Enpro Inc (NPO) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the EnPro Industries first-quarter 2006 financial results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to Mr. Don Washington. Please go ahead, sir.

Well, good morning, everyone, and welcome to EnPro Industries' quarterly earnings conference call. On the call this morning we have Ernie Schaub, our President and CEO, who will discuss the results for the first quarter and give you some insight into our outlook for the remainder of the year. Bill Dries, our CFO, and Rick Magee, our General Counsel, are also here and present to participate in the Q&A session.

In just a moment, Ernie will make his remarks and then we will open the lines for your questions. First, 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 or 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 31st, 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 change in assumptions or circumstances on which such statements are based.

This call is being webcast on enproindustries.com, and a replay will be available by telephone and on the webcast; dial-in information for the telephone replay is available in our earnings release.

If your questions aren't answered on the call or if you have follow-up questions, feel free to contact me later today or at your convenience at area code 704-731-1527. And now I'll turn the call over to Ernie.

Thank you, Don. Good morning everyone. I'm glad you joined us today. We have a very exciting quarter to talk about. The first quarter of 2006 was the best we reported in many respects. It gives us a good start for the year. In general, we are encouraged by the condition of our markets and are confident in our outlook for the rest of 2006.

In the first three months, our sales, segment profits and profit margins were all the highest we reported in any quarter since we became an independent public company. While we have reported higher net income and earnings per share in a couple of previous quarters, those results included gains that increased earnings and didn't reflect what we felt was our true performance. That's why we can say unequivocally that this was our best quarter yet.

Sales in the first quarter were $228 million, a 7% increase over the first quarter of 2005 despite a weaker euro. Had the value of the euro not declined, our sales would have increased by 10%. Very healthy conditions in most of our markets and our operating performance lead to a 29% increase in earnings before interest, taxes, depreciation and amortization, or EBITDA, which was $32.3 million in the first quarter compared to 25.1 a year ago.

Overall, as I mentioned, our markets were in very good shape in the first quarter, and our segment results are the proof of that statement. Segment profits were $38.3 million, or more than 30% higher than a year ago, and nearly 15% better than our previous strongest quarter. Segment margins were also our best ever, hitting 16.8%, as both the Sealing Products and Engineered Products segments reported margins well in excess of 15% for the first time in our history.

Corporate expenses up for the first quarter of 2006, but the increase was partly because of a higher stock price and the effect of price on stock-based compensation.

Net income was $14.8 million, or $0.69 a share first quarter, a significant improvement over net income last year, which was $10 million, or $0.47 a share. Even if you add back the effect of last year's contract write-downs at Fairbanks Morse Engine, which was a little over $2 million, or $0.11 a share, we had a healthy increase in our earnings over last year.

Let's take a minute to look at our segment results in some detail, beginning with the Sealing Products segment. In Sealing Products, sales were up about 7%, as all operations reported increases. The heavy-duty truck and trailer markets served by Stemco remained strong, driven by steady demand in the aftermarket and strong demand from OEMs, as their production picks up ahead of new environmental regulations.

Increased maintenance spending in oil and gas and hydrocarbon processing markets, especially in the Gulf Coast of the United States, improved Garlock's sales, as did more activity in general industrial markets in the United States and demand for the power generation industry.

Garlock's Asia operations also saw improvements, driven by increased demand for metals and mining industries serving China. In Europe, Garlock's volume increased as activity picked up in certain markets, but sales were down slightly because of the weaker euro.

Overall, the segment's profits grew 17%, and segment margins improved by 150 basis points to 19.5%. Profits and margins were by far the best this segment has reported in our four-year history, as Garlock and Stemco were both up significantly over last year.

Profits and margins in this segment reflect higher volumes from the strength in markets, better prices from some of the segments' products and increased productivity in our operations. A small restructuring charge associated with the Garlock modernization project reduced segment profits slightly.

In the Engineered Products segment, sales improved to $97.3 million, a 6% increase over last year. Because a significant portion of this segment's sales are in Europe, the weaker euro limited the segment's increase. Before the effect of the euro. sales in this segment were up 11%.

