UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2010
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
23218-2189
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of shares of common stock, without par value, outstanding as of September 30, 2010: 14,291,122.
I N D E X
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
Consolidated Statements of Income – Third Quarter and Nine Months Ended September 30, 2010 and September 30, 2009
Consolidated Balance Sheets – September 30, 2010 and December 31, 2009
Consolidated Statements of Shareholders’ Equity – Nine Months Ended September 30, 2010 and Year Ended December 31, 2009
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2010 and September 30, 2009
Notes to 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 2. Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 6. Exhibits
SIGNATURES
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ITEM 1. Financial Statements
NEWMARKET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per-share amounts)
(Unaudited)
Revenue:
Net sales - product
Rental revenue
Costs:
Cost of goods sold - product
Cost of rental
Gross profit
Selling, general, and administrative expenses
Research, development, and testing expenses
Operating profit
Interest and financing expenses
Other expense, net
Income before income tax expense
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
Cash dividends declared per common share
See accompanying Notes to the Consolidated Financial Statements.
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CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
Current assets:
Cash and cash equivalents
Short-term investments
Trade and other accounts receivable, less allowance for doubtful accounts ($717 in 2010 and $1,195 in 2009)
Inventories:
Finished goods
Raw materials
Stores, supplies and other
Deferred income taxes
Prepaid expenses and other current assets
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) and goodwill
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued expenses
Dividends payable
Book overdraft
Long-term debt, current portion
Income taxes payable
Total current liabilities
Long-term debt
Other noncurrent liabilities
Commitments and contingencies (Note 9)
Shareholders’ equity:
Common stock (without par value) and paid-in capital; authorized shares - 80,000,000; Outstanding shares - 14,291,122 in 2010 and 15,209,989 in 2009
Accumulated other comprehensive loss
Retained earnings
Total liabilities and shareholders’ equity
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NewMarket Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Equity
(in thousands, except share amounts)
(unaudited)
Balance at December 31, 2008
Comprehensive income:
Changes in (net of tax):
Foreign currency translation adjustments
Pension plans and other postretirement benefit adjustments:
Prior service cost
Unrecognized gain
Transition obligation
Derivative net loss
Total comprehensive income
Cash dividends ($1.075 per share)
Stock options exercised
Issuance of stock
Balance at December 31, 2009
Cash dividends ($1.125 per share)
Common stock repurchase
Balance at September 30, 2010
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
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 environmental remediation and dismantling
Noncash pension benefits expense
Noncash postretirement benefits expense
Noncash foreign exchange (gain) loss
Loss on derivative instruments, net
Working capital changes
Cash pension benefits contributions
Cash postretirement benefits contributions
Other, net
Cash provided from operating activities
Cash flows from investing activities:
Capital expenditures
Foundry Park I capital expenditures
Purchase of short-term investment
Acquisition of business (net of cash acquired of $1.8 million)
Payments on settlement of interest rate swap
Receipts from settlement of interest rate swap
Deposits for interest rate swap
Return of deposits for interest rate swap
Deposits for interest rate lock agreement
Return of deposits for interest rate lock agreement
Cash used in investing activities
Cash flows from financing activities:
Repayment of Foundry Park I construction loan
Borrowing under Foundry Park I mortgage loan
Repayment on Foundry Park I mortgage loan
Draws on Foundry Park I construction loan
Net borrowings (repayments) under revolving credit agreement
Repurchases of common stock
Dividends
Change in book overdraft
Payment for financed intangible asset
Debt issuance costs
Proceeds from exercise of stock options
Payments on capital leases
Cash used in financing activities
Effect of foreign exchange on cash and cash equivalents
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying consolidated financial statements of NewMarket Corporation and its subsidiaries contain all necessary adjustments for the fair presentation of, in all material respects, our consolidated financial position and shareholders’ equity for the nine months ended September 30, 2010 and the year ended December 31, 2009, as well as our consolidated results of operations for the third quarter and nine months ended September 30, 2010 and September 30, 2009, and cash flows for the nine months ended September 30, 2010 and September 30, 2009. 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 year ended December 31, 2009 (2009 Annual Report), as filed with the Securities and Exchange Commission (SEC). The results of operations for the nine month period ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year ending December 31, 2010. The December 31, 2009 consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
Unless the context otherwise requires, all references to “we,” “us,” “our,” the “Company” and “NewMarket” are to NewMarket Corporation and its consolidated subsidiaries.
Certain amounts in the accompanying financial statements have been reclassified to conform to the current presentation. There was no effect on net income.
At both September 30, 2010 and December 31, 2009, 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. There are no agreements with the same banks to offset the presented balance. We transfer cash on an as-needed basis to fund these items as they clear the bank in subsequent periods.
Cash dividends totaling $1.125 per share for the nine months ended September 30, 2010 and 70 cents per share for the nine months ended September 30, 2009 were declared and paid as shown in the table below.
Year
2010
2009
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On March 5, 2010, Afton Chemical Corporation (Afton) completed the acquisition of 100% of the Polartech group of companies (Polartech) for $43.1 million in cash. Polartech is a global company specializing in the supply of metalworking additives. The acquisition agreement included all physical assets of the Polartech business including the headquarters, research and development, and manufacturing facilities in the United Kingdom, as well as manufacturing sites in India, China, and the United States.
We performed a valuation of the assets acquired to determine the purchase price allocation. This valuation resulted in the recognition of $6 million of identifiable intangibles, including formulas and technology, customer base, and trademarks/trade names. We also acquired property, plant, and equipment of $28.4 million, as well as working capital.
As part of the acquisition, we recorded $4.2 million of goodwill, which resulted from deferred taxes which were recognized related to the acquisition. All of the goodwill recognized is part of the petroleum additives segment, and none is deductible for tax purposes.
Pro forma consolidated results of operations for the nine months ended September 30, 2010 and September 30, 2009 assuming the acquisition had occurred on January 1, 2010 or January 1, 2009, would not be materially different from the actual results reported for NewMarket Corporation for the nine months ended September 30, 2010 and September 30, 2009.
Our asset retirement obligations are related primarily to our tetraethyl lead (TEL) operations. The following table illustrates the activity associated with our asset retirement obligations for the nine months ended September 30, 2010 and September 30, 2009.
Asset retirement obligations, January 1
Liabilities incurred
Accretion expense
Liabilities settled
Changes in expected cash flows and timing
Asset retirement obligations, September 30
The tables below show our consolidated revenue, operating profit (including a reconciliation of segment operating profit to consolidated income before income taxes), and depreciation and amortization.
The “All other” category includes the operations of the TEL business, as well as certain contract manufacturing Ethyl Corporation (Ethyl) provides to Afton and to third parties.
