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NewMarket Corp. (NYSE:NEU)

Q4 2008 Earnings Call

February 5, 2009 10:00 am ET

Executives

David Fiorenza - VP, Treasurer and Principal Financial Officer

Teddy Gottwald - President and CEO

Analysts

Saul Ludwig - KeyBanc Capital Markets

Robert Felice - Gabelli & Company

Ian Zaffino - Oppenheimer

Operator

Welcome to the New Market Corporation Fourth Quarter 2008 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 New Market Corporation. Thank you, Mr. Fiorenza. You may begin.

David Fiorenza

Thank you, Brain. Thank you for joining me to discuss our fourth quarter and year end results. With me today is our CEO, Teddy Gottwald. Following our normal format, I have a few planned comments, after which we'll open the lines for 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 based 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 2007 10-K. We will be filing our 2008 10-K towards the end of February. I encourage you to review that filing for more information on the performance and financial condition of the company.

As you saw yesterday, we reported our fourth quarter and year end results. To recap the year, income from continuing operations for the year was $73 million, an increase of 6% from earnings on the same basis for 2007 of $69 million before special items.

Earnings per share on this basis for the year 2008 were $4.75 a share, an improvement of 17% over earnings per share on this basis for '07, or $4.07 a share before special items. The earnings per share percentage increase was more than the net income percentage increase due to the stock repurchase activity during each year. We did not purchase any stock in the fourth quarter of 2008.

During the year 2007, discontinued operations and special items, net income for the year was $95 million, or $5.62 a share. The discontinued income was associated with the termination of the TEL marketing agreement. We are very pleased with this year's performance.

We also announced our fourth quarter results. Income from continuing operations for the fourth quarter was $19.4 million, an increase of 26% from earnings on the same basis for the fourth quarter of '07 of $15.4 million before special items.

Earnings per share for the fourth quarter of 2008 were $1.27 per share, an increase of 32% from earnings per share in the fourth quarter of $0.96 a share before special items. Including fourth quarter 2007 special items, net income for the fourth quarter of last year was $27 million, or $1.68 a share.

You may recall that the special item in 2007 fourth quarter was primarily associated with the reversal of taxes previously provided for on the undistributed earnings of certain of our foreign subsidiaries. You will find this topic in detail on the discontinued operations reflected separately for clarifications in the summary of earnings schedule at the end of the press release.

Our petroleum additives operation had another good year, with annual sales increasing 18% on an improvement of 4% of shipments. The remainder of the improvement in revenue was due to our raising prices during 2008 to recover the rapid increase in raw materials that we experienced during the first 10 months of 2008. Operating profits for the year was $130 million, a small improvement over 2007 performance.

For the fourth quarter, petroleum additives net sales were $366 million, which was 1% increase from the comparable period last year. In this comparison volume shift were down approximately 19%. Operating profit for the fourth quarter this year increased to $32.5 million, an improvement of 13% over last year's fourth quarters operating profit of $29 million.

We did experience some improvement in margins in the fourth quarter, with operating margins of 8.9%, compared to 6.4% in the third quarter. The operating margin for the fourth quarter of '07 was 8%.

Our Petroleum Additives business experienced two radically different business environments in 2008. During the first three quarters, our plants operated at very high rates and crude oil prices continued to escalate from $70 to over a $140 a barrel.

The (inaudible) chemicals market was one of tightness of supply and rapidly escalating prices. We managed the demand these factors placed on us during this period. We maintained uninterrupted supply to our customers and implemented multiple price increases to recover the rapidly escalating raw material and other cost increases.

This growth period had a significantly negative impact on our cash flow position, as our working capital needs consumed $72 million during these three quarters. The last quarter of 2008, and more specifically the last two months, were significantly different from the first 10 months of 2008.

Our business during October was excellent, but beginning in November, demand decreased dramatically. During the last quarter of 2008, the cost of crude oil plummeted to under $50 a barrel and commodity chemical companies began idling facilities and reducing their workforces.

We believe that there are two primary factors that resulted from such a dramatic decrease in demand for our products in the last two months of 2008. We believe our customers were lowering their inventory levels, using their existing higher price inventory and anticipating price decreases, since the price of base oil had fallen. The second factor was the worldwide economic slowdown.

We immediately took action upon recognizing the change in conditions. We reduced production in our plants, in order to manage inventory levels. To support the existing business levels, during the first 10 months of 2008, our inventories had been at higher and were necessary to support the demand for our products that we saw in the last two months.

We took internal actions to control spending, and increased our focus on managing customer accounts and the related accounts receivables. We have taken measures to control costs in spending and are not adding to our workforce. We believe we have taken the appropriate actions needed at this time.

We will continue to monitor demand and take further actions as necessary. We know that modern machinery requires the products our industry produces to function properly. We are uncertain when the de-stocking at our customers will cease, as well as what the ultimate level of business activity will be.