A significant portion of the segment's growth in the first quarter came from Quincy Compressor. Quincy's industrial and oil and gas markets in the United States are very strong and sales there increased accordingly. In the U.S. markets served by France Compressor Products, they were not as strong as Quincy's U.S. markets, but demand in Europe improved and sales of France Compressor Products were higher than they were a year ago.

Looking at our bearings business, GGB's European markets were stronger this year and volumes improved, but because the euro was weaker, sales declined. The segment profits were $16.6 million in the first quarter, or 26% better than the first quarter a year ago, and again, were the best this segment has reported as part of EnPro. The weaker euro reduced the increase by about 4%. This segment's margins were 17.1%; that is a 270 basis point increase over last year and the first time we've reported margins in this segment above 15%.

The improved profits and margins came from volume increases, productivity improvements and some price improvement. The better performance by GGB's Slovakian operations also contributed to the improvements here.

Turning to Engine Products and Services, we saw that Fairbanks Morse reported $23.3 million in sales, an 11% increase compared to last year. The increase came as the business shipped more new engines and associated equipment to U.S. Navy shipbuilding programs.

This segment improved to a small profit in the first quarter compared to the loss last year when we reported some contract loss business. However, the mix of business overall was unfavorable compared to last year because of the increased shipments in new engines and the accessories. And these are also at low margin, whereas the aftermarket parts and services carry higher margins. As a result, profits were modest a 2.6% of sales.

Looking at the balance sheet, our financial position continues to remain very healthy. At the end of the quarter, we had about $92 million in cash on hand. That is a decrease of about $18 million from the end of the year. Working capital increased by about $26 million in the first quarter and this is typical for this time of the year because of seasonal activity in many of our markets.

Net cash outflows for asbestos claims and expenses increased significantly in the first quarter, up from about $2 million -- they are up about $2 million last year to over $21 million this year. The difference between this year and last year is primarily the $22 million in delinquent insurance payments that we received in the first quarter of 2005.

We continue to see a declining number of new asbestos claims. We received 2900 new claims in the first quarter this year, or 53% fewer claims than in the first quarter last year. Looking back over the past 12 months, only 12,000 new claims were filed. That is a drop of almost 75% from the peak annual filings a couple of years ago, and fewer claims than we received in any calendar year since before 1987.

The decline in new claims is apparently a result of number of factors. Science tells us that exposed population continues to decline modestly each year. Legislative and judicial reforms have raised the standards for filing new claims in some states, which in particular has reduced the number of claims by people who don't have a malignant disease. Also, mass screenings have come under increased scrutiny in the past several months and it has become more difficult for plaintiffs' attorneys to file claims based on these techniques. However, as the number of new claims has declined, the cost of settling serious disease cases has gone up.

Turning to the courtroom, we won an important appeal near the end of the first quarter when a panel of the Ohio Court of Appeals unanimously overturned a $6.4 million verdict against Garlock and granted a new trial. No dates have been set for the new trial yet.

We have posted a bond in connection with the appeal, and this will be released in the second quarter. At the time of the release, we will move cash associated with the bond from our restricted cash balance to our unrestricted cash balance.

As you probably know, we also have a California case on appeal. The bond associated with that appeal is about $35 million and the cash collateral remains in our restricted cash balance.

Looking now at asbestos insurance, we had about $548 million of solvent coverage at the end of the first quarter. Of the total, $247 million is due from insurers for claims that we have paid but have not yet been reimbursed for. Another $264 million of the insurance is allocated to known and unknown claims that our valuation expert estimates will be paid over the next 10 years.

That leaves $37 million of unallocated coverage at the end of March compared to $77 million left at the end of last year. That amount was reduced by payments of insured legal fees, which we accrue and pay as services rendered; higher than anticipated settlement payments; and increases in the number and value of claims our expert estimates will be paid over the next 10 years.

At the point our insurance is fully allocated, we will begin to record charges to income. These charges will cover increases in the liabilities of future claims, payments for asbestos-related legal fees and expenses, and any loss or impairment of our insurance assets. We expect we will begin to book those charges in 2006, although we're not certain which quarter because of all the variables involved in this.

