Enpro Inc (NPO) 2008 Q1 法說會逐字稿

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

Thank you and good morning, everyone. Welcome to EnPro Industries' quarterly earnings conference call. This morning we've got the pleasure of introducing you to Steve Macadam who joined EnPro as President and CEO last month. I'm sure you're all looking forward to hearing from Steve and I'll turn the call over to him in just a few minutes. He'll be joined this morning by Bill Dries, Senior Vice President and CFO, who will discuss our financials. In addition, we've got other members of the corporate staff here and present, prepared to participate in the Q&A session.

Before Steve and Bill make their remarks and we open the lines for your questions 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, 2007. We do not undertake to update any forward-looking statements 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 and a replay of the call will be available on the website shortly after it concludes. If you have any questions that 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. With that I'll turn the call over to Steve.

Thank you, Don. Good morning to everyone. I'm happy to be with you this morning. I want to begin by saying it's a privilege to join EnPro us obviously the Company has had tremendous success over the past six years, which is a real testament to the sound strategies that the Board and management team have established early on, as well as to the leadership of my predecessor, Ernie Schaub, and also to the outstanding effort of our 4,700 employees around the world.

Ernie put a lasting imprint on this company and prepared it very well for the future. I'm excited to step into the role he filled so well for so long and I will certainly do my best to keep EnPro on a path that leads to continued improvement and even greater success.

As you know, I've been in the job for only a few weeks now, so I may not have all the answers to your questions, especially when it comes to my specific plans and potential changes to our future strategic direction. I've begun an in-depth assessment of our strategy and operations, but EnPro is large, diverse and spread out geographically, so it will take some time. However, I do want to assure you that I believe EnPro is in fine shape and that our strategies and operational capabilities are fundamentally sound.

My first priority is to maintain our focus on the management practices and accretive growth strategies that have served the Company so well to date. As I spend the next couple of months on my assessment my goal is to understand all the factors that will drive our future. By the time we release our second-quarter earnings in August I will have had a chance to develop more specific insights into our company and my vision for it. I hope I'll have a chance to meet many of you and I look forward to hearing your views on our company and direction.

Now let's talk about the first quarter of 2008. In a few minutes Bill will review our financial performance, but, as you can see from our earnings release, the quarter was a very good one. Our sales were the best ever for a quarter and were 14% higher than last year's first quarter. Segment profits also set a quarterly record and were up 11% over last year. Segment margins were a strong 16.5%. Our GAAP earnings were $0.61 a share compared to $0.56 a share last year, a 9% improvement. Our earnings before asbestos and other selected items were $1.07 a share, also a quarterly record and 13% better than last year.

Besides the earnings we announced this morning, the first quarter was notable for a number of other significant events. Of course my personal highlight was being asked by the Board to take this job, but there was other news as well. We closed two important acquisitions, we got new greenfield operations up and running in China, we moved closer to production and a second new building at Garlock's Palmyra facility, and we announced a $100 million share repurchase authorization and we settled our proxy contest with Steel Partners.

On the acquisition front, we completed the purchase of V.W. Kaiser, a manufacturer of aftermarket parts for commercial vehicle based in Michigan. This acquisition broadens our product offerings in this market and will give Kaiser exposure to a wider range of customers through Stemco's strong market presence and distribution network. We also closed the purchase of a small Chinese distributor and manufacturer of Sealing Products that is now doing business as Garlock Sealing Technologies in Shanghai.

Also in China we've opened a new manufacturing facility that is shared by GGB and Stemco. GGP has begun producing bearings there for the local market and Stemco is in the final phases of setting up manufacturing of its wheel end products. As you know, Quincy has been in China for some time, so with this facility four of our six major businesses now have a manufacturing presence in China compared to just one this time last year. We are clearly excited about our growth prospects in Asia with these investments.

At Garlock's facility in Palmyra, New York we are nearing completion of construction on the second new building at the site and we expect to be making product in it before the end of the year. We're about halfway through this five-year project and I think it's one of the most ambitious and promising growth investments going on in the Company today.

