UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2005
OR
For the transition period from to
Commission File Number 1-32190
NEWMARKET CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
330 SOUTH FOURTH STREET
RICHMOND, VIRGINIA
Registrant’s telephone number, including area code - (804) 788-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Number of shares of common stock, without par value, outstanding as of July 31, 2005: 17,039,059.
INDEX
PART I.FINANCIAL INFORMATION
ITEM 1.Financial Statements
Condensed Consolidated Statements of Income – Three and Six Months Ended June 30, 2005 and 2004
Condensed Consolidated Balance Sheets – June 30, 2005 and December 31, 2004
Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2005 and 2004
Notes to Condensed Consolidated Financial Statements
ITEM 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.Quantitative and Qualitative Disclosures About Market Risk
ITEM 4.Controls and Procedures
PART II.OTHER INFORMATION
ITEM 1.Legal Proceedings
ITEM 4.Submission of Matters to a Vote of Security Holders
ITEM 5.Other Information
ITEM 6.Exhibits
SIGNATURES
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
NEWMARKET CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Six Months Ended
June 30
Net sales
Cost of goods sold
Gross profit
Operating profit from TEL marketing agreements services
Selling, general, and administrative expenses
Research, development, and testing expenses
Special item income
Operating profit
Interest and financing expenses
Other income, net
Income before income taxes
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
Shares used to compute basic earnings per share
Shares used to compute diluted earnings per share
See accompanying notes to the condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
2005
Current assets:
Cash and cash equivalents
Restricted cash
Trade and other accounts receivable, less allowance for doubtful accounts ($1,051 - 2005; $1,067 - 2004)
Receivable - TEL marketing agreements services
Inventories:
Finished goods
Raw materials
Stores, supplies and other
Deferred income taxes
Prepaid expenses
Total current assets
Property, plant and equipment, at cost
Less accumulated depreciation and amortization
Net property, plant and equipment
Prepaid pension cost
Other assets and deferred charges
Intangibles, net of amortization
Total assets
Current liabilities:
Accounts payable
Accrued expenses
Book overdraft
Long-term debt, current portion
Income taxes payable
Total current liabilities
Long-term debt
Other noncurrent liabilities
Commitments and contingencies (Note 10)
Shareholders’ equity:
Common stock and paid-in capital (without par value) Issued - 17,033,059 in 2005 and 16,980,759 in 2004
Accumulated other comprehensive loss
Retained earnings
Total liabilities and shareholders’ equity
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash and cash equivalents at beginning of year
Cash flows from operating activities:
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and other amortization
Amortization of deferred financing costs
Noncash pension expense
Deferred income tax benefit
Gain on insurance settlement
Working capital changes
Cash pension contributions
Proceeds from insurance settlement
Long-term receivable - TEL marketing agreements
Other, net
Cash provided from operating activities
Cash flows from investing activities:
Capital expenditures
Cash used in investing activities
Cash flows from financing activities:
Borrowing under revolving credit agreement
Repayment of debt - previous agreements
Change in book overdraft
Financing costs
Proceeds from exercise of stock options
Decrease in capital lease
Cash provided from (used in) financing activities
Effect of foreign exchange on cash and cash equivalents
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at end of period
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying condensed consolidated financial statements of NewMarket Corporation and Subsidiaries contain all necessary adjustments for the fair presentation of, in all material respects, our consolidated financial position as of June 30, 2005, as well as our consolidated results of operations for the three-months and six-months ended June 30, 2005 and 2004 and our consolidated cash flows for the six-months ended June 30, 2005 and 2004. The financial statements are subject to normal year-end adjustments and do not include comprehensive footnotes. All adjustments are of a normal, recurring nature, unless otherwise disclosed. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the NewMarket Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (2004 Annual Report), as filed with the Securities and Exchange Commission (SEC). The results of operations for the three-month and six-month periods ended June 30, 2005 are not necessarily indicative of the results to be expected for the full year.
Unless the context otherwise requires, all references to “we,” “us,” “our,” the “Company” and “NewMarket” are to NewMarket Corporation and its subsidiaries.
At both June 30, 2005 and December 31, 2004, we had a book overdraft for some of our disbursement cash accounts. A book overdraft represents transactions that have not cleared the bank accounts at the end of the reporting period. We transfer cash on an as-needed basis to fund these items as they clear the bank in subsequent periods.
Both second quarter and six months 2004 segment operating profit were adjusted from previously reported information to reflect the current allocation of certain costs in alignment with the 2004 transition to a holding company structure, which was effective as of June 18, 2004. The reclassification had no effect on net income.
Our asset retirement obligations are related primarily to tetraethyl lead (TEL) operations. These obligations had been previously fully accrued. Upon the January 1, 2003 adoption of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143), these accruals were discounted to their net present value, which resulted in the recognition of a gain. Current accretion of the asset retirement obligations is expensed in operations. The following table illustrates the activity associated with SFAS No. 143 for the six months ended June 30, 2005 and the year ended December 31, 2004.
6
Asset retirement obligation, beginning of period
Accretion expense
Liabilities settled
Changes in expected cash flows and timing
Foreign currency impact
Asset retirement obligation, end of period
We account for the stock-based compensation plan using the intrinsic-value method. Under this method, we do not record compensation cost for stock options unless the quoted market price of the stock at grant date or other measurement date exceeds the amount the employee must pay to exercise the stock option. Compensation cost for restricted stock grants, if issued, is recognized over the vesting period. See Note 12 of the Notes to Condensed Consolidated Financial Statements for information on an accounting standard which we will adopt in 2006 related to the accounting for stock-based compensation. See Note 16 of the Notes to Consolidated Financial Statements in our 2004 Annual Report for further information on our stock-based compensation plan.
