Enpro Inc (NPO) 2007 Q3 法說會逐字稿

Good day and welcome to this EnPro Industries third-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.

Good morning, everyone, and welcome to EnPro Industries quarterly earnings conference call. This morning Ernie Schaub, our President and CEO, will discuss our earnings for the third quarter of 2007 and our outlook for the remainder of this 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 minute, Ernie will make his remarks and then we'll 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 a belief, expectation, or intention, as well as those that are not historical fact. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements. These risks and uncertainties are referenced in the Safe Harbor statement included in our press release and are described in more detail along with other risks and uncertainties in our filings with the SEC, including our Form 10-K for the year ended December 31, 2006, and the quarter ended June 30, 2007.

We do not undertake to update any forward-looking statement made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based. This call is also being webcast on enproindustries.com, our website. A replay of the call will be available there shortly after the call is completed. If your questions are not answered on the call or if you have any follow-up questions, please feel free to contact me at 704-731-1527.

Now I will turn the call over to Ernie.

Thank you, Don. Good morning, everyone. We're glad you joined us today. If you had a chance to read our earnings release, you know that we had a very good third quarter and continued the record pace we sat in the first two quarters of the year.

Sales exceeded $250 million for the second quarter in a row and our segment profits exceeded $40 million for the third consecutive quarter. Based on where we are after nine months and our expectations for the fourth quarter, it is safe to say it looks like 2007 will be another great year for us.

Let's look at the quarter in more detail. It is not unusual to see seasonal factors slow things down during this time of year, but sales are up 11% over the third quarter last year to almost $253 million. And they were essentially flat with a very strong second quarter of 2007. Internal growth initiatives contributed about 5 percentage points of the increase, while acquisitions and foreign exchange accounted for the other 6 points.

Segment profits are up almost 30% to just over $40 million. Again, this was comparable to the segment profits we reported in the first two quarters of the year. Segment margins were 16% compared to 13.6% a year ago, when they were reduced by the cost overruns at Fairbanks Morse Engine. But even after adjusting last year's margins for the overruns, there was a strong year-over-year improvement.

Margins expanded this year as volumes increased and pricing improved and as we benefited from our total customer value lean manufacturing program. Our managers and employees have made TCV part of our culture and we believe will continue to benefit us in the future as we go forward.

Our performance also reflects improvements at Fairbanks Morse Engine, which is operating at a level of profitability we always believed possible. Looking at SG&A expense, we see that it increased by about $10 million or 21% over the third quarter of last year. Increased spending on R&D and on sales and marketing as part of our strategies have contributed to the increase. The other half of the increase was the result of the weaker dollar and higher amortization expense associated with the acquisitions we made.

Asbestos-related expenses were $11.5 million in the third quarter compared to almost $29 million a year ago. This year's expenses were about equally divided between cash expenses and non-cash charges to update the ten-year estimate of the liability. In the first three quarters of 2007, our asbestos-related expenses averaged a little less than $13 million a quarter including cash and non-cash charges. This is at the low end of our expected range of normal expenses which we think are likely to average $13 million to $16 million a quarter for the next few years.

We ill continue to monitor our estimated liability and make updates as required, which could result in additional charges and increased expenses in the future.

Moving to the bottom line, we reported net income of about $12 million or $0.54 a share this year, compared to a net loss of about $4 million or $0.20 a share last year. Reduced asbestos-related expense and a 30% increase in segment profits drove improvement.

The contribution of our segment performance is clearer if we look at our earnings before asbestos and restructuring expenses. On that basis, our income improved to $19.5 million or $0.86 a share. That is 34% better than the third quarter of last year. All of my references to earnings per share are on a diluted share basis.

Over the first nine months of the year, sales were up 10% to just over $754 million. About half of the growth was organic and about half came from foreign exchange and acquisitions. Segment profits were almost $127 million or 20% better than the first nine months of last year. Segment margins reached 16.8% for the first nine months, compared to 15.4% for the first nine months of last year.

