Enpro Inc (NPO) 2005 Q3 法說會逐字稿

Good day and welcome to this EnPro Industries third-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.

Thank you. Good morning, everyone. Welcome to EnPro Industries quarterly earnings conference call. This morning, Ernie Schaub, our President and CEO, will discuss our earnings for the third quarter of 2005 and our outlook for the remainder of the year. As usual, Bill Dries, our CFO, and Rick Magee, our General Counsel, are also present and prepared to participate in the Q&A session.

Before I turn the conference over to Ernie for his remarks, I'd like to remind you that you may hear statements during the course of this call that express a 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 risks and uncertainties in our filings with the SEC, including the Form 10-K for the year ended December 31, 2004 and the Form 10-Q for the quarter ended June 30, 2005. 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 of substance or circumstances on which such statements are based.

The call is being webcast on our website, EnProIndustries.com. And a replay will be available by telephone and on the website. Dial-in information for the telephone replay is available in the release.

At the conclusion of Ernie's remarks, he will open up the line for a Q&A session. If your questions are not answered or if you have any follow-up questions, please feel free to contact me. And now, I will turn the call over to Ernie.

Thank you, Don, and good morning, everyone. The third quarter 2005 continued the steady path of improvement that we have seen over the past 3 years. Profits and profit margins improved in each of our segments over the third quarter of 2004. Segment profits increased by $13.3 million to $27.8 million, a 92% improvement over last year when they were $14.5 million. Our comparison reflects restructuring expenses and contract losses, which reduced segment profits last year by about $9 million. Even if we ignore the effect of those items on last year's segment profits, the improvement is still significant at about 17% or $4.3 million. Segment profit margins also grew to 13.9% from 7.5% last year when they were reduced by the loss provisions and restructuring.

Sales in the quarter were up about 4% or about $7.5 million. The Sealing Products and Engineered Products segments reported increases of 6 and 7% respectively, indicating that we have been able to continue to take advantage of opportunities in our industrial markets. The overall increase in sales however was affected by our Engine Products and Services segment, which shipped fewer diesel engines this year than last year and reported a 13% decline in sales.

As we note in the earnings release, asbestos-related expenses was substantially higher in the third quarter 2005. Expenses increased due to higher legal fees and the impact of insolvent insurance coverage. Early in the fourth quarter however, we received a $4.4 million payment from an insolvent insurer that will more than offset the impact of the insolvent coverage in the third quarter. As a result, asbestos-related expenses for the full year of 2005 will not increase significantly from the amount we spent in the first 9 months of the year.

Earnings per share in the third quarter were $0.47 or about the same as last year. All the references I make to earnings per share are on a diluted basis.

Several items that we consider significant to understanding our performance impacted EPS in both quarters. In the third quarter of 2005, these items increased net income by $0.08 a share. The largest of those items was a mark-to-market adjustment in the value of the Goodrich co-op options we own in connection with the TIDES securities. The value of the options increased as the Goodrich share price increased during the quarter. Last year, significant items included the loss provisions of Fairbanks Morse, an environmental insurance settlement, and other items increased net income by about $0.12. A summary of these significant items and their effect on net income in both periods is attached to our earnings release.

Now let's discuss our segment results. In the Sealing Products segment, sales increased by 6% over last year, as all of the segments' operations except Plastomer Technologies reported improvements. Total sales in the segments were $97 million compared to $91.7 million a year ago. Sales were up about 5% each at Garlock Sealing Technologies and Stemco, the segments' two largest operations. The increase at Garlock reflects stronger demand in the upstream oil and gas sector, which benefited the Pikotek business; higher shipments to the power generation and mining markets; and higher volumes in European markets.

At Stemco, sales benefited from continued strength in the original equipment market for Class A trucks and trailers. Rounding out the increase in segment sales, Garlock Rubber Technologies, one of the smaller businesses in this segment, increased sales by over 20%, as it benefited from operational improvements and improved pricing on certain products.

The Sealing Products segments reported a 28% increase in segment profits, which grew to almost $17 million from just over $13 million last year. Segment margins also improved to 17.4% compared to 14.4% a year ago.