The following table illustrates the effect on net income and earnings per share as if we had applied the fair-value method of accounting for the stock-based compensation plan.
Net income, as reported
Less: Total stock-based employee compensation expense determined under the fair-value based method, net of related tax effect
Net income, pro forma
Earnings per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
7
The tables below show our consolidated net sales by segment, operating profit by segment including a reconciliation to income before income taxes, and depreciation and amortization by segment.
Net Sales by Segment
(in millions)
Petroleum additives
Tetraethyl lead
Consolidated net sales
Segment Operating Profit
Tetraethyl lead (a)
Contract manufacturing and other
Segment operating profit
Corporate, general and administrative expense
Interest expense
Other expense, net
The prior period has been reclassified to conform to the current presentation. The reclassifications consist of an allocation of certain costs in alignment with the 2004 transition to a holding company structure. There was no impact on net income in any period.
8
Depreciation and Amortization
Other long-lived assets
Total depreciation and amortization
During the second quarter 2005, Octel advised us that one of the major TEL customers under our marketing agreements has indicated that it was discontinuing the use of TEL earlier than we had previously expected. Because of this development, we evaluated the prepayment for TEL marketing agreement services for impairment and concluded the unamortized value of $17.5 million reflected in our financial statements at June 30, 2005 is not impaired. We adjusted the rate of amortization for these prepayments from a 20% declining balance method to a 30% declining balance method. In addition, based on revised projections of product shipments and product life expectancy, we adjusted the amortization period to run through 2012. This change will have an insignificant impact on 2005 earnings. Total amortization related to the TEL marketing agreements is currently projected to be:
·
This amortization for each year is included in tetraethyl lead in the table above.
During the first six months of 2005, we made contributions of approximately $2.1 million for domestic pension plans and approximately $900 thousand for domestic postretirement plans. We expect to make total contributions in 2005 of approximately $4 million to $6 million for our domestic pension plans and approximately $2 million to $3 million for our domestic postretirement plans.
We made contributions of approximately $3.0 million for our foreign pension plans during the first six months of 2005 and expect to make total contributions to our foreign pension plans of approximately $6 million to $7 million during 2005.
9
The tables below present information on periodic benefit cost for our domestic pension and postretirement plans. The third table presents the same information for the foreign pension plans.
Three Months Ended
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net loss
Amortization of transition asset
10
Basic and diluted earnings per share are calculated as shown in the table below. Options are not included in the computation of diluted earnings per share when the option exercise price exceeds the average market price of the common stock. At both June 30, 2005 and June 30, 2004, we had outstanding options to purchase 50,000 shares of NewMarket common stock at $44.375 per share. These options were not included in the computation of diluted earnings per share for any period due to their anti-dilutive impact.
Numerator:
Income available to shareholders, as reported
Denominator:
Average number of shares of common stock outstanding
Shares issuable upon exercise of stock options
Total shares
11
The following table provides certain information related to our intangible assets.
Amortizing intangible assets
Formulas
Contracts
Nonamortizing intangible assetsMinimum pension liabilities
Aggregate amortization expense
Estimated amortization expense in thousands for the next five years is expected to be:
2006
2007
2008
2009
We amortize the cost of intangible assets by the straight-line method, over their economic lives. Contracts are generally amortized over 5 to 10 years. Formulas are generally amortized over 20 years.
Long-term debt consisted of the following:
December 31
2004
Senior notes
Revolving loan agreement
Capital lease obligations
Current maturities of long-term debt
12
Senior Notes - On April 30, 2003, Ethyl Corporation (Ethyl) sold senior notes in the aggregate principal amount of $150 million that bear interest at a fixed rate of 8.875% and are due in 2010.
The senior notes are our senior unsecured obligations and are jointly and severally guaranteed on an unsecured basis by all of our existing and future wholly-owned domestic restricted subsidiaries and certain of our existing wholly-owned foreign subsidiaries. We incurred financing costs of approximately $5 million related to the senior notes, which are being amortized over seven years.
In connection with the holding company formation, NewMarket assumed all of Ethyl’s rights, liabilities and obligations under the senior notes, effective June 18, 2004.
The senior notes and the subsidiary guarantees rank:
The indenture governing the senior notes contains covenants that, among other things, limit our ability and the ability of our restricted subsidiaries to:
We were in compliance with these covenants as of both June 30, 2005 and December 31, 2004.
Senior Credit Facility - On April 30, 2003, we entered into a long-term debt structure for Ethyl. The debt structure included the senior notes discussed above and a senior credit facility with a bank term loan and a revolving credit facility.
On June 18, 2004, prior to the completion of the holding company formation, Ethyl entered into an Amended and Restated Credit Agreement, which consists of a $100 million revolving credit facility. This agreement amended and restated the credit agreement that Ethyl had entered into on April 30, 2003. Effective with the completion of the holding company formation, NewMarket assumed all of Ethyl’s rights and obligations under the Amended and Restated Credit Agreement pursuant to the First Amendment thereto. We incurred additional financing costs of approximately $1 million, which resulted in total deferred financing costs of approximately $6 million related to the amended and restated credit facility. These costs are being amortized over five years.
