EnPro Industries Inc

NYSE:NPO

Earnings Call Transcript 2020-Q3

[Operator]

Hello. And welcome to the EnPro Industries Q3 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It’s now my pleasure to introduce Jerry Johnson, Senior Vice President for Corporate Development and Strategy. Please go ahead sir.

[Jerry Johnson]

Thank you. Good morning, and welcome to EnPro's quarterly earnings conference call. I’ll remind you that our call is also being webcast at enproindustries.com, where you can find the presentation that accompanies the call.

With me today are Marvin Riley, our CEO; and Milt Childress, our CFO. We are holding our call virtually and are dialed in from different locations, so we will ask for your understanding should we encounter any technical issues as we coordinate our responses during Q&A.

Before we begin our discussion, a friendly reminder that we will be making statements on this call that are not historical facts and that are considered forward-looking in nature. These statements involve a number of risk and uncertainties, including impacts from the COVID-19 pandemic and related governmental responses and their impacts on the general economy, as well as other risks and uncertainties that are described in our filings with the SEC, including our most recent Form 10-K and Form 10-Q. We do not undertake to update any of these forward-looking statements.

Also during the call, we will reference a number of non-GAAP financial measures. Tables reconciling these measures to comparable GAAP measures are included in the appendix to the presentation materials. I also want to remind you that, as a result of the sale of Fairbanks Morse in January 2020, the former Power Systems segment is accounted for as discontinued operations in our financial statements for both current year and prior year periods. Unless otherwise noted, all our comments today will refer to continuing operations.

And now, I will turn the call over to Marvin.

[Marvin Riley, President and Chief Executive Officer]

Thanks, Jerry, and good morning, everyone. Thank you for joining us today. I hope that you and your families remain safe and healthy during this time. Before I begin today’s call, I’d like to welcome the newest member of our management team, Jerry Johnson, who recently joined EnPro as Senior Vice President of Corporate Development, Strategy, and Investor Relations.

Jerry brings tremendous knowledge and experience from his prior roles in merchant banking, private equity and management consultant. I am delighted he has joined our team and I am confident his deep expertise will be a significant contributor to EnPro’s success as we continue to execute our strategic priorities.

As we continue to navigate the COVID-19 pandemic, I am extremely proud of how our team has risen to the challenge of practicing enhanced safety protocols and incorporating new ways of working throughout the organization and while keeping our core values of safety, excellence and respect for all people at the forefront of their actions and excelling and delivering quality products and solutions to our customers.

As I mentioned on our call last quarter, EnPro stands against racism and discrimination of any type, which are a violation of our core values and what we stand for as a company. Over the last year, we have taken several concrete actions to increase diversity and inclusion at EnPro and we’ll continue to do so. We stand together in solidarity in response to systemic racism and social injustice and are committed to being part of an enduring solution in creating real sustainable change starting right here at EnPro.

I’d like to start by discussing three key themes reflected in our third quarter results. First, I am pleased to report better than expected third quarter top and bottom-line performance despite the challenges created by the pandemic. Our third quarter adjusted EBITDA margin expanded 140 basis points to 15.7% with adjusted EBITDA of $42.1 million, a modest decline of 1.4% year-over-year.

This strong performance was a result of actions taken over the past year to reshape our portfolio, as well as quick and decisive cost mitigation initiatives in response to COVID.

Second, we’ve made significant progress in our portfolio evolution towards more profitable businesses and higher growth markets that generate higher cash flow return on investment resulting in improved stability of financial results over time.

The acquisition of Alluxa completed last week marks another milestone in this journey extending our presence in high growth, high margin, material science businesses with technology-based competitive advantages.

And third, we will maintain a disciplined capital allocation approach and strong balance sheet as we drive long-term shareholder returns with approximately $204 million of cash on the balance sheet following the Alluxa acquisition, a largely untapped revolver, a relentless focus on cash generation and strong performing businesses, we are well positioned to consider additional bolt-on acquisition opportunities that may arise.

Turning to Slide 5, and an update on our four-phased approach in navigating the COVID-19 pandemic. Phase 1 focused on health and safety. Phase 2 is centered on business stability and progression. Phase 3 emphasized cost and process improvement, and Phase 4 positions EnPro to capture growth as our markets recover.

At the onset of the pandemic, we took quick and decisive action including applying the processes and protocols across our network that were developed at our Asian facilities. We then moved swiftly to redesign how our manufacturing teams conduct their work and have fully implemented baseline COVID testing across the Americas and are in the process of implementing digital contact tracing technology in the U.S. and Europe.