Garlock made the largest contribution to the increase in profits and also reported a significant increase in margins as a result of price and volume increases and cost reduction initiatives as well as the elimination of unprofitable product lines that were included in last year's results. Garlock Rubber Technologies also made a significant contribution to the increase in segment profits compared to last year when they reported a loss due to high scrap costs. Stemco reported higher profits and better margins than it reported a year ago as a result of price increases and higher volume.

Sales in the Engineered Products segments increased 7% over a year ago to about $83 million, reflecting higher sales at Quincy Compressor and France Compressor Products. Quincy benefited from its industrial markets, which supported increased demand for compressors and aftermarket parts, and their sales increased by 14% compared to last year. France Compressor Products reported a sales increase of 25% on increased demands from its customers in natural gas compression and transmission industries. GGB's results reflected weak demand from European industrial markets and sales. As a result, sales were about the same as they were in the third quarter of last year.

Overall, the Engineered Products segments' profits improved by $2.4 million or 32% compared to last year, and margins rose to 12.1% from 9.8% last year. Restructuring expenses, primarily associated with the relocation of France Compressor Products' principal North American manufacturing facility to the Gulf Coast reduced the results in the segment last year by $1.5 million.

Profits at Quincy Compressor grew by over 35% compared to last year, as they benefited from increased volume, a more favorable product mix, and price increases. France Compressor Products reported a profit in the third quarter of 2005 after being about breakeven in the third quarter of 2004. The improvement however is primarily attributable to a decrease in the restructuring expenses.

Conditions at GGB's European markets led to lower volumes and an unfavorable product mix in that region. Those conditions combined with expenses associated with GGB's new facility in Slovakia led to a decline in profit and profit margins in our bearing business compared to the third quarter 2004.

In the Engine Products and Service segment, sales were about $20 million, down 13% or $3 million from third quarter of last year. This decline reflects the shipment of fewer engines than in third quarter of 2004; although, parts and service sales were higher compared to 2004. Profits improved in the segment to just under $1 million from a loss of $6.3 million a year ago when the segment recorded a $7.5 million loss provision associated with several engine-manufacturing programs.

Looking at cash, at the end of September, we had an unrestricted cash balance of $77 million compared to $108 million at the end of the first half of 2004. Our restricted cash balance was $45 million at the end of September compared to only $3 million a year ago. The reduction in unrestricted cash and the increase in restricted cash reflect collateral for fuel bonds we were required to post earlier this year in connection with asbestos verdicts against Garlock. We continue to remain optimistic these verdicts will be overturned on appeal. But the appeal process could take several years.

Working capital increased by about $30 million in the first 9 months of the year; it was approximately the same as at the end of the second quarter. Increased activity in our markets resulted in higher levels of working capital compared to the first 9 months of 2004 when it increased by about $22 million. Typically, working capital levels decline as we approach the end of the year, and we expect this pattern will occur in 2005 as well.

Net cash outflows for asbestos claims and expenses were about $30 million in the first 9 months of 2005 compared to about 23 million in the first 9 months of 2004. Higher legal fees and settlement costs contributed to the increase. For the full year 2005, we continue to expect net cash outflows for claims and expenses to be lower than they were in 2004, as we benefit through anticipated insurance collections in the fourth quarter and lower settlement commitments.

Capital spending in the first 9 months of the year was $19 million compared to about $24 million in the first 9 months of 2004. We continue to expect capital spending for the full year to be slightly lower than $37 million we spent last year.

Looking at asbestos claims, we saw about 11,000 new asbestos claims filed against Garlock in the first 9 months of 2005 compared to 15,400 in the first 9 months of last year. The rate of new filings continues at the lowest levels since the early 1990s. As we have noted in the past, we attribute the decline to state reforms that discourage claims by the unimpaired, the success of our settlement strategy, and the fact that the number of people who are exposed to asbestos in the workplace decreases every year.

The number of open claims at the end of the quarter was down 15% compared to the end of September 2004, reflecting the factors I just mentioned along with increasing claims dismissals. The outlook for federal asbestos reform remains uncertain, and we expect no action on the proposed legislation this year. We remain actively involved in supporting legislation, and we are encouraged by reports that the Senate intends to take up the Fair Act right after the first of the year.

