Enpro Inc (NPO) 2004 Q2 法說會逐字稿

Good day and welcome to this EnPro Industries second-quarter 2004 financial results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Don Washington.

Good morning, everyone, and welcome to EnPro Industries second-quarter 2004 earnings conference call. Hosting the call today is our President and CEO, Ernie Schaub. Also joining Ernie are Bill Dries, our CFO, and Rick Magee, our General Counsel, who are both prepared to participate in the Q&A session.

In just a moment, Ernie will make his remarks and then we'll open the lines for your questions, but first I would like to remind you that you may hear statements during in the course of this call that express belief, expectation or intention, as well as those that are not historical fact. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements. These risks and uncertainties are referenced in the safe harbor statement included in our press release and are described in more detail, along with other risk and uncertainties, in our filings with the SEC, including the Form 10-K for the year ended December 31, 2003 and the Form 10-Q for the quarter ended March 31, 2004.

We do not undertake to update any forward-looking statement made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based. I will remind you that this call is being Webcast on enproindustries.com, and a replay will be available by telephone and on the Website. Dialing information for the telephone replay is available in our earnings release.

I would also like to remind you that we will be at the Baird Small Cap conference in New York tomorrow, and that presentation will be Webcast. You can access the Webcast from our Website, enproindustries.com. Our presentation will begin at 10:00 AM Eastern time.

We've set aside about an hour this morning for the call. If your questions are not answered, if you have follow-up questions or if you need a copy of the release, please contact me after the call at 704-731-1527. And now I'll turn the call over to Ernie.

Thank you, John, and good morning, everyone. We have had quite a few positive developments since our last conference call, including the settlement of our dispute with Equitas, a couple of strategic divestitures, and another quarter of good operating results. Before we get into these and other events, I would like to address our asbestos claims and the statement in our earnings release about asbestos accruals.

The trend in asbestos claims is very encouraging because the number of new claims continues to decline. We received about 3500 claims in the second quarter, which was the lowest quarterly number since before 1990. On a trailing 12-month basis, new claims were about 23,000, compared the over 40,000 new claims received in both 2002 and 2003. Obviously, we are very encouraged by this trend and we remain optimistic that serious disease cases are in decline. But we continue to deal with a large number of cases that do not involve a recognizable disease, so the future remains uncertain.

We will continue to work hard to minimize the effects of claims on our cash flow, but it is clear to us that the federal legislation is the most appropriate way to effectively reform our system for handling and resolving asbestos claims in the United States. The bipartisan discussions in Washington give us hope that federal reform may yet occur. Although there are a number of open issues to be resolved, we believe the prospects for a compromise have improved tremendously over the past couple of months. We also note the positive trend of reform in various states, most recently in Ohio.

As we mentioned our press release, we are revising our accounting for asbestos claims. Until now, we have recorded a liability only for settled claims or claims that are far enough along in the system that we can reasonably estimate a value for them. We have held this position consistently, and we continue to believe that other claims are very difficult to accurately quantify.

However, recent developments have led us to reconsider our position. These developments include the fact that many other companies with potential asbestos liabilities have made estimates of their future claims; the fact that conduct (ph) letters from the SEC -- the SEC has provided to other companies requesting them to make an estimate for future claims; and finally an attempt by many people to estimate future claims in connection with the potential legislation I talked about.

None of these developments are a threat to our strategy or our recent success at managing asbestos claims, but they do lead us to conclude that we should renew our efforts to make a reasonable estimate of the liability for future claims. In our financial statements for the second quarter, we will include an estimated liability for all asbestos claims already filed, as well as those claims that we estimate will be asserted over some period in the future. This estimate is not expected to exceed the solvent insurance we have available for asbestos claims, and as a result, we will record a liability for these potential claims and a corresponding receivable from our insurance carriers. But there will be no impact on our results or our operations.