This is in addition to our existing manual contact tracing, temperature checks and ample PPE at all of our facilities. We’ve applied the tools, processes and technology to protect our employees’ safety, while they continue to deliver the high level of service that EnPro customers expect.

Delving deeper into the fourth and final phase of our COVID-19 response playbook let me discuss our supply chain and working together from anywhere initiatives.

Our supply chain team remains a notable strength that we have had no significant supply chain disruptions. Our supply chain organization is built around resilience and has supported operations seamlessly during this time.

We have built inventory of PPE and established a full loop system to test, trace and monitor any COVID infections in our employee base. As a standard practice, we continue to closely monitor supplier viability, as well as operational and financial risk.

Our working together from anywhere initiative demonstrates our team’s ability to respond with agility and adapt successfully enabling us to continue working smoothly in the new environment. Our IT team supports the tools necessary to work remotely, which limits employee risk as the office setting generally has one of the highest people densities in all of our facilities.

We have seen many benefits to working this way including increased collections, and productivity across our businesses and geographies, as well as a greater ability to use our colleagues’ unique talents and provide job opportunities across the global organization.

We have created customized plans to optimize our working environment, while evaluating a reduction in office space across our footprint remaining focused on providing the appropriate workforce density, air quality and social distancing to protect the health of each of our team members.

Given the success and seamless integration of the working together from anywhere initiative, we have communicated to our employees that we will continue to work this way through the end of 2021.

As market conditions recover, we expect our businesses to be better positioned to deliver results owing to the structural improvements made to our cost base, productivity and supply chain, as well as the benefits of the portfolio transformation work we have completed over the past year. While demand continues to remain soft across several core markets, we are focused on continuing to execute our profitable growth strategy.

Now let me spend a few moments discussing our strategy and actions taken over the last year to reposition our portfolio towards a more durable business in higher growth markets that generate higher margins and cash flow.

Our strategy is focused on three areas; first, reshaping our portfolio to accelerate growth through the addition of niche, high margin material science-related businesses with leading technologies and strong cash flow in markets with favorable tailwinds.

Second, increasing our aftermarket exposure and driving greater recurring revenues and third, leveraging the EnPro operating system to increase margins and cash flow return on investment. As we implement our enduring strategy, we are committed to disciplined capital allocation, with a goal of maximizing long-term shareholder returns. Let me briefly summarize the main actions we have taken to reshape our portfolio over the last year and how they have benefited our overall business.

First, I’ll cover divestitures, and business exits by segment. In January, we completed the $450 million sale of Fairbanks Morse which constituted the former Power Systems segment. After careful review, we determined Fairbanks Morse was no longer a fit, given the strategy I just described.

In our Sealing Products segment, we conducted an extensive review during the second half of 2019, to identify businesses and product lines that are no longer aligned with our long-term strategy. As a result, we have exited or divested several businesses in our heavy-duty truck business.

During the second half of 2019, we divested our brake shoe business and seized operations of three underperforming product lines. In September of this year, we closed the sale of the Motor Wheel and Crewson businesses.

Finally, in early August, we announced the definitive agreement to sell our Air Springs business which is expected to close in the fourth quarter. Upon completion of the Air Springs divestiture, we will have completed the Heavy-Duty truck portfolio reshaping work in line with our previously communicated year end 2020 timeframe.

Going forward, our STEMCO heavy-duty truck business will be focused on our high margin, wheel and sealing systems and suspension components. With these actions, we anticipate our heavy-duty truck business annual sales will range from $125 million to $175 million reducing the percentage of our sales in trucking from the mid 20s to the mid-teens.

Now, our Sealing segment as a whole have significantly reduced cyclicality, and increased exposure to resilient, technology-oriented aftermarket businesses with a predominant focus on material science technology leading to increased adjusted EBITDA margins and cash flow return on investment.

Moving to our Engineered Products segment, in June, we announced plans to exit operations at GGB’s bushing block manufacturing facility headquartered in Dieuze, France to refocus the business on higher margin product lines. We’ve been successful in attaining an agreement for the sale of this business which is expected to close by the end of the fourth quarter.

Next, I’ll cover our recent acquisitions. We made two strategic acquisitions in 2019. LeanTeq was closed in late September and Aseptic Group which closed in early July. These acquisitions expanded our reach into the attractive semiconductor aftermarket and pharmaceutical and biopharmaceutical industries respectively.

