NewMarket Corp (NEU) 2010 Q3 法說會逐字稿

Greetings and welcome to the New Market Corporation third quarter 2010 financial results conference call. (Operator Instructions). It is now my pleasure to introduce your host, David Fiorenza, Vice President and Treasurer of New Market Corporation. Thank you, Mr. Fiorenza, you may begin.

Thank you, LaTonya. And thanks to everyone for joining us to discuss our results this morning. With me is Teddy Gottwald, our CEO. And then we'll follow our normal format witha few planned comments after which we'll take your 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 2009 10K. We just filed our 10Q a couple of minutes ago. Please review it for more details on the performance of the Company during the quarter.

Net income for the quarter was $45.7 million or $3.18 a share. For the first nine months of this year, net income was $128 million or $8.64 a share. Net income for the third quarter and the first nine months included charges to earnings from recording at fair value and interest rate swap agreement related to Foundry Park. Excluding these charges, net income for the third quarter was $49 million or $3.41 a share, and for nine months it was $138 million or $9.37 a share.

Our consolidated revenue for the third quarter was $472 million, which was an increase of about 13% from the third quarter of last year's level, which was $418 million. Similarly, nine months' results for revenue increased 19% to $1.36 billion so far this year.

Petroleum additive net sales for the third quarter of $465 million increased $51 million or 12% from $414 million for the third quarter last year. The increase in sales reflects higher total product shipments of 6%, including the benefit of Polartech shipments in the third quarter. The increase in product shipments was across the lubricant additives product lines while the fuel additive product lines were essentially unchanged. Selling prices were also favorable when comparing the two third quarter periods.

Partially offsetting these favorable impacts during the third quarter was an unfavorable Foreign Exchange impact of about $8 million. Nine months PA net sales of $1.3 billion were about 18% higher than nine months last year. The comparison included about a 16% increase in product shipments. Selling prices are also favorable for nine months. Foreign currency resulted in an unfavorable impact of about $5 million, partially offsetting these favorable factors.

During the first half of last year, product shipments were lower than we would have expected for this business which we believe was caused by the worldwide economic slowdown. We have seen a steady improvement in demand from these low levels, and believe the overall demand for petroleum additive products has recovered from recessionary effects and are now at levels consistent with normal market demands. The petroleum additives operating profit was $80 million for the quarter, which was the best performance of the last four quarters.

Our business is performing extremely well. Our plants are running at high operating rates, and demand is healthy. The operating profit margin for the quarter was 17.2%, which is in line with our expectations for this business, and the margin for the first nine months was also 17.2%.

As we have discussed multiple times in the past, we believe this business is capable of continuing to deliver this level of margins subject to the normal variations of our business. The there have been no significant changes to the industry conditions. Supply and demand remain relatively balanced. Raw materials are tight but sufficient. And the demand for the goods and services we offer has returned to more normal levels. I'm not going to make any comparisons to the extremely highly profitable third quarter of last year.

As we discussed, that was an outlier quarter with an unsustainably high operating profit margin, and one which we said would not be repeated. The comparison to the third quarter can be found in our 10-Q. When you take a look at the third quarter compared to the second quarter, operating profit is $80 million, up from $76.6 million. Revenue was essentially the same on about 1% lower shipments.

We believe the volume in the third quarter is consistent with patterns we often see in this business. We believe the second quarter may have benefited from some inventory restocking. We saw a very strong demand in the second quarter, particularly in Asia Pacific, and suspect that that was a variable in that demand.

The second quarter typically also benefits from preparations for the hurricane season, and so the performance for the third quarter is understandable as compared to the second quarter.

The real estate development segment had revenue of $2.9 million for the quarter and $8.6 million for the year. This is the rental income we receive on the Foundry Park building. The building was completed in late 2009, and this is the first year we're recognizing revenue. Operating profit for the real estate segment was $1.8 million for the third quarter, and $5.3 million for nine months. The third quarter is representative of the performance that we expect for each quarter going forward for this segment.