Our estimate is not fully complete, so we didn't include the balance sheet with our earnings release. However, we expect to file our 10-Q, including a full balance sheet that reflects our estimate, by next Monday. We will periodically review our estimate and adjust it if it is necessary. If in the future our estimate exceeds the amount of solvent insurance available, the excess will be charged to earnings.

I want to point out to you that this revision will have no impact on the ultimate amount paid for asbestos-related claims against our subsidiaries, nor does it change our strategy for managing the settlement of asbestos claims. For us, it continues to be a matter of working to keep our settlement commitments to a level below our annual insurance recoveries in order to minimize the impact on overall cash flows. We have been successful in this strategy over the past two years and we do not intend to stray from it.

We think it is important for you to know about this decision, because we have always tried to be as straightforward as possible in our disclosure about asbestos claims and our strategy for managing them. We do not intend to change our practice and we want to emphasize that the Company's current health and future prospects are in no way affected by this decision.

Now let's talk about our business in the second quarter. As we said in our first-quarter conference call, we expect the first two quarters of 2004 to be very similar. Business picked up nicely early in the year, and because it was so strong in the first quarter, we did not see the kind of sequential improvements that we sometimes see between first and second quarters.

Segment results in the quarter improved over the second quarter of last year, which was the strongest quarter of last year. Sales were up 9 percent, including 2 percent from foreign exchange, and segment profits were up 11 percent, including 1 percent from foreign exchange. The improvement in profits is after incurring more than $2 million in expenses related to our operating initiatives, primarily the relocation France Compressor Products from Newtown, Pennsylvania to Houston.

Earnings per share were 40 cents in the second quarter, including 9 cents in losses, primarily on asset sales and reductions in the market value of our Goodrich call options. Last year, if you recall, we earned 56 cents a share in the second quarter, but that included 8 cents of gains, primarily on increases in the market value of Goodrich's call options at that time and income from some tax settlements.

The bottom line is that we are off to a strong start in the first half of 2004. We are well ahead of where we were a year ago, and we are well on our way to improving our operational performance over our performance in 2003. As is typical in our business, the second half of the year will probably be weaker than the first half of the year, when activity is at a peak, but we continue to expect our operations to do better this year than they did last year.

In that light, we expect a significant increase in diesel engine sales in the second half of the year. Higher engine sales combined with the normal seasonal slowdown of our industrial markets will result in lower margin mix of businesses in the last six months of 2004, and so our results are not likely to be as strong as they were in the first half of the year.

Looking at the performance of our segments in the first half of the year, almost all of our businesses benefited from increased demand and higher volumes. In the Sealing Products segment, Stemco's heavy-duty truck markets have been very strong all year long. In the second quarter, sales and profits improved from a year ago, reflecting not only strong original equipment sales, as production of both tractors and trailers increased, but also increased aftermarket activity and market share gains.

Sales and profits at Garlock Sealing Technologies benefited from foreign exchange and the addition of Pikotek, which was acquired in the fourth quarter of 2003. Garlock also benefited from increased orders of sealing products into the steel industry as steel output increased. However, the recovery in chemical and petrochemical industries, which make up Garlock's largest markets, has lagged behind other industries, and that market remains soft by historical comparisons, especially as the U.S. customer base shifts to Asia.

Our Engineered Products segment benefited from improvements on a broad number of industries. Increased demand for bearings in automotive and most industrial markets, both in the U.S. and Europe, benefited GGB. Both sales and profits improved there, although profits were reduced somewhat by higher raw material costs.

Quincy Compressor also benefited from broad-based improvements in industrial markets, which led to higher sales of products across all of its lines of air compressors. These higher sales at Quincy led to higher profits as well.

The relocation of France Compressor Products to Houston from Pennsylvania reduced segment profits by over $2 million, reflecting expenses associated with the relocation. This relocation will move France Compressor closer to their oil and gas customer base and into a lower-cost area. We continue to remain optimistic in our outlook for France Compressor Products as their main markets, oil and gas, have seen prices rise and output is high.

