NewMarket Corp (NEU) 2008 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NewMarket Corporation second quarter 2008 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 for NewMarket Corporation. Thank you Mr. Fiorenza, you may begin.

Thank you, and good morning. Thanks for joining us to discuss the second quarter performance.

With me today is Teddy Gottwald, our CEO. I have a few planned comments, after which we'll 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 bounds of what we know about our business and operations. However, we offer no assurance that actual results will not differ materially from our expectations, due to uncertainties and factors that are difficult to predict and beyond our control. A full discussion of these factors can be found in our 200710-K. We filed our second quarter 10-Q last night also.

As you saw, we released earnings yesterday. Income from continuing operations for the quarter were $17.6 million or $1.03 a share, compared with 17.4 million or $1.00 a share for the second quarter of last year. Last year, we exited the TEL business outside of North America, and classified that former operation as discontinued business. There was no effect from that business in our second quarter results of this year, although we made $13.5 million in the second quarter of 2007 when we sold our participation in that business. Total income for last year's second quarter was $30.9 million, or $1.78 a share.

Turning now to our segment performance, petroleum additives net sales in the second quarter of $421 million were up $83 million or about 24% from the second quarter of last year. Shipments were up 15%, mainly in the lubricant additives area. The other components that contributed to the higher revenue figure were higher selling prices, customer mix, and a favorable impact of foreign currencies translated into US dollars. Our net sales benefit when the US dollar is weak. Petroleum additives operating profits decreased to $31.6 million from 35 -- $36.5 million, when comparing the 2008 and 2007 second quarters. The change in operating profit between both the second quarter and six months is the result of several key factors. We have seen a significant reduction in operating margins due to rapidly rising raw material costs in energy plant-related costs. We had favorable impact from higher product shipments. We continued to invest in selling, general, and administrative, as well as research and development costs. We have had a favorable impact from increasing some selling prices, and a favorable impact from foreign exchange.

During both the second quarter and six months of this year, there has been a significant compression of operating margins due to the increased cost of raw materials. From May of this year to July 2nd, the posted price of certain base-oil stocks in the United States increased 47%. At the same time, the supply of several of other key raw materials is tight,with costs rising. We are implementing price increases in the marketplace to attempt to recover these rising costs, but our margins are unfavorably impacted as our suppliers are able to raise our costs more quickly than we can raise selling prices to our customers. Both selling, general, administrative, and R&D expenses were up when comparing the two second quarter periods. They increased as we continued to invest to development and deliver goods and services our customers need, and to expand our geographical presence.

Beginning the first quarter of 2008, we started reporting our real estate development activities and segment operating profit. Because of the current immateriality of the real estate segment, it's results are reported in "All other." The real estate development segment represents the activity of Foundry Park 1, which is constructing an office building for MeadWestvaco's corporate headquarters. The project is well underway. The building is now above ground and the steel structure is being erected. We are on schedule and on budget. We building phase of the project will last until late 2009. For 2008 and most of 2009, we will be capitalizing the majority of the costs of the project and the financing expenses.

The "All other" category also includes the results of our TEL sales and activities in North America by our subsidiary, Ethyl Corporation. The results from the second quarter include these normal operations. For six months the "All other" category has a profit of $500,000, which is in line with our expectations.

Interest and financing expenses for both second quarters were essentially the same at about $2.9 million. While we did borrow under our revolving credit facility during the quarter, we ended the quarter without any borrowings on that facility.

Turning to cash. Cash at the end of the quarter was about $40 million, which is a decrease of $32 million from the end of the year. The primary use of cash included an increase of $56.5 million in certain working capital requirements. The main cause of this increase is the increase in volumes and higher prices in costs we're experiencing. We have discussed this situation before. As raw materials rise, inventory evaluations go up, and account receivables go up, and so does working capital.

We used $32 million of cash to invest in our investing activities in the first half. $13.2 million we used to fund investments in our existing business, excluding Foundry Park. We estimate our total capital spending during 2008 to be about $35 million, excluding Foundry Park. We expect to continue to finance capital spending through cash on hand and cash provided from operations, together with borrowing available under our credit facility. We funded capital expenditures of about $19 million for Foundry Park during the first six months. We expect capital expenditures in '08 related to this activity to be about $60 million, with $6 million of that amount from cash from operations, and the remainder being borrowed.

