EnPro : Reports Results for the Second Quarter of 2014

EnPro Industries, Inc. (NYSE: NPO) today reported consolidated sales of $313.1 million in the second quarter of 2014, a 2% increase over the second quarter of 2013. Higher revenues from truck parts and high performance products for nuclear, aerospace and semiconductor markets were partially offset by softer demand for pipeline sealing products and by lower engine revenues. Foreign exchange accounted for 1% of the growth. Segment profit margin decreased to 11.2% in the second quarter of 2014 from 14.0% in the second quarter of 2013 due to a less profitable mix and higher operating costs in the Sealing Products and Power Systems segments, including increases in R&D and other SG&A expenses.

Net income in the second quarter of 2014 was $8.3 million, or $0.32 a share, compared to $8.0 million, or $0.35 a share, in the second quarter of 2013. Before selected items, including interest due to Garlock Sealing Technologies LLC (GST LLC), a deconsolidated subsidiary, restructuring costs, and a non-cash loss on the exchange of convertible debentures, net income was $15.0 million, or $0.57 a share. In the second quarter of 2013, income before selected items was $19.5 million, or $0.87 a share.

Consolidated earnings before interest, income taxes, depreciation and amortization and other selected items (adjusted EBITDA) were $39.3 million in the second quarter of 2014, a 19% decrease over the second quarter of 2013, when adjusted EBITDA was $48.4 million.

A table attached to this press release shows the effect of selected items on net income and earnings per share in the quarter and first six months of 2014 and 2013. All per share amounts in this release are stated on a diluted basis.

The company’s average diluted share count in the second quarter of 2014 increased by 3.5 million shares from the same period a year ago. The increase reflects the effect of a higher price for the company’s common stock on the number of shares the company would be required to deliver in connection with its convertible debentures and the effect of exchanges in the first quarter of 2014 of 1.7 million shares of the company’s common stock (in addition to cash payments for accrued and unpaid interest) for $56.1 million in aggregate principal amount of convertible debentures. The diluted share count does not include the future benefit of the hedge transaction that will mature in late 2015. At an assumed share price of $72, approximately 2.7 million shares would be returned to EnPro upon maturity of the hedge arrangement.

In late June 2014, the company entered into an additional exchange for approximately $41.6 million in aggregate principal amount of the convertible debentures for approximately 1.3 million shares of EnPro’s common stock, plus cash payments of accrued and unpaid interest and for fractional shares. The company recognized a non-cash $2.4 million pre-tax loss on the exchange ($1.5 million net of tax) which is included in other (non-operating) expense in the accompanying Consolidated Statement of Operations. In addition, there was a $0.6 million tax benefit recorded directly to equity. Since this exchange occurred late in the quarter, it did not significantly affect the average diluted share count for the quarter.

These exchange transactions reduced the aggregate principal amount of the convertible debentures outstanding to approximately $74.8 million. These exchange transactions did not reduce the respective obligations under the hedge and warrant transactions entered into in connection with the original sale of the convertible debentures, which remain in force with respect to the original $172.5 million amount of the convertible debentures.

Six Months Results

Sales for the first six months of 2014 were $600.3 million, a 1% increase over the first half of 2013. Excluding the effect of foreign exchange, sales were flat compared to last year. Stronger demand for truck parts, semiconductor equipment, high performance seals and bearings slightly offset declines in demand for sealing products, pipeline protection components, and compressor parts and services, and lower engine revenues.

Adjusted EBITDA for the first half of 2014 was $71.5 million, a 15% decrease over the first half of 2013 when adjusted EBITDA was $84.6 million. The decrease primarily reflects the performance of the Sealing Products and Power Systems segments partially offset by improvement at Engineered Products.

Net income for the first six months of the year was $9.6 million, or $0.38 a share, compared to $16.6 million, or $0.74 a share, in the first six months of 2013. Before selected items, net income in the first half of 2014 was $24.8 million, or $0.97 a share, compared to $32.0 million, or $1.43 a share, in the first six months of 2013.

In the second quarter of 2014, sales in the Sealing Products segment increased 6% over the second quarter of 2013. Excluding the benefit of acquisitions and foreign exchange, the segment’s sales increased by 4%. Sales benefited from increased demand for heavy duty truck parts in North America and increased activity in semiconductor, aerospace and nuclear power markets. Lower project-related demand for pipeline products and softer demand for sealing products in European process markets partially offset these increases.