The increase in interest in financing expenses in the comparisons was primarily related to the mortgage loan on the foundry park building as well as higher average outstanding debt on the revolving credit facility. Prior to obtaining the mortgage loan, we were in the construction phase and the interest and financing expenses were being capitalized.

Other expenses net for the quarter were $5.5 million. This amount primarily represents a loss associated with recording our interest rate swap at fair value. This goes through our P&L. This has been a recurring item this year with the total for the year being $17.6 million charge.

There are no items of note associated with income tax expense this quarter. The effective rate was 32.3% for the quarter, and our year to date rate is 33%. Each of these rates is somewhat lower than last year, benefiting primarily from higher income in foreign jurisdictions with lower tax rates. In addition, nine months of this year also benefited from a higher domestic manufacturing deduction.

I'll turn now to cash flows. Cash at the end of the quarter was $50 million, which is $101 million lower than we started the year. Our business continues to generate significant cash flows that we have used to support the expansion of our business and repurchase stock.

I'm going to discuss the cash flow items for the quarter with reference to the year to date when appropriate. The cash flow details for the year to date are fully disclosed in the 10-Q. Our operating activities generated $54 million of cash during the quarter. From this starting point, we added $1 million of borrowing to manage the activities.

As was true for the first six months, the working capital requirements of our business were a net use of cash again in the third quarter with working capital using about $22 million. The most significant demand on cash in working capital was associated with a build in inventory levels. The increase in inventory reflects increased quantities at certain locations to respond to demand for our products, improve customer service levels, and improve security of supply.

Our team has a high degree of focus on our inventory levels, and constantly works to balance the trade off of the demands of our customers with the use of cash. For the year, the demand on cash from working capital has been around $61 million. We used the remainder of the $33 million to fund dividends of $5.3 million, repurchase stock of $9.7 million, and make capital investments of $7.1 million. Additionally, the cash requirements to comply with the terms of the swap this quarter were $7.5 million.

In July our Board authorized a stock repurchase program of up to $200 million of our stock, and this authorization is valid until December of 2012. During the third quarter we repurchased 98,903 shares at an average price of $98.57 a share. Approximately $190 million remains on this authorization. For the first three-quarters we have spent $89 million on stock repurchases.

Our year to date capital expenditures have been $25.1 million. We estimate the total for the year will be in the $30 million to $35 million range. Our total debt at the end of the quarter was $237 million, which included $150 million of bond, $67 million from the Foundry Park mortgage, and $20 million drawn on our revolving line of credit. Our EBITDA for the four quarters ending September was $305 million, giving us a debt to EBITDA ratio of 0.78. The unused portion on our $150 million revolver stood at $121 million at the end of the quarter.

We had $20 million drawn and $5 million of letter of credits issued. We're extremely pleased with the performance of our business for the quarter and for the entire nine months of this year. We began the year with solid results, built on a diverse product offering, customer base and geographical presence.

Our margins are good, and we continue to demonstrate our ability to adjust prices to compensate for increases in raw material costs. We believe the overall demand for the petroleum additive products has recovered from recessionary effects and are now at levels consistent with normal market demand. Our technology is strong, and we're well positioned to deliver the products and services our customers need to grow their businesses.

The new engine oil specification GF 5 is being successfully introduced into the market place. That introduction will continue through early next year. Our project to expand our supply chain capabilities in the Far East has progressed well, and we are now shipping product from that location. We expect that our business will continue to perform well in the fourth quarter subject to the normal fluctuations in typical fourth quarter events associated with this business. We have been implementing price increases during the year to recover the costs associated with certain of our raw materials. We do not believe that we are fully caught up with those increases.

We also typically run our plants at a somewhat lower rate in the fourth quarter which means we have a little higher costs associated with that action. While we are still working to integrate Polartech into our business, we continue to have acquisitions as the highest priority for the use of cash and borrowing capacity. Our primary focus for acquisitions remains in the petroleum additives industry, as we believe this will have the highest probability of success.

Within petroleum additives, industrial lubricant additives and fuel additives are our main focus. We will also continue to evaluate alternate uses of our cash to enhance shareholder value, including stock repurchases and dividends. On October 18 our Board of Directors declared a quarterly dividend of $0.44 a share, on our common stock.

