NewMarket Corp (NEU) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NewMarket Corporation (technical difficulty) quarter 2006 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, Treasurer and Principal Financial Officer of NewMarket Corporation. Thank you, Mr. Fiorenza, you may begin.

Thank you for joining us to discuss our year-end and fourth-quarter performance. I am David Fiorenza, and with me today is Teddy Gottwald, our CEO. I 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 we base our statements 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. We expect to file this year's 10-K at the end of February.

Net income was $57.5 million or $3.30 per share in 2006, compared to $42.4 million or $2.45 per share last year. Net income for the fourth quarter of this year was $4.5 million or $0.26 per share, while net income for the fourth quarter last year was $11 million or $0.64 a share.

Due to the significant impact on earnings and special items, I'm mainly going to be discussing earnings per share excluding those special items. Even though earnings excluding special items are not financial measures required by or calculated in accordance with accounting principles generally accepted in the United States, we believe this information often provides more meaningful information about our operations, and in doing so, provides transparency to investors and enhances period-to-period comparability of performance.

Earnings for the year 2006, excluding special items, increased to $53.7 million or $3.08 a share, a 52% improvement over earnings on the same basis for last year of $35 million or $2.02 per share. Earnings for the fourth quarter 2006, excluding special items, improved to $10.5 million or $0.60 a share, compared to earnings on the same basis for the fourth quarter last year of $8 million or $0.46 per share. This represents a 30% increase.

I'll turn now to discussing segment operating profit. As a holding company, NewMarket evaluates the performance of Afton's petroleum additives business and Ethyl's TEL business, based on segment operating profit. NewMarket's services department and other expenses are billed to Afton and Ethyl based on the services provided under the holding company structure, pursuant to services agreements that NewMarket services has with Afton and Ethyl.

Petroleum additives -- our petroleum additives net sales improved by $185 million or 17% over the 2005 level. The increase was across all major product lines. Increases in selling prices resulted in most of the improvement in net sales, with changes in the mix of products sold also contributing to the higher sales.

Total shipments were very slightly down or essentially unchanged on a year-to-year basis. This comparison remains difficult, as we are constantly working to introduce more efficient products, which have the effect of lowering shipments but raising margins. Our fourth-quarter sales were $304 million, which is $11 million higher than last year's fourth quarter. Shipments were down in this quarter-to-quarter comparison.

The year 2006 reflected significant improvements in operating profit across all petroleum additives product lines, as compared to last year. We supply our customers with a diverse portfolio of products to meet their needs, and we believe this is reflected in our results. While the petroleum additives industry experienced escalating raw material costs in 2006, we were able to recover these costs through improved pricing and the introduction of more cost-effective products. Our production facilities are operating at high levels, and we are selling a mix of products with higher margins.

Petroleum additives' operating profit $104 million for 2006 increased $44 million or 74%, when compared to the 2005 level of $60 million. Operating profit for 2006 includes a one-time gain of $4 million associated with legal settlements. The increase in operating profit was across all product lines, which is a reflection of increased sales and increased profit margins.

Total research and development expenses were $70 million in 2006, compared to $65 million in 2005. This increase in spending was in support of our customers, as we are committed to supply them with modern, cost-effective solutions to their needs.

SG&A in 2006 for this segment was approximately $10 million higher than last year. The increase primarily resulted from higher professional fees and personnel-related expenses.

Turning to tetraethyl lead, TEL sales in areas not covered by the Innospec marketing agreements were up slightly in 2006 over last year. The increase is primarily the result of price increases.

The operating profit contribution from our marketing agreements was $8 million in 2006, compared to $23 million in 2005. As we expected, volumes were significantly lower in 2006 than in 2005, being down 62%. Pricing did improve when comparing periods, but certainly was not sufficient to overcome such a significant decline in demand.

In addition, amortization of the prepayment for services was approximately $2 million lower in 2006 than in 2005. The decrease in volumes shipped primarily reflects the result of the final major TEL customers under the marketing agreement discontinuing use of the product, as well as the continuing overall general decline of this product in the market. The loss from other TEL operations that are not part of the marketing agreements was virtually unchanged when comparing 2006 to 2005.

Turning to special item, special-item income was $15 million in 2006 and included a $5.3 million gain related to an earnout for certain pharmaceutical intellectual property that was sold in 1994. A $3.3 million gain associated with legal settlements related to transportation charges was also realized in 2006, as was a $3 million net gain resulting from other legal settlements and $3.3 million from the sale of property.