To remind you, we are investing about $35 million in the Palmyra campus over approximately five years. At the end of the project we will have two new state-of-the-art manufacturing facilities on the site. We will have made substantial reductions in the square footage under roof and substantial improvements in productivity and our cost position.

The project was made possible with the cooperation of our workforce in Palmyra as well as the support of state and local governments. Those efforts, combined with the efficiency improvements and other cost savings generated by the new facility, are already producing returns.

We also made an investment in our own shares in the first quarter. On March 3rd we announced that our Board authorized the repurchase of up to $100 million of our common stock. We completed half of the authorization immediately through an accelerated share repurchase program, or ASR, which reduced our shares outstanding by 1.7 million. Depending on market conditions and our financial results and other factors, we expect to initiate the second half of the authorization later this year through open market purchases.

The final event I'll mention was the settlement of our proxy contest with Steel Partners. As part of this settlement we will expand our Board from eight members to nine at our upcoming annual shareholders meeting which is scheduled for June 9th. Don DeFosset, who was an independent Steel nominee, will fill the new spot and join our Board after the meeting. Both Bill Holland, our Chairman, and I have had a chance to speak with Don; he is an experienced executive with a strong operating background, most recently at Walter Industries where he was Chairman, President and CEO. We're looking forward to introducing him to the rest of our Board and to working with him.

As part of the settlement we also agreed to support declassification of our Board so that all directors will continue to stand for election annually. Currently our charter calls for the Board to be separated into three classes of directors, each with a three-year term, if its size is increased to nine or more members. To declassify the Board we need shareholder approval, so we have filed a revised proxy for this year's annual meeting that includes this proposal. We are asking all shareholders to vote in favor of it, otherwise the Board will become classified in June when Don joins.

Revised proxies will go into the mail this week. For your shares to count you must vote the revised proxy even if you have already submitted the proxy we mailed earlier this year. Now I'll turn the call over to Bill for a financial review.

Thanks, Steve. As Steve said, we are pleased with the results of the first quarter and our double-digit percentage increases from sales, segment income and adjusted earnings. Sales increased by 4% compared to last year reaching $283 million. 5 points of the 14 point increase came from favorable foreign exchange. The other 9 points came from acquisitions and organic growth.

Gross margins were 36.6%, the highest gross margin level we've ever achieved and an increase of 80 basis points over the first quarter of last year. The improvement was primarily a reflection of the performance of Fairbanks Morse Engine which benefited from higher part sales and improved productivity.

Our SG&A increased by 19%, largely reflecting the impact of the acquisitions and stronger foreign currencies. Asbestos-related expenses declined by 6% due to the decrease in the non-cash charge required to maintain our 10-year estimate for the liability. Our operating income increased by 26% over last year to just under $25 million. Interest expense was about the same as a year ago, while interest income was down reflecting our lower cash balances.

Other expense of $2.8 million related largely to costs associated with the proxy contest through the end of March. On this score we have incurred additional cost of about $1.5 million related to the proxy contest which will be reported in the second quarter. First quarters tax rate was essentially the same as last year at 37.2%.

That all boils down to net income of $13.2 million and earnings per share of $0.61 per share or 9% higher than last year. Our earnings before asbestos and other selected expenses were $1.07 per share 2008, 13% better than the first quarter of 2007. About half of the increase was related to foreign exchange.

The share repurchase in early March reduced our average diluted share count by about 500,000 shares. We calculate that the repurchase added about a penny of share to our earnings in the first quarter.

Now looking at the individual segments -- Sealing Products sales were $124 million, up 7% from 2007 with about 4 percentage points of that coming from foreign exchange. All of our Garlock businesses reported increases in activity as they benefited from strength in steel, mining, nuclear power and energy related markets in the United States, Europe, the Middle East and Asia. Garlock also has benefited from stronger foreign currencies. On the other hand, it did see some softening trends in general industrial activity.

Stemco's OEM markets remained soft, but the aftermarket improved slightly over the first quarter of 2007. The incremental sales from Kaiser, after its acquisition in late February, kept Stemco's sales flat with the level of a year ago. Sales were down at us Plastomer Technology which continues to experience weakness in its semiconductor markets.