Before we move on to our outlook, I'd like to spend a moment talking about our recent convertible debenture offering; with which, we will refinance the TIDES securities. Because the TIDES are convertible into Goodrich shares, they pose significant risk to EnPro. An increase in Goodrich's share price could require us to spend an amount in excess of the TIDES' liquidation value to buy Goodrich shares in the open market. Our Goodrich call options have protected us against this risk. But because we have to mark the value of the options to market each quarter, they contribute to volatility in our earnings, as they did this quarter. The call options are also getting closer to their expiration date, and we believe they would be very expensive to replace.

For the past several quarters, we have explored alternatives to improving our capital structure by refinancing the TIDES. We've looked at the available options, including bank borrowing, high-debt yields and convertible securities. We concluded a convertible debenture offering was the most efficient and cost-effective option. And on October 26, we sold $172.5 million in convertible senior debentures. These debentures provide a number of benefits to us. They are 10-year notes, which carry an interest rate of 3.9% compared to a 5.25% rate for the TIDES. A lower rate will reduce our annual interest expense by about $1 million a year. The rate is also very attractive compared to high-yield debt or bank debt, which would have carried significantly higher interest rates. These alternatives also would've contained covenants and other restrictions that could have limited our ability to pursue one of our strategic initiatives and that is opportunities to improve our mix of businesses.

We mitigated the dilutive impact of the debentures through the net share settlement feature and through the call spread we purchased as part of the transaction. The net shares settlement means that the principal amount of debentures will be settled in cash, and only the premium will be settled in shares. As part of the call spread, we purchased call options from the underwriter at a very attractive after-tax cost. The option gives us the ability to purchase the shares needed for conversion at the conversion price of about $34 a share.

At the same time, we sold warrants to the underwriters that allowed them to buy shares from us at just under $47 a share. As a result, the effective conversion price is just under $47 a share. Conversion at less than that price would require no new shares to be issued and thus results in no dilution to our shares outstanding. In that event, we would exercise our options to buy shares at lower price.

I should point out that even though we would not issue additional shares until the price went above $47, accounting rules require us to calculate earnings per share as if there were dilution for potential conversions above the $34 conversion price. We are confident that this financing offers us the best opportunity for long-term growth. We worked very hard over the past 3 years to create value for our shareholders, and we believe this financing will allow us to continue to pursue those strategies with an improved capital structure and without restrictions that would have come with other types of financing.

Our businesses remain very healthy. Our outlook is positive. And we believe that without question, we've acted in the best long-term interest of our Company and our shareholders. Now, let's look at our expectations for operations.

Our businesses have set a steady pace of improvement in the first 9 months of 2005, and we expect the pace will continue through the final quarter of the year. Overall, our markets are stable; although, we see some exceptions especially in Europe. Our operations are performing well, and we fully expect them to continue to perform well for the rest of the year and into next year as well. In the fourth quarter, segment profits and profit margins should be higher than those we reported in the fourth quarter 2004. These expectations reflect lower restructuring charges as well as increased demands from our Sealing Products and Engineered Products markets and better pricing for certain products.

In summary, based on the results of the first 9 months of 2005 and our outlook for the fourth quarter, we expect sales, profits and profit margins all to increase in 2005. Our performance should reflect better markets, improved performance at our operations, and better pricing for certain products. It will also benefit from lower restructuring costs compared to last year. We continue to expect those factors to increase our net income in 2005 compared to 2004 even after excluding the effect of significant items in both periods. With that, I thank you for your attention. And now, we will open the lines for your questions.

(OPERATOR INSTRUCTIONS). Andrea Sharkey (ph), Sidoti & Co.

I wanted to talk a little bit about asbestos first. I believed last I had heard was that your expectation for the asbestos expense line item on the income statement would be in the 12 to $13 million range this year. Obviously, including this quarter, you kind of already exceeded 13 million a little bit. Was that something that was expected? Or did it come about kind of suddenly this quarter? And do you think what we see this quarter in terms of that line item will stay at that higher level, or will it drop back down going forward?