Both companies have strong competitive positions in high growth markets, excellent margins, robust cash flow and strong secular trends supporting long-term growth. These acquisitions align with our growth strategy, due to their technical expertise, niche market leadership, mission-critical applications and recurring revenue models.

Both businesses are showing resilience in the wake of COVID with solid order intake and backlog. More specifically, both LeanTeq and Aseptic Group’s year-over-year revenue growth remains strong despite market challenges.

We’ve been very pleased with the overall performance and are currently executing capacity expansion plans to support LeanTeq’s current demand growth. We look forward to continued contributions from both LeanTeq and Aseptic as demand remains strong.

So now I am excited to share further details on our previously announced acquisition of Alluxa which closed Monday of last week. Alluxa is a technology company that provides specialty optical filters complementing our growing material science capabilities.

Alluxa offers a unique and compelling customer value proposition enabled by its technology platform, processes and technical knowhow, including the proprietary advanced SIRRUS automated plasma deposition software. The addition strengthens and extends our existing thin film technical expertise and intellectual property portfolio and more specifically, provides a platform for entry into specialty photonics and optics.

The acquisition is consistent with the strategy I communicated earlier and is aligned to our stated M&A criteria. Alluxa’s financial profile is compelling with an attractive revenue and margin profile including 18 quarters of consecutive revenue growth. We expect Alluxa’s track record of double-digit annual revenue growth to continue under our leadership using the EnPro operating system.

We believe we can accelerate Alluxa’s growth as we leverage our capabilities that are specifically in the areas of data science and commercial excellence. We will also be leveraging our industry relationships, global footprint, and extensive capital resources to support Alluxa.

Going deeper on Alluxa’s end-markets and growth rates within the broader $13 billion optical coating market, Alluxa participates in a $1.7 billion addressable niche market that is focused on ultra high-precision coatings. We estimate that Alluxa’s niche will grow at a compounded annual growth rate of approximately 10% through 2024 and we expect Alluxa’s growth rate to exceed that of the markets.

Alluxa exclusively provides filters for the most challenging applications in the industry and does not participate in the market for high volume, more commoditized filters. Alluxa serves a broad array of high growth end-markets with primary exposure to industrial technology and life sciences, as well as smaller position in niche semiconductor and aerospace and defense markets.

To share some specific examples of Alluxa’s applications within these end-markets, Alluxa provides filters for lidar and autonomous vehicles, filters for PCR testing for COVID DNA sequencing, extreme ultraviolet lithography in semiconductor and also flow cytometry. Further, we’ve identified pockets of nascent growth where we can utilize EnPro’s existing market strength to help accelerate Alluxa’s growth in these markets.

We are thrilled to welcome the Founder of Alluxa, Mike Scobey, who will continue to lead the business with his highly talented team and we look forward to working together to create value for our customers and shareholders.

Collectively, the actions we have taken to proactively manage our portfolio and acquire complementary businesses increases our exposure to more resilient leading edge advanced technology in material science-based niche markets that are poised for growth with semiconductor as our largest end-market. We will continue to identify inorganic growth opportunities that align with our strategies through a disciplined set of strategic and financial filters.

We have a seasoned M&A team overseeing this effort including the addition of Jerry. Beyond sourcing and acquiring, we have the right talent in place to integrate and optimize acquired businesses and expect to continue to create value through our approach.

And now, I’ll turn the call over to Milt for additional discussion on our third quarter results.

[Milton Childress]

Thank you, Marvin, and good morning, everyone. In the third quarter, sales were $268 million a decrease of 10.3% year-over-year reflecting weakness across many of our end-markets. However, this performance was better than what we expected when we announced second quarter results.

On a sequential basis, sales increased 8.6% in the third quarter. We experienced growth in our legacy semiconductor business in addition to the contribution from LeanTeq, which was acquired at the end of the third quarter of last year.

Excluding the impact of foreign exchange translations and sales from acquired and divested businesses, organic sales for the quarter declined 12.4% year-over-year. Gross profit margin was 35.2%, an increase of 250 basis points versus the prior year period driven by the benefit of acquisitions, supply chain initiatives, company-wide cost reduction programs, and improved operating performance including a reduction in warranty expense, offset impart by the impact of the sales decline.

Adjusted EBITDA was $42.1 million, a decline of only 1.4% as the continued impact of COVID was nearly offset by the addition of strategic acquisitions, divestitures of underperforming businesses, and cost reductions across the company. Adjusted EBITDA margin of 15.7% increased approximately 140 basis points.