The dividend is payable on January 1 to shareholders of record at December 15. This represents an increase of about 17% from the previous level of $0.375per share.

Thank you for your attention. That's all of my planned remarks. LaTonya, I'd like to open the lines for questions.

Thank you. (Operator Instructions). One moment, please, while we poll for our first question. Our first question comes from Mike Sison with KeyBanc. Please proceed with your question.

Hey. Good morning. Nice quarter.

Thank you.

In terms of in the 10-Q you noted that you felt good about getting all the pricing you needed to offset raw materials. You didn't really have any comments on the opening there. Could you give us a little more color on that?

This is David. We took actions -- what I'm trying to communicate, we took actions earlier in the quarter. Timing on all of those are different. And what we're saying is those actions would result in us being fully balanced if raw materials don't move in the fourth quarter.

And your outlook for raw materials in the fourth quarter is not to move up further?

Well, we believe they're pretty stable right now.

Okay. So the delta between the 17% and let's say the higher end of what you believe the normal range is, is that basically the squeeze that you're seeing in raw materials?

Mike, I don't think that we could put it on any one point. It's certainly variable, but it's not -- 17.2% is a good number for us in this business. We're happy with that margin.

Yes, I would agree. And then in terms of volume growth for the fourth quarter and maybe heading into 2011 it sounds to me that in the third I guess it was sort of half-half? The 6% was maybe half Polartech, half core volume growth?

I don't think Polartech would have been half but it would have been some of it. The rest is core volume growth. So you would expect the fourth Q to be more of a normal comparison.

Right. So back to sort of this low single-digit type growth heading into 2011?

That's correct.

Okay. Great. Thank you.

You're welcome.

Our next question comes from Saul Ludwig with Northcoast Research. Please proceed with your question.

Good morning, guys. If you think about -- this is a longer term question. If you think about the, let's say the industry growing 3% in volume, does there come a point where you would have to add some capacity, or if we look at a 3% long term growth rate in volume, how many years would you be able to go with your existing facilities before you would need to have an expansion?

Good morning, Saul. It's Teddy. First of all, 3% is probably a higher number than we might think. But just marginally so. But pick any number in the low single digits. And yes, we do need to add capacity periodically.

We've done that over the past few years, some by bottleneck and some with the investment in Singapore. As we look forward at the next couple of years we expect to need to add more than has typically been the case. Higher capital spending. But it's incremental type of investment. I don't expect us or sort of really anybody else to be adding a huge new slug of capacity that will disrupt anything. But you give a 2% growth rate on the size of our industry and we do need to add capacity as we go forward.

So it sounds like the only new plant is certainly the Lubrisol plant in China. So you think in terms of building any major new facilities that's going to be it for the industry for an extended period of time?

Well, I don't know. But I'm not aware of any other announcements. And any new capacity generally takes two to three years to come on. Our new facilities in Singapore are ones we're excited about. And our current plans are to add additional capacity most likely in that region but nothing specific at this time.

Okay, great. Thank you very much, Teddy.

Sure.

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

Hi. Thank you. The question would be on the raw materials side. How long is the lag between when raw material prices go up and when you're able to actually get the pricing? Not just announce but actually through and hitting the P&L?

Ian, I think the short answer is two months. I think the longer answer is that there are circumstances where we make accommodations where it's longer than two months. But it's typically not less than that.

Okay. So if I was to average it might be kind of two and a half to three months across the portfolio?

That would be correct.

Okay. And then on the M&A side, what are your thoughts about cash or stock? And can you give us kind of a magnitude of the type of deal you'd be looking at?

We're interested in any deal of any size in our industry. Our focus on the acquisition side is in petroleum additives. There are a number of small niche players particularly in the industrial and in the fuel additive areas. Most of them are in kind of the Polartech range in the under $50 million size. There are a few bigger opportunities but not many, so I think most of the opportunities that we get a chance to look at are in that $25 million to $50 million range.

Okay. So a $400 million deal or $500 million deal is unlikely?

Yes.

Okay. And so then if they were smaller than that you'd just use cash or -- as opposed to stock, correct?

That's right.

Okay. All right. Thank you very much.

Sure.

Our next question comes from Todd Vencil with Davenport & Company. Please proceed with your question.

Thanks guys, good morning.

Good morning.

So if we think about demand and the volume growth that we saw in the third quarter across sort of different product types that I'm thinking about, fuel versus engine lubricants versus drive line and other industrial specialty lubricants, can you kind of talk about what that looked like?

I'm not exactly sure I understand your question, can you --

I'm saying was there a difference in sort of growth that you guys saw in drive line versus engine versus fuel?

Yes. Fuels was as we said was relatively flat. Andthe other side just because of the comparison, industrial and drive line had a nice rebound from third quarter of last year, which was low because of that area took a little bit longer to catch up. I don't read anything into it. It's just the way it rebounded.

The more sort of normalizing a little bit later than the other parts of the business?

Yes, that's right.

Fair enough. Any big geographic comps along the same lines? I mean, you mentioned that a year ago you saw a lot of demand from Asia Pacific. What did the comp for this year look like?

No. I probably wasn't real clear. What we said is second quarter we saw a strong demand in Asia Pacific. And we kind of thought they were catching back up. But no geographical thing to point out in the third quarter.

Got it. And you mentioned that you weren't quite fully caught up on price and you thought with what you'd put in now, by the time it closed there you would be. If you'd been fully caught up on price in the quarter, do you have a feel for how much margin that would have added?

I haven't done the arithmetic but it wouldn't have moved that 17% back to that 23%.

That narrows it right down. Okay. I appreciate that.

All right.

And the plants are what you said are at high operating rates. Do you feel like you still have some room to go yet to sort of accommodate the slower more normalized level of volume growth?

It just depends on the unit. Some of our component units have additional room, some are very tight today. And we're paying close attention to it.

Got it. Here's a question that you always get. And it's on everybody's mind. And are you feeling any -- and I heard your comment about continuing to be able to pass through higher costs -- are you feeling any sort of like that's nearing any kind of threshold or do you still believe you just have -- it's always hard to raise prices on customers, I understand, but do you still feel like you have the same sort of ability to do that or is it starting to get harder?

I think in a broader sense, Todd, I don't see any real significant changes in the fundamentals of the industry today.

Got it. One final one for David, corporate unallocated was up a little bit and it certainly wasn't out of the realm of what we've seen before. But was there anything in particular going on there?

It was quite a list of all immaterial type items, Todd. And I can talk with you about that offline if you want to. But there was no one thing. Probably the one biggest thing was some of the salaries and benefits have some tie to the closing price of the stock. And the stock had a great run up in the third quarter.

That makes sense. Do you think the run rate's going to be at level that it was this quarter or is it going to drop back a little bit?

It most likely will drop back a little bit, yes.

Okay. That's great. Thanks, guys.

Our next question comes from Dimitri Silverstein with Longbow Research. Please proceed with your question.

Good morning, everybody. I would just like to follow up a couple of things you've talked about already. First of all on the price realization you got on the quarter you talked about volumes being up 6% which is about half of the growth you saw in additives, and then you had a negative Foreign Exchange component. So am I to understand that pricing went up somewhere close to 10%?

What we show in the 10-Q, we have a little table in there that changed the revenue change for you. So we had about a $30 million increase in revenue due to selling prices and mix off of a base of $400 million.

Okay.

So that's closer to 7% or 8% doing that in my head.

Okay. And that was price mix. Okay. That's helpful. Secondly, when you spoke about some inventory building took place in Asia in the second quarter, does that mean that in the third quarter you saw revenues or volumes down in Asia? Do you think that inventories are now at a point where we can see resumption of growth in the fourth quarter or next year?

Resumption of growth of business? Is that what you're asking?

Yes. Yes.

I think we're back to normal across the regions, yes. The answer is yes.

Okay. But did you see actually lower volumes in Asia in the first quarter?

