Enpro Inc (NPO) 2007 Q2 法說會逐字稿

Good day and welcome to this EnPro Industries second-quarter earnings 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, Katy, and good morning everyone. We welcome you to EnPro Industries quarterly earnings conference call. We've got Ernie Schaub, our President and CEO with us this morning to discuss the results for the second quarter and our outlook for the rest of the year. Bill Dries, our CFO, and Rick Magee, our General Counsel are also here and prepared to participate in the Q&A. In just a minute Ernie will make his remarks and then we'll open the lines for your questions.

But first I want 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 actually 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, 2006 and the quarter ended March 31, 2007. We do not undertake to update any forward-looking statement made on this conference call to reflect any change in managements expectations or any change in assumptions or circumstances on which such statements are based.

This call is being webcast on our website, enproindustries.com. A replay of the call will also be available on the website. If you have any questions after the call that aren't answered or if you want to have any follow-up questions, give me a call afterward at 704-731-1527.

And with that, I'll turn the call over to Ernie.

Thanks, Don, and good morning everyone. We're glad you joined us today. I'm very pleased to tell you that for the second consecutive quarter we set new records for our performance in terms of sales, segment profits and to segment profit margins. Our performance in each of those categories exceeded our previous highs which we reached in the first quarter of this year and certainly gives us confidence as we enter the second half of the year.

But before I go into the details of our performance in the quarter, I'd like to take a minute or two to review recent acquisition activity. Over the past twelve months, we've announced six acquisitions, five of the six related to our France Compressor Products business. Through the acquisition process, we transformed FCP into an important part of our core business. To remind you, FCP provides seals, valves and other aftermarket parts as well as service for reciprocating compressors using chemical plants, refineries and natural gas processing and transmission. It is currently enjoying very active markets.

You might recall that last year we completed the acquisition of Allwest Compressor Services, Southwest Compressor Services, HAR Compressor Products, and in the second quarter of this year, we acquired TexFlo Machining. These four acquisitions primarily increased our presence in the natural gas markets in Western Canada. They also enhanced our service capabilities, expanded our productline and increased our manufacturing capabilities for these products and services.

We completed the fifth and largest acquisition this week when we closed on the purchase of Compressor Products International or CPI. The addition of CPI and our early acquisitions more than doubles our compressor products sales and moves the business into the top tier of EnPro Companies. These investments are a perfect fit with our core strategy of focusing on high margin businesses with strong market shares and good brand names.

With the CPI acquisition, we have created a larger and stronger business with a leading marketshare and a truly international presence as CP and CPI complement each other very well. They have similar product lines and similar customers although CPI is more active in the OEM markets. They have little geographic overlap. FCP is stronger in North America and has a smaller but meaningful presence in Europe. CPI is stronger in Europe with a smaller presence in North America. CPI also has greater exposure in the Middle East and a growing presence in South America and Asia.

The combined businesses will be one of the world's largest supplier of the sealing components for reciprocating compressor and an important OEM supplier as well. Because Compressor Products International is a more accurate description of the business and our objective of addressing international markets, the combined business will be called by that name. We're obviously excited about CPI and the growth of our compressor products business. It shows our acquisition strategy is viable and effective at identifying opportunities to improve the value of our Company.

The CPI acquisition like all those we've made to date was completed out of our own cash balances. Integration costs will limit its contribution to our results this year but beginning next year we will see increasing contributions from the transaction and our expanded compressor products business.

Now let's take a look at the second quarter. As I mentioned, it was a record quarter. Our sales increased 12% to $254.4 million. Organic growth drove about 7 percentage points of that increase while acquisitions and foreign exchange drove about 5 points of the growth. Segment profits were up 22% to $43.9 million and segment margins reached 17.3%, almost 1.5 points better than margins in the second quarter of last year.

Both segment profits and margins were the best we've ever recorded. They benefited from higher volumes, better pricing, a stronger euro, acquisition and lower pension expense. The increase also reflects the performance of Fairbanks Morse Engine where we've seen the steady improvement over the past three quarters.

Asbestos-related expenses declined to $13.1 million in the second quarter compared to $20.7 million a year ago. The expense in 2007 included $6.7 million for legal fees and other cash expenses incurred in the quarter and non-cash charges of $6.4 million, primarily to update the liability so that we maintain a rolling ten-year estimate.

