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NPO > SEC Filings for NPO > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for ENPRO INDUSTRIES, INC

Form 10-K for ENPRO INDUSTRIES, INC


25-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management's discussion and analysis of certain significant factors that have affected our consolidated financial condition and operating results during the periods included in the accompanying audited Consolidated Financial Statements and the related notes. You should read the following discussion in conjunction with our audited Consolidated Financial Statements and the related notes, included elsewhere in this annual report. Forward-Looking Statements
This report contains certain statements that are "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995 (the "Act") and releases issued by the Securities and Exchange Commission (the "SEC"). The words "may," "hope," "will," "should," "could," "expect," "plan," "anticipate," "intend," "believe," "estimate," "predict," "potential," "continue," and other expressions which are predictions of or indicate future events and trends and which do not relate to historical matters identify forward-looking statements. We believe that it is important to communicate our future expectations to our shareholders, and we therefore make forward-looking statements in reliance upon the safe harbor provisions of the Act. However, there may be events in the future that we are not able to accurately predict or control, and our actual results may differ materially from the expectations we describe in our forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. We advise you to read further about certain of these and other risk factors set forth in Item 1A of this annual report, entitled "Risk Factors." We undertake no obligation to publicly update or revise any forward-looking statement, either as a result of new information, future events or otherwise. Whenever you read or hear any subsequent written or oral forward-looking statements attributed to us or any person acting on our behalf, you should keep in mind the cautionary statements contained or referred to in this section.


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Overview and Outlook
Overview. We design, develop, manufacture, service and market proprietary engineered industrial products. We have 62 primary manufacturing facilities located in 13 countries, including the United States.
We manage our business as three segments: a Sealing Products segment, an Engineered Products segment, and an Engine Products and Services segment. Our Sealing Products segment designs, manufactures and sells sealing products, including: metallic, non-metallic and composite material gaskets; dynamic seals; compression packing; resilient metal seals; elastomeric seals; hydraulic components; expansion joints; heavy-duty truck wheel-end component systems, including brake products; flange sealing and isolation products; pipeline casing spacers/isolators; casing end seals; modular sealing systems for sealing pipeline penetrations; hole forming products; manhole infiltration sealing systems; safety-related signage for pipelines; bellows and bellows assemblies; pedestals for semiconductor manufacturing; PTFE products; conveyor belting; and sheeted rubber products. These products are used in a variety of industries, including chemical and petrochemical processing, petroleum extraction and refining, pulp and paper processing, heavy-duty trucking, power generation, food and pharmaceutical processing, primary metal manufacturing, mining, water and waste treatment, aerospace, medical, filtration and semiconductor fabrication. In many of these industries, performance and durability are vital for safety and environmental protection. Many of our products are used in applications that are highly demanding, e.g., where extreme temperatures, extreme pressures, corrosive environments, strict tolerances, and/or worn equipment make product performance difficult.
Our Engineered Products segment includes operations that design, manufacture and sell self-lubricating, non-rolling, metal-polymer, solid polymer and filament wound bearing products, aluminum blocks for hydraulic applications and precision engineered components and lubrication systems for reciprocating compressors. These products are used in a wide range of applications, including the automotive, pharmaceutical, pulp and paper, natural gas, health, power generation, machine tools, air treatment, refining, petrochemical and general industrial markets.
Our Engine Products and Services segment designs, manufactures, sells and services heavy-duty, medium-speed diesel, natural gas and dual fuel reciprocating engines. The United States government and the general markets for marine propulsion, power generation, and pump and compressor applications use these products and services.
The historical business operations of certain subsidiaries of our subsidiary, Coltec Industries Inc ("Coltec"), principally Garlock Sealing Technologies LLC ("GST LLC") and The Anchor Packing Company ("Anchor"), have resulted in a substantial volume of asbestos litigation in which plaintiffs have alleged personal injury or death as a result of exposure to asbestos fibers. Information about GST LLC's asbestos litigation is contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations in the "Asbestos" subsection of the "Contingencies" section.
On June 5, 2010 (the "Petition Date"), GST LLC, Anchor and Garrison Litigation Management Group, Ltd. ("Garrison") 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"). GST LLC, Anchor and Garrison are sometimes referred to collectively as "GST" in this report. The filings were the initial step in a claims resolution process. GST LLC is one of the businesses in our broader Garlock group. GST LLC and its subsidiaries operate five significant manufacturing facilities, including operations in Palmyra, New York and Houston, Texas. The filings did not include EnPro Industries, Inc., or any other EnPro Industries, Inc. operating subsidiary.
GST LLC now operates in the ordinary course under court protection from asbestos claims. All pending litigation against GST is stayed during the process. We address our actions to permanently resolve GST LLC's asbestos litigation in this Management's Discussion and Analysis of Financial Condition and Results of Operations in the "Garlock Sealing Technologies LLC and Garrison Litigation Management Group, Ltd." section.
The financial results of GST and 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 ours, generally must be prospectively deconsolidated from the parent and the investment accounted for using the cost method. At deconsolidation, our investment was recorded at its estimated fair value as of June 4, 2010, resulting in a gain for reporting purposes. The cost method requires us to present our ownership interests in the net assets of GST at the Petition Date as an investment and not recognize any income or loss from GST and subsidiaries in our results of operations during the reorganization period. Our investment of $236.9 million as of December 31, 2013 and 2012, was subject to periodic reviews for impairment. When GST emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting will be determined based upon the applicable facts and circumstances at such time, including the terms


