NewMarket Corporation (NEU) Q1 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the NewMarket Corporation First Quarter 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Fiorenza, Vice President and CFO of NewMarket Corporation. Thank you. Mr. Fiorenza, you may begin.

Thank you, Melisa and thanks to everyone for joining us to discuss first quarter performance. With me today is our CEO, Teddy Gottwald. 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 2011 10-K. We plan to file our 10-Q the first or second day of May and it will contain more details on the operation of our company. Please take the time to review it. Our business started the year on a positive note. Petroleum Additives set record operating profit levels, we replaced our fixed rate bonds with a new bank revolving facility which will significantly lower our cost of borrowing, and we posted record net income and earnings per share for the corporation. Net income for the first quarter increased to $66.5 million, an improvement of 34% over net income for the first quarter of last year. Earnings per share increased to $4.96 a share, a 39% improvement. Earnings for both first quarter of this year and the first quarter last year include income benefits from an interest rate swap, while the first quarter of this year also includes a charge for the early extinguishment of on our debt. If you exclude both of those items in each period, our earnings per share was $5.03 compared to $3.53 last year. These numbers are detailed on the front page of the press release that we put out yesterday. Petroleum Additives net sales for the quarter increased to $557 million, which is an increase of about 11% over last year's performance, while tons shipped were roughly the same, being down about 1%. The improvement in revenues is the result of pricing actions taken throughout 2011 and a continual upgrade of the value of the products we sell. Demand has rebounded from the low levels of the fourth quarter, increasing about 11% on a sequential basis. We continue to face an uncertain pattern of demand with any given year as it remains difficult to predict the exact buying behavior of our numerous customers. During the quarter, Petroleum Additives posted an operating profit of $107 million, compared to $81 million in the first quarter of last year and $59 million in the fourth quarter of last year. The 1Q to 1Q comparison is a margin story, as raw materials retreated somewhat in the first quarter of 2012. The 1Q to 4Q story is one of volume rebound and the same issue on raw materials. This is quite a large swing in profits in a very short period of time but it's consistent with our long-term understanding of our business. The fact is we did not run our business any differently in any of those 3 quarters. We continue to focus on developing and delivering the goods and services our customers have come to expect. This is demonstrated by our continuous high levels of spending in R&D and S&A in support of this strategy and our continued spending in our capital program to ensure uninterrupted supply around the globe. We believe the long-term fundamentals of the business are unchanged. The rebound in profits from the fourth quarter only reinforces our belief. We remain confident that we are able to recover raw material movements in the marketplace with a lag. Sometimes margins contract, sometimes they expand but it's within the fundamentals of the slow growth industry. We still see an industry that grows about 1% to 2% over time in an industry that produces products that are essential for the proper operation of modern equipment. We have plans to beat that growth somewhat by focusing on areas where we are underrepresented and delivering products that specifically meet the needs of those areas. For the four quarters that ended in March, our operating margin was 15.4%, which is within our expectations of the performance of this business. In summary, the quarter was characterized by great numbers but within the normal variation of the many variables that we manage each day with this business. We do not expect that we will post for 4 quarters like this one. We did not repurchase any stock in the first quarter and ended the year with 13.4 million shares outstanding. There is nothing of note in our tax rate for the quarter, other than the fact that Congress has not yet extended the R&D tax credit for the year, so there is no benefit of that in that number. During the quarter, we made some significant changes to our debt structure. We entered into a new $650 million, 5-year unsecured revolving credit facility, which replaced our previous $300 million unsecured facility, which was due to have matured in November of 2015. This new credit facility provides us with significantly lower cost of borrowing, increased operating flexibility so we can execute our long-term business plan. We believe the terms of this new credit facility reflect the strength of our business, the significant cash flow regenerate and the strength of our balance sheet. Since we have established this new facility, we funded the early redemption of all of the bonds we had outstanding at the end of the year. Those bonds had a principal amount of $150 million and a coupon rate of 7 1/8% and were due in December of 2016. Those bonds were redeemed on April 16. It is our intention to repay the $63 million mortgage loan secured by the Foundry Park office building in early May. During the quarter, we recorded a pretax charge of $3 million and expect to have another $7 million in the second quarter associated with this early extinguishment. These charges result from the accelerated amortization of financing fees associated with prior credit agreement and costs associated with redeeming the bonds. As a result of a new credit facility, repayment of the mortgage loan and redemption of the senior notes, we expect to lower our annual pretax interest expense in the $9 million to $10 million per year range. We had good cash flow generation in the quarter, recording EBITDA of $113 million. We invested $22 million more in working capital, reduced our revolving borrowers to 0 using another $22 million, paid $10 million in dividends, $7 million in capital expenditures. We ended the quarter with about $22 million more cash than at year end. We expect capital expenditures for the year to be in the $50 million range. We continue to operate with very low debt leverage. Our debt to EBITDA at the end of the quarter was 0.5x. In summary, we’ve begun 2012 with very good results. We believe the fundamentals of how we run our business, our long-term views, safety first culture, customer-focused solutions, technology-driven product offerings, world-class supply chain capability and a regional organization to better understand our customers continues to pay dividends for all of our stakeholders. We expect 2012, to be a more profitable year than 2011, as we project an increase in volume, revenue and net income. Over the past years, we've made significant investments to expand our capabilities around the world. These investments had been in people, research centers and production capacity. We intend to use these new capabilities to improve our ability to deliver the goods and service that our customers value and to expand our business and profits. In summary, we expect the business practices that has produced the outstanding results of the past several years to continue in 2012. That's the end of my planned comments. Melissa, can we open up the lines for questions?