Following the adjustment of our asbestos liability in the fourth quarter of last year when we began recording it at a point within the range of possible liabilities rather than at the low end of the range, our asbestos-related expenses have stabilized. They were about $13 million in each of the first two quarters of 2007 and we expect to remain in a range of around $13 million to $15 million a quarter for the near term. Longer-term, however, we expect these quarterly charges to decline.

Higher segment income and lower asbestos-related expenses helped our net income increase by more than three times over the second quarter of last year. Net income rose to $13.8 million from $4.2 million last year or $0.61 a share from $0.19 a share. My references to per share amounts are on a fully diluted basis.

The improvement in net income is impressive and we are proud of it. However, another way to look at our performance is to consider our earnings before asbestos and restructuring expenses which is a better reflection of how the operations perform themselves. On that basis, our income improved 33% to $22.8 million or $1.01 a share compared to $17.1 million or $0.79 a share last year.

Briefly looking at our results in the first half of the year, sales are up 10% to $501.7 million. About half of that growth came from foreign exchange and acquisitions. Segment profits for the first half of the year were $86.1 million. That's 16% better than the first half of last year. Segment margins reached 17.2% in the first half compared to 16.3% last year.

Net income in the first half was $26.1 million or $1.17 a share. That's an improvement in income of 37% over last year. Before asbestos and restructuring expenses, income improved by 24% over last year to $43.9 million or $1.97 a share.

Now let's take a look at the quarter segment results in some detail. We will begin with the Sealing Products segment. In that segment, sales were up about 9% to $118.3 million. About 5 percentage points of the improvement were the results of favorable foreign exchange rates and the benefit of the acquisition of Amicon Plastics. Sales increased by 17% at Garlock on healthy markets in France and Germany and strong oil and gas markets both in the upstream and downstream sectors. Garlock also benefited from pricing improvements and foreign exchange.

And Plastomer Technologies, an acquisition made last year which is the Amicon one, contributed to a solid increase in sales. As we anticipated, the heavy-duty truck and trailer markets served by Stemco remain soft. Sales there were down about 7% as both OEM and aftermarket demand fell from the very high levels of a year ago. Garlock's performance helped profits in the segment increased to $22.1 million, a 19% improvement over last year. Garlock benefited from the higher volumes we talked about, some better pricing, but a more profitable mix and operational improvements also aided. Even though restructuring costs associated with the Palmyra modernization increased by about $1 million, profits at Garlock were up substantially from last year.

Reduced demand led to lower profits at Stemco. Profits were down slightly at Plastomer Technology because of weakness in the semiconductor market and costs associated with relocating operations from near Philadelphia to Houston. Longer-term, we expect that that move will result in improved efficiency in Plastomer.

Garlock's strong performance in the quarter helped the segment's margins improve to 18.7%, more than 1.5 points better than last year's second quarter. Before restructuring costs, profits improved about 24% and margins were 17.9%. We're really pleased with this performance and the high-level at which the Sealing Products segments has performed over the past several quarters.

Let's take a look at Engineered Products. In the Engineered Products segment, sales improved to $108.3 million, an 8% increase over last year. As was the case in Sealing Products segment, sales benefited from favorable foreign exchange rates and acquisitions. They combined to contribute about 6 points of the increase. At FCP, sales and profits each increased by more than 40% over the second quarter of last year. Acquisitions and higher activity in North America and Europe drove this increase.

Sales at GGB increased about 9% as the bearing business benefited from activity in Europe and a favorable foreign exchange. Softer conditions in automotive and industrial markets resulted in a slight decrease in GGB's North America sales.

Quincy Compressor also reported a slight decrease from its record sales of last year as demand for compressors for markets in North America softened from those high levels. Overall, the segment's profits improved 12% over last year to $18.4 million. Higher volumes, better pricing and cost reductions benefited both GGB and FCP. GGB also benefited from favorable foreign exchange rates while acquisitions provided additional improvement at FCP. Profits were down slightly at Quincy Compressor in association with the volume decline.

The segment's profit margins reached 17% compared to 16.3% a year ago. Again, we're quite pleased with this improvement in margin despite mixed conditions in its markets.

Finally, we turn to the Engine Products and Services segment who recorded the strongest year-over-year improvement of any of our businesses. Sales in the segment increased by 54% over 2006 to $28.2 million as Fairbanks Morse Engine shipped three engines in the second quarter of 2007 compared to shipping none in the second quarter of 2006. In addition to the higher engine sales, sales of aftermarket parts and services also increased.

Importantly, profit more than tripled over the second quarter of last year to $3.4 million from $1.1 million and the segment's margins more than doubled to reach 12.1%. The improvement shows our turnaround efforts at Fairbanks Morse are paying off. We've put a lot of work into making this a better business. Over the past three quarters, it has performed at its most consistent level in five years that we've been an independent company. We're now confident that it's headed in the right direction.

Turning to cash flows, our operations generated about $44 million in cash in the first half of the year compared to about $17 million in the first half of last year. The difference primarily reflects improved working capital performance especially at Fairbanks Morse Engine and a reduction in net asbestos cash outflows. The working capital increase was $12 million in the first half of the year compared to over $33 million in the first half of last year. Typically our working capital needs are higher in the first half of the year and they decline in the second half as seasonal demand abates.

Capital expenditures were about $19 million in the first half of this year compared to about $16 million in the first half of last year. The additional spending was primarily related to Garlock's Palmyra modernization which I've got to tell you is proceeding very nicely. Demolition of older buildings is being completed this summer and we expect to begin construction on a second new building later this year. This building will house Garlock's GYLON static seal productline. If you remember, our earlier building was for our dynamic seal business.

We spent about $12.5 million on acquisitions in the first half of 2007 compared to about $11.6 million in the first half of 2006. Acquisition spending in the first half of the year of course doesn't include the CPI transaction because that closed at the end of the second quarter.

Total asbestos-related payments were about $68 million in the first half of the year. The total included payments about $14 million for fees and expenses in the first six months and about $54 million for settlements and judgments. Total payments in the first half of 2006 were about the same at $69 million.

Insurance receipts increased over the first half of last year because of $22 million in payments we received this year in connection with the settlement of an insurance dispute. As a result, total insurance receipts in the first half of 2007 were almost $65 million. The net outflow was about $3 million. In the first half of last year, insurance receipts were about $46 million and the net outflow was $23.5 million. The lower net outflow in the first half of this year reflects the timing of collection of the $22 million. Even though we expect net outflows to increase in the second half of the year, for the full-year they should be below last year's net outflows.

Insurance collections in the first half of 2007 reduced the amount of solvent insurance available for asbestos claims to $405 million at the end of June. The total estimated asbestos liability over the next 10 years declined to $527 million at the end of June from $568 million at the end of 2006. The change primarily reflects settlement payments. The liability does not include legal fees and expenses which are recorded as they are incurred.

We received 1200 new claims in the second quarter and a total of 3100 in the first half of the year. The first half total is about 26% less than the first half of last year although the number in the second quarter filings, the number of second-quarter filings was about the same as second quarter of last year. New filings appear to have leveled off at an annualized rate of just over 6000. That number compares very favorably to the nearly 45,000 claims filed against Garlock in the peak year of 2003.

As you know, managing the asbestos liability of our subsidiaries is one of our core strategies. Beside the financial implications, the strategy also involves managing claims and making tough decisions about how we proceed in the courtroom, both in trials and appeals. In that regard, we are pleased today that Garlock won a jury verdict in Boston in the second quarter. It was the only asbestos case our subsidiaries tried the verdict during the quarter. Garlock has now won the past four cases it has tried the verdict dating back to the second half of 2006.

Also in the second quarter, a New York appeals court overturned a 2004 verdict against Garlock that was rendered in upstate New York. Garlock was granted a new trial. We have now resolved a large majority of pending appeals. Only two appeals of verdicts for a total of just over $1 million remained unresolved.

Now let's take a look at what we expect in the second half of 2007. While there's been some softening in the rate of growth in the U.S., the general market conditions we encountered in the first half of the year should extend into the second half. In addition, it is not unusual for us to see some seasonal decline in the second half and especially in the third quarter. However, our European markets remain strong. And demand there should be good especially from customers in France and Germany during the final six months of the year.

Our oil and gas markets are very healthy as well. In the U.S., our industrial markets are mixed and our heavy-duty truck market will probably continue at the level below the very high level we experienced last year. These market conditions combined to our acquisitions and an increase in engine shipments at Fairbanks Morse Engine should produce higher sales in the second half of 2007 than we reported in the second half of 2006.

At the current rate of growth in our Sealing Products and Engineered Products segments, and with increased engine shipments from Fairbanks Morse, we expect to end the year with slightly more than $1 billion in sales.

We expect restructuring expenses to increase in the second half of the year as we proceed with the Palmyra project and the relocation of Plastomer Technologies. Despite these additional costs, our segments should perform better than they did in the second half of 2006. Segment profits and margins should increase from that rate as we benefit from the diversity of our markets, strong aftermarket sales, acquisition and operational improvements.

Looking at cash flows, working capital levels should decline during the second half of the year as seasonal activity decreases. Capital spending should continue to exceed the levels of 2006 when we spent $41 million for the full year. This year we will be spending to expand our presence in both China and in India; to continue the modernization of Garlock's Palmyra facility; to consolidate Plastomer operations; and to take other steps to improve productivity.

The amount of cash used for acquisitions will increase in the second half of the year as a result of the CPI acquisition and be substantially higher for the full year than it was in 2006. But our balance sheet should remain strong and leave us in good position to meet our obligations, to pursue additional acquisitions and for other opportunities that will build value. We expect asbestos net cash outflows will be higher in the second half of the year than the first half. But for the full year, they should be significantly lower than in 2006 when they totaled $38 million.

All in all, we're very happy about that performance in the first half of 2007. We believe that it points to the effectiveness of our strategies, and our ability to implement them and leaves us in a great position to continue to improve our performance over the rest of this year into 2008.

Before I close my remarks, I'd like to point out that we celebrated our five-year anniversary as an independent public company in June. We've come a long way during those five years. We've achieved compounded annual sales growth of 8%. Segment operating income has grown at a compounded annual rate of 16%, and our share price has increased more than 600% from about $7 a share on June 3, 2002 to $41 a share as of yesterday's close.

All of this is made possible by our 4400 hard-working employees around the world who have embraced our strategies and welcome the challenge of continuous improvement. Some of you have been with us from the beginning. We're proud of what we accomplish together and we thank you for your continued confidence in us.

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

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

Good morning, Ernie. In terms of the Engine Products and Services, usually when you ship engines there's so much lower margin that the overall margin of the segment go down. This time it went up dramatically. Is there a change in the licensing agreement or is it just better pricing?

Actually there are several things going on. As you recall, last year we took some write-downs on new engine shipments. We also went back to our licensor and did make some changes in the agreements that we had with them in licensing the product. But we've also changed our management team out at Fairbanks Morse and brought back the guy who was doing some of the operations from a while ago and we made some great productivity improvements there to get those engines out. We've also negotiated with our customers on different pricing.

So it's a combination of events that have made the big difference, not one single item. We believe going forward as we told you a while ago that we would fix this program. And we believe going forward we fixed the problem so that we will not be selling engines in the future at a loss as we did in the past. Bill, anything else you want to add to that?

No, I think you pretty much covered the gamut. The one thing I would add, we also, Liam, in addition to the increase in the engine shipments we also had a nice increase on our parts and service aftermarket revenues as well which is obviously a pretty decent margin business.

Right, okay. Thank you.

Tom Brinkman, Davenport & Co.

Good morning everybody. Just wanted to know a little bit more about I guess the acquisition environment. There has been some talk recently that maybe some of the private equity players have pulled back somewhat due to a little bit tougher market conditions for debt financing. Anything you can say about that? Is it related to your pickup in acquisitions or is it just coincidence?

I think that's a little bit early and it's more coincidence than anything. That is a very recent event, only in the past week or two. And the acquisitions that we've made have all been private organizations, made on the basis of some personal relationships and activities by our divisions. So they're not in the same scope I think. Bill, anybody, have a comment you want to add?

I think to the point that you just made, Ernie, a number of these acquisitions, we've been in discussions formal and/or informal for six months, a year, two years. So there has been a lot of relationship work over time. So this is not -- these are not a reflection of less competition on the private equity side. The jury is still out on what impact that will have as we continue to actively seek other acquisition opportunities.

Okay. Also you said you made five, the six acquisitions in the past year have been related to compressor products. Can you tell us what kind of costs might be able to be taken out from synergistic kind of the situation there? And what the timeframe might be for those kind of operational improvements?

Well, the first group of acquisitions we made were smaller acquisitions and most of them in Western Canada. I think all four of them really were Western Canadian operations. And they gave us two things. They gave us a market expansion to an area we had not geographically been serving very well and they gave us some new products and service and customer bases which helped us. So I don't see in the immediate or in the near term much leveraging of that except for the fact that now we make parts for each other and we brought each other some customers that we had in the past.

So there is not a lot of I'll call overlap and synergistic opportunities there except for increased sales. And you know, to that extent, we've seen that. Some customers that were being served by one of these operations that we bought are now being served by several of them which is to our benefit.

