Enpro Industries, Inc. — Form 10-Q Summary
Business context and reporting period
EnPro designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products, and Power Systems. The filing covers the unaudited quarter ended March 31, 2014, compared with the quarter ended March 31, 2013. The company operated 63 primary manufacturing facilities in 13 countries.
The former Engine Products and Services segment was renamed Power Systems; its composition and reported results were unchanged. GST-related entities remain deconsolidated because of their Chapter 11 proceedings, while EnPro carries its investment in GST using the cost method.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $287.2 million | $286.9 million | 0.1% |
| Gross profit | $96.5 million | $94.2 million | 2.4% |
| Gross margin | 33.6% | 32.9% | Up 70 bps |
| Operating income | $17.4 million | $20.7 million | Down 16.0% |
| Operating margin | 6.1% | 7.2% | Down 110 bps |
| Income before taxes | $2.3 million | $9.7 million | Down 76.3% |
| Net income | $1.3 million | $8.6 million | Down 84.9% |
| Diluted EPS | $0.05 | $0.39 | Down $0.34 |
| Net cash used in operating activities | $(25.0) million | $(17.8) million | Higher use of $7.2 million |
Cash and cash equivalents were $59.8 million at March 31, 2014, versus $64.4 million at December 31, 2013. Accounts receivable increased to $215.7 million from $193.1 million, and inventories increased to $160.6 million from $149.1 million, contributing to operating cash consumption.
Investing activities used $11.3 million, including $6.7 million for property, plant and equipment, $2.8 million for internal-use software, and $1.9 million for acquisitions. Financing activities provided $31.8 million, including $70.3 million of debt proceeds and $34.5 million of debt repayments.
At March 31, 2014, the senior secured revolving credit facility had $78.8 million of borrowing availability after $43.4 million of revolver borrowings and $4.8 million of letters of credit. Reported debt and debt-like obligations included $107.1 million of current maturities of long-term debt, $44.3 million of long-term debt, $271.0 million of notes payable to GST, and $23.1 million of short-term borrowings from GST. The convertible debentures had approximately $116.4 million of principal outstanding after March exchange transactions and were classified as currently convertible.
Material changes versus the prior comparable period
- Consolidated sales were essentially flat, but segment mix shifted materially: Sealing Products sales rose 6% to $155.0 million, Engineered Products sales were unchanged at $91.8 million, and Power Systems sales declined 17% to $41.1 million.
- Sealing Products segment profit declined 20% to $17.1 million, with margin falling to 11.0% from 14.5%, due to lower Garlock volumes, higher manufacturing and research costs, severance, headcount additions, and the absence of a prior-year acquisition earnout release.
- Engineered Products segment profit increased to $8.7 million from $5.8 million, and margin improved to 9.5% from 6.3%, reflecting manufacturing efficiencies, pricing, higher GGB volumes, and lower restructuring costs.
- Power Systems segment profit fell to $3.3 million from $4.8 million, with margin declining to 8.0% from 9.7%, primarily because of lower environmental upgrade, parts and service, and percentage-of-completion engine revenue.
- Other expense increased by $3.7 million, primarily due to a $3.6 million pretax loss on the exchange of convertible debentures.
- The effective tax rate increased to 45.7% from 11.4%. Management attributed the change primarily to the expiration of certain U.S. tax provisions and the absence of a prior-year discrete tax benefit.
- Corporate expenses increased $1.0 million to $10.1 million, driven principally by higher purchased services, legal fees, travel, and director fees.
Acquisitions, debt and unusual items
In March 2014, EnPro acquired the remaining interest in Stemco Crewson LLC and acquired Strong-Tight Co. Ltd., an Asian manufacturer and seller of gaskets and industrial sealing products. Total purchase consideration was $5.6 million; $1.9 million was paid in March, with the balance payable in installments during and after 2014.
EnPro exchanged approximately $56.1 million of convertible debenture principal for approximately 1.7 million common shares and cash for accrued interest and fractional shares. The transaction reduced outstanding principal to approximately $116.4 million and generated a $3.6 million pretax loss, or $2.3 million after tax. The debentures remained convertible through June 30, 2014, subject to the stated conversion conditions.
Guidance, outlook and risks
- Management was optimistic that the improvement observed in March would continue into the second quarter, supported by seasonal demand and improving European and North American markets.
- Second-quarter margins were expected to benefit from higher volumes and efficiency improvements, although a greater proportion of original-equipment sales could reduce mix-related margins. Segment profit was expected to be in line with the second quarter of 2013.
- For full-year 2014, management expected moderate market improvement, low but stable European growth, and modest growth in most North American markets.
- Management expected a 2014 effective tax rate of 31% to 35%, subject to discrete tax events and possible renewal of expired U.S. tax incentives.
- U.S. defined benefit pension contributions were estimated at $20.4 million for 2014, including $5.1 million contributed during the first quarter. Full-year pension expense was estimated at $3.6 million.
- GST’s Chapter 11 process remains unresolved. The Bankruptcy Court estimated present and future mesothelioma liability at $125 million, but amounts for other asbestos claims, administrative costs, appeals, and a confirmed plan remain undetermined. GST’s recorded asbestos liability was $466.8 million.
- GST reported $121.1 million of remaining available insurance coverage for asbestos-related claims and expenses, but collection timing and ultimate recoverability are not assured. EnPro’s investment in GST was $236.9 million, and its related income tax receivable was $60.4 million.
- Environmental liabilities totaled $15.6 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 potential allocation.
- Other risks include cyclical markets, raw-material pricing and availability, foreign-currency exposure, pension funding requirements, convertible-debt liquidity, and unresolved litigation involving former businesses.
Most important facts for investors to verify
- Whether GST’s revised plan of reorganization, asbestos liability, and any required EnPro funding or guarantees materially change the company’s $236.9 million GST investment and related tax receivable.
- Whether the convertible debentures are converted, refinanced, or repaid before their October 15, 2015 maturity and the resulting cash and dilution impact.
- Whether working-capital investment reverses and operating cash flow improves after the first-quarter $25.0 million cash use.
- Whether Sealing Products margins recover from 11.0% and whether Power Systems demand and mix improve.
- The eventual allocation of responsibility for the Lower Passaic River remediation and any additional environmental or legacy liabilities.
- Whether management’s 31%–35% annual tax-rate expectation and second-quarter profit outlook are achieved.