of the TEL business activity is through the agreements with Octel, under which we do not record the sales transactions. We do sell some outside of those agreements. Our total operating profit for the TEL segment includes the profits from our agreements with Octel, as well as certain other operations not included in those agreements.

The operating profit contribution from our marketing agreements were $23 million in 2005 compared to $33 million in 2004. As expected, volumes declined when comparing the two periods. Volumes were 27% lower in that comparison. Pricing did improve year-on-year. Additionally, amortization of the prepayment for services was about $1 million lower in '05 than in '04.

These are not enough to offset the decrease in shipments. The decrease in volume shipped was primarily the result of one of the major TEL customers under the agreements discontinuing use of the product. As we have stated many, many times, the TEL market will continue to decline as customers discontinue the use of the product.

The loss from the other TEL operations that were not part of the marketing agreements was about $9 million unfavorable when comparing 2005 to 2004. The large variants are primarily due to onetime events related to certain insurance settlements.

The 2005 results include a special item of $4 million for an insurance settlement gain, while the 2004 year included a special item gain of $12 million from an insurance settlement. The 2005 item happened in the second quarter and was previously communicated.

Turning to Petroleum Additives, net sales for Petroleum Additives in 2005 increased $182 million, or 21%, over 2004 levels. The increase is across all product lines. Shipments were about 7% higher than in '04, with the increases being in the industrial, engine oils, and fuels businesses. Price increases and favorable foreign currency impacts also contributed to the higher net sales.

The components of the Petroleum Additives increase in net sales of $182 million were about $80 million due to increases in shipments in product mix, with the remainder due to price increases implemented to try to recover the increase in our raw material costs.

Petroleum Additives' operating profit improved by 19 million over last year. This represents a 44% increase. The increases were primarily in the industrial engine oil and fuels product lines. Overall, the [increasing] operating profit of 21% higher net sales and 7% higher shipments.

For the calendar year 2005, the impact of increases in selling prices that we were able to achieve during the year were roughly sufficient to cover the increases of raw materials in that year.

Total R&D expenses were $65 million, both in '05 and '04. We continued to spend at a high rate to meet the very demanding needs of our customers and the industry in which we participate. All the R&D expenses for NewMarket Corporation are related to the Petroleum Additives segment.

SG&A for Petroleum Additives were about $2 million higher in '05 than in '04. As a percentage of net sales, SG&A combined with R&D was 13.2% in '05, compared to [15.8%] in '04. The improvement in the percentages when comparing each of the years reflect larger increases in net sales as compared to the smaller increases in SG&A and R&D.

I will now cover a few items not specifically related to segments. We did have quite a few nonrecurring or special items of note in 2005. Net income from special items was 8.7 million in '05, and included gains on the sale of property, settlement of insurance issues, and the benefit of tax settlements with the IRS. Special income in 2004 was 8.4 million, and represented a gain on insurance settlement. Under the terms of that settlement, we received the final payment of $4 million this month.

Interest and financing expenses were $17 million in 2005 compared to 18 million in 2004. Lower average debt resulted in a $1.6 million reduction in interest and financing expenses, while higher average interest rates resulted in an increase of about $800,000. Fees and amortization of financing costs were $600,000 lower in 2005 compared to '04.

Income tax expense was $15 million in '05 compared to $12 million in '04. The effective rate was 25.6 in '05 and 25.9 in '04. The effective tax rate in each year reflects certain foreign and other tax benefits. Additionally, the '05 rate included the favorable impact of about $1 million from the settlement of certain tax years with the Internal Revenue Service.

Looking at cash flows, we generated cash from operating activities of $64 million in 2005. We realized $14 million in proceeds from the sale of corporate assets, and we used these assets, these proceeds, as well as the cash flow from operating activities, to fund $18 million in capital expenditures, pay off our outstanding $30 million of bank debt. These items resulted in an increase of cash of $28 million on our balance sheet.

Included in the '05 cash flow from operating activities were collections of $4 million related to the 2004 insurance settlement and $7 million from the 2005 insurance settlement related to certain environmental liabilities. We also paid $12 million to fund our pension plans.

We ended the year with relatively high accounts payable as compared to last quarter. This increase is mainly due to the timing of services and products received, and we expect that it will revert to more normal levels during the first quarter, thereby being a use of funds in that quarter.