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Consolidated Revenue by Segment
(in millions)
Petroleum additives
Real estate development
All other
Consolidated revenue
Segment Operating Profit
Segment operating profit
Corporate, general, and administrative expenses
Loss on interest rate swap agreement (a)
Other income (expense), net
Income before income taxes
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Segment Depreciation and Amortization
Total depreciation and amortization
During the nine months ended September 30, 2010, we made cash contributions of approximately $9.5 million for domestic pension plans and approximately $1.2 million for domestic postretirement benefit plans. We expect to make total cash contributions in 2010 of approximately $13.9 million for our domestic pension plans and approximately $1.7 million for our domestic postretirement benefit plans.
We made cash contributions of approximately $4.7 million for our foreign pension plans and approximately $130 thousand for a foreign postretirement benefit plan during the nine months ended September 30, 2010. During 2010, we expect to make total cash contributions of approximately $6.4 million for our foreign pension plans and approximately $170 thousand for our foreign postretirement benefit plan.
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The tables below present information on periodic benefit cost for our pension and postretirement benefit plans.
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net loss (gain)
Net periodic benefit cost
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Amortization of transition (asset) obligation
Amortization of net loss
Settlement loss
In March 2010, the Patient Protection and Affordable Care Act was signed into law, as was a related reconciliation bill. Included in the provisions of the laws are changes to the taxation related to the federal subsidy available to companies that provide retiree healthcare benefit plans that include a benefit that is at least actuarially equivalent to the benefits of Medicare Part D. Our retiree medical plan does include a drug subsidy benefit that is actuarially equivalent to Medicare Part D. However, we are not impacted by the changes in the taxation of the federal subsidy, as we assigned the subsidy to our insurance provider several years ago in consideration of premium determination. At the time we assigned the benefit to our insurance provider, we adjusted our deferred taxes accordingly. We are currently evaluating all of the provisions of the law and its impact on our company but have made no adjustments to our financial statements as a result of the legislation.
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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 underlying common share, as the impact on earnings per share would be anti-dilutive. We had no anti-dilutive options that were excluded from the calculation of earnings per share for any period presented.
Numerator:
Denominator:
Weighted-average number of shares of common stock outstanding
Shares issuable upon exercise of stock options
Total shares
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The following table provides certain information related to our intangible assets. All of the intangibles relate to the petroleum additives segment.
Amortizing intangible assets
Formulas and technology
Contracts
Customer base
Trademarks and trade name
Goodwill
The increase in intangible assets and goodwill since December 31, 2009 was the result of the purchase of Polartech.
Amortization expense was (in millions):
• Third quarter ended September 30, 2010
• Nine months ended September 30, 2010
• Third quarter ended September 30, 2009
• Nine months ended September 30, 2009
Currently, estimated annual amortization expense related to our intangible assets for the next five years is expected to be (in millions):
• 2010
• 2011
• 2012
• 2013
• 2014
Generally, we amortize the cost of the customer base intangible by an accelerated method and the cost of the remaining intangible assets by the straight-line method over their estimated economic lives. We generally amortize contracts over 1.5 to 10 years and formulas and technology over 5 to 20 years. Trademarks and the trade name are amortized over 10 years.
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Long-term debt consisted of:
Senior notes - 7.125% due 2016
Foundry Park I mortgage loan - due 2015
Revolving credit facility
Foundry Park I construction loan - due 2010
Capital lease obligations
Current maturities of long-term debt
We had outstanding borrowings under our revolving credit facility of $20.0 million at September 30, 2010 at an interest rate of 4.75%. We had no outstanding borrowings on the revolving credit facility at December 31, 2009. We had outstanding letters of credit of $8.8 million at September 30, 2010, resulting in the unused portion of the revolving credit facility amounting to $121.2 million.
On January 28, 2010, Foundry Park I entered into a mortgage loan agreement in the amount of $68.4 million. The loan, which is collateralized by the Foundry Park I office building, is for a period of five years, with two thirteen-month extension options. NewMarket Corporation is fully guaranteeing the loan. The mortgage loan bears interest at a variable rate of LIBOR plus a margin of 400 basis points, with a minimum LIBOR of 200 basis points. At September 30, 2010, the interest rate was 4.26%. Concurrently with the closing of the mortgage loan, Foundry Park I obtained an interest rate swap to effectively convert the variable interest rate of the loan to a fixed interest rate by setting LIBOR at 2.642% for five years. Further information on the interest rate swap is in Note 10. Principal payments on the loan are being made monthly based on a 15-year amortization schedule, with all remaining amounts due in five years, unless we exercise the extension options. On January 29, 2010, we paid off the outstanding balance of $99.1 million on the Foundry Park I construction loan with proceeds of $68.4 million from the Foundry Park I mortgage loan agreement, as well as cash on hand of $30.7 million.
We were in compliance with all covenants under our debt agreements at September 30, 2010 and December 31, 2009.
There have been no significant changes in our contractual commitments and contingencies from those reported in our 2009 Annual Report on Form 10-K in Note 19. The information below provides information on certain contractual commitments and contingencies.
Litigation
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. Some of these legal proceedings relate to environmental matters and involve governmental authorities. For further information, see “Environmental” below.
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While it is not possible to predict or determine with certainty the outcome of any legal proceeding, we believe the outcome of any of these proceedings, or all of them combined, will not result in a material adverse effect on our consolidated financial condition or results of operations.
Environmental
During 2000, the U.S. Environmental Protection Agency (EPA) named us as a potentially responsible party (PRP) under Superfund law for the clean-up of soil and groundwater contamination at the Sauget Area 2 Site in Sauget, Illinois. Without admitting any fact, responsibility, fault, or liability in connection with this site, we are participating with other PRPs in site investigations and feasibility studies.
The Sauget Area 2 Site PRPs received notice of approval from the EPA of their October 2009 Human Health Risk Assessment. Additionally, the PRPs have submitted their Feasibility Study (FS) to the EPA Remedy Review Board. We have accrued our estimated proportional share of the expenses for the FS, as well as our best estimate of our proportional share of the remediation liability proposed in our ongoing discussions and submissions with the agencies involved. We do not believe there is any additional information available as a basis for revision of the liability that we have established. The amount currently accrued for this site is not material.
At a former TEL plant site located in Louisiana, we have completed significant environmental remediation, although we will be monitoring and treating the site for an extended period. The accrual for this site was $6.9 million at September 30, 2010 and $7.5 million at December 31, 2009. We based these amounts on the best estimate of future costs discounted at approximately 3% in both 2010 and 2009. An inflation factor is included in the estimate. The undiscounted liability was $9.0 million at September 30, 2010 and $9.7 million at December 31, 2009. The expected payments over the next five years amount to approximately $800 thousand in each of 2010 and 2011, $700 thousand in 2012, $500 thousand in 2013, and $600 thousand in 2014. Expected payments thereafter amount to approximately $6.2 million.