Our decremental year-over-year adjusted EBITDA margins were approximately 35% this quarter excluding the impact of acquisitions, divestitures and foreign exchange translation, which remains significantly below our weighted average contribution margin.

This result was achieved largely through our cost management actions which as we discussed last quarter are expected to result in full year 2020 savings of approximately $30 million, about half of which we expect to be permanent in an improved economic environment.

Adjusted diluted earnings per share of $0.67 decreased 8.2%. Excluding amortization of intangibles, our adjusted diluted earnings per share decreased 1.5% versus the prior year period.

I’d also like to note that in the third quarter, we recognized other operating and non-operating charges aggregating $46 million. The primary components of which relate to settlements of two long pending litigation matters, non-cash impairments of trademarks and sealing products, and the impairment of assets of our bushing block business in Dieuze, France.

Regarding the litigation matters, in recent weeks, we have been successful in resolving claims by the State of Mississippi related to environmental contamination at the site of a legacy business divested in 1996 and product claims by a customer related to bearings that GGB last supplied in 2008. With these settlements, including those previously communicated, we have significantly reduced our legacy contingent liabilities.

During the past month, we were also successful in obtaining an agreement for the sale of GGB’s non-strategic and unprofitable bushing block business in Dieuze, France. We recognized an impairment charge of $6.2 million in the third quarter and expect the sale to close before year end.

Achieving a sale of this business is a great result by our team and for the employees in Dieuze, which the buyer plans to retain. Exiting the bushing block business through either a sale or shutdown was one of our 2020 portfolio shaping objectives.

Turning to segment performance, Sealing Products sales of $202 million declined 8.1% amid soft demand in heavy-duty truck and aerospace and flat performance in general industrial and food and pharma markets, somewhat offset by strength in semiconductor.

The LeanTeq acquisition, which closed in September 2019 was a benefit, while the strategic trending of our heavy-duty truck product portfolio over the past twelve months served as an offset. Excluding the impact of foreign exchange translation and sales from acquired and divested businesses, sales decreased 10.3%.

Despite the sales decline, segment adjusted EBITDA increased 22.7% to $45.4 million and segment-adjusted EBITDA margin expanded 560 basis points to 22.5%. Contributions from LeanTeq, and more favorable mix in heavy-duty trucking owing impart to the strategic exits in this business and cost management actions drove the strong results.

Excluding the impact of acquisitions, divestitures and foreign exchange translations, segment adjusted EBITDA margin contracted 50 basis points to 19.2% compared to last year. Sales in engineered products of $68 million decreased 16.5%, primarily due to broad based end-market weakness including general industrial, oil and gas, automotive and petrochemical markets.

The lower sales volumes resulted in a third quarter segment adjusted EBITDA decline of 46.6% and an adjusted EBITDA margin decline of 650 basis points to 11.7%. On a sequential basis, we saw significant improvement from the 8.4% adjusted EBITDA margin reported last quarter.

Now let’s turn to our financial position. Our balance sheet remains strong. We ended the quarter with cash of $441 million and had full availability of our $400 million revolver, less $11 million in outstanding letters of credit.

At the end of September, our net debt to adjusted EBITDA ratio was approximately 0.3 times. Subsequent to the end of the third quarter, we financed the Alluxa acquisition through a combination of $237 million of cash and rollover equity from Alluxa executives equating to 7% of Alluxa.

When taking this transaction, our divestitures, and our exits since the fourth quarter of last year into account, our pro forma net debt to adjusted EBITDA leverage ratio would be lower than our long-term target leverage rang of 1.5 times to 2.0 times. We have no debt coming due until 2024, subject to applicable reinvestment requirements related to the Fairbanks Morse and other divestitures, which we have largely met as a result of the Alluxa acquisition.

Year-to-date free cash flow of $36.6 million was down from $76 million in the prior year period driven by cash that’s paid in conjunction with the gain on the sale of Fairbanks Morse and payments made related to settlements of environmental matters. Excluding these two items, year-to-date cash flow would have been greater than that of the prior year.

During the third quarter, we paid a $0.26 per share quarterly dividend totaling $5.4 million. We announced this morning that the Board of Directors approved a new two year share repurchase authorization, under which we may repurchase up to $50 million of shares in both open markets and privately negotiated transactions.

While we are prioritizing investments in organic and inorganic growth currently, this authorization provides us with the flexibility to return capital to shareholders based on balance sheet and growth investment considerations.