At Fairbanks Morse Engine, we had lower sales and profits in the quarter. This decrease was driven by two factors. First, the service business has declined because the war effort has kept the Navy fleet at sea and repairs and overhauls have been delayed. Second, we shipped fewer engines in the second quarter of 2004 than we shipped the year ago. We had expected higher engine shipments in the quarter, but we encountered some difficulties in production and testing of a new type of engine, and some shipments were therefore delayed. However, we expect the shipments to be back on track by the end of the year. You may have seen in our announcement yesterday of a new Navy contract with Fairbanks Morse. This contract underscores the strength of Fairbanks Morse's backlog of work for the Navy.

All of our operations experienced the effect of higher raw materials and energy costs in the quarter. Higher steel prices are not all that bad, however, because they led to increased output of steel and higher sales of Garlock's Klozure seals into the steel industry. But other units have been on the other side of increased prices for energy, steel, and other raw materials. We have been able to offset some of the higher costs with price increases and our operating initiatives, but overall, raw material costs have been a negative for us.

Operating activities used about $12 million in cash in the first half of the year, as markets improved and working capital increased. Capital spending was almost $14 million in the first half of the year, or about twice what we spent in the first half of 2003. We expect spending will continue at a higher pace for the rest of the year and be about double the $20 million we spent in 2003.

First half cash flow was also impacted by a dispute regarding payment terms of some of our insurance carriers over documentation requirements and standards. This dispute caused the latest receipt (ph) of insurance recoveries. But as we announced earlier in the month, we resolved the dispute with Equitas and we will receive $30 million in delayed insurance reimbursements in the third quarter as part of a $118 million settlement.

The $30 million payment puts us back in position to reduce net cash flows for asbestos settlements below the level of 2003, depending on the outcome of our continued dispute with the other London carriers.

The balance of the Equitas settlement will be placed in a trust that will be used to resolve future claims that would have been made against coverage provided by Equitas. The trust will be administered by an independent third party. We're very pleased with this outcome because it brings us up-to-date on reimbursements from Equitas and because the establishment of the trust removes Equitas insolvency risk potential.

As I mentioned, the settlement does not resolve all of our disputes with our insurers. We are continuing our arbitration case with the other London carriers. We expect a favorable resolution in the dispute, but the arbitration has been delayed by the settlements with Equitas and could extend into the first quarter of next year. If the dispute is resolved this year and we are successful in collecting reimbursements from those insurers, net cash outflows for asbestos claims in 2004 should decrease from levels in 2003.

Now let's look at some of the other activities of the quarter. As I mentioned, we completed the sale of our tool and die business in two transactions, one of which closed in June and the other which closed in July. Both transactions, however, affected the second quarter, resulting in a loss, as I mentioned.

We will continue to pursue divestitures like these, which means we will keep looking for buyers of businesses that don't fit with our strategic vision. At the same time, we will keep looking for acquisitions like Pikotek that improve our core strengths, especially in the sealing and bearings business.

As a result the sale of the tool and die business, margins should improve, because we end up with a stronger mix of businesses. The tool and die businesses were included in our Engineered Products segment, and their margins were several points below the overall segment margin.

This divestiture and last year's acquisition of Pikotek make a good illustration of our overall strategy for improving the mix of businesses. The non-core tool and die business is one where we were not likely to add any value. It did not fit our skill set. It operated in a very fracted market and it was too small to merit any substantial investment on our part. On the other hand, Pikotek sales are lower, but they bring a substantially higher contribution to profit and profit margins. As a business, it is very complementary to our existing sealing business and has excellent potential to grow in importance as part of our Company.

On the international front, Quincy Compressor facility in Kunshan, China shipped its first compressors in June to a customer in Thailand. We are planning a grand opening of the facility next month. This plant will assemble compressors for China and Asian markets.

Construction on the GGB facility in (indiscernible), Slovakia is progressing very well, and we expect operations at that facility to start up late in the fourth quarter of this year, so that too is on track.