[Operator Instructions] Our first question comes from the line of Ivan Marcuse with KeyBanc Capital Markets.

The first one is could you give me the bridge, the year-over-year bridge for the revenue? The dollar amount for the price volume FX?

Sure. So we had $502.7 million last year's first quarter, volume, negative $4.4 million, price, positive $61.4 million and FX negative $2 million.

All right. So then, when you look at the raw materials, was there one specific -- because I know base oil didn't really change much quarter-to-quarter, and I know crude was pretty much flat to trending higher. Was there one material that you're maybe short in the fourth quarter that caused it to be higher than lower in the first quarter? How would you sort of explain the dynamics or is it just some multitude of moving parts?

It's the multitude of moving parts; we’ve started to see the decrease of raw material sometime in the fourth quarter. It takes 60 to 90 days to work its way through our accounting system so we saw it lowering into the first quarter. And you may also recall that in the fourth quarter, we talked about a $10 million one-time abnormal kind of charges so we had the absence of that in the first quarter also.

Great. But that $10 million, that was a charge, it wasn't a -- there wasn't a reversal of it like yet? You got it back? [indiscernible]

That's right.

Got you. And then is there -- outside just the natural raw material, is there any sort of positive effect [ph] that you're getting from natural gas cost to going lower at your plant? Basically to help margins out or operating margins at all or is it de minimis?

We're not a big consumer of the natural gas. Of course, it would add to somewhat lower utility bill in our big plans. But I don't think it's measurable for this discussion.

Great. And then I know it's hard to tell, but second quarter last year there's some price increases that were coming maybe some pre-buy. Do you think there's any sort of activity like that happening this quarter within the space of [ph] any prices going higher since base oil started to move higher, going into this quarter than through the quarter moved up at least once or twice out of a few of the groups.

It's Teddy. I can't say that we're seeing any -- as we said in the earnings release, we're pretty comfortable that the volumes we're seeing right now are consistent with our view of industry consumption and our share of the market.

Great. And then just one last question. I know a competitor, I believe they are adding some capacity component. I think a detergent maybe in the industry. Is that a benefit to the industry? Or how do you view it? And are you going to need to add some capacity in blending or components of whatever you use in order to keep growing in markets that maybe you're underpenetrated right now?

Even with a low growth rate in the industry of 1% to 2%, where the industry is in supply demand balance, we need to be adding capacity as we go forward. I believe all competitors have been adding some, we've added some. Our view is that over the next couple of years, we'll be adding more. The additions that are coming on that I'm aware of are not disruptive to that supply/demand balance. They just allow us to, as an industry, keep pace with the growth.

Great. And then your competitors, you guys will buy from each other every once with a different components, right? It's more of the mixing is where you compete?

Yes. You probably should think of that more of a -- on the chart, a little bit on that [ph] side bias from emphasis, we don't compete at the manufactured component stage. Your last question was correct.

Our next question comes from the line of Saul Ludwig with Northcoast Research.

Just a little more granularity on raw materials. If you look at sort of unit raw material change, what was the percentage change, let's say, first quarter versus first quarter year ago or first quarter versus fourth quarter as it's reflected through your P&L.

The raw material change, I don't have. I can tell you that -- if you think of our margin in the first quarter of this year compared to the fourth quarter, the margin was probably benefited in the range of 2 percentage points of that 19% total margin for raw materials. As you know, we buy a lot of different products and they're all moving at different stages. I think the key here is that we're still confident we can recover whatever comes our way in the marketplace and that this is still a very profitable business.

If you look at your unit selling price here in the first quarter and you’ve commented on raw material cost increasing, would you expect, at least directionally without quantifying it, directionally that your unit selling price in the second quarter would be somewhat higher than it was in the first quarter?

No, I don't have any reason to believe that.

So you think it should be fairly level?

Compared to the first quarter, I don't see it moving a lot.

