Enpro Industries, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014. The interim financial statements are unaudited. EnPro designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products and Power Systems. The company operates approximately 60 primary manufacturing facilities in 13 countries.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $313.1 million | $305.8 million | $600.3 million | $592.7 million |
| Gross profit | $108.1 million | $109.2 million | $204.6 million | $203.4 million |
| Operating income | $24.1 million | $30.8 million | $41.5 million | $51.5 million |
| Net income | $8.3 million | $8.0 million | $9.6 million | $16.6 million |
| Diluted EPS | $0.32 | $0.35 | $0.38 | $0.74 |
| Operating cash flow | Not separately provided | Not separately provided | $(13.8) million | $5.5 million |
Q2 gross margin was approximately 34.5%, compared with 35.7% in the prior-year quarter. Operating margin was approximately 7.7%, compared with 10.1%. Six-month gross margin was approximately 34.1%, compared with 34.3%, while operating margin was approximately 6.9%, compared with 8.7%.
- Q2 sales increased 2.4%; six-month sales increased 1.3%.
- Q2 corporate expenses increased $2.2 million to $10.7 million, primarily from higher medical costs, purchased services, incentive compensation, and salaries.
- Interest expense, net declined $0.9 million in Q2 and $1.0 million for the six months, mainly because of reduced convertible-debt principal.
- Q2 other expense, net declined $6.9 million, primarily because of lower environmental reserve adjustments and lower GST bankruptcy-related legal fees, partly offset by a $2.4 million debt-exchange loss.
Segment Performance
| Segment | Q2 2014 sales | Q2 2014 profit | Change in profit |
|---|---|---|---|
| Sealing Products | $175.4 million | $22.8 million | Down from $27.7 million |
| Engineered Products | $95.5 million | $8.9 million | Up from $8.6 million |
| Power Systems | $43.0 million | $3.4 million | Down from $6.4 million |
- Sealing Products sales rose 5.7%, helped by acquisitions, foreign exchange, and higher nuclear, aerospace, semiconductor and trucking demand. Margin declined to 13.0% from 16.7% because of lower Garlock volumes, higher manufacturing costs, increased headcount and higher research and development spending.
- Engineered Products sales were essentially flat; profit increased modestly and margin improved to 9.3% from 9.0%.
- Power Systems sales declined 4% because of lower engine sales, partly offset by stronger parts and service revenue. Margin fell to 7.9% from 14.2% due to product mix, higher research and development spending and manufacturing costs.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $64.9 million at June 30, 2014, versus $64.4 million at December 31, 2013. Approximately $65 million was held outside the United States; no cash or cash equivalents were held in the United States.
- Operating activities used $13.8 million in the first six months, primarily because of lower earnings and increased working capital. Accounts receivable increased to $235.1 million from $193.1 million and inventories increased to $164.5 million from $149.1 million.
- Investing activities used $23.2 million, including $14.2 million of property, plant and equipment purchases, $4.8 million of capitalized software and $4.3 million for acquisitions.
- Financing activities provided $36.4 million. The revolving credit facility had $48.7 million outstanding, $5.7 million of letters of credit, and $79.8 million of remaining borrowing availability at June 30, 2014.
- Current maturities of long-term debt were $69.7 million and long-term debt was $49.5 million. Convertible Debentures with approximately $74.8 million of principal remained outstanding and were currently convertible; they mature October 15, 2015 unless converted earlier.
- In March and June 2014, EnPro exchanged approximately $97.7 million of convertible-debt principal for approximately 3.0 million common shares and recognized aggregate pretax losses of $6.0 million.
- Notes payable to GST totaled $271.0 million, including 11% interest with a cash and payment-in-kind component.
Material Changes and Unusual Items
- EnPro acquired the remaining interest in Stemco Crewson LLC and acquired Taiwanese sealing-product business Strong-Tight Co. Ltd. for $4.3 million, net of cash acquired.
- The company renamed the Engine Products and Services segment to Power Systems; segment composition and historical results were unchanged.
- GST’s Chapter 11 asbestos proceeding remains unresolved. GST’s amended proposed plan calls for $275 million of total funding, including $245 million from GST and $30 million from Coltec. The plan has not been confirmed.
- GST reduced its recorded asbestos liability to $280.5 million at June 30, 2014. The Bankruptcy Court previously estimated present and future mesothelioma liability at $125 million, but that estimate excludes certain other claims and administrative costs and is being challenged by the asbestos claimants’ committee.
- EnPro’s investment in GST was $236.9 million, and its income-tax receivable from GST was $66.6 million. The realizability of these balances depends partly on the outcome of the bankruptcy process.
- Environmental liabilities were $14.5 million. The EPA’s proposed remediation for the Lower Passaic River has estimated aggregate costs of approximately $953 million to $1.731 billion, but EnPro cannot estimate its potential share.
Outlook and Management Commentary
- Management expected improving conditions in most markets during the balance of 2014, with robust order activity in semiconductor, aerospace and trucking markets and improvement in some process industries.
- Management expected second-half Power Systems revenue and segment profit to exceed both first-half 2014 and second-half 2013 levels, driven by higher engine revenue and stronger aftermarket sales.
- The expected 2014 effective tax rate was 30% to 33%, subject to quarterly discrete items and the possible renewal of expired U.S. tax incentives.
- Management estimated 2014 U.S. defined-benefit pension contributions of $15.3 million based on currently available data and expected full-year pension expense of $2.2 million. The filing also states an expectation to contribute $20.4 million in total during 2014; the filing text does not clearly reconcile these two amounts.
Principal Risks and Contingencies
- GST’s bankruptcy plan could be delayed, rejected, appealed or materially changed. Claimants have asserted potential derivative, veil-piercing and alter-ego claims against EnPro and affiliates.
- Insurance recoveries for asbestos claims may be delayed or unavailable; $100.7 million of coverage was considered available at June 30, 2014, subject to policy terms, competing claims and insurer performance.
- Power Systems is exposed to potential reductions in U.S. Navy engine requirements and government-contracting risks.
- International operations expose EnPro to foreign-exchange, tax, regulatory, trade, political and compliance risks.
- Raw-material price volatility, environmental obligations, pension funding requirements, product claims, cybersecurity disruptions and cyclical demand could adversely affect results.
Investor Verification Checklist
- Verify the final outcome, funding requirements and releases associated with GST’s proposed asbestos plan.
- Assess the collectability of the $236.9 million GST investment and $66.6 million GST tax receivable.
- Monitor convertible-debt conversion activity, cash settlement requirements, hedge and warrant dilution, and the 2015 maturity.
- Reconcile the stated 2014 pension contribution estimates and track required contributions.
- Evaluate working-capital trends, particularly the increase in receivables and inventories and the resulting negative operating cash flow.
- Review developments concerning the Lower Passaic River environmental matter and the company’s potential allocation of remediation costs.
- Compare second-half Power Systems improvement against management’s stated outlook and monitor Sealing Products margin recovery.