At a plant site in Houston, Texas, we have accruals of $7.8 million at September 30, 2010 and $7.9 million at December 31, 2009 for environmental remediation, dismantling, and decontamination. Included in these amounts are $7.5 million at September 30, 2010 and $7.6 million at December 31, 2009 for remediation. Of the total remediation, $7.2 million at both September 30, 2010 and December 31, 2009 relates to remediation of groundwater and soil. The accruals for this site are discounted at approximately 3% at both September 30, 2010 and December 31, 2009. The accruals include an inflation factor. The undiscounted accrual for this site was $11.4 million at September 30, 2010 and $11.2 million at December 31, 2009. The expected payments over the next five years are approximately $400 thousand in 2010, $500 thousand in each of 2011 and 2012, $600 thousand in 2013, and $1.7 million in 2014. Expected payments thereafter amount to approximately $7.9 million.
At a Superfund site in Louisiana, we have an accrual of $2.0 million at September 30, 2010 and $2.6 million at December 31, 2009 for environmental remediation. The accrual for this site was discounted at approximately 3% at both September 30, 2010 and December 31, 2009 and included an inflation factor. The undiscounted accrual for this site was $2.5 million at September 30, 2010 and $3.2 million at December 31, 2009. The expected payments over the next five years amount to approximately $400 thousand in each of 2010 and 2011, and $200 thousand each for years 2012 through 2014. Expected payments thereafter amount to approximately $1.8 million.
The remaining environmental liabilities are not discounted.
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We accrue for environmental remediation and monitoring activities for which costs can be reasonably estimated and are probable. These estimates are based on an assessment of the site, available clean-up methods, and prior experience in handling remediation. While we believe we are currently fully accrued for known environmental issues, it is possible that unexpected future costs could have a significant impact on our financial position and results of operations.
Our total accruals for environmental remediation were approximately $21.6 million at September 30, 2010 and $22.0 million at December 31, 2009. In addition to the accruals for environmental remediation, we also have accruals for dismantling and decommissioning costs of $500 thousand at both September 30, 2010 and December 31, 2009.
Letters of Credit and Guarantees
We have outstanding guarantees with several financial institutions in the amount of $53.4 million at September 30, 2010. The guarantees are secured by letters of credit, as well as cash collateral. A portion of these guarantees is unsecured. The outstanding letters of credit amounted to $8.8 million at September 30, 2010, all of which were issued under the letter of credit sub-facility of our revolving credit facility. The letters of credit primarily relate to insurance guarantees and performance guarantees. We renew letters of credit as necessary. The remaining amounts represent additional performance, lease, custom and excise tax guarantees, as well as a cash deposit of $31.9 million related to the Goldman Sachs Bank USA (Goldman Sachs) interest rate swap. The cash deposit is recorded in “Other assets and deferred charges” on the Consolidated Balance Sheet. Expiration dates of the letters of credit and certain guarantees range from 2010 to 2013. Some of the guarantees have no expiration date.
We cannot estimate the maximum amount of potential liability under the guarantees. However, we accrue for potential liabilities when a future payment is probable and the range of loss can be reasonably estimated.
Accounting Policy for Derivative Instruments and Hedging Activities
We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain of our risks, even though hedge accounting does not apply or we elect not to apply hedge accounting. We do not enter into derivative instruments for speculative purposes.
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Risk Management Objective of Using Derivatives
We are exposed to certain risks arising from both our business operations and economic conditions. We primarily manage our exposures to a wide variety of business and operational risks through management of our core business activities.
We manage certain economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding, as well as through the use of derivative financial instruments. Specifically, we have entered into interest rate swaps to manage our exposure to interest rate movements.
Our foreign operations expose us to fluctuations of foreign exchange rates. These fluctuations may impact the value of our cash receipts and payments as compared to our reporting currency, the U.S. Dollar. To manage this exposure, we sometimes enter into foreign currency forward contracts to minimize currency exposure due to cash flows from foreign operations.
Cash Flow Hedge of Interest Rate Risk
In January 2010, we entered into an interest rate swap to manage our exposure to interest rate movements on the Foundry Park I mortgage loan and to reduce variability in interest expense. Further information on the mortgage loan is in Note 8. We also had an interest rate swap to manage our exposure to interest rate movements on the Foundry Park I construction loan and add stability to capitalized interest expense. The Foundry Park I construction loan interest rate swap matured on January 1, 2010. Further information on the construction loan is in our 2009 Annual Report in Note 13. Both interest rate swaps are designated and qualify as a cash flow hedge. As such, the effective portion of changes in the fair value of the swaps is recorded in accumulated other comprehensive loss and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Any ineffective portion of changes in the fair value of the swap is recognized immediately in earnings. We assess the effectiveness of the mortgage loan interest rate swap quarterly, just as we assessed the effectiveness of the construction loan interest rate swap quarterly, by comparing the changes in the fair value of the derivative hedging instrument with the change in present value of the expected future cash flows of the hedged transaction.
Both interest rate swaps involve the receipt of variable-rate amounts based on LIBOR in exchange for fixed-rate payments over the life of the agreement without exchange of the underlying notional amount. The fixed-rate payments are at a rate of 2.642% for the mortgage loan interest rate swap, while the fixed-rate payments on the construction loan interest rate swap were at a rate of 4.975%. The notional amount of the mortgage loan interest rate swap was $68.4 million at origination and approximately $66.9 million at September 30, 2010. The notional amount of the mortgage loan swap amortizes to approximately $53.7 million over the term of the swap. The amortizing notional amount is necessary to maintain the swap notional at an amount that matches the declining mortgage loan principal balance over the loan term. The mortgage loan interest swap matures on January 25, 2015. The notional amount of the construction loan interest rate swap was approximately $94.0 million at December 31, 2009, just prior to its January 1, 2010 maturity. The accreting notional amount was necessary to maintain the construction loan interest rate swap notional at an amount that represented approximately 85% of the projected construction loan principal balance over the loan term.
The unrealized loss, net of tax, related to the fair value of the mortgage loan interest rate swap is recorded in accumulated other comprehensive loss in shareholders’ equity on the Consolidated Balance Sheets, amounted to approximately $2.4 million at September 30, 2010. The unrealized
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loss, net of tax, related to the fair value of the construction loan interest rate swap and recorded in accumulated other comprehensive loss amounted to approximately $37 thousand at December 31, 2009. This amount was settled on January 1, 2010. Also recorded as a component of accumulated other comprehensive loss in shareholders’ equity on the Consolidated Balance Sheets was the accumulated losses related to the construction loan interest rate swap. This amounted to approximately $2.6 million, net of tax, at both September 30, 2010 and December 31, 2009. The amounts remaining in accumulated other comprehensive loss related to the construction loan interest rate swap are being recognized in the Consolidated Statements of Income over the depreciable life of the office building beginning in January 2010. Approximately $1.0 million, net of tax, currently recognized in accumulated other comprehensive loss related to both the construction loan interest rate swap and the mortgage loan interest rate swap is expected to be reclassified into earnings over the next twelve months.