We expect the first quarter will have other significant uses of funds as we pay our taxes and other items that are due the first quarter. We expect that free cash flow will be in the 40 to $50 million range for '06, but once again, that will be impacted by our working capital needs.

For the last few quarters, we have been in the leverage range where debt reduction is no longer a priority. We have begun building cash as we continue to review other investment opportunities and alternate uses of that cash.

In summary, for the year 2005, excluding certain items that I just discussed, our earnings were $33.7 million, or $1.95 a share, which represents a significant improvement over earnings on the same basis last year of $24.7, million or $1.43 a share.

As we look forward, we expect TEL will earn less in '06 than in '05 and will continue to be a declining contributor to the profit of the Corporation. This is a volume-driven expectation as this product continues to be phased out around the world.

We expect that Petroleum Additives will earn more in '06 than '05 as we continue to bring value-added solutions to our customers. I would like to turn it over to Warren.

Good morning. Just to hit a few high points on the Afton side. Last year was full of challenges. I feel I have dodged a couple of bullets. Two devastating hurricanes [forced] material from several of our suppliers and a huge run-up on raw material costs, just to name a few.

I am happy to report that despite all these challenges, we have been able to keep our customers fully supplied throughout this difficult period. We are very proud of our supply chain organization. In addition to keeping our customers happy, they set many production records and did it in a very safe and efficient manner.

On the sales and marketing side, we launched a number of new products and continue to expand our sales coverage around the world. Our strategy is twofold. Cost management in the commodity area through reformulation and new component introduction; and growth through product differentiation in the specialty area, where margins are higher. As David reported earlier, we grew volume by 7% in '05 and improved upon our mix as well.

Looking ahead, high costs of the raw materials plus the recent sharp rise of freight and energy costs continues to be a major concern for us. We have instituted multiple price increases in '05, but have yet to restore the margins to the level we used to have prior to the cost run-up. We were hoping that the rate of increase would slow this year, but early signs are not encouraging. A major supplier of base oil just introduced a record price increase effective February 1.

Basic chemicals that we buy continue to move up in price, chemicals such as polybutene, maleic anhydride, [ethylene ammo] and alpha olefin. It is obvious to us that we have not yet seen the peak of the cost runup.

On the R&D front, I just want to say that we have invested heavily in research and development in the past and we will continue to do so in the future in order to meet new technical requirements in automotive designs and to be in step with our customers' desire, to be market innovation leaders.

Last year was the first full year of Afton's operation. As we stated before, the holding company structure will provide a better focus and greater accountability for Afton's operations, and our results have proven that. We are confident that we have the right strategy and our focus on providing value-added solutions to our customers will allow us to continue to grow our business.

Thank you. I will turn it over to Teddy.

Thank you, Warren. I would like to turn to NewMarket now and our overall strategy. David mentioned our success in paying down debt over the course of 2005. We are in a strong financial position today, with net debt being less than 1.5 times our cash flow, and we expect to continue to generate quite a bit of free cash.

Our overall strategy has not changed from what we have been communicating with you over the last year or more. It is our intent to leverage our financial strength to grow the business, with acquisitions being our preferred route. While we are looking at numerous industries, our primary focus in the acquisition area remains on the Petroleum Additives industry. In today's M&A environment, looking close to home provides the greatest opportunities for good return on investment while minimizing the risk.

As before, I want to emphasize patience here. We have plenty of internal opportunities to fuel growth in the near term. We will wait and we will make the right acquisition for us. We just can't afford to get it wrong, and we're not going to jump at the first acquisition that comes our way.

With 150 million in bonds that are not callable until next year and with excess cash building up, we are considering a full range of uses of cash. We announced last month that our Board has approved stock repurchases up to $50 million, and our Board continues to study the resumption of a dividend program.

We will be studying a range of other investments as well, and we will balance all of these options with the likelihood of acquisition activity and decide on the best course of action to increase shareholder value.

I am very pleased with the performance of our Afton and Ethyl subsidiaries and I look forward to an exciting and challenging year in 2006.

Thank you, Ted. That is all our planned comments. I would like to open lines now for questions, if there are any.

(OPERATOR INSTRUCTIONS) Alex Goldman, Morgan Stanley.