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of any plan of reorganization. See Note 18 to the Consolidated Financial Statements in this Form 10-K for condensed financial information of GST and subsidiaries.
During 2013, 2012, and 2011, we completed a number of acquisitions and a disposition of a business. Please refer to "Acquisitions and Dispositions" in Item 1 - Business for additional discussion regarding these transactions. We completed our required annual impairment test of goodwill as of October 1, 2013. The estimated fair value of our CPI reporting unit, included in our Engineered Products segment, exceeded its book value by 24%, 10%, and 37% in 2013, 2012, and 2011, respectively. There is $54.2 million of goodwill allocated to CPI. The fair value of the CPI reporting unit was calculated using both discounted cash flow and market valuation approaches. The key assumptions used for the discounted cash flow approach include business projections, growth rates, and a discount rate of 10.3%. The discount rate we use is based on our weighted average cost of capital. For the market approach, we chose a group of 14 companies we believe are representative of our diversified industrial peers. We used a 70% weighting for the discounted cash flow valuation approach and a 30% weighting for the market valuation approach, reflecting our belief that the discounted cash flow valuation approach provides a better indicator of value since it reflects the specific cash flows anticipated to be generated in the future by the business. For sensitivity purposes, a 100-basis-point increase in the discount rate would result in this reporting unit exceeding its 2013 book value by 20%. Conversely, a 100-basis-point decrease in the discount rate would result in this reporting unit exceeding its 2013 book value by 29%. The future cash flows modeled for CPI are dependent on certain cost saving restructuring initiatives and a customer-focused organizational realignment, both launched in 2012. Non-recurring restructuring expenses in 2013 and 2012 were $4.1 million and $2.3 million, respectively. In addition, approximately $7.0 million of labor and facilities cost was removed from our future cost structure. The customer-focused organizational realignment during 2012 and 2013 was critical to price and volume opportunities identified while developing the 2014 forecast. While there is uncertainty associated with the customer price and volume opportunities, only a portion of these opportunities were forecasted in the future cash flow model utilized for goodwill impairment testing. Finally, we are dependent on the strength of our customers and their respective industries to achieve sales forecasted for 2014. Except for 2014, which is based on a detailed forecast, the remaining years in the cash flow model are based on the 2014 forecast, adjusted for assumed macro-economic forecasts for Industrial Production changes at each of our major geographic markets per the DuPont Economic outlook as of September 2013. Since our products serve a variety of industries, Industrial Production is a good indicator for demand changes for our products and services. The nominal growth rates for 2015 and beyond, are approximately 5%, 4%, and 12% for North America, Europe, and Asia, respectively. Management believes that all assumptions used were reasonable based on historical operating results and expected future trends. However, if future operating results are unfavorable as compared with forecasts, the results of future goodwill impairment evaluations could be negatively affected. We determined all other reporting units had fair values substantially in excess of carrying values and there were no subsequent indicators of impairment through December 31, 2013.
Outlook

For the first time in several quarters, we saw meaningful growth in European demand and in demand for our products used by the semiconductor industry. These improvements in the market place coupled with the recent court decision estimating GST's liability for mesothelioma claims at $125 million and endorsing GST's arguments on key factors in the case provide an encouraging start to 2014.