Net income in the nine months was over $38 million or $1.71 a share, a significant improvement over last year when net income was almost $15 million or $0.68 a share. The comparison is affected by the same factors that benefited the third quarter this year, a decrease in asbestos expense, which is down 35%, and an increase in segment profits, which were up 20%. Before asbestos and restructuring expenses, income in the first nine months improved by 29% over last year to about $63 million or $2.83 a share.

Turning to our segment's performance in the quarter, Sealing Product sales improved by about 5% over the third quarter of last year to almost $113 million. About 3 points of the improvement came from foreign exchange. Garlock Sealing Technologies made the largest contribution to the segment sales growth. Garlock continues to benefit in the quarter from strong European markets, growth in North America, and record oil prices, which has stimulated upstream oil and gas markets.

The heavy-duty truck market served by Stemco were not as active during 2006 when they were at record levels. Demand was down from original equipment customers and to a much lesser degree from aftermarket customers. Original equipment sales declined as expected after operators added to their fleets last year in advance of new environmental regulations. Aftermarket sales reflect the level of truck ton miles, which has decreased as U.S. construction and automotive markets have slowed down.

Also within Sealing Products segment, Plastomer Technologies reported decreased sales as semiconductor equipment markets weakened. Profits in the Sealing Products segment improved by 15% to $20.5 million and profit margins improved 150 basis points to 18.2%. Garlock led the improvements as it continued to benefit from higher volumes, better pricing, a more profitable product mix, and operational improvements. Both profits and profit margins improved significantly there.

Restructuring costs associated with the modernization of Garlock's Palmyra, New York facility did not have a significant impact on the results. Overall this project is progressing well, but some aspects of it have been delayed and restructuring costs have been pushed into later periods. At Garlock Rubber Technologies, pricing and increased efficiencies both contributed improved profits and profit margins.

Although Stemco sales were lower, profits were about the same as a year ago and margins improved thanks to a higher mix of aftermarket sales, which are generally more profitable than the original equipment sales. Profits and margins at Plastomer Technologies declined on their lowest sales volume.

Looking at the Engineered Products segments, sales increased by 15% over last year's third quarter to $111.5 million. The most significant factor in the segment sales growth was the contribution of acquisitions we completed earlier in the year. They contributed about 7 percentage points of the growth. The remaining 8 points were equally divided between foreign exchange and organic growth.

Compressor Products International, the business we used to call France Compressor Products, made the largest contribution to the segment sales growth. As you recall, Compressor Products International, or CPI, is the name of the business we acquired in the third quarter and we adopted that name for the combined businesses. That acquisition plus Texflo that we made earlier in the year, made a significant contribution to the increase in sales at CPI.

But the core business also benefited from stronger refining and natural gas transmission markets in North America and improved OEM markets in Europe. The combination of acquisitions and strong core markets of CPI sales nearly doubled from a year ago.

GGB sales also increased over last year reflecting foreign exchange and higher demand in European industrial markets, especially in Germany and other Central European countries. GGB's North American markets were mixed with increases in agriculture and aerospace markets but declines in construction and related markets.

Declines in North American construction market also affected Quincy Compressor sales which were down from last year's record levels. Profits in the Engineered Products segment increased 15% to about $17 million, but margins improved only slightly to 15.5%. Although GGB experienced increases in some raw material costs, profits and profit margins were higher as volumes and pricing improved and efficiencies increased.

At Quincy, even though sales were down compared to last year's third quarter, profits were about the same as last year and margins actually improved because of increased efficiencies and material cost savings from supply chain initiatives.

At CPI, the acquisitions contributed to an increase in profits, as did higher volumes and better pricing; however, CPI's margins were lower than a year ago because of increased non-cash amortization expense associated with the acquisitions. The increase in amortization offset the improvements in margins at GGB and Quincy and was responsible for the limited improvement in the segments' overall margins.

In the Engine Products and Services segment, increased parts shipments to both military and commercial customers produced a 19% increase in sales, which rose to almost $29 million in the quarter. The value of new engines and associated equipment shipped to Fairbanks Morse in the third quarter was about the same as it was in third quarter last year.