It's interesting, when you just look at base oil, representing thinking the base oil was just one piece of the pie. If we look at base oil price first quarter this year versus first quarter of last quarter, we think it was up about 12%. But then base oil took a huge jump last year in the second quarter. And if I we look at current base oil prices and compare it to what the second quarter was a year ago, there's really no change. So it seemed like, year to year, at least as far as base oil is concerned, the second quarter to second quarter wouldn't have a lot of change. And so that's one thing. And then secondly, I don't know how many years ago back but isn't your second quarter earnings typically higher than your first quarter earnings in terms of earnings per share, net income, anyway you slice it. And why wouldn't that be that the case this year?

As far as base oil goes, I can't argue with your analysis other than to say that there's a lag effect in what we may see in the timing of that and our earnings may be different from announced changes in the marketplace. As far as historical analysis of various quarters, it's certainly been true in the past that the second and third quarters have been stronger than the first and fourth but as we've been saying, the quarterly variation has been considerably harder to predict than in prior years. So I can't predict that second and third quarters this year would be stronger than the first on any basis. It's just [indiscernible]

Well you can't predict it, just thinking about logically, what would be the influences that would cause that not to be the case?

The same influences; it's all a big drop in the fourth quarter and a recovery quickly in the first.

Okay. And then finally, David, why did SG&A decline a couple million bucks here in this $1.5 million? The trend has always been rising SG&A, not only in terms of comp but your new marketing initiatives to penetrate other geographies? Was there something unusual about this first quarter that's not going to repeat in subsequent quarters?

There wasn't anything unusual. And when the year is done, in S&A and R&D will have gone up with inflation plus just like it's done historically. How our quarter shapes out is just not something we focus on.

And then finally, the $9 million to $10 million in lower interest rates on an annual basis, so that's $2.5 million a quarter. Will that first appear in the third quarter?

You’d have 2 months of it in the second quarter and then full quarter starting in the third.

Oh, you will have 2 months of it in the second quarter and then full quarters.

[Operator Instructions] Our next question comes from the line of Todd Vencil with Sterne Agee.

So as we think about that 19.2% margin in the quarter, which you guys said in the press release or probably at least alluded that on an annualized first quarter. First of all, is it fair to say that you still feel normalized margins are in sort of a 15%, 16% range?

Yes, we do.

So if we look at the next couple of quarters, I assume we're thinking they are going to refer to that over some period. Is there going to be a little bit of a follow-through in the strength you think in the second quarter is you think about the raws coming through or do you think the second quarter ought to be fairly normal or is just too tough to say?

Todd, if you have all the data that we have it's really tough to say. I mean, when we give this indication of the profitability of our business, we really are thinking annual and over long periods of time.

Fair enough. Ted, you mentioned that the industry probably needs to continue to expand over time just to keep up with the expansion demand. Are you guys thinking about any particular expansion plans down the road for new market?

Yes, we are. And we're not really in a position to be specific about it but we are looking at continuing to follow the market. And that means the Asia-Pacific region with additional capacity. Again, I can only speak to our plans but I think that we’ll be investing more over the next couple of years versus our historicals but not any kind of step-out kind of huge chunk of new capacity.

Got it. So more sort of incremental additions along the way?

Big for us, modest for the industry.

Got it. Would any CapEx relating to something like that be sort of within that $50 million you talked about for this year or would it fit within that or it be a sizable step up from there when and if you decide to go forward?

When and if we decide, it would be bigger, yes.

Okay. And relatedly, you guys have talked about finding acquisitions where you can. Any update or some thoughts on that front?

Our views and desires haven't changed. We're still looking hard. We're very interested and we're focused on controlling that in this industry but nothing new to report there.

Our next question comes from the line of Dmitry Silversteyn with Longbow Research.

Getting back to that margin bridge. You talked about 2% of the benefit or 2 points of margin coming from the raw material cost. Was the rest just pricing, given that your volumes was down a little bit and probably little bit of a headwind or is there some mix component there as well?

Let me drop back just for a second to make sure we're comparing the same thing to the same thing. So when you look at the fourth quarter to the first quarter, is where my raw material comment was. Also remember that the first quarter compared to the fourth had shipments go up 11%. So we had big volume component. We had some benefits from raw materials. We had the absence of those one-time costs we talked about in the fourth quarter, and all of that together gets you there.

Got you, okay. On the tax rate, are we still expecting kind of 33% to 34% or have your guidance changed at all?

It has not changed.

You're looking at CapEx of about $50 million for this year. Is that the level we should think about going forward or do you expect to ratchet down CapEx, given that the growth of the industry is fairly small? You talked about meeting capacity additions but I can't imagine that there will be too much above maintenance.

I mean, I think $40 million to $50 million is the number I think about for continuing and then projects will sit on top of that.

Okay. So $40 million to $50 million really is maintenance tied.

Well, yes. It's not only maintenance. We always do de-bottlenecking in this and that. So I mean, just strictly maintenance will be lower than that.