These charges will reduce net income and earnings per share. Our cash flows, however, will be no different than they would be otherwise. We will continue to manage settlements with the objective of minimizing their effect on our cash flows.

Now let's take a look at what we expect for the second quarter and the remainder of 2006. First, we that our cash flows in 2006 will improve over 2005. Working capital levels should decline over the balance of the year after the seasonal buildup of the first half. Capital spending for the year should increase over last year's $32 million to about $40 million as spending picks up on the multiyear Garlock modernization project.

We will focus on reducing total cash outflows for asbestos to a level below last year's $129 million, but our insurance collections will be lower than the $107 million we collected last year when we benefited from the delinquent payments due for previous years and high collections that we received from insolvent carriers. Because insurance collections won't be as high this year, net outflows for asbestos claims and expenses are likely to increase over the $22 million we reported in 2005. However, we expect they should remain well below the net outflows of any other previous year in our history.

Looking at sales and income, to reiterate what I said at the beginning of the call, the market conditions and the levels of activities that we experienced in the first quarter have continued thus far into the second quarter, and our results should benefit from this environment.

For the full year, we're encouraged by a generally healthy industry economy and our exposure to a broad range of markets. Both of those factors will help us continue our pattern of year-over-year gains in sales and profits. Specifically, volume increases in productivity improvement should help us increase sales, segment profits and profit margins compared to 2005.

As I mentioned, our asbestos insurance is likely to be fully allocated sometime this year, and when that happens, it will result in additional charges to income. Those charges potentially could reduce our reported net income in 2006 by a significant amount. However, they would have no incremental effect on cash flows. When we begin taking those charges, we will clearly identify their effect on our net income and earnings per share in order to enable you to make a more accurate comparison of our operating performance between periods.

In summary, we had a great first quarter and we expect our markets to remain healthy and our operations to perform well for the rest of 2006. We're encouraged by the current operating environment and will continue to focus on executing our four key management strategies as a way to take advantage of the opportunities they present us.

Thanks for your attention. That concludes my prepared remarks. Now we will open the lines for your questions.

(OPERATOR INSTRUCTIONS) Rob Norfleet with Davenport & Company.

Hi, y'all. Great quarter. Just a couple questions. I guess first, if you wouldn't mind, maybe, Ernie, diving a little bit more into the margin line. I mean clearly margins in the first quarter at 16.8% were significantly higher than year-over-year and any sequential comparison we've seen. And again, I know obviously were seeing pricing enhancements, volume increases and productivity gains.

But I guess the little more color I'm trying to get is as we look out over the course of the year, is there anything that happened in the first quarter to somewhat aid margins that we shouldn't anticipate in the second half of the year? And what is the sustainability of margins being well above where they've been at prior-level periods?

Rob, first let me thank you for your comment on the first quarter. It was a great quarter. To tell you the truth, it was a surprisingly strong quarter. We saw the economy continue its strength.

And fortunately for us, and I think part of the answer to your question is, some of our business sectors that have good margins already were able to sustain them with higher volumes, and that helped us significantly. Some of our businesses which don't have as high margins didn't have the volume increases that we saw elsewhere.

But I think it is a series of events. We have maintained productivity increases and the activities that we have aimed at lean manufacturing across the board, and we've seen that spread throughout the Company. As we told the Board recently, we have a good culture now in the Company of cost management and productivity improvement. I think the effects of our spending of capital the past few years is starting to show some of their results and we're seeing some sustainable productivity improvements.

And we've also been able to get selective pricing. I think we are more attuned to materials changes in the environment and we are keeping closer to the pricing situation.

Bill, do have any comments or thought that you might want to add --?

Sure. Just to add on to what Ernie just said, in terms of looking out the balance of the year -- just keep in mind the first half is typically our strongest -- our first and second quarters, our volume levels are up and we are very successful this year in leveraging that volume. Volume levels normally will fall off in the second half; we won't achieve that leverage. And therefore, generally we would see margins fall off a little bit.