13
Borrowings under the $100 million revolving credit facility are used for working capital and other general corporate purposes for NewMarket and our subsidiaries. The revolving credit facility includes a sub-facility for letters of credit. Borrowings bear interest, at our election, at either a base rate plus a margin (75 basis points as of June 30, 2005) or LIBOR plus a margin (225 basis points as of June 30, 2005). The revolving credit facility matures on June 18, 2009. Borrowings outstanding at June 30, 2005 under the revolving credit facility were $34 million and bore interest at rates of 5.4% to 6.75%, depending upon the type of borrowing. At June 30, 2005, we had outstanding letters of credit of $23.7 million, resulting in the unused portion of the revolver amounting to $42.3 million.
The revolving credit facility is secured by liens on substantially all of our U.S. assets. In addition, the credit facility is guaranteed by our U.S. subsidiaries and certain foreign subsidiaries to the extent that such guarantees would not result in adverse tax consequences.
The credit agreement contains covenants, representations, and events of default that management considers typical of a credit agreement of this nature. The financial covenants include:
There have been no significant changes in our contractual commitments and contingencies from those reported in our 2004 Annual Report, except for changes related to the legal proceedings concerning the TEL case in Maryland. In that case, Ethyl was served as a defendant in the case filed in the Circuit Court for Baltimore City, Maryland, in September 1999. Smith, et al. v. Lead Industries Association, Inc., et al., alleged personal injuries for seven children from lead exposure arising from lead paint and dust from tailpipe emissions due to leaded gasoline. The court dismissed Ethyl and some other defendants from the case in February 2002 and granted summary judgment to other defendants in November 2002. The plaintiffs have appealed both decisions, but did not appeal the dismissal of Ethyl as a defendant. On April 4, 2005, the Court of Appeals of Maryland dismissed the appeal on the basis that the trial court’s decision was not a final decision that could be appealed, and the case is once again pending in the trial court. If such claims are further pursued against Ethyl, we believe Ethyl has strong defenses and will vigorously defend any such claims.
Our accruals for environmental remediation were approximately $23 million at June 30, 2005 and $22 million at December 31, 2004. In addition to the accruals for environmental remediation, we also have accruals for dismantling and decommissioning costs of approximately $8 million at June 30, 2005 and $7 million at December 31, 2004.
14
During the second quarter 2005 we entered into an agreement with Travelers Indemnity Company (Travelers) resolving certain long standing issues regarding our coverage for certain premises asbestos claims. In addition, our agreement with Travelers provides a procedure for allocating defense and indemnity costs with respect to future premises asbestos claims. The lawsuit against Travelers in the Southern District of Texas was dismissed.
We also settled our outstanding receivable from Albemarle Corporation (Albemarle) for premises asbestos liability obligations. As a result of the insurance settlement described above, the outstanding amount owed to us by Albemarle is now $1.4 million, compared to $4 million at year end. The $1.4 million is scheduled to be paid to us by Albemarle in the third quarter of this year.
These settlements resulted in a gain of $3.9 million ($2.5 million after income taxes), which is included as a special item this quarter. The gain represents monies paid to us to settle historical claims in excess of the receivables we carried on our books from both Travelers and Albemarle.
The components of comprehensive income consist of the following:
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on marketable equity securities
Unrealized gain on derivative instruments
Foreign currency translation adjustments
Other comprehensive loss
Comprehensive income
The components of accumulated other comprehensive loss consist of the following:
Unrealized gain on marketable equity securities
Minimum pension liability adjustment
Unrealized gain (loss) on derivative instruments
15
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections,” (SFAS 154). SFAS 154 replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” and is effective for fiscal years beginning after December 15, 2005. SFAS 154 addresses the accounting and reporting of a change in accounting principle. We do not expect SFAS 154 to have an impact on our financial statements, unless we adopt a change in accounting principle.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” In general, SFAS 123 provides guidance in accounting for transactions in which a company obtains employee services in exchange for share-based payments. SFAS 123R requires that the cost from share-based payment transactions be recognized in the financial statements and be determined using a fair-value-based measurement method. SFAS 123R was to be effective for interim periods beginning after June 15, 2005. In April 2005, the SEC delayed the effective date to the first fiscal year beginning after June 15, 2005. SFAS 123R applies to all share-based payment transactions initiated or modified after the effective date. We are evaluating SFAS 123R, but do not expect it to have a significant impact on our financial results.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 clarifies certain aspects of FASB No. 143, “Accounting for Asset Retirement Obligations” and is effective no later than December 31, 2005. We are currently evaluating the impact of FIN 47.
The senior notes are fully and unconditionally guaranteed by certain of our subsidiaries (Guarantor Subsidiaries) on a joint and several unsecured senior basis. The Guarantor Subsidiaries include all of our existing and future wholly-owned domestic restricted subsidiaries and certain of our existing wholly-owned foreign subsidiaries. The Guarantor Subsidiaries and the subsidiaries that do not guarantee the senior notes (the Non-Guarantor Subsidiaries) are wholly owned by NewMarket Corporation (the Parent). The Guarantor Subsidiaries consist of the following:
Domestic Subsidiaries
Ethyl Corporation
Afton Chemical Corporation
Ethyl Asia Pacific LLC
Afton Chemical Asia Pacific LLC
Ethyl Canada Holdings, Inc.
Afton Chemical Canada Holdings, Inc.
Ethyl Export Corporation
Afton Chemical Japan Holdings, Inc.
Ethyl Interamerica Corporation
Afton Chemical Additives Corporation
Ethyl Ventures, Inc.