The segment’s profits decreased by 18% and segment profit margins declined to 13.0% in the second quarter of 2014. The change in margins reflects increased shipments of lower-margin OEM products, higher manufacturing costs, and increased investments in R&D and other SG&A expenses compared to 2013.

The segment’s sales in the first half of the year were 6% higher than in the first half of 2013 but segment profits and profit margins declined. Factors affecting the segment’s performance in the first half of the year were similar to those described above for second quarter results.

Engineered Products Segment

The Engineered Products segment’s sales in the second quarter were nearly unchanged from the second quarter of 2013, as stronger automotive and general industrial demand in Europe and North America offset continued weakness in CPI’s North American natural gas markets.

Segment profits increased 3% and segment margins grew slightly due to price increases, operational improvements and lower raw material costs.

For the first half of 2014, the Engineered Products segment’s sales were flat compared to the first half of 2013 for reasons similar to those that affected the quarterly year-over-year comparison. However, segment profits and profit margins increased in the first half of 2014 primarily due to price increases, raw material and operating cost improvements and a $0.7 million restructuring charge incurred in the first quarter of 2013.

In the Power Systems segment, sales declined by 4% from the second quarter of 2013 as lower engine revenues and decreased revenues for engine upgrades more than offset increased parts revenues.

Segment profits decreased by 47% and segment profit margins fell to 7.9% from 14.2% in the second quarter of 2013, primarily as a result of lower engine margins due to both volume and mix, higher manufacturing costs, and increased R&D investment in connection with the development of the OP 2.0 engine. Also, a $1.9 million expense for an early retirement program in the second quarter of 2013 did not recur this year.

The segment’s sales in the first half of 2014 were 11% below the first half of 2013 due to the combination of lower engine revenues and engine upgrades revenue. Segment profits and margins declined in the first half of 2014 due to the reasons cited for the current quarter.

Sales at the deconsolidated operations of GST LLC and its subsidiaries (collectively “GST”) in the second quarter of 2014 decreased by 3% from the second quarter of 2013 reflecting lower demand in North American petrochemical, refinery and metals processing markets as well as lower intercompany shipments to European affiliates. Operating profits were down 16% from the second quarter of 2013, reflecting lower volume and higher SG&A expenses. Operating margins were 22.0% in the second quarter compared to 25.6% a year ago when GST benefitted from increased demand for certain high margin products.

GST’s adjusted net income, which excludes intercompany interest income and income or expense associated with the asbestos claims resolution process, decreased to $9.3 million. Asbestos-related income was $181.3 million in the second quarter of 2014 compared to asbestos-related expense of $13.1 million in the second quarter of 2013. The year-over-year change reflects a reduction of $186.3 million in GST’s accrued estimate of asbestos-related claims liabilities pursuant to the amended plan of reorganization filed on May 29, 2014 and lower litigation expenses compared to the second quarter of 2013 when preparations for the liability estimation trial were underway.

GST’s sales in the first half of 2014 were 5% lower than the first half of 2013 reflecting lower demand in North America. Operating profit and profit margins declined reflecting lower volume for certain high margin products and higher SG&A expenses. GST’s asbestos-related income totaled $178.1 million in the first half of 2014 compared to a $24.1 million expense in the first half of 2013.

The results of GST LLC and certain subsidiaries were deconsolidated effective June 5, 2010, when GST filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy code. These filings were the initial step in a process to reach a permanent resolution of all of GST’s current and future asbestos claims. Tables attached to this press release illustrate, on a pro-forma basis, condensed consolidated financial results for the second quarter and first six months of 2014 and 2013 as if GST were reconsolidated with EnPro based on confirmation and consummation of GST’s amended plan of reorganization. The narrative preceding those tables includes an important discussion of the risks and uncertainties applicable to confirmation and consummation of the amended plan of reorganization. Due to these risks and uncertainties, reconsolidation of GST is not currently probable under Regulation S-X of the Securities and Exchange Commission (SEC) and pro forma financial statements are not required by the SEC. We are providing the pro forma financial information in this release as supplemental information in response to requests from investors for this information.

Cash Flows

EnPro’s cash balance stood at $64.9 million at June 30, 2014 compared to $58.2 million at the end of the second quarter in 2013. Operating activities used $13.8 million of cash in the first six months of 2014. Operating activities provided cash of $5.5 million in the first six months of 2013. Segment working capital increased by approximately $50 million compared to $31 million in the first six months of 2013.

