NewMarket Corp (NEU) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen. Welcome to the NewMarket Corporation's third quarter 2006 financial results conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Fiorenza, Vice President, Treasurer, and Principal Financial Officer of NewMarket Corporation. Sir, you may begin.

Thank you for joining me to discuss our third quarter performance. With me today is Ted Gottwald, our Chief Executive Officer. I have a few planned comments, after which we'll open the line for any questions. As a reminder some of the comments we'll make today are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We believe we base our statements on reasonable expectations and assumptions within the bounds of what we know about our business and operations. However, we offer no assurance that the 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. We intend to file our 10-Q next week, and we encourage you to read that.

Our net income for the third quarter was $19 million or $1.09 per share. This compares to net income for the third quarter last year of 13 million or $0.77 per share. Nine-month 2006 net income was $53 million or $3.05 a share as compared to 31 million or $1.80 per share for nine months last year. Both comparison periods had special income items. If we look at our performance excluding those special items, we have third-quarter earnings of $0.82 per share this quarter compared to $0.61 per share last year's third quarter. The nine-month comparison would show us earning $2.49 a share compared to $1.51 a share last year. That's a 65% improvement. We've certainly had a good year thus far.

The first nine months continued to reflect improvements in net sales, as well as operating profit across all petroleum additive product lines as compared to last year. We have a diverse portfolio of products that meet the growing needs of our customers and our successes reflected it. While the petroleum additives industry experienced rapidly escalating raw material costs most of this year, we have been able to manage the impact of these costs by increasing prices and by introducing more cost effective products. Our facilities are operating at high levels, and we're selling our product mix with higher margins. As expected, the tetraethyl lead segment results are lower than last year which reflects a significant drop in worldwide demand. Our balance sheet remained strong at the end of September. We have significant resources tied up in working capital in support of our business growth and continue to have no outstanding bank debt.

I am going to focus the majority of my comments on our settlement performance which is included in the press release. Petroleum additives. Net sales in petroleum additives of $324 million for this quarter was up 56 million or 21% from the same period last year. The mix of products sold contributed to the increase in net sales as did higher selling prices. The higher selling prices were the dominant factor which accounted for about two-thirds of the increase with the remaining one third due to change in shipments in product mix. We see a similar pattern for the whole nine months.

Sales were 948 million which is 175 million higher or 23% than nine months last year. The increase in shipments and sales was across all major product lines. As in the quarter, the year-to-date results, the improvements were about one third due to shipments in mix with two-thirds due to higher selling prices. Petroleum additives also showed significant improvement in operating profit when comparing 2006 and 2005 third quarter periods. The third quarter of 2006 operating profit was about $30 million compared to 17 million for the third quarter of 2005. The 2006 period includes a gain of 2.6 million pretax associated with a legal settlement related to transportation charges.

As we said, net sales were about 21% higher when comparing the third quarter. The higher operating profit resulted from several factors. Our production facilities are operating at high rates, and we're selling more efficient product formulations. These improved product formulations lower both our costs as well as our customers overall costs. These had the effect of showing us as having increased margins yet dampened our volume statistics. In addition to improving pricing, we're selling a product mix with higher profit margins. The improved pricing of products has contributed to the recovery of margins which had been depressed due to increases in raw material costs. Selling, general, and administrative expenses were $2 million higher when comparing the two third quarter periods. The increase was primarily the result of higher personnel costs and legal expenses. In addition, R&D expenses increased $1 million in the two third quarter period comparisons.

When we look at nine months, we see the same pattern repeated as we've seen in the third quarter. Nine months 2006 operating profit was $83 million while nine-months last year was 42 million. The nine-month period includes the gain of 2.6 that I just mentioned. The increase in operating profit was across all product lines reflecting improved net sales and profit margins. As I mentioned net sales were approximately 23% higher than the nine months 2005. While raw material costs have escalated in 2006, we've been able to implement certain price increases. These price increases have enabled us to mostly restore our margins that have been under pressure since the significant increase in raw material costs began in mid-2004.

In addition, as I just discussed, our production facilities were operating at high rates, and we're selling a product mix with higher margins. We've also recognized additional improvements in operating profit through the introduction of more cost effective product. SG&A expenses were 6.4 million higher for nine months of this year compared to nine months of last year. Similar to the third quarter, the increase was primarily due to higher personnel costs and legal expenses. R&D expenses also increased $3 million when comparing the two nine-month periods.

