Enpro Inc (NPO) 2005 Q1 法說會逐字稿

Good day and welcome to this EnPro Industries first quarter 2005 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. Please go ahead, sir.

Good morning, everyone, and welcome to EnPro Industries' quarterly earnings conference call. This morning Ernie Schaub, our President and CEO, will discuss earnings for the first quarter of this year. As usual, we also have Bill Dries, our CFO, and Rick Magee, our General Counsel, present and prepared to participate in the Q&A. In just a minute Ernie will make his remarks and then we will open the lines for your questions.

First I need to remind you that you may hear statements during the course of this call that express the belief, expectation or intention (technical difficulty) 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 described in more detail along with other risks and uncertainties in our filings with the SEC, including the 10-K for the year ended December 31, 2004, and the 10-Q for the quarter ended March 31, 2005, which was filed yesterday afternoon.

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 changes in assumptions or circumstances on which such statements are based. This call is being web cast on enpproindustries.com, and a replay will be available by telephone and on the website. Dialing information for the replay is available in the release, the earnings release. If your questions aren't answered on the call or if you have follow-up questions, please feel free to contact me at 704-731-1527. And now I will turn the call over to Ernie.

Thank you, Don, and morning everyone. Thanks for joining us today to hear about our earnings for the first quarter of 2005. Let me start by saying that even though our overall results were reduced by a loss on U.S. Navy programs on Engine Products and Services, we were very pleased with the performance of our Sealing Products and Engineered Products businesses in the quarter. Because our industrial markets were strong and our operating initiatives have been effective, both Sealing Products and Engineered Products segments reported very good quarters. Our earnings for the quarter were $10 million, or $0.47 a share. Compared to the same period last year, earnings declined by $1.4 million or $0.07 a share. But earnings in 2005 were reduced by about $0.09 a share, primarily as a result of the loss provisions recorded in the engine products and service segment. Earnings in 2004 were increased by about $0.04 a share by an asset sale. The table clarifying these items is attached to our earnings release.

Both Sealing Products and Engineered Products segments reported increased sales compared to last year, and on the higher sales they produced significantly higher profits than the year ago. Together these segments produced profits of about $31 million on sales of $192 million, a profit margin of over 16%. The loss of Fairbanks Morse lowered our total segment margins, but even so, they were nearly 14%. So we are clearly on track toward our objective of bringing our overall returns on sales into the midteens.

The loss provisions of Fairbanks Morse Engine came on orders we received in the quarter, but on quotes which were based -- the quotes on which they were based were made as far back as 2001. The fluctuation in foreign exchange rates and performance issues that we discussed in the third quarter last year also affected these orders. I want to emphasize, however, that with these losses we have now recognized all known losses on all open quotations and contracts at Fairbanks Morse.

Looking at sales for the first quarter, they were $212 million, down about $1.3 million or 1% below the first quarter of 2004. Foreign exchange added about 1% to sales, so if you adjusted for the foreign exchange sales were down about 2%. We had over $13 million of sales last year that weren't repeated this year. So flat sales don't really reflect the level of activity in many of our important markets in the first quarter of the year. The total of sales that didn't repeat came from two areas. First, the diesel engine shipments at Fairbanks Morse was substantially below the first quarter of last year. Sales in the Engine Products and Services segment declined by about $8 million.

Because these engines are primarily associated with U.S. Navy shipbuilding program, the sales don't relate to overall market conditions in our industrial markets. Secondly, we sold our tool and dye business in midyear 2004 as part of our strategic effort to lower -- to exit lower margin businesses. Those businesses contributed $5.3 million to sales in 2004 and they were not repeated this year. So you can see we were able to make up ground in other areas, and I will explain this as we look more closely at the performance of the businesses in the first quarter. Looking at the Sealing Products segment, sales were up about $5 million or 5% from the first quarter 2004 to just over $100 million. 1% of the improvement came from foreign exchange and except for Garlock Sealing Technologies, sales were higher at all operations in the segments.

