Enpro Inc (NPO) 2006 Q2 法說會逐字稿

Good morning. My name is Vonda and I will be your conference facilitator today. At this time I would like to welcome everyone to the second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference is being recorded today, July 27, 2006. Thank you. I would now like to introduce Don Washington, Director of Investor Relations and Corporate Communications. Mr. Washington, you may begin your conference.

Thank you, Vonda, and good morning, everybody. We welcome you to EnPro Industries quarterly earnings conference call. This morning Ernie Schaub, our President and CEO, will discuss our earnings and other events of the second quarter and the first half of a year and he will discuss our outlook for the remainder of the year. Bill Dries, our CFO, and Rick Magee, our General Counsel, are also present and prepared to participate in the Q&A session.

In just a moment, Ernie will make his remarks and then we'll open up the lines for your questions, but first I would like to a remind you that you may hear statements during the course of this call to 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 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 a Form 10-K for 2005 and the Form 10-Q for first quarter 2006. We don't undertake to update any forward-looking statement made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based.

The call is being webcast this morning on EnProIndustries.com and our replay of the call will be available on the Web site. We will also have a telephone replay. Dial in information for the telephone replay is available in our earnings release. If your questions aren't answered on the call this morning or if you have any follow-up questions please feel free to contact me at 704-731-1527, and now I'll turn the call over to Ernie.

Thanks, Don, and good morning everyone. It is great to be able to report another strong operating performance for the second quarter and first-half 2006. Our Sealing Products and Engineered Products businesses reported solid growth in the quarter and first-half of year. Their performance reflects the benefits of our operational initiatives and the momentum of our industrial markets.

Our segment profit margin was approximately 16% both in the second quarter and for the first half of the year, solidly in the range we think our companies are capable of producing consistently.

We're a little less than a month into the third quarter but we continue to remain very positive about the outlook for our businesses then both in the third quarter and for the second half of the year. Our operations are performing very well and our markets are healthy, so even though the stock market seems somewhat skeptical about the state of the economy, we expect to continue to do well for the rest of 2006.

As we described in our earnings release we recorded significant asbestos-related charges to income in the second quarter. We took the charge because we had fully allocated our remaining asbestos insurance depending and estimated future claims, and we had additional asbestos-related expenditures above that amount. I will discuss these charges in more detail in a few minutes, but I want one to emphasize to you that they had no additional impact on asbestos-related cash flows in the quarter.

There were also a couple of developments related to Garlock asbestos development -- asbestos liabilities that we believe will have positive long-term benefits for us. Before asbestos charges and other significant items, income improved 17% in the second quarter of 2006 to $0.79 a share, compared to $0.69 a share in the same basis last year. Income before asbestos expenses and other items improved 20% in the first half of the year to $1.64 a share, from $1.37 per share.

Our reported GAAP net income in the second quarter was $0.19 a share, compared to $0.99 last year. For the first half of the year GAAP net income was $0.88 a share, compared to $1.46 last year. A reconciliation of our GAAP earnings to non-GAAP earnings is attached to the earnings release so please take a look at it.

I would like to take a few minutes now to discuss our operating performance in the second quarter. Sales, segment profits, and segment profit margins were the best we have reported in any second quarter ever. And with the record results we also reported in the first quarter, we are off to an exceptional good start in 2006.

Sales up 3% compared to the second quarter in 2005 but that doesn't reflect an accurate picture of our operations. Sealing Products and Engineered Products sales were up 6% and 13%, respectively, where sales of the Engine Products and Services segments were down 37% because customers changed delivery schedules which delayed engine shipments.

Segment profit improved 7% over 2005 benefiting from our improved property performance and from healthy industrial markets. Our segment profit margin was 15.9% compared to 15.3% last year, as the Sealing Products and Engineered Products segments each reported profit margins above 16% for the quarter.