Before I close, I want to reiterate that we expect 2004 to be a better year that 2003, but as diesel engine sales increase in the second half of the year and as our industrial markets come off of their first-half peaks, the mix of businesses will be weaker and results are not likely to be as strong as they were in the first half. Also, I want to remind you that they will be no cash charges and no change in the way we manage the settlement of asbestos claims as a result of our revising our accounting for these asbestos claims. Thanks for your attention, and now we will open the line for questions.

(OPERATOR INSTRUCTIONS) Greg Macosko with Lord Abbett.

I just wanted to understand the costs and the different things that are in the quarter and your statement about the second half of the year. You had some restructuring charges, I know, in the businesses. And so if we adjust for those restructuring charges and also for the other charges that you mentioned at the top of the release, is that what you are comparing the first half -- is that the basis of comparison first half versus the second half?

I'm not sure I fully understand the question.

I believe in the release, you have a $2.6 million or so restructuring charge there.

Right, okay.

That I believe --

Is that 2.6? Yes. Okay.

And that is separate from the losses that you had from the tool and die business as well as the Goodrich options, right?

Bill, why don't -- you want to --? Most of that is associated with the relocation from Newtown to Houston.

We anticipate, as we typically experience each year, a drop-off in activity during the second half of the year. So to the extent that our activity levels will be down. Also there is a change in the mix of businesses, as well, as Ernie alluded to during the course of this talk, but we have a higher mix of engine shipments in the second half.

And we will also have higher restructuring charges in the second half. Not only will we conclude the relocation -- the FCP relocation that Ernie described, but we will also be gearing up and be finalizing the consolidation of our GGB operations in Europe as well, so we would expect those charges to be higher in the second half.

So, in other words, in the second half, they will be more than the 2.6 that you identify there.

Well, the 2.6 was just Q2. For the first half, we had just a shade over 3 million, and yes, we anticipate charges in the second half higher than the 3 million.

I should point out to you, Greg, that this was part of our plan and we said last year that we expected this to happen this year as part of our capital expenditures and part of our expansion plans in these businesses.

We have indicated that we expect overall restructuring charges for the year to be somewhere between 8 to 9 million.

Okay, so it is coming in a little bit less than you expected? (multiple speakers)

It should be (multiple speakers) year.

Coming in at 8 to 9, and we are not coming off of that. We have incurred 3 million in the first half. The balance will be incurred in the second half.

I see. So it is going to be higher in the second half. And with respect to -- but if we adjust for those charges -- and I understand that they're going forward -- even so, what kind of a hit was the cost for additional commodity costs?

You're saying raw material increases.

Raw materials and commodities, yes -- I'm sorry.

Bill may have a better number, but let me tell you that across the board -- it wasn't an across-the-board issue. Some of our divisions don't use much steel, but they use more PTFE; and as I noted to you, our PTFE, we're in pretty good shape on. Ernie. Steel prices will vary division by division. But overall year-to-date, we've seen prices increase by about 88 percent. But again, it depends on the amount of steel that we have in each of our commodity businesses and how much we have longer-term contracts, even with steel people. So I can't give you an overall -- do have an overall, Bill (multiple speakers)?

By and large, I think that the increase in raw material costs from the first half unanticipated were probably in the neighborhood of $1 million. We were able, as Ernie said, to offset some of that, one through some operational improvements, but also we were able to get some pricing, not able to recover all of it.

We do anticipate the second half, though -- again, there was a recent runup in price increases announced by steel mills in the early part of July, so we would expect further increases in the second half of the year of roughly the same magnitude or maybe a little more. Again, in some cases, we will be successful in recovering those prices, but not in all cases.

Have you implemented surcharges at this point?

Some of our businesses have incurred some and some have just put it into pricing.

And you will continue to do that? Can you give me the specifics on that, how those surcharges are implemented?

Again, it varies business by business. One of our divisions, for example, just announced a price increase effective August 1, and some I know were effective July 1. They're going to be all over the board and they're not going to be on every single product, as you might imagine.