Garlock's U.S. industrial markets were generally strong in the quarter, but sales in the U.S. were below last year reflecting the discontinuation of several unprofitable product lines at Garlock. European sales at Garlock were up slightly, although the improvement really came from foreign -- favorable foreign exchange rates. The combination of these factors reduced Garlock sales by about 1% overall. Stemco also benefited from active markets in the first quarter and sales were up over 10%. The heavy-duty truck and trailer market in the United States continues to grow. Because Stemco is a leader in this market, the conditions helped them report their sixth consecutive quarter of year-over-year, double-digit sales increases.

These strong markets also helped to increase sales at the two smaller units in the segment, Plastomer Technologies, and Garlock Rubber Technologies, both which reported sales increases around 20% compared to the first quarter 2004. The $5 million increase in Sealing Products segment sales contributed to a $2.3 million increase in segment profits, a 15% improvement over last year. Margins in the segment improved by 1.5 percentage points compared to last year, reaching 18%. Although sales at Garlock were down slightly, profits there improved by over 15% and profit margins were the highest in several years.

A number of factors including increased sales of higher margin products, the discontinuation of the lower margin products I talked about, and better pricing in the United States all contributed to this improvement. At Plastomer Technologies and Garlock Rubber Technologies, profits were up substantially as those businesses benefited from sales of more profitable products, pricing improvements and cost reductions associated with our TCV lean manufacturing program. Profitability at Stemco remains high, but profits and margins in the first quarter were basically flat with levels of last year because of the higher percentage of sales to original equipment markets, and they created a less profitable overall product mix.

Looking at the Engineered Products segment, sales were up about 2%, the increase is the result of foreign exchange, but the comparison also includes the $5.3 million that the tool and dye businesses contributed to sales last year. If the comparisons were adjusted for those sales, the increase in the Engineered Products segment would be similar to the 5% increase we saw on the Sealing Products segment. The most substantial sales growth in the segment came at Quincy Compressor where the year-over-year improvement was about 15%. Volumes from Quincy's industrial markets in the United States improved significantly and the business' sales also benefited from price improvements.

GGB and France Compressor Products each reported a sales increase in the 5% range. Both operations benefited primarily from the stronger euro, but GGB also benefited from the stronger U.S. industrial markets and from penetrating new segments of its automotive and industrial markets by expanding applications for its bearings. Profits in the segment improved by just under $2 million or about 15%, and margins improved to 14.4% compared to 12.8% last year. The tool and dye businesses contributed less than half of $1 million to last year's segment profits. Looking at Quincy, their profits more than doubled and they reported a substantial increase in profit margins and benefited from higher volumes, and price improvements.

GGB benefited from improved performance of its U.S. operations and the stronger euro, but higher material costs somewhat offset the benefits. Profits were up only slightly over last year and margins declined slightly. Profits and profit margins improved the France Compressor Products reflecting a stronger euro, sales of higher margin products, price improvement, and lower restructuring costs. In the Engine Products and Services segment, sales were almost $21 million, down the $8 million I mentioned earlier or 28% compared to the first quarter last year. The decline is the result of fewer engine shipments to the U.S. Navy programs in the first quarter of 2005 compared to the first quarter of 2004.

As we have noted before, engine sales are recognized when an engine is shipped and shipments are irregular because they are based on requirements of the customer, typically a shipyard working under a U.S. Navy contract. This segment reported a loss of $2 million, including $3.5 million of loss provisions associated with the new engine orders for U.S. Navy shipbuilding programs in the future. These engines will be shipped at various times over the next three years, with the first of them going out later this year. I should point out that there is some opportunity to reduce the scope of these loss provisions over time, since shipments of these engines extend so far into the future.

In addition, one of the engines is associated with a prototype ship that the Navy has commissioned. If the prototype is successful and put into production, Fairbanks Morse's participation in the program could lead to a long series of what we expect to be profitable engine orders. Fairbanks Morse benefited from the more profitable mix of parts and service work compared to the first quarter of 2004. So except for the loss provision, profits in the first quarter would have been about the same as they were last year when they were $1.6 million.