Non-designated Hedges
On June 25, 2009, we entered into an interest rate swap with Goldman Sachs in the notional amount of $97 million and with a maturity date of January 19, 2022 (Goldman Sachs interest rate swap). NewMarket entered into the Goldman Sachs interest rate swap in connection with the termination of a loan application and related rate lock agreement between Foundry Park I and Principal Commercial Funding II, LLC (Principal). See Note 19 in our 2009 Annual Report for further information on the transaction between Foundry Park I and Principal. When the rate lock agreement was originally executed in 2007, Principal simultaneously entered into an interest rate swap with a third party to hedge Principal’s exposure to fluctuation in the ten-year Treasuries rate. Upon the termination on June 25, 2009 of the rate lock agreement, Goldman Sachs both assumed Principal’s position with the third party and entered into an offsetting interest rate swap with NewMarket. Under the terms of this interest rate swap, NewMarket will make fixed rate payments at 5.3075% and Goldman Sachs will make variable rate payments based on three-month LIBOR. We have collateralized this exposure through cash deposits posted with Goldman Sachs amounting to $31.9 million at September 30, 2010. This transaction effectively preserves the impact of the original rate lock agreement for the possible application to a future loan amount of $97 million of a similar structure.
In December 2008, we entered into $16.8 million of Euro-denominated forward contracts to minimize foreign currency exposure from expected cash flows from foreign operations. The forward contracts obligated us to sell Euros for U.S. Dollars at a fixed exchange rate of 1.403, which was agreed to at the inception of the contracts. These contracts had maturity dates through December 2009. There were no outstanding foreign currency forward contracts at September 30, 2010 or December 31, 2009.
We do not use hedge accounting for either the Goldman Sachs interest rate swap or the forward contracts, and therefore, immediately recognize any change in the fair value of these derivative financial instruments in earnings.
*****
The table below presents the fair value of our derivative financial instruments, as well as their classification on the Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009.
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Fair Value of Derivative Instruments
(in thousands)
Derivatives Designated as Hedging Instruments
Mortgage loan interest rateswap
Construction loan interest rateswap
Derivatives Not Designated as Hedging Instruments
Goldman Sachs interest rateswap
The total fair value reflected in the table above includes amounts recorded in accrued expenses of approximately $100 thousand for the mortgage loan interest rate swap and approximately $900 thousand for the Goldman Sachs interest rate swap.
The tables below present the effect of our derivative financial instruments on the Consolidated Statements of Income.
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Effect of Derivative Instruments on the Consolidated Statements of Income
Designated Cash Flow Hedges
Derivatives in Cash FlowHedging Relationship
Amount of Gain(Loss) Recognizedin OCI onDerivative(Effective Portion)
Location of Gain(Loss) Reclassifiedfrom AccumulatedOCI into Income
(Effective Portion)
Amount of Gain (Loss)Reclassified fromAccumulated OCIintoIncome (EffectivePortion)
Location of Gain(Loss) Recognized inIncome on Derivative(Ineffective Portionand AmountExcluded fromEffectiveness Testing)
Amount of Gain (Loss)Recognized in Income onDerivative (IneffectivePortion and AmountExcluded fromEffectiveness Testing)
Mortgage loan interest rate swap
Construction loan interest rate swap
Not Designated Derivatives
Derivatives Not Designated as
Hedging Instruments
Goldman Sachs interest rate swap
Foreign currency forward contracts
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Credit-risk-related Contingent Features
We have agreements with both of our current derivative counterparties that contain a provision where we could be declared in default on our derivative obligations if repayment of indebtedness is accelerated by the lender due to our default on the indebtedness.
As of September 30, 2010, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $30.1 million. We have minimum collateral posting thresholds with one of our derivative counterparties and have posted cash collateral of $31.9 million as of September 30, 2010. If required, we could have settled our obligations under the agreements at their termination value of $30.1 million at September 30, 2010.
The components of comprehensive income consist of the following:
Other comprehensive income, net of tax
Pension plans and other postretirement benefits adjustments
Tax expense
Unrealized loss on derivative instruments
Tax benefit (expense)
Other comprehensive income (loss)
Comprehensive income
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The components of accumulated other comprehensive loss consist of the following:
Pension plans and other postretirement benefit adjustments
Accumulated loss on derivative instruments
The following table provides information on assets and liabilities measured at fair value on a recurring basis. No events occurred during the nine months ended September 30, 2010, requiring adjustment to the recognized balances of assets or liabilities which are recorded at fair value on a nonrecurring basis.
Interest rate swaps liability
Interest rate swap liability
We determine the fair value of the derivative instruments shown in the table above by using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each instrument. The analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs.
The fair value of the interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates derived from observable market interest rate curves. In determining the fair value measurements, we
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incorporate credit valuation adjustments to appropriately reflect both our nonperformance risk and the counterparties’ nonperformance risk.
Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustment associated with the derivatives utilizes Level 3 inputs. These Level 3 inputs include estimates of current credit spreads to evaluate the likelihood of default by both us and the counterparties to the derivatives. As of September 30, 2010, we have assessed the significance of the impact of the credit valuation adjustment on the overall valuation of our derivatives and have determined that the credit valuation adjustment is not significant to the overall valuation of the derivatives. Accordingly, we have determined that our derivative valuations should be classified in Level 2 of the fair value hierarchy.
We record the value of our long-term debt at historical cost. The estimated fair value of our long-term debt is shown in the table below and is based primarily on estimated current rates available to us for debt of the same remaining duration and adjusted for nonperformance risk and credit risk.
Long-term debt, including current maturities
The 7.125% senior notes due 2016 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 100% owned domestic restricted subsidiaries. The Guarantor Subsidiaries and the subsidiaries that do not guarantee the senior notes (the Non-Guarantor Subsidiaries) are 100% owned by NewMarket Corporation (the Parent Company). The Guarantor Subsidiaries consist of the following:
We conduct all of our business and derive essentially 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 Company.
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The following sets forth the Consolidating Statements of Income for the third quarter and nine months ended September 30, 2010 and September 30, 2009; Consolidating Balance Sheets as of September 30, 2010 and December 31, 2009; and Condensed Consolidating Statements of Cash Flows for the nine months ended September 30, 2010 and September 30, 2009 for the Parent Company, the Guarantor Subsidiaries, and Non-Guarantor Subsidiaries. The financial information is based on our understanding of the SEC’s interpretation and application of Rule 3-10 of the SEC Regulation S-X.
The financial information may not necessarily be indicative of their results of operations or financial positions had the Guarantor Subsidiaries or Non-Guarantor Subsidiaries operated as independent entities. The Parent Company accounts for investments in these subsidiaries using the equity method.