Turning to tetraethyl lead, the TEL sales for the third quarter were lower than the third quarter last year. These represent sales made in North America. Nine-month sales were essentially unchanged when comparing the two periods. The results of our TEL segment include the operating profit contribution from our marketing agreements with [Inospec], as well as certain TEL operations not included in the marketing agreements.

The operating profit from our marketing agreements for the third quarter was 3.2 million which was 3.1 million lower than the third quarter last year. Nine-month 2006 operating profit from the marketing agreements was 6.4 million as compared to nine months 2005 of 19.6 million. This year-to-date comparison is most important when trying to understand this segment. The 2006 period reflected improved pricing over 2005. However, this is more than offset by a decrease in volumes of 64% for the nine months 2006 when compared to nine months 2005. This represents another significant step function downward change in this product's demand. We expect that the volumes for this business will continue to decline over time.

Amortization of prepayment for services was approximately 4300,000 lower for the third quarter 2006 as compared to third quarter 2005. Profits from other TEL operations not included in the marketing agreements were 2.4 million lower this quarter compared to the third quarter of '05. And 3.4 million lower when comparing nine months. The nine months of 2005 results did include a special item gain of $3.9 million for an insurance settlement related to certain liability claims and policies. The other TEL operation results for both the third quarter and nine month period include charges for environmental sites and environmental reserves.

Special items income was 7.8 million for the third quarter of this year and 11.1 million for the first nine months. The 7.8 million includes a $5.3 million gain related to an earnout agreement for certain pharmaceutical intellectual property that we sold in 1995 as well as a 2.6 million gain associated with a legal settlement related to transportation charges that I also mentioned in discussing the petroleum additive segment results. Nine months also includes 3.3 million gain on the sale of some property that happened much earlier this year. The third quarter interest and financing expenses were essentially flat with the third quarter of last year. Nine months interest and financing expenses were about $1 million lower. The decrease primarily resulted the lower debt levels. We have no drawn debt under our revolving credit facility as I mentioned earlier.

Income taxes reflect an effective tax rate of 36.5% for the quarter and 35.8 for the year-to-date. This is a higher rate than last year mainly due to the fact that Congress has not extended the research and development credit beyond 2005. The rate was also lower last year because of the benefit of about $1.1 million that we received from the settlement of certain tax years with the IRS. Cash at September 30, was $87 million which is an increase of 30 million over December 31, of '05 and includes a $2.5 million negative impact of foreign currency translation. Cash flow from operating activities for nine months of this year were $43 million. We also realized cash loads of 3.4 million from the sale of corporate property and 5.3 million from an earnout of pharmaceuticals which we sold in '95. We spent 14.4 million on capital expenditures and funded dividends of 6.5 million.

Included in the 2006 cash flow were collections of 4.2 million related to the 2004 environmental insurance settlement and the 2.3 million of legal settlement of transportations. We've also seen an increase in our working capital. The increase in working capital primarily reflects higher inventories. The increase in inventories results from higher costs as well as an increase in volumes due to increased customer demand.

The Financial Accounting Standards Board recently issued a new ruling for accounting for defined benefit pension and other post retirement plans. This standard will require all companies that offer defined benefit plans to recognize the funded status which is defined as the difference between the fair value of the plan asset and the benefit obligation on the balance sheet. This change will impact us. It is effective with our next 10-K. While the actual effect of the standard is dependent upon a lot of variables that are not yet been determined as well as other assumptions that will be determined by the end of the year, we expect that we will have significant impact to our total assets, total liabilities, and total equity when this is implemented. At this stage we estimate the total liabilities will increase approximately $60 million, total shareholder equity will decrease approximately 40 million, and our deferred tax asset will increase 20 million. We do not expect the adoption of this standard to have an adverse effect on our compliance with any of our debt obligations.

Petroleum additive segment has posted excellent earnings during first three quarters of this year. The year-to-date performance is significantly ahead of the entire performance of last year. The outlook for this business remains strong. Our plants are running at high levels, and the overall industry supply/demand balance remained tight. Raw materials remained tight. To date we have seen only one small reduction in the pricing of base oils. We continue to work with our customers to develop and deliver cost effective solutions for their marketplace and believe our strategy is working.

Tetraethyl lead operating profit dropped significantly in the first nine months of this year. This segment will experience significantly lower operating profit this year than last and will become a less significant contributor to the overall performance of the Company. The reduction in operating profit is a function of lower demand around the world as all significant countries that formerly used this product have discontinued its use. That's all of my comments. Can we open the line for questions?

