Enpro Industries, Inc. — Q3 2019 Form 10-Q Summary
Business Context and Reporting Period
EnPro designs, manufactures, services and markets engineered industrial products through three reportable segments: Sealing Products, Engineered Products and Power Systems. The unaudited filing covers the quarter and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $373.0 million | $388.2 million | $1,120.3 million | $1,150.6 million |
| Gross profit | $115.0 million | $124.1 million | $353.2 million | $365.0 million |
| Gross margin | 30.8% | 32.0% | 31.5% | 31.7% |
| Operating income | $28.6 million | $44.2 million | $92.8 million | $98.3 million |
| Net income (loss) | $(1.5) million | $24.2 million | $35.5 million | $46.7 million |
| Diluted EPS | $(0.08) | $1.16 | $1.71 | $2.20 |
| Operating cash flow | Not separately provided | Not separately provided | $150.7 million | $158.4 million |
Q3 operating margin was 7.7%, versus 11.4% in the prior-year quarter. Nine-month operating margin was 8.3%, versus 8.5%. The Q3 effective tax rate was 878.7%, primarily because of very low pretax income, the geographic mix of earnings, foreign minimum taxes and higher-tax foreign jurisdictions. The nine-month effective tax rate was 33.0%, versus 26.0%.
- Segment sales and profit: Q3 Sealing Products sales were $226.9 million and segment profit was $19.4 million; Engineered Products sales were $72.9 million and profit was $9.0 million; Power Systems sales were $74.0 million and profit was $8.9 million.
- Cash and liquidity: Cash was $112.1 million at September 30, 2019, compared with $129.6 million at December 31, 2018. Cash declined $17.5 million during the nine months.
- Debt: Long-term debt was $665.9 million, plus $0.4 million of current maturities. Revolver borrowings were $169.7 million, the term loan was $150.0 million, and letters of credit were $17.5 million. Available borrowing capacity was $212.8 million. The company was in compliance with its debt covenants.
- Capital allocation: The company paid $15.7 million of dividends and repurchased $15.0 million of stock during the first nine months. The quarterly dividend was increased to $0.25 per share, and $35.0 million remained available under the repurchase authorization.
- Backlog: Remaining performance obligations were $404.3 million at September 30, 2019, with approximately 88% expected to be satisfied within one year.
Cash Flow and Balance Sheet Changes
Operating cash flow decreased to $150.7 million from $158.4 million, reflecting lower net income, lower tax refunds and lower asbestos insurance receipts, partly offset by improved working capital in Power Systems and lower pension contributions. Investing cash flow was $(332.7) million, principally due to $310.4 million of acquisitions and $23.8 million of capital expenditures. Financing cash flow was $166.1 million, primarily reflecting new debt proceeds of $566.9 million less debt repayments of $365.1 million.
Total assets increased to $2.07 billion from $1.72 billion, primarily due to acquisitions. Goodwill increased to $485.0 million from $333.7 million and other intangible assets increased to $494.3 million from $297.3 million. Total liabilities increased to $1.17 billion from $858.1 million.
Material Changes Versus the Prior Comparable Period
- Sales declined 3.9% in Q3 and 2.6% for the first nine months. On a nine-month basis, acquisitions and divestitures reduced sales by 0.9%, foreign currency reduced sales by 1.4%, and organic sales declined 0.3%.
- Sealing Products sales declined 9.1% in Q3 and 6.3% for the nine months, driven by weakness in heavy-duty trucking and semiconductor capital equipment, foreign exchange and the exit from the gas turbine business. Q3 segment margin fell to 8.6% from 14.4%.
- Engineered Products sales declined 6.7% in Q3 and 7.2% for the nine months, primarily because of automotive, general industrial and foreign exchange headwinds. Nine-month segment profit declined 27.5% to $25.3 million.
- Power Systems sales increased 20.5% in Q3 and 20.3% for the nine months, supported by military marine engines and aftermarket parts and services. Nine-month segment profit nearly doubled to $24.6 million.
- The company acquired Aseptic for $39.2 million and LeanTeq for $271.2 million in cash, net of cash acquired, plus rollover equity. The acquisitions added $152.5 million of goodwill and $219.0 million of identifiable intangible assets.
- The company recorded a $15.2 million pretax loss on the divestiture of its Rome, Georgia brake products business and related facility. The transaction generated $3.6 million of proceeds in Q3, with additional proceeds expected in Q4 2019 and 2020.
- Other expense increased materially because of the divestiture loss, environmental reserve adjustments and other costs associated with disposed businesses. The prior-year period included a $12.8 million pension settlement charge.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantitative full-year earnings or revenue guidance in the filing. Management expects continued growth in military marine engines, engine aftermarket parts and services, aerospace and midstream oil and gas, but cited continuing weakness in heavy-duty trucking, semiconductor capital equipment, general industrial and automotive markets. Management also expects to evaluate additional acquisitions and strategic divestitures.
- EDF engine contract: The company increased its cumulative loss provision to $20.9 million at September 30, 2019, including a $4.1 million increase during the first nine months. Four production engine-generator sets and two spares remained to be shipped; late-delivery penalties, additional service requirements and cost overruns could create further losses.
- Environmental matters: Environmental liabilities totaled $34.6 million. The company retained a $2.8 million accrual for the Lower Passaic River matter, increased the Onondaga Lake reserve to $10.0 million, and increased the Water Valley, Mississippi reserve to $7.5 million. Additional losses may exceed recorded amounts, and certain exposures cannot be reasonably estimated.
- Legal claims: A BorgWarner-related claim has a disclosed reasonably possible loss range of approximately €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses; the company has accrued €0.4 million.
- Asbestos insurance: Approximately $6.7 million of insurance proceeds were expected from solvent carriers, including $4.2 million in Q4 2019 and $2.5 million in 2020, although collection timing is not assured.
- Internal controls: Disclosure controls remained ineffective because of an unremediated material weakness in controls over income-tax accounting. The weakness contributed to approximately $5.0 million of understated income tax expense in the 2018 financial statements before revision. Management began remediation during Q3.
- Accounting adoption: The company adopted the lease standard and recognized approximately $30 million of operating lease right-of-use assets and liabilities at adoption. It also reclassified an $11.5 million net tax benefit from accumulated other comprehensive loss to opening retained earnings.
Important Facts for Investors to Verify
- Whether the material weakness in income-tax controls is fully remediated and whether additional restatements or control deficiencies arise.
- Integration progress, earnings contribution and final purchase-price allocations for LeanTeq and Aseptic.
- Sealing Products recovery in heavy-duty trucking and semiconductor markets, including warranty-cost trends.
- Execution, remaining costs, delivery timing and potential penalties under the EDF contract.
- Debt reduction capacity, covenant headroom, interest-rate exposure and liquidity after the acquisitions.
- Ultimate costs and timing of environmental, asbestos and other legacy liabilities beyond recorded reserves.
- Collection of projected asbestos insurance proceeds and completion of the Rome facility sale.