Enpro Industries, Inc. 2020 Q2 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 six months ended June 30, 2020, compared with the corresponding 2019 periods. Results were materially affected by COVID-19, weakness in heavy-duty trucking, automotive, industrial, aerospace and oil and gas markets, and the January 2020 divestiture of Fairbanks Morse.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $247.0 million | $317.2 million | $529.7 million | $620.2 million |
| Gross profit | $82.5 million | $108.5 million | $177.8 million | $208.0 million |
| Gross margin | 33.4% | 34.2% | 33.6% | 33.5% |
| Operating income | $1.8 million | $30.7 million | $22.3 million | $47.3 million |
| Income from continuing operations attributable to EnPro | $(3.3) million | $16.6 million | $6.8 million | $24.4 million |
| Net income attributable to EnPro | $(6.5) million | $23.9 million | $212.2 million | $37.0 million |
| Diluted EPS from continuing operations | $(0.16) | $0.80 | $0.33 | $1.17 |
| Adjusted EBITDA | $37.5 million | $49.3 million | $78.1 million | $83.4 million |
Q2 operating margin was approximately 0.7%, compared with 9.7% in the prior-year quarter. Six-month operating margin was approximately 4.2%, compared with 7.6% in the prior-year period. Q2 adjusted diluted EPS from continuing operations was $0.54 versus $0.93; six-month adjusted diluted EPS was $1.17 versus $1.38.
- Sealing Products sales declined 17.9% in Q2 to $189.9 million and 10.9% for the six months to $399.6 million. Segment profit declined to $11.0 million in Q2 and $36.5 million for the six months.
- Engineered Products sales declined 32.9% in Q2 to $58.6 million and 23.5% for the six months to $133.7 million. Segment profit was a $0.3 million loss in Q2 and $3.3 million for the six months.
- Cash flow from continuing operations was $33.4 million for the six months, broadly consistent with $33.6 million in 2019. Capital expenditures were $8.9 million.
- Investing cash flow was $433.6 million, including $444.9 million of proceeds from business sales, primarily Fairbanks Morse.
- Financing cash flow was $(152.8) million, including debt repayments of $160.3 million, share repurchases of $5.3 million and dividends of $10.8 million.
- Cash and cash equivalents were $424.3 million at June 30, 2020, versus $121.2 million at December 31, 2019. Approximately $155.6 million was held outside the United States.
- Long-term debt, including current maturities, was approximately $494.2 million at June 30, 2020, compared with $629.3 million at year-end 2019. The company had $148.1 million outstanding under its term loan and $387.4 million of revolver availability after letters of credit.
- Backlog was $190.3 million, with approximately 96% expected to be satisfied within one year; management cautioned that backlog is not highly predictive because of short lead times and seasonality.
Material changes versus the prior comparable period
- Q2 sales decreased 22.1%, while six-month sales decreased 14.6%. Organic sales declined 23.6% in Q2 and 15.5% for the six months, excluding acquisition, divestiture and foreign-currency effects.
- Continuing-operations earnings deteriorated substantially because of lower demand, particularly in heavy-duty trucking, automotive, general industrial, aerospace, oil and gas and petrochemical markets.
- The company recorded $17.5 million of Q2 and $18.9 million of six-month restructuring and impairment charges, compared with $1.0 million and $2.3 million, respectively, in 2019.
- EnPro exited the STEMCO Motor Wheel brake drum and Crewson brake-adjuster businesses and agreed to sell the Lunar air-disc-brake business. The Lunar sale was expected in Q3 2020.
- Fairbanks Morse was sold on January 21, 2020 for $450.0 million. The six-month results include a $205.4 million after-tax discontinued-operations benefit, primarily the gain on sale. This benefit explains why reported net income increased despite lower continuing earnings.
- Income taxes were unusually high relative to pretax income: the Q2 effective tax rate was negative 123.5% and the six-month rate was 57.3%, driven by geographic earnings mix, minimum taxes, foreign tax rates and valuation allowances.
- Share repurchases were suspended in March 2020 because of COVID-19. The authorization had $29.7 million remaining at June 30, 2020 and was scheduled to expire in October 2020.
Guidance, outlook, risks and unusual items
Management did not provide a quantitative full-year earnings or revenue forecast. It stated that most businesses continued to experience reduced order levels, that Q3 normally has softer seasonal demand and could be further affected by longer lead-time orders, and that a modest sequential improvement was expected in Q4.
- COVID-19 remains the principal near-term risk. Facilities had reopened by the filing date, but future closures, health-related disruptions, supply-chain issues, customer weakness and government restrictions remained possible.
- Management expects continued weakness in cyclical end markets, especially automotive, oil and gas and heavy-duty trucking, while semiconductor and food and pharmaceutical demand showed relative strength.
- The company expects approximately $4.0 million of U.S. defined-benefit pension contributions in Q3 2020.
- Fairbanks Morse sale proceeds may require debt prepayment and cash collateral for letters of credit in Q1 2021 if not sufficiently reinvested. The Senior Notes indenture could require an offer to repurchase notes in Q2 2021 under similar asset-sale provisions.
- EnPro announced an intended exit from its Bushing Block business in Dieuze, France. It offered approximately €5.4 million of severance and benefits, but had not accrued charges because the total cost remained uncertain.
- On August 3, 2020, the company announced an agreement to sell its Air Springs business for $32.0 million in cash plus a $7.5 million face-value promissory note, subject to closing conditions and expected to close in Q3 2020.
- Goodwill was not impaired in the interim test, but the Technetics reporting unit had only an estimated 5% excess of fair value over carrying value. A 100-basis-point increase in the discount rate would have caused carrying value to exceed fair value by 2%.
- Environmental liabilities totaled $19.0 million. The company identified potentially significant uncertainty related to the Lower Passaic River matter, where its remaining accrual was $2.7 million but future costs could be significantly higher.
- A BorgWarner bearing dispute had a reasonably possible loss range of approximately €0.4 million to €6.6 million, plus potentially undetermined legal expenses; the recorded accrual was €0.4 million.
- Disclosure controls remained ineffective because a material weakness in income-tax controls identified at December 31, 2019 had not been fully remediated. Management stated that remediation was in progress but required successful execution through year-end 2020.
Investor verification checklist
- Verify the sustainability of continuing-operations earnings and cash flow excluding the Fairbanks Morse disposal gain and other nonrecurring items.
- Assess the pace of recovery in heavy-duty trucking, automotive, industrial, oil and gas and aerospace markets, and monitor semiconductor and pharmaceutical demand.
- Track restructuring cash costs, the Lunar and Air Springs divestitures, and the potential Bushing Block exit costs.
- Confirm compliance with debt covenants and determine whether Fairbanks Morse proceeds will trigger required term-loan prepayments, letter-of-credit collateral or Senior Notes repurchases.
- Monitor goodwill headroom, especially for Technetics, in light of COVID-19 uncertainty and discount-rate sensitivity.
- Review the remediation of the income-tax internal-control material weakness and the effect of future tax-rate adjustments.
- Evaluate environmental, asbestos-insurance, BorgWarner and other legacy liabilities beyond recorded accruals.