[OPERATOR INSTRUCTIONS] Our first question is from [Trace Snow] of Priority Capital.

Good morning. Regarding your price increases, are you still in a catchup mode on you are now sort of setting current base prices?

We believe we mostly caught up.

Mostly?

Yes. I mean just take it. We believe we've caught up.

Are you still raising prices in the fourth quarter? Or is it flattish?

There are some other price increases that will be implemented in the fourth quarter. Some things don't -- we may launch one in the third quarter and they take awhile to finish, so there will be some other price increases that will finish up in the fourth quarter.

Okay. And you mentioned on the profitability side of the additives business mostly price increases, but also a higher rate of production or utilization, I guess, and product mix. Out of those two categories, which one is more -- had more impact on profitability?

Which two you're referring to again?

The high rate of production, the production efficiencies or the product mix.

It would be product mix. We've been running at high rates for all year long, so that hasn't changed much during the year.

Were you running at a rate in the third quarter that was the same as second or a little bit higher?

Probably first, second, third quarters of this year all the rates have been very close.

Okay. And last question, I missed what you said again, on the inventory increase. Could you just review that again? That was a pretty big step up.

Yes. Inventories are up $30 million, and about half is due to just the price effect that things are costing more, and the other half is carrying more inventory as our business expands. Even though inventory turns may have improved, we still are carrying more inventory.

Okay. Have you increased your reserve at all?

No, we have not.

Great. Congratulations. Very good quarter.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question is coming from Robert Haley of Gabelli and Company.

Hi, gentlemen.

Good morning.

Just a couple of quick questions. I guess year-to-date the margin expansion on the additive side has really been stellar. As you said a good portion of that has come from a shift to lower cost, higher margin product. I guess I am wondering as we look out into '07, once that full shift has been implemented through '06, do you expect to realize continued benefit from those initiatives in '07 or would you expect it is fully phased in this year?

Very good question. Mostly phased in would be the bottom line. Our business isn't static, though. I was looking the other day, and in the third quarter this year we sold round numbers 800 SKUs and a couple years ago we sold 800, and only 70% are the same. But to answer -- the direct answer to your question is most of it has been phased in.

Most of it has been phased in. Okay. We've seen oil come off a bit in the last couple of weeks, and is doesn't look like you're getting any pushback yet on pricing. I am wondering if goal looking out over the next quarter and into '07 contingent on oil staying at this price, if you expect to give back any pricing or to feel some pushback there.

This is Ted. It is really hard to answer that question. We have seen as David mentioned one modest price reduction in base oil after a quite a large number of increases. Base oil is just one raw material that we purchased. But we're not seeing any relief on the chemicals side, and a number of chemicals are very tight in the market today, poly butane, amines, and alcohol being some good examples there. You would think that if oil, crude oil had pulled back, that ultimately that will have some impact on petro chemicals, but there are a lot of variables involved in the supply and demand balances of each of those chemicals as well as some uncertainty in what crude is going to do. We really don't have a solid view going forward.

Okay. It sounds like net/net you're not expecting any significant decline in pricing or any significant increase. Is that fair?

We haven't seen any indication of relief. We're hoping it will come, but yes, I think that's a fair statement. Compared with the last five quarters, we're seeing a slower rate of change to that.

Okay. And then I guess I was curious to know as we get closer to the January 1, 2007, full implementation of the new diesel standards, I haven't heard you talk much about I guess due products or new additives to service, that side of the market, and I was hoping you could shed some color on how you're approaching that?

I can comment on that in kind of a broader view on changing specifications on fuels and lubricants. I would include the growth of biofuels in this comment as well. These changes do impact us, but I see them at least all of the ones on the horizon as being incremental type of changes. I don't see any of them being step changes in demand or new opportunity for us.

Okay. Well, I guess what I am wondering is I know a certain portion of your business services the diesel side, and I know there is that shift over, so I guess what I am wondering is what portion of your revenue or your business on the petroleum additives side is at risk if you don't convert it over to this new product or these new specifications, and I guess what's being done on the product development side to protect that?

Well, we've generally done talk about what portion of our business is in the different categories. Our R&D is in solid shape today across the board, and we're prepared for all changes that we know are coming. Again, I just would go back to these type of changes being incremental, and not a step change in either direction.

Okay. So it sounds like as we head into '07 you're really not expecting any material increase or decrease in volumes based on that fundamental?