For the first half of the year sales were up 5% but again were affected by delayed engine shipments and lower sales in the Engine Products and Services segments. Total segment profit increased 18% over the first half of 2005 and the first half segment profit margin was a 16.3% this year compared to 14.6% a year ago. Last year profits and profit margins in the first-half of the year were reduced by contract write-downs at Fairbanks Morse. But even so the first half of 2006 was our best six-months ever, and the second quarter was our second best quarter ever only after the first quarter this year. So we are off to a great start this year and we're looking forward to maintaining our momentum throughout the year.

Now let's take a look at our segment results for the quarter in some detail, beginning with the Sealing Products segment. In that segment sales grew by 6% in the second quarter, increased at all operations. Much of the increase was driven by Stemco where sales grew slightly faster than the segment as a whole. Stemco benefited from active heavy-duty truck and trailer markets and orders from OEMs who are experiencing increased demand in advance of new environmental regulations for engines.

Garlock sales improved, as demand from oil and gas customers increased, although sales in Europe declined, as demand there weakened. Sales in the segment have also benefited from some selective price increases in some product lines.

The segment's profits and profit margins remain strong in the second quarter. Profits of $18.5 million were about the same as last year, but margins were lower because of a less favorable product mix. Demand for some of Garlock's higher product -- higher margin products especially seals sold primarily into metal markets was not as strong as last year and demand for Stemco's OEM products, which generally carry lower margins, increased.

In the Engineered Products segment, sales exceeded $100 million the first time ever, an improvement of 13% compared to last year's second quarter. The increase was driven largely by Quincy Compressor, where sales benefited from strong order levels and robust industrial markets in the United States. The rate of sales growth at Quincy was substantially better than the segment as a whole.

But GGB also reported improvement in North American industrial markets, but just like Garlock Sealing Technology, GGB's European markets was not as strong, and sales improved only slightly there. France Compressor Products, the smallest operation in the segment, also had a modest sales increase primarily because of the acquisition of Allwest Compressor Services late in the quarter.

The segment's profit improved 38% compared to the second quarter last year, reaching 16.3% of sales. Profits and profit margins improved at all operations, although the improvement at Quincy was far greater than in the other operations in the segment. Quincy benefited from higher volumes, with GGB reporting improved performance at its Slovakia facilities, but every business in the segment benefited from our lean manufacturing initiatives.

As I noted earlier, sales at the Engine Products and Service segment were affected by customer delays that postponed engine shipments. The segment sales were down 37% and profits were 6% of sales, compared to over 10% last year. As you know, this segment is very closely tied to the U.S. Navy shipbuilding programs, and many of the shipyards served by Fairbanks Morse on the Gulf Coast were damaged severely in last year's hurricanes. The damage has delayed both shipbuilding programs and ship repairs. As a result, engine shipments schedules are shifted and demand for aftermarket parts and services has weakened. In addition, the segment has been affected by higher material costs. As a result, both profits and profit margins in the segment declined compared to last year.

Turning to our financial position, our balance sheet remains very healthy. At the end of the quarter, we had about $106 million in cash on hand, compared to about $70 million a year ago. The balance benefited by about $6 million that was reclassified from restricted to unrestricted cash is a result of the successful appeal of an asbestos verdict against Garlock in Ohio.

The balance was also affected however by cash we paid for an acquisition. Net debt to total capital was little over 12% at June 30. You note the working capital increased by about $34 million in the first six months of 2006. As we have often noted, working capital normally builds in the first of the year because of seasonal activity in many of our markets. Working capital should return to lower-levels in the second half of the year.

Capital expenditures increased to about $16 million in the first half of 2005, with about $30 million last year. The increase is primarily the result of spending on Garlock Palmyra modernization project, which is moving along nicely. After several months of moving dirt and pouring foundations, steel is starting to rise up on the first new building. This is the first new building to be erected on that site in nearly 50 years. Spending at Palmyra will increase in the second half the year, but by the end of year we should begin manufacturing products in the new building and moving into the next phase of the project.