That, plus the fact that on a consolidated basis, Fairbanks Morse has some very heavy engine shipments scheduled for the latter part of this year, which on an overall consolidated basis, has a tendency to drive our margins down as well.

But I think going back to the basic question on sustainability, I think I would be presumptuous to assume that we could sustain these levels throughout the year, Rob.

Right. That certainly makes sense. But clearly, with the trends we're seeing, we should certainly see nice improvements over the 2005 period.

That is fully our expectation. We see that happening. We had planned that throughout the year. I think this quarter was unusually strong for us.

Okay. And quickly -- and again I know we've talked about this on prior calls, and again, we can't really quantify the charges yet related to allocating some of these accruals that we've taken for legal fees, etc., that when the unallocated insurance runs out, we obviously start having to take a charge on the earnings line.

But I guess if you looked into your 10-K and look at insured legal fees have averaged about $5 million a quarter. And then if you kind of look at what you have been accruing for future and current claims and fees, it has been about $8 million a quarter. I mean are either one of those numbers good numbers to look at as once this unallocated insurance runs out, kind of looking at what we're likely to take as a charge as we are obviously not being aided by having insurance pay for our trial fees and legal fees going forward?

Rob, all numbers are good numbers to look at, by the way. Bill or Rick, you guys may be better prepared to answer the amount of the variability in those numbers. I just want to tell you there's a lot of elements in there that create the variability in what could happen in that amount. And we're trying to really get a good handle on the ability of our expert to predict future claims, and that is a key ingredient in that. So, Rick, you may --.

Let me take a shot, Rob. Bill, I'm sure, will have some things to say about it too. The two things you indicated -- and by the way, we tried to lay out in the 10-K as best we could the variables and how to approach looking at it. But the one variable you didn't mention that probably has the biggest impact is any changes in the estimate of the liability that our expert provides for us on a quarterly basis.

We would expect that estimate you go down every quarter for obvious reasons; we're paying significant claims out every quarter, which are part of their estimate. So as we pay those claims down, we'd expect their estimate of our future claims also to go down.

What we've seen over the six quarters now, five or six quarters now that we have had them is that their estimate has stayed relatively the same despite our paying out claims in a quarter, which in essence increases the liability. And therefore, we have to allocate insurance to the same amount of liability when we've used insurance to pay claims in a quarter. So we've got our assets being used every quarter as we pay the insurance and our liability, in essence, going up because their estimate has not been coming down commensurate with our payment of claims.

So that has been that biggest influence on that. And we hope that that estimate is going to start going down, but the fact that it has not is what makes us unable to predict for you when we're going to fully allocate our insurance and what the impact of that is going to be. Assuming that estimate comes down in line with what we are paying every quarter -- which obviously is an assumption we can't make -- but if that were the case, then the items that you have mentioned would be the two biggest impacts on that liability every quarter. And I don't know if that answers it or if that confuses the issue.

No, that is very helpful. And again, I'm not going to belabor this, but the last point is companies like USG and Grace and others come out of bankruptcy over the next six to 12 months. Clearly, they have established significant trusts with billions of dollars. And then as they emerge from bankruptcy and those dollars start being, obviously, allocated to claimants in the market, do you think that has a positive effect on you all?

We very much do. Obviously, plaintiff lawyers who are getting X dollars for a claim want X dollars for the next similar claim. The dollars that you are talking about that are going into those trusts to pay claims had been on the sidelines now for as much as four or five years. And there will be billions of dollars freed up as those trusts are as established, and they will be going to pay claims. That should reduce our share of the settlements for those cases.

Having said that, once the plaintiffs are getting X dollars from you as a defendant for a kind of claim, they will be reluctant to give up that kind of payment, even though they are getting payments from other people. But that decline that you've mentioned is embedded in our expert's estimate and it's something that we are counting on being reality as soon as those billions of dollars come on line and start paying claims.

Great. Well I'll get off and let somebody us get on and get back into queue. But again, I want to commend you all on an excellent quarter and keep up the good work.