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Consolidating Statements of Income
Third Quarter Ended September 30, 2010
Operating (loss) profit
Interest and financing expenses (income)
Other (expense) income, net
(Loss) income before income tax expense and equity income of subsidiaries
Equity income of subsidiaries
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Third Quarter Ended September 30, 2009
Gross profit (loss)
(Loss) income before income tax (benefit) expense and equity income of subsidiaries
Income tax (benefit) expense
Net income (loss)
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Nine Months Ended September 30, 2010
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Nine Months Ended September 30, 2009
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Consolidating Balance Sheets
September 30, 2010
Trade and other accounts receivable, net
Amounts due from affiliated companies
Inventories
Investment in consolidated subsidiaries
Amounts due to affiliated companies
Total liabilities
Common stock and paid-in capital
Total shareholders’ equity
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December 31, 2009
Retained earnings (deficit)
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Condensed Consolidating Statements of Cash Flows
Cash (used in) provided from operating activities
Increase in intercompany loans
Cash dividends from subsidiaries
Cash provided from (used in) investing activities
Net borrowings under revolving credit agreement
Repayment of intercompany note payable
Financing from affiliated companies
Cash (used in) provided from financing activities
Decrease in cash and cash equivalents
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Net repayments under revolving credit agreement
Increase in cash and cash equivalents
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In July 2010, the Financial Accounts Standard board (FASB) issued Accounting Standards Update 2010-20, “Receivables (Topic 320) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (ASU 2010-20). ASU 2010-20 requires disclosures surrounding the nature of credit risk inherent in financing receivables, how that risk is assessed in determining the allowance for credit losses, and changes, as well as the reason for the changes, in the allowance for credit losses. ASU 2010-20 is effective for interim and annual reporting periods ending on or after December 15, 2010. We are evaluating any potential impact on our financial statements, and will make any additional required disclosures in our December 31, 2010 financial statements.
On October 18, 2010, our Board of Directors declared a quarterly dividend in the amount of 44 cents per share on our common stock. The dividend is payable January 1, 2011 to shareholders of record at the close of business on December 15, 2010.
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Financial Condition and Results of Operations
Forward-Looking Statements
The following discussion contains forward-looking statements about future events and expectations 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,” “should,” “could,” “may,” “will,” 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, 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.
Factors that could cause actual results to differ materially from expectations include, but are not limited to: availability of raw materials and transportation systems; ability to respond effectively to technological changes in our industry; supply disruptions at single-sourced facilities; failure to protect our intellectual property rights; political, economic, and regulatory factors concerning our products; hazards common to chemical businesses; occurrence or threat of extraordinary events, including natural disasters and terrorist attacks; competition from other manufacturers; sudden or sharp raw materials price increases; gain or loss of significant customers; risks related to operating outside of the United States; the impact of fluctuations in foreign exchange rates; future governmental regulation; resolution of environmental liabilities or legal proceedings; inability to complete future acquisitions or successfully integrate future acquisitions into our business and other factors detailed from time to time in the reports that NewMarket files with the Securities and Exchange Commission, including the risk factors in Item 1A, “Risk Factors” of our 2009 Annual Report, which is available to shareholders upon request.
You should keep in mind that any forward-looking statement made by us in this discussion or elsewhere 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.
Overview
Operations during the first nine months of 2010 continued to generate excellent results with operating profit in our petroleum additives segment increasing 6.1% over nine months 2009. During nine months 2010, we acquired the Polartech business for $43.1 million, paid down our debt by $12.8 million, and repurchased $89.0 million of our common stock. Further information on the Polartech acquisition is in Note 2.
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Results of Operations
Revenue
Our consolidated revenue for the third quarter 2010 amounted to $471.8 million, representing an increase of approximately 13% from the 2009 third quarter level of $417.8 million. Similarly, nine months consolidated revenue increased approximately 19% from $1,125.9 million for 2009 to $1,336.7 million for 2010. The table below shows our revenue by segment.
Petroleum Additives Segment
Petroleum additives net sales for the third quarter 2010 of $465.1 million increased $51.4 million, or approximately 12%, from $413.7 million for the third quarter 2009. The increase in sales reflects higher total product shipments of 6% including the benefit of Polartech shipments for the third quarter 2010. The increase in product shipments was across the lubricant additives product lines, while the fuel additives product lines were essentially flat. Selling prices were also favorable when comparing the two third quarter periods. Partially offsetting these favorable impacts from higher product shipments and selling prices during the third quarter 2010, was an unfavorable foreign currency impact. The unfavorable foreign currency impact reflects the strengthening of the U.S. Dollar between the two third quarter periods versus the other currencies in which we conduct business.
Nine months petroleum additive net sales of $1,319.4 million was approximately 18% higher than nine months 2009 results of $1,116.7 million. Similar to the third quarter results, the increase between the two nine months periods reflects a 16% increase in product shipments. The increase in shipments was the predominant factor in the higher net sales between the two nine month periods and was across all product lines, but primarily in the lubricant additives product lines. Selling prices were also favorable for nine months 2010 as compared to nine months 2009. Foreign currency partially offset the favorable impacts of product shipments and selling prices resulting in an unfavorable impact when comparing nine months 2010 and nine months 2009.
While recovering in 2009 from the worldwide economic slowdown, product shipments were weaker than normal during the first half of 2009. We believe the overall demand for petroleum additive products has recovered from recessionary effects and are now at levels consistent with normal market demands.
The table below details the approximate components, in millions, of the increase between the two third quarter and nine months periods.
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Period ended September 30, 2009
Increase in shipments, including changes in product mix
Increase in selling prices, including changes in customer mix
Decrease due to foreign currency
Period ended September 30, 2010
Real Estate Development Segment
The revenue of $2.9 million for third quarter 2010 and $8.6 million for nine months 2010 for the real estate development segment represents the rental of the office building which was constructed by Foundry Park I. The building was completed in late 2009 and we began recognizing rental revenue in January 2010.
All Other
The “All other” category includes the operations of the TEL business and certain contract manufacturing that Ethyl provides to Afton and to third parties.
NewMarket evaluates the performance of the petroleum additives business and the real estate development business based on segment operating profit. NewMarket Services Corporation (NewMarket Services) departments and other expenses are charged to NewMarket and each subsidiary pursuant to service agreements between the companies. Depreciation on segment property, plant, and equipment, as well as amortization of segment intangible assets is included in segment operating profit.
The table below reports segment operating profit for the third quarter and nine months ended September 30, 2010 and September 30, 2009.
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The petroleum additives operating profit decreased $16.3 million when comparing third quarter 2010 to third quarter 2009 and increased $13.0 million when comparing nine months 2010 to nine months 2009. The operating profit margin was 17.2% for third quarter 2010 and 23.3% for third quarter 2009. The operating profit margins for the nine months periods were 17.2% for 2010 and 19.2% for 2009. When compared to 2009 operating profit levels, the third quarter 2010 results are lower across all product lines, while the nine months 2010 results are significantly higher across the lubricant additives product lines, but lower in the fuel additives product lines.