That's correct.

Okay. And just one last question. Your equity over the last couple of months has been really quite strong, and I was wondering with the currency this valuable, and a very conservative balance sheet, I was hoping you can shed some color on your M&A outlook? And it seems like you're in a pretty good position to go shopping right now.

Well, you're right, it is a nice position to be in for a change. We are quite actively searching for acquisitions. I have used the term in the past that we're patient, and I think that's still true today. Yes, our equity is a better currency today, and our balance sheet is quite strong. Our focus has been on areas where we can get synergy, on areas close to our business and we haven't had much success in finding willing participants in our area, and when we get beyond our area, I don't need to tell you how much money there is out there also looking for acquisitions and what multiples are today. We're not really anxious to get in a bidding war with other buyers. If we don't have an edge, if we don't have a bucket of synergy that we're looking at, and so we're just going to be patient while continuing to look within our industry, and any other areas where we think we can find synergy, otherwise we'll just wait until the overall M&A market conditions improve.

Okay. So it sounds like you're actively looking, but nothing imminent on the horizon.

Nothing imminent of any large size to speak of, yes.

Okay. Thank you for taking my questions. I will hop back in queue.

Thank you.

Our next question is coming from Jim Stanley of Merrill Lynch. Please proceed with your question.

Good morning.

Good morning.

I was wondering if you could shed a little more light on your outlook for '07. The previous caller was asking about the effects of different standard, trucking standards coming in. You said that would be incremental. What I am really getting at is this business historically has been a very lumpy business I think year to year. And for the past few years, if I am not mistaken, are the business has been sort of on a run volume wise. I am wondering what your thoughts are as far as whether there is any payback period or not at some point in the future with volumes for the petroleum additives business? Historically we've had up years and the next year it is down. So do you have any thoughts on that going into next year?

Yes. We're right in the middle of our planning process, but I will answer your question as best I can. You're right that there have been up years and have been down years. Our volumes have been relatively steady. The thing I would point you to right now is that the industry overall we believe is in a still a very tight supply/demand balance, and our margins as you know have restored -- but our margins are still below what we would consider investment return kind of levels, so as I look out with a big macro and not having done our AOP just yet, I don't see anything radically different when I look out near term than we're seeing right now.

On that note margin wise, I don't know if you have targets out there or not, but do you as far as what should the EBITDA margin be for the petroleum additives business or what are you aspiring to.

I have got to point you back to the comment I made a little bit earlier with literally 1,000 different products, we don't have a number we're shooting at. The last data we published I noticed we were operating profit as a percent of sales at 8.5, and also in the second quarter of '04 we were at almost 8%, so they've been down and they come back up, but I don't have an exact number for you.

Okay. I didn't know. Do you know where we stand, though from an historical standpoint as far as highs and lows of historical margins?

I was looking at something, and we're actually still below where we were in like the turn of the century 2000, 2001. We're below those levels.

Below those levels. Okay. Finally, maybe you mentioned this. I am sorry if you did. I got on the call a little late. Just a little help with the fourth quarter, seasonally what usually happens? Did you give any guidance on the fourth quarter relative to the third?

What we've said and say is that typically because of driving patterns and so forth, the middle two quarters are a touch are a small amount stronger than the edge quarters, but I would have been wrong in the last two years by telling you that, so -- but that's typically the way it works out.

Okay. Thanks for the help.

You're welcome.

Our next question is coming from Robert Haley of Gabelli and Company, please proceed with your question.

Hi. Just quick follow-up. I know that you haven't given specific margin guidance. But just following off of '06 heading into '07 directionally, would you expect that the margins in the additives business will continue their upward trend or you have the mix factor that shouldn't play in as much in '07. I would imagine that utilization will continue at a tight pace, but just trying it get some color on that.

You know, I really can't give you any guidance on that, and I just have to point you back to the comment I made a minute ago about the industry still running pretty full and raw materials are going to determine a lot. The answer to your question, I don't know what those raw materials are going to be. I can't help you. I am sorry.

Well, I guess if we assume for a second raw materials constant, just make that assumption, would that change your view at all?

Then I would think they should be similar to how they have been.

I am sorry. Can you repeat that.

The margins should be similar to how they have been.

They should be similar to this year. Right. Thank you.

You're welcome.

Gentlemen, I show no further questions in the queue at this time. Do you have any closing remarks.

No. Thank everyone for joining. Have a good day. Good bye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation.