Enpro Inc (NPO) 2006 Q3 法說會逐字稿

Good day and welcome to this EnPro Industries third quarter 2006 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 our third quarter earnings conference call. Ernie Schaub, our President and CEO is with this us this morning to discuss the earnings for the quarter and other events as well as to discuss our outlook. Bill Dries, our CFO and Rick Magee, our general counsel are also here, as usual and prepared to participate in the Q&A session at the end of our earnings remarks. In just a moment Ernie will begin his remarks, and after he completes them we will open the lines for your questions.

But first I'd like to remind you that you may hear statements during the course of this call that express the belief, expectation or intention like (technical difficulty) like any change in our expectations or any change in assumptions or circumstances on which such statements are based. The call is being webcast on our website EnPro Industries.com and a replay of the call will be available, both on the website and by telephone, dial-in information for the telephone replay is available on our earnings release. As always, if you have any questions that aren't answered on the call or if you have any 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. Good morning, everyone. EnPro continued on a path of steady operating improvement during the quarter. Sealing Products and Engineered Product segments both performed well in the quarter, and our overall performance improved at the segment level. We continued to make progress on our strategic objectives in the quarter, and we are very encouraged about the condition of our markets and the direction of our business.

As we expected, asbestos related expenses increased substantially over the third quarter of last year, and our earnings decreased to a net loss of $0.20 a share in the third quarter. The higher asbestos related expenses are the results of the full allocation of the asbestos insurance, the pending and future claims earlier this year. However, it's important to note that the charges don't have any additional effect on cash flows associated with asbestos. I will talk more about asbestos related expenses in a few minutes, but I don't want them to overshadow what was otherwise a good performance by our businesses in the third quarter.

Overall, our performance strengthened once again over 2005. Sales in the third quarter increased 15% over last year and segment income was 12% higher. Despite the fact that Engine Products and Services segment recorded a loss. The loss was a result of additional costs associated with long-term contracts to supply engines to U.S. Navy shipbuilding programs. Because of the loss in Engine Products and Services, segment margins were down slightly in the quarter to 13.6%, but for the nine months of the year they increased by a full percentage point over the same period last year to 15.4%.

Cash flows have been strong this year, and our balance sheet remains in excellent condition. We made four acquisitions in 2006 to strengthen attractive parts of our company, and they are already beginning to contribute to our results. In general, we are pleased with the way our businesses have performed this year, and we expect them to continue to perform well for the rest of the year. To illustrate the performance of our businesses let's look at the income before asbestos related expenses and other significant items.

In the third quarter of 2006 our income on that basis was $0.64 a share, a 10% increase over last year despite the accrual of the additional costs of the Engine Products and Service segment. These costs reduced income by another $0.09 a share in the quarter. For the first nine months of the year income before asbestos related expenses and other significant items was $2.27 a share, a 23% betterment than a year ago.

Looking at our GAAP results, our net loss was $0.20 a share in the quarter compared to net income of $0.47 a share last year. For the first nine months of this year GAAP earnings were $0.68 a share compared to $1.93 a share last year. A reconciliation of GAAP and non-GAAP earnings is attached to our press release.

Now let's look at the operating performance in a little more detail. Sales in the third quarter were the highest of any quarter in our history. And as I mentioned, segment profits grew by double digits over the third quarter 2005. For the first nine months of the year sales were up 8%. Segment profits however were up 16% over last year. As I mentioned, our segment margins of 15.4% were a full percentage point higher than in the first nine months of last year.

Let's look at each of these segments in a little more detail. For the third quarter Sealing Products segments reported sales growth of 11% through a combination of market activity, contributions from an acquisition and a stronger euro. About 5 percentage points of that growth came through the acquisition and foreign exchange. Every business in the segment reported higher sales. At Garlock Sealing Technologies sales benefited from higher demand from North American industrial markets, increased demand from the oil and gas industry, especially for Pikotek's critical service gaskets and increased activity in Europe as nuclear energy markets strengthened there.

Plastomer Technologies sales grew substantially as a result of our acquisition of Amicon Plastics early this year. And at Stemco, sales increased to higher levels of activity in heavy-duty truck and trailer markets as OEMs bought new equipment in advance of changes and environmental regulations for engines. The segment's profits increased about 6% in the quarter, but margins declined slightly to 16.7% from 17.4% last year. The lower margins were caused by Stemco's business mix, which was weighted more heavily toward lower margin sales to the original equipment manufacturers and toward pass-through sales. Profits and margins at Stemco were down as a result although margins there remain high relative to the segment as a whole.

Both profits and margins improved at Garlock Sealing Technologies and Plastomer Technologies. Volumes and pricing benefited Garlock even though that Garlock absorbed increased restructuring costs associated with the Palmyra, New York facilities modernization. Plastomer benefited from the Amicon acquisition which substantially increased Plastomer's profits and margins.

Looking at the Engineered Product segment, their sales were up by 17% compared to the third quarter 2005. The increase is once again led by Quincy Compressor where sales benefited from strong order levels and robust industrial and energy markets in the United States. The segment's growth also reflect favorable foreign exchange rates and the acquisition of Allwest Compressor Services, each of which added about two percentage points to the sales increase. At GGB Bearing Technology stronger European industrial markets benefited their sales at Bearing as well as the France Compressor Products. GGB's North American industrial markets were flat, and its automotive markets in North America and Europe were somewhat weaker than last year. The segment's profits improved 50% compared to the third quarter last year, reaching 15.4% of sales. Profits and profit margins strengthened significantly at all operations in the segment, reflecting the acquisition of Allwest and higher volumes along with favorable pricing and efficiency improvements at all three businesses in the segment.

In the Engine Products and Service segment, sales improved by 20% as Fairbanks Morse shipped more engines in the third quarter 2006 than in the same quarter 2005. However, as I mentioned earlier, the segment reported a loss of $1.8 million because of an accrual for additional costs. The accrual totaled $3.1 million. As you have noted in the past, engines are manufactured under long-term contracts that are often awarded far in advance of the time the engines will be delivered. As a result, there is a risk of unanticipated changes in costs as we experienced in the third quarter this year.

Turning to our financial position, our balance sheet remains very healthy. Our cash balance of $138 million benefited from $34 million that was reclassified in the third quarter to unrestricted cash from restricted cash. The reclassification was a result of the settlement on an asbestos verdict against Garlock. In the first nine months of 2006 working capital increased by about $18 million compared with an increase of $30 million in the same period last year. However, from the end of June to the end of September working capital balances declined about $16 million, which is consistent with the seasonal pattern of our markets.

Capital expenditures increased to about $30 million in the first nine months of 2006 compared to only $19 million last year. The increase is primarily the result of spending on Garlock's Palmyra, New York modernization project, which is moving along on schedule and on budget. The first new building to be constructed as part of the project is now enclosed. Interior construction is underway, and by the end of the year we should be ready to begin manufacturing products there. All in all, we spent $27 million on acquisitions in 2006 compared to less than $2 million last year. And as I mentioned earlier, all of the acquisitions are doing very well for us.

Net cash outflows for asbestos claims and expenses in the first nine months of 2006 were about $36 million compared to $30 million last year. Our total spending for asbestos claims and expenses was less in the first nine months of this year than it was in the first nine months of last year even though this year's payments included several verdicts from previous years. However, our insurance collections were also lower this year because we had a sizable delinquent insurance collection last year.

Asbestos claims continue to come in at the lowest rate we've seen in almost 20 years. Through the first nine months of the year 6100 new claims were filed, compared to 11,000 in the first three quarters of last year. That is a 45% decline from year-to-year. Over the past 12 months 10,000 new claims were filed, which is fewer than in any calendar year since before 1987. Since we talked about them at length in the past I won't go through the list of factors we believe are contributing to this decline, but we are pleased with the trend and particularly with the decline in malignant claims we saw during the first nine months of this year. Those claims have been relatively steady over the past three years, lower numbers of these claims support well-known studies that predict the incidence of asbestos related disease will begin to decline steadily over the next several years.

Turning to asbestos insurance, at the end of the third quarter we had $490 million of solvent coverage available to pay claims in the future. Of the total, $253 million is allocated to insurable claims that have been paid but not yet reimbursed. And the balance has been allocated to pending and future claims. Because Garlock's asbestos insurance is fully allocated, we recorded a charge to income of about $29 million in the quarter. The charge reflects legal fees and other expenses incurred during the quarter, as well as an increase in the estimate of the future of liability. In previous quarters, much of this expense would have been allocated to insurance to be collected in the future and would not have been recorded in income.