Cash used in investing activities, which mainly includes capital expenditures, was $23.2 million for the first six months of 2014 compared to $22.1 million for the comparable period in 2013.

GST finished the first half of 2014 with cash and investments totaling of $216.2 million dollars, compared with $172.8 million at the end of the second quarter of 2013.

Outlook

“We expect improved results in most of our businesses for the balance of the year as we benefit from activity in our markets and internal developments,” said Steve Macadam, president and chief executive officer. “Order activity remains robust in our semiconductor, aerospace and trucking markets, and orders have improved in the process industries served by the Garlock family of companies and CPI.” Macadam also pointed out that the company expects second half revenues and segment profits in the Power Systems segment to increase over the first half of 2014 and the second half of 2013, primarily as a result of higher engine revenues and stronger aftermarket sales. “At the same time we are seeing these developments in our markets, we also expect to benefit longer term from a number of strategic growth initiatives underway, including our investments in the Stemco distribution center, the new opposed piston engine in Power Systems, and focused business development efforts across the company,” Macadam concluded.

Conference Call and Webcast Information

EnPro will hold a conference call today, July 31, at 10:00 a.m. Eastern Time to discuss second quarter 2014 results. Investors who wish to participate in the call should dial 1-800-851-4704 approximately 10 minutes before the call begins and provide conference id number 75536508. A live audio webcast of the call and accompanying slide presentation will be accessible from the company’s website, http://www.enproindustries.com. To access the presentation, log on to the webcast by clicking the link on the company’s home page.

Deconsolidation of Garlock Sealing Technologies LLC

Results for the second quarters and first six months of 2014 and 2013 reflect the deconsolidation of Garlock Sealing Technologies LLC (GST) and its subsidiaries, effective June 5, 2010, when GST filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code to begin a process in pursuit of an efficient and permanent resolution to all current and future asbestos claims against it. Deconsolidation is required by generally accepted accounting principles. To aid in comparisons of year-over-year data, the company has attached a schedule to this press release showing key operating measures for both EnPro and GST on a pro forma basis.

Non-GAAP Financial Information

This press release contains financial measures that have not been prepared in accordance with GAAP. They include income before asbestos-related expenses and other selected items, EBITDA-A, EBITDA and related per share amounts. Tables showing the effect of these non-GAAP financial measures for second quarters and first six months of 2014 and 2013 are attached to the release.

Forward-Looking Statements

Statements in this press release that express a belief, expectation or intention, as well as those that are not historical fact, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. They 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 include, but are not limited to: general economic conditions in the markets served by our businesses, some of which are cyclical and experience periodic downturns; prices and availability of raw materials; and the amount of any payments required to satisfy contingent liabilities related to discontinued operations of our predecessors, including liabilities for certain products, environmental matters, guaranteed debt payments, employee benefit obligations and other matters. In addition, adverse developments could arise in regard to voluntary petitions filed by certain of our subsidiaries in U.S. Bankruptcy Court to establish a trust that would resolve all current and future asbestos claims. Our filings with the Securities and Exchange Commission, including the Form 10-K for the year ended December 31, 2013 and Form 10-Q for the quarter ended March 31, 2014, describe these and other risks and uncertainties in more detail. We do not undertake to update any forward-looking statement made in this press release to reflect any change in management's expectations or any change in the assumptions or circumstances on which such statements are based.

About EnPro Industries

EnPro Industries, Inc. is a leader in sealing products, metal polymer and filament wound bearings, components and service for reciprocating compressors, diesel and dual-fuel engines and other engineered products for use in critical applications by industries worldwide. For more information about EnPro, visit the company’s website at http://www.enproindustries.com.

Segment profit is total segment revenue reduced by operating expenses and restructuring and other costs identifiable with the segment. Corporate expenses include general corporate administrative costs. Expenses not directly attributable to the segments, corporate expenses, net interest expense, gains/losses related to the sale of assets and income taxes are not included in the computation of segment profit. The accounting policies of the reportable segments are the same as those for the Company.

Management of the Company believes that it would be helpful to the readers of the financial statements to understand the impact of certain selected items on the Company's reported net income and earnings per share, including items that may recur from time to time. This presentation enables readers to better compare EnPro Industries, Inc. to other diversified industrial manufacturing companies that do not incur the sporadic impact of restructuring activities or other selected items. Management acknowledges that there are many items that impact a company's reported results and this list is not intended to present all items that may have impacted these results.

