Enpro Industries, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The interim financial statements are unaudited. EnPro designs, manufactures and services engineered industrial products through its Sealing Products, Engineered Products and Power Systems segments.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $388.2 million | $343.7 million | $1,150.6 million | $947.1 million |
| Gross profit | $124.1 million | $115.1 million | $365.0 million | $321.4 million |
| Gross margin | 32.0% | 33.5% | 31.7% | 33.9% |
| Operating income | $44.2 million | $18.3 million | $98.3 million | $73.5 million |
| Operating margin | 11.4% | 5.3% | 8.5% | 7.8% |
| Net income | $24.2 million | $490.2 million | $46.7 million | $505.6 million |
| Diluted EPS | $1.16 | $22.49 | $2.20 | $23.32 |
Q3 2017 and 9M 2017 net income included a $534.4 million pretax gain from reconsolidating GST and OldCo following the asbestos-related Chapter 11 reorganization. Accordingly, reported earnings comparisons are not representative of underlying operating trends.
- Segment sales, Q3: Sealing Products $249.6 million, Engineered Products $78.1 million and Power Systems $61.4 million.
- Segment profit, Q3: $35.9 million, $8.4 million and $8.7 million, respectively.
- Segment sales, 9M: Sealing Products $737.2 million, Engineered Products $249.4 million and Power Systems $167.2 million.
- Backlog: Remaining performance obligations were $413.5 million at September 30, 2018, with approximately 89% expected to be satisfied within one year.
- Cash flow: Operating activities generated $158.4 million in 9M 2018 versus $64.4 million in 9M 2017. Capital expenditures were $45.7 million, and investing activities used $11.8 million.
- Cash and liquidity: Cash was $119.9 million versus $189.3 million at December 31, 2017. All cash was held outside the United States. Revolver availability was $299.9 million after $34.1 million of borrowings and $16.0 million of letters of credit.
- Debt: Long-term debt was $480.0 million plus $0.3 million of current maturities, compared with $618.3 million and $0.2 million, respectively, at year-end 2017. The company was in compliance with its credit facility covenants.
- Shareholder returns: EnPro paid $15.3 million of dividends and repurchased approximately 0.7 million shares for $50.0 million during the first nine months. The quarterly dividend was $0.24 per share.
Material changes versus the prior comparable period
- Q3 sales increased 12.9%; 9M sales increased 21.5%. Management attributed growth to favorable demand across semiconductor, aerospace, food and pharmaceutical, heavy-duty trucking, general industrial, metals and mining, and oil and gas markets.
- Q3 operating income increased substantially, helped by higher sales, lower corporate expenses, lower interest expense and the absence of the prior-year impairment and other unusual items. Gross margin declined because of manufacturing, material and tariff-related costs.
- Sealing Products delivered strong Q3 growth and a 14.4% segment margin, but its 9M margin declined to 10.7% from 11.1% because of mix, manufacturing and material costs, medical costs and unusual warranty charges.
- Engineered Products improved both sales and margins, with 9M segment margin increasing to 14.0% from 11.3%.
- Power Systems sales increased, but 9M segment profit declined to $12.5 million from $20.9 million, primarily due to unfavorable foreign-exchange effects on the EDF contract. Q3 performance improved, and management reported a robust backlog.
- Operating cash flow benefited from tax refunds, including a $95.8 million federal refund received in June 2018, lower interest payments and other working-capital changes.
- EnPro adopted the new revenue recognition standard in 2018, increasing opening retained earnings by $0.4 million and increasing 9M 2018 net sales by $1.3 million relative to the prior guidance.
Guidance, outlook, risks and unusual items
Management stated that all divisions performed well in Q3, demand remained favorable in several end markets, and the company expected a positive finish to 2018. Power Systems was expected to benefit from improved Q3 performance and backlog. No quantitative full-year revenue or earnings guidance was provided.
- EnPro exited its industrial gas turbine business in Oxford, Massachusetts. The transaction generated a $21.7 million gain on the property sale, but total net restructuring costs were $4.0 million, including severance, asset write-downs and intangible-asset write-offs.
- Approximately $4.8 million of unusual warranty expense related to two heavy-duty trucking products was recorded during the first nine months. The warranty liability was $9.0 million at September 30, 2018, and future adjustments may be required.
- A pension annuity transaction transferred approximately $68 million of projected benefit obligations and resulted in a $12.8 million pretax settlement charge in Q3. EnPro expected no additional U.S. defined-benefit pension contributions until 2020 or later, subject to investment performance and other factors.
- The EDF Power Systems contract remained loss-making. The cumulative program loss was $13.7 million at September 30, 2018, and profitability remains sensitive to currency movements, project costs, billing adjustments, efficiency gains and potential late-delivery penalties.
- After quarter-end, EnPro issued $350.0 million of 5.75% Senior Notes due 2026 and used the proceeds plus revolver borrowings to redeem $450.0 million of 5.875% notes due 2022. The company expected an approximately $18.1 million loss on redemption in Q4 2018.
- Environmental liabilities totaled $24.2 million. Significant contingencies include the Lower Passaic River Superfund matter, the Onondaga Lake site, Arizona uranium mines and Mississippi groundwater and vapor-intrusion matters. Potential losses beyond recorded reserves cannot be estimated for several matters.
- The company estimated a reasonably possible loss of approximately €0.4 million to €6.6 million, plus potentially undetermined legal costs, in litigation brought by BorgWarner against GGB France.
- Asbestos claims are subject to the court-approved Chapter 11 plan and Section 524(g) injunctions. EnPro reported approximately $27.6 million of available solvent-insurer coverage, although collection timing and ultimate recovery are not assured.
- Key operating risks include cyclical end markets, raw-material and tariff inflation, foreign-exchange volatility, long-term contract estimation risk, warranty claims, contractual penalties and environmental and other legacy liabilities.
Investor verification priorities
- Separate sustainable operating earnings from the nonrecurring 2017 GST and OldCo reconsolidation gain.
- Assess whether Sealing Products can recover its 9M margin decline and absorb trucking warranty, labor, material and tariff costs.
- Track Power Systems’ EDF contract loss provision, foreign-exchange exposure, backlog conversion and late-delivery risk.
- Verify the post-refinancing debt balance, revolver utilization, covenant compliance and the expected Q4 2018 debt-redemption loss.
- Review cash held outside the United States, tax-refund timing and the company’s ability to fund dividends, repurchases, capital expenditures and acquisitions.
- Monitor environmental, BorgWarner, asbestos-insurance and other legacy contingencies, including amounts potentially exceeding recorded reserves.
- Evaluate the effect of the 2019 lease-accounting adoption, which management expected to materially increase reported assets and liabilities.