It is our current expectation that the first quarter will be relatively low in demand, similar to November and December. We also expect a gradual recovery over the following three quarters under the assumption that the de-stocking phenomenon will have ended. We will be reporting on this topic throughout the year.

Turning to the balance sheet and cash flow. We are generating cash from operating activities of $21 million in 2008, compared to $110 in 2007, quite a significant change. The single largest component in this drop and cash generated was the working capital requirements in 2008.

During 2008, working capital consumed $89 million of the cash that our operations generated. Cash receivables increased $14 million, inventories increased $36 million, and accounts payable decreased $42 million. So, it was a highly unusual year with respect to the demands on working capital.

The increases in account receivable and inventories were due to the rapid increase in business during the first 10 months; rather drop in accounts payable resulted from slowing our plans and reducing our purchases significantly during December.

We ended the year with $42 million of debt under our revolver credit agreement, $150 million of bonds and $43 million drawn under the Foundry Park construction loan. Our total capital expenditures for 2008 were $75 million, with $43 million being used for Foundry Park. We expect the capital expenditures for 2009 will be around $63 million for Foundry Park, and $30 million for the remainder of our business.

We also expect that working capital will be a source of cash during 2009. With the price of materials dropping and demand slowing, we will be able to run with lower inventory and should see our accounts payable levels increase to support our purchasing activity. We expect that some significant portion of the working capital use of cash last year will return to us this year.

We also noticed in our balance sheet a significant increase in long-term liabilities. This is related to the poor performance of the equity markets, where the majority of our pension assets are invested. We believe we're not like any other company. Everyone has experienced this, as our controller says when he opened his 201k statement this year at quite a drop.

The increase in our books about $42 million, the increased liabilities. We've gone from an over funded situation to an under funded situation with respect to our crude benefit obligation. We expect we'll make a modest increase in our contributions in 2009 to the pension funding, and expect pension expense to increase about $2 million in 2009 over 2008.

In the Petroleum Additives segment, we're beginning 2009 with a great deal of uncertainty for the demand of our products, due to worldwide recessionary impacts and how our customers may manage their inventories. The products that our industry produces are not discretionary, as modern equipment requires a sophisticated level of lubrication.

We believe the demand will improve from the very low level seen in November, December and continuing into January. We have every expectation that our business will perform well in this difficult time. We have a solid business base, a good technical product offering and an excellent team who is dedicated to our customers and our business.

We believe the de-stocking may last through the first quarter, and that the underlying market demand will be within 5% to 8% percent of historic levels. Those are all the comments I have planned. I'd like to open the lines now for questions.

Question-and-Answer Session

Operator

(Operator instructions.) Our first question comes from the line of Saul Ludwig with KeyBanc Capital Markets.

Saul Ludwig - KeyBanc Capital Markets

Good morning. This is Saul.

David Fiorenza

Hello, Saul.

Saul Ludwig - KeyBanc Capital Markets

And my 201k is performing about the same. When you say demand will be within 5% to 8% of historical levels, you talk about end markets. What do you mean by that? That means down 5% to 8% versus last year. What do you really mean by that?

Teddy Gottwald

Yes, Saul, it's Teddy. That's what we were saying. We expect market demand in '09 to be 5% to 8% weaker than 2008.

Saul Ludwig - KeyBanc Capital Markets

And assuming that projection was exactly a reality, given the additional volume behind that you expect to experience in the first quarter, then your volume decline would be somewhat greater. Is that correct?

Teddy Gottwald

Yes, something towards the high end of that range.

Saul Ludwig - KeyBanc Capital Markets

Okay. And then, Dave, as you cut back production in the fourth quarter, you ran your plants at lower than full utilization. To what extent did your fourth quarter earnings, where they impacted by unabsorbed overhead – that normally would have gone into inventory, but probably went into period costs?

David Fiorenza

Yes, that factor, there were several millions of dollars in that and there would be some of that in the beginning of the first quarter.

Saul Ludwig - KeyBanc Capital Markets

And you mean, may be like $5 millionish?

David Fiorenza

Yes, that's fair.

Saul Ludwig - KeyBanc Capital Markets

I mean, is that too high, too low?

David Fiorenza

No, that's (inaudible).

Saul Ludwig - KeyBanc Capital Markets

Okay. And then finally, I suspect that in the fourth quarter, your price increases that you had put in place, prior to that, you probably have to keep most of that in the fourth quarter, yet you benefited, you are on LIFO, all right?

David Fiorenza

We are in LIFO in the United States and the conglomeration of methods around the world.