Over the term of the construction project, we expect to borrow 85% of the total costs of the construction of the office building, and to fund the remaining with cash on hand or borrowings from our revolver. Except for Foundry Park construction loan, our debt position is substantially unchanged since the end of the year. Including Foundry Park, our debt was $173 million. Other uses of cash of note in the first half were $6.8 million used to repurchase stock in the first quarter, and about $6 million for dividend payments.

Turning to the outlook, as we reach the middle of this year, our business is performing well and demand is strong. Our facilities are operating at high rates, and we're meeting our customers' demand, while continuing to invest in R&D. We are also experiencing unprecedented increases in our raw materials costs. I gave the example earlier of base oil rising in the United States. Base oil represents the largest dollar purchase of our raw materials. and consequently an increase in oil costs alone would result in a significant increase in our costs. In addition, our other raw materials continue to escalate in costs. This has resulted in significant negative pressure on our operating margins.

To address this situation, we have been in the marketplace implementing price increases for our products, with the objective of maintaining operating margins. We have had good success in our efforts, but as we have raised selling prices we have continued to experience additional increases in raw material costs. We generally experience a lag of two to three months between the time when our raw material costs increase, and when we are able to effect the change in the selling price of our products. During 2008, this has resulted in us continuously seeking to recover the increase in costs. If raw material costs stabilize, so too will our operating margins. The outlook for raw material costs is mixed, and some predictions indicate continued cost increases, while others are forecasting decreasing or stabilizing costs. We are committed to recovering any further raw material costs increases.

We expect that 2008 petroleum additives operating profit will exceed the results of last year. The unpredictability of raw material costs, our ability to recover raw material costs increases in the marketplace, and the future demand for our products will be the variables that we will manage to meet that expectation.

Another impact of the raw -- of the rapid increase in raw material costs is the negative impact on cash flows. As we raise prices to recover those increases, we have more of our working capital committed to accounts receivable and inventories. We have had negative free cash flow for the first half of 2008, and expect free cash flow generation to be minimal for the remainder of the year, if the current conditions continue. We view this as a short-term issue, as our business generates significant free cash flow on a normal basis.

As we have -- as we have communicated in the past, we intend to leverage our financial strength to increase shareholder value by growing our business, with acquisitions being an area of primary interest. Our focus in the acquisition area remains on the petroleum additives industry. e remain patient in this pursuit, and intend to make the right acquisition for our company when the opportunity arises. Meanwhile we believe we have many internal opportunities for growth in the near term both, from geographical and product-line extensions. Until an acquisition materializes, we will build cash on our balance sheet and will continue to evaluate all alternative uses for that cash to enhance shareholder value, including stock repurchases and dividends. Our project to develop a portion of the town Richmond, Virginia continues to progress on schedule and within our cost estimates, and it is our expectation that it will stay that way until the project is completed at the end of the year. That concludes my planned comments. Melissa, can we open the lines, please?

Thank you. (OPERATOR INSTRUCTIONS) Thank you. Our first question comes from the line of Mr. Robert Felice with Gabelli & Company. Please proceed with your question.

Hey, guys, just a couple of quick questions. First, what was the magnitude of the price cost gap during the quarter?

It's in the 200, 250 basis point range.

Okay. And then I, I guess, what is the cumulative amount of pricing you have announced year-to-date? And how much of that have you realized?

We don't announce price increases in the sense of a stated price increase, but we have been out several times already this year -- three times as a matter of fact, and we're having good success with it.

Okay. Well you seemed clear in the press release that there are no fundamental changes to the industry, and the margin compression during the quarter is really a timing issue. So to that end, how quickly do you expect your margins to snap back here?

This is Teddy. I think we'll see margins improve in the third quarter, barring any unanticipated further increases in raw materials. We've -- we've been out in the marketplace. We have agreement on a -- a lot of the increases, and they are rolling through now.