The new engine orders were received after the first of the year but they relate to bids associated with open quotations made under previous bidding practices. I want to repeat the point that we made last fall. Stringent review and control procedures will ensure all future contracts are bid at acceptable levels of profitability and mitigate the effective of fluctuations in foreign exchange and changes in costs, between bid and award. Also, I want to reiterate that with these losses we have now recognized all known losses on all open bids and contracts for U.S. Navy programs.

Let's look now at cash flows. Operating activities used about $2 million in the first quarter compared to about $16 million in the first quarter last year. The year-over-year change reflects our receipt of $22 million in past due insurance reimbursements during the first quarter of 2005. Working capital increased to about $30 million which is typical as activities increased in the first half of the year. Capital expenditures were about $5 million in the first quarter, slightly below the first quarter of 2004. However we believe we remain on track to keep capital expenditures between 35 and $40 million this year.

Our cash balances declined to $66 million from the $108 million at the end of 2004, primarily because we were required to use $35 million as collateral for bonds while two verdicts against Garlock Sealing Technologies are under appeal. We continue to be confident that Garlock will prevail in these appeals, but in the meantime these funds are classified as restricted cash on our balance sheet. Net cash outflow for asbestos claims and expenses was about $2 million in the compared to about 22 million -- $20 million in the first quarter of 2004. The decrease reflects the $22 million insurance payment that I mentioned previously.

Let's look at asbestos claims now. They continue to come in at relatively low levels as they did in the preceding six quarters. Garlock received about 6,200 new claims in the quarter, compared to 8,400 in the first quarter of 2004. We believe one factor in the lower rate of new claims is declining incidences of diseases. But other factors include the positive effect of tort reform in certain states, steps taken by courts to limit claims by people with no discernible disease, and previous efforts by plaintiffs to file cases ahead of potential federal reform.

As you may know, the Senate Judiciary Committee is holding a markup session on the Fair Act today. We are encouraged by the bipartisan efforts of that reform, and we hope the committee will see fit to approve this legislation and submit it to the entire Senate. Clearly legislation will be a benefit to us and we support the bill as it is currently drafted. We are confident that the diminishing number of claims combined with effectiveness of our settlement strategy, will continue to minimize the effect of asbestos settlements on our cash flows. Regardless of what happens in Washington, we believe we can accomplish our goals for the growth of our businesses.

Before we open the lines for questions, I would like to take a moment to discuss the investment we will be making at Garlock and to update you on our outlook. Yesterday our Board of Directors approved a project to modernize the Garlock Sealing Technologies facility in Palmyra, New York. The project will cost between 30 and $35 million over five years before factoring in incentives that we should receive. About half of the cost will be expensed and half capitalized. In the process we intend to reduce square footage at the facility from about 700,000 to about 350,000 square feet and transform a 100 year old facility into a center of modern, efficient manufacturing excellence.

We have received commitments from state and local incentives for this program totaling over $8 million and this will reduce our net cash outflow. We have also achieved significant reductions in labor costs thanks to the union support of the project. Because of these factors and the resulting improvements and efficiency at Palmyra, we anticipate the project will pay for itself in the time required to complete the project. We will start work on it in the second half of the year, but the project will have no significant impact on our earnings in 2005, and so does not affect our outlook for the rest of the year.

Looking at the second quarter, to this point in the quarter the level of activity in our industrial markets remains consistent with that which we saw in the first quarter. We will ship more engines in the second quarter and we expect to see a normal seasonal increase in activity in certain Sealing products markets. These factors should combine to produce higher sales than we reported in the second quarter of 2004. Higher sales, combined with our cost reduction programs and efficiency improvements should generate higher profits and profit margins when compared to the second quarter of last year. Looking at the rest of the year, our visibility is somewhat limited by the short cycle times of many of our businesses.

In North America, many of our markets seem to be holding their strength although we're seeing indications some segments of our markets may be softening. We're also seeing some signs of softening in Europe. We're certainly aware that high commodity prices and other issues have created concerns about the conditions of the U.S. economy. However, our overall outlook remains consistent with our statement at the end of the first quarter. We expect higher sales and increased volumes in 2005 compared to 2004. These higher volumes combined with the benefits of operating efficiencies, new products, market expansion, and the stronger mix of businesses should lead to improved profitability. We continue to expect we'll produce higher profits in 2005 than we have produced in 2004.

