Enpro Industries, Inc. — 2019 Q2 Form 10-Q Summary
Business context and reporting period
EnPro designs, manufactures, services and markets engineered industrial products through three segments: Sealing Products, Engineered Products and Power Systems. The filing covers the unaudited quarter and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|
| Net sales | $387.0 million | $393.6 million | $747.3 million | $762.4 million |
| Gross profit | $125.1 million | $115.8 million | $238.2 million | $240.9 million |
| Gross margin | 32.3% | 29.4% | 31.9% | 31.6% |
| Operating income | $40.3 million | $22.1 million | $64.2 million | $54.1 million |
| Operating margin | 10.4% | 5.6% | 8.6% | 7.1% |
| Net income | $23.9 million | $9.9 million | $37.0 million | $22.5 million |
| Diluted EPS | $1.15 | $0.47 | $1.78 | $1.05 |
| Operating cash flow | Not separately provided | Not separately provided | $78.0 million | $109.6 million |
- Q2 sales declined 1.7% year over year; six-month sales declined 2.0%. Organic sales excluding foreign currency declined 0.2% in Q2 and 0.2% for the six months.
- Q2 operating income increased 82%, while net income increased 141%. Six-month operating income increased 19% and net income increased 64%.
- Interest expense, net declined to $4.2 million in Q2 from $7.1 million and to $8.7 million for the six months from $14.9 million, primarily reflecting lower debt, lower average interest rates and cross-currency swap benefits.
- Q2 effective tax rate was 31.4%, compared with 28.6%; the six-month rate was 29.8%, compared with 41.8%. The 2018 six-month rate included a $5.4 million discrete tax charge related to prior domestic production activity tax benefits.
Segment performance and material changes
| Segment | Q2 2019 sales | Year-over-year sales change | Q2 2019 segment profit |
|---|
| Sealing Products | $239.3 million | (6.4%) | $29.4 million |
| Engineered Products | $79.0 million | (7.5%) | $10.1 million |
| Power Systems | $69.8 million | 30.0% | $9.0 million |
- Sealing Products: Sales were pressured by semiconductor capital equipment and heavy-duty trucking weakness, the 2018 exit from the industrial gas turbine business and foreign exchange. Profitability improved due to restructuring benefits, lower unusual warranty charges, pricing and manufacturing efficiencies. Segment margin rose to 12.3% from 7.5%.
- Engineered Products: Sales and profit declined because of weakness in automotive and general industrial markets, lower volume, higher manufacturing and selling costs, and increased research and development spending. Segment margin fell to 12.8% from 14.2%.
- Power Systems: Sales and profit increased substantially, driven by military marine engines and aftermarket parts and services. Segment margin improved to 12.9% from negative 0.4%. The EDF contract loss provision increased by $1.1 million during the six months, bringing cumulative recognized loss to $17.9 million.
Cash flow, liquidity and debt
- Six-month operating cash flow was $78.0 million, down from $109.6 million, primarily because of lower tax refunds and asbestos insurance receipts, partly offset by higher net income and improved working capital in Power Systems.
- Investing cash use was $18.5 million, including $17.0 million of capital expenditures, compared with $3.8 million of net use in 2018. The prior-year period included $26.3 million of proceeds from fixed-asset sales.
- Financing cash use was $64.4 million, including $34.6 million of net revolver repayments, $14.6 million of share repurchases and $10.6 million of dividends.
- Cash was $124.3 million at June 30, 2019, compared with $129.6 million at December 31, 2018. All cash and cash equivalents were held outside the United States.
- Total debt was approximately $428.2 million, consisting primarily of $427.9 million of long-term debt and $0.3 million of current maturities. Approximate net debt was $303.9 million.
- The company had an $82.1 million revolver balance, $17.5 million of outstanding letters of credit and $250.4 million of borrowing availability under its $350.0 million secured revolving facility. The company was in compliance with its debt covenants.
- The company had $35.0 million remaining under its $50.0 million share-repurchase authorization at June 30, 2019. The quarterly dividend was increased to $0.25 per share.
Guidance, outlook, risks and unusual items
- No specific consolidated revenue or earnings guidance is provided. Management expects continued benefit from Power Systems demand, aftermarket activity, productivity and cost controls, but cites weakness in Engineered Products, semiconductor capital equipment headwinds, foreign exchange and the Sealing Products business exits.
- Backlog or remaining performance obligations were $406.7 million at June 30, 2019, with approximately 90% expected to be satisfied within one year. Management cautions that backlog is not necessarily predictive of future sales.
- On July 2, 2019, EnPro acquired The Aseptic Group. On July 19, 2019, it agreed to acquire LeanTeq, subject to regulatory and customary closing conditions. The combined purchase price was approximately $345.0 million, to be funded with cash, expanded revolver borrowings, a new term loan and rollover equity.
- Environmental accruals totaled $28.5 million. Significant uncertainties remain regarding the Lower Passaic River, Onondaga Lake, uranium mine and Water Valley matters. The company states that potential costs could materially exceed recorded reserves in certain matters.
- GGB France faces a BorgWarner claim with an estimated reasonably possible loss range of approximately €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses; the recorded accrual was €0.4 million.
- Available asbestos-related insurance receivables were approximately $11.3 million, with expected collections of $8.8 million in 2019 and $2.5 million in 2020, subject to insurer performance and potential competing claims.
- The Fairbanks Morse EDF contract remains exposed to foreign exchange, delivery penalties, additional costs and service claims. Fourteen of the remaining 22 engine-generator sets had been delivered by June 30, 2019.
- Management identified a material weakness in internal control over financial reporting related to income-tax accounting and concluded that disclosure controls were ineffective as of June 30, 2019. The weakness resulted in an approximately $5.0 million understatement of 2018 income-tax expense that was subsequently corrected; remediation is underway.
- Other risks include cyclical end markets, raw-material and commodity inflation, tariffs, currency movements, acquisition execution, contractual penalties, product claims and legacy liabilities.
Most important facts for investors to verify
- Whether the substantial Q2 margin and earnings improvement is sustainable after excluding lower unusual warranty charges, restructuring benefits, product mix and foreign-exchange effects.
- Execution and financing of the approximately $345.0 million Aseptic Group and LeanTeq acquisitions, including incremental leverage and integration results.
- Power Systems backlog, aftermarket demand and the remaining economics and delivery risk under the EDF contract.
- Progress in remediating the income-tax internal-control material weakness and whether further restatements or control deficiencies arise.
- Developments in environmental, asbestos, BorgWarner and other legacy contingencies, where potential losses may exceed recorded reserves.
- Cash availability and covenant compliance after acquisition-related borrowing, given that cash is held outside the United States and the company had $250.4 million of revolver availability at quarter end.