Do you think those margins will get back to levels commensurate with third quarter of '07 or just improve sequentially?

I think they'll improve sequentially, and it's certainly our intent by the end of the year to be at that same kind of third quarter '07 margin rate.

Well, historically your fourth quarter has been weaker than your third. Would you expect that to persist this year and fourth quarter of '08 to be on par with fourth quarter of '08, or to actually see improvements in margin continually through the year, such that fourth quarter will actually be up around that 10% level?

It's our objective to get there in the fourth quarter. It's -- it's hard to say. The -- the rate of increase of raw materials that was seen this year has just been unprecedented. So it's kind of hard to -- to predict out two quarters right now on what costs are going to do, and if the costs continue to move, we'll continue to be in the marketplace recovering those costs. From a volume standpoint, fourth quarter tends to be lighter than the -- the middle couple of quarters, and we know of no reason to expect anything different this year.

If we were to assume that the base oil prices don't move, do you have enough pricing in place right now to recover all of the costs? Or do you have to go out with additional increases?

I -- we believe the actions that we have in place now would get us there.

Okay. And then I guess lastly, your volume for the first half is really quite strong. What is your full-year expectation for volumes?

As -- as you pointed out, the first half compared to the first half of last year, we're up about 15%. It's very strong. We're not going to finish at 15% or above, because sequentially we're up 5%. So we're going to have strong volume. I don't have an exact number for you. The demand -- the demand continues there. Our customers are doing well. And we're doing well.

Well, I guess -- you know, your other publicly-traded competitor mentioned on their call yesterday that they are revisiting their analysis of the industry's long-term growth rate, and that perhaps there are some fundamental changes occurring, like changes to drain interval and demand in emerging markets that have caused that volume number -- that long-term volume number to rise perhaps above that zero to 2% range. What are your thoughts on that?

We have done some work in that area earlier this year. We've held to that zero to 2% kind of range. The work we did earlier this year indicated it might be more in the 2 to 3% range. I'd be real hesitant to indicate anything more than that, but it's a -- it's an issue that we will continue to -- to readdress as well.

Okay. Great. Thanks for taking my questions.

Sure.

Thank you. Our next question comes from Mr. Ian Zaffino with Oppenheimer. Please proceed with your question.

Great. Thank you very much. Couple of questions here. Can you break out the volume growth between the US and your foreign exposure?

Yes. If you do Q2 to Q2, and - it's up 15 percentage points. Four of those percentage points are from North America, and the rest is outside of North America.

So 4% is in America. 11%, you said, is foreign?

Correct.

Okay.

North America was 4%.

Okay. And what was the timing of your three price increases? When did they actually go in to effect?

They've -- they've just rolled in through the course of the year. They are still rolling in right now. And -- I don't have the exact times on them.

Okay. Can you give us a sensitivity of your base oil, either mow gallons of base oil you use or -- just some metric that we could kind of figure out what the sensitivity is there with the movements in base oil?

Base oil is our largest raw material, and as probably around 20% of all of our raw material purchases.

You don't have a volume --

No. I mean -- yes, it's product by product, but it's a about 20% of our raw material purchases.

Okay. But that tends to move around a lot, depending on what your pricing is and --

Sure.

And when you talk about margin in all of our discussions, that's margin dollars or margin percent? You know, when you say the actions taken will help you recover margin?

Percentage.

Okay. So everything is percentage. Okay. I think that's it. Thank you very much.

Okay. Ian.

Thank you. Our next question comes from Mr. J.T. [ Wright] with [Croft] Capital. Please proceed with your question.

Hello?

Hello.

Hey, thanks for a good quarter - well, not necessarily a good quarter this quarter, but it looks line things are strong on the sales side of the business.

Thank you.

One thing I wanted to talk about was -- I got the impression that on your base oil side, on your cost side, that the contracts you have with your suppliers are somewhat floating nature, renegotiated - pricing is sort of determined weekly or very short-term. How is the relationship with contract terms for your customers? Does that have like a three-month period? Or is -- obviously it is a little longer term than it is on your supplier side. Could you give us some color on that?