The segment's profits were about the same as last year, but margins decreased 17.4%, a little more than a point below the level of last year. Lower volumes at both Stemco and Plastomer and restructuring expenses at Plastomer reduced profits and margins at those two businesses and depressed the segment's overall margins offsetting the improvements at Garlock.

Engineered Products' sales were up over 25% over last year to $133 million. Acquisitions accounted for the largest portion of the increase adding about 12 points while organic growth added about 6 points, the rest came from foreign exchange. Sales at GGB and CPI increased while Quincy's sales were flat with a year ago. GGB benefited from strong volumes in its European operations while increases in the United States were more modest reflecting soft automotive markets.

Quincy reported increase sales in China which countered a slight decline in the United States due to weaker demand from construction related markets. At CPI sales doubled as a result of acquisitions completed in the second half of last year. Profits for the segment increased 16% to $21.8 million as all three operations produced higher earnings.

However, margins in the segment were 16.4% compared to 17.7% a year ago, reflecting a decline at CPI driven by conditions at businesses it acquired in the United Kingdom and Canada. Its UK operations were impacted by integration costs and an unusually high mix of lower margin OEM sales.

In Canada markets were temporarily weakened by uncertainty over the fate of proposed legislation that would have impacted energy producers and by the strong Canadian dollar which reduced exports to the United States. We expect the product mix in the UK to improve and demand in Canada is returning. So we're optimistic CPI's performance will improve over the rest of the year.

Engine Products and Services reported another strong performance in the first quarter. Sales were slightly above last year at $26.5 million, part sales increased while engine sales were flat with a year ago. Productivity improvements helped drive segment profits up by 75%. Segment profit margins improved to 13.2%, almost 5.5 percentage points better than last year.

Looking at cash flows, cash generated by operations amounted to $9.4 million compared to $19.5 million a year ago. Working capital increased $23 million this year compared to $15 million a year ago, partly due to higher activity levels. We normally see significant working capital increases in the first half of the year as seasonal activity increases. Operating cash flows also reflected higher net asbestos-related payments which were $7.5 million in 2008 compared to $3 million in the first quarter of 2007.

Before I continue with the cash flow discussion I just want to point out that asbestos trends remained positive in the first quarter. As we note in the press release, new claims are declining significantly. We're also us committing to pay less for new settlements and we continue to do well in the court room. We took one case to verdict in the first quarter and the jury found in our favor. We're very confident our strategy is the most effective way to minimize the impact of asbestos on our results and we intend to continue to follow it.

Now returning to cash flows -- we spent about $27 million on acquisitions in the first quarter as we purchased the two businesses that Steve mentioned earlier. Capital spending increased by about $4 million as we continue to invest in facility improvements and international expansion. We also spent $50 million on our share repurchase program. We ended the quarter with a cash balance of just over $49 million.

That completes my review. I'll now turn it back to Steve for a discussion of our outlook and his concluding remarks.

Thanks, Bill. Before we open the lines to your questions, I'll wrap-up our comments with some thoughts on our outlook for the second quarter and the balance of the year. The first quarter of 2008 got off to a good start and we expect year-over-year improvements to continue in the second quarter and through the remainder of 2008.

Our operating cash flow should be sufficient to fund an increase in capital spending and additional share repurchases as well as any acquisitions we might complete. Total asbestos payments should decline compared to 2007, but we'll collect about $20 million less in insurance, so the net outlays for the full year will be closer to the levels we saw in 2006.

Looking at sales and income, we anticipate the same sort of quarterly pattern in 2008 that we experienced in 2007. We expect that sales will benefit from growth in volume as well as from the contribution of acquisitions and foreign exchange, assuming that the dollar does not strengthen against the euro.

As sales grow segment profits should improve and profit margins should increase. We expect increased volumes to benefit income and earnings per share. Earnings per share will also benefit from a reduction in shares of a result of our share repurchases.

In conclusion, we are very well prepared for continued growth in 2008, although acknowledge there's certainly a great deal of economic uncertainty at the moment that could change our outlook. We're off to a good start for the year. Our markets are generally in good health; our operations are performing well; we continue to generate cash which we will use to improve our returns to shareholders.