Saul Ludwig - KeyBanc Capital Markets

So you benefited as your raw material costs came down in the fourth quarter, and you had the widening margins, as you expected when you issued your third quarter outlook at the end of the third quarter. What do you think is going to happen to pricing relative to costs? With base oil plummeting again this week, do you see your selling prices trending lower, but maybe not as fast as raw material costs are coming down, and had you known those for sure, how are you handicapping the margin outlook for this year?

Teddy Gottwald

We are seeing our cost come down. You mentioned base oil. Base oil has dropped quite a bit. Some of our other raw materials are also seeing some pretty good decreases and our customers will see the benefits of those, as well our raw material costs, as we work the cheaper materials through our system. It's certainly our goal to maintain decent margins and that's about all I can say on that.

Saul Ludwig - KeyBanc Capital Markets

David, I wondered if you can address the tax rate, favorable. It was very nice in the fourth quarter. How should we be thinking about the tax rate this year?

David Fiorenza

Yeah, it is 33%. I used to think of '09.

Saul Ludwig - KeyBanc Capital Markets

What happened so it was there in '08, it's not going to happen again.

David Fiorenza

Well, I think 33% is a good number. What happens in the fourth quarter, when Congress waits to pass the R&D tax credit. You can't anticipate it, so effectively, we're taking a whole year's benefit in one quarter, because Congress took that long, might be negative. It just took that long to pass the bill saying we could do it.

Saul Ludwig - KeyBanc Capital Markets

Right. And are you assuming you are going to get the R&D tax credit again?

David Fiorenza

Yes, I am.

Saul Ludwig - KeyBanc Capital Markets

We are in that 33%. You're just assuming its going to be more equally balanced?

David Fiorenza

No, I don't know when it will pass again. It's already been, I have just been told it has already been passed. So, yes, it will be equally balanced.

Saul Ludwig - KeyBanc Capital Markets

Okay, great. Thank you very much. Nice quarter, guys.

David Fiorenza

Thank you.

Operator

Our next question comes from the line of Robert Felice with Gabelli & Company

Robert Felice - Gabelli & Company

Hey, guys, congrats on a very nice quarter. I just wanted to follow-up on Saul's question regarding raw material cost and pricing. Maybe I'll ask it a little differently. Given the decline in volumes that you've seen so far, have you seen any change in pricing rationality amongst you and your competitors? In other words, is the supply-demand balance, listen to the point, where you would be forced to give back on price in any kind of meaningful rapid way and, to that end, have you had to give back on price yet?

Teddy Gottwald

We are in discussions with essentially all of our customers about the change in the cost structure and price structure, and yes, we are seeing some lowering of prices. As an industry, I would say, we aren't seeing any significant change from the dynamics of 2008.

Robert Felice - Gabelli & Company

So, as I think about your margins for 2009, should I think that you will be able to hold on to your pricing long enough, given the drop in base oil costs that your margins will revert back to more historical levels. So, in other words, can you capture a decent portion of that price cost gap?

Teddy Gottwald

Well, I have to say I certainly hope so. We got burned on the way up through the better part of nine months of 2008, as the costs were going up. So, yes, I would hope that we would see some improvement as it comes down.

Robert Felice - Gabelli & Company

So as I try to balance the dual dynamics we have here at lower volumes, but favorable price cost, should I expect that '09 operating income for petroleum additives will be greater than that in 2008?

Teddy Gottwald

We don't give that kind of guidance, and the tumultuous world that we're in today. I'm glad we don't give that kind of guidance. I think it is safe to assume, though, that the first quarter from a profit standpoint will be weak.

Robert Felice - Gabelli & Company

Okay, thanks for taking my questions. Thank you.

Teddy Gottwald

Thanks.

Operator

Our next question is from the line of Ian Zaffino with Oppenheimer.

Ian Zaffino - Oppenheimer

Hi, thank you. Just want to get a sense of the pricing right now. The prices that are in place right now, how much are they up year-over-year?

David Fiorenza

Percentage wise, I think, I don't have that number.

Ian Zaffino - Oppenheimer

Okay, as I guess --

David Fiorenza

It will be in our 10-K, we'll be able to calculate that for you.

Ian Zaffino - Oppenheimer

Okay, I'm just trying, the point I am trying to get at is, what do the revenues in the first quarter look like? Recent volumes are down 20%, prices were probably enough to offset that. Is that the right way to look at it?

David Fiorenza

Yes, absolutely, we said we were up 1%, but volumes were down at 19% and prices were enough to cover.

Ian Zaffino - Oppenheimer

Okay, okay and then --

David Fiorenza

I was talking fourth quarter, right?

Ian Zaffino - Oppenheimer

Right, I'm talking first quarter though, I mean, what you've seen so far.

David Fiorenza

We've got one month in the book and volumes were in line with November-December. That's all we know right now.

Ian Zaffino - Oppenheimer

And pricing has been relatively the same as November-December?