NewMarket Services Corporation
Interamerica Terminals Corporation
The Edwin Cooper Corporation
Afton Chemical Intangibles LLC
Old Town LLC
Foreign Subsidiaries
Ethyl Europe S.P.R.L.
Afton Chemical S.P.R.L.
Ethyl Administration GmbH
Afton Chemical Industria de Aditivos Ltda
Ethyl Services GmbH
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We conduct all of our business and derive all of our income from our subsidiaries. Therefore, our ability to make payments on the senior notes or other obligations is dependent on the earnings and the distribution of funds from our subsidiaries. There are no restrictions on the ability of any of our domestic subsidiaries to transfer funds to the Parent. We are currently able to transfer funds from our foreign subsidiaries, although certain conditions may arise occasionally that may restrict these transfers.
The following sets forth the consolidating statements of income for the three months and six months ended June 30, 2005 and 2004, consolidating balance sheets as of June 30, 2005 and December 31, 2004, and condensed consolidating statements of cash flows for the six months ended June 30, 2005 and 2004 for the Parent, the Guarantor Subsidiaries and Non-Guarantor Subsidiaries. Certain amounts in these financial statements have been reclassified for the transition to a holding company structure effective as of June 18, 2004. The financial information is based on our understanding of the SEC’s interpretation and application of Rule 3-10 of the Regulation S-X promulgated by the SEC.
The financial information may not necessarily be indicative of the results of operations or financial position had the Guarantor Subsidiaries or Non-Guarantor Subsidiaries operated as independent entities.
17
NewMarket Corporation and Subsidiaries
Consolidating Statements of Income
Three Months Ended June 30, 2005
(in thousands)
Gross (loss) profit
Intercompany service fee income (expense) from TEL marketing agreements
Operating (loss) profit
Other (expense) income, net
(Loss) income before income taxes and equity income of subsidiaries
Income tax (benefit) expense
Equity income of subsidiaries
18
Three Months Ended June 30, 2004
19
Six Months Ended June 30, 2005
20
Six Months Ended June 30, 2004
Guarantor
Subsidiaries
Non-Guarantor
Total
Consolidating
Adjustments
Other income (expense), net
21
Consolidating Balance Sheets
June 30, 2005
Trade and other accounts receivable, net
Amounts due from affiliated companies
Inventories
Less accumulated depreciation & amortization
Investment in consolidated subsidiaries
LIABILITIES AND SHAREHOLDERS’ EQUITY
Amounts due to affiliated companies
Total liabilities
Common stock and paid-in capital
Total shareholders’ equity
22
December 31, 2004
23
Condensed Consolidating Statements of Cash Flows
Cash (used in) provided from operating activities
Cash flows from investing activities
Increase in intercompany loans
Cash dividends from subsidiaries
Cash flows from financing activities
Borrowings under revolving credit agreement
Financing from affiliated companies
Cash dividends paid
Cash provided from financing activities
24
Cash provided from (used in) investing activities
Repayments of debt - previous agreements
Repayment of intercompany note payable
Debt issuance costs
Cash (used in) provided from financing activities
Decrease (increase) in cash and cash equivalents
25
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
The following discussion contains statements about future events and expectations, or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements on our current expectations and projections about future results. When we use words in this document, such as “anticipates,” “intends,” “plans,” “believes,” “estimates,” “expects,” and similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements we make regarding future prospects of growth in the petroleum additives market, the level of future declines in the market for tetraethyl lead (TEL), other trends in the petroleum additives market, our ability to maintain or increase our market share, and our future capital expenditure levels.
We believe our forward-looking statements are based 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.
These factors include, but are not limited to, timing of sales orders, gain or loss of significant customers, competition from other manufacturers, resolution of environmental liabilities, changes in the demand for our products, significant changes in new product introduction, increases in product cost, the impact of fluctuations in foreign exchange rates on reported results of operations, changes in various markets, geopolitical risks in certain of the countries in which we conduct business, and the impact of consolidation of the petroleum additives industry. In addition, we also discuss certain risk factors in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in the 2004 Annual Report and incorporate the same herein by reference.
You should keep in mind that any forward-looking statement made by us in this discussion speaks only as of the date on which we make it. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do not intend to, update or revise the forward-looking statements in this discussion after the date hereof, except as may be required by law. In light of these risks and uncertainties, you should keep in mind that the events described in any forward-looking statement, made in this discussion or elsewhere, might not occur.
Results of Operations
Net Sales
Our consolidated net sales for the second quarter 2005 amounted to $271.8 million, representing an increase of 23% from the 2004 level of $221.5 million. The six months 2005 consolidated net sales were $511.0 million as compared to $438.3 million for the same 2004 period, which represents an increase of 17% over six months 2004. The table below shows our consolidated net sales by segment.
26
Petroleum Additives Segment
Petroleum additives net sales in the second quarter 2005 of $269.0 million were up $50.9 million, or approximately 23%, from $218.1 million in the second quarter 2004. Shipments for the second quarter 2005 increased approximately 13% as compared to second quarter 2004. The increase in shipments was the result of significantly higher shipments in the engine oil additives product line. Shipments in the other product lines for the second quarter 2005 were generally unchanged compared to the second quarter 2004. Selling prices, which were higher in second quarter 2005 than the same 2004 period, as well as a favorable foreign currency impact, also resulted in the higher net sales between the two second quarter periods.
