EnPro Industries, Inc. — 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 quarter and nine months ended September 30, 2017. The interim financial statements are unaudited.
Effective July 31, 2017, GST and OldCo were reconsolidated following consummation of the asbestos Joint Plan of Reorganization. Their results are included in EnPro’s consolidated results only from that date, so reported comparisons are affected by the change in consolidation.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $343.7 million | $292.7 million | $947.1 million | $900.8 million |
| Gross profit | $115.2 million | $98.6 million | $321.3 million | $304.1 million |
| Gross margin | 33.5% | 33.7% | 33.9% | 33.8% |
| Operating income (loss) | $18.5 million | $25.3 million | $73.2 million | $(18.0) million |
| Operating margin | 5.4% | 8.6% | 7.7% | (2.0)% |
| Net income (loss) | $490.2 million | $6.0 million | $505.6 million | $(37.2) million |
| Diluted EPS | $22.49 | $0.28 | $23.32 | $(1.71) |
Q3 sales increased 17.4%, while nine-month sales increased 5.1%. Nine-month segment sales were $584.3 million for Sealing Products, $226.3 million for Engineered Products and $139.4 million for Power Systems. Nine-month segment profit was $65.0 million, $25.4 million and $20.6 million, respectively.
Cash provided by operating activities was $64.4 million for the first nine months, compared with $7.9 million in the prior-year period. Investing activities used $74.2 million, including $39.5 million for the Qualiseal acquisition, $23.6 million for property, plant and equipment and $2.6 million for internal-use software. Financing activities provided $65.4 million. Ending cash was $176.1 million, compared with $111.5 million at December 31, 2016.
At September 30, 2017, total assets were $1.842 billion and shareholders’ equity was $866.5 million. Long-term debt was $560.4 million, and current maturities were $0.2 million. The $300 million revolving facility had $115.8 million drawn, $14.5 million in letters of credit and $169.7 million of availability. EnPro was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Reported net income was materially increased by a $534.4 million pretax gain from reconsolidating GST and OldCo. The gain included a $248.3 million revaluation of the investment and $286.1 million from eliminating net amounts payable to the entities.
- The reconsolidation added $35.5 million of sales and $3.3 million of pretax income in the quarter and nine months after July 31, 2017.
- Q3 operating income declined despite higher sales, primarily because of a $10.1 million impairment charge for ATDynamics intangible assets, higher corporate expenses and unfavorable mix and manufacturing costs in Sealing Products.
- Engineered Products delivered substantially higher profit, with Q3 segment profit increasing to $7.7 million from $2.9 million and nine-month profit increasing to $25.4 million from $10.4 million.
- Power Systems’ nine-month sales declined 11.3%, but segment profit increased 32.9% due to cost reductions, price increases, lower warranty costs and favorable EDF contract adjustments.
- The prior-year nine-month period included an $80.0 million asbestos settlement charge; no comparable charge was recorded in 2017.
Guidance, outlook, risks and unusual items
- Management expects 2017’s effective tax rate to be 8% to 13%, inclusive of the GST and OldCo reconsolidation gain. The Q3 rate was 9.3% and the nine-month rate was 9.9%; these rates are not representative of ordinary operating profitability.
- Management reported strengthening conditions in several core markets, continued improvement in Power Systems activity in the fourth quarter, and positive Q3 performance in Sealing Products and Engineered Products. Five facilities were affected by hurricanes; estimated losses were approximately $2 million, with expected insurance recovery exceeding $1 million that was not recorded in the financial statements.
- The asbestos Joint Plan permanently resolves current and future covered asbestos claims through a trust and related injunctions. Required contributions included $400 million of cash contributions by GST, Garrison and OldCo, plus deferred contributions of $60 million and a potential $20 million stock-or-cash obligation. EnPro expects tax deductions and related refunds from these payments, but the timing and final amount remain subject to tax filing and possible IRS review.
- Approximately $44.4 million of insurance coverage or receivables remained available for GST asbestos-related payments at September 30, 2017. Collection is subject to insurer performance and ongoing litigation involving two insurers covering $15 million.
- Environmental liabilities totaled $24.8 million. Significant uncertainties remain regarding the Lower Passaic River, Onondaga Lake, Arizona uranium mines and Mississippi groundwater matters; potential losses beyond recorded accruals are not fully estimable.
- BorgWarner litigation against GGB France carries an estimated reasonably possible loss range of €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses. The recorded accrual was €0.4 million.
- The EDF contract remains exposed to foreign-exchange movements, delivery penalties and cost-to-complete assumptions. The nine-month loss provision was reduced by $2.8 million, including $7.6 million of favorable currency effects partly offset by $4.8 million of higher projected costs.
- All $176.1 million of reported cash was held outside the United States. Repatriation could create tax consequences depending on the method used, although management currently intends to permanently reinvest the funds outside the United States.
Most important facts for investors to verify
- Separate recurring operating performance from the $534.4 million nonrecurring reconsolidation gain and related tax effects.
- Confirm the final purchase-price allocation and valuation of GST and OldCo, including $132.6 million of goodwill and $180.8 million of acquired intangible assets.
- Monitor debt reduction, revolver availability, covenant compliance and the maturity or treatment of related-party notes previously payable to GST.
- Assess whether the $10.1 million ATDynamics impairment signals broader weakness in the Sealing Products portfolio.
- Verify the timing and realizability of expected asbestos insurance recoveries and tax refunds.
- Track environmental, product-liability, BorgWarner and other legacy contingencies for exposures beyond recorded reserves.
- Evaluate the sustainability of segment margins excluding reconsolidated GST and OldCo operations, hurricane effects, foreign-exchange movements and EDF contract adjustments.