Our effective tax rate is directly affected by the relative proportions of revenue and income before taxes in the jurisdictions in which we operate. Based on the expected mix of domestic and foreign earnings, we anticipate our effective tax rate to remain lower than the U.S. statutory rate primarily due to a significant portion of our earnings originating in lower rate foreign jurisdictions. We also benefit from certain tax incentives such as the deduction for domestic production activities, and credits for research and development. Discrete tax events may cause our effective rate to fluctuate on a quarterly basis. Certain events, including, for example, acquisitions and other business changes, which are difficult to predict, may also cause our effective tax rate to fluctuate. We are subject to changing tax laws, regulations, and interpretations in multiple jurisdictions. Corporate tax reform continues to be a priority in the U.S. and other jurisdictions. Changes to the tax system in the U.S. could have significant effects, positive and negative, on our effective tax rate, and on our deferred tax assets and liabilities.

As of December 31, 2013, various tax provisions applicable to the Company expired, and have not yet been renewed by the United States Congress. These include credits for research and development, bonus depreciation, certain employment


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incentives, and an exclusion for passive income earned by controlled foreign corporations. As a result, we expect that our income tax provision for 2014 will exclude certain tax benefits that will significantly increase our annual effective tax rate.

The IRS completed the field examination for our 2008, 2009, and 2010 U.S. federal income tax returns during the third quarter of 2012, which resulted in incremental taxes payable of $1.5 million and tax expense of $1.4 million. As a result of the IRS's conclusion of its field examination, we reduced our liability for uncertain tax positions by $2.4 million to reflect amounts determined to be effectively settled, which lowered income tax expense by $1.9 million. Finally, we recorded $1.2 million of additional income tax expense related to the 2011 tax return filed in the third quarter of 2012. Although the IRS fieldwork was completed with respect to the 2008, 2009, and 2010 tax returns, we disagreed with and protested certain adjustments included in the audit results. While these audit years remain open, the only items under appeal that are not considered to be effectively settled relate to our deconsolidated GST operations. The Company has agreed in principal with the IRS to resolve this matter on a time-value-of-money basis under Section 6.02(4) of Revenue Procedure 2002-18. As part of this settlement, the Company may incur a $7 million specified payment in the next twelve months in anticipation of finalizing a closing agreement with the IRS for these years. No further recognition of income tax expense or benefit to the Company's results is expected, as the assessment is against the combined tax group for which the Company is responsible for payment, and then will seek a reimbursement from GST.

Our U.S. defined benefit plans continue to be underfunded. Based on currently available data, which is subject to change, we estimate we will be required to make contributions to the U.S. defined benefit plans in 2014 totaling approximately $20.4 million. We expect 2014 contributions to non-U.S. defined benefit plans to be insignificant. Additional significant cash contributions to the U.S. defined benefit plans are likely to be required in 2015 and beyond. Future contribution requirements depend on pension asset returns, pension valuation assumptions, plan design, and legislative actions. In July 2012, the President signed the Moving Ahead for Progress in the 21st Century Act (MAP-21). Although MAP-21 reduced short-term minimum pension contribution requirements in 2012 and 2013, we expect additional significant cash contributions to be required in 2015 and beyond. We estimate that annual GAAP pension expense in 2014 will be approximately $5 million, which is $5.5 million less than in 2013. The expected decrease in pension expense is due to a higher discount rate assumption, contributions made by EnPro during 2013, and strong performance of the pension plan assets during 2013.
In connection with our growth strategy, we will continue to evaluate acquisitions in 2014; however, the effect of such acquisitions cannot be predicted and therefore is not reflected in this outlook.
We address our outlook on our actions to permanently resolve GST LLC's asbestos litigation in this "Management's Discussion and Analysis of Financial Condition and Results of Operations - Garlock Sealing Technologies LLC and Garrison Litigation Management Group, Ltd." section.

Results of Operations
The following table does not include results for GST and its subsidiaries after the day preceding the Petition Date. See Note 18 to our Consolidated Financial Statements in this Form 10-K for condensed financial information for GST and subsidiaries.