Net cash outflows for asbestos claims and expenses in the first half of the year were $23.5 million, about the same as they were in the first half of last year. Asbestos claims are coming in at a rate that could result in nearly a 20 year low for new filings by the end of the year.

There were 4200 new claims filed in the first half of 2006, or 50% fewer than a year ago. Over the past twelve months, only 11,000 new claims were filed. That is almost 34,000 fewer than we had at the peak of our new filings in 2003, when about 45,000 new claims were filed. And fewer claims than were received in any calendar year since before 1987.

The trend is obviously very promising. It appears to be the result of several things. Legislative and judicial reforms have raised the standards for filing new claims in some states. Negative publicity has reduced the number of mass screenings used to recruit claims that had little or no impairment from asbestos exposure. The population exposed to asbestos has declined. However, even as new filings have declined, filings of serious disease claims have been relatively flat over the past three years.

Turning to the asbestos insurance, we had $505 million of solvent coverage available at the end of the second quarter. Of the total, $246 million is allocated to insurable claims that have been paid but have not yet been reimbursed. The remaining $259 million is allocated to pending claims and future claims that have not been filed, but that our evaluation expert estimates will be paid over the next ten years.

At the end of the first quarter of 2006 we had about $37 million in unallocated insurance. In the second quarter we allocated the full amount of asbestos-related claims and expenses, and we recorded additional expenses of almost $21 million.

I mentioned earlier, the full allocation of our insurance and the recognition of additional charges is the result of several factors. Let me go through them for you. They include normal legal fees and expenses we occurred during the quarter. Some of them would have been allocated to insurance in past quarters. It also includes settlement payments that are normally allocated to insurance. The third thing they include is an increase in Garlock's liability for asbestos claims our expert estimates will be filed over the next ten years.

The increase was driven by several recent settlements, including the settlement of the large 2004 California verdict that was on appeal. And lastly, they include the resolution of a long-standing dispute with one of our interest that solidified the coverage provided by the insurer, but reduced our unallocated coverage by about $19 million.

We are pleased to have settled the claims and to resolve this insurance dispute. The settlements resolve a number of key claims and provide greater certainty to the amount we will pay for those claims of the next few years. The settlement of the California case eliminated the possibility of punitive damages and set the stage for a key settlement of several other California cases.

In addition, we will be able to move $34 million of cash held as collateral for the appeal bond into our unrestricted balance sometime during the third quarter. Resolving the dispute with our insurance gives us access to coverage that had been withheld pending the results of arbitration and avoid significant annual expense to pursue our claims against this insurer.

We are really satisfied with the way we have been able to manage our asbestos insurance settle -- insurance in the settlement claims. Charges to income recorded in second quarter came so much sooner than we expected, but the timing of the charges came for two good reasons. The recent agreements settled in claims and a resolution of our insurance dispute. Absent those two positive and important developments, some insurance would have remained unallocated at the end of the second quarter.

Earlier I mentioned the continuing decline in new claim filings that we have seen over the past several consecutive quarters. This is one of several important changes that we have noticed since we began making an estimate of future claims back in the fourth quarter of 2004. As a number of unimpaired claims has declined, the number of serious disease cases has leveled off, but the cost of settling those cases has grown, as we receive adverse verdicts and as trial risks have increased.

On the other hand, a number of asbestos-related bankruptcies has been resolved and the trust established by those bankruptcies is set to begin paying claims in the near future, which could affect Garlock payments. We consider the factors that I just mentioned when we work with our outside expert to develop a range of values for Garlock's estimated asbestos liability.

The expert develops a broad range of potential liabilities and under accounting rules, we booked the liability at the low end of the range, which is $277 million at the end of June. The low end increased modestly during the second quarter, but the entire range expanded dramatically and the high-end went from $379 million to $623 million. We are now working with the expert to monitor developments and to review assumptions in an effort to determine if the model can be refined to narrow this range of Garlock's estimated liabilities. The outcome of our work of the expert could result in further charges to earnings.