The segment reported a profit of $2.6 million in the third quarter compared to a loss of $1.8 million last year, which was the result of a little over $3 million in cost overruns. This year profits and margins benefited from efficiency improvements, better pricing, and the increase in parts business, which carry better margins.

The management and employees of Fairbanks Morse have put a lot of effort into getting this business back on track and their efforts have produced improving results over the past several quarters.

Turning to cash flows, better working capital and management and lower net cash outflows for asbestos help our operations generate $75 million in cash for the first nine months of the year. We generated $42.5 million for the first nine months of last year. Our working capital increase in the first nine months of the year was $5 million compared to $17 million in the first nine months of last year. Typically if you recall, working capital needs decline in the second half of the year along with seasonal demand.

Capital expenditures were about the same this year as last year, a little over $30 million. The largest single capital project is Garlock's Palmyra modernization, where we have begun construction of a second new building, one which will house the GYLON product line.

Spending on acquisitions increased to just over $72 million this year compared to about $27 million last year. I remind you we closed two acquisitions this [fiscal] year including CPI, which is our largest to date.

Through the first nine months of the year, asbestos-related payments totaled about $91 million compared to total payments of $98 million in the first nine months of last year. Insurance receipts in the first nine months of this year were about $77 million, resulting in a net outflow of about $14 million. This compares to a net outflow of almost $36 million in the first nine months of 2006.

For the full year 2007, we expect to collect approximately the same amount of insurance as we collected in 2006 when we received about $88 million. However, total spending on asbestos should be significantly less than last year and net cash outflows for the full year should be well below last year's $38 million.

At the end of September, about $393 million of solvent insurance remains to be collected for asbestos claims. The total estimated asbestos liability over the next 10 years was $517 million. The liability does not include legal fees and expenses which are recorded as they are incurred and were about $21 million in the first nine months of this year.

To make sure this point is clear, both the insurance available for asbestos claims and the liability for asbestos claims should continue to decline over time. However the gap between the insurance available to be collected and the liability grows as we maintain our 10-year estimate of liability. As we have noted repeatedly in the past, this does not present an impediment to our ability to invest our growth or to create a bigger, stronger, more valuable company.

Through the end of September, we received about 4300 new asbestos claims against Garlock, including about 1200 in the third quarter. Year-to-date, new claims are 40% below the same time last year and remain at the lowest level we've seen since the 1980s. Most of the decline has come from claims in nonmalignant diseases, although we've also seen a decline in claims for malignant diseases as well.

We expect the trend of declining claims to continue for many reasons. Among them are reforms, which have eliminated abuses of the system and contributed a reduction of nonmalignant claims, and declining incidences in malignant asbestos related diseases. The decline in malignant diseases is in line with the public demographic studies which predict they will decline at a 4% average rate for the next five years and steadily increasing rates thereafter.

Before I open the lines to your questions, let's take a look at what we expect in the fourth quarter. In general, the market conditions that have benefited us so far this year should continue through the end of the year. Our energy related markets and European markets remain healthy. Overall, North American industrial growth should continue at about the same pace we've seen throughout the year.

Despite seasonal factors that often reduce sales and profits for us in the fourth quarter, these market conditions combined with our acquisitions and new engine shipments at Fairbanks Morse should produce an increase in sales over the fourth quarter of 2006 and we continue to expect to complete the full year with slightly more than $1 billion in sales. We also expect segment profits to improve over last year, although the increase is likely to be slight given the strength of last year's fourth quarter.

Looking at cash flows, working capital levels should remain relatively low as seasonal activity decreases. Capital spending should exceed the $41 million we spent in 2006 as we expand our presence in China and in India, continue the modernization of Garlock's Palmyra facility, and take other steps to improve productivity throughout the Company.

As I mentioned, net cash outflows for asbestos will be lower for the full year 2007 than they were for the full year 2006. In the fourth quarter, however, they will increase compared to last year.

