Enpro Industries, Inc. — First-Quarter 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparative period ended March 31, 2017. The interim financial statements are unaudited. EnPro designs and manufactures engineered industrial products across Sealing Products, Engineered Products, and Power Systems. GST and OldCo were reconsolidated effective July 31, 2017, so the 2018 results include their operations while the 2017 comparative period does not, limiting comparability.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $368.8 million | $295.8 million | 24.7% increase |
| Gross profit | $125.1 million | $101.7 million | 23.0% increase |
| Gross margin | 33.9% | 34.4% | Down 0.5 percentage points |
| Operating income | $32.0 million | $27.7 million | 15.5% increase |
| Operating margin | 8.7% | 9.4% | Down 0.7 percentage points |
| Net income | $12.6 million | $6.4 million | 96.9% increase |
| Diluted EPS | $0.58 | $0.30 | 93.3% increase |
| Effective tax rate | 49.2% | 31.8% | Up 17.4 percentage points |
| Net cash used in operating activities | $(20.0) million | $(19.6) million | Higher use of cash |
Segment performance: Sealing Products sales were $231.9 million, up 29.3%, with segment profit of $23.7 million, up 16.2%. Engineered Products sales were $85.9 million, up 14.4%, with segment profit of $14.4 million, up 51.6%. Power Systems sales were $52.1 million, up 22.9%, while segment profit declined 36.5% to $4.0 million.
Cash and liquidity: Cash and cash equivalents were $118.1 million at March 31, 2018, down from $189.3 million at December 31, 2017. Cash flow was affected by working-capital investment, including increases of $20.1 million in accounts receivable and $9.8 million in inventories. Capital expenditures were $14.9 million, plus $0.7 million of capitalized internal-use software.
Debt: Long-term debt was $606.6 million, compared with $618.3 million at year-end 2017. The company had $161.5 million of revolver borrowings, $15.2 million of outstanding letters of credit, and $123.3 million of borrowing availability under its $300 million revolving facility. EnPro was in compliance with all debt covenants.
Balance sheet: Total assets were $1.855 billion and shareholders’ equity was $901.1 million at March 31, 2018. Accounts receivable were $283.2 million, inventories were $215.0 million, and income tax receivables were $133.6 million.
Material Changes Versus the Prior Comparable Period
- Sales increased $73.0 million, primarily reflecting the reconsolidation of GST and OldCo, acquisitions, favorable foreign currency translation, and organic growth.
- Reconsolidated businesses contributed $50.4 million of third-party sales in the quarter, including $48.5 million in Sealing Products, $0.4 million in Engineered Products, and $1.5 million in Power Systems.
- Interest expense declined by $6.7 million, principally because interest previously paid on notes payable to GST was eliminated following reconsolidation.
- Other expense improved by $4.1 million, partly because the first quarter of 2017 included a $3.3 million increase in environmental reserves.
- Net income benefited from higher operating results and lower interest and other expense, but was constrained by a 49.2% effective tax rate and a significant discrete tax charge related to the Tax Cuts and Jobs Act and IRS interpretive guidance.
- Sealing Products margins declined to 10.2% from 11.4%, reflecting higher metals costs, unfavorable product mix, and unusual legal, warranty, and facility-relocation costs in heavy-duty trucking.
- Power Systems profitability declined because of a higher proportion of lower-margin engine revenue, including $3.9 million of additional zero-margin EDF contract revenue compared with the prior year.
- The company repurchased approximately 0.2 million shares for $17.0 million during the quarter and paid $5.3 million of dividends. The quarterly dividend was increased to $0.24 per share.
Guidance, Outlook, Risks, and Unusual Items
- Management described the company as having a strong start to 2018, with year-over-year sales growth in each division and segment and favorable momentum in many markets.
- Management expects Power Systems aftermarket parts and services to improve in the second half of 2018 and expects margins on new engine sales to improve. It is also pursuing actions to mitigate higher commodity costs.
- Management expects a 2018 annual effective tax rate of 33% to 38%, including the significant first-quarter discrete tax item.
- Management expects full-year 2018 pension expense of approximately $2.6 million and does not expect additional U.S. defined-benefit pension contributions after $14.4 million contributed in April.
- Backlog was $390.4 million at March 31, 2018, with approximately 88% expected to be satisfied within one year. Management cautions that backlog is not necessarily predictive of actual sales timing or amounts.
- The company expects a federal tax refund of approximately $127.5 million by year-end 2018 from carrying back losses associated with the $495.8 million asbestos trust funding, subject to possible IRS review or delay. It also expects $30.8 million of foreign tax credits to offset future federal tax liabilities.
- All $118.1 million of cash was held outside the United States at March 31, 2018. EnPro repatriated $83.4 million of previously taxed foreign earnings in March and anticipates further repatriation.
- The EDF contract remains subject to delivery penalties and execution risk. The cumulative program loss provision declined to $9.4 million from $12.6 million at year-end 2017, including a $3.2 million favorable adjustment in the quarter.
- Environmental liabilities totaled $26.1 million. Additional exposure remains uncertain for the Lower Passaic River, Onondaga Lake, Arizona uranium mines, and Mississippi groundwater and vapor-intrusion matters.
- A BorgWarner claim against GGB France has a disclosed reasonably possible loss range of approximately €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses; the company has retained a €0.4 million accrual.
- Available asbestos-related insurance coverage was approximately $43.1 million, but collection timing is uncertain and EnPro is litigating with insurers over $15 million of coverage.
- EnPro adopted new revenue recognition, intra-entity transfer tax, pension presentation, and hedging standards in the first quarter. The revenue standard had an immaterial current-period effect and increased opening retained earnings by $0.4 million.
- Commodity prices, proposed tariffs, foreign exchange, cyclical end markets, contract cost estimates, environmental obligations, and other legacy liabilities could adversely affect results.
Investor Verification Checklist
- Verify the effect of GST and OldCo reconsolidation when assessing year-over-year growth and margins.
- Reconcile the expected $127.5 million federal tax refund, the $133.6 million income tax receivable, and the timing of related cash receipts.
- Monitor Power Systems margins, the EDF contract loss provision, delivery performance, and the mix between engine sales and aftermarket revenue.
- Assess whether higher metals, commodity, and tariff-related costs can be passed through to customers without further margin erosion.
- Review revolver maturity in August 2019, debt covenant headroom, $123.3 million of borrowing availability, and the 2022 maturity of the senior notes.
- Track environmental reserves and unresolved potential losses, particularly the Passaic River, Onondaga Lake, Arizona, and Mississippi matters.
- Confirm collection timing and legal developments related to the $43.1 million of asbestos insurance coverage.
- Evaluate cash conversion, given negative operating cash flow, elevated receivables and inventories, capital expenditures, share repurchases, and dividends.