Thanks for your attention these past few minutes. Now we'll open the lines for your questions.

(OPERATOR INSTRUCTIONS). Todd Vencil, Davenport & Co.

Good morning, guys. Nice quarter. Steve, welcome aboard.

Thank you.

You said at the outset that you didn't feel like you've been around quite long enough to want to go into too much detail on the future strategic direction. So I'm going to bug you about it. Particularly with regard to what you said about your conversations with Don DeFosset, and I'm just wondering if there's anything you can talk about with regard to where he may be leaning. I know Steel's issues with the Company were largely driven by strategic issues, particularly with regard to the balance sheet. So any comments on what he's likely to advocate?

Well, look, first of all, Steel's position has not been strategic, it's been totally financial. I think Steel has been, and I've also met with the Steel leadership as well, and I think quite frankly they've been very complementary on the core operations of the Company, the strategic direction and what not.

I think they would like the Company. You know where they come from, it's a hedge fund obviously and they're financial guys, they live in a high leverage world. I think they'd like the Company to have a lot more leverage and be a lot more aggressive in the marketplace. Quite frankly, in today's market with the economic uncertainty and the position of the Company we feel like it's prudent to have some dry powder.

The acquisitions that we've done -- we've spent $210 million over the last few years in acquisitions, which has been an absolutely fabulous use of our cash. Every one of them has been accretive and every one of them has been a very, very nice strategic fit for the business that has done the acquisition.

So we certainly believe at this point that the best way to create shareholder value is to continue to drive that growth, both organically and through acquisitions. And I don't have any concerns at all about convincing our new Board members that that's going to be the right way to grow.

Good. Any thoughts on the diesel engine business?

Well, I don't know the history. Actually I'm going up there in a couple of weeks as I'm visiting all the businesses. So I've just seen the numbers and heard folks here talk about it. I have met the guy that we have now running that business who's been there for a couple years. I think he's doing a very, very nice job. I think we've improved the productivity, the cost position and the focus quite a bit in terms of running the basics of the plant.

It's a tricky business because it's not got an unlimited market, but it's got a nice aftermarket stream of revenue and generates pretty decent returns, returns on investment at this point. So we've got to kind of get figured out whether it's -- what the long-term future of the engine business is. But I'm looking forward to visiting. We've got a very strong work force up there and we run a really good plant.

Thanks for that. Moving around to more mundane financial issues. One of the things I'm hearing from a lot of the companies that I'm hearing from and that I follow, they're all screaming about input costs and you guys aren't. I guess I'm just curious as to what you're seeing and it seems as though you're not having any trouble passing those through or offsetting the productivity, but can you talk about what you're seeing and what may be noticeable to you on the input cost side?

Yes. I'm going to let Bill address that.

Okays.

Todd, we've seen there are certainly -- many of our commodities have seen price increases since the beginning of the year. Many of our businesses enter into pricing agreements the duration of which last anywhere between 6 to 18 months. So most of the recent run-ups in a lot of the commodity prices haven't directly impacted us as yet because we're covered under those contracts.

But as those contracts start to roll off in the second half of the year and early next year, to the extent those commodity prices are still up there, those will be passed on to us and we'll be looking to attempt to improve our productivity as well as potentially passing on price increases to our customers.

Can you tell me where you're primarily hedged and to what extent you're hedged generally?

Hedged by virtue of having signed --

Right.

Supply contracts -- again, if you look at our commodity, we're -- about half of our total cost of sales are raw materials. Steel is probably the single biggest in one shape, form or another, it probably accounts for 20, 25% of that, but it's a variety of different types, shapes and types of steel. We also buy a fair amount of copper and bronze, PTFE, elastomers. And by and large we have contracts covering most -- agreements covering most of those commodities.

Okay. All right, thanks for that. I'll jump back in the queue.

Randy Laufman, Imperial Capital.

Good morning, guys. A couple questions. First of all, it sounds like obviously you're getting a lot of strength on the aftermarket side across all your segments. And it seems like that's been a big focus of recent acquisitions. Just wondering if you can talk about the strategy going forward as far as continuing to focus on aftermarket acquisitions as well as what the mix of business is looking like right now as aftermarket continues to go up and OE maybe is steady to slightly down?