The six months 2005 petroleum additives net sales of $506.2 million were $73.4 million, or 17%, higher than the 2004 six months petroleum additives net sales of $432.8 million. Total petroleum additives shipments increased 6% when comparing six months 2005 to six months 2004. Again, the higher shipments resulted from an increase in the engine oil additives product line. Shipments in the other product lines were down less than 4%. Similar to the second quarter results, higher selling prices and favorable foreign currency also resulted in higher net sales when comparing six months 2005 and six months 2004.
The components of the petroleum additives increase in net sales of $50.9 million between the two second quarter periods and $73.4 million between the two six months periods are shown below (in millions):
Second
Quarter
Six
Months
Period ended June 30, 2004
Change in shipments and product mix
Changes in selling prices including foreign currency impact
Period ended June 30, 2005
Tetraethyl Lead Segment
Most of the TEL marketing activity is through marketing agreements with The Associated Octel Company Limited and its affiliates (Octel), under which we do not record the sales transactions. Therefore, the TEL net sales shown in the table above are those made by Ethyl Corporation (Ethyl) in areas not covered by the marketing agreements. The sales made in areas not covered by the Octel marketing agreements are very minor compared to the TEL sales made through the marketing agreements.
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Total TEL sales for the second quarter and six months 2005 were lower than the same periods in 2004. These changes were caused substantially by variation in the quarter-to-quarter timing of sales orders.
NewMarket evaluates the performance of the petroleum additives business of Afton Chemical Corporation (Afton) and Ethyl’s TEL business based on segment operating profit. Corporate departments and other expenses are billed to Afton and Ethyl based on the services provided under the holding company structure. Depreciation on segment property, plant, and equipment and amortization of segment intangible assets and the prepayment for services are included in the operating profit of each segment.
The table below reports operating profit by segment for the second quarter and six months of 2005 and 2004. Certain prior periods have been reclassified to conform to the current presentation. The reclassifications consist of an allocation of certain costs in alignment with the June 18, 2004 transition to a holding company structure.
The “Contract manufacturing and other” classification in the table below primarily represents certain manufacturing operations that Ethyl provides to Afton.
Second Quarter 2005 vs. Second Quarter 2004 - Petroleum additives second quarter 2005 operating profit was $17.0 million as compared to $17.3 million for second quarter 2004.
While net sales were approximately 23% higher and shipments were approximately 13% higher, unrecovered rising costs of raw materials, as well as small increases in selling, general, and administrative (SG&A) expenses and research, development, and testing (R&D) expenses, resulted in operating profit being generally unchanged when comparing second quarter 2005 to second quarter 2004 results. The 2005 results also include a favorable foreign currency impact. Raw material costs have continued to increase since June 30, 2005. We are currently attempting to recover the most recent increases in the marketplace.
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The increase in R&D expenses in the petroleum additives segment between the two first quarter periods was $500 thousand and included a small unfavorable foreign currency impact.
SG&A expenses for this segment increased about $500 thousand, or approximately 3%, from second quarter 2004 levels and resulted substantially from an unfavorable foreign currency impact. As a percentage of net sales, SG&A expenses combined with R&D expenses, decreased from 15.4% for the second quarter 2004 to 12.8% for the same period this year. This decrease reflects higher sales, partially offset by the 3% increase in combined SG&A and R&D expenses.
Six Months 2005 vs. Six Months 2004 - Petroleum additives six months 2005 operating profit was $26.8 million, which was a decrease of 11% from the six months 2004 level of $30.2 million. The six months 2005 decrease was across most major product lines.
Continuing the trend from the first three months 2005, net sales were approximately 17% higher and shipments were approximately 6% higher. Despite the favorable trend in net sales, operating profit for six months 2005 was lower than six months 2004 due to unrecovered rising costs of raw materials, as well as the small increases in SG&A expenses and R&D expenses. We have increased selling prices during six months 2005, but the rising costs of raw materials has outpaced the selling price increases during the year. The 2005 results also include a favorable foreign currency impact.
Petroleum additives segment R&D expenses increased $900 thousand when comparing six months 2005 to six months 2004. The increase was across most product lines and included a small unfavorable foreign currency impact.
The six months 2005 SG&A expenses for the petroleum additives segment increased about $1 million, or approximately 3%, when comparing to six months 2004 levels. The increase was across all product lines and included a significant unfavorable foreign currency impact. As a percentage of net sales, SG&A expenses combined with R&D expenses decreased from 15.4% for six months 2004 to 13.5% for six months 2005. This decrease reflects higher sales, partially offset by the 3% increase in combined SG&A and R&D expenses.
TEL Segment
Results of our TEL segment include the operating profit contribution from our marketing agreements with Octel, as well as certain TEL operations not included in the marketing agreements.
The operating profit from our marketing agreements for the second quarter 2005 was $6.8 million, which was $3.9 million lower than the second quarter last year. Similarly, the six months 2005 marketing agreements operating results of $13.3 million were $4.8 million lower than six months 2004. Both 2005 periods reflect improved pricing over 2004, but volumes were 40% lower for the second quarter 2005 and 31% lower for six months 2005 compared to the same periods in 2004. Amortization of the prepayment for services was about $400 thousand lower for the second quarter 2005 and $800 thousand lower for six months 2005 than the same periods in 2004, reflecting the declining balance method of amortization.
The decrease in operating profit from the marketing agreements is primarily due to lower shipments. During the second quarter 2005, Octel advised us that one of the major TEL customers under our marketing agreements has indicated that it was discontinuing the use of TEL earlier than we had previously expected. The TEL market will continue to decline as other customers discontinue use of the product.