Interest and financing expenses were $15 million in 2006, compared to $17 million in 2005. The decrease resulted primarily from lower debt during 2006 as compared to 2005. We had no drawn bank debt under our revolving credit agreements at the end of 2006.

In December of 2006, through a tender offer, we purchased 149,750,000 of the outstanding 150 million 8.875% senior notes which were due in 2010. As a result of this action, we recognized a loss of $11 million on the early extinguishment of debt. This loss included the write-off of unamortized deferred financing costs of $2.6 million in cash paid associated with the purchase of $8.6 million.

Other net income was $7 million in 2006. This includes a $4 million gain on interest income from an income tax settlement, as well as $2 million investment income.

Our effective tax rate in 2006 was 34.7%, compared to 25.6% in 2005. The effective rate in each year reflects certain foreign and other tax benefits.

The increase in our income between years resulted in an increase of $8 million in taxes, and the increase in the effective tax rate resulted in an $8 million in extra taxes. Part of the rate increase in 2006 relates to the strengthening of certain foreign currencies, which resulted in a higher tax provision on the undistributed earnings of foreign subsidiaries.

Another factor contributing to the increase in rate was the American jobs Creation Act of 2004, which repealed the Foreign Sales Corporation Repeal and Extraterritorial Income Exclusion Act of 2006. This change phases out the previous benefit, and will be completely eliminated in 2007.

We generated cash from operating activities of $41 million in 2006. We realized cash of $3 million from sale of property, $5 million from the earnout of pharmaceuticals that I mentioned. We used these funds to support capital expenditures of $20 million, purchase manufacturing facility and related assets of $10 million, pay dividends on our common stock of $9 million and pay debt issuance costs of $4 million. Included in the 2006 cash flows from operating activities were collections of $11 million from settlements and payments of $18 million to fund our pension plans and $9 million for the costs related to the early extinguishment of our 8.875% senior notes.

As I mentioned in November of last year, we commenced the cash tender for all of our then outstanding 8.875% notes. We brought back in essentially all of those, and we will purchase the remaining $250,000 of the 8.875% notes this month.

On December the 12th, we issued senior notes in the aggregate principal amount of $150 million that bear interest at a fixed rate of 7.125% and are due in 2016. The 7.125% senior notes are our senior unsecured obligations, and are guaranteed on an unsecured basis by all our existing and future wholly-owned domestic restricted subsidiaries.

On December the 21st, we entered our second amended and restated credit agreement. The senior credit facility consists of $100 million of revolving credit, and has an option to increase the revolving credit facility commitment by an amount not to exceed $50 million, subject to the satisfaction of certain terms and conditions. We incurred additional financing costs of approximately $600,000, which resulted in total unamortized deferred financing costs of approximately $3 million related to this facility.

We believe these two facilities give us the operational flexibility we need to implement our plans and that are at rates and terms more favorable than the ones we replaced. The annual interest charge for the new bonds will be $2.6 million pretax less than the ones we retired.

At the end of 2006, we had working capital of $302 million, compared to $245 million at the end of last year. The increase in working capital primarily reflects higher accounts receivables and higher inventories. The increase in accounts receivable is due to higher sales. The increase in inventory results from higher costs, as well as certain volume increases due to increased customer needs.

We expect capital expenditures to be approximately (technical difficulty) in 2007, which we will finance through cash from operations. We believe we are in a strong financial position today.

Our overall strategy remains the same. It is our intent to leverage our financial strength to grow the business, with acquisitions being an area of primary interest. Our primary focus in the acquisition area remains on the petroleum additives industry. We believe that in the current mergers and acquisition environment, this industry will provide the greatest opportunity for a good return on investment while minimizing risks.

As we have stated in the past, we remain patient in this pursuit. We have many internal opportunities for growth in the near term, both from geographical and product extensions. We will wait and make the right acquisition for our company when the opportunity arises.

Early this year, we announced our plan to develop some of the downtown Richmond property that we own by constructing a multi-story office building for MeadWestvaco. It is our intention to primarily finance this project with debt. The main need for cash for this project will not begin until 2008.