With that, we will now open the lines for your questions.

(OPERATOR INSTRUCTIONS). Liam Burke with Ferris, Baker Watts.

Your asbestos-related expenses on the income statement were up to 4.2 million. Could you give me some background as to why they increased so much?

Sure. I will answer it briefly and then Rick can embellish that a little bit. But basically it is just a reflection of increased trial legwork. You remember, you recall those expenses are primarily uninsured legal fees. And as Ernie mentioned during the presentation, we did have a number of trials and we have had a higher level of trial activity. Rick, do you have anything to add to that?

That is what it is. It is (technical difficulty) as a result of our strategy to keep our costs down, we are going to trial more often.

Bill, I know Ernie touched on this in the discussion, but your working capital needs for the first quarter were pretty high both on the receivables and inventory, and then payables came down a bit. Is that a function both of seasonality and timing, or is there something else in there?

Yes and yes. You can see, and our historical pattern has generally been to build up working capital levels in the beginning first half of the year. We usually are coming off -- the fourth quarter is far and away our lowest activity-wise. We end up running our working capital levels down fairly low and then we begin to build up, first and second quarters are our highest from an activity perspective. That said, we generally see a fairly large consumption, but if you look at the metrics, year-over-year, our DSO's, DSI's, days of working capital, returns on investments, they are pretty much where we expected and in fact slightly improved from last year. So there is no degradation in the performance.

I see also point out that, as I said, we're expecting a good strong second quarter. And in order to fuel that second quarter you need to have the materials to do it, you know?

Fair enough, thank you.

Ted Wheeler with Buckingham Research.

On the capital expenditure at Palmyra, I just wondered if you could, over five years maybe, is it a straight line or front-end loaded or back-end loaded on the costs, or on the CapEx. And then if you could ballpark kind of the savings or productivity or impact that you envision again. Do you think that is front-end loaded or how do we assess the timing of it?

I wish I had the presentation we had for the Board. I don't have it. As I recall, Ted, we don't much this year, but we see a significant spending next year and the year after. Then it slows a little bit, and then at the end there is more money spent. And the reason that money is spent kind of at the end is the demolition of the last buildings, which is an expense.

The processes that we will start, as I recall, Bill you jump in if you are recall anymore on this, we'll start tearing down some buildings and then building a building or two, and then getting those operational and realizing the benefits at that point in time. And then there is kind of a little pause as we do that, and then tearing down the rest of the buildings while we evacuate everything.

Again, it happens along the lines of what Ernie said. There is no one year that really bears a disproportionate share or amount of the cost. Again, the demolition piece is what will run through earnings. The analysis would show that, I think, of the next five years there is really only one year in which we have net negative impact on our earnings, i.e., that the costs, the restructuring costs, exceed the benefits. I think on an annualized basis we would be looking all-in savings, this is when we are fully up and running, from the 6 to $7 million a year range.

In other words, after --.

Once we're fully running and functioning we would expect annualized savings versus where we are today in that general range.

Is that strictly operational or does that factor in -- you didn't disclose any tax incentives and other things?

That is the whole package. As I said, we receive incentives from the state local government. There is efficiency savings involved by the way, utilities savings. These buildings are old multi-story buildings, and we will be moving into modern energy-efficient facilities and so on. So there is a variety of places that is comes from.

Okay. The cost benefit, I guess those are obviously operating costs, basically restructuring and inefficiency costs, not the capital costs. Is that right? In other words you said the costs will exceed the benefits in only one year. Those are not capital?

That is just P&L, that's right.

Just the P&L?

Just the P&L. We will have -- that cash flow is probably skewed towards the front-end, so we will be negative cash flow probably in the first couple of years. But from a P&L perspective, the half that runs through the P&L, I think there is only about one year out of the five which will have a negative impact.

Having said that, we don't expect to see a real major increase in CapEx going forward. This will be modest.

Right, in the 30, 35 million range that you are running now?

Right, exactly right.

What kind of sales base is this facility? I know it is the major plant. Is it half of overall Garlock?

