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NewMarket Corp. (NYSE:NEU)

Q2 2008 Earnings Call Transcript

August 1, 2008 10:00 am ET

Executives

David Fiorenza - VP, Principal Financial Officer and Treasurer

Teddy Gottwald - CEO

Analysts

Robert Felice - Gabelli & Company

Ian Zaffino - Oppenheimer

J.P Wright - Cross Capital

Operator

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.

David Fiorenza

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 balance 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 filed our second quarter 10-Q last night also.

As you saw, we released earnings yesterday. Income from continuing operations for the quarter was $17.6 million or $1.13 a share, compared with $17.4 million or $1 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 affect 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.

Turing now to our segment performance. Petroleum additive 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 additive 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 US dollar is weak.

Petroleum additives operating profit decreased to $31.6 million from $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 and energy plant-related costs. We had a favorable impact from higher product shipments. We continued to invest in selling, general and administrative as well as research and development costs. We 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 of the 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 expense were up when comparing the two second quarter periods. They increased as we continued to invest to develop 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, its results are reported in all other.

The real estate development segment represents a activity of Foundry Park 1 activity, which is constructing an office building for MeadWestvaco’s corporate headquarters. The project is well underway. The building is now above ground and steel structure is being erected. We are on schedule and on budget. The building phase of the project will last until late 2009. For 2008 and most of 2009, we will be capitalizing the majority of the cost 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 for the second quarter include these normal operations. For six months, the all other category has a profit of $0.5 million which is 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 $34 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 and costs we’re experiencing.

We discussed this situation before. As raw materials rise, inventory evaluations go up, and accounts receivables go up, and so do 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 cost 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 a $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 rate and we are meeting our customers’ demand while continuing 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 base oil costs alone would result in a significant 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 increasing 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 costs 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 recovery 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 rapid increase in raw material costs is the negative impact on cash flows. As we raised prices to recovery those increases we have more of our working capital committed to account 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’ve communicated in the past, we intend to leverage our financial strength to increase shareholder value by growing our business with acquisitions being in area of primary interest. Our focus in the acquisition area remains on the petroleum additives industry. We remain patient in this pursuit and intend to make the right acquisition for our company when the opportunity arises. Meanwhile we believe we have internal opportunities for growth in the near term, both from a 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 the portion of the downtown 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 our planned comments. Melissa, can we open the lines, please?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question comes from the line of Mr. Robert Felice with Gabelli & Company. Please proceed with your question.

Robert Felice - Gabelli & Company

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

David Fiorenza

It’s in the 200-250 basis point range.

Robert Felice - Gabelli & Company

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

David Fiorenza

We don’t announce price increases as a sense of the stated price increase. But we have announced several times already this year, three times as a matter of fact, and we’re having good success with it.

Robert Felice - Gabelli & Company

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

Teddy Gottwald

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

Robert Felice - Gabelli & Company

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

Teddy Gottwald

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

Robert Felice - Gabelli & Company

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 seeing improvement in margins continually through the year of such that fourth quarter or that should be up around that 10% level?

Teddy Gottwald

It's our objective to get there in the fourth quarter. It's hard to say, the rate of increase of raw materials that we have seen this year has just been unprecedented. So it's kind of hard to predict out two quarters right now and what cost it going to do, and if the cost 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 middle couple of quarter and we know we have no reason to expect anything different this year.

Robert Felice - Gabelli & Company

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 cost, or do you have to go out with additional increases?

David Fiorenza

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

Robert Felice - Gabelli & Company

Okay, and then I guess lastly, your volume for the first half had been really quite strong, what's your full year expectation for volumes?

Teddy Gottwald

As you pointed out, the first half compared to the first half of last year we were up about 15%. It's very strong, we’re not going to finish at 15% 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 continues there, our customers are doing, and we’re doing well.

Robert Felice - Gabelli & Company

Well I guess your other publicly traded competitor mentioned on their call yesterday that they are revisiting their analysis of the industries long-term growth rate and perhaps their for some fundamental changes occurring -- like changes to drain interval and demand in emerging market that have caused that volume number, long-term volume to rise perhaps above that period of 2% range, what are you guys thoughts on that?

Teddy Gottwald

We have done some work in that area earlier this year. We held to that 0% to 2% kind of range. The work we did earlier this year indicated it might be more in the 2% to 3% range. I’ll be real hesitant to call at anything more than that, but it’s an issue that will continue to readdress as well.

Robert Felice - Gabelli & Company

Okay, great, thanks for taking my question.

Teddy Gottwald

Sure.

Operator

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

Ian Zaffino - Oppenheimer

Great, thank you very much. Couple of questions here, can you breakout some volume growth between the U.S. and your foreign exposure?

David Fiorenza

Yeah, if you do 2Q-to-2Q and it’s up 15 percentage points, four of those percentage points are from North America and the rest is outside of North America.

Ian Zaffino - Oppenheimer

So, 4% is in America, 11% you said it’s foreign?

David Fiorenza

Correct.

Ian Zaffino - Oppenheimer

Okay.

David Fiorenza

North America was 4%.