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                                    Years Ended December 31,
                                2013          2012          2011
                                          (in millions)
Sales
Sealing Products             $   622.9     $   609.1     $   534.9
Engineered Products              356.4         363.0         386.7
Engine Products and Services     167.6         214.6         185.8
                               1,146.9       1,186.7       1,107.4
Intersegment sales                (2.7 )        (2.5 )        (1.9 )
Total sales                  $ 1,144.2     $ 1,184.2     $ 1,105.5
Segment Profit
Sealing Products             $    97.1     $    88.8     $    81.2
Engineered Products               17.6          20.5          29.2
Engine Products and Services      14.0          39.2          30.6
Total segment profit             128.7         148.5         141.0
Corporate expenses               (33.3 )       (32.3 )       (32.6 )
Interest expense, net            (44.3 )       (42.8 )       (39.6 )
Other expense, net               (15.3 )        (9.9 )        (3.8 )
Income before income taxes   $    35.8     $    63.5     $    65.0

Segment profit is total segment revenue reduced by operating, restructuring and other expenses identifiable with the segment. Corporate expenses include general corporate administrative costs. Expenses not directly attributable to the segments, corporate expenses, net interest expense, asbestos-related expenses, 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 EnPro. 2013 Compared to 2012
Sales of $1,144.2 million in 2013 decreased 3% from $1,184.2 million in 2012. The following table illustrates the effects of key factors resulting in the change in sales by segment:

Sales                                      Percent Change 2013 vs. 2012
                                              Foreign     Engine
increase/(decrease)          Acquisitions    Currency    Revenue     Other     Total
EnPro Industries, Inc.             1.4 %        0.6 %     (2.6 )%   (2.8 )%    (3.4 )%
Sealing Products                   2.7 %        0.7 %      n/a      (1.1 )%     2.3  %
Engineered Products                  - %        0.8 %      n/a      (2.6 )%    (1.8 )%
Engine Products & Services           - %          - %    (14.5 )%   (7.4 )%   (21.9 )%

Following are key points regarding changes in sales for 2013 compared to 2012:
The acquisition of Motorwheel in April 2012 and the acquisition of certain assets and assumption of certain liabilities of a small distributor of industrial seals in January 2013; both included in the Sealing Products segment

Favorable foreign currency exchange rate fluctuations in 2013 compared to 2012

Lower revenues in the Engine Products & Services segment, which is discussed further in the discussion of segment results following

Segment profit, management's primary measure of how our operations perform, decreased 13% to $128.7 million in 2013 from $148.5 million in 2012. Earnings from acquisitions contributed $2.7 million, favorable exchange fluctuations increased segment profit $1.0 million, and selected price increases generated $11.2 million. These favorable changes were more than offset by volume reductions of $23.7 million and increased costs of $11.0 million.


