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 Engine Products and Services. This report covers the quarter and nine months ended September 30, 2011, compared with the same periods in 2010. The financial statements are unaudited and presented under U.S. GAAP.
Comparability is affected by the 2010 deconsolidation of Garlock Sealing Technologies and related entities (“GST”) following their Chapter 11 filings, and by the sale of Quincy Compressor, which is reported as discontinued operations in 2010.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $300.8 million | $194.5 million | $834.1 million | $673.5 million |
| Gross profit | $96.8 million | $73.2 million | $290.1 million | $253.5 million |
| Gross margin | 32.2% | 37.6% | 34.8% | 37.6% |
| Operating income | $29.6 million | $16.5 million | $88.9 million | $48.3 million |
| Income from continuing operations | $14.2 million | $4.9 million | $41.6 million | $55.0 million |
| Net income | $14.2 million | $4.9 million | $41.6 million | $149.1 million |
| Diluted EPS | $0.66 | $0.24 | $1.92 | $7.25 |
Q3 operating margin was 9.8%, compared with 8.5% in the prior-year quarter. Nine-month operating margin was 10.7%, compared with 7.2% in 2010. The 2010 nine-month results included $94.1 million of discontinued-operation income, including a $92.5 million after-tax gain on the Quincy sale, and a $54.1 million pre-tax gain from GST deconsolidation.
Cash flow, liquidity and debt
- Operating cash flow from continuing operations was $32.6 million for the first nine months of 2011, versus $19.1 million in 2010.
- Investing activities used $243.6 million, including $228.2 million for acquisitions and $17.0 million for capital expenditures.
- Financing activities provided $14.2 million, including approximately $28 million of net revolver borrowings, partly offset by debt and short-term borrowing repayments.
- Cash declined to $22.9 million at September 30, 2011, from $219.2 million at December 31, 2010.
- Accounts receivable increased to $200.9 million from $142.1 million, and inventories increased to $121.7 million from $77.0 million.
- The amended senior secured revolving credit facility has maximum availability of $175 million, including a $30 million letter-of-credit sublimit. Actual availability at September 30 was $68.4 million after $28.0 million of borrowings and $4.1 million of letters of credit.
- Balance-sheet debt included $170.4 million of long-term debt, $1.0 million of current maturities, $10.0 million of short-term borrowings, and $237.4 million of notes payable to GST. The $172.5 million convertible debentures mature October 15, 2015 and carry a 3.9375% coupon.
- Total shareholders’ equity was $524.4 million, compared with $476.4 million at year-end 2010.
Material changes versus the prior comparable period
- Q3 sales increased 55%, with acquisitions contributing approximately 27 percentage points, higher volumes, selected price increases, and favorable foreign exchange also contributing.
- Q3 segment profit increased 30% to $35.4 million. Segment margin declined to 11.8% from 14.0%, primarily because of lower margins in Engine Products and Services and the mix of acquired businesses.
- Sealing Products sales increased 75% to $144.3 million and segment profit increased 45% to $22.5 million, although segment margin declined to 15.6% from 18.8%.
- Engineered Products sales increased 33% to $98.2 million and segment profit increased 121% to $6.4 million; segment margin improved to 6.5% from 3.9%.
- Engine Products and Services sales increased 53% to $58.8 million, but segment profit declined to $6.5 million from $8.8 million. The segment recorded a $1.4 million warranty expense and a $3.0 million estimated contract loss.
- Acquisitions completed in 2011 cost $228.2 million in cash and added $79.1 million of goodwill and $104.2 million of identifiable intangible assets. Acquired businesses contributed $49.4 million of Q3 sales and $106.1 million of nine-month sales.
- Interest expense increased materially, primarily because of revolver borrowings and interest on notes payable to GST that had previously been eliminated in consolidation.
- The Engine Products and Services segment began using percentage-of-completion accounting for qualifying new engine contracts. This contributed $3.3 million of sales and $0.6 million of operating income in Q3 and the first nine months.
- Comprehensive income was negative $1.2 million in Q3, primarily because of a $15.5 million unfavorable foreign-currency translation adjustment.
Outlook, contingencies and risks
- Management expects Q4 2011 sales to improve from Q4 2010, with approximately $50 million of sales expected from 2011 acquisitions. Management expects normal seasonality, lower sequential engine shipments, and Q4 segment profit margins generally in line with Q4 2010.
- Management expects percentage-of-completion accounting to add approximately $3.6 million of Q4 sales and $0.6 million of Engine Products and Services segment profit.
- Management expects a 33%–35% effective tax rate for the remainder of 2011, subject to changes in geographic earnings mix, tax audits, legislation and discrete items.
- GST remains in Chapter 11. EnPro carries a $236.9 million investment in GST that is subject to impairment review. The ultimate value depends on the bankruptcy plan, asbestos liabilities, insurance recoveries and other proceedings.
- EnPro reported approximately $160 million of insurance coverage believed available for current and future asbestos claims, with $30.6 million collected since the petition date. Coverage may be subject to competing claims and insurer recoverability risks.
- Environmental liabilities were accrued at $13.1 million at September 30, 2011. EnPro is involved at 15 environmental sites, including three where investigations remain in progress.
- U.S. pension plans remain underfunded. EnPro contributed $5.9 million in cash during the first nine months and a $21.4 million guaranteed investment contract; management expected no further 2011 U.S. contribution but indicated that significant contributions may be required in 2012 and later.
- Management identifies risks from cyclical end markets, raw-material prices and availability, foreign exchange, interest rates, acquisitions and integration, environmental liabilities, legacy liabilities, asbestos claims, and GST’s bankruptcy.
- The $172.5 million convertible debentures could require substantial cash settlement upon conversion or a change of control. No conversion condition was satisfied at September 30, 2011, but liquidity and credit-facility restrictions could constrain future payments.
Most important facts for investors to verify
- Whether acquisition-related revenue growth translates into sustainable margins and cash generation after integration costs.
- The availability and borrowing-base capacity under the $175 million revolving credit facility, including compliance with fixed-charge and other covenants.
- The amount and timing of required pension contributions beginning in 2012.
- Developments in GST’s Chapter 11 case, the value of the $236.9 million GST investment, asbestos claims and insurance recoveries.
- Potential revisions to engine contract estimates under percentage-of-completion accounting, including the recorded $3.0 million contract loss and $1.4 million warranty provision.
- Exposure to foreign-exchange movements, raw-material inflation, cyclical demand and the profitability of newly acquired operations.