Congratulations on a solid quarter. I was wondering if you could break out the sales growth in Petroleum Additives for the fourth quarter. You were kind enough to provide rough guidelines for how it breaks for '05, but how does it break out between volume, price and FX in the fourth quarter specifically?

I didn't bring that with me. I will have to get back to you on that. I just did it for the year.

Okay. Well, I guess more sort of more broader picture speaking, could you give us some understanding of what is driving such strength in that business? For three quarters in a row now, you have had sales growth of over 20%. Has there been some sort of a step function in the way that business grows? Are you winning share or is it mostly pricing that is being implemented to offset raw material cost increases?

We have a number of factors to end up with a strong quarter and strong year. We launched several new products, as I said earlier, that is certainly gaining additional market share for us. But we also grew -- several of our customers are really having a strong year in sales, and so we grew with them as well.

Then on the profit side, you have to understand that we're running a fairly high rate now, so the marginal additional volume, that has a bigger impact in general for us. I hope that answers your question.

Well, can you give an understanding of how much are new products accounting out of this -- in the fourth quarter, I'm calculating 28% sales growth. So I am trying to understand how much of that is driven by these factors that you have mentioned.

I guess we didn't count on it going into the further detailed discussions. But it is really hard to break down because some of our customers took us into the new areas, and is that additional market share growth in existing market space or is it a new market area? But we're solidly happy with the results.

The other thing to remember is that last year's fourth quarter was, in my view, an abnormally light quarter, especially from profit side. So all of these comparisons may be a little difficult to be making.

What I'm calculating for the fourth quarter of last year was sales growth of about 13%, which, at least historically speaking, is actually pretty strong. Have we moved away from Petroleum Additives growing volume-wise in low single digits or is it something unusual that's going on for the past year or so?

Our view of the Petroleum Additives industry growth rate is still -- globally is still pretty low, around 1 to 2% range. And clearly, that last year was a little bit unusual in that we did grow with our customer, we did (indiscernible) a couple of big accounts and we launched several new [haulouts].

So it certainly doesn't indicate that the market is expanding at [twice] the rate than we saw before.

Would you expect Petroleum Additives' volume growth to return to historic trendline in '06? Or do you expect this above trend strength to continue into next year as well?

We expect that the industry will return to the historical growth rate level. But I talked a little bit about our strategy and we certainly could expect to grow a little bit better than that. But generally in the new area, new product area, with additional new product launch.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) Bob Robotti, Robotti & Company.

I guess I am kind of following on the same kind of question, actually. And I guess what you actually did say is that in '06 you expect industry growth to slow down in terms of volume, but you are actually thinking that you're going to grow above industry rates.

My recollection is actually last year, in terms of volume of course, was a really phenomenal year -- like the '04 year, I thought you were up in terms of volume kind of midteens. So 7% has already shown that it's kind of moderating some.

Would you expect the '06 growth rate in terms of volume would be equal to, better than, worse than -- how would it compare it with the '05 year?

Let me just clear up one thing. We believe the industry rates are in that 1 to 2% range, have been and will be. We're really just talking about our rates, right? It really depends on the success of our customer. I know Warren said it. We're out there trying to help them differentiate.

Our expectation is we'll beat the industry average next year, but no comment on how we'll do relative to the 7% this year.

I guess one of the things you did say this year is that not only was there growth in volume, but as importantly, the mix has improved. Would you expect the same thing too? Does the trend for at least the short-term foreseeable future speak to somewhat better growth in the industry and also continuing improvement in mix?

Yes. That is our strategy. That is our plan.

One of the things you mentioned was that, of course because of the continual cost increases during the year, you have had a number of price increases, attempting to restore the historical margins in the business. What have been the historical margins that at some point you had hoped to be able to get back to a point where costs do moderate and you may be able to achieve that?

I think when we make those comments, Bob, we're looking in the '03 timelines, where before this rapid runup. But we did not have a specific 0.X% in mind. But we are looking back to the pre-runup of raw materials. And we looked at -- '05 just kind of balanced itself.

So therefore, if you're saying look back at the '03 kind of financials, when you say margins, what is the kind of margins that we as outside investors should use -- kind of what it was?