Before I move onto our outlook, I'd like to mention a couple of other items that I believe are significant. First we recently completed two acquisitions, one which closed in the second quarter and the other which closed at the end of -- after the end of the quarter. These are both small acquisitions relatively so, but are immediately accretive and will add value as they are integrated into our operations over the rest of the year.

The second thing we did is that we also recently made changes to our U.S. defined benefit pension plans, which will help us control our obligation to fund a plan in the future. The defined benefit plans are now closed to all new participants, and effective January 1, 2007, we will freeze the benefits of participation who are under age 40. For those employees affected by the change, we have enhanced our defined benefit contribution.

Now let's take a look at what we expect for the third quarter in the second half of 2006. First of all, our cash flows should continue to improve. Working capital levels should decline as seasonal activity diminishes, although capital spending will increase during the second half of the year to a total of about $40 million for the full year. If you recall, a portion of the increase of the second half will go to Garlock's modernization project.

Our total cash outflows for asbestos should improve modestly for the year compared to $129 million we recorded last year. Our net outflows for asbestos claims and expenses in the second half of the year should be lower than they were in the first half.

Looking at sales and income, the market conditions and level of activity that we experienced in the first six months of the year so far have continued into the third quarter. Our results therefore should benefit from this environment, although we anticipate the normal seasonal reduction in activity compared to the first half of the year. For the full year of 2006 we're encouraged by the generally healthy industrial economy and our exposure to a broad range of markets.

Volume increases in our industrial markets, increased engine shipments, productivity improvements, and modest contributions from acquisitions should enable us to continue producing strong sales, segment profits, segment profit margins, and cash flows for the second half of 2006.

Because we are no longer able to allocate asbestos expenditures to insurance, we expect to book additional asbestos-related charges to income in the second half of the year. The amount of these charges depends on a number of factors, including any increase in our expert's estimate and the outcome of our work with the expert to refine the estimation model.

Because these factors are beyond our control, we can't predict what these charges will be. However as we've said before, they won't result in any additional cash outflows in the second half and we will continue to focus our attention on managing both the settlement of claims and the collection of insurances.

In summary, we expect our markets to remain healthy and our operations to perform well for the rest of 2006. We are encouraged by the current operating environment and will continue to focus on executing our 4 management strategies to take advantage of the opportunities before us. Thank you for your attention. That concludes my remarks and now we'll open the lines for questions.

Okay, Vonda, we are ready to queue up the Q&A.

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

Ernie, you mentioned margin improvement from a number of sources, but specifically how has Slovakia come on and contributed to profitability?

As you know, we saw the Slovakia operation just about full-time this past year and we had some struggles initially with employment, with training and so on. We have put the resources of GGB both in France and in the United States and Germany, all operations over there, and we made remarkable recovery.

They have improved very nicely, and you know that is not a profit center per se. It is really a cost center because in our strategy they make the lower volume, higher labor content bearings for us. And the key to that was being able to get these bearings made at a reasonable cost so that we could become profitable on all GGB. That facility serves all of Europe, but also any other place where we have, what we call, these lower volume orders or specialty type bearings in many cases.

And that is such an important facility to us. I will tell you we are going over -- our board's meeting in Slovakia next week, so they are anxious to see as well but it's coming along very well and I can tell you because I just prepared the slides, well, reviewed the slides for the board meeting. Their output has come up significantly, dramatically in the past six, seven months and we've started to see the results of that in the results of GGB.

The other question I had is you closed the second quarter acquisition. Did it have any meaningful contribution to revenues in the quarter?

Not really meaningful. We closed one at the end of the quarter, AllWest, a small one. Then we just closed one right shortly thereafter, Amicon. Allwest didn't have a meaningful result. In fact, combined, Bill, what we have?

It was less than $1 million, Liam.

If there are no further questions, we will turn the call back over to Mr. Washington for any concluding remarks.

Well, okay, everyone. We thank you for tuning in this morning and if you have any further questions, please don't hesitate to give any one of us a call.