NewMarket Corporation — Q2 2013 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2013, compared with the same 2012 periods. NewMarket’s core business is petroleum additives, principally lubricant and fuel additives. The real estate development segment is presented as discontinued operations following the decision to sell Foundry Park I.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $583.8 million | $587.5 million | $1,143.5 million | $1,147.4 million |
| Operating profit | $93.1 million | $94.4 million | $189.5 million | $197.4 million |
| Continuing-operations income | $64.4 million | $55.1 million | $131.3 million | $121.2 million |
| Net income | $64.0 million | $55.3 million | $131.8 million | $121.8 million |
| Diluted EPS | $4.81 | $4.12 | $9.88 | $9.09 |
- Q2 revenue declined 0.6%; six-month revenue declined 0.3%. Product shipments were broadly stable. Lubricant-additive shipments rose, partly offset by lower fuel-additive shipments, lower selling prices, and unfavorable currency effects.
- Gross profit increased to $169.4 million in Q2 and $337.8 million for six months. Cost of goods sold was 71.1% of revenue in Q2 versus 72.7% a year earlier, and 70.5% versus 71.4% for the six-month periods. Higher-value product mix and favorable raw-material costs helped, partly offset by selling-price and manufacturing-conversion costs.
- Petroleum-additives operating profit was $97.8 million in Q2, up $0.9 million, and $199.8 million for six months, down $4.3 million. Segment operating margins were 16.8% and 17.5%, respectively, versus 16.6% and 17.9% a year earlier.
- R&D expense rose 28.3% in Q2 to $36.4 million and 19.7% for six months to $67.5 million. SG&A was $39.9 million in Q2 and $80.9 million for six months. Higher development spending and six-month SG&A weighed on operating profit.
- Q2 other income included a $5.1 million gain on a non-designated interest-rate swap, compared with a $5.7 million loss in Q2 2012. The swap’s fair-value movements are recognized in earnings and can cause volatility. Interest expense was $4.6 million in Q2 and $9.4 million for six months, higher year over year.
- Income-tax expense was $29.5 million for Q2 and $55.0 million for six months; the respective effective tax rates were 31.4% and 29.5%. Management cites the reinstated R&D tax credit and a greater contribution from lower-tax foreign jurisdictions as benefits.
Cash flow, balance sheet, and liquidity
- Six-month operating cash flow was $122.9 million, up from $97.5 million. Working-capital changes used $35.5 million of cash. Capital expenditures were $31.8 million; investing activities used $25.0 million.
- Financing activities used $108.5 million, including $60.0 million of revolving-credit repayments, $24.0 million of dividends, and $26.8 million of share repurchases. Cash declined $15.6 million to $73.5 million.
- Total debt, including current maturities, was $372.2 million at June 30, down $56.6 million from year-end. It included $350 million principal of 4.10% senior notes due 2022, $15.0 million drawn on the revolving facility, and $7.8 million of subsidiary lines of credit. The $650 million revolver had $631.9 million available, net of borrowings and letters of credit.
- Management reported compliance with debt covenants. The leverage ratio was 0.97 against a maximum of 3.00; the interest-coverage ratio was 22.06 against a minimum of 3.00. Total debt was 44.4% of capitalization, versus 51.6% at year-end.
- Working capital, including discontinued-operation assets and liabilities, was $611.2 million; the current ratio was 3.49 to 1. Cash and cash equivalents held by foreign subsidiaries were approximately $68.4 million, much of which management considers indefinitely reinvested; repatriation could trigger additional U.S. tax.
- Shareholders’ equity was $466.4 million. Six-month dividends declared were $1.80 per share, compared with $1.50 in 2012. The company repurchased $26.8 million of shares; approximately $223 million remained under its repurchase authorization at June 30.
Material developments, outlook, and risks
- On July 2, 2013, Foundry Park I sold its real estate assets for $143.6 million cash. Management expected to recognize a $35.8 million pretax gain, or $21.9 million after tax, in Q3 2013. At June 30, the assets and related liabilities were classified as held for sale.
- Management expects 2013 petroleum-additives results to improve and forecasts industry shipment-demand growth averaging 1%–2% annually over the next five years. It assumes a modest worldwide economic recovery, which had not been evident in the first half. Full-year 2013 R&D expense is expected to exceed 2012; capital spending is estimated at $70–$80 million.
- Management says operating cash flow and available revolver capacity should cover foreseeable operating needs. It continues to assess acquisitions, primarily in petroleum additives, alongside dividends and share repurchases as uses of cash.
- In April, the company discontinued production of a fuel additive at its Ethyl Canada facility and reduced the workforce. Severance and asset-impairment charges were described as not material.
- The Department of Justice is reviewing certain foreign activities regarding U.S. sanctions and anti-corruption compliance, as well as certain historical domestic conduct. The company is cooperating and conducting an internal review. Management says pending legal matters are not expected to have a material adverse effect, but environmental remediation estimates could change and unexpected costs could be significant.
- Environmental remediation accruals were approximately $19.4 million at June 30, plus $0.4 million for dismantling and decommissioning. The filing also identifies single-site production dependence, chemical-operations hazards, raw-material and transportation risks, customer concentration, foreign-exchange exposure, and economic and regulatory risks.
- Other comprehensive loss was $17.3 million for the first half, primarily reflecting a $22.4 million foreign-currency translation loss. The company also had a $24.5 million fair-value liability on its Goldman Sachs interest-rate swap and had posted $28.3 million of collateral.
Investor verification priorities
- Confirm the closing proceeds, Q3 gain, tax impact, and use of the Foundry Park I sale proceeds in subsequent reporting.
- Track petroleum-additives segment margins and the balance between lubricant- and fuel-additive shipments, pricing, raw-material costs, and currency effects.
- Assess whether higher R&D spending and planned capital expenditures translate into growth and operating-profit improvement.
- Monitor swap valuation, collateral requirements, and the resulting earnings volatility, as well as debt repayment and covenant headroom.
- Follow developments in the DOJ review, environmental liabilities, and the discontinued Ethyl Canada product’s operational and financial effects.
- Evaluate foreign cash availability and potential tax consequences if indefinitely reinvested earnings are repatriated.