Okay, Andrea, let me ask Rick to hit that question because he's better tuned to the receivables and the insurance collections we have going on. Rick?

I think what we have usually said there is that we expect that number to be 12 to $15 million in any particular year, and we continue to say that. It was a little bit unexpected where we got to at the end of the third quarter because we had expected the $4.4 million recovery that Ernie spoke about from an insolvent carrier to have come in during the third quarter. Our agreement with that carrier was for that to have been paid during the third quarter. That money has come in now but not until the fourth quarter. Because of that recovery and because of the other expected activity in the fourth quarter, we don't expect the total amount for the year to be much different from where we are at the end of the third quarter.

Let me clarify the 4 million that you're expecting from the insolvent insurer. Now correct me if I'm wrong because I may have this incorrectly, but I thought that insurance payments don't affect the income statement portion that that is what you pay -- litigation expenses -- that it's not covered by insurance. So that that insurance, 4 million, should affect your net cash outflow and the cash flow line item but wouldn't impact the income statement item. Is that correct?

Andrea, I will let Bill talk about that. But it's different when it comes to the insolvent insurance. But Bill, why don't you--?

Yes, everything you said is true except with respect to insolvents. Effectively, this is money that the insolvents owe us from a long time ago and that we took a P&L charge a long time ago because we did not collect it. So anything we get from insolvents is potentially found money and falls to the bottom line.

I should point out, we have already received that money. It's not that we will receive; we have already received it -- that 4.4 million.

Andrea, one more point on that -- this is Rick again -- part of the reason that our expenses were so high year to date is we hit some insolvent layers in the coverage. And so we had the adverse impact of some insolvent layers that we had to cover during the quarter without the benefit of this insolvent collection that we had expected to collect. As so now that we have collected that, that's more than offset the impact of that insolvent coverage that we hit during the quarter.

I guess next question would be -- looking at GGB, sales were flat; profits were down it seems because of Europe. Kind of wondering now is that including I am hearing that's automotive industry; it's slowing. Is that having an impact or do you expect that to have an even greater negative impact going forward?

GGB in Europe does more automotive work that we do GGB in North America; you're right about that. But even that, our total automotive sales as a Company is only Bill, what about 9%?

7, 8%.

7 to 8%. So automotive isn't the whole driver. Through the trucking and automotive industry combined, we have about 23% I believe it is. But automotive is only about 7 or 8%, as Bill said. Having said that, what happened to GGB is the industrial markets overall weren't as strong as we expected them to be. And the automotive market continued at its reasonable pace. And so you had kind of a mix shift there with automotive, which is generally lower margins than the industrial markets having an impact. In addition, we had some expenses in the startup of Slovakia, as we ramp that production up going forward.

Do you think those problems at Slovakia, that's something that's just this quarter. And as it gets ramped up more that those issues will go away?

Well, we've seen steady improvements, Andrea, as we have gone along. And I would say by the end of the year, Slovakia should be back to its normal position. I should say the position we expect -- not a normal position -- the position we expected it to be in terms of performance.

Then flipping over to Fairbanks Morse, it seems like it's improving a bit but it's still not performing very well profit margin-wise and compared to the rest of your businesses. What are your plans there in terms of kind of getting that into better shape or maybe divesting it? Or what's the story there?

Well, we expect Fairbanks Morse to have a difficult year this year as we made the transition. You know, we took the loss provisions last year. We took one again early this year, and that's certainly impacting Fairbanks Morse for the year. But we believe Fairbanks Morse is on a track to return the kind of margins that we believe is expected of that industry. And it remains to be seen whether we are going to see them next year. We believe that will happen. We put in a lot of improvements both in operational performance; we put in pricing and control improvements and believe that Fairbanks Morse is on track to recovery.

Last question I wanted to ask is, in general, where do you see kind of your strongest end markets being for the rest of this year and maybe into '06? Which industries do you see driving your biggest growth?