It is the major portion of Garlock.

The major portion? More than half then of Garlock?

51%. It is a good chunk of it, it really is. You know that. It is the most important part of the Garlock operations, the largest part of the Garlock operations.

Okay. Just maybe bouncing back to asbestos, I guess the quarterly rate sequentially did pick up. I don't know if you can game (ph) or ballpark. What do you think the quarterly rate sustainable ought to be?

I am sorry, I am sorry. I can rephrase that.

We want to bring them on.

I agree. Zero is a good number.

You're going to show that to Rick. Go ahead Rick.

What we think the quarterly rate ought to be and what it is are two different things.

As you predict it though.

First quarter has tended to be the largest number of claims. In fact last year, more than half of the claims that we received all year came in the first quarter. So while this is a tick-up from the second, third and fourth quarters of last year, it is significantly down from the first quarter last year and even down further from the first quarter of the year before. There was a big slug of Kentucky cases in there that we think are junk cases that skewed the number up some. Our April numbers are back down considerably and we expect the numbers for the year to be consistent with the continuing declining year-to-year trends.

Great. Good quarter. Thanks guys.

(OPERATOR INSTRUCTIONS). Bill Cram with Reed, Connor & Birdwell.

Thank you. Just had a quick question. You mentioned earlier, specifically with the tool and dye business, that you exited that just because it was a lower margin business. And I was kind of wondering going forward, it seems like the Fairbanks Morse unit kind of fits into that mold of a low profit margin business, and I wanted to see what your thoughts are for that business looking long-term? Thanks.

Let me start with the tool and dye business. We exited that. It had lower contribution margin overall, you're right. But it also had limited growth potential. So it had some strategic implications in where we could take the business and we didn't see it as a fit with us. And finally, it didn't have enough mass to have relevance in the Corporation. Fairbanks Morse has some mass and some relevance and has some other technologies. Having said that, our objective here is to get Fairbanks Morse back to its profitability state. It had a couple of difficult years as you know. And we are now on the verge, we believe, we have corrected the problems in Fairbanks Morse to bring it to the state where we believe it will be a contributor to the Company on an ongoing basis.

When coupled with what we see the program activity for Navy ships that require engines of the size of Fairbanks Morse, we think it can be a profitable contributor to the Company for at least the next several years, in the foreseeable future. Beyond that, it is difficult to tell where it might fit, and I think it is a questionable issue.

So I guess in the next one to three-year time frame, you kind of see this remaining as a core part of your business, and then as you get things kind of fixed up, possibly looking at options further on down the road?

I think that is a fair statement, yes.

Okay. A follow-up on that, considering that Fairbanks will still be in the mix here the next several years, if I look longer-term, what are your -- your margins were impressive this quarter, particularly in ceiling and engineered. What are your long-term margin goals from an operating margin?

We had always said one of our strategic objectives was to return the Company to midteens margins on a sustainable basis. And though I would like to feel comfortable, Bill, one quarter doesn't make a year. And we still feel there are opportunities for us to make some other improvements. So on that basis, we believe that we can now get to the midteens and keep it as a survivable rate and an ongoing rate and we will strive to probably get a little bit better than that now.

But I have said it all along, that years ago some of these businesses were high teens margins. At that they weren't growing. Our objective is to obtain some growth in the business and reinvest back into the businesses in some of the engineering capabilities that we need to have and some of the capital investments that we need to have to improve the operating efficiencies. And as you see, we are doing that in Palmyra. We have done that in the past couple of years in GGB. So we will continue to do that. And to answer your question very directly, I would say probably mid to upper teens is about where we would be on an ongoing basis.

And your time frame, would that be -- to get there would that be two years, three years?

We think we should be there, yes, about that time frame. That sounds reasonable.

Thank you.

(OPERATOR INSTRUCTIONS). Mr. Washington, there appears to be no further questions. I will turn the call back to you for any closing comments.

Thank you all for joining us this morning. We appreciate your interest in our results for the first quarter and we look forward to talking to you again at the end of the second quarter. In the meantime if you have any questions or follow-up questions, please give me a call at 704-731-1527. Thanks.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.