Enpro Industries, Inc. — 2020 Third-Quarter Form 10-Q Summary
Business context and reporting period
EnPro designs, manufactures, services and markets engineered industrial products through two reportable segments: Sealing Products and Engineered Products. The filing covers the quarter and nine months ended September 30, 2020. Results reflect the COVID-19 pandemic, the January 2020 sale of Fairbanks Morse, portfolio restructuring and several businesses classified as held for sale.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $268.3 million | $299.0 million | $798.0 million | $919.2 million |
| Gross profit | $94.5 million | $97.7 million | $272.3 million | $305.7 million |
| Gross margin | 35.2% | 32.7% | 34.1% | 33.3% |
| Operating income (loss) | $(7.5) million | $19.1 million | $14.8 million | $66.4 million |
| Income (loss) from continuing operations attributable to EnPro | $(21.6) million | $(8.4) million | $(14.8) million | $16.0 million |
| Net income (loss) attributable to EnPro | $(19.7) million | $(1.5) million | $192.5 million | $35.5 million |
| Diluted EPS from continuing operations | $(1.05) | $(0.41) | $(0.72) | $0.77 |
| Adjusted EBITDA | $42.1 million | $42.7 million | $120.2 million | $126.1 million |
Q3 sales declined 10.3% year over year, while nine-month sales declined 13.2%. Q3 operating margin was negative 2.8%, compared with 6.4% in the prior-year quarter. The nine-month operating margin was 1.9%, compared with 7.2% in 2019. Reported net income for the nine-month period included $207.3 million of after-tax income from discontinued operations, principally the $208.4 million after-tax gain on the Fairbanks Morse sale.
- Sealing Products sales decreased 8.1% in Q3 and 10.0% for the nine months. Segment profit increased to $33.0 million in Q3 from $17.8 million, and to $69.5 million for the nine months from $66.2 million.
- Engineered Products sales decreased 16.5% in Q3 and 21.3% for the nine months. Segment results declined to a $3.5 million loss in Q3 from $10.6 million of profit and to a $0.2 million loss for the nine months from $28.7 million of profit.
- Adjusted EBITDA declined modestly, but Q3 adjusted segment EBITDA increased to $53.3 million from $51.8 million, supported by cost reductions and portfolio actions.
- Backlog was $201.1 million at September 30, 2020, with approximately 95% expected to be satisfied within one year; management cautioned that backlog is not particularly predictive because of short lead times and seasonality.
Cash flow, liquidity and debt
- Cash provided by continuing operating activities was $48.4 million for the first nine months of 2020, down from $91.1 million in 2019.
- Investing activities provided $439.5 million, including $453.9 million of proceeds from business sales, principally Fairbanks Morse.
- Financing activities used $160.0 million, including $136.5 million of net debt repayment, $5.3 million of share repurchases and $16.2 million of dividends.
- Cash and cash equivalents increased to $441.0 million at September 30, 2020 from $121.2 million at December 31, 2019. Approximately $184.7 million was held outside the United States.
- Total debt was approximately $493.2 million, consisting principally of $147.1 million outstanding under the term loan and $350.0 million of 5.75% senior notes due 2026. Revolver availability was $388.6 million after $11.4 million of letters of credit.
- The company was in compliance with its debt covenants at September 30, 2020. Fairbanks Morse sale proceeds could require term-loan prepayment and cash collateralization of letters of credit in the first quarter of 2021, and could require an offer to repurchase senior notes in the second quarter of 2021, depending on the use of proceeds.
Material changes, outlook and unusual items
- COVID-19 reduced demand, particularly in heavy-duty truck, automotive, oil and gas, aerospace, general industrial and petrochemical markets. Semiconductor and food and pharmaceutical demand was comparatively stronger.
- Management expected fourth-quarter demand to remain solid in semiconductor and food and pharmaceutical markets, with continued softness in heavy-duty truck, general industrial, oil and gas, petrochemical and aerospace markets. No quantitative earnings guidance was provided.
- The company recorded $21.1 million of restructuring and impairment charges in Q3 and $40.0 million for the nine months. Q3 included $16.1 million of indefinite-lived trademark impairments and a $6.2 million impairment related to the Dieuze bushing block business.
- Other significant Q3 items included a $14.0 million environmental reserve expense related to a Mississippi settlement and a $7.4 million legal settlement expense, including a $6.2 million accrual related to the BorgWarner matter.
- EnPro completed the sale of the Motor Wheel and Crewson businesses for $8.9 million net of fees, classified Air Springs and the Dieuze business as held for sale, and expected the Air Springs and Lunar Shanghai transactions to close in Q4 2020.
- On October 26, 2020, after the reporting date, EnPro completed the $237 million cash acquisition of Alluxa, funded with available cash and rollover equity. Purchase accounting was incomplete at the filing date.
- Management stated that the cash balance and revolver availability provided substantial liquidity to pursue portfolio reshaping and withstand an extended weak economic environment.
- A material weakness in internal control over financial reporting related to income-tax controls remained unremediated as of September 30, 2020. Management reported progress but stated that full remediation required successful design and execution of annual tax controls for 2020.
Risks, contingencies and other matters
- COVID-19 could cause further demand reductions, facility closures, supply-chain disruption, operating inefficiencies and additional impairment charges, potentially into 2021 and later years.
- Environmental liabilities totaled $31.4 million at September 30, 2020. The Lower Passaic River matter could result in costs materially above the remaining $2.6 million accrual, and the company could not estimate a reasonably possible range for several other environmental exposures.
- The company accrued $17.7 million for the Water Valley, Mississippi environmental matter, including the $14 million settlement payment due by November 10, 2020.
- Asbestos-related insurance recoveries remain subject to collection and competing claims. The company estimated approximately $4.2 million of available coverage from solvent insurers and potential additional recoveries over time.
- Foreign exchange, interest rates, commodity prices, raw-material availability, cyclical end markets and customer and supplier financial conditions remain material risks.
Important facts for investors to verify
- Whether demand and margins recover in the targeted semiconductor and food and pharmaceutical markets while weakness persists in transportation, energy and industrial markets.
- The final outcome and cash cost of Air Springs, Lunar Shanghai and Dieuze transactions, including working-capital adjustments and required closing conditions.
- Use of Fairbanks Morse proceeds and any required 2021 debt prepayments, senior-note repurchase offer or cash collateralization.
- The post-acquisition balance sheet, purchase accounting and leverage impact of the Alluxa acquisition.
- Progress toward remediation of the income-tax internal-control material weakness.
- Future impairment exposure, particularly for goodwill, trademarks and other long-lived assets given COVID-19 uncertainty and the limited valuation cushion at the Technetics reporting unit.
- Actual cash payments and potential additional exposure from environmental, product-liability, asbestos and other legacy contingencies.