We will continue to look at acquisition candidates and we may close a couple of small deals before the end of the year. Our balance sheet is strong, which puts us in good position to pursue additional acquisitions and other opportunities to build value.

We're in good shape as we look forward to the rest of the year and into 2008. I'm both pleased and proud of this, because as you know I plan on retiring next year. In anticipation of my retirement, the Board has begun a search for my successor. The search is ongoing and includes both internal and external candidates. Speaking as a member of the Board, I can tell you that we intend to find the right person for the job, someone whose philosophy is aligned with the strategies that have made the Company successful over the past five years and will keep EnPro on the path of continuous improvement.

In the meantime, my commitment to our strategies and my dedication to our employees and improving our companies will not change. With the help of a very capable management team and highly dedicated employees and the full support of our Board, we have plans in place that will enable EnPro to continue to achieve good things for our shareholders for a long time.

We're pleased with what we've achieved over the past 5.5 years and we are very confident about our future. Our sales, segment profits, and segment profit margins are on track to reach new highs again in 2007. We're comfortable that asbestos related cash flows remain very manageable as our Company grows stronger. We intend to continue to invest in acquisitions and other opportunities to improve the strength, diversity, and value of our Company. We're confident in our strategies and the ability of our management and employees to implement them.

We're in great shape to continue on our path of improvement as we prepare for 2008.

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.

I think this is a question for Bill though. You mentioned -- it is mentioned both in the release and in your prepared remarks that the margins on Engineered Products were held down because of amortization related to acquisition and then non-cash expenses. What -- if I netted those out, what would the margin improvement have been just generally?

We picked up a point or more each at both Quincy and GGB and I think at CPI I am going to guess it was maybe down between 1 point and 2 points. So I think overall we would have had more significant improvement I'm guessing of 1 point or more.

Okay, great. Thank you.

(OPERATOR INSTRUCTIONS) Randy Laufman, Imperial Capital.

A question on the two recent acquisitions and how that compares on a margin basis to the overall Engineered Products group. If you could give us a little bit more color on how that is going to impact the margins going forward?

Well, Bill, do you want to take a shot at that one?

Sure. I would think that at least initially our margins, our EBIT margins will be depressed a little bit primarily because, as we said, the non-cash amortization expense. There are some of those intangibles that will be amortized over a short, very short period of time, so there will be some depression there, although I think if you looked at it at the EBITDA line, it will be much less significant. These businesses pretty much function and operate in line with our existing businesses. So I think you'd see very little diminution at the EBITDA margin line.

Okay, great. Thank you. And then also, you mentioned that you are continuing to look at acquisition opportunities and you may even close a couple in the near term. I was wondering if you could talk about the markets that you're targeting and also whether that would continue to be in the Engineered Products segment or if you're looking at acquisitions in your other segments?

No, we don't look at any particular markets or segments. We look at opportunities for the Company to create value. We don't look either geographically or market wise. What we focus -- we try to focus on our -- those in which we have good, strong positions, which are clearly our sealing business and our bearings business.

While we look at those businesses primarily, we look at opportunities overall and each of our divisions come forth with ideas and suggestions, and then we look at them ourselves in a macro sense and use investment houses. So we are not focused on any one particular item or area. Bill, anything you can add to that?

I think, Ernie, you said it right. We look at businesses that will complement our existing businesses, strengthen market share, help us fill out our product line, help us fill out or broaden our geographic mix. At the end of the day to the extent we think we can bring value or that they help us by broadening our participation in various markets, it is a net win for both. That's our focus.

I think the CPI one shows you an example that we had a good business in France Compressor and we added to it and we have become a very good, strong market presence by adding a couple of companies together.

Okay, thank you guys very much and very nice quarter.

(OPERATOR INSTRUCTIONS) We have no further questions in the queue. I'll turn the conference back over to Mr. Washington for additional or closing remarks.

Again, thank you very much for tuning in this morning and if you have any further questions or any follow-up, please feel free to contact me at 704-731-1527 and we'll look forward to talking to you again next quarter. Thanks.

That concludes today's conference. You may disconnect at this time.