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Other TEL operations not included in the marketing agreements were $4.3 million favorable when comparing second quarter 2005 to second quarter 2004 and $3.1 million favorable when comparing six months 2005 to the same 2004 period. Both the second quarter and six months 2005 results include a special item of $3.9 million before income taxes for insurance settlement gains related to our premises asbestos liabilities. The other TEL operations results for both the second quarter and six months 2005 periods also reflect lower expenses for premises asbestos charges reflecting the favorable impact of a change in expected future insurance reimbursements, which was largely offset by an increase in certain plant clean-up costs.
While the market for this product is declining, this business continues to supply Ethyl with substantial cash flows.
The following discussion references the Condensed Consolidated Financial Statements beginning on page 3 of this Quarterly Report on Form 10-Q.
Special Item Income
Interest and Financing Expenses
Both second quarter 2005 and second quarter 2004 interest and financing expenses were $4.5 million. Average debt, as well as average interest rates, was substantially unchanged between the two periods. Fees and amortization of financing costs were $79 thousand lower for the 2005 quarter.
Six months 2005 interest and financing expenses were $8.8 million as compared to $9.7 million for six months 2004. Lower average debt resulted in a decrease in interest and financing expenses of $300 thousand, while higher average interest rates resulted in an increase of $39 thousand. Fees and amortization of financing costs were $700 thousand lower for the 2005 period.
Other Income, Net
Other income, net was $100 thousand for the second quarter 2005 compared to $300 thousand for the second quarter 2004. Both the 2005 and 2004 six months periods were $400 thousand. All periods were comprised of a number of non-material items.
Income Taxes
Income taxes were $5.7 million for both the second quarter 2005 and 2004. The effective tax rate was 30.4% for the second quarter 2005 and 33.4% for the second quarter 2004. The increase in income before income taxes from 2005 to 2004 resulted in an increase of $600 thousand in income taxes in the second quarter 2005, while the decrease in the effective tax rate between 2005 and 2004 resulted in an offsetting decrease in tax expense of $600 thousand.
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Six months 2005 income taxes were $7.8 million with an effective tax rate of 30.5%. The income taxes for six months 2004 were $8.8 million with an effective tax rate of 33.8%. The decrease in the effective tax rate resulted in a decrease of $900 thousand in income taxes. The remaining $100 thousand decrease was the result of the lower income before income taxes for six months 2005.
The effective tax rate for both 2005 periods reflects a larger research and development tax credit in 2005.
Our deferred taxes are in a net asset position. Based on forecast operating plans, we believe that we will recover the full benefit of our deferred tax assets.
Cash Flows, Financial Condition, and Liquidity
Cash and cash equivalents at June 30, 2005 were $31.5 million, which was an increase of $2.7 million since December 31, 2004 and included a $3.4 million negative impact from foreign currency. Cash flows from operating activities for the six months 2005 were $8.0 million. We used these cash flows and $4.0 million of additional borrowing to fund capital expenditures of $7.1 million and cover additional book overdrafts of $1.2 million. Included in the 2005 cash flows from operating activities were collections of $3.7 million related to the 2004 environmental insurance settlement, as well as $6.0 million from a 2005 insurance settlement related to our premises asbestos liabilities. Cash flows from operating activities for the 2005 period also included higher working capital requirements, which are discussed more fully below under “Working Capital.” We expect that cash from operations, together with borrowing available under our senior credit facility, will continue to be sufficient to cover our operating expenses and planned capital expenditures.
The terms of the 2004 environmental insurance settlement provide for a total payment of $15.6 million. In addition to the $7.7 million received during 2004, we received $3.7 million in the first quarter 2005 and will receive the remaining $4.2 million in the first quarter 2006.
Cash
We had restricted cash of $1.4 million at June 30, 2005 and $1.7 million at December 31, 2004. Of these funds at June 30, 2005, $900 thousand was cash received from Metropolitan Life Insurance Company (Metropolitan) in 2003. These funds amounted to $1.1 million at December 31, 2004.
The funds from Metropolitan are used to reduce the employee portion of retiree health benefits costs. The remaining $500 thousand of restricted cash represents funds related to the issuance of a European bank guarantee.
Debt
Senior Notes - On April 30, 2003, Ethyl sold senior notes in the aggregate principal amount of $150 million that bear interest at a fixed rate of 8.875% and are due in 2010.
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Borrowings under the $100 million revolving credit facility are used for working capital and other general corporate purposes for NewMarket and our subsidiaries. The revolving credit facility includes a sub-facility for letters of credit. Borrowings bear interest, at our election, at either a base rate plus a margin (75 basis points as of June 30, 2005) or LIBOR plus a margin (225 basis points as of June 30, 2005). The revolving credit facility matures on June 18, 2009. Borrowings outstanding at June 30, 2005 under the revolving credit facility were $34.0 million and bore interest at rates of 5.40% to 6.75%, depending upon the type of borrowing. At June 30, 2005, we had outstanding letters of credit of $23.7 million, resulting in the unused portion of the revolver amounting to $42.3 million.
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** *
We had combined current and noncurrent long-term debt of $188.1 million at June 30, 2005, representing an increase of $3.7 million in our total debt since December 31, 2004. The increase resulted from additional borrowing of $4 million on the revolving credit facility, which was partially offset by a $300 thousand decrease on a capital lease.
