Enpro Industries, Inc. — Q2 2013 Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. The interim financial statements are unaudited. EnPro designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products, and Engine Products and Services.
Financial Performance and Position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|
| Net sales | $305.8 million | $301.7 million | $592.7 million | $613.2 million |
| Gross profit | $109.2 million | $103.0 million | $203.4 million | $210.2 million |
| Operating income | $30.8 million | $26.4 million | $51.5 million | $58.6 million |
| Net income | $8.0 million | $10.2 million | $16.6 million | $24.0 million |
| Diluted EPS | $0.35 | $0.47 | $0.74 | $1.11 |
| Operating margin | 10.1% | 8.7% | 8.7% | 9.6% |
- Q2 sales increased 1%, while six-month sales declined 3% year over year.
- Q2 gross margin improved to approximately 35.7% from 34.1%; six-month gross margin declined to approximately 34.3% from 34.3% in 2012, essentially flat.
- Q2 net income declined 22%, primarily reflecting higher other expense, including a $6.3 million environmental reserve adjustment, and higher taxes.
- Six-month net income declined 31%, primarily due to lower sales and segment profit, higher other expense, and the absence of the prior-year comparison benefit from the 2012 acquisition timing.
- Cash flow from operations was $5.5 million in both six-month periods. Capital expenditures and capitalized software totaled $20.3 million in the first half of 2013.
- Cash and cash equivalents were $58.2 million at June 30, 2013, all held outside the United States according to management. Total assets were $1.401 billion and shareholders’ equity was $536.6 million.
- Borrowing availability under the $175 million senior secured revolving credit facility was $83.9 million, after $47.6 million of revolver borrowings and $4.8 million of letters of credit.
- Current maturities of long-term debt increased to $152.7 million from $1.0 million at year-end because the convertible debentures became currently convertible. The debentures had $172.5 million of principal outstanding and mature October 15, 2015 unless converted earlier.
Segment Results
| Segment | Q2 2013 sales | Q2 2012 sales | Q2 2013 profit | Q2 2012 profit |
|---|
| Sealing Products | $165.9 million | $165.1 million | $27.7 million | $22.8 million |
| Engineered Products | $95.1 million | $95.1 million | $8.6 million | $6.8 million |
| Engine Products and Services | $45.0 million | $42.1 million | $6.4 million | $7.8 million |
- Sealing Products profit increased 21%, supported by cost savings, higher Stemco volumes, pricing, product mix, and lower restructuring and acquisition costs. Margin improved to 16.7% from 13.8%.
- Engineered Products profit increased to $8.6 million, with pricing and manufacturing efficiencies offsetting lower volume. Margin improved to 9.0% from 7.2%.
- Engine Products and Services sales rose 7%, but profit declined because of a $1.9 million early-retirement restructuring charge. Margin fell to 14.2% from 18.5%.
- For the first six months, total segment profit declined 8% to $74.6 million. Segment margin decreased to 12.6% from 13.2%, with the largest deterioration in Engine Products and Services.
Material Changes and Unusual Items
- The company accrued $6.25 million in Q2 for environmental remediation related to the former Trent Tube facility in Wisconsin. Total environmental liabilities increased to $16.0 million from $11.3 million at December 31, 2012. Estimated remediation costs for that site are $7 million to $10 million, less approximately $0.75 million held in a remediation trust.
- Foreign currency hedge accounting was discontinued in the first quarter of 2013; previously deferred amounts were reclassified to income. Foreign exchange contracts had a $71.8 million notional amount at June 30, 2013.
- The company’s $236.9 million investment in GST remains accounted for under the cost method following GST’s 2010 deconsolidation.
- GST recorded $22.8 million of Chapter 11 case-related fees in the first half of 2013, compared with $15.4 million in the prior-year period.
Outlook, Risks, and Contingencies
- Management stated that many markets had stabilized but expected limited growth in the second half of 2013. It expected little or no improvement in European Sealing Products and Engineered Products markets and only modest North American improvement.
- Management expected second-half Engine Products and Services revenue to decline by more than 10% from the second half of 2012, driven by lower aftermarket product and service demand.
- Management projected a 2013 effective tax rate of approximately 30% to 33%, subject to geographic earnings mix and discrete tax events.
- Management expected approximately $24 million of 2013 contributions to U.S. defined benefit pension plans; $12.3 million had been contributed through June 30. Additional contributions are expected in 2014 and beyond.
- GST’s Chapter 11 estimation trial began July 22, 2013 and was continuing at the filing date. GST’s proposed plan contemplated approximately $270 million of payments for present and future claims and a $30 million EnPro contribution, but claimant representatives opposed the plan and asserted that GST’s liability exceeds its value.
- GST’s recorded asbestos liability was $466.8 million at June 30, 2013. Available remaining insurance coverage was reported at $123.1 million, although collection timing and ultimate recovery are uncertain.
- The potential impact of the GST bankruptcy, including possible derivative claims against EnPro or Coltec, remains uncertain. The filing states that GST’s ultimate costs could range up to the total value of GST, although management considers that an unlikely worst-case scenario.
- Other risks include cyclical end markets, raw-material prices and availability, environmental matters, pension funding, foreign currency exposure, litigation, and the liquidity required if convertible debentures are converted or repurchased.
Most Important Facts for Investors to Verify
- Whether GST’s Chapter 11 estimation process results in a confirmed plan, the amount ultimately funded by EnPro, and whether derivative claims against EnPro are pursued.
- The timing and cost of refinancing or satisfying the currