NewMarket Corp (NEU) 2011 Q3 法說會逐字稿

Greetings and welcome to the NewMarket Corporation's third quarter 2011 financial results conference call. (Operator Instructions) It is now my pleasure to introduce your host, David Fiorenza, Vice President, Treasurer and Principal Financial Officer for NewMarket Corporation. Thank you. Mr. Fiorenza, you may begin.

Thank you for joining us to discuss our third quarter results. With me today is our CEO, Teddy Gottwald. Following our normal format, I have a 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 10-K. We filed our 10-K this morning. It contains more details on all aspects of the quarter and I encourage you to review it. I'm going to focus today on those items that I consider of main importance.

Net income for the third quarter improved to $71.4 million or $5.22 per share. This significant improvement benefited from an after-tax gain of $23.9 million associated with the settlement of certain legal actions and it also included an extra charge of $4.6 million associated with marking our interest swap to market over last year's third quarter numbers. Excluding these two items, to get a better picture of our underlying business, our net income increased $6.4 million. Yesterday's press release breaks out the impact of these events in the table on the first page.

Petroleum additives net sales for the quarter were $552 million, which is an increase of $87 million or about 19% from last year. The increase in sales primarily resulted from higher selling prices and a favorable impact from foreign exchange. Product shipments between the two third quarter periods were essentially unchanged. Breaking the 19% improvement into its component parts shows 1 percentage point due to shipments, 3 due to currency and the remainder due to price changes.

The petroleum additives segment includes a pretax gain of $38.7 million related to the legal settlement previously mentioned. Excluding the legal settlement, the petroleum additives operating profit increased $4.1 million in the quarterly comparison and has increased $23.2 million in the year-to-date comparison. For the quarterly comparison, the major favorable factor was margin recovery, partially offsetting that was the unfavorable effect of planned higher spending in S&A and R&D and higher cost of production due to plant loadings. Our S&A, together with R&D were about $5.9 million higher for the third quarter as compared to the third quarter last year. S&A increased about $1.8 million while R&D increased about $4 million.

The spending this quarter was the highest quarterly spend in our history for our research activities. It is our belief that in order to continue our success, we must continually increase our investments in S&A and R&D to support our customers' programs and to develop the technology required to remain a leader in this industry. We view R&D as a major contributor to our success and we plan to continue to invest in the people and resources required to maintain that high level of performance.

Our shipments for the quarter were essentially unchanged from the third quarter of last year and down about 14% from the second quarter of this year. The short-term demand for our products has slowed somewhat but our long-term view of our business and the demand for the goods and services we deliver has not changed. We've all seen the ups and downs in the economies around the world and no business is totally immune from those forces. We expect that this softness in demand will continue during the fourth quarter which is typically a slower volume demand quarter.

Raw material costs are moving; some up, some down, many unchanged. On the whole, we have not seen reductions in our total basket of raw materials that we purchased.

The effective tax rate for the quarter was 30.9% compared to 32.3% last year. The primary reason for the lower effective tax rate this year is due to the inclusion of the R&D tax credit which was not available until the end of 2010, as well as a higher domestic manufacturing tax credit. We continue to believe that 32% to 33% is a good planning base for our effective tax rate.

Cash was $55 million at quarter's end. That represents a decrease of $6.4 million from the June level, while our debt increased $11 million. There's a summary of the cash flow statement included in the press release and a detailed cash flow statement in the Q.

Our business continues to generate significant cash but the business is also consuming a lot of cash in working capital. For the first nine months, working capital requirements increased $88 million to support our business growth and as a consequence of escalating raw material prices, which impacts both receivables and inventory values.

We also spent $43 million in the first three quarters for capital expenditures to support our business. We expect the total number for CapEx for the year to be about $50 million. During the quarter we repurchased 442,300 shares of our stock at an average price of $150.54. We have about $60 million remaining on our Board authorization for future stock purchases.

For the 12 months ending September, we had EBITDA of $390 million and a debt of $276 million, which gives a 0.8 debt to EBITDA ratio. We continue to operate with very low leverage. The quarter's ending availability on our revolving line of credit was $238 million.

We are very pleased with the overall performance of our business during the first three quarters. Our businesses continue to run well and we remain focused on the long-term by providing the goods and services our customers expect of us. The overall industry dynamics remain fairly constant during the first nine months of 2011 and we anticipate no change in the near term. We continue to operate under the assumption that this remains a low growth industry, in the 2% per year category, while we develop plans to grow better than that rate through our customer service model.

Our balance sheet remains strong, our business continues to generate cash and we have significant debt capacity to support the expansion and growth aspirations of our businesses. We continue to focus on acquisitions in the petroleum additives industry to support our overall growth. We remain focused on this strategy and evaluate any future opportunities. Nonetheless, we are patient in this pursuit and intend to make the right acquisition when the opportunity arises. Until then, we will continue to evaluate all alternative uses of our cash to enhance shareholder value.

That concludes my planned remarks. Jackie, I'd like to open the lines up for questions.

(Operator Instructions) Ivan Marcuse, KeyBanc Capital Markets.

If you look at where raw material costs are today and if they were to stay stable or flat into the fourth quarter, would you expect where your pricing is and the pricing actions you've taken through the year for that margin to increase on a sequential basis or do you think the lower volume will probably keep margins flat or down into the fourth quarter? How should I think about that going forward?

The fourth quarter, as you've just pointed out, is always a bit softer, so you might expect them to go down. Raw materials, they are where they are and we've taken our pricing actions so I think it's going to depend on the volume for the quarter.

For base oil the group lineup has declined but group two has sort of been unmoved and group three unmoved basically. Do you use more group three, group two in base oil or is it a mix of all three groups?

It is a mix, but remember we talk about to gather base oil and we typically talk about base group one because it's easy to see and everybody sees it, but base oil is only 20% of our raw material basket and that's why I had my planned comment; we haven't seen reductions in a lot of them. A lot of them are the same, some have gone up. My data says the weight average of our raw material baskets hasn't moved much in the last three months.

If you look at it on a year-over-year basis, how much would your material costs be up per unit?

I don't have that in front of me on a dollar per ton but it's up a fair amount.

Then looking more at the long-term growth that you mentioned, at what point - I know acquisitions you're looking for them, but they tend to be few and far between. At what point do you need to add capacity or would you think about maybe building a plant or doing something in that basis? What's your thought process there? At what point do you need to do that or would you want to do that?

We're constantly evaluating that and we're constantly adding bits and pieces where our bottlenecks are. So we've been adding some capacity. Right now we're in pretty good shape to meet requirements in the near term. I do think that our spending for new plants will be higher over the next couple of years, two or three years than it's been. We will need to add some, but we're in pretty good shape today.

Dmitry Silversteyn, Longbow Research.

Just looking at your debt increases versus the end of 2010, you've been pretty consistently increasing debt. Is that all share repurchases or are you spending more money on working capital? Where is the debt increase coming from and how should we think about that going forward?

On that consolidated cash flow statement that's in the press release is probably the best place to look at that one. We used an additional $88 million this year to support our business in working capital. We did buy back $85 million of stock and paid a good dividend so it's just where do you want to apportion those to what. That's the major uses of that cash. The top line, cash from operations remains very very strong.

So as we look forward to kind of over the next two, three, four quarters, are your investing initiatives still going to be a call on cash or do you expect to be unwinding some of the investments and perhaps paying down debt on a year-over-year basis?

I'm not sure I understand your question about unwinding our investments.

I'm trying to understand - should I be modeling that your debt increases - continues to increase as you continue to invest in the business and repurchase shares or is there some peak that you're going to be reaching and I'm starting to pay it down?

We have 0.8 debt to EBITDA so we view that we have a very low leverage ratio. On an annual basis, this business is cash flow positive. Whether we actually reduce the debt or not depends on whatever circumstances come and alternate uses of the cash.

Secondly, regarding your petroleum additive volumes, you talked about the last nine months being kind of similar end market performance and trends and yet we've seen quite a bit of volatility in your volumes. They were off double digits in the first half of the year and then we got into the third quarter and even though the comps year-over-year looks like they're a little bit easier, you actually flattened out in terms of volume. So was there some prebuying or inventory fill by your customers, was there a onetime purchase from perhaps a large new customer that's not repeating? As you look down kind of below the surface of the market being steady, what's driving your volume volatility?

We don't see any specific action that we can identify from any one customer that's driving it. And I think that our ability to predict volumes in the near term has gotten tougher. We have seen more volatility from a quarter to the next and we think that a lot of that has to do with the volatility in the pricing environment, the raw material environment and oil in general. It's our view that there's some expectation by our customers that base oil, which is a major purchase of theirs, is going to drop, so there may be a bit of a wait and see and some inventory draining going on by our customers in anticipation of lower costs.

In addition, I think that the overall uncertainty in the global economy has our customers watching a bit closer to what the world economic situation is going to do and maybe a little bit more cautious in keeping tanks filled.

You mentioned that at least part of your raw material basket may be declining, overall it's kind of steady. As you're looking at perhaps a little bit of a decelerating just global economic conditions and base oil rolling over, despite the fact that it's only 20% of your cost of goods sold I think from a customers' point of view they look at that as a cost relief for you. To the extent that you haven't realized all the pricing that you put in earlier in the year, do you think it's going to make it more difficult for you to get that final X percentage of pricing in the second half of the year, given the economic conditions or do you still think that as you renegotiate your contracts you'll be able to get pricing up?

Dmitry, I think we're where we're going to be on pricing. We don't have any need to go back out. We think we've taken the necessary actions that are reflective of our data.

I understand that you're not going to be getting any new pricing, but to the extent that you've announced prices earlier in the second quarter that takes months or however long to make it into the market, is it going to make it any more difficult to get that final price pushed across the finish line?

No, I don't anticipate any change.

Final question on your real estate business, any changes in occupancy rates, any gains or major losses of tenants, anything going on there that will change the baseline of profitability on that small business?

No, Dmitry, that building has one tenant who occupies 100% of the building and I would expect 2011's performance on the books to look just like 2010.

Saul Ludwig, Northcoast Research.

This is Kevin Hocevar calling in for Saul Ludwig. I just have a quick question. Going back to the volume really quick, I know you mentioned it's very difficult to predict at this time, but looking just for the rest of this year, is the high single digit volume growth still the goal after the relatively flat third quarter? Should we still think of that as the target?

Yes.

Okay. And looking to 2012, again, I know it's tough to predict, but is there any initial thoughts on volume there?

Just what we've said before, that we expect the market to grow in the 2% range and we have plans in place to do better than that, but as far as any more specific guidance, no.

(Operator Instructions) Harris Arch, DuPont Capital Management.

Just two quick questions here. The first is on historical margins in the additive business. If I go back over the past five-six years and just compare year-over-year, recognizing there's a lot of seasonality so just comparing Q3 margins '05, '06, '07, '08 were anywhere from 6% to 10%, really '09 and 2010 is when we saw 17%, 23% margins in '09. Now we're at 15%. What I'm trying to get at is where are we going from here? Could we return to margins in that high teens, low 20s? You mentioned as far as future pricing, given where raw materials are, there isn't a need to do another price increase, but are we kind of stabilizing in that mid teens? And then like devil's advocate, why won't we go back to margins we've seen in the '05 to '08 time cycle where it was anywhere from 6% to 10%?

I just have a couple of comments. One is, you can call me after the meeting and we'll go through some of the history behind all that. It takes a little bit more. But the other point is, with the way the arithmetic is working, remember that when the raw materials go up, your costs go up, even if you can raise price. We still believe this business is in the mid to upper teens kind of a margin business. That's the short answer to a long question but I'm happy to go through that history with you so you can have a better background.

Okay, I'll follow-up after the call on that but mid to upper teens. Then the other question I had on share repurchases, so this year just like last year, you've been buying back a decent amount of stock. What's your view of future share repurchases? Should we see it continuing at this same rate increasing, decreasing; could you give some more color on share repurchases?

I'd be happy to. As we look forward, we don't have a defined plan in place to buy so many shares. We weigh the need for cash. Certainly our preference would be to use cash and available capacity for acquisitions. There are only so many opportunities in our field and that's where we're concentrating and so at any given point, we weigh the likelihood of acquisitions of various sizes versus the current stock price and any other demands on cash and we make decisions based on those factors.

And then as far as comparing share repurchases to dividends as a return of cash to shareholders, I know you've increased the dividend, views on dividend versus share repurchases?

We see those as independent issues. Certainly on the dividend, as we commented on earlier this year, we do have a desire to pay a higher payout as a percent of net income than we have if you look back one, two, three years. So we have stepped it up. We've made a couple of significant steps this year and this puts us in a position of payout ratio that we feel pretty good about, when we compare the current rate with, let's say the trailing year's earnings. We don't have a specific payout number that we're shooting for, but it's a higher number than it's been in the past. But we make those decisions independent of stock repurchase.

(Operator Instructions) Ivan Marcuse, KeyBanc Capital Markets.

Hey Teddy, I have a quick question. You said that you expect new market to grow above the 2% industry rate over the next couple of years through a variety of different initiatives. Could you give me a few examples of what those are? Is that just basically the benefit that you'll get from debottlenecking or is this new products or is this going to different regions? Where would you put in this different markets where the growth is going to come from above and beyond the 2%?

Our future growth is really based on technology, on strong technology and the ability to get intimate with our customers and understand their needs and provide solutions to their needs that help them grow their business. So, we see the growth coming from that strategy of providing top-notch technology and solutions to our customers. Part of the reason we think we can maintain a growth rate above the industry average is due to the strategy.

Another part of it is the fact that we're still underrepresented in certain markets. We still have a lot higher market share in North America, let's say, and in Western Europe than we do in Asia or Eastern Europe. We have a higher market share in certain segments of our market and it's our desire to grow in a market with four players for the most part, to a representative market share in every product line where we compete and in every region where we compete. So there's room there.

At this time there are no further questions. I'd like to hand the floor back over to management for any closing comments.

That concludes the planned comments I had today. See you next quarter. Thank you.

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