NewMarket Corp (NEU) 2007 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NewMarket Corporation first quarter 2007 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 of NewMarket Corporation. Thank you, Mr. Fiorenza, you may begin.

Thank you. Thank you for joining us to discuss our first quarter performance. with me today is Teddy Gottwald, our CEO. I have a few planned comments, after which we'll open the lines for 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 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 or beyond our control. A full discussion of these factors can be found in our most recently-filed 10-K.

As an overview, our net income for the first quarter was $16.2 million or $0.93 a share. This compares to net income the first quarter last year of $13.8 million or $0.79 per share. This is an 18% increase in earnings. The first quarter reflects improvements in operating profit in the petroleum additive segment and the TEL segment. Our balance sheet remains strong and we continue to have no outstanding bank debt. We've also begun to recognize the benefit of the new debt structure that we put in place at the end of last year through lower interest and financing expenses.

We evaluate the performance of the petroleum additives business and the TEL business based on segment operating profit. NewMarket Services Corporation departments are built to Afton and Ethyl based on the services provided under the holding company structure that we have in place today. Depreciation on segment plant property and equipment, amortization of segment intangible assets, and the prepayment for services are included in the operating profit of each segment.

Discussing petroleum additives first, petroleum additive's net sales this quarter were $307 million, which were up $7.7 million or 3% from the first quarter of last year. Total shipments for the first quarter were down compared to the first quarter of '06. While the first quarter shipments were slightly below our expectations, the volumes were within the range of normal variations that are typical for this time of year. We believe there may have been some inventory adjustments made by our customers over the past two quarters and we expect shipments to improve in the second quarter. Although the volume of product shipments had a negative impact on net sales, the overall mix of products sold and higher selling prices resulted in the increase in net sales between these two periods.

Petroleum additive's operating profit improved to $29 million from $25.7 million when comparing the two first periods -- first quarter periods. The improved profit is reflected across most product lines. The higher operating profit resulted from several factors. We are recognizing the benefit of our progress and restoring margins on certain products through the introduction of more cost effective product formulations for our customers. These improved product formulations lower both our cost as well as our customer's cost. We are also recognizing the benefit of price increases achieved during 2006. In addition to the improved pricing, we're selling a product mix with a higher profit margins.

Selling, general and administrative expenses were about $900,000 higher when comparing the two first quarter periods. The increase is primarily a result of higher personnel costs. In addition, research and development expenses increased $2.2 million from the first quarter of last year.

Turning to tetraethylin, the results of our TEL segment include the operating profit from our marketing agreements with Innospec, as well as certain TEL operations not included in the Innospec marketing agreement. The operating profit from our marketing agreements for the first quarter was $3.5 million, which is $2.1 million higher than the first quarter last year. This improvement in operating profit reflects both improved pricing and higher shipments. We believe, however, that the increase in shipments is predominantly due to timing of customer orders. We continue to expect lower shipments for 2007 as compared to 2006 in this segment. We also expect the improvement in pricing in 2007 will be completely offset by the anticipated reduction in shipments resulting in lower TEL earnings this year compared to last year.

Our other TEL operations not included in the marketing agreements were approximately $500,000 lower when comparing the first quarter of this year to the first quarter of last year. The first quarter '07 interest and financing expenses were $3 million compared to $3.9 million last year for this same period. The decrease reflects lower interest as well as lower fees and amortization of deferred financing costs resulting from the restructuring of our debt. As you recall in December of '06, we purchased substantially all of our outstanding 8.875 senior notes and issued $150 million of 7.125 senior notes. The effective tax rate for this quarter was 34.4% compared to 33.4 last year. The '06 income tax rate includes a favorable impact from the extra territorial income exclusion. For 2007 and future, no such benefit is allowed.

I'll now discuss our cash flows. Cash at the end of March was $72.9 million, which is an increase of $12.6 million since the end of the year. Cash flows from operating activities for the three months were $28.2 million. We use these cash flows for various activities, including funding $10.9 million of capital expenditures, paying $2.2 million of dividends on our common stocks, and making a $1.1 million payment on an interest rate guarantee related to the construction of the office building at Foundry Park. Excluding the expenditures for the construction of the office building by Foundry Park, which we expect to do mostly with debt, we expect that cash from operations and cash on hand and borrowing available under our senior facilities will be sufficient to cover our operating expenses and plan capital for the foreseeable future.

