Enpro Inc. quarterly report, Q1 FY2015

Enpro Industries, Inc. — 2015 Q1 Form 10-Q Summary

Business context and reporting period

EnPro designs and manufactures engineered industrial products through three reportable segments: Sealing Products, Engineered Products, and Power Systems. The filing covers the unaudited three months ended March 31, 2015, compared with the first quarter of 2014.

Financial performance and key metrics

Metric	Q1 2015	Q1 2014	Change
Net sales	$277.5 million	$287.2 million	Down 3.4%
Gross profit	$89.8 million	$96.5 million	Down 6.9%
Gross margin	32.4%	33.6%	Down 1.2 percentage points
Operating income	$11.4 million	$17.4 million	Down 34.5%
Operating margin	4.1%	6.1%	Down 2.0 percentage points
Net income (loss)	$(1.6) million	$1.3 million	Decreased $2.9 million
Diluted EPS	$(0.07)	$0.05	Decreased $0.12
Cash flow from operations	$(21.5) million	$(25.0) million	Use improved $3.5 million

• Segment sales were $160.9 million for Sealing Products, $77.2 million for Engineered Products, and $40.2 million for Power Systems.
• Sealing Products sales increased 3.8% and segment profit increased to $18.0 million from $17.1 million. Organic sales increased 6.0%, excluding acquisitions, divestiture effects, and foreign currency.
• Engineered Products sales declined 15.9% and segment profit declined to $3.4 million from $8.7 million, primarily due to lower volumes, unfavorable foreign exchange, and $1.0 million of CPI restructuring costs.
• Power Systems sales declined 2.2% and segment profit declined to $0.6 million from $3.3 million. Results included a $6.2 million loss provision on a euro-denominated EDF engine contract caused by the stronger U.S. dollar.
• Interest expense increased to $13.0 million from $11.1 million, principally reflecting higher borrowings, including the $300 million Senior Notes issued in September 2014.
• The company recorded a $4.0 million income-tax benefit on a $5.6 million pretax loss. The benefit included a $3.2 million discrete valuation-allowance release in France.

Cash flow, balance sheet, debt, and liquidity

• Cash and cash equivalents fell to $72.2 million at March 31, 2015, from $194.2 million at December 31, 2014. All reported cash was held outside the United States.
• Operating cash flow was negative $21.5 million. Investing cash flow was negative $40.8 million, including $30.6 million for the acquisition of ATDynamics and $10.2 million for property, plant, equipment, and internal-use software.
• Financing cash flow was negative $56.9 million, including $44.9 million to repurchase convertible debentures, $47.4 million for settled share repurchases, and $4.8 million of dividends, partially offset by $41.4 million of debt proceeds.
• Total liabilities were $979.4 million and shareholders’ equity was $539.9 million at March 31, 2015. Long-term debt was $340.1 million, and notes payable to GST were $283.2 million including current and long-term amounts.
• The $300 million senior secured revolving credit facility had $41.4 million drawn and $10.7 million of letters of credit outstanding, leaving reported availability of $247.9 million.
• In March 2015, EnPro repurchased approximately $21.3 million principal amount of convertible debentures for $44.9 million, reducing principal outstanding to approximately $2.2 million. The company recognized a $2.8 million pretax loss on the transaction.
• EnPro initiated an $80.0 million share repurchase program. It repurchased 814,727 shares for $54.3 million during the first quarter; the program was completed in April with total purchases of 1,198,337 shares at a weighted average price of $66.76.

Material changes versus the prior comparable period

• Revenue decreased despite acquisition-related growth, primarily because of unfavorable foreign currency translation, the fourth-quarter 2014 divestiture of GRT, and weaker oil and gas market activity.
• Profitability deteriorated as gross margin and operating margin compressed, while interest expense increased.
• The company shifted from prior-year net income to a net loss, although operating cash use improved modestly due to lower pension contributions and income-tax payments.
• ATDynamics was acquired in February 2015 for $30.6 million net of cash acquired and added to Sealing Products.
• CPI reduced headcount by approximately 30 positions at the end of the quarter, with expected annualized savings of approximately $3 million. Management indicated that additional restructuring and strategic actions may follow.
• Accumulated other comprehensive loss increased to $50.3 million from $34.1 million, largely reflecting foreign currency translation losses.

Guidance, outlook, risks, contingencies, and unusual items

• Management reported firm OEM order activity in semiconductor, aerospace, and trucking markets, a healthy Power Systems backlog and order rate, and stable automotive and general industrial markets. Oil and gas weakness, international economic volatility, and currency movements remained headwinds.
• Management expected a 2015 effective tax rate of approximately 30% to 34%, subject to discrete tax events and potential changes in U.S. tax incentives.
• Management estimated 2015 pension expense of approximately $5.0 million and did not expect contributions to U.S. defined benefit pension plans during 2015 based on available information.
• GST, Garlock Sealing Technologies and related entities remain in Chapter 11 proceedings and are deconsolidated from EnPro. The second amended plan proposed a $220 million GST settlement-facility contribution, a $30 million Coltec contribution, $77.5 million of additional GST contributions over seven years, and a $30 million GST litigation fund.
• EnPro would guarantee GST’s deferred contributions and certain potential supplementary litigation-fund contributions. The maximum aggregate contingent supplementary contributions under the plan were stated as $132 million, although management assessed the low end of the reasonably possible loss for those contributions as zero.
• The Bankruptcy Court approved the plan disclosure statement and claims procedures on April 10, 2015. The confirmation hearing was scheduled to begin June 20, 2016, but confirmation and consummation remained uncertain.
• GST recorded a $337.5 million asbestos liability at March 31, 2015. Available insurance coverage for current and future asbestos claims was estimated at $100.7 million, subject to collection and competing-claim risks.
• Environmental liabilities accrued by EnPro totaled $17.0 million. The company accrued $3.5 million for the Lower Passaic River matter but could not estimate the upper end of potential costs; the EPA’s aggregate remediation estimate for the affected area was approximately $953 million to $1.731 billion before allocation among potentially responsible parties.
• BorgWarner claims against GGB France remained under technical review; the company could not estimate a reasonably possible loss.
• The company adopted a new quarterly dividend policy and declared a $0.20-per-share dividend payable in June 2015.

Most important facts for investors to verify

1. Whether the substantial decline in Engineered Products and Power Systems profitability is temporary or reflects sustained market weakness.
2. The impact of foreign exchange rates, particularly on the EDF contract and on reported international sales and earnings.
3. Cash availability and access to the revolving credit facility given negative operating cash flow, acquisitions, debt service, dividends, and share repurchases.
4. The final outcome, timing, funding requirements, and potential guarantees associated with GST’s Chapter 11 asbestos plan.
5. Potential exposure beyond recorded environmental reserves, especially the Lower Passaic River and Onondaga Lake matters.
6. Whether CPI restructuring produces the expected approximately $3 million annualized savings and prevents goodwill impairment; the CPI reporting unit exceeded book value by only 10% at the October 1, 2014 impairment test.