As a percentage of total capitalization (total long-term debt and shareholders’ equity), our total debt decreased from 44.3% at the end of 2004 to 43.3% at June 30, 2005. The increased debt level partially offset the increases in shareholders’ equity, which were primarily due to net income. Normally, we repay long-term debt with cash from operations, as well as with proceeds from occasional sales of business units, plant sites, or other assets.
Capital Expenditures
We funded capital expenditures of $7.1 million through June 30, 2005, and we estimate our total capital spending during 2005 will be approximately $20 million. We expect to continue to finance capital spending through cash provided from operations.
Working Capital
We had working capital at June 30, 2005 of $253.2 million, resulting in a current ratio of 2.93 to 1. At December 31, 2004, the working capital was $220.1 million and the current ratio was 2.57 to 1.
The increase in working capital and the current ratio primarily reflects increases in accounts receivable and prepaid insurance, as well as decreases in accounts payable and accrued expenses. The accounts receivable increase is due to the higher sales levels, reflecting both increased volumes shipped and higher prices. The increase in prepaid insurance is the result of the timing of premium payments which are amortized over the year. Accounts payable and accrued expenses are lower due to sales rebate payments made during the first quarter and normal fluctuations.
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Critical Accounting Policies
It is our goal to clearly present our financial information in a manner that enhances the understanding of our sources of earnings and our financial condition. We do this by including the information required by the SEC, as well as additional information that gives further insight into our financial operations.
This report, as well as the 2004 Annual Report, includes a discussion of our accounting principles, as well as methods and estimates used in the preparation of our financial statements. We believe these discussions and statements fairly represent the financial position and operating results of our company. The purpose of this portion of our discussion is to further emphasize some of the more critical areas where a significant change in facts and circumstances in our operating and financial environment might cause a change in reported financial results.
As discussed in the 2004 Annual Report, we have made certain payments related to our TEL marketing agreements. The unamortized total at June 30, 2005 for these prepayments is $17.5 million. We are amortizing these costs on an accelerated basis using a declining balance method over the life of the contracts. We believe this is the appropriate methodology and time period for this amortization based on the facts and circumstances of our TEL operations and the estimated product life of TEL. The customer base of TEL is significantly concentrated in a few countries and when conditions change that cause a shorter product life or other restrictions outside of our control, the amortization period and/or rate is adjusted accordingly. Any adjustment to the amortization period would impact earnings, but would have no effect on cash flows. We continue to keep our accounting for this issue current with the business conditions.
During the second quarter 2005, Octel advised us that one of the major TEL customers under our marketing agreements has indicated that it was discontinuing the use of TEL earlier than we had previously expected. Because of this development, we evaluated the prepayment for maketing agreement services for impairment and concluded the unamortized value at June 30, 2005 is not impaired. We adjusted the rate of amortization from a 20% declining balance method to a 30% declining balance method. In addition, based on revised projections of product shipments and product life expectancy, we adjusted the amortization period to run through 2012. This change will have an insignificant impact on 2005 earnings. Total amortization related to the TEL marketing agreements is currently projected to be:
We also have certain identifiable intangibles amounting to $48.3 million at June 30, 2005. These intangibles relate to our petroleum additives business and are being amortized over periods with up to eleven years of remaining life. We continue to assess the market related to these intangibles, as well as their specific values, and conclude the amortization periods and values are appropriate. We also evaluate these intangibles for any potential impairment. These evaluations continue to support the value at which these identifiable intangibles are carried on our financial statements. However, if conditions were to deteriorate substantially in this market, it could possibly cause a reduction in the periods of this amortization charge or could possibly result in a noncash write-off of a portion of the
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intangibles’ carrying value. A reduction in the amortization period would have no cash effect. While we do not anticipate such a change in the market conditions, this disclosure is provided to enhance the understanding of the factors involved.
We have made disclosure of our environmental issues in Part I, Item I of the 2004 Annual Report, as well as in the Notes to Consolidated Financial Statements of the 2004 Annual Report. We believe our environmental accruals are appropriate for the exposures and regulatory guidelines under which we currently operate. While we currently do not anticipate significant changes to the many factors that could impact our environmental requirements, we continue to keep our accruals consistent with these requirements as they change.
Also, as noted in the discussion of Legal Proceedings in Item 3 of the 2004 Annual Report, while it is not possible to predict or determine the outcome of any legal proceeding, it is our opinion that we will not experience materially adverse effects on our results of operations or financial condition as a result of any pending or threatened proceeding.
We use significant assumptions to record the impact of the pension and postretirement plans in the financial statements. These assumptions include the discount rate, expected long-term rate of return, rate of compensation increase, and health care cost trend rate. A change in any one of these assumptions could result in significantly different results for the plans. We develop these assumptions after considering advice from a major global actuarial consulting firm. Information is provided on the pension and postretirement plans in Note 19 of the 2004 Annual Report. In addition, further disclosure on the impact of changes in these assumptions is provided in the “Financial Position and Liquidity” section of Item 7 of the 2004 Annual Report.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” In general, SFAS 123R provides guidance in accounting for transactions in which a company obtains employee services in exchange for share-based payments. SFAS 123R requires that the cost from share-based payment transactions be recognized in the financial statements and be determined using a fair-value-based measurement method. SFAS 123R was to be effective for interim periods beginning after June 15, 2005. In April 2005, the SEC delayed the effective date to the first fiscal year beginning after June 15, 2005. SFAS 123R applies to all share-based payment transactions initiated or modified after the effective date. We are evaluating SFAS 123R, but do not expect it to have a significant impact on our financial results.