Before you do that, Bill, do you have anything else that you --?

The only thing I just wanted to add in, Rob, since we've beaten this subject to death -- but the other potential significant impact is to the extent there is any impairment of any other of our insurance assets, as we've disclosed in our K and our Qs repeatedly, we have some issues with a couple of insurance carriers we are still negotiating through, and hopefully will resolve. But to the extent that there's any sort of compromise reached on something less than a nominal amount of the insurance, that would also eat into the unallocated as well.

Okay, thanks so much.

(OPERATOR INSTRUCTIONS) Sidoti & Company's, Andrea Sharkey.

Good morning, everyone. How is everyone doing?

Fine, thank you, Andrea.

Just a few questions. I don't know if you can disclose this, but I was just curious about how many engines you shipped this quarter, since obviously we saw some nice revenue growth there?

Yes, we shipped two engines in the quarter. I think also, Andrea, when we said we had related accessories -- there were also some related accessories and these also went out. And they are part of the engine, and they went out with it as well, and they also went out at no profitability, essentially.

And then, Bill, I think it was you that mentioned that you have a lot more heavy engine shipments coming through the rest of '06. And I was just curious if it is kind of that same two engine a quarter run rate, or do you expect that to kind of increase and be a higher number of engines?

Right now based on the schedule, we anticipate to see a significant increase late in the year -- actually in the fourth quarter we anticipate a significant increase.

And that is still going to be pretty close to euro margin products, though.

Low margin. We've gotten away from quoting zero margin; we make a little bit of money. But obviously, it still brings our overall margins down.

Okay, great. And then I don't know if you can break this -- I know you have a lot of different businesses -- but I was just curious, with the price increases, how much of your revenue growth was attributable to pricing?

On the revenue growth, not much. Maybe 10% -- 10 to 15% at most.

Okay. So 10 to 15% of the 7% revenue growth?

No, I'm sorry, no. 10 to 15% of the absolute dollars, so it would be 10% of 7%. So it would be less (multiple speakers).

That is what she is saying.

Okay. And then I guess kind of on price increases and materials costs, I've been hearing things that steel might be picking up a bit. And I was just curious if you think that that might put some pressure on your gross margins for the rest of the year, and if you have the ability to pretty easily pass that on to your end customers.

On some of our customers, we have some adjustments to be made. And as the price changes, we can pass the price change through. On some of them we don't, Andrea; it's going to depend business by business. Right now, steel hasn't affected us much this year, but we've heard the same thing, that steel is supposed to go up significantly this year. We are seeing some increase in copper this year, and that has been -- copper and bronze have been our biggest drivers, I think right now.

Great. And then actually, I don't know if you have ever disclosed it -- I don't seem to have it in my information -- but do you break out -- out of your cost of goods sold, how much is related to say copper and to steel? How big a piece of your costs are those two materials?

We don't break out material by item. Some of them -- it is hard to do that because some of them we receive in alloy, some of them we receive in bar stock, some in sheet stock. There are so many variables and it depends division by division. So it is hard for us to see that and how we do it.

And sometimes, by the way, when you talk about a steel increase, we don't see it in every single division either. Sometimes high alloy steels aren't seeing much of an increase whereas carbon steels are and vice versa.

Okay. And then a quick question on the asbestos. The 4.9 million on the P&L this quarter, would you say that is a pretty good run rate to use for the rest of the year? Or do you think that is a little bit high for -- the other quarters might be a little bit lower?

That is the breakage --?

On the asbestos charges?

Yes.

Absent what we've just alluded to, if we just look at what we call -- we call that breakage, the uninsured legal fees, the insolvents. Absent the other issue we just talked about, that in and of itself would be a pretty decent indication of a run rate.

Okay, great. And that is the cash portion of that asbestos expense, correct?

Yes.

And then I don't know if you have this number available, but just how many open actions did you have at the end of the quarter?

I think Rick might know that.

Yes, I do have that information. They were down some. The exact number will be in the Q. Give me a second and I will give you a rough number. It came down -- I think it is around 117,000, so it is down about 4 or 5000 from year end.