Looking out, by any measure, 2006 was an outstanding year for our petroleum additives segment. We continue to focus on growing our business by helping our customers be successful in their marketplace. Our strategy is twofold -- cost management in those areas that are commodity-like in their characteristics, through reformulations and new component introduction, and grow the through product differentiation in areas where margins are higher. We expect that our approach in 2007 will be much the same.

As in any year, there are many variables which will determine the ultimate profit delivered for that year. Raw material costs remain a significant unknown. Despite a recent downward trend in feedstock, crude oil and natural gas, significant volatility is still being experienced. Base oil pricing has decreased coming into 2007. This is primarily a result of higher inventories, which may not be sustained as demand picks up or as plant turnarounds are taken in 2007.

However, prices of other raw materials that we buy today remain tight, and they tend to be governed by the supply-and-demand balance of their own market and are not directly affected by crude. On the demand side, worldwide usage remains strong and our plants continue to operate at very high rates. We see no slowdown during the year.

As is a constant feature of our business, the costs continue to escalate. Our R&D investment increased by 9% in 2006 over 2005, and we expect it to go up again this year. The newly introduced REITs legislation in Europe will further increase our costs.

We had worked hard in the past to provide better, more cost-effective products to our customers. As a result, our margins have improved in 2007. However, the margins in the engine oil areas remain below reinvestment economics.

On tetraethyl lead, this segment took a significant step-down in its overall contribution to the Corporation during 2006. This product is being phased out around the world, and we expect it to remain a small contributor to the overall profits of the Company. Our plans are to continue to manage costs within this business, and to raise prices to reflect the economic value of the product.

That concludes my planned comments. I would like to open the lines now for questions, please.

(OPERATOR INSTRUCTIONS). Robert Felice, Gabelli & Company.

During the quarter, your revenue growth slowed materially year over year. I was just wondering, with the price of oil off so much recently, whether you faced any pushback from customers during the quarter on pricing. I guess, to that end, could you comment on the pricing environment as we look to Q1 and for all of 2007?

Our customers are certainly aware of base oil prices backing down from the peak that we saw in the third quarter last year. But I think everyone is understanding that base oil prices don't reflect the total picture of raw material costs in our business. We really haven't seen a broad or general decrease in pricing of our raw materials. Many of them are still tight, and even the trend in base oil is uncertain at this time. It's a little too early to tell.

We expect continued tightness into 2007 of many of our raw materials. It's our expectation that it will continue to be in a high-cost environment throughout the course of the coming year.

So you haven't had to cede on any pricing during the fourth quarter?

I'm not going to comment on any pricing discussions we may or may not be having with customers. But from the overall standpoint, costs remain high, and I think our customers understand that.

Okay, because I look at the fourth quarter and it seems like your margins in petroleum additives compressed sequentially a bit, and just offhand, I guess I have a thesis or a premise, and that might be that perhaps you have ceded on pricing a little bit, and you still had some high-cost inventory flowing through the P&L, and that caused some margin compression. Could you comment on that a little bit?

Yes. The margin compression in the fourth quarter was not caused by lower prices. It's more a function of the seasonality of our business in the fourth quarter generally being lighter. David, do you have any other comments?

Yes. Typically, our business is a little bit lighter on the edges, first quarter and fourth quarter. I think what you're seeing when you look at that margin compression is more a function of -- we tend to have a little bit higher unit costs in the fourth quarter as maybe we slow our plants down a little bit. R&D and [S&A] tend to be the same, whether the revenue is high or low. So I think that is what you are seeing, as opposed to any margin compression at the customer.

I guess there had been some speculation that perhaps you won a large new account on the engine oil additives side. I was hoping you could comment on that and, perhaps more broadly, on your expectations for volume growth in 2007. It looks like the last couple of years, you have been able to sustain some decent volume growth above what I would say are longer-term industry averages, and hoping you could comment on that as we look forward.

Yes. Our volumes have grown probably at a rate exceeding the industry volume growth over the last couple of years. We have picked up some additional business. Our expectation is that our volume will be up slightly year on year, but nothing -- certainly not in a major way.

And to the new account on the engine oil additives side?

Yes?

Any color on that?

No, we don't comment on specific customers.

Fair enough. David, you had mentioned in your prepared remarks that R&D spend stepped up a little bit and you expect it to be a bit higher in 2007. I was hoping you could perhaps delve into where that incremental money is being put to work. As you look out over the next couple of years, where do you see the growth opportunity?