Bob, it's all over the place, because mix changes. But when we talk, we typically talk about gross profit as a percent of sales.

Because it would seem as if, all things being equal, to get back to where you were at the '03 would actually be a little bit of a disappointment, because you've got higher volumes so you're going to have better throughputs, better absorptions. And of course you mentioned that there's been a continual product mix improvement. Some from those points of view, here I am sticking an extra burden on you, right? So not only should you get back to where you were in '03, but there's some expectation you can actually do somewhat better than that, given (multiple speakers).

You said it better than I could have said it. That is accurate. That is exactly accurate. We are talking about -- when we talk about margins -- just recovering the raw material run-up. And then you add on everything you mentioned.

In the TEL business, could you help me understand the part that is not affiliated with the Octel joint marketing agreement? It would appear as in this quarter, of course -- the fourth quarter -- there were almost no direct sales. You only had 300,000 or so, and that was down from 2 million, 2.8 billion, 3.5 million.

It would look as if the expenses for that segment or what is not attributable to the alliance, therefore, is directly picked up someplace, runs 4.1 million, 4 million, 4.3 million, 4.9 million. Is that -- what are the dynamics? Is that the way to think of that? And what happened in the fourth quarter, is that a continuing thing?

Because as you pointed out, the direct profit this year was actually a loss of close to $9 million. And I guess last year, since me it was a decrease of about $9 million, that means it must have about broken even last year. I don't recall the numbers.

So what should we kind of expect on a go-forward basis, or are there certain legacy expenses that really are part of what's going on there in terms of what the direct loss is?

The best way to look at it is a bigger slice of the time than quarters. There is really no meaning when you compare a quarter three to a quarter four and try to make a comment on a volume. Look at it as a year is the best way to look at it.

And there are legacy costs associated with that business that go to the other part. And then there are support costs of running that business that go to that. And our strategy in that area is to try to whittle those costs down over time. And its sales are into areas not covered by the agreements, which is North America.

So what you're saying is the abnormality quarter-to-quarter really is just a timing difference in shipments. So [really you] can look at the annual revenues of 8.5 or so million. And that number also is probably -- is that declining too or is that a kind of constant number or is that market kind of a flat market?

That market is typically the aviation and a few other ones, and it is a relatively flat to slightly declining market.

Do you have any kind of guidance on the expenses in terms of how much might be legacy expenses and how much that loss -- would you expect to lose more money on the direct sales in '06 than '05?

In a macro sense, I would not.

The tax rate, as you pointed out, there were a couple benefits this year. And it has been lower, and obviously in the fourth quarter, was significantly lower -- I guess to catch up for the full year. What would you look forward to the '06 year being like there?

We've been telling you to use 37 or so, but probably 33 is a better number. We have R&D tax credits, we have foreign source income and so forth. So 33% is the answer to your question.

Okay. Lastly, on cash flow, you do say for the full year maybe 40, 50 million. That is after a CapEx number, I'm pretty sure -- right?

That is correct.

Then what you do say is but at least in the first quarter, it would seem as if some of that is going to be absorbed by working capital changes.

That is correct.

For the full year '06, what would you expect working capital -- would it consume much cash flow or would it at the end of the year kind of moderate or what's the expectation there?

Is tied to the comment Warren made earlier that just when we thought things slowed down on raw materials. So if raw materials keep running up, Bob, we will wind up the year with more accounts receivables, etc.

So we are going to a period planning working capital will be neutral on an annual basis, and then we close it out wherever it winds up.

What was the full year '05 on a working capital basis? Did you use some capital for that, some cash?

I recall that Accounts Receivable went up a fair amount, but inventories went down. So I think it was pretty close to a push for the whole year.

That was kind of what my thought was -- that you actually didn't actually consume it in the year in which you had rising costs, and obviously, you did a great job to not have working capital -- use of part of the capital.

That's right. But remember, it wasn't smooth.

I know, at the middle of the year, it really ballooned up and then came back down in the third quarter.

That's correct.

Thanks a lot.

(OPERATOR INSTRUCTIONS) Ladies and gentlemen, there are no further questions at this time. I will now turn the conference back over to your hosts to conclude.

Thank you very much for attending and we'll talk to you next quarter.

Thank you. This concludes today's conference. All parties can disconnect now.