Now let’s provide a high level look at the impact of our portfolio reshaping on sales, adjusted EBITDA and adjusted EBITDA margins. As shown on Slide 13, on a last 12 months basis, our pro forma net adjusted EBITDA margins would increase approximately 175 basis points on a revenue decline of $95 million.

This analysis shows the impact of the Alluxa acquisition, the reshaping of the heavy-duty truck business and the pending sale of GGB’s bushing block business, as that all these transactions occurred at the end of the third quarter of last year. Note that this pro forma information is based on last 12 months results and we expect these strategic actions to lead to higher sales and earnings growth, increasing margins, and reduced cyclicality as we look ahead.

Now I’d like to spend a few minutes – a few moments providing you with our latest thinking about the year. As Marvin and I noted earlier, our third quarter operating earnings were stronger than we expected a quarter ago, driven primarily by results in our semiconductor business, improvements in heavy-duty trucking as a result of our portfolio shaping work; and better than expected top-line results.

For the fourth quarter, we anticipate year-over-year demand to be solid for both semiconductor and food and pharma with continued softness in heavy-duty truck, general industrial, oil and gas, petrochemical and aerospace. For the full year, as a result of the market dynamics, portfolio reshaping actions, and seasonal and customer-specific demand patterns, we expect a year-over-year sales decline of a little over 15% and adjusted EBITDA margins of approximately 15%.

This compares to our prior scenario planning ranges of a 15% to 25% decline in sales and adjusted EBITDA margins of 13% to 14%. Note that these expectations do not include contributions from the acquired Alluxa business nor uncertainties surrounding how the resurging COVID-19 crisis might impact demand and revenue. However, they do include the impact of completed and announced divestitures.

Now I’ll turn the call back to Marvin for closing comments.

[Marvin Riley, President and Chief Executive Officer]

Thank you, Milt. I am proud of the meaningful strides we have made in improving the quality and resilience of our portfolio. In a short period, we have acquired several businesses that align with our long-term material science vision and exited or divested those that were no longer strategic fit.

With these actions, we are well on our way to transforming EnPro into a leading technology company using material science to push the boundaries of semiconductor, life sciences and other technology-enabled sectors.

We continue to drive to capture above market growth, expand margins and increased cash flow return on investment to maximize shareholder value. Our teams have adapted well to the new ways of working as we navigate the COVID-19 pandemic and we are well positioned as our markets recover. We continue to focus on driving operational excellence by leveraging the EnPro operating system to reduce cost, improve productivity, and achieve quality control across all our businesses.

We are emerging from this challenging environment a stronger company with many opportunities on the horizon. EnPro’s success will be fueled by our commitment to our strategy, our cycle tested leadership team, our increasingly diverse and dedicated workforce, our strong financial position, and our focus on driving long-term shareholder value.

Thank you again for joining us on the call today. Let’s open the line for questions.

[Operator]

[Operator Instructions] Our first question today is coming from Jeff Hammond from KeyBanc. Your line is now live.

[Jeff Hammond, KeyBanc Capital Market]

Hey. Good morning guys.

[Marvin Riley, President and Chief Executive Officer]

Good morning, Jeff.

[Milton Childress]

Good morning, Jeff.

[Jeff Hammond, KeyBanc Capital Market]

Yes. So, just on Alluxa, I wanted to get a better sense of – I think, it looks like the historical growth is faster than the forward growth and just want to understand that a little bit better. And then, I don’t know if you can frame, kind of the 2020 revenue runrate as a starting point? And kind of any profitability metrics around Alluxa would be helpful.

[Marvin Riley, President and Chief Executive Officer]

So, what I’d like to do, Jeff, since I assume we’ll have a lot of questions on Alluxa. I might take a little bit more time just to talk a little bit more about Alluxa in general. As I said in the prepared remarks, the TAM is roughly $13 billion and SAM is $1.7 billion growing it roughly 9% a year. As we think about the CAGR going forward, in our planning, we’ve thought about mid-teens, branded the underlying markets that it participates in from an application perspective, they are growing a little bit faster than that.

But for planning purposes, we want to be thoughtful and we want to be conservative as we think about things. So, if you think about Alluxa and where they participate today, in life sciences it has really nice growth characteristics in cytometry, endoscopy, things of that nature or it’s participates in semiconductor and lithography, it’s got really nice growth characteristics, high teens in some cases.

We have growth characteristics that maybe in 20s. We feel like we will perform exceptionally well. But we want to be thoughtful and conservative in our approach as we look at Alluxa. So, I can spend a little bit more time there on sort of why and fit and some of those things. But I’ll wait to hear some of your more specific questions.