The higher operating profit margin during the third quarter 2009 resulted primarily from decreased raw material costs and a favorable foreign currency impact during the 2009 period. The operating profit margin for both third quarter 2010 and nine months 2010 reflects increased raw material costs, as well as an unfavorable foreign currency impact of approximately $3.0 million for the quarter period and a favorable currency impact of approximately $300 thousand for nine months 2010. For the third quarter 2010, as well as nine months 2010, increased product shipments and selling prices, as discussed in the Revenue section above, were significant favorable factors in the operating profit and operating profit margin when compared to the same 2009 periods. However, while overall product shipments have increased over 2009 levels, operating margins for 2010 have been unfavorably impacted by product mix reflected in the decrease of shipments of certain high margin products, as well as increased spending in our supply chain operations.
In response to the increase of raw material costs during 2010, we have been implementing selling price increases. Some of the pricing actions in 2010 have not yet been fully realized in our operating profit results, but should be during the fourth quarter 2010.
Finally, our selling, general, and administrative expenses (SG&A), together with research, development, and testing expenses (R&D), were approximately $7.5 million, or 16.9%, higher for third quarter 2010 as compared to third quarter 2009 and were approximately $22.1 million, or 17.1%, higher for nine months 2010 as compared to nine months 2009.
SG&A increased approximately $6.4 million or 27.8% for third quarter 2010 compared to third quarter 2009 and $17.7 million or 26.2% when comparing the two nine months periods. The increase for both third quarter 2010 and nine months 2010 was primarily the result of certain growth-related costs, largely reflecting the inclusion of the Polartech operations in 2010, as well as higher personnel-related costs and professional fees. R&D increased approximately $1.1 million, or 5.2%, for third quarter 2010 when compared to the same 2009 period. Nine months 2010 R&D was $4.4 million, or 7.2%, higher than nine months 2009. The increase in combined SG&A and R&D included an approximate $900 thousand favorable foreign currency impact for third quarter 2010 as compared to third quarter 2009 and a $1.6 million unfavorable impact when comparing the two nine months periods. We continue to invest in SG&A and R&D to support our customers’ programs and to develop the technology required to remain a leader in this industry.
Operating profit for the real estate development segment was $1.8 million for third quarter 2010 and $5.3 million for nine months 2010, compared to an operating loss of $200 thousand for third quarter 2009 and $500 thousand for nine months 2009. During 2009, the office building was under construction resulting in no rental revenue and limited non-capital expenses.
The following discussion references the Consolidated Financial Statements beginning on page 3 of this Quarterly Report on Form 10-Q.
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Interest and Financing Expenses
Interest and financing expenses were $4.5 million for third quarter 2010 and $2.9 million for third quarter 2009. Nine months 2010 amounted to $12.7 million, while nine months 2009 was $8.7 million.
The increase in interest and financing expenses between both the third quarter and nine months periods for 2010 and 2009 was primarily related to the mortgage loan on the Foundry Park I office building, as well as higher average outstanding debt on the revolving credit facility during 2010. Prior to obtaining the mortgage loan in January 2010, the interest and financing expenses for the construction phase of the office building were capitalized.
Other Expense, Net
Other expense, net for third quarter 2010 was $5.5 million, while third quarter 2009 was $3.8 million. The amount for nine months 2010 was $17.0 million, while nine months 2009 was $15.7 million. These amounts for both the 2010 and 2009 periods primarily represent a loss on a derivative instrument representing an interest rate swap recorded at fair value through profit and loss, which we entered into on June 25, 2009. See Note 10 for additional information on the interest rate swap.
Income Tax Expense
Income tax expense was $21.9 million for third quarter 2010 and $30.4 million for third quarter 2009. The effective tax rate was 32.3% for third quarter 2010 and 34.9% for third quarter 2009. The decrease in income before income tax expense resulted in a decrease of $6.8 million in income taxes, while the lower effective tax rate in 2010 as compared to 2009 resulted in a decrease of approximately $1.7 million in income taxes when comparing the third quarter 2010 and 2009 periods.
Nine months 2010 income tax expense was $62.8 million with an effective tax rate of 33.0%. Income tax expense for nine months 2009 was $60.4 million with an effective tax rate of 34.2%. The increase in income before income tax expense from 2009 to 2010 resulted in an increase of $4.8 million, which was partially offset by the reduction in the effective tax rate, resulting in a decrease in income tax expense of $2.4 million.
The effective tax rate for both the third quarter 2010 and nine months 2010 benefitted primarily from higher income in foreign jurisdictions with lower tax rates. In addition, the nine months 2010 tax rate also benefitted from a higher domestic manufacturing deduction in 2010.
Cash Flows, Financial Condition, and Liquidity
Cash and cash equivalents at September 30, 2010 were $50.3 million, which was a decrease of $101.5 million since December 31, 2009 and included a $1.0 million unfavorable impact from foreign currency translation.
We expect that cash from operations, together with borrowings available under our revolving credit facility, will continue to be sufficient to cover our operating expenses for the foreseeable future.
Cash Flows – Operating Activities
Cash flows provided from operating activities for the nine months 2010 were $104.9 million and included a decrease of $61.2 million due to higher working capital levels, including higher accounts receivable and inventories, partially offset by lower prepaid expenses and higher accounts payable. The increase in accounts receivable is primarily due to higher sales levels when
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comparing the third quarter 2010 with the fourth quarter 2009. The increase in inventories reflects increased quantities at certain locations to respond to demand for our products. The decrease in prepaid expenses reflects a reduction of deferred taxes on intercompany profit in inventory. The fluctuation in accounts payable is from normal differences in timing of payments. The changes in working capital also include the impact of Polartech since the acquisition.
Including cash and the current portion of long-term debt, we had working capital of $399.8 million at September 30, 2010 and $405.1 million at December 31, 2009. The current ratio was 2.98 to 1 at September 30, 2010 and 3.05 to 1 at December 31, 2009. In addition to the working capital factors discussed above, the change in the current portion of long-term debt of $30.8 million had a significant effect on working capital levels due to the refinancing of the construction loan in January 2010, resulting in a decrease in the amount of long-term debt being due within one year.
Cash Flows – Investing Activities
Cash used in investing activities was $85.5 million during nine months 2010 and included $41.3 million related to the acquisition of Polartech, as well as $25.1 million for capital expenditures and a net deposit of $16.6 million and a net settlement of $2.4 million related to the Goldman Sachs interest rate swap. Further information on the interest rate swap is discussed below and in Note 10. We estimate our total capital spending during 2010 will be approximately $30 million to $35 million. We expect to continue to finance capital spending through cash on hand and cash provided from operations, together with borrowing available under our revolving credit facility.