But the CPI acquisition is a much larger acquisition than the other two and I think it gives us an opportunity for synergistic gains but we're not sure what they will be yet. We have a good idea, a rough idea what they will be but we haven't gone through the detail of implementing it. And as I told you, we don't expect to see any improvement in returns from this thing this year at all. We expect there will be costs to implement any changes that we make, any transitions that we make for this year but we expect the profit to come next year. Bill?

I think you pretty much covered it, Ernie.

Okay, all right, good. I just want to make sure we hit the issues here. Okay, Tom?

Okay. And can you tell us what the backlog is at Fairbanks Morse in terms of the engines? You mentioned that engine shipments are also going to rise in the second half --

Off the top of my head I don't know. (multiple speakers)

This is Don. I'll get you that answer and get back to you.

Okay.

What I can tell you is that we just agreed to some additional engines for 2009, 2010. So I know that it's pretty nice, the guys have done a good job there.

We've got about 240 million in total backlog and Fairbanks Morse represents a little more than half of that.

Okay.

Typically, you know.

And then you mentioned of course strength in Europe. Can you just talk about the I guess industrial outlook for the second half of the year in terms of your end markets in Europe? That is all I had for you. Thank you.

Yes, the industrial markets in Europe have really been surprisingly strong to be honest. You know, with the euro as high as it is, not much of it is going exported out. A lot of it is going to Eastern Europe and to each other internal within Europe. The strength there has been across the board.

Just about every operation that we have in Europe has been pretty strong whether it is our Bearings business or our Sealing business and it has been helped a little bit from our operations here in the U.S. that we've been able to ship some more product over there because of the dollar relationship. So I think that the combination of the weak dollar for us and the overall economic environment in Europe has strengthened those markets nicely for us and surprisingly good for us. Bill?

Yes. No, I think you've summarized that well.

Okay, thanks. I will get back in queue.

(OPERATOR INSTRUCTIONS) Henry Schacht, Schacht Value Investors LLC.

Thank you, good morning. As one of the shareholders that has been around since the beginning, thank you for the accomplishments and all the hard work of the last five years and I remember these calls when you guys seemed to be talking to yourselves. That's when I didn't ask questions.

In any case, you mentioned that there in addition to further acquisitions you do see other opportunities to build value. I'm one that is hoping for a share repurchase and/or a dividend. And if you could comment on either of those two things or both, I would appreciate it. Thanks. all.

First of all, Henry, let me thank you for sticking with us for five years. Because of some loyal, valuable investors that we've been able to survive and do well, we appreciate your support.

But let me try to answer your question as best I can. First of all, we just recently had a Board meeting and as we do at every Board meeting, the issue of buybacks and dividends comes up. And we look at it every Board meeting, consider it, discuss it and usually has been the past is always something that we want to keep continuing to look at. So there is nothing -- it's not an item we throw off the agenda; it's not an item that doesn't get considered every Board meeting. In fact, at one of our recent meetings, we brought in our financial advisers to talk about the pros and cons and what the alternatives are, how to do it, what to do, and so on.

So it's not an item that is treated very lightly. It's always given strong consideration, but at this point, the Board has said to us that the strategies that we have identified and have been implementing have -- as you see the 600% increase in the share value have done a great job in increasing value for the company. And as long as we believe that we can continue to do that, they think that would be the best investment for us at this time.

And to that point, they've charged us to carry out the strategic plan and the strategies that we've defined for them and of course, one of the key responsibilities of the Board is to make sure that our strategies are well-defined, have reasonables to them and have an accomplishing capability. I think that is the target we're on right at this time. Anybody else? Bill?

Yes, I think it will remain on the agenda. We will continue to consider it as we go along. If we get to the point where we think that makes more sense, I think we'd be willing to entertain that. But at this point, to Ernie's point, we believe we can bring more value by continuing along and following the four core strategies which we've adopted and adhered to since the day we spun out.

Yes, early on, Henry, I will tell you the Board kind of threw those ideas out but at this point in time, there is very, very serious consideration of it. To Bill's point, at the time when we can't do it, should we be unable to execute the strategies, I think the Board is poised.

Fair enough. All I will say is I don't view a dividend or a buyback as being mutually exclusive or opposed to the strategy that you are going forward with. I think they can work in combination very well. And secondarily, if you ever looking for another voice on the Board, give me a call. Thanks.

Thank you.

It appears we have no further questions at this time. I'd like to turn the conference back over to Mr. Washington for any additional or closing remarks.

Thank you everyone for dialing in today. We appreciate your joining us on the call, your questions and your attention. And as I say, if you have any other questions, give me a call, 704-731-1527. Thanks and we will talk to you next quarter.