The amounts above, which may be considered non-GAAP financial measures, are shown on an after-tax basis and have been calculated by applying the Company's tax rate to the pre-tax amount. The interest expense with GST is included in interest expense, and the restructuring costs, loss on exchange of debt, environmental reserve adjustment and other are included as part of other operating expense and other expense. Per share amounts were calculated by dividing by the weighted-average shares of diluted common stock outstanding during the periods.

For a reconciliation of segment profit to net income, please refer to the Segment Information (Unaudited) schedule.

* Adjusted net sales reflect third party sales only, which differ from the sales reported on the accompanying consolidated statements of operations which include intercompany sales from EnPro to GST.

Unaudited Pro Forma Information Reflecting the Reconsolidation of Garlock Sealing Technologies

The historical business operations of Garlock Sealing Technologies LLC (“GST LLC”) and The Anchor Packing Company (“Anchor”) resulted in a substantial volume of asbestos litigation in which plaintiffs alleged personal injury or death as a result of exposure to asbestos fibers. Those subsidiaries manufactured and/or sold industrial sealing products, predominately gaskets and packing, that contained encapsulated asbestos fibers. Anchor is an inactive and insolvent indirect subsidiary of Coltec Industries Inc (“Coltec”). EnPro’s subsidiaries’ exposure to asbestos litigation and their relationships with insurance carriers have been managed through another Coltec subsidiary, Garrison Litigation Management Group, Ltd. (“Garrison”). GST LLC, Anchor and Garrison are collectively referred to as “GST.”

On June 5, 2010 (the “Petition Date”), GST filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the U.S. Bankruptcy Court for the Western District of North Carolina in Charlotte (the “Bankruptcy Court”). The filings were the initial step in an asbestos claims resolution process, which is ongoing. The filings did not include EnPro Industries, Inc., or any other EnPro Industries, Inc. operating subsidiary.

The financial results of GST and its subsidiaries are included in our consolidated results through June 4, 2010, the day prior to the Petition Date. However, U.S. generally accepted accounting principles require an entity that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, whose financial statements were previously consolidated with those of its parent, as GST’s and its subsidiaries’ were with EnPro’s, generally must be prospectively deconsolidated from the parent and the investment accounted for using the cost method. Accordingly, the financial results of GST and its subsidiaries are not included in EnPro’s consolidated results after June 4, 2010.

On May 29, 2014, GST LLC filed an amended proposed plan of reorganization (the “Amended Plan”) with the Bankruptcy Court that provides $275 million in total funding for (a) present and future asbestos claims against GST that have not been resolved by settlement or verdict prior to the Petition Date, and (b) administrative and litigation costs. The $275 million is to be funded by GST ($245 million) and Coltec ($30 million), through two facilities—a settlement facility (which would receive $245 million) and a litigation facility (which would receive $30 million). Funds contained in the settlement facility and the litigation facility would provide the exclusive remedies for current and future GST asbestos claimants other than claimants whose claims had been resolved by settlement or verdict prior to the Petition Date and were not paid prior to the Petition Date in full. With respect to claims resolved by verdict, such payment will be made only to the extent the verdict becomes final. The amount of such claims resolved by verdict is $2.4 million. GST estimates the range of its aggregate liability for such unpaid settled asbestos claims to be from $3.1 million to $16.4 million. The Amended Plan incorporates the Bankruptcy Court’s determination in January 2014 that $125 million is sufficient to satisfy GST’s aggregate liability for present and future mesothelioma claims. Under the terms of the Amended Plan, EnPro will retain 100% of the equity interests of GST LLC.

If the Amended Plan is confirmed by the Bankruptcy Court and is consummated, GST will be re-consolidated with EnPro’s results for financial reporting purposes. The Amended Plan is subject to confirmation by the Bankruptcy Court and EnPro cannot assure you that GST will be able to obtain necessary Bankruptcy Court approval of the Amended Plan, including the settlement of asbestos claims and related releases of claims against us included therein, and that the Amended Plan will be consummated.