As it relates to financials, and as it relates to its runrate revenue, we are trying to be careful not to communicate too much as it relates to its financial profile or its margin profile strictly for competitive reasons.

I mean, what I’ll tell you is, it’s a great business. It’s an exceptional business in terms of its growth, exceptional in terms of its margins, and I mean exceptional. And so, we want to be thoughtful about not giving away too much of that from a competitive perspective.

[Jeff Hammond, KeyBanc Capital Market]

Okay. And I appreciate that.

[Milton Childress]

This is – yes. Hey, Jeff, this is Milt. It’s one of the reasons we provided the pro forma look to give you a better idea of with all the moves that we’ve made on a CPM basis what the profile of the company looks like, what’s again its CPM it’s not looking forward. But it does give an idea of overall sales, EBITDA margins as we look ahead.

[Jeff Hammond, KeyBanc Capital Market]

And just to be clear on that, Milt, the $95 million of sales that come out net and the EBITDA adjustment, that includes what? The Air Springs, the GGB, bushing block, the motor wheel and then the Alluxa coming in or is there anything else in that?

[Milton Childress]

That’s pretty much. Yes, those are the big pieces. Yes.

[Jeff Hammond, KeyBanc Capital Market]

Okay. Okay, great. And then, just on the revenue guide, good to see that’s coming closer to the better end. Can you just frame what comes – how much is coming out in the fourth quarter for Motor Wheel and Air Springs as we kind of firm up our models?

[Milton Childress]

Well, I think that – I think the best way to think about it Jeff, is, with the three quarters that we have completed and if you look at our guidance, it will give you a overall pretty good result, I mean, pretty good idea of what we are expecting for the fourth quarter and then you can circle that pretty tightly. And that is going to reflect the revenues that come out.

It is going to reflect the impact of Dieuze, the impact of Air Springs, the impact of Motor Wheel and Crewson. What it does not reflect the guidance that we gave, what it does not reflect is the contribution from Alluxa. So, we do expect some upside in the fourth quarter for that reason. We also have not yet closed the Air Springs divestiture, as you know.

And so, since the timing of that remains uncertain at this point, there could be some upside depending on where we end up closing Air Springs, because it currently is operating in a profitable fashion.

[Jeff Hammond, KeyBanc Capital Market]

Okay. And then, just last one, if you look at the sequential revenue improvement maybe versus your internal models, what end-markets or businesses surprised you the most?

[Marvin Riley, President and Chief Executive Officer]

Well, I mean, automotive, as you might see with us and as well as other companies, really on a sequential basis rebounded quite nicely. Same thing with heavy-duty truck, obviously, still down year-over-year, but heavy-duty truck rebounded nicely.

We saw a nice sequential improvement in oil and gas and of course semiconductor. So, the big stand out was automotive. It kind of came roaring back for us, of course, and then, heavy-duty truck came back nicely as I said before in semiconductor, as well.

[Jeff Hammond, KeyBanc Capital Market]

Okay. Great. Thanks guys. Appreciate it.

[Operator]

Thanks. Our next question today is coming from Ian Zaffino from Oppenheimer. Your line is now live.

[Ian Zaffino, Oppenheimer]

Hi. Great. Thank you. I guess, a question will be on the buyback. So, you announced the buyback, but it also seems like you are trying to shift the portfolio to higher growth areas. So, what’s the priority? Or how does the capital returns stay into – which is of priorities versus going out and keeping into other areas? Thanks.

[Marvin Riley, President and Chief Executive Officer]

Yes. I’ll start Milt, and then you can chime in. I’ll start first with the authorization. We thought it’s very important for us to have an authorization, not that we intend to pull the trigger and immediately use it, but it’s important for us to have all the tools available to us given what might happen. So we start with that, right. We want to make sure that we have every tool available to us.

As we think about prioritization though, we are thinking about obviously organic growth in some of the areas where we’ve already made investments. If you look at our LeanTeq investment, which we did last year, it’s growing nicely. We’ve got some capacity expansion plans that are underway in that business. We want to continue to support the growth of that business.

And obviously, the same goes for the Aseptic business. We want to continue to support the growth of that business, as well. And we are bringing Alluxa online. They’ll obviously want support to continue their expansion plans. And obviously, on the inorganic side, we are able to find another Alluxa, another LeanTeq or another Aseptic, we would definitely want to take advantage of those opportunities.

