Enpro Industries, Inc. — Fiscal 2018 Form 10-K Summary
Reporting period: Year ended December 31, 2018, with fourth-quarter results disclosed. EnPro designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products, and Power Systems. The company operated 50 primary manufacturing facilities in 12 countries and had approximately 5,900 employees.
Financial performance and key metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $1,532.0 million | $1,309.6 million | 17.0% increase |
| Gross profit | $479.0 million | $444.3 million | 7.8% increase |
| Operating income | $117.3 million | $101.7 million | 15.3% increase |
| Income before taxes | $46.6 million | $577.5 million | Lower due primarily to the 2017 reconsolidation gain |
| Net income | $24.6 million | $539.8 million | Significant decrease |
| Diluted EPS | $1.16 | $24.76 | Significant decrease |
| Operating cash flow | $226.4 million | $46.6 million | Strong increase |
| Capital expenditures | $62.6 million | $41.0 million | Increase |
| Total debt, including current portion | $464.9 million | $618.5 million | Decrease |
| Cash and cash equivalents | $129.6 million | $189.3 million | Decrease |
Gross margin was approximately 31.3% in 2018 versus 33.9% in 2017. Net margin was approximately 1.6% versus 41.2%, reflecting the unusual 2017 gain on reconsolidation of GST and OldCo. The 2018 effective tax rate was 47.3%, compared with 6.5% in 2017; 2018 tax expense reflected GILTI and final refinements related to the Tax Cuts and Jobs Act.
Segment results
| Segment | 2018 sales | 2018 segment profit | 2018 margin | Comparison with 2017 |
|---|---|---|---|---|
| Sealing Products | $954.4 million | $85.2 million | 8.9% | Sales increased 18.7%; profit decreased 5.8% |
| Engineered Products | $323.9 million | $40.1 million | 12.4% | Sales increased 7.6%; profit increased 33.2% |
| Power Systems | $257.9 million | $29.3 million | 11.4% | Sales increased 23.9%; profit was broadly flat |
Sealing Products was pressured by lower aftermarket mix in heavy-duty trucking, higher metals and freight costs, increased brake-drum manufacturing costs, and $7.6 million of higher warranty charges. Engineered Products benefited from higher volumes and favorable foreign exchange. Power Systems benefited from record aftermarket parts and services sales, but results were affected by unfavorable foreign exchange on the EDF contract.
Cash flow, liquidity and capital structure
- Operating cash flow of $226.4 million was supported by lower asbestos-related payments and tax refunds, including $95.8 million received in June 2018 and $1.1 million in July 2018.
- Investing cash outflow was $26.0 million. Capital expenditures were $62.6 million, partially offset by $30.7 million of proceeds from asset sales and $9.3 million from derivative settlements.
- Financing cash outflow was $252.4 million, including $50.0 million of share repurchases, $20.3 million of dividends, and net debt-related repayments.
- In October 2018, EnPro issued $350.0 million of 5.75% senior notes due 2026 and used the proceeds, together with revolver borrowings, to redeem $450.0 million of 5.875% notes due 2022. The transaction produced an $18.1 million loss on debt extinguishment.
- At December 31, 2018, the $350.0 million revolving credit facility had $116.7 million drawn, $15.9 million of letters of credit, and $217.4 million of available borrowing capacity. EnPro was in compliance with all credit-facility covenants.
- Cash balances were $2.3 million in the United States and $127.3 million outside the United States. The company also reported a $41.3 million net current income-tax receivable.
Material changes and unusual items
- 2018 results were not directly comparable with 2017 because GST and OldCo were included in consolidated results beginning July 31, 2017. The 2017 results included a $534.4 million pretax gain from their reconsolidation.
- EnPro recorded $22.4 million of restructuring costs in 2018, including $15.4 million in the fourth quarter, primarily for discontinuing Stemco brake-drum friction manufacturing.
- EnPro exited its industrial gas turbine business in Oxford, Massachusetts. The sale of the related land and building generated a $21.7 million gain, while total net restructuring costs for the exit were $3.5 million.
- A $12.8 million pretax pension settlement charge was recorded after transferring approximately $68 million of U.S. pension obligations through a group annuity contract.
- Warranty expense increased substantially, and the product warranty liability rose to $11.7 million at year-end from $5.3 million.
- The cumulative projected loss on the EDF engine-generator contract increased to $16.8 million at December 31, 2018, including $4.2 million of additional provision recognized in 2018.
- EnPro repurchased approximately 0.7 million shares for $50.0 million during 2018. The board authorized an additional two-year, $50.0 million repurchase program in October 2018, but no purchases occurred in the fourth quarter.
Outlook, risks and contingencies
Management expected modest growth in 2019, citing anticipated weakness in semiconductor, automotive and heavy-duty truck original-equipment demand, uncertainty related to tariffs and trade tensions, and planned improvements in Stemco’s Brake Products Group. Management also cited favorable demand in aerospace, food and pharmaceuticals, heavy-duty tractors and trailers, metals and mining, refining and processing, oil and gas, and naval engines and aftermarket services.
- Backlog was $380.9 million at December 31, 2018, compared with $377.0 million a year earlier; approximately 24% was expected to be filled after 2019. Management cautioned that backlog is not necessarily predictive of future sales.
- Environmental liabilities totaled $31.1 million at year-end. Significant contingencies include the Lower Passaic River Superfund matter, the Onondaga Lake site, Arizona uranium mines, and Water Valley, Mississippi groundwater contamination. Several potential losses cannot currently be estimated and may exceed recorded reserves.
- The company increased its Onondaga reserve by $5.0 million to $6.5 million and reported a $4.5 million remaining reserve for Water Valley. Additional remediation, monitoring, litigation and regulatory costs remain possible.
- A BorgWarner claim against GGB France had a reasonably possible loss range of approximately €0.4 million to €6.6 million, plus potentially undetermined proceeding expenses; €0.4 million was accrued.
- Major business risks include cyclical end markets, competition and pricing pressure, raw-material inflation, supply-chain disruption, foreign-exchange exposure, government-contracting risk, product liability and warranty claims, cybersecurity, intellectual-property licensing, acquisitions, and environmental liabilities.
- In December 2018, EnPro settled litigation with two insurers and received approximately $13.1 million related to asbestos insurance coverage. Separately, approximately $12.6 million of additional solvent-insurer coverage was expected to be collected in 2019 and 2020, subject to policy and collection risks.
Most important facts for investors to verify
- Separate recurring operating performance from the nonrecurring 2017 $534.4 million reconsolidation gain and other unusual items.
- Assess whether Sealing Products can recover margins after heavy-duty trucking cost inflation, warranty charges, unfavorable mix and restructuring.
- Monitor the EDF contract loss provision, foreign-exchange exposure and Power Systems contract execution.
- Review debt covenants, $116.7 million of revolver borrowings, the 2026 notes, liquidity, and the timing of contractual obligations.
- Evaluate the adequacy of environmental, warranty and other legacy-liability reserves, particularly where the filing states that the ultimate loss cannot be estimated.
- Confirm the sustainability of operating cash flow after tax refunds, asbestos-related timing effects and working-capital requirements.
- Consider the impact of the expected 2019 market weakness and the company’s modest-growth outlook.