Okay, great. Thanks a lot, guys.

(OPERATOR INSTRUCTIONS) Jack Howard with Steel Partners.

Hey, guys. We talked about this in the past, but do you think over time you're going to be able to get the earnings power of engine products up to where you want it to be? It just seems like this is so volatile and not up to kind of what your expectations were.

Will we get it where we want it to? The answer is yes, we believe we can. Will we get it to where the rest of the company is? No, we do not believe we will.

The rest of the company, Jack, as you've seen, has just had a tremendous quarter. And overall, the rest of the company has always been superior to our engine business.

I think I remember kind of 10% operating margins -- was that (multiple speakers) target?

And that's our target that we have and we believe that that is the kind of level we want to get to at minimal, yes.

Does that take two more years, do you think, or is it something you could see run rate at some point in the not-that-distant future?

That is hard to say. That is our target. Certainly we would be there in two years, I believe, yes. We're shooting for as quickly as we can get there; we try to do everything we can -- put in productivity measures, give them the equipment they need to do the job; and work with them to try to get there; and work on the cost side of it as much as we can.

But we also work on the pricing side. We're trying to get our customers to recognize that we can't be in the business at low profit margins. That is not what we are in business for.

I know you guys have mentioned that the working capital is seasonal, but is day sales receivable still in line with where you guys are comfortable?

Yes, we in fact saw no change at all. We are at the low 50s, consistently in the low 50s. Again, keep in mind that is a mix. 40% of our sales go to customers outside of the U.S., and particularly in some of the Western European countries the norm is a much higher than that. So our domestic DSOs pretty much stayed in the low 40s, and overall in 50ish, and that has pretty well stayed level.

Okay. And how is the construction of the new facility in New York going?

We just -- I think I just saw the other day they poured concrete, they've got footers all done. Obviously, they cleared the land, did all the stuff like that. We had little problems in the process. You know, this is a 100-year-old site. We found some water and sewage lines that were not on anybody's maps as we dug up -- nothing major.

So right now, footers are going in and we expect to be in that building by the end of the year, operating by the end of the year. So it is going -- it's a little bit behind -- that is the first building, yes. It is a little bit behind, but not a quarter behind. It's maybe a month or so behind right about now, Jack.

And are they as far along and lean as Stemco and is this plant being laid out from the ground floor up as a lean operation?

Very much so. In fact, one of the things that we are doing as we are doing this, we are changing the equipment that we are using and doing things of that nature. We've had lean experts come in and work with our people. People at GST have gone through all the lean training. We have lean champions up there as well. All the processes throughout the Company now, as I've said, lean manufacturing.

Stemco is clearly further along than any operation -- don't let me kind you in that respect. Stemco is clearly further along in the operation we have. But these guys are doing a nice job in laying out the equipment to minimize traffic, to minimize work movement and to increase productivity significantly in the first building that we are laying out now.

And how many buildings will you have ultimately?

We will be building another building after this one comes down. We're going down from about 20-something to seven, I think we're going down from 26 to seven, if I'm not mistaken -- in that ballpark. We're only building two new buildings, but we're tearing down quite a few and refurbishing a couple.

Okay. Lastly, the new facility in Eastern Europe, I forget which --

Slovakia.

Yes. How is that going?

It is going very well. As we said in the comments, Slovakia contributed to the profitability of GGB nicely this year. We continue to build up manning and machining operations in Slovakia, and it's doing very well for us. It is coming along about where we expected it to and it's adding to our profitability count.

Yes, we had a rough start last year, but they have turned it around and they are solidly profitable.

And I might point out, Jack, they also get the same lean training and things that we do here in the States. We go through the same process over there as well.

Okay, thank you.

And gentlemen, there are no further questions. I'll turn things back over to you for any additional or closing remarks.

Thank you, everyone, for listening in this morning. Again, if you have any questions or anything you need to follow up on, please feel free to give me a call at 704-731-1527. Thanks for listening and we look forward to talking to you next quarter.

And that does conclude today's teleconference. Thank you for joining. You may now disconnect.