Those are rare businesses that have unique characteristics growing really fast with really high margins. We wouldn’t want to pass up an opportunity like that if it fits and matches our capabilities. And so, that’s how we think about it. And that’s how we would likely go forward in our planning. I don’t know if you want to add anything there, Milt?

[Milton Childress]

I think you covered it well. It’s just a good distinction Ian, between having the authorization in place versus using it. And as Marvin has described, we are currently focused on supporting the growth of our company.

[Ian Zaffino, Oppenheimer]

Okay, great. And then, also, as you look at divestitures, I mean, are there more to come? What’s sort of the criteria for divestments? And how do you think about maybe losing scale, as you divest out of certain areas, but then you are still in certain areas?

[Marvin Riley, President and Chief Executive Officer]

Yes. That’s a really, really good question. I really appreciate you asking that question. It’s one where we spend a lot of time. So, thank you for that. So, as we think about EnPro, let me just kind of start big picture as we think about EnPro, we want to make sure that all of the businesses that we own have a material science capability, right.

We have IP. We have technology. We have knowhow, et cetera, et cetera, all around material science. So that’s first and foremost as we think about a criteria. Then we think about the margin performance of the business, right. What can the business deliver and what we set as the minimum threshold is 20%. Obviously, we are in the middle of a pandemic.

Some businesses are experiencing declines. We want to be thoughtful about the kind of work that’s required to bring those businesses back. But we also have good analytical capabilities that give us a sense of whether or not we can get there based on the capabilities that we have in our capability center and the knowhow that’s built in our operating system, right.

And so, then we are looking at cash flow return on investment, right. We want businesses that throw off a fair amount of cash. We have our own formula that we use here for cash flow return on investment and we set a minimum threshold there, as well of 20%, right. And we want to make sure that the businesses that we have in the portfolio meet those characteristics and that’s – those characteristics we consider to be pretty strict.

And we want to be reasonable. We want to make sure we make the best efforts to get all of our businesses there. But we also need to be disciplined in terms of what we are trying to create. We know that the cash flywheel we are trying to generate only works at a certain level. So the businesses need to perform at that level. So that we can continue the growth that we have in mind.

And obviously, as we think about adding, we want to add in areas that have good momentum as well, which is why we think about that end-market having an underlying growth in the 5% to 7% range and we’d like to be north of that as possible. So, hopefully that gives you a sense of how we are thinking about it.

We don’t – as a policy, we don’t intend to specifically say this particular business or that particular business is one that we are looking at just because our employees are our primary concern here. We want to be thoughtful and respectful. We also don’t want to hurt our chances in the market if we decide to make them up.

[Ian Zaffino, Oppenheimer]

Alright. Thank you very much for the color.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from Justin Bergner from G. Research. Your line is now live.

[Justin Bergner, G. Research]

Good morning, Marvin. Good morning, Milt. Good morning, Jerry.

[Milton Childress]

Good morning.

[Marvin Riley, President and Chief Executive Officer]

Hey, Just, how are you?

[Jerry Johnson]

Hey. Good morning.

[Justin Bergner, G. Research]

I have a couple clean up questions and then some sort of bigger picture questions. On the clean up questions, the close of the Air Springs sale, the guidance, sort of what does that assume like a mid-quarter close at present or end of year close?

[Marvin Riley, President and Chief Executive Officer]

It assumes a mid Q4 close. So, to the extent that we go beyond that, it could affect on the margin. It’s not going to be material to the overall view that we have at the year. But that’s the assumption that we made, Justin.

[Justin Bergner, G. Research]

Okay. Understood. And then, on the legal side, I mean, this is $21 million in cash. I assume that’s going to be going out the door to fund these legal settlements. Just to verify that’s the case? And then, the remaining legal liabilities after these two settlements de minimis?

[Marvin Riley, President and Chief Executive Officer]

Yes. If you look at what affected the quarter, the big areas – there are four primary areas that led to the provision in the third quarter. One was the Dieuze exit that we talked about. And probably, two-thirds, roughly two-thirds of that number will end up being cash at some future point fourth quarter, maybe some of it drifts into the first quarter of next year.

The second item was the impairments. And that’s just the impairments of investments, trade names and it’s just a function of what’s happening in the market on the top-line, because it’s that valuation is all tied to sales. The third was the BorgWarner settlement that we mentioned and then the fourth was the Water Valley legal settlement. So those were the two settlements.

That concludes all of the open items where we’ve had active – I would say active negotiations and discussions. We have very – most of our other impairments, I think we have roughly 20 environmental matters going on.