That's a good question. We serve so many industries and areas it's a difficult one. We expect to see the recovery of the Gulf Coast area to have a positive impact. The problem has been that we haven't seen it yet, but we fully expect that to be a driving force. The general overall economic conditions are helping Quincy. And in the truck and trailer business, there's been a record production and output of Class A tractors and trailers, so those markets have been very strong. So I don't know -- I don't see -- Bill, do you have any thoughts on any markets you can see?

The oil and gas have been strong. As Ernie indicated, the general industrial market has -- I guess the one economic metric that they look at and gauge is compressor utilization that has been stronger. And as a result, their markets overall have been much stronger. So I think that pretty much covers it -- covers most of it.

Unfortunately, I'd love to have one index or one market or one point that we can always look at, and that would help us. We are so diverse; it's not that easy.

Jeff Brawnchip (ph), RCP (ph) Investment Management.

What is the target margin for Engine Products in '06 and then longer-term? What is the industry standard that you referred to?

Well, we see that business getting up to double-digit margins.

Over the long haul. So how does it progress to there? What's a good number for '06 that you would be happy with at year end?

I would be happy with double-digit margins.

Is that a likely -- I'd be happy with Cameron Diaz, but is that likely in '06?

Well, I cannot comment on Cameron Diaz, but I'd say there is a reasonable chance. It depends on a couple of issues. There is volume pick-up. Do we get the aftermarket's parts and service that we expect? All of those kind of things, there is a reasonable belief that we can get there, yes.

And just so I understand this, so there's $76 million of unrestricted cash. And the 45 million that is restricted, that's posted for bonds in a variety of trials and appeals?

Yes.

And as these things wind their way through, you may or may not be paying that out?

Yes, that's true. Well, we know right now we won't pay the entire amount that is in there. Because probably the single largest bond relates to a case in California. California has a law that requires you post 150% of the verdict. So we know automatically we are going to get some of that back. And we've had preliminary discussions with parties on the other side, and offers have been made to settle a number of those cases at significantly less than the amounts that are included in that bond. So we would expect when it's all said and done to recoup most of that cash.

We remain confident that we are right; we will prevail in those appeals, Jeff.

And does the Company actually have a bank line right now?

Yes, it does. We have a revolving line of credit for $60 million.

And is that a sufficient amount of financing to -- given your acquisition strategy?

Well, it's been adequate up till now since we've never borrowed anything under it. But we are in the process of -- actually that line expires -- it is a 4-year line and it expires next May. We are in the process of renegotiating right now and very well may be changing some of the terms of that.

As far as size, you should be able to borrow more than that, right?

Yes. And more favorable terms --

I was going to say in better terms as well, Jeff.

So we have 76 plus conceptual access to part of that 45 and an untapped bank line that is -- it's somewhere between 60 and 100. I'll close by saying I still have no idea why you did that convertible deal. Thanks a lot.

Liam Burke, Ferris, Baker Watts.

Could I talk a little bit more about Slovakia? If we looked at your year-to-year performance in Engineered Products, you had a 240 basis point improvement on operating profit. But you had the benefit of a year ago, you had that expense on the France Compressor. How much was Slovakia vis-à-vis the France Compressor expense last year this year?

(multiple speakers) I don't know if I get the question.

It cost you about 1.5 million to move France Compressor down to Houston last year, and that's reflected in the operating margin last year. This year, you had some expenses related to the Slovakia move, which sort of brought down your operating margin. How much of Slovakia is in there? How much improvement would you have gotten on an apples-to-apples basis?

Most of the expenses associated with the actual setting up and movement of Slovakia have been incurred in prior years. The issues really this year get down to our inability to transition production at the other facilities more efficiently and timely. And so it's not as if we spent money in connection with the move for the setting up; it's more a function of it having been a slower process to transition the production from other plants. So it's really embedded within their operating results. There's no --

They have been operational issues and issues with starting up new equipment. At the same time, we have been trying to put in some new processes. In this business of bearings, you have to get what they call a PPAC, which is a production approval from the automobile suppliers who are larger -- in these areas -- larger customers. And so every product, not only you have to make it into the same way you did, you now have to get approval from them that you did make it they have to test it and verify and so on and so forth.