I would like to address this liability for a moment. Last year we told you -- last quarter we told you we were working with our expert to determine if the range of Garlock's asbestos liability could be narrowed. We were concerned about the volatility we had seen in the range, including consistent increases in the low end of the range and the dramatic expansion at the high end of the range in the second quarter. During the third quarter our expert reviewed with us the various scenarios and models he used to estimate the range of potential liabilities. An extensive number of factors go into his analysis and he has concluded the range continues to be valid even though it remains very broad. It remains broad for reasons primarily related to defendants currently in bankruptcy. Their reorganizations have removed dollars from the system over the past several years and caused a relative contributions of nonbankrupt companies like Garlock to increase. As bankruptcies are resolved and trusts are established, significant funds should become available for settlement of claims. Some estimates expect the trust could contain more than $30 billion. The availability of these dollars for claim payments should result in the decrease in settlement payments made by Garlock and other nonbankrupt defenders.

However, until the bankruptcy trusts are established and paying claims, it is difficult to estimate their impact. Experts reasonable and probable range of Garlock's liability is $279 million to $623 million. The high end of the range is about the same as at the end of the second quarter, but the low end increased by about $2 million despite the fact that we spent about $22 million on settlements during the quarter. The net increase in the estimate was driven by new settlement agreements and an appellate decision against Garlock upholding a verdict that was on appeal in Baltimore.

Before I leave our discussions of asbestos I want to mention that we've reached an agreement in principle that would resolve a dispute with a group of insurers. We hope to finalize agreement in the next several weeks. The total amount of insurance involved is $194 million. We expect to complete the agreement shortly. It calls for us to receive the entire amount of insurance in annual payments of various amounts over 11 years beginning next year. Once this agreement is in place, all significant disputes with our insurers will have been resolved.

Now let's turn to the outlook. The overall condition of our markets continues to be good. North American industrial markets are healthy; oil and gas markets are strong, and we're seeing some improvements in Europe. We anticipate the original equipment segment of our heavy-duty truck market will slow down but that business is driven primarily by aftermarket activity, so a slower OEM market shouldn't have a significant impact to us.

Sales and income should continue to benefit from these conditions in the fourth quarter. We expect to book additional asbestos related charges to income in the fourth quarter as well. The amount depends on a number of factors including any increase in our expert's estimate of the potential liability and fees and expenses we incur in the quarter. Because changes in the expert's estimate are beyond our control we can't predict what charges might arise from an increase in the estimate. We do not accrue fees and expenses until they are incurred. However, they have averaged about $8 million a quarter over the past two years.

As always, we will continue to focus our attention on managing both the settlement of claims and the collection of insurance to minimize the effect on our cash flows. Total spending for asbestos claims and expenses should be about the same this year compared to 2005. However, we won't collect as much insurance this year as we did last year when we collected substantial amounts of delinquent insurance. Additionally, some of the insurance we expected to collect in the fourth quarter of this year will be delayed until next year by the agreement that I mentioned earlier. As a result, our net outflows for the full year will be higher than last year, although we expect only a modest increase for the rest of 2006. Because of our insurance agreement and because we have resolved and paid significant prior year verdicts in 2006, we expect a substantial improvement in net cash outflows for asbestos in 2007.

In summary, we expect our results for the fourth quarter to benefit from the positive environment we've worked in for the past several years. Volumes should increase, productivity should continue to improve, and we will benefit from the acquisitions we made in 2006. We are encouraged by the current operating environment, and will continue to focus on executing our four key management strategies to take advantage of the opportunities that lay before us.

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

(OPERATOR INSTRUCTIONS) Andrea Sharkey, Sidoti & Co.

Just a quick question. You mentioned in the press release and in your remarks that there were four acquisitions, and I just wanted to -- I mean I know Amicon and Allwest; what were the other two that you were referring to?

There was Southwest compressor products and H.A.R. Southwest Compressor Products is located in Houston. It is a small business that makes compressor parts for the big compressors that France Compressor makes parts for vis-a-vis the big reciprocating compressors for the gas patch. And H.A.R. makes injection molded parts primarily again for those markets.

So both of those would be included with France Compressor now?

