Enpro Industries, Inc. — Form 10-Q Summary
Business context and reporting period
EnPro designs and manufactures engineered industrial products across Sealing Products, Engineered Products, and Power Systems. The filing covers the quarter and six months ended June 30, 2018. Results are not fully comparable with 2017 because GST and OldCo were reconsolidated effective July 31, 2017; their 2018 results are included, but their results were excluded from the comparable 2017 periods.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $393.6 million | $307.6 million | $762.4 million | $603.4 million |
| Gross profit | $115.8 million | $104.6 million | $240.9 million | $206.3 million |
| Gross margin | 29.4% | 34.0% | 31.6% | 34.2% |
| Operating income | $22.1 million | $27.5 million | $54.1 million | $55.2 million |
| Operating margin | 5.6% | 8.9% | 7.1% | 9.1% |
| Net income | $9.9 million | $9.0 million | $22.5 million | $15.4 million |
| Diluted EPS | $0.47 | $0.41 | $1.05 | $0.71 |
| Operating cash flow | Not separately provided | Not separately provided | $109.6 million | $28.0 million |
- Q2 sales increased 28.0%; six-month sales increased 26.4%. Management attributed growth to GST/OldCo reconsolidation, acquisitions, foreign exchange, and organic growth.
- Q2 net income rose 10.0%, while six-month net income rose 46.1%. Lower interest expense helped offset lower operating income and higher tax rates.
- Cash and cash equivalents were $93.4 million at June 30, 2018, down from $189.3 million at December 31, 2017. All reported cash was held outside the United States.
- Six-month investing cash use was $3.8 million, including $28.1 million of capital expenditures and $26.3 million of proceeds from asset sales. Financing used $197.5 million, including $131.1 million of net revolver repayments, $49.5 million of share repurchases, and $10.3 million of dividends.
- Long-term debt was $488.0 million, including $487.8 million on the balance sheet as long-term debt and $0.2 million of current maturities, versus $618.5 million at December 31, 2017.
- The amended revolving facility has $350.0 million of capacity. Availability was $291.4 million after $42.5 million of borrowings and $16.1 million of letters of credit. EnPro was in compliance with its covenants.
- Backlog, or remaining performance obligations, was $385.9 million at June 30, 2018; approximately 94% was expected to be satisfied within one year.
Material changes versus the prior comparable period
- Sealing Products sales increased 33.7% in Q2 and 31.6% for the six months, but segment margins declined to 7.5% and 8.8%, respectively, from 11.1% and 11.2%.
- Engineered Products sales increased 12.8% in Q2 and 13.6% for the six months; segment margins improved to 14.2% and 15.5% from 11.0% and 11.8%.
- Power Systems sales increased 29.1% in Q2 and 26.0% for the six months, but segment profit declined to a $0.2 million loss in Q2 and $3.8 million for the six months, compared with profits of $6.3 million and $12.6 million.
- Interest expense declined by $9.0 million in Q2 and $16.0 million for the six months, primarily because interest on GST notes payable was eliminated following reconsolidation.
- Q2 and six-month results included unusual heavy-duty trucking warranty charges of approximately $4.4 million and $4.9 million, respectively. The total warranty liability was $8.8 million at June 30, 2018, versus $4.5 million a year earlier.
- EnPro began exiting its industrial gas turbine business in Oxford, Massachusetts. The property sale generated a $21.7 million gain, but related severance, write-downs, intangible-asset write-offs, and other costs resulted in net restructuring costs of $4.1 million in Q2. Approximately $3.5 million of additional exit costs were expected during 2018.
- The EDF engine contract remained loss-making, with cumulative program losses of $13.0 million at June 30, 2018. Second-quarter results included a $3.2 million increase in the loss reserve, principally due to currency effects.
- The six-month effective tax rate increased to 41.8% from 25.2%, primarily due to Tax Cuts and Jobs Act-related items and a discrete tax charge. Q2 effective tax rates were 28.6% versus 19.6%.
Guidance, outlook, risks, and unusual items
- Management stated that four of six divisions performed well in Q2 and expected stronger second-half performance in Sealing Products and Power Systems, while remaining optimistic about overall second-half performance.
- Management expected a 2018 effective tax rate of 35% to 40%, including the significant first-quarter discrete tax item.
- A group annuity transaction closed July 3, 2018, transferring approximately $68 million of pension obligations and using $70.9 million of plan assets. EnPro expects a pre-tax pension settlement charge of approximately $12.8 million in Q3 2018.
- EnPro contributed $20.0 million to U.S. defined-benefit pension plans during the first six months and did not expect additional contributions for the rest of 2018, excluding the annuity transaction effects.
- Environmental liabilities totaled $25.3 million. Significant matters include the Lower Passaic River Superfund litigation, for which EnPro accrued $3.5 million but stated actual costs could be significantly higher, and other matters where a reasonably possible loss range could not be estimated.
- Occidental Chemical sued more than 120 parties, including EnPro, under CERCLA on June 30, 2018, seeking recovery of response costs related to the Lower Passaic River.
- EnPro estimated a reasonably possible loss range of €0.4 million to €6.6 million, plus potentially undetermined proceedings expenses, in the BorgWarner bearing litigation; €0.4 million was accrued.
- Risks include cyclical end markets, raw-material and tariff-related cost inflation, foreign-currency movements, long-term contract estimates, warranty claims, environmental and other contingent liabilities, and the timing and collectability of asbestos-related insurance recoveries.
- EnPro expected approximately $15.0 million of asbestos-related insurance recoveries, including $4.6 million in 2018, $5.8 million in 2019, and $2.5 million in 2020, but noted that collection timing and payment are not assured.
Most important facts for investors to verify
- Assess the comparability of year-over-year growth given GST and OldCo reconsolidation and identify the underlying organic growth rate.
- Monitor whether Sealing Products can recover margins after warranty charges, commodity and tariff costs, unfavorable mix, and the gas-turbine exit.
- Evaluate the EDF contract’s remaining loss exposure, currency sensitivity, delivery obligations, and potential penalties.
- Confirm post-quarter pension settlement accounting and the expected $12.8 million Q3 charge.
- Track cash availability, revolver borrowings, debt covenants, and restrictions on further share repurchases under the senior-note indenture.
- Review environmental, CERCLA, BorgWarner, asbestos-insurance, and other contingent liabilities because several potential loss ranges remain uncertain.
- Verify the ultimate 2018 tax rate and the timing and amount of the expected additional federal tax refund.