I'll let Bill comment with the specific numbers, but my sense is that the OEM markets have only fallen in -- the demand has only dropped in specific segments and specific geographies, for instance U.S. commercial truck manufacturing is obviously off, U.S. auto is off. But when you look at OEM uses for expanding oil and gas facilities and in even European auto and many of the regions around the world, we're seeing strength in both the OEM business as well as the aftermarket business.

And so, one of the real benefits of this Company obviously is it's very well spread out geographically, industrial -- or industry and in use segment wise as well as aftermarket versus OEM. So I would not characterize it as we're seeing widespread reduction in our OEM sales. And I because of that I would guess it hasn't moved the overall mix of the Company enough to really register. Is that accurate?

Steve, I'd agree with that. I think the needle hasn't moved that much. We're still roughly 50-50 aftermarket/OEM split. And the second part of your question, as we've looked at and we'll continue to look at acquisitions going forward, certainly the aftermarket content is an important consideration to look at and evaluate.

Okay, great. The next question is on CPI and you mentioned that there were some integration costs during the quarter. Don't know if you can quantify that, Bill? Also if you could talk about how long we may see some of those integration costs before it's fully up and running?

Sure. I won't quantify the integration costs, we typically wouldn't quantify something like that. But that wasn't the major driver in their performance. They had some market issues. As I mentioned in the course of the talk before, they have some market issues in their UK operations, a little bit of a shift in mix along with these integration costs and some market issues up in their Canadian operations. So they've fallen short of margin expectations, but their markets overall are pretty strong globally and we're fairly optimistic that we will see significant strengthening as the year goes on there.

Yes. Just to elaborate a little bit on the Canadian comment that Bill made. What happened was there was a proposed increase in royalties on new gas wells in Alberta and as a result of that drilling slowed. But that was kind of a January/February phenomenon and so -- although that proposal has not been formally withdrawn, it hasn't gained any support, so it's kind of been put on the back burner and the wells have really -- in March, really started to return to normal levels which we expect going forward. So it wasn't a structural change in the Canadian demand I guess is the point I wanted to make.

Okay, great. Lastly, I just wanted to -- a couple of housekeeping items on the asbestos. Can you tell us what the 10-year liability was at quarter end as well as the available insurance and what was collected during the quarter?

Yes, we can. Actually Rick Magee, our General Counsel who manages the whole asbestos program, is also here. So I'm going to let Rick address that.

Sure. Randy, how are you doing?

Good, thanks.

Our estimate for the 10-year liability now is $511 million; that's a decrease from last quarter when it was $519 million, so down by $8 million for the quarter. Our remaining insurance, the total amount of remaining solvent insurance that we expect to collect is now at $382 million -- I'm sorry, at $369 million, $369 million, which is down from $382 million at the end of the year.

So we collected $13 million and our liability declined by $8 million. Obviously the difference there -- more than the difference there is the amount by which our liability went up because of the new quarter added to the liability which was $6.5 million this quarter.

Great, thanks a lot, guys. Nice quarter.

(OPERATOR INSTRUCTIONS). [Joe Mondello], Sidoti & Co.

Good morning, gentlemen. First off, just about the acquisitions that you acquired recently. I know you don't want to quantify how much they contributed to sales, but could you give us a sense just how significant it did add? I know you said acquisitions and organic growth attributed to 9% on the quarter, but could you just give a sense of maybe how much of that is or --?

Well, the acquisitions we made in the first quarter of this year contributed very little. Most of what you're seeing there are the acquisitions we made last year.

The CPI, right.

Yes, the CPI that we did not have in the first quarter last year that we acquired midway through the year. All in our acquisitions probably accounted for 5 points of that 14 point increase.

Okay. And also could you talk about maybe -- about your end markets, maybe more specifically on your troubled end markets, heavy-duty trucking and the semiconductors over at Plastomer, just what you're as seeing, if you see maybe a bottom coming and what you're looking forward to in the rest of '08 in that respect?

I don't know that we have any particularly good crystal ball visibility into that that you all don't have and kind of the general economic condition because that's really what it's more tied to. The commercial truck market really dropped significantly starting in the middle of last year and has continued this year even -- at least in the first quarter even below what our expectations were going into the year.