Except for the February 2007 redemption of $250,000 of the remaining 8.875 senior notes, our debt position is substantially unchanged since the end of the year. At the end of the quarter, we have the outstanding notes of $150 million at the 7.125 and these notes are not due until 2016. There are no borrowings against our revolving credit facility. Excluding the expenditures for the office buildings, we funded capital expenditures of $10.3 million through March. We estimate our total capital spending this year, excluding Foundry Park, will be about $30 million. During the quarter, we did fund approximately $700,000 for the Foundry Park activities.

We had working capital at March of $310 million compared to $302 million at the end of last year. The increase in working capital primarily reflects higher cash and lower accrued expenses, offset by decreases in accounts receivable and inventories. The reduction in accrued expenses results primarily from the payment of certain personnel-related and product-related costs. The decrease in inventory results from the planned reduction of certain product, while the decrease in accounts receivable results from the collection of outstanding income tax receivables, as well as a reduction in day sales outstanding.

Looking forward, we're continuing a strong financial position today. Our overall strategy remains unchanged. It's our intent to leverage our financial strength to grow the business with acquisitions being an area of significant interest. Our primary focus is in the acquisition area remains on 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 risk. As we've stated in the past, we remain patient in this pursuit. We believe we have many internal opportunities for growth in the near term, both from a geographical and product line extensions. We will wait and make the right acquisition for our company when the opportunity arises. Meanwhile, we will build cash on our balance sheet and continue to evaluate all alternatives use for that cash.

Earlier this year we announced our plans to develop some of the downtown Richmond property that we own by constructing a multistory office building for MeadWestvaco Corporation. We are in the preconstruction phase of that project. We have assembled an excellent team to assist us in the development and construction. We expect to borrow approximately 85% of the cost of construction and will be capitalizing the cost and interest throughout the building phase. We expect to spend about $5 million on this project during this year. We anticipate that the project will be completed by the end of 2009 at which time we expect it to be accretive to our earnings. It is our plan to finance the effort at that stage with long-term debt, which will be nonrecourse to the Corporation.

Petroleum additives had an excellent performance this quarter. 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 growth through product differentiation in other areas where margins justify that approach. There are many variables which will determine the ultimate profit this year in this segment. Raw material costs remain a significant unknown.

We continue to expect high prices to purchase our raw materials, as many materials remain extremely tight in supply. Base oil pricing has decreased somewhat at the beginning of this year, but it is unknown if this reduction will be sustained throughout the year. Other than base oils, the prices for other raw materials continue to be substantially unchanged on the whole. Our plants continue to operate at very high rates and we anticipate it will remain that way for the balance of this year. As is a constant feature of our business, our costs continue to escalate. Our R&D investment increased about 7% in '06 over '05 and we expect it to increase again this year. We expect to continue on the successes of last year and the first quarter and expect that petroleum additives will have a higher operating profit in '07 as compared to '06.

Finally, on tetraethyl lead, the segment took a significant step down in its overall contribution to our results during 2006. This product is being phased out around the world and we expect it to remain a small contributor to our overall profits. Our plans are to continue to manage costs within this business and to raise prices to reflect the economic value of the product. The profits of the first quarter 2007 do not change our overall view for the outlook for this segment. This concludes my planned comments. I'll now open the lines for any questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Robert Felice with Gabelli and Company. Pleasant state your question.

Hi, guys. Just a couple of quick questions. Just wondering, what portion of the volume decline during the quarter on petroleum additives would you attribute to tougher comps versus the first quarter of last year following the hurricanes? If I'm not mistaken, that was a pretty strong volume quarter.

Yes, you're right. It was a strong volume quarter, a smaller portion than you might first think, so a small portion is on the tougher comps.

So most of it was on the inventory side?

The inventory side and we've communicated that our plants are running tight and some of the volume that we don't have anymore was our choice.