But we're talking about price increases, not surcharges?

Yes, that's right.

Okay, I will get back in line.

Farukh Farooqi of Jefferies & Company.

Good morning. I just want to go back to this issue of charges and what the ongoing EPS was in the quarter. If I look at the three items that you outline in your earnings, you have restructuring charges of 2.6 million. And arguably, you're moving facilities, so that is a sort of a onetime item or onetime type item. Then you had a loss of 3.3 million on the sale and then you had mark-to-market of 1 million. That adds up to 6.9 million pretax. If I after-tax it at, say, a 36 percent tax rate, that is 4.4 million, for an add-back of 21 cents.

So you reported 40 cents. If I were to add back these three items, I am coming up with 61 cents. And I just want to hear you comment on that -- whether you agree with that or not.

I'll comment. The restructuring charges, we do not add those back. We do not treat them or consider them to be -- you, Farukh, as well as I know that lots of companies have been criticized roundly for adding back these "onetime restructuring charges." We don't do that. Restructuring charges are a part of life. We think they'll be higher this year than -- they clearly are higher this year than they have been, and we would not expect this level; but we do not add those back. I don't dispute any of the numbers you have mentioned, but we do not consider that to be something we add back for purposes of coming up with a "normalized" earnings number.

Okay, that is admirable. But I just want to make sure that I am looking at this properly. The second question I had was -- actually let me ask you -- I have two more questions. One, could you quantify the impact of Pikotek to the quarter? And second, can you give us some color on what you saw in Europe in terms of your operations?

Pikotek was very small. I don't think it amounted to a penny maybe (multiple speakers).

I think the overall swing may be close to a penny, but not just Pikotek.

And your second question was the overall situation in Europe?

We see European markets, as I guess everybody else does, as slowing down overall. We have two primary businesses in Europe, Sealing and GGB bearings. Sealing has been a little bit mixed. We have seen the UK pick up a little bit, but we've seen Germany and France kind of be slow. With our bearings business, however, we have been very successful in Europe. Despite the slowdown, our business has been very strong. And that is due to some of the initiatives that we identified a couple of years ago in terms of getting new products out and in terms of getting into new market areas. We have been aggressively pursuing new market opportunities for our bearings business and we have been successful in doing that, and we have a lot of new applications. We've been very pleased there.

Thank you.

(OPERATOR INSTRUCTIONS) Seaver Wang with Sidoti & Company.

I just had a follow-up to the restructuring/new facility line. Can you give us an idea of what we can expect for '05 in terms of restructuring/new facility costs?

We haven't built an '05 budget yet, to be honest with you. But I can tell you what our plans might be to some extent. We don't plan the magnitude of the things that you've seen. As Bill said, this year was unusually high in terms of restructuring costs. But I can tell you that our plan is to continue our efforts growing in China, and in '05, we may see something either with bearings or sealing moving into China.

And the same thing in Europe. We expect to see some sealing operation -- do some introductory processing in Europe. So each of those will not be a new plant per se, or the magnitude of what we have seen this year, but there will be some continued efforts doing those types of things.

With the new facilities in China and Slovakia, is it going to hurt margins in the ramp-up of production for those products?

I don't think it would hurt margins. I think initially you might see some added costs as we put a little inventory in these places and things of that nature. But overall, they should improve margins. Clearly, that is the intent. Both of those are lower-cost areas serving markets that are growing faster than the rest of the European or U.S. markets.

Okay, thank you.

There are no further questions at this time. I would like to turn the call back over to the speakers for any additional or closing comments.

All right. We thank you all for joining us this morning. And again, if you have any further questions or want more information, please give me a call at 704-731-1527. And I'll also remind you again that we will be in New York tomorrow for the Baird conference, presenting at 10:00, and you can access that presentation on our Website. Thank you very much.

This concludes today's conference call. Thank you for your participation. You may now disconnect.