We manage R&D in a total, and then in any given year, depending on what specification is coming up or what we see in the marketplaces, it's directed. So that is a bit dynamic. My comment was overall with just escalating costs and the possible need to spend more money in Europe to get some of these registrations going on the REITs legislation. Ted?

As far as the future growth goes, it's consistent with our strategy of the last couple of years -- expand geographically and expand our product lines. As we do that, that oftentimes means meeting new specifications around the world, and that's where a certain amount of the increased research is targeted.

A good portion of the margin expansion that you experienced this year was due to I guess what you called the shift toward more cost-effective product. I was hoping that you could perhaps quantify how much of the gross margin expansion was due to that, versus pricing for raw material costs. So I guess what I'm asking for is a bridge from 2005 to 2006.

We struggled with the exact arithmetic on that 2005 to 2006. We've discussed before we sell about 900 different products. I don't have an answer to your question.

Well, I guess, as I look at that shift to more cost-effective product, do you see that as something that phased in over 2006 and should continue to benefit you in 2007, or have you really largely felt the incremental impact of that?

I believe that we will continue to see it in 2007 if all variables stay the same.

Bob Goldberg, Scopus Asset Management.

On the fourth quarter, I just wanted to be clear -- the reduction in revenue you feel was due to just normal seasonality. I think last year, you benefited in the fourth quarter from hurricane-related demand, because from 3Q to 4Q last year, revenue was up maybe about 10% sequentially in the petroleum additives segment.

So I just wanted to understand -- was this a more normal year? Was there destocking because there were no hurricanes this year? How did you view the volume environment in the fourth quarter?

I think you have a pretty good grip on in. We see it as a more normal year. We suspect that there was a certain amount of destocking going on, because there was no hurricane or major one, as you pointed out. It remains to be seen whether there's anything abnormal in these numbers. We will just have to see how the year unfolds.

So are you back to operating full-out now, as we enter 2007? Is there still some element of destocking going on out there?

We continue to operate our plants at high levels. That didn't particularly change the way we're running our operations.

On the margin side, you did a great job in 2006 of raising the operating margin by 240 basis points in petroleum additives. I'm just wondering what your thoughts are on seeing further improvement as we looked out the next 12, 24, 36 months. Where would you like to see these margins? I think competitors are still a bit higher.

We're going to keep working on them, through research and improving our products, our cost-effectiveness and improving our product mix and expanding our business. Otherwise, who knows what raw materials are going to do? There's been a little bit of slowdown in volatility, but we're coming off an extremely volatile 18 months. It just remains to be seen what the next 18 months are going to bring on that front. But that will certainly have a major impact on our margins.

I guess my question is, what is your expectation level of where you think these margins can get to in a normalized state for raw materials, if there is such a thing? I'm just wondering, is the easy work is done to get to 8%? I know it's very incremental benefit from here. Or is there more?

We don't see any (multiple speakers).

Not that anything's easy, but --

We don't see any obvious step function up. So from here on, if you look at the 8.6% margin in the third quarter, that's a good go-forward number, and we will work to work it out.

Lastly, anything new on the M&A front that you want to talk about or can talk about? Is the M&A environment any easier, harder, more competitive -- or how is the landscape?

Our view on that hasn't changed, and our approach to it really hasn't changed. If anything, we've said in the past that our focus is on the petroleum additives market, and that we will be patient to find the right acquisition. If anything, our view has sharpened a little bit more on the petroleum additives industry. We still think there's opportunities there, but we don't have anything to report on.

With overall M&A activity being as high as it is, and as much money as is out there, and acquisition multiples being what they are, we don't anticipate a successful acquisition outside of the petroleum additives industry. It's too expensive.

I just wasn't clear -- the industry's growth rate in petroleum additives is very low single digits, and you have been growing much faster than that. The growth rate decelerated in the fourth quarter. Do you expect to grow faster than the industry, as we look out at the next year or two, three, four years? Or do you expect to grow more in line with the industry?

It depends on whether you're talking revenue, volume or profits. I would say that in all three categories, it would certainly be our hope to grow faster than the industry. Part of that is just a function of being the smallest of the four major players, and we are underrepresented in certain product lines and certain geographic regions. So we see there being an opportunity for us to improve our position, maybe better than the competition. We certainly don't have major plans to grow market share, but we do have ambitions to do better than the rest of the industry.

Amy Levine, Shenkman Capital.