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Corporate expenses for 2013 increased by $1.0 million compared to 2012. The increase was primarily driven by an increase in inventory valuation allowance reserve ($0.7 million), workers' compensation costs ($0.4 million), employee incentive compensation ($0.7 million), salaries/severance ($0.9 million), travel costs ($0.5 million) and board of directors expenses ($0.4 million), partially offset by lower employee medical costs ($2.6 million).
Net interest expense in 2013 was $44.3 million compared to $42.8 million in 2012. The increase was due to an increase in the note payable to GST because of capitalized PIK interest partially offset by lower borrowings against the senior secured revolving credit facility.
Other expense, net in 2013 was $15.3 million compared to $9.9 million in 2012. The increase was due to higher environmental reserves ($5.1 million) and increased ACRP costs as activity in relation to GST's asbestos liability estimation trial increased ($1.7 million), partially offset by lower discontinued operations expense ($3.0 million).
Income tax expense in 2013 was $8.4 million compared to $22.5 million reported in 2012. The decrease in tax expense reflects a similar decrease in pre-tax income over both periods, as well as a larger proportion of our 2013 earnings in foreign jurisdictions that carry an effective tax rate significantly lower than the U.S. The overall effective tax rate in 2013 is 23.4%, substantially lower than the 35.3% reported in 2012. In the U.S., we historically have benefited from federal income tax incentives such as the deduction for domestic production activities and credits for research and development. However, as of December 31, 2012, certain tax incentives expired and were not renewed before the end of 2012. These include the research and experimentation credit, certain employment credits, and an exclusion for passive income earned by controlled foreign corporations. In January 2013, the United States Congress passed the American Taxpayer Relief Act (ATRA) of 2012 which retroactively extended these tax provisions. The effective tax rate for 2012 reflects the tax law that was in place as of December 31, 2012. Had the ATRA been enacted prior to January 1, 2013, our overall tax expense in 2012 would have been approximately $20.9 million, resulting in an overall 2012 effective tax rate of 32.7%. This $1.6 million difference was reflected in tax expense during the first quarter of 2013, lowering the 2013 annual effective tax rate by 4.4%.
Income from continuing operations was $27.4 million, or $1.17 per share, in 2013 compared to $41.0 million, or $1.90 per share, in 2012. Earnings per share are expressed on a diluted basis.
Following is a discussion of operating results for each segment during the year:
Sealing Products. Sales of $622.9 million in 2013 were 2% higher than the $609.1 million reported in 2012. Excluding the benefit from the acquisitions of Motorwheel ($14.4 million) and a small product line ($2.6 million) and favorable foreign exchange ($3.8 million), sales were down 1% or $7.0 million. Higher demand in the North American heavy-duty truck markets ($8.6 million) and price increases across the segment ($2.1 million) were more than offset by lower volumes at Technetics ($11.2 million) and Garlock ($7.0 million). Segment profit increased to $97.1 million in 2013 from $88.8 million in 2012. Excluding the benefit from acquisitions ($2.7 million) and foreign exchange ($0.6 million), profit was up 6% or $5.0 million due to selected price increases across the segment ($1.5 million) and various factors at each division. At Garlock, lower volumes ($3.4 million) were offset by improved product mix ($3.1 million), cost savings due to restructuring activities in the prior year ($0.6 million), and lower restructuring costs in 2013 ($0.8 million). At Technetics, lower volumes due to weaker overall markets ($7.8 million) were offset by lower manufacturing costs ($4.7 million), R&D tax credits in France ($2.9 million), and the release of an acquisition earnout provision ($2.0 million). At Stemco, higher volumes ($5.7 million) were offset by increased costs ($5.4 million) due to the increased activity and opening of the distribution center. Including the acquisition and foreign exchange effects, operating margins for the segment increased to 15.6% in 2013 from 14.6% in 2012.
Engineered Products. Sales of $356.4 million in 2013 were 2% lower than the $363.0 million reported in 2012. Excluding the favorable foreign exchange ($2.9 million), sales were down 3% or $9.5 million due to lower demand in the European automotive markets and in CPI's North American markets partially offset by price increases across the segment
Segment profit in 2013 was $17.6 million compared to $20.5 million in 2012. Excluding the benefit from foreign exchange ($0.4 million), profit was down 16% or $3.3 million. Lower volumes at both GGB and CPI ($9.7 million) and higher restructuring costs at CPI ($1.8 million) more than offset price increases at both GGB and CPI ($6.6 million), lower restructuring costs at GGB ($1.2 million), and manufacturing increases at CPI ($0.3 million). Including foreign exchange effects, operating margins for the segment decreased to 4.9% in 2013 from 5.6% in 2012.
Engine Products and Services. Sales decreased 22% to $167.6 million in 2013 from $214.6 million in 2012, due primarily to a decrease in engine revenue. Although ten engines were shipped in 2013 compared to fourteen in 2012, revenue for six of the engines shipped in 2012 was recognized under the completed contract method ($28.1 million) versus zero in 2013. The remaining decrease in sales was driven by lower parts and service revenue due to the U.S. government sequestration and the


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timing of scheduled maintenance ($19.8 million) and lower percentage-of-completion engine revenue ($7.0 million) partially offset by strong year-over-year sales of new environmental upgrade products ($5.2 million) and price increases ($2.5 million).
The segment reported a profit of $14.0 million in 2013 compared to $39.2 million in 2012. The year-over-year decline in segment profit was primarily due to volume decreases and a less attractive product mix as parts and service sales declined. Operating margins decreased to 8.4% in 2013 from 18.3% in 2012. 2012 Compared to 2011
Sales of $1,184.2 million in 2012 increased 7% from $1,105.5 million in 2011. The following table illustrates the effects of key factors resulting in the change in sales by segment:

Sales                                      Percent Change 2012 vs. 2011
                                               Foreign     Engine
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