Confirmation and consummation of the Amended Plan are subject to a number of risks and uncertainties, including the actions and decisions of creditors and other third parties that have an interest in the bankruptcy proceedings, delays in the confirmation or effective date of the Amended Plan due to factors beyond GST's or EnPro’s control, which would result in greater costs and the impairment of value of GST, appeals and other challenges to the Amended Plan and risks and uncertainties affecting GST and Coltec's ability to fund anticipated contributions under the Amended Plan as a result of adverse changes in their results of operations, financial condition and capital resources, including as a result of economic factors beyond their control.

In light of the risks and uncertainties, including those noted above, the confirmation and consummation of the Amended Plan is not currently probable under Regulation S-X of the SEC and therefore, the reconsolidation of GST LLC with EnPro’s results for financial reporting purposes on the basis of confirmation and consummation of the Amended Plan is not currently probable. Accordingly, pro forma financial statements are not required by the SEC and the following pro forma condensed consolidated financial information may not include all information required to be included in pro forma financial statements prepared in accordance with Regulation S-X of the SEC. EnPro is providing the unaudited pro forma condensed consolidated financial information which assumes the confirmation and consummation of the Amended Plan for illustrative purposes only in light of specific requests for such pro forma information by investors.

The unaudited pro forma condensed consolidated financial information presented below has been prepared to illustrate the effects of the reconsolidation of GST and its subsidiaries with EnPro assuming the confirmation and consummation of the Amended Plan and is based upon the historical balance sheet of EnPro as of June 30, 2014, the estimated fair value of assets and liabilities of GST as of June 30, 2014 and the historical results of GST operations after consideration of the adjustments to the fair value of assets and liabilities. The unaudited pro forma condensed consolidated balance sheet as of June 30, 2014 gives effect to the reconsolidation as if it occurred on June 30, 2014. The unaudited pro forma condensed consolidated statements of operations for the quarters and six months ended June 30, 2014 and 2013 give effect to the reconsolidation as if it had occurred on January 1, 2013.

Under generally accepted accounting principles, the reconsolidation of GST requires that the tangible and intangible assets and liabilities of GST be reflected at their estimated fair values. The preliminary fair value amounts used in the unaudited pro forma condensed consolidated financial information reflects management’s best estimates of fair value. Upon completion of detailed valuation studies and the final determination of fair value, EnPro may make additional adjustments to the fair value allocation, which may differ significantly from the valuations set forth in the unaudited pro forma condensed consolidated financial information.

The unaudited pro forma condensed consolidated statements of operations are based on estimates and assumptions, which have been made solely for the purposes of developing such pro forma information. The unaudited pro forma condensed consolidated statements of operations also include certain adjustments such as increased depreciation and amortization expense on tangible and intangible assets, increased interest expense on the debt incurred to complete the reconsolidation as well as the tax impacts related to these adjustments. The pro forma adjustments are based upon available information and certain assumptions that EnPro believes are reasonable.

The unaudited pro forma condensed consolidated financial information has been presented for information purposes only and is not necessarily indicative of what the consolidated company’s financial position or results of operations actually would have been had the reconsolidation been completed as of the dates indicated, nor is it necessarily indicative of the future operating results or financial position of the consolidated company. Therefore, the actual amounts recorded at the date the reconsolidation occurs may differ from the information presented herein.

(1) Eliminate intercompany sales of $14.9 million.

(2) Reflects the increase in depreciation expense of $0.2 million due to adjusting property, plant and equipment to fair value. The total fair value adjustment to property, plant and equipment was $19.8 million of which $14.6 million related to depreciable buildings and improvements and machinery and equipment that have a net estimated remaining economic life of 14.1 years.

(3) Reflects the increase in amortization expense as a result of the estimated fair value adjustment due to the creation of the finite- lived intangible assets. The estimated useful life of the finite-lived intangible assets is 15 years.

(4) Eliminate asbestos-related expenses which would cease upon confirmation and consummation of the Amended Plan.

(5) Represents $0.3 million of additional interest expense due to borrowings needed to fund the Amended Plan. We estimated that the establishment of the settlement facility and litigation facility contemplated by the Amended Plan and payments of claims resolved by settlement or verdict prior to the Petition Date that were not paid prior to the Petition Date would require $40.5 million of borrowings in addition to $240 million of cash on hand. We used an estimated interest rate of 3% for all periods.

(6) Eliminate intercompany interest of $7.6 million.

(7) For purposes of the consolidated pro forma financial information, the estimated effective tax rate of 36% has been used for all periods presented to calculate the tax effect associated with the pro forma adjustments.