Yes, they are.

When you were talking about the acquisitions and what they added, you did break down on the engineered side 2% from the acquisition, 2% from foreign exchange, but I believe you didn't on the Sealing Products. Could you break that down? I think in the press release it said 5% from both acquisitions and foreign exchange, but could you give us a split of what that was?

Off the top of my head, no, but Bill knows --

3%, 3 of the 5 came from acquisitions and 2 points came from a stronger euro.

Thank you. And then in terms of the restructuring charges for Garlock I saw that increased a bit this quarter. Is that a similar run rate of what you would expect it to be going forward the next few quarters, or was that an anomaly in some way? I guess could you just give us a little bit more color on the restructuring charges?

Garlock is going to fluctuate. It's going to have fits and starts, Andrea, because some of it is associated with building new buildings. Some of it is associated with tearing down buildings, and some of it is associated with capital additions, new equipment into new buildings. I don't think there is any smoothness to that flow at all. Bill, do you have any --

What I would tell you, though, is the run rate in 2006 is lower than what we should see. We will start to see increased demolition activity beginning next year actually which is really where most of the expense is. So we would anticipate an increase next year over what we are running now.

Okay. That's helpful. And then I guess into -- I know it is kind of far down the road, but looking out into '08 then, would that fall off a little bit or is there still going to be continued demolition into '08?

In Garlock? We should start construction again. We should have less demolition and we should restart the construction.

I think you will see likely a fall off. There will still be demolition expenses but we will likely see a fall off. So I think you will probably see a peak in those expenses in '07.

Just to remind you again this is about a five-year project which we are taking 27 buildings down to 7 -- we will build 2 new, totally new buildings and modernize a couple of others, and we will go from about 700,000 square feet to about half that amount. So that will be, as we build a new building we will have to tear down something else to put the next new one up, and tear down some of the old ones over time.

Okay. And on the engine side of the business, I was wondering if you could tell me how many engines you shipped this quarter, what your expectations are going forward? And then on the loss that you incurred, I know that this has been an issue because of the long-term nature of the contact. Is there anything that you guys can do in the way of maybe adding as commodity prices go up you have some kind of clauses in there that could pull in some extra payments. Or is there anything you're doing to try to eliminate this issue going forward?

Andrea, you asked a good question here. Let's start with the number of engines; we shipped four engines this quarter, Bill? And only two last year. So that is part of the change. And we have a pretty hefty fourth quarter. I got to tell you that coming up if we can get them all going. The problems -- about two years ago we had some problems there, and we put a program together that we thought would resolve these problems. We have come to find out that for a series of reasons the programs were not implemented as completely as we thought they would be, and we weren't protected as much as we thought we would have been. So when this new incident came up we put together a task force from several divisions and from corporate, and they went out and they spent about a week out of Fairbanks Morse defining what the problems are and coming back with some good recommendations for us. Some of these changes are pretty simple in terms of line of responsibility, and costing issues and putting in escalators and things of that nature. But most of them resolve around management and management's ability and execution. As you know, Andrea, we changed the division President out there, we've changed the Chief Financial Officer out there. So we believe that with our involvement one of the other recommendations the task force has we got corporate people now going out there, getting involved in the reviews every quarter to make sure that we don't fall behind in this again; we can't afford to do this once more. I'm telling you that right now.

Okay,great. I will hop back in line and let somebody else have a chance. Thanks a lot.

Andrea, hang on.

I just want to add just a little bit of color to that as well. While some of it is self-inflicted, as Ernie described, some we had anticipated being able to resource and move production from higher cost locations to U.S. and for a variety of reasons we were not able to do that and in some situations just because we had trouble finding qualified suppliers. So we were not able to execute a number of the programs we had anticipated that would have allowed us or enabled us to reduce our cost because of the inability to really find qualified suppliers.

That's a good point because you know one of the problems we had last time is everything was European source, and we said we're going to source more in the U.S. Well, unfortunately or fortunately for us as a country, the U.S. economy picked up very nicely in the past year or so. And everybody has been pretty busy; as a result it was hard to find people who could handle the size of the parts that we have in the timeframes that we needed. So we were not able to source everything here internally.

So you are still sourcing some stuff from Europe and that also hurt the cost?