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Outlook
Petroleum Additives
This segment performed well in the marketplace in the first half of this year as evidenced by its significant revenue and volume gains when compared to the first half of 2004. Unfortunately, when the profits for the two six month periods are compared, the negative impact of rising raw material costs continues to obscure the favorable accomplishments.
Since the end of the second quarter there has been another round of raw material price increases and, once again, we are in the marketplace attempting to recover those increases through price increases for our products. This business cycle results in higher working capital in receivables and has reduced the amount of cash we have available for debt reduction.
We continue to expect that the operating profit for petroleum additives will be higher in 2005 than in 2004. The many business factors detailed in our 2004 Annual Report and the compression of our margins mentioned above will be major factors in the ultimate profitability of this segment for the year.
TEL
This segment had a relatively good performance in the first half of 2005. Nonetheless, we believe profits in the second half of the year will be significantly lower than the first six months of 2005. The anticipated decline in profitability is volume driven, and we expect that TEL will earn less in 2005 than in 2004. As we have continually stated, this segment will continue to decline in profitability as its use is phased-out around the world.
Cash Flow
As discussed above, as our revenue grows from both business gains and price increases, the working capital needs of our business have increased significantly this year, mainly in the accounts receivable area. While our cash generated from earnings remains strong, the working capital increases have lowered our free cash flow. We now expect that our debt reduction capacity from our cash flow for 2005 will be in the $25 million to $30 million range.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Except for foreign currency risk discussed below, there have been no significant changes in our market risk from the information provided in the 2004 Annual Report.
During 2004, we entered into $26 million of Euro-denominated forward contracts to minimize currency exposure from expected cash flows from foreign operations. The contracts all have maturity dates in 2005. At June 30, 2005, there were $13 million remaining of these Euro-denominated contracts. With other variables held constant, a hypothetical 10% adverse change in the June 30, 2005 forward Euro rates would have resulted in a decrease of about $1 million in the value of the contracts.
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Evaluation of Disclosure Controls and Procedures
We maintain a system of internal control over financial reporting to provide reasonable, but not absolute, assurance of the reliability of the financial records and the protection of assets. Our controls and procedures include written policies and procedures, careful selection and training of qualified personnel, and an internal audit program. We use a third-party firm, separate from our independent registered public accounting firm, to assist with internal audit services.
We work closely with the business groups, operations personnel, and information technology to ensure transactions are recorded properly. Environmental and legal staff are consulted to determine the appropriateness of our environmental and legal liabilities for each reporting period. We regularly review the regulations and rule changes that affect our financial disclosures.
Our disclosure control procedures include signed representation letters from our regional officers, as well as senior management.
We have formed a Financial Disclosure Committee, which is made up of the president and senior vice president of Afton, the president of Ethyl, and the general counsel and controller of NewMarket. The committee, as well as regional management, makes representations with regard to the financial statements that, to the best of their knowledge, the report does not contain any misstatement of a material fact or omit a material fact that is necessary to make the statements not misleading with respect to the periods covered by the report.
The committee and the regional management also represent, to the best of their knowledge, that the financial statements and other financial information included in the report fairly present, in all material respects, the financial condition, results of operations and cash flows of the company as of and for the periods presented in the report.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the Exchange Act), we carried out an evaluation, with the participation of our management, including our principal executive officer and our principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e)) under the Exchange Act as of the end of the period covered by this report. Based upon that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures are effective.
There has been no change in our internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, during the quarter ended June 30, 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II – Other Information
We are involved in legal proceedings that are incidental to our business and include administrative or judicial actions seeking remediation under environmental laws, such as Superfund.
These proceedings include certain product liability cases. The only product liability cases of potential consequence in which we are involved are TEL-related. In one case, Ethyl was served as a defendant in a case filed in the Circuit Court for Baltimore City, Maryland, in September 1999. Smith, et al. v. Lead Industries Association, Inc., et al., alleged personal injuries for seven children from lead exposure arising from lead paint and dust from tailpipe emissions due to leaded gasoline. The court dismissed Ethyl and some other defendants from the case in February 2002 and granted summary judgment to other defendants in November 2002. The plaintiffs have appealed both decisions, but did not appeal the dismissal of Ethyl as a defendant. On April 4, 2005, the Court of Appeals of Maryland dismissed the appeal on the basis that the trial court’s decision was not a final decision that could be appealed, and the case is once again pending in the trial court. If such claims are further pursued against Ethyl, we believe Ethyl has strong defenses and will vigorously defend any such claims.
At the annual meeting of NewMarket shareholders held on May 26, 2005, the shareholders elected the directors nominated in the NewMarket Proxy Statement, dated April 18, 2005, with the following affirmative votes and votes withheld:
Director
Phyllis L. Cothran
Bruce C. Gottwald
Thomas E. Gottwald
Patrick D. Hanley
James E. Rogers
Sidney Buford Scott
Charles B. Walker
The shareholders also approved the following proposal:
Proposal
To ratify the appointment of PricewaterhouseCoopers LLP as independent registered public accounting firm for the fiscal year ending December 31, 2005
There were no broker non-votes with respect to the election of directors or the ratification of our independent registered public accounting firm.
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None
ITEM 6. Exhibits
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: August 1, 2005
By:
/s/ D. A. Fiorenza
David A. Fiorenza
Vice President and Treasurer
(Principal Financial Officer)
/s/ Wayne C. Drinkwater
Wayne C. Drinkwater
Controller
(Principal Accounting Officer)
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EXHIBIT INDEX
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