Cash Flows – Financing Activities
Cash used in financing activities during nine months 2010 amounted to $120.0 million, including the repayment of $99.1 million for the Foundry Park I construction loan and borrowing of $68.4 million for the Foundry Park I mortgage loan. We also borrowed $20.0 million under our revolving credit facility during the nine months 2010 and repaid $1.5 million on the mortgage loan. In addition, the use of cash included the repurchase of common stock of $89.0 million and funding of dividends of $16.4 million, as well as debt issuance costs of $1.5 million.
We had total long-term debt, including the current portion, of $237.3 million at September 30, 2010, representing a decrease of approximately $12.8 million in our total debt since December 31, 2009. The decrease resulted from borrowing $20.0 million under the revolving credit facility which was offset by the payment of the outstanding balance of $99.1 million under the construction loan agreement with proceeds of $68.4 million from the Foundry Park I mortgage loan agreement and cash on hand. We made principal payments of approximately $1.5 million on the mortgage loan, as well as $600 thousand on capital leases.
At September 30, 2010, in addition to the Foundry Park I mortgage loan and the revolving credit facility which are discussed below, we had outstanding senior notes in the aggregate principal amount of $150 million that bear interest at a fixed rate of 7.125% and are due in 2016.
At September 30, 2010, we also had a $150 million revolving credit facility for working capital and other general corporate purposes for NewMarket and our subsidiaries, inclusive of a $75 million sub-facility for letters of credit. Borrowings bear interest at variable rates. The facility matures on December 21, 2011. At September 30, 2010, we had $20.0 million of outstanding borrowings under the revolving credit facility. We had outstanding letters of credit of $8.8 million at September 30, 2010, resulting in the unused portion of the revolver amounting to $121.2 million.
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Both the senior notes and the revolving credit facility contain covenants, representations, and events of default that management considers typical of credit agreements of this nature. We were in compliance with all covenants under both the senior notes and the revolving credit facility as of both September 30, 2010 and December 31, 2009.
The more restrictive and significant of the covenants under the senior notes include a minimum fixed charge ratio of 2.00, as well as a limitation on restricted payments, as defined in the agreement. Our fixed charge coverage ratio was 18.93 at September 30, 2010 and 22.62 at December 31, 2009 under the senior notes. In addition, we would have been permitted to make additional restricted payments in the amount of approximately $67 million at September 30, 2010 and $84 million at December 31, 2009 under the senior notes.
The more restrictive and significant financial covenants under the revolving credit facility include:
Minimum consolidated net worth as defined in Section 6.3 of the revolving credit facility;
A minimum fixed charge coverage ratio of 1.15; and
A maximum leverage ratio of 3.50.
Our consolidated net worth, as defined, exceeded the minimum requirement under the revolving credit facility by approximately $61 million at September 30, 2010 and approximately $102 million at December 31, 2009. Also at September 30, 2010, the fixed charge coverage ratio was 5.58 and the leverage ratio was 0.84, while at December 31, 2009 the fixed charge coverage ratio was 5.43 and the leverage ratio was 0.91.
As a percentage of total capitalization (total debt and shareholders’ equity), our total debt percentage decreased from 35.3% at the end of 2009 to 33.1% at September 30, 2010. The change in the percentage was primarily the result of the decrease in debt, as well as increase in shareholders’ equity. The increase in shareholders’ equity reflects our earnings, partially offset by the impact of dividend payments and the repurchase of our common stock. Normally, we repay any outstanding long-term debt with cash from operations or refinancing activities.
Foundry Park I Mortgage Loan Agreement and Interest Rate Swap
On January 28, 2010, Foundry Park I entered into a mortgage loan agreement in the amount of $68.4 million. The loan, which is collateralized by the Foundry Park I office building, is for a period of five years, with two thirteen-month extension options. NewMarket Corporation is fully guaranteeing the loan. The mortgage loan bears interest at a variable rate of LIBOR plus a margin of 400 basis points, with a minimum LIBOR of 200 basis points. Concurrently with the closing of the mortgage loan, Foundry Park I obtained an interest rate swap to effectively convert the variable interest rate of the loan to a fixed interest rate by setting LIBOR at 2.642% for five years. The interest rate swap is discussed in Note 10. Principal payments on the loan are being made monthly based on a 15-year amortization schedule, with all remaining amounts due in five years, unless we exercise the extension option.
Interest Rate Lock Agreement and Goldman Sachs Interest Rate Swap
We financed the construction loan for the Foundry Park I project to construct an office building for MeadWestvaco Corporation through a group of banks. Prior to commencing construction, we took actions to identify the possible permanent lending source after construction. To that end, Foundry Park I entered into an Application with Principal dated February 26, 2007, which outlined the terms and conditions under which Principal would provide permanent, fixed-rate financing in the maximum amount of $116,000,000 amortized over 25 years with all amounts due 13.5 years after the date of the loan. The Application was not a loan commitment due to the then lengthy
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time period of thirty-four months until the completion of the building. In order to obtain a fixed-rate loan, we entered into a rate lock agreement with Principal dated February 26, 2007. Principal simultaneously entered into a hedge with a third party based mainly on the forward rates of ten-year Treasuries. We were not a party to that hedging agreement. Under the rate lock agreement, we agreed to post a deposit with Principal and to increase the amount of that deposit if the exposure to Principal on their hedge increased.
In June 2009, Principal and Foundry Park I determined that the loan terms set forth in the Application could not be syndicated based on then current market conditions. As a result, Principal and Foundry Park I terminated the loan application and related rate lock agreement and mutually released each other from their respective rights and obligations under those arrangements. See Note 10 for additional information on the termination of the rate lock agreement and subsequent entry into an interest rate swap with Goldman Sachs related to the Foundry Park I project. All amounts which we had deposited with Principal under the rate lock agreement have effectively been returned to us at the termination of the rate lock agreement as Principal transferred the deposited funds to Goldman Sachs as collateral for the interest rate swap related to the Foundry Park I project.
Other Matters
In March 2010, the Patient Protection and Affordable Care Act was signed into law, as was a related reconciliation bill. Included in the provisions of the laws are changes to the taxation related to the federal subsidy available to companies that provide retiree healthcare benefit plans that include a benefit that is at least actuarially equivalent to the benefits of Medicare Part D. Our retiree medical plan does include a drug subsidy benefit that is actuarially equivalent to Medicare Part D. However, we are not impacted by the changes in the taxation of the federal subsidy, as we assigned the subsidy to our insurance provider several years ago in consideration of premium determination. At the time we assigned the benefit to our insurance provider, we adjusted our deferred taxes accordingly. We are currently evaluating the provisions of the law and its impact on our company, but have made no adjustments to our financial statements as a result of the legislation.
