Enpro Industries, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
EnPro designs, manufactures, services and markets engineered industrial products through three segments: Sealing Products, Engineered Products and Power Systems. The filing covers the unaudited three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $360.3 million | $368.8 million | Down 2.3% |
| Gross profit | $113.1 million | $125.1 million | Down 9.6% |
| Gross margin | 31.4% | 33.9% | Down 250 bps |
| Operating income | $23.9 million | $32.0 million | Down 25.3% |
| Operating margin | 6.6% | 8.7% | Down 200 bps |
| Income before taxes | $17.9 million | $24.8 million | Down 27.8% |
| Net income | $13.1 million | $12.6 million | Up 4.0% |
| Diluted EPS | $0.63 | $0.58 | Up $0.05 |
| Effective tax rate | 26.8% | 49.2% | Down 2,240 bps |
| Operating cash flow | $9.9 million | $(20.0) million | Improved $29.9 million |
| Capital expenditures and software | $10.7 million | $15.6 million | Down $4.9 million |
| Cash at March 31 | $130.9 million | $118.1 million | Up $12.8 million |
Segment sales and profit were $224.5 million and $20.8 million for Sealing Products, $79.5 million and $6.2 million for Engineered Products, and $57.3 million and $6.7 million for Power Systems. Company backlog, defined as remaining performance obligations, was $410.0 million at March 31, 2019, with approximately 86% expected to be satisfied within one year.
Total debt was approximately $473.2 million, consisting principally of $350.0 million of 5.75% Senior Notes due 2026 and $127.0 million of revolver borrowings. Approximate net debt was $342.3 million using reported cash. Revolver availability was $207.1 million after outstanding borrowings and letters of credit. The Company was in compliance with all debt covenants.
Material changes versus the prior comparable period
- Sales declined primarily because of unfavorable foreign currency translation, weakness in Asian and European markets within Engineered Products, semiconductor market softness, and the 2018 exit from the industrial gas turbine business.
- Sealing Products sales declined 3.2% and segment profit declined 12.2%; margin decreased to 9.3% from 10.2%. Higher material costs, unfavorable mix and lower sales more than offset pricing and restructuring-related savings.
- Engineered Products sales declined 7.5% and segment profit declined 56.9%; margin decreased to 7.8% from 16.8%, driven by regional market weakness, higher manufacturing costs, lower sales and higher selling, general and administrative expenses.
- Power Systems sales increased 10.0% and segment profit increased 67.5%; margin improved to 11.7% from 7.7%, supported by military marine engines and aftermarket parts and services.
- Interest expense, net decreased by $3.3 million because of lower outstanding debt following the 2018 refinancing.
- Net income and EPS increased despite lower operating income, primarily because the effective tax rate fell from 49.2% to 26.8%. The 2018 rate included a $5.4 million discrete tax charge related to domestic production activities.
- Operating cash flow improved substantially, reflecting the timing of interest payments after the refinancing, a cross-currency swap payment and a larger income-tax refund.
Outlook, commentary, risks and unusual items
Management described Power Systems as strong in the quarter but noted unexpected weakness in Asian and European Engineered Products markets, semiconductor headwinds, a negative foreign-exchange translation effect and lower Sealing Products sales following the gas-turbine exit. No quantitative full-year earnings or sales guidance was provided. Management expects to continue evaluating acquisitions, but potential acquisitions were not reflected in the outlook.
The EDF engine contract generated a $1.0 million increase in the cumulative loss provision during Q1 2019, bringing the cumulative recognized program loss to $17.8 million. The change reflected unfavorable euro-dollar movement and higher projected costs, partly offset by favorable contractual revenue adjustments. The contract also contains potential late-delivery penalties and depends on anticipated internal efficiency gains.
Environmental liabilities totaled $30.1 million. Significant contingencies include the Lower Passaic River matter, for which the remaining accrual was $2.9 million but future costs could be materially higher; Onondaga Lake claims, for which the Company had a $6.5 million reserve and could not estimate the upper end of potential loss; uranium-mine investigations with a $2.7 million reserve; and Water Valley, Mississippi remediation with a $4.2 million reserve. Additional losses from these matters and related litigation cannot presently be estimated in many cases.
GGB France retained a €0.4 million accrual for BorgWarner claims, while the disclosed reasonably possible loss range was approximately €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses. The Company also reported approximately $11.3 million of anticipated asbestos insurance recoveries, expected to be collected in 2019 and 2020, subject to insurer performance and potential competing claims.
EnPro adopted the new lease standard in Q1 2019 and recognized approximately $30.0 million of operating lease right-of-use assets and $30.3 million of lease liabilities. It also reclassified an $11.5 million net tax benefit from accumulated other comprehensive loss to opening retained earnings, with no income-statement or cash-flow impact.
The Company held all $130.9 million of cash outside the United States and reported a net current income-tax receivable of $24.4 million. It repurchased $2.4 million of shares during the quarter and had $47.6 million remaining under its $50 million authorization at March 31; an additional $4.0 million was repurchased through April 29, 2019.
Important facts for investors to verify
- Whether Engineered Products margins recover from the sharp Q1 decline and whether Asian and European weakness persists.
- Power Systems demand, particularly military marine and aftermarket activity, and the remaining economics and delivery risks of the EDF contract.
- Progress on gross-margin recovery, including material-cost inflation, product mix, pricing and restructuring savings.
- Cash conversion and working-capital requirements, particularly the increase in inventory to $249.3 million from $233.1 million at year-end.
- Leverage, revolver availability and compliance with the 4.0-to-1 maximum net leverage and 2.5-to-1 minimum interest coverage covenants.
- Potential cash costs above recorded reserves for environmental, litigation, asbestos and warranty matters.
- The timing and collectability of the expected $11.3 million asbestos insurance recoveries.
- Foreign-exchange effects, commodity costs and any contractual penalties or cost overruns affecting the EDF program.