Right and we've also ordered machinery and had the new machinery starting up at Fairbanks Morse so that we can manufacture for ourselves.

Okay, great. Thanks a lot.

(OPERATOR INSTRUCTIONS)Randy Laufman, Imperial Capital.

Congratulations on a very good quarter. Just following up on the last question about the Engine Products business, last quarter you talked about some of the delays you're experiencing in the shipyards. You mentioned that four engines were shipped this quarter versus two last year. Is this a more normal level of activity; are we still seeing delays in the shipyards?

The shipyards are sporadic in their demand for engines. So it would be nice to say that we could deliver -- I'll pick a number -- two to four engines every quarter. That's not the way it works. They build a hull, then they need four engines if that is how many fit in the ship and usually that's what it is. Then they need the four engines now, and then they close the hull up while they put in the electronics, the armament and all the other things to the rest of the ship. So they may not need engines for the next ship until nine months let's say later on, and the shipyards are both on the Gulf Coast and the West Coast. So there are different shipyards for different customers, and the ones on the Gulf Coast are the ones that were affected, of course, by Katrina. Did I answer your question, Randy? I would like to give you as clear a statement that we will deliver two a month or two a quarter for the next year but that is not going to happen. It is sluggish. It is sporadic. As I said we did four this quarter. I think we have four more, four now coming up? (multiple speakers)

It is a very -- as Ernie said it is very lumpy, for the most part deliveries or schedules are outside of our control. It is when the shipyard or the Navy requires them and we can go, we generally make anywhere from 15 to 20 engines a year, and there are some quarters that half of the year's commitments can go in that one quarter. It just depends on the schedule. It is very lumpy and unpredictable.

As you might expect, some of the parts that we're working on now are mid to late 2007, but we have to work on them as we have the time to fill our schedules so we can make their schedules for final shipments.

Okay. I see. Now also following up -- as far as the profitability of that segment goes, and you touched on some of the programs and some of the people that have been appointed there to kind of right size that business, can we expect to see margins similar to previous years as early as the next quarter? Or is there something that we should expect the improvements to start in '07 sometime?

I think we would look for them in '07. That is a long-term -- excuse me, Randy -- that is a long-term business, and to turn that around in a couple of months would be a miracle. I'm confident that the guy we got in there, Tony Gioffredi, is capable and I wish he would be able to turn around that quickly but I don't think he would be able to turn it around in three months. And Tony, by the way was the Vice President of Operations of that division, so he is coming back into that division. He knows enough about it, and we are all confident that Tony can do the job and help turn that around.

Okay, great. And then touching on the asbestos, you mentioned the insurance dispute that you expect to resolve in the coming quarter. Is that included in the 490 million available insurance that you reported, or is that incremental insurance that you could collect?

It is included in that, and what we are doing here is just kind of firming up that insurance and making sure that all these carriers are viable, good carriers and that they are going to pay their bills and so on and so forth. And having insurance and collecting insurance are sometimes two separate things. Maybe Rick could comment more. Rick, anything else you want to add to that?

No, you've answered it correctly. It is insurance that we have always had in our solid U.S. insurance block, and we've had this policy in place. The good news here is that we will collect the entire amount, the entire nominal amount for the policies -- there won't be any commutation in the amount.

Okay, and then I think I may have missed it on the call but what was the actual new filings during the quarter and the actual payments, not the net cash outflows but the payments made in the quarter?

Filings and payments are two different things, you know. The number of new filings in the quarter, Rick, you have that off the top of your head there?

New filings for the nine months are 6,000 versus 11,000, and I don't have the quarterly data in front of me.

That's fine.

The point here, Randy, is two, one is that they have come down dramatically and two, the malignant cases have stabilized and actually started to show some decreases which is really, really important to us.

The other part of your question was total spending or --?

Yes, the actual payments, not the net cash outflows.

Bill, you know the payments in the quarter (inaudible)?

I know for again for the nine months the payments and expenses in total were down 8% from the nine months last year.

Okay, that works. I can do the math. All right, great. That covers it. Thanks a lot, guys.

It appears we have no further questions at this time.

All right. In that case we will say thank you for joining us this morning, and again if you have any follow-up questions or further questions please do not hesitate to give me a call at 704-731-1527. Thank you.

Once again that does conclude today's call. We do appreciate your participation, and you may now disconnect.