Okay. Just a little interesting. One of your competitors reported and it seems like they saw a sequential tick-up in volume versus inventory corrections over the last two quarters or so, and I'm just wondering why the delay for NewMarket? Is there something more going on there? Has there been any shift in share or something else?

This is Teddy. We don't -- we don't see that. We don't see any significant change in market share. When you cut through the noise that's in the numbers comparing first quarter this year to first quarter last year and you take out the impact of some low-margin business that we chose not to continue and you take out some reformulations that are really progress made on our part to be more cost effective, we think the underlying business is fine and the volume is within a normal variation for the quarter.

Okay. Just parsing through the revenue growth number, can you give a more detailed breakdown of the price volume mix contribution?

Yes. Ask another question while I look it up.

I can do that.

I got it, I got it. So changes in price drove the revenue up about $27 million, and changes in shipments and product mix drove it down about $19 million.

Okay. And what portion of the $19 million would you attribute to the inventory versus conscientious decisions in terms of walking away?

I can make a guess, but I don't have an answer to that, so why -- I just don't know. We've talked to our customers, that's what they tell us, it's hard to then go back and dissect that number.

Okay, fair enough. In terms of the volume decline, what side was that on, was that on the engine oil side?

The reformulation was predominantly on the engine oil side. But it's across the board, as you know.

Okay. Then lastly, I was hoping that you could rank your products for me in terms of profitability at this point. I know you've played a little catch-up in terms of regaining margins and I know that driveline is typically more profitable than engine. Just kind of wondering where fuel falls in the mix there?

Fuel's kind of all over the map, really. Certain parts of it are high margin, certain parts of it we're not real pleased with. Overall, I'd put it in between driveline and engine oil.

So if you had to average it out and rank your driveline is most profitable followed by fuel followed by engine oil?

Yes.

Okay. Then just wondering, as I look out on the rest of the year, perhaps you can kind of characterize the external environment in a little more detail and shed some color on your volume price expectations as the remaining quarters unfold.

We're running at very high rates in our plants and it's our view that the entire industry is. Supply and demand is tight. A big question for us is what's going to happen with raw materials. The same question that existed last year. Raw materials are tight. Some of them are hard to find at any price. We have seen a little price reduction on the crude -- or the base oil side, but crude's come back a bit and supply and demand in base oil, we think, is tightening up some, so it remains to be seen what's going to happen there. So we're watching the raw material cost line very closely as we move forward here. Does that answer your question?

Yes, it helps with some color. It kind of sounds like if raw materials continue to rise, though, the market is tight enough to absorb further price increases?

I don't know.

All right. I'll hop back in queue.

Thank you.

Our next question comes from Alex Mitchell with Scopus Asset Management.

Hi, this is Bob Goldberg.

Hello.

Can you hear me?

Yes.

Curious if you could go a little bit more in depth into the improvement in the margin on petroleum additives given that feedstocks are as tight as they are? Just wondering what's driving the margin and do you see it sustainable at the current level?

If you go back and look at some of our margins last year, the data I'm looking at, we were about 8.6 in the performance of the first quarter last year and we're a little over 9 this quarter. We don't sell a homogeneous set of products, so there's a lot of mix in those numbers. But I guess I feel like the performance of the first quarter is representative of our business mix today. So it would be sustainable.

But what -- so what accounts, though, for the improvement in margin? Is that base oil coming down or is it a mix -- better mix on your part?

It's the items we've been discussing. The reformulation is an important feature and the mix of products sold is the other one.

Okay. In terms of seasonality, what kind of improvement in revenue would you normally see from the March quarter to the June quarter?

Traditionally, the second and third quarters are a little bit stronger than the first and fourth. David, what, 5%, maybe--.

Right.

-- in terms of volume. It's not really predictable, though.

Okay. You made the comment on the destocking, customers have been destocking. Is there any sense from the order patterns that that has ceased, or is it hard to tell?

Well, we're only 20-something days into the quarter, so it's hard to tell, but that's our expectation.

In terms of the M&A environment, I apologize if I missed this, but have you commented on how the M&A environment looks for your ability to grow the business beyond what you're doing organically?

