Enpro Industries, Inc. — Q3 2014 Form 10-Q Summary
Business context and reporting period
EnPro designs, manufactures and markets engineered industrial products through three segments: Sealing Products, Engineered Products and Power Systems. The filing covers the unaudited quarter and nine months ended September 30, 2014, compared with the corresponding 2013 periods. The company operated 60 primary manufacturing facilities in 13 countries.
- Sealing Products: gaskets, seals, wheel-end components, pipeline products and related engineered products.
- Engineered Products: self-lubricating bearings, hydraulic components, compressor components and lubrication systems.
- Power Systems: heavy-duty reciprocating engines, parts and services.
- 2014 acquisitions included the remaining interest in Stemco Crewson LLC and Strong-Tight Co. Ltd.; aggregate cash paid, net of cash acquired, was $4.3 million.
Financial results and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $302.6 million | $276.0 million | $902.9 million | $868.7 million |
| Gross profit | $106.2 million | $92.1 million | $310.8 million | $295.5 million |
| Gross margin | 35.1% | 33.4% | 34.4% | 34.0% |
| Operating income | $27.6 million | $18.3 million | $69.1 million | $69.8 million |
| Operating margin | 9.1% | 6.6% | 7.7% | 8.0% |
| Net income | $8.6 million | $5.6 million | $18.2 million | $22.2 million |
| Diluted EPS | $0.33 | $0.23 | $0.71 | $0.96 |
Quarterly sales increased 9.6%, while nine-month sales increased 3.9%. Quarterly net income rose 53.6%, but nine-month net income declined 18.0%. The company reported a quarterly effective tax rate of 34.3% and a nine-month rate of 32.3%.
For the nine months, operating activities used $9.9 million of cash versus $38.1 million provided in 2013. Investing activities used $31.7 million, including $20.4 million for property, plant and equipment, $7.1 million for capitalized software and $4.3 million for acquisitions. Financing activities provided $176.9 million. Cash and cash equivalents increased to $198.4 million from $64.4 million at December 31, 2013.
| Balance-sheet item | September 30, 2014 | December 31, 2013 |
|---|---|---|
| Total assets | $1,582.7 million | $1,398.3 million |
| Current assets | $636.0 million | $456.7 million |
| Current liabilities | $277.0 million | $417.4 million |
| Long-term debt | $298.5 million | $8.5 million |
| Notes payable to GST | $271.0 million | $259.3 million |
| Shareholders’ equity | $668.4 million | $597.5 million |
Segment performance and material changes
- Sealing Products: Q3 sales increased 7.0% to $168.9 million, but segment profit declined 5.0% to $23.0 million. Margin fell to 13.6% from 15.3%, primarily due to higher manufacturing costs, increased headcount and lower Garlock volumes.
- Engineered Products: Q3 sales increased 4.8% to $88.1 million and segment profit increased to $6.0 million from $2.9 million. Margin improved to 6.8% from 3.4%, aided by higher volumes, pricing and lower restructuring costs.
- Power Systems: Q3 sales increased 33.2% to $46.5 million and segment profit rose to $9.6 million from $2.3 million. Margin increased to 20.6% from 6.6%, driven by higher parts and service volumes and favorable mix.
- Corporate expenses increased $2.5 million in Q3 and $5.7 million for the nine months, primarily due to higher employee medical costs, incentive compensation, purchased services and salaries.
- Interest expense declined modestly as convertible debt was reduced, partly offset by interest on the new Senior Notes and higher PIK interest on GST notes.
- Other expense included a $4.0 million pretax loss on the September convertible-debt tender offer. Nine-month other expense also included $3.6 million and $2.4 million pretax losses on the March and June convertible-debt exchanges.
Debt, liquidity and capital structure
- In September 2014, EnPro issued $300 million of 5.875% unsecured Senior Notes due September 15, 2022. Proceeds were used partly to repay revolver borrowings and fund the convertible-debt tender offer.
- In August 2014, the company amended its senior secured revolver to provide a five-year, $300 million facility. Availability at September 30 was $294.3 million after $5.7 million of letters of credit.
- The company exchanged or repurchased most of its convertible debentures during 2014, reducing aggregate principal outstanding to approximately $23.4 million. The remaining debentures were convertible through December 31, 2014, subject to the stated conditions.
- The revolver includes a maximum consolidated total net leverage ratio of 4.0 to 1.0 and a minimum consolidated interest coverage ratio of 2.5 to 1.0, along with customary restrictive covenants.
- Cash or cash equivalents totaled approximately $122.0 million in the United States and $76.4 million outside the United States. Management stated that foreign cash was intended to remain permanently reinvested outside the United States.
Guidance, outlook and unusual items
- Management was cautiously optimistic that fourth-quarter sales would be near the third-quarter level. Semiconductor, aerospace and trucking OEM order activity remained firm, and Power Systems had a substantial shippable backlog.
- Fourth-quarter segment margins could be lower because engine and OEM revenues generally carry lower margins than aftermarket revenues.
- Management forecast a 2014 effective tax rate of 31% to 33%, subject to discrete tax events and possible renewal of expired U.S. tax provisions.
- The company contributed $48.5 million to U.S. defined benefit pension plans and did not anticipate additional contributions before December 31, 2014. It estimated full-year 2014 pension expense of approximately $2.2 million.
- Management planned to evaluate additional acquisitions in 2014 and 2015, but no future acquisition effects were included in the outlook.
Risks, contingencies and other important matters
- GST, Anchor and Garrison remain in Chapter 11 proceedings arising from asbestos claims and are deconsolidated from EnPro. EnPro reported a $236.9 million investment in GST and a $66.3 million tax receivable from GST.
- GST’s amended proposed reorganization plan provides $275 million of total funding, including $245 million from GST and $30 million from EnPro subsidiary Coltec. The plan remained subject to Bankruptcy Court approval, creditor actions, appeals and other uncertainties.
- The Bankruptcy Court estimated present and future mesothelioma liability at $125 million, while GST’s recorded asbestos liability at September 30, 2014 was $279.6 million. The timing and ultimate resolution of the bankruptcy proceeding were not determinable.
- Available insurance coverage for current and future asbestos claims was estimated at $100.7 million, although collection timing and competing claims could affect recoveries.
- Environmental liabilities accrued were $13.9 million. The EPA’s proposed Lower Passaic River remedy estimated aggregate remediation costs of approximately $953 million to $1.731 billion, but EnPro could not estimate its share because the remedy and allocation among potentially responsible parties had not been determined.
- Other contingencies include potential liabilities related to divested businesses, former Crucible operations, product claims asserted by BorgWarner against GGB France and ordinary-course litigation.
- The company adopted no new revenue recognition standard during the period; it was evaluating the standard effective for fiscal years beginning after December 15, 2016.
Investor verification points
- Verify whether GST’s amended plan received Bankruptcy Court approval and whether the proposed $30 million Coltec contribution and related parent settlement were ultimately required.
- Assess the sustainability of quarterly margin gains in Engineered Products and Power Systems and the margin pressure in Sealing Products.
- Reconcile the negative operating cash flow with reported earnings, particularly pension contributions, taxes and working-capital investment.
- Review leverage, covenant compliance and liquidity after issuance of the $300 million Senior Notes and retirement of convertible debt.
- Monitor the realizability of the $236.9 million GST investment and $66.3 million GST tax receivable.
- Track environmental developments, especially the Lower Passaic River matter, because the company did not provide a reasonably possible loss range beyond recorded liabilities.
- Confirm the effect of expired or renewed U.S. tax incentives on the projected 31%–33% annual effective tax rate.