Okay. Some growth capital in there?

Yes.

Very good. Can you -- do you have an idea of what your base oil pricing average for the quarter, just to maintain our data series?

I don't have it.

Okay. We’ll figure it out from the market. And finally, your overall volumes were kind of flattish to down 1%. Was there one geography or the other where their growth rates were significantly different from that? Or adversely, are there particular product lines or market niches that are doing better or worse than? Can you give us some more granularity on kind of what your business segments are doing?

Europe had some negative comparisons and that was probably the major negative in that 1Q to 1Q. It's just the lower economic activity in Western Europe that potentially makes its way into all businesses. I really don't have anything else to really note, to we to talk about in that comparison.

Okay. So, nothing in the emerging markets that has changed? No weakness in the U.S.? You're kind of seeing the fourth quarter drawdowns if there were any unknown inventories reversing themselves?

We're really pleased with the way all our regions are performing right now.

Okay. All right. So if we look at -- let's forget about the kind of the bigger use of SG&A, if you look at the gross margin sequentially from the first quarter to the second quarter, in the 30% margin in the March quarter, raw materials are going to be up a little bit obviously. Sequentially, your pricing is probably going to be flattish. So assuming there's a little bit of volume recovery just a better driving season, wouldn't that suggest that high '20s is kind of where you want to be for the gross margin for the second quarter?

I can't argue with your arithmetic. But -- We don't sit down and talk about it that way or think about it. We think longer-term, we are looking more out for our year or so than exactly what's next quarter going to be.

Our next question comes from the line of Saul Ludwig with Northcoast Research.

I'm thinking about this revolving, this new credit arrangement. $650 million, that's a lot of money, David. And particularly for a company that's generating tremendous amounts of cash just from your day-to-day operations. Why so much? Is the pipeline for acquisitions look more frothy? Or you've talked about cash spending $40 million to $50 million plus a project. Could a project be, if you're going to build a new plant in Asia a couple hundred million dollars, help me understand why you went for so much money and how much you use it. You have to have some idea for having gone for that much credit.

There are always a couple of features that play into that. One of them is where are we, the borrower, on our curve of our performance and by any measure in wear [ph] solid gold. And then the other curve on that is what's the bank's appetite to extend credit. And sometimes all of these things come together and our bank group was able to get us this facility and it's almost well, why not? The pricing is really good. We can lower our overall cost and it just gives us the flexibility to move forward.

What are some ideas that you might do with the money?

I just wanted to add to what David said so, it's not a whole lot more money than we had in total in our former agreements. We had a $300 million revolver, $150 million in bonds and $65 million mortgage. So it's an increase but it's not a substantial increase over what we have in place already.

What do you see in the acquisition pipeline, Teddy?

It's a pretty defined industry with not a whole lot of opportunities there. There’s -- as we’ve said before, there’s more players beyond just the normal big ones that you might normally think of. There's niche players, particularly in industrial and fuels areas and we're continuing to pursue opportunities there. It's a small field, though. And of course, it takes 2 to have a transaction.

If you were going to build a new plant, would that be a couple hundred million dollar deal?

I don't think you should be thinking about that much, about that big in investment.

How much would it be?

Less than that.

Our next question comes from the line of Dmitry Silverstein with Longbow Research.

I just wanted to get a better clarification on the all the moving parts in the debt refinancing that you've done. You talked about $97 million lower interest expense going forward. Was that -- or once this is all completed. Was that off of the kind of the $17 million to $19 million or the $19 million run rate you had in 2011?

Yes.

Okay. And so this would take place after you redeem your $150 million in some of the 7 1/8% notes which will be done this year?

The bonds have already been gained past tense and we're going to redeem the Foundry Park next week.

Okay. So basically you should get to that run rate if you will, on interest expense in the second half of the year?

That's correct.

We have another follow-up question from Ivan Marcuse with KeyBanc Capital Markets.

You have, I think $60 million you said, left in your buyback and you haven't been buying stock in the last couple of years, I believe. I don't know if there's been any time in history you let a buyback expire. How do you look at buybacks right now versus, I don't know, not that you have a lot of debt or a cost too much of paying back debt or just increasing your dividend again?

Well, we did buy back over 600,000 shares last year. So it hasn't been quite that long. But our process, our methodology, the decision-making hasn't changed. We still look at availability of cash, the outlook on the business, the possibility of acquisition and the relative price of the stock to make those decisions.

Mr. Fiorenza, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments.

Before David wraps up, Saul, I wasn't trying to be flip with my answer to your question about the CapEx going forward. We're just, we haven't finished our analysis and we're not prepared yet to elaborate on our plans. When we have gotten further along in the analysis, we'll give you all a better indication of what CapEx will be over the next few years. David?

Thanks, Teddy. I don't have any other comments. Have a good evening. Thanks for joining us.

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