Right. No, we hadn't commented on that and it's a fair question. We continue to scour our businesses for acquisition opportunities. Our focus is not exclusively within the additives arena, but it's where we're putting most of our efforts. And that's for a couple of reasons.

It's what we know best and today's M&A climate with so much -- so much money out there and multiples as high as they are, unless we have an edge, we're just not really willing to compete with financial buyers for businesses we don't know that well. We've talked about patience and patience is still the operative word here. We feel that we still have good growth opportunities internally. We're putting a fair amount of money back into the business right now to debottleneck and to support growth and I think that should allow us to continue to generate good results for our shareholders, but I'm hopeful that over the next couple of years we'll be able to find some bolt-on acquisitions in the additive arena, be they lube additives or fuel additives, because I think there's opportunities there.

Thank you for your comments.

Thank you.

Our next question comes from Robert Felice, Gabelli and Company.

Just a follow-up. I wanted to go back to the pricing side of things a second. If your facilities are running quite tight at this point and I know your largest competitor is a fairly rational straight forward stance on pricing, if raws escalate, what would prevent you from getting incremental pricing at this point?

It's our hope that if raw materials do escalate, we'll be able to recover that in the industry. I don't see anything fundamentally changed from the last 12 to 18 months. We've had a big run up in cost and as a company and I think probably as an industry, we've been able to recover those costs. I don't see anything fundamentally different today.

Okay, fair enough.

[OPERATOR INSTRUCTIONS] Our next question comes from Seth Harvey with UBS.

Good morning.

Good morning.

If I could go back to what you were referring to in terms of the loss volumes, is there any way you could break out for us what percentage or even majority is related to the reformulation and what percentage is more just kind of volumes that you walked away from or volumes you didn't compete for?

It's really -- I'm sorry, I wish we could give you that kind of detail, but it's not a number that we really focus on. When we reformulate certainly the business folks understand the impact that that has on our volume and our ability to go find more opportunities in the marketplace, but it's not something that we dig deeply in in the quarter to analyze how much of it was due to that.

Is there any way that you can kind of help us out and think about, should we expect a similar trend going forward, is that you're going to have, you're going to be losing volume on the topline because of this reformulation, but again, picking it up in terms of profit because you're improving your cost efficiency.

I guess all I can say is that year-in and year-out, a large part of our research effort is geared towards trying to develop more cost-effective products. Oftentimes, that translates into lower treat rates for our products and it varies. Some of the -- sometimes our research efforts allow us to reduce a product's treat rate by, say, 20%; other times, it might be more modest in the 5 to 10% range. Once developed, it takes a while to roll that out into the marketplace. I guess I see it as kind of a fundamental element of understanding how we operate. I think overall for our volumes, it's a modest impact, very low single digit percent kind of impact on our total business year-in and year-out, but on a quarterly basis, we might see more of it if it's a big treat rate change that affects a large number of product.

Okay. My second question, are you seeing any type of capacity growth across any of your product lines? Are people debottlenecking or pretty much your capacity situation is unchanged?

I think -- I can tell you about us. I looked at some numbers very recently that showed demand and capacity in eight major production units over let's say a three-year period. If we hadn't of debottlenecked all eight of those units, then we'd be short of demand in seven of the eight today. My point there is that we debottleneck where necessary and we don't make a big splash of it and generally it doesn't require large amounts of capital when we do it. There's some exceptions, but generally it's, let's say 2 to $5 million a shot. We've been debottlenecking, we continue to do it. I would assume that our competitors are doing it also as needed to meet the demand that's out there today. I haven't really seen of any significant new capacity announced by anyone. I don't expect to hear any because these debottlenecking efforts have been successful and we all need to kind of look not just a year out but three to five years out at what demand may be doing for some of these products. We're in a low-growth industry, our research efforts generally are successful in developing more cost effective products that kind of free up capacity. So it's a balancing act and I think today we've got it right.

Thank you.

There are no further questions at this time.

Thank everyone for joining. Have a good day.

This concludes today's conference. Thank you for your participation.