Now, that said, it can't go a lot lower, the demand is off significantly even from the weak levels of last year. And you continue to see the ton haulage numbers in the U.S. are barely holding up reasonably well. So, sooner or later we are going to need more trucks and trailers. So I don't know.

I mean, it is always tough to say we are at the bottom, but if we are not there, we've got to be very, very close. That is the one that really impacts us most directly, that it is obviously a cyclical business and we could be right in there in the deep of that cyclical business.

Finally, could you just go -- just geographically, could you just give some sense of how you're looking geographically; what you are seeing and what you expect going forward?

I think our European operations would all say that demand continues to be okay. I don't think anyone would characterize it as real hot demand. I think they would say that the growth they have been seeing over the last number of years has slowed. While it is still growing, it is not growing at the pace that it was.

We are new into China and getting those up. So I would anticipate regardless of what the fundamentals do over there, we are obviously a small player in the grand scheme of things in China, but we have nothing to do but grow over there because it is basically new operations and it is a growing new market for us. So we are very excited about the prospects there.

Obviously, the Middle East is still doing well with the strength and energy in oil and gas markets. And then when you look in the U.S., it is very mixed. Our metal and mining, our steel, our energy, our nuclear energy, all of those markets are actually pretty strong. And it's the general industrial portion of the U.S. as well as the truck and automotive which we've talked about that are the ones that are weak.

Thank you very much, guys.

You're welcome.

Todd Vencil, Davenport & Company.

I just wanted to do a little housekeeping items here. Bill, what were you're shares diluted out at the end of the quarter?

The average shares for the quarter were 21.5, I believe. Again, we did that share repurchase in March, so we only really had a third of the benefit of that. Our share count should go down to 20.3, 20.4, I think.

When are you going to -- with regard to the other 50, my understanding has been sometimes you see companies that have an authorization and maybe they use it, maybe they don't. Your intention is to go ahead and knock that out; is that correct, when the time comes that you want to start?

Yes. Obviously, our Board did the authorization with the intention that that's what we were going to do. But, of course, we will look at prevailing market conditions, the situation of the Company, etc. as we go into that phase, which should be starting in the fall time period after we get done with the ASR.

Okay. And just out of curiosity, you say once you get done with the ASR, what are the mechanics on that that are still going on? Is your counterparty out there actually accumulating shares against their short or how does that work?

At the time that the ASR was executed the counterparty went out and borrowed 1.7 million shares, the equivalent of 50 million shares of the market price at the time, borrowed those 1.7 million, turned them over to us and they were immediately retired and now over the course of a three- to five-month period they are in the market buying those shares to repay the people that they borrowed them from.

Got it. And you think that will be three to five months you said? Okay.

Yes, the time period is somewhere within the three- to five-month time period. And then to the extent that the $50 million is different than the average price during that period of time there will be a settle up some time in the third quarter.

Are you guys on the hook for the entirety of that settlement? By which I mean to say, do you share the market risk there or do you bear the whole market risk?

No, we have the market risk and we will -- at the end of the term we have an option of either settling up in cash or we can issue additional shares to the counterparty.

Got it, okay. The next issue, you mentioned you're going to have another $1.5 million of proxy expenses, proxy fight related expenses in the second quarter, was that pretax?

Yes.

Okay. And then can you talk about just what your CapEx and D&A expectations are for the year?

Sure. Our capital spending, we had indicated last year, I think we spent 47, 48 last year, we indicated that we anticipated an increase in that spending -- a slight increase. That's still in our forecast at this stage and our depreciation is in the low 30s or low to mid-30s, 34, 35, I believe for the full year.

Okay. Thanks a lot.

Thanks, Todd.

That does conclude the question-and-answer session. At this time I'll turn the conference back over to Mr. Washington for any closing remarks.

Thanks, everyone, for dialing in, we appreciate you joining us this morning. And again, if you have follow-up questions, please feel free to call me at 704-731-1527. We look forward to talking to you again in the future.

That does conclude today's conference. Again, thank you for your participation.