So as you move each product, it takes a little bit longer than we expected. And then we've had, truthfully, we've had operational issues in doing that. We've incurred some scrap in doing it and so on and so forth. So it has not been as smooth as we expected it to be, Liam.

Real quick, have you started the renovation of Palmyra? Or where are you there?

In fact, the official -- we started prostia (ph) to answer your question, yes. But the official groundbreaking for the first building will be in about a month. But we have started the renovating and tearing out some things and getting buildings ready and so on and so forth. But the expenses for that for this year will be really very nominal. We won't see much of that; it will not really start till next year.

Ted Wheeler, Buckingham Research.

Just two quick questions, one on the asbestos comments. If you look at this year as a whole and the expense and when we go to next year assuming no conditions change, the expense would be 4 million higher I guess, right?

Wow, that's hard to project. The expense would be --

Well I am just saying if we hold this year's conditions into next year. Because you have got the expense -- has this for one-time recovery in it for the year, right?

Actually, Ted, the insolvent recoveries are not one time. We are out there -- we have got 70 to $80 million worth of insolvent coverage. We are out there constantly going after insolvent carriers, and we have been fairly successful in recovering amounts. So the amounts that we have been reporting on an annual basis reflect the combination of both hitting insolvent layers as well as recoveries.

So it's a normal -- it's kind of a normal part for the whole process, and it has been embedded in our annual expense all along. But we would not -- I guess the short answer to your question is, we would continue to believe that we ought to be in that kind of $15 million plus or minus range on an annual basis and don't really see that changing next year.

And the other question that popped up was the comments on Stemco; that OEM business was strong. Now does that imply that the aftermarket business -- because that had been strong -- did that soften up a bit? And if so, why?

Aftermarket has remained kind of flat. I think the transportation industry is putting their money into tractors and trailers. You know, next year, I think 2007, there is a new EPA -- another EPA law -- something on engines. And so a lot of guys are buying tractors -- are just about sold out for 2006.

In addition to that, quite frankly, our product is lasting longer. It's a better performing product. It's doing better. And so there is less -- cycle time is not as frequent in terms of the change out.

I would throw one last thing in there as well. Particularly this year with the dramatic run-up in fuel prices, unfortunately, a lot of these fleets have had to shift their spending priorities away from kind of routine maintenance into fuel. So they spend less money allocated to the normal maintenance and aftermarket business.

Before you -- did we answer your question there, Ted?

Yes, you did. Thanks.

Before you wander off, I didn't get a chance to talk to you -- the convertible deal, you haven't commented on it.

By my math, it looks like a pretty good deal. If you want to spend money on other things, which you do, it seems like a terrific move.

Thanks. I just wanted to get your impression. Thanks.

I think that was a planted question.

No, seriously, I didn't. I just wanted to get your view on it. I know you followed us for years and years. And you said we should do something with the TIDES when we get the chance, and I was just curious --

It seems appropriate to me. And well obviously, we are going to hold you accountable when you reinvest the money in the future to earning a good return.

You always have.

We can wait for that.

(OPERATOR INSTRUCTIONS). Ryan Bartamen (ph), Griffin Partners.

The Goodrich options, what are the carrying value of those right now? And what are you expecting to do with those now that you're going to up the (inaudible)?

The carrying value at the end of September was about six. I would imagine it is probably down some now because of what's happened to the Goodrich stock price in the last week. But let's say it is going to be 5 to 6 million when it's all said and then. We would expect to sell those when the TIDES have been recalled at the end of November.

Refresh me. What is the strike price on those and then the expiration?

Strike price is $52 and change. And the expiration is February of '07.

Thank you very much. Good quarter.

And it appears there is no further questions at this time. So I'd like to turn the call back to you, Mr. Washington, for any additional or closing remarks.

We thank you all for listening in this morning. If you have any questions or any follow-up, please call me at 704-731-1527. I'll also remind you that we will be at the JP Morgan Small Cap Conference tomorrow, and that presentation will be webcast on our website. Thank you very much.

That does conclude today's conference. Thank you for your participation, and you may disconnect at this time.