Ian Zaffino - Oppenheimer

Okay. And what was the timing of your fee price increases, when did they actually go into effect?

Teddy Gottwald

They have 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 it.

Ian Zaffino - Oppenheimer

Okay, can you give us a sensitivity of your base oil either how many gallons of base oil you use or give some metrics that we can kind of figure out what the sensitivity is there with movements in base oil?

David Fiorenza

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

Ian Zaffino - Oppenheimer

We don’t have a volume.

David Fiorenza

No, I mean it’s product by product, but it’s about 20% of our raw material purchases.

Ian Zaffino - Oppenheimer

Okay, but that’s actually around the market. Can I get what your pricing is?

David Fiorenza

Sure.

Ian Zaffino - Oppenheimer

And when you talk about margin all of our discussions. That’s a margin dollars or margin percentage. You know when you said action has taken we hope you recover margins?

David Fiorenza

Percentage.

Ian Zaffino - Oppenheimer

Okay, so everything is percentage. Okay, I think that’s it, thank you very much.

David Fiorenza

Thank you, Ian.

Operator

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

J.P Wright - Cross Capital

Hello.

David Fiorenza

Hello.

J.P Wright - Cross Capital

Hi, thanks for good quarter, and that’s really a good quarter, this quarter, but it looks like things are very strong on the sales side of the business?

David Fiorenza

Thank you.

J.P Wright - Cross Capital

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

Teddy Gottwald

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

J.P Wright - Cross Capital

Alright, can you talk a little bit kind of maybe on a 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?

Teddy Gottwald

They are the same company.

J.P Wright - Cross Capital

Same company, not. You know, if base oil goes down, I guess the longer duration on the sales contracts helps, keep them from re-negotiating I guess. Is there more pressure there -- do you feel like sales get delayed if we see a declining base oil environment?

Teddy Gottwald

I don’t remember revenue. I am kidding.

J.P Wright - Cross Capital

I don’t have --

Teddy Gottwald

I am kidding.

J.P Wright - Cross Capital

In a short-term period?

Teddy Gottwald

But, even if we see crude continue to drop from it's high.

J.P Wright - Cross Capital

Yeah.

Teddy Gottwald

It takes the crude, the impact of the high crude of oil to roll to 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 at any time soon, because our supply chain is still dealing with $100 to $110 crude type of cost to their material.

J.P Wright - Cross Capital

Right, and then I have just one final question, on your base oil -- to what extent that the volume of base oil grow this quarter?

David Fiorenza

It would be directionally correct to assume, it just grows linear with our shipments.

J.P Wright - Cross Capital

Okay.

David Fiorenza

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

J.P Wright - Cross Capital

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

David Fiorenza

I think it’s a pretty steady stake.

J.P Wright - Cross Capital

Okay.

Teddy Gottwald

Than vary a whole lot quarter-to-quarter, year-to-year.

J.P Wright - Cross Capital

Alright, well appreciate it, thank you very much.

Teddy Gottwald

Thank you.

Operator

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

Robert Felice - Gabelli & Company

Guys, just one or two more questions, if we were to assume that raw material cost don’t escalate further don’t decline for the remainder of the year. They still stay at this elevated level. What is the absolute amount of cost inflation you would see in '08 versus '07, so with incremental like?

Teddy Gottwald

I haven’t done that arithmetic, Robert.

Robert Felice - Gabelli & Company

Well, I am just trying to get a sense for the magnitude of pricing you need to offset that and then how much additional you need to recoup the margin.

David Fiorenza

Yeah, I’ll have to work on that and get back to you. I don’t have it.

Robert Felice - Gabelli & Company

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

David Fiorenza

Yeah, plus minus one is a view for the year.

Robert Felice - Gabelli & Company

Okay, great.

David Fiorenza

Thank you.

Operator

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

Ian Zaffino - Oppenheimer

Hi, thanks, to just a couple of follow-ups here, what is the pricing on base oil that you have seen since the quarter and so, you gained that 47% from May and July, what are you seeing in July?

David Fiorenza

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

Ian Zaffino - Oppenheimer

Okay.

David Fiorenza

Yeah.

Ian Zaffino - Oppenheimer

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

David Fiorenza

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

Ian Zaffino - Oppenheimer

And how long is that supply chain?

Teddy Gottwald

Another couple of months. One or two month.

Ian Zaffino - Oppenheimer

Okay, so –

Teddy Gottwald

So, don’t be looking for any raw material reductions if crude today is at 120-ish is the message?

Ian Zaffino - Oppenheimer

I am actually looking the other way, if you’re seeing it is still processing 110. Are they going to see price increases?

Teddy Gottwald

We don’t expect it.

Ian Zaffino - Oppenheimer

Okay and then lastly, when you spoke of the tight supply of your other raw material, what were you basically alluding to?

Teddy Gottwald

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

Ian Zaffino - Oppenheimer

Okay. Thank you very much.

Teddy Gottwald

You bet.

Operator

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.

David Fiorenza

Well thanks everyone for joining and talk to you next quarter. Have a good day.

Operator

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

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