Most of those with the legacy businesses and 18 of the 20 are in steady state maintenance mode where we are just pursuing annual ongoing clean up for our remediation plan where the cost of that is fairly nominal.

And then that leads to the outstanding matters. Once again, this detail has been in our Q, but it’s two areas that we can’t – we are not following that along and determining what the exposure might be. But the bottom-line is, we made significant progress and I mean, significant progress over the last couple of years in getting most of these major legacy matters behind us.

And I really want to give a lot of credit to our legal and environmental teams that have worked diligently on bringing a number of these matters to a close.

[Justin Bergner, G. Research]

Okay. Just two clarification questions there. The $21 million in legal that is going to be cash and that is not against the environmental reserve charges. This is a separate sort of legal bucket. And then you mentioned the first issue, which I didn’t catch. Two-thirds of that number being cash, just maybe that came in a bit fast.

[Marvin Riley, President and Chief Executive Officer]

Okay. I am sorry. Could you repeat the second part of the question?

[Justin Bergner, G. Research]

Well, you said there were four matters in the quarter and then the first one you – I didn’t catch it all and you said, two-thirds of that number is cash. What was that?

[Marvin Riley, President and Chief Executive Officer]

That was the Dieuze - exit the bushing block exit, in Dieuze France.

[Justin Bergner, G. Research]

Okay.

[Marvin Riley, President and Chief Executive Officer]

Yes. So, and then, to answer your question, if you look at the two legal settlements, one is an environmental settlement. The Water Valley is an environmental settlement. The other was the supply of bearings more than a decade ago that GGB supplied to BorgWarner.

[Justin Bergner, G. Research]

Okay. Got it. I won’t delve too much hunger there. Then, maybe big picture on Alluxa, thank you for the detail on the bridge with respect to revenue and EBITDA. As you look at Alluxa, you mentioned sort of it’s in markets that are growing mid-teens, but then you said, some of its markets growing high-teens or low-20s.

Were you trying to suggest sort of the life sciences and semi conductor end-markets as a whole are growing high-teens, maybe as high as low-20s? And then, that would make industrial technology portion growing more of a low double-digit? Or were you just highlighting certain sub-end-markets in life sciences and semiconductor with that comment?

[Marvin Riley, President and Chief Executive Officer]

Yes. So, I might get a little more specific here than we are accustomed to. But it’s easier for me to give you the thinking behind how we see some of these micro verticals that Alluxa plays in. So, what we are communicating, obviously is that, the CAGR we are thinking about is mid-teens.

But I wanted to make sure that we communicated they are obviously playing in markets that are growing even faster than that and it is possible that it will outperform, but we want to be thoughtful and constructive as we think about the acquisitions we bring on board, right. So, if you look at, where they play in semiconductor, which is specifically in lithography, our work says that, that may grow about 15%.

And if we look at some of the other micro verticals that we are in - that they are in like, flow cytometry and endoscopy, those areas are going to grow 20 plus percent as we go forward. And in the industrial tech space, the industrial sensors are growing 15% or so, lidar, 20% or so.

It all depends on how the business grows, going forward where we can gain more share going forward, but based on that mix of growth in the micro verticals, it is possible that we might beat the mid-teens that we have built into our model. But that’s what I wanted to communicate.

[Justin Bergner, G. Research]

Okay. That’s very helpful. I appreciate that clarity. Finally, on the margins on Alluxa and I realize you are not clarifying what they are for us. But is the general profile for how you intend to bring this business into hold sort of keeping the margins constantly, you grow the top-line or are you expecting any meaningful improvement or perhaps deterioration of the margins from their current high level over the next couple of years?

[Marvin Riley, President and Chief Executive Officer]

No, ideally, we want to keep the margin profile. But that’s how we are thinking about it. I mean, if we obviously, as the business plateaued, but we are talking a substantially larger business at that point before we start seeing any degradation in the margins. But our thinking is to maintain the margin, focus on these micro verticals, try not to attack any verticals that would require margin compression, so that we can maintain the rich profile that we purchased.

[Justin Bergner, G. Research]

Great. Thanks for taking my questions.

[Marvin Riley, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. We’ve reached the end of our Question-and-Answer Session. I would like to turn the floor back over to Jerry for any further or closing comments.

[Jerry Johnson]

Yes, just wanted to say, thank you Kevin, and thank you all for joining us this morning and have a good day.

[Operator]

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

[Milton Childress]

Thank you.