Yes, it is in many cases, it's longer on our customer's side than it is on our -- our supply side, at least the pricing mechanisms and when they can be readdressed. Historically this hadn't been an issue. It's only been really recently with the -- the dramatic rate of increase in raw materials that this has become a -- a real issue for us. We're addressing it. We're doing our best to tighten up that time lag that -- that we see because of the -- the volatility in our cost structure today. I can't give you any -- any more exact data, because our -- our contracts range all over the map. But in general, we are working towards tightening that time lag up, so that we don't get caught quite in the situation we have been in the last few months.

Right. Is the -- can you talk a little bit or kind of maybe on the qualitative side of your relationship with your customers? If I understand it correctly, in many cases or at least in some cases, your suppliers and your customers -- are they the same person?

They are the same company.

Same company, yes. If base oil goes down, I guess the -- I guess the longer duration on the sales side -- on the sales contracts helps, you know, keep them from renegotiating, I guess, is there more pressure there -- do you feel like sales get delayed if we see a declining base oil environment?

I don't remember --

I know.

I'm kidding.

Short-term period.

But, you know, even if we see crude continue to drop from its -- its high --

Yes.

-- it takes the -- the crude -- the impact of the high crude a while to roll through our supply chain, and I think if crude continues to drop more, we hope to see some base oil and other raw material softening, but we don't expect it any time soon, because our supply chain is still dealing with -- let's say $100 to $110 crude-type of costs for their material.

Right. And then just one final question. On your base oil -- you know, to what extent did the volume of base oil grow this quarter?

It would be directionally correct in saying it just grows linear with our shipments.

Okay.

So, you know, we were up sequentially 5% this quarter over last quarter, or 15% quarter-to-quarter, so base oil would have followed that.

Is base oil becoming a higher percentage -- are you needing to buy more gallons of base oil per gallon of additive that you are selling, or is that declining? Is there more other stuff, non-base oil stuff, in your finished product?

I think it's a pretty steady state.

Okay.

It doesn't vary a whole lot, quarter-to-quarter, year-to-year.

All right. Well, appreciate it. Thank you very much.

Thank you.

Thank you. Our next question is from Mr. Robert Felice of Gabelli & Company. Please proceed with your question.

Guys, was just one or two more questions. If we were to assume that raw material costs don't escalate further, don't decline for the remainder of the year, they stay at this elevated level, what is the absolute amount of cost inflation you would face in '08 versus '07? So what would the increment look like?

I haven't done that arithmetic, Robert.

I'm just trying to get a sense for the magnitude of pricing you would need to offset that, and then how much additional you would need to recoup the margin?

I'd have to work on that and get back with you. I don't have it.

Okay. I'll follow up with you offline on that one. Then lastly, the "all other" line item, are you still expecting that to be about flat for the year?

Plus or minus 1 is the view for the year.

Okay. Great.

Thank you.

Thank you. Our next question from Mr. Ian Zaffino with Oppenheimer. Please proceed with your question.

Hi, thanks. Just a couple of follow-ups here. What has been the -- the pricing on base oil that you have seen since the quarter end? So you gave that 47% from May to July. What are you seeing -- what did you see in July?

I think the base oil market has been pretty stable the last month or so.

Right. Okay.

Yes.

Yes.

And then you mentioned that the chain is still seeing $110 oil?

I don't have an exact figure on that. My point was that the supply chain has not been seeing $140-a-barrel oil. They have been seeing something less than that. So just because oil has retreated off of its max, or crude has, doesn't mean that we expect to see a corresponding decrease in our costs.

And how long is that supply chain?

A couple of months. One or two months.

Okay. So --

So don't be looking for any raw material reductions if crude stays at $120-ish is the message.

I'm actually looking the other way. If you are saying it is still processing $110, are they going - are you going to see price increases?

We don't expect it.

Okay. And then lastly, when you spoke about the tight supply of your other raw materials, what were you specifically alluding to?

We buy a lot of different commodity chemicals in different smaller amounts, and we were talking about the environment in general, and not any specific one.

Okay. All right. Well, thank you very much.

Thank you. There are no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Thanks everyone for joining, and I'll talk to you next quarter. Have a good day.

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