Critical Accounting Policies
This report, as well as the 2009 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 financial statements fairly represent the financial position and operating results of our company in all material respects. 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.
Intangibles (Net of Amortization) and Goodwill
We have certain identifiable intangibles, as well as goodwill, amounting to $48.7 million at September 30, 2010. This amount includes approximately $9.9 million related to the Polartech acquisition earlier in 2010. These intangibles relate to our petroleum additives business and, except for the goodwill, are being amortized over periods with up to approximately twenty years of remaining life. We continue to assess the market related to these intangibles, as well as their specific values, and have concluded the values and amortization periods are appropriate. We also evaluate these intangibles for any potential impairment when significant events or circumstances occur that might impair the value of these assets. These evaluations continue to support the value at which these identifiable intangibles are carried on our financial statements. However, if conditions were to substantially deteriorate in this market, it could possibly cause a reduction in
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the periods of the amortization charge or result in a noncash write-off of a portion of the intangibles’ carrying value. A reduction in the amortization period would have no effect on cash flows. We do not anticipate such a change in the market conditions.
Environmental and Legal Proceedings
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.
While it is not possible to predict or determine with certainty the outcome of any legal proceeding, it is our opinion, based on our current knowledge, 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.
Pension Plans and Other Postretirement Benefits
We use 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 on plan assets, rate of compensation increase, and health care cost trend rate. A change in any one of these assumptions could result in different results for the plans. We develop these assumptions after considering available information that we deem relevant. Information is provided on the pension and postretirement plans in Note 20 of the 2009 Annual Report. In addition, further disclosure on the effect of changes in these assumptions is provided in the “Financial Position and Liquidity” section of Part II, Item 7 of the 2009 Annual Report.
Income Taxes
We file consolidated U.S. federal income and both consolidated and individual state income tax returns, as well as individual foreign income tax returns, under which assumptions may be made to determine the deductibility of certain costs. We make estimates related to the impact of tax positions taken on our financial statements when we believe the tax position is more likely than not to be upheld on audit. In addition, we make certain assumptions in the determination of the estimated future recovery of deferred tax assets.
Recently Issued Accounting Pronouncements
For a full discussion of the more significant pronouncements which may impact our financial statements, see Note 14.
Outlook
We are very pleased with the performance of our businesses during the first nine months of 2010. We began the year with solid results built upon a diverse product offering, customer base, and geographical presence. Our margins are good, and we continue to demonstrate our ability to adjust our prices to compensate for increases in raw material costs. We believe the overall demand for petroleum additive products has recovered from recessionary effects and are now at levels consistent with normal market demands. Our technology is strong, and we are well-positioned to help our customers transition to GF-5, the new passenger car motor oil specification that is being introduced in North America. Our project to expand our supply chain capabilities in the Far East has progressed well, and we are now shipping product from this location. We expect to continue to perform well in the fourth quarter, subject to the normal fluctuations associated with this business.
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While we are integrating Polartech into our business this year, we continue to have acquisitions as the highest priority for the use of our cash and borrowing capacity. Our primary focus for acquisitions remains in the petroleum additives industry, as we believe this will have the highest probability for success. Within petroleum additives, industrial lubricant additives and fuel additives are our main focus. We will also continue to evaluate alternative uses of our cash to enhance shareholder value, including stock repurchases and dividends.
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Other than obtaining a mortgage loan and the entry into a related interest rate swap, there have been no significant changes in our market risk from the information provided in the 2009 Annual Report.
On January 28, 2010, Foundry Park I entered into a mortgage loan agreement in the amount of $68.4 million, which bears interest at a variable rate of LIBOR plus a margin of 400 basis points. Concurrently with the closing of the mortgage loan, Foundry Park I obtained an interest rate swap to effectively convert the variable interest rate of the loan to a fixed interest rate by setting LIBOR at 2.642% for five years. Accordingly, in combination, there is no interest rate risk associated with the mortgage loan and related interest rate swap, other than the change in the value of the interest rate swap due to changes in the yield curve. Any change in fair value is recognized immediately in accumulated other comprehensive income, to the degree of effectiveness of the swap. With other variables held constant, a hypothetical 50 basis point adverse parallel shift in the LIBOR yield curve would have resulted in an increase of approximately $1.3 million in the fair value liability of the mortgage loan interest rate swap at September 30, 2010.
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 (the committee), which is made up of the president of Afton, the general counsel of NewMarket, and the 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
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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 September 30, 2010, 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. Some of these legal proceedings relate to environmental matters and involve governmental authorities. For further information, see “Environmental” in Part I, Item 1 of our 2009 Annual Report and Note 9 in this Form 10-Q.
On July 23, 2010, Afton Chemical Corporation and NewMarket Corporation filed a complaint in Federal District Court in Richmond, Virginia against Innospec Inc. (Innospec). The complaint alleges that Innospec violated the Robinson-Patman Act, the Sherman Act, the Virginia Antitrust Act and Virginia Business Conspiracy Act based on the disclosures that Innospec recently made in its plea agreements with the U.S. Department of Justice and the Securities and Exchange Commission, as well as the UK Serious Fraud Office. In those agreements, Innospec pled guilty to violating the Foreign Corrupt Practices Act by bribing government officials in Iraq and Indonesia. Innospec paid the bribes to secure the sale of its product and to exclude NewMarket’s product in Iraq and Indonesia. Afton Chemical Corporation and NewMarket Corporation are seeking treble damages, all reasonable attorneys’ fees, expenses, and costs for injuries sustained as a result of these bribes.
On July 31, 2008, our Board of Directors approved a share repurchase program that authorized management to repurchase up to $100 million of NewMarket Corporation’s outstanding common stock until December 31, 2010, as market conditions warrant and covenants under our existing agreements permitted. We could conduct the share repurchases in the open market and in privately negotiated transactions. The repurchase program did not require NewMarket to acquire any specific number of shares and could be terminated or suspended at any time. The 2008 repurchase program was terminated on July 21, 2010.
Also, on July 21, 2010, our Board of Directors approved a new share repurchase program authorizing management to repurchase up to $200 million of NewMarket Corporation’s outstanding common stock until December 31, 2012, as market conditions warrant and covenants under our existing agreements permit. We may conduct the share repurchases in the open market and in privately negotiated transactions. The repurchase program does not require NewMarket to acquire any specific number of shares and may be terminated or suspended at any time. Approximately $190 million remained available under the 2010 authorization at September 30, 2010. The following table outlines the purchases during the third quarter 2010 under this authorization.
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ISSUER PURCHASES OF EQUITY SECURITIES
Period
July 1 to July 31
August 1 to August 31
September 1 to September 30
Total
Exhibit 3.1
Exhibit 3.2
Exhibit 31(a)
Exhibit 31(b)
Exhibit 32(a)
Exhibit 32(b)
Exhibit 101
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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.
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EXHIBIT INDEX
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