A little bit lower than in the second quarter. But totally consistent with what's going on.

Okay. So I guess I'm trying to understand. If there was inventory build in the second quarter did it impact demand in the quarter so the slowdown was beyond seasonal, it was because there was some inventory sell-through? Is that the right way to think about it?

Yes, I think that's right.

Very good. And then final question you mentioned kind of the size of acquisitions that you were looking at. Are most of these -- or could you characterize if these are parts of large companies or these are smaller, independent, private companies?

I think most of the small ones are not parts of large companies.

Okay. Is there any acceleration, if you will, in the geoflow or are people more willing to sell now before the end of the year and the change in tax laws just from kind of an inheritance and generational transfer point of view?

We've seen a little bit of evidence of that, yes.

Okay. All right. Thank you very much.

Sure.

Our next question comes from Andre [Joglicier] with MAC. Please proceed with your question.

Gentlemen, how are you?

Fine, thank you.

Quick question on your comment about the new oil standard, the GF 5? Just based on some of the stuff out there, it sounds like it requires a different type of base oil, which is probably a little bit more expensive, and then certain additives also require molybdenum, an ingredient which I think some people estimate that new standard could be 20% to 30% more expensive to produce than the current kind of additives that are out there in the market. So can you talk a little bit about how you guys plan to deal with that and what's your strategy on passing through that additional costs that you incur?

We've got some industry-leading technology to meet the GF 5 spec. And we're not seeing a need for more expensive base oil for our customers. And not seeing a dramatic change in the overall cost picture for our customers.

Understood. Thank you.

(Operator Instructions). Our next question comes from Ivan Marcus with Northcoast Research. Please proceed with your question.

I just have a couple quick questions. Last year in the fourth quarter you had a pop in R&D spending. Are you expecting a similar type of pop, or where do you think R&D spending will come out for the fourth quarter, full year?

I've been going from memory. The last year's fourth quarter was some testing that was associated with this passenger car spec we've been talking about. So I'd expect fourth quarter to be more normal, inflationary kind of movement.

Okay. And then for -- on the volume side the total additives business, I know there's seasonality to it. What sort of now that we're in normalized demand rate, what's the typical percentage decline from third quarter to fourth quarter? Is it a 10% lower historically on average or what's sort of the range there?

Two or three percentage points.

Okay.

So whatever percent is that to you.

Got it. Appreciate it. Thanks.

Certainly.

Our next question comes from Robert [Solis] with Jay Goldman.

Hey, guys. Thanks for taking my questions. Given the way the way pricing has [flown in] thus far during the year, would you expect price to accelerate from the third quarter into the fourth quarter?

What do you mean by accelerate? There's some pricing action that's just going to flow through the fourth quarter. That has already been dealt with from the customer base. So what do you mean by accelerate?

So there's no new incremental pricing that's yet to hit at some of your customers that might accelerate pricing? Any higher pricing in the fourth quarter versus the third?

It would be very modest if any, yes.

Okay. So really then based on Ivan's last question, the way to think about your revenue excluding FX and mix for a moment is that you'd anticipate the fourth quarter to be about two, three percent lower than the third quarter. Is that fair?

Yes, if you're just looking at the volume effect and then a little bit of plus from the price effect, yes.

Okay. And then I guess just lastly, one of your competitors noted during the quarter that some of the (inaudible) from some of the base oil suppliers impacted raw material costs during the quarter in terms of some spikes. Not necessarily in listed prices but spikes in prices just in terms of abilities to secure supply. Did that impact you at all?

Yes, our supply guys deal with those. We don't call them out on pretty much a recurring basis. There's things that are going on. So there's effect. And our first goal is to get the product to deliver it to the customers and we've done it. So yes, it affects us but we don't talk about it or measure it publicly.

Okay. Thanks, guys. Thanks for taking my questions.

You're welcome.

(Operator Instructions). There are no further questions in queue at this time. I would like to turn it back over to management for closing comments.

Well, thanks everyone for dialing in and we'll see you next quarter. Have a good day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.