I just was hoping you could comment on your CapEx guidance for 2007. It sounded a little higher than it has been historically. Maybe you can comment on why that is and what you are spending on?

It's a slightly higher. We spent $20 million CapEx last year, then we spent another $10 million for acquisition of plant and other assets. $25 million to $30 million is our guidance. I used the higher end of that. Just routine capital, a little debottlenecking and then some changes that we're making to complying with some new legislations that are coming in around the world.

If you could comment maybe on the industry as a whole, if there is an increase in spending or any new capacity coming on that you have become aware of?

I would expect that the industry, our competition, is debottlenecking as needed. But we are not aware of any new capacity, significant new capacity coming into the industry. Generally, it's a two to three-year implementation from announcement to production. We haven't heard of anything.

I think there's -- certainly, we feel that the industry does not need a new slug of additional capacity. Industry volumes, demand for petroleum additives is not growing at a very fast rate. We are operating at high rates today, but we generally know how to debottleneck and spend in a targeted way to handle the demand in our business. That's what I expect the future to hold, the near future.

You mentioned the downtown Richmond development product project for MeadWestvaco. How much do you expect to spend on that in total?

We put out a release on that. It was $110 million to $140 million is our range on that, and we haven't finalized the plan. So that's why we have the range.

Would you expect to finance that on your balance sheet, or would it be just project financing for the actual project?

It will be project financing. But the way things work these days, you will see it on our balance sheet.

Melinda Newman, Post Advisory Group.

I am looking for a little more clarification on the direction of the margins, what we should anticipate excluding TEL in 2007 versus 2006. The shape of the year, if you look at the top line of the margins, the top line grew very robustly the first three quarters, and then there was a lot of margin expansion in the first half of the year, little less so third quarter and fourth quarter. I heard you discuss increased costs, but when you were questioned about the diminishment in margin expansion in the fourth quarter, you said that there's seasonality, which makes a lot of sense.

If all things were the same in terms of mix, would you expect year-over-year EBITDA margins before TEL to stay stable where they are or to move slightly up? What should we -- it sounds like you are optimistic but not that optimistic.

Optimistic but stable this what I would expect for the year, year to year.

So does that mean the shape of this year, where margins are much better in the first half than the second half -- is that typical seasonality? I know you said, actually, it was second and third quarter where you do better. But this year, actually, EBITDA margins were better in the first half than in the second half.

My answer was on the year, and the quarters will shape out as the volume demands shapes out.

In terms of use of cash, you will be spending your own cash for this real estate project? Or you are going to take on debt, project-finance debt?

75% is a good number to think that we will try to do with debt.

But you think it will be ring-fenced from the Company?

It will be what?

It will be ring-fenced from the Company, the project financing, non-recourse?

Yes, when it's done, when the building is up and done, it will be non-recourse [type] debt to the Company.

So then, looking back at -- if you can do something like $125 million or so in EBITDA and $30 million of CapEx, interest is below $15 million and your current dividend -- you still have quite a lot of free cash flow. Although I know you have stated you're interested in acquisitions, the space seems to be fairly consolidated. So any deal would have to be a very large deal, if you stay within additives. I don't know how likely it is to happen. What are the other uses of cash that you would anticipate, barring a large acquisition?

Well, I will comment on the uses of cash in the acquisitions, and then maybe David can comment on what we expect our cash flow to kind of look like this year. As far as acquisitions go, there's a wide range of possibilities within the petroleum additives business. They range from small, very niche-oriented players that would be good technology acquisitions to round out certain product lines. It could be, let's say, in the $10 million to $20 million kind of size range -- to larger, what you might call second-tier players that participate in a broader but not full-line area in our business. They could be in the $200 million to $300 million acquisition range.

Our preference would be to make bigger steps than smaller ones, but we are looking at all of them out there. Again, I'll just stress that patience rules on that.

In terms of multiples for the larger type acquisitions, are we talking sort of 9, 10 times multiples?

It's a bit hard to say. I've said in the past that generally, we look at add-on acquisitions as having a very high level of synergy that comes with them. So we might be willing to pay a high multiple, in the 9 to 10 range, if that means bringing in a large amount of synergy. If there's a lot of duplication in the businesses that we can address quickly, then our multiple threshold would be higher.

(OPERATOR INSTRUCTIONS). Ladies and gentlemen, there are no further questions at this time.

Thank you for your participation today.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.