Enpro Inc. quarterly report, Q3 FY2016

EnPro Industries, Inc. — 2016 Q3 Form 10-Q Summary

Business context and reporting period

EnPro designs, manufactures, services and markets engineered industrial products through three reportable segments: Sealing Products, Engineered Products and Power Systems. The filing covers the unaudited quarter and nine months ended September 30, 2016, compared with the same periods in 2015.

GST, Anchor and Garrison remain deconsolidated because of their Chapter 11 asbestos proceedings. EnPro carries its investment in GST at cost and reported an investment balance of $236.9 million at September 30, 2016.

Financial performance and key metrics

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Net sales	$292.7 million	$306.6 million	$900.8 million	$882.5 million
Gross profit	$98.6 million	$101.4 million	$304.1 million	$292.5 million
Gross margin	33.7%	33.1%	33.8%	33.1%
Operating income (loss)	$25.3 million	$24.9 million	$(18.0) million	$16.0 million
Net income (loss)	$6.0 million	$11.4 million	$(37.2) million	$(27.5) million
Diluted EPS	$0.28	$0.51	$(1.71)	$(1.21)
Operating cash flow	Not provided for quarter	Not provided for quarter	$7.9 million	$32.0 million

Q3 operating margin was approximately 8.6%, compared with 8.1% in the prior-year quarter. The nine-month operating margin was negative because of the $80.0 million asbestos settlement charge in 2016; the prior-year period included a $47.0 million goodwill and intangible-asset impairment charge.

Q3 segment sales were $175.3 million for Sealing Products, $65.7 million for Engineered Products and $52.5 million for Power Systems.
Q3 segment profit was $23.1 million, $2.9 million and $7.3 million, respectively.
Nine-month segment sales increased in Sealing Products and Power Systems but declined in Engineered Products. Power Systems sales rose 14.6% year over year, while Engineered Products sales fell 6.3%.
Cash and cash equivalents were $114.8 million at September 30, 2016, all held outside the United States.
Cash flow from operations was $7.9 million; investing cash use was $52.5 million, including $24.6 million of capital expenditures and $28.5 million for acquisitions.
Financing activities provided $67.7 million, primarily reflecting net revolving-credit borrowings, partly offset by $26.2 million of share repurchases and $13.6 million of dividends.
Total shareholders’ equity was $384.1 million, down from $459.8 million at December 31, 2015.

Debt, liquidity and capital allocation

At September 30, 2016, EnPro had $462.5 million of long-term debt, $0.1 million of current maturities, $168.0 million of revolving borrowings and $295.9 million of current notes payable to GST, plus $27.8 million of short-term borrowings from GST. The $300 million revolving facility had $121.6 million of availability after outstanding borrowings and letters of credit. EnPro was in compliance with its debt covenants.

The company has $300 million of 5.875% senior notes due 2022. Notes payable to GST bear interest at 11%, including cash and payment-in-kind components, and were scheduled to mature January 1, 2017; EnPro was seeking extensions. The October 2016 revolving-credit amendment permitted transactions related to the contemplated Coltec restructuring.

EnPro repurchased approximately 0.5 million shares for $25.8 million during the first nine months and repurchased an additional $2.4 million through November 1, 2016. The board declared a $0.21 per-share dividend payable December 15, 2016.

Material changes versus the prior comparable period

Q3 sales declined 4.5%, primarily from organic volume weakness in Sealing Products and Engineered Products; Power Systems sales increased 6.9%.
Q3 net income fell 47% to $6.0 million, reflecting lower sales, higher interest expense and higher other expense.
Nine-month sales increased 2.1%, but the company reported a larger net loss because of the $80.0 million asbestos settlement accrual. The prior-year period included a $47.0 million impairment charge.
Operating cash generation declined $24.1 million year over year, primarily because of a $14.8 million pension contribution and higher interest and tax payments.
Interest expense increased $2.4 million for the nine-month period because of higher average indebtedness.
Restructuring and cost-reduction actions generated approximately $3 million of Q3 cost reductions and are expected to produce approximately $18 million of annualized savings. Approximately $4 million of related restructuring charges were recorded in the first nine months.
Rubber Fab was acquired in April 2016 for inclusion in Sealing Products; total acquisition spending was $28.5 million in the first nine months.

Guidance, outlook, risks and unusual items

Management expects a 2016 effective tax rate between 38% and 42%, subject to geographic earnings mix and discrete tax events.
Full-year 2016 pension expense is estimated at approximately $6 million. No additional U.S. defined-benefit pension contributions were anticipated for the remainder of 2016 based on available information.
Additional Q4 2016 restructuring charges related to future foreign-location headcount reductions were expected to be approximately $2 million.
Management continued to expect confirmation and consummation of the asbestos Joint Plan, with anticipated GST reconsolidation in late summer of the following year; the filing states that timing and consummation are not assured.
The Joint Plan requires approval by at least 75% of voting asbestos claimants, the Bankruptcy Court and the District Court. It contemplates a $480 million trust funding requirement for GST and Coltec asbestos claims, including $370 million from GST/Garrison and $110 million from Coltec. EnPro guarantees the deferred $60 million contribution and may be required to fund contributions.
GST had accrued $387.0 million for asbestos-related claims, while Coltec had accrued $110.0 million for its planned contributions. The plan remains subject to restructuring consents, Canadian claims resolution and favorable IRS treatment of the trust.
Available GST asbestos insurance coverage was $62.0 million at September 30, 2016, although collection timing and competing claims could affect recoveries.
Environmental liabilities totaled $20.7 million. Material uncertainties include the Lower Passaic River Superfund matter, for which EnPro accrued $3.5 million while acknowledging actual costs could be significantly higher, and the Onondaga Lake matter, for which a reasonably possible loss range could not be estimated.
The Power Systems segment remains exposed to the unhedged, Euro-denominated EDF contract, including foreign-exchange effects, execution risk and potential late-delivery penalties. Fairbanks Morse also settled the AVL litigation for $2.7 million in April 2016.
Management identified cyclical industrial demand, raw-material prices, foreign exchange, asbestos claims, environmental liabilities and other predecessor-business contingencies as significant risks.

Most important facts for investors to verify

Whether the asbestos Joint Plan receives the required claimant and court approvals and whether the contemplated Coltec restructuring and GST reconsolidation occur as expected.
The ultimate cash funding burden and guarantee exposure associated with the $480 million asbestos trust, including the $110 million Coltec contribution and EnPro’s guarantee of the deferred contribution.
Whether $121.6 million of revolver availability and operating cash flow are sufficient to support debt maturities, acquisitions, dividends, share repurchases and potential legal or environmental payments.
The extension or refinancing of the $295.9 million of notes payable to GST scheduled to mature January 1, 2017.
Whether the expected $18 million of annualized cost savings offset continued organic demand weakness, particularly in Sealing Products and Engineered Products.
The eventual cost allocation and EnPro’s share of environmental exposures, especially the Lower Passaic River and Onondaga Lake matters.
Actual results under the EDF contract, including foreign-exchange sensitivity, projected losses and delivery penalties.