David Fiorenza

Well, you know, there is no easy answer to that. We have a lot of customers and we have different situations that exist.

Ian Zaffino - Oppenheimer

So is that biased to our pricing pressure or pricing power?

David Fiorenza

Ian, there's going to be a lot of pressure. Customers know exactly what's going on at the raw material side.

Ian Zaffino - Oppenheimer

Okay. All right, thank you very much.

David Fiorenza

Okay.

Operator

(Operator Instructions.) We have a follow-up question from Robert Felice.

Robert Felice - Gabelli & Company

Hey, guys, just as a point of clarification, would you expect your first quarter earnings to be weaker on a sequential basis or on a year-over-year basis or both?

Teddy Gottwald

Both, because they are both about the same round numbers.

Robert Felice - Gabelli & Company

Okay. Why would you expect first quarter to be so weak? I understand that the volumes are off quite a bit, but imagine you're still benefiting from the favorable widening of your price cost gap, and the volume deterioration, as you mentioned, will be at the high end of that 5% to 8% range, but not materially different than 4Q. So some clarification on 1Q profitability levels would be appreciated.

David Fiorenza

Yeah. I guess there are couple of points. As I said in my planned comments, we had a good October and not a good November-December. And so, we are also telling you that first quarter is looking more November-Decemberish. So I got three November-Decembers, we look at that way.

And then we are going to be working some inventories down. As Saul asked earlier, we'll likely have some negative impact of the unabsorbed cost in the first quarter. So, all those factors together lead to us to make the comments that we are making.

Robert Felice - Gabelli & Company

Okay, that's helpful.

Operator

Our next question comes from the line of [Jim Leonard] with SunTrust Investment Services.

Unidentified Analyst

Hi, Teddy. Hi, David.

Teddy Gottwald

Hi.

Unidentified Analyst

Teddy, how is the golf going?

Teddy Gottwald

Non-existent.

Unidentified Analyst

I understand. Being with a bank and all kind of things we're going through right now. Just wanted to ask, do you have any concerns about accounts receivable and bad debts, will put some of the clients?

Teddy Gottwald

Yes, during the end of last year, it was great to have such a first class set of customers. The answer to that question is, there are always one or two you worry about, but, by and large, we have no concern.

Unidentified Analyst

Thank you, have a great day.

Operator

Our next question is a follow up question from Mr. Ludwig with KeyBanc Capital Markets.

Saul Ludwig - KeyBanc Capital Markets

Hi. With regard to balance sheet part, and obviously the need to get some long-term financing there... When is that construction loan, it has to be paid off... What are you doing about that, and what's your back stop plan if credit conditions don't get a lot better than they are right now?

David Fiorenza

The construction loan is due in August of 2010.

Saul Ludwig - KeyBanc Capital Markets

August, okay.

David Fiorenza

And to answer to your question, what if they don't get better, we are going to be chasing down alternative path, either short-term solution or long-term, confident that we will find something in the timeline that we have to deal with.

Saul Ludwig - KeyBanc Capital Markets

Okay. You mentioned that your pension expense would be up about only $2 million.

David Fiorenza

That's right.

Saul Ludwig - KeyBanc Capital Markets

Okay, you've got the assets and your pension plan was about a $100 million, and they got clipped by probably $30 million to $40 million, so I got you 7% return on that, that results in the additional expense. Okay. And how are you thinking about FX and its influence on your earnings this year, and how much did FX help you in '08 that may go away this year?

David Fiorenza

In our last Q, we said 10ish million help, and '08 versus '07 fourth quarter was relatively zero. So, the answer to your question would be $10 million, if rates stayed where they are now, all year.

Saul Ludwig - KeyBanc Capital Markets

That goes against you.

David Fiorenza

Correct.

Saul Ludwig - KeyBanc Capital Markets

And then didn't you also have, was it the first quarter of last year, this may help in the first quarter, didn't you win a lawsuit or something that you had some income in the first quarter of '08?

David Fiorenza

Yes. We had $3 million of pre-tax benefit in the first quarter of '08 from…

Saul Ludwig - KeyBanc Capital Markets

So, that's $2 million, I mean that's $0.12 a share right there that goes away, right?

David Fiorenza

Yes.

Saul Ludwig - KeyBanc Capital Markets

Okay. I think that would maybe, a little clarity to, you know, part of your first quarter expectation of directionally lower results. Okay, great. Thank you very much.

David Fiorenza

You're welcome.

Operator

(Operator Instructions.) Seeing as there are no further questions, I'd like to turn the call back to management for concluding remarks.

David Fiorenza

Well, thank you for joining us and we'll talk to you next time. Have a good day.

Operator

Ladies and gentlemen, this concludes today's teleconference. Thank you all for your participation.

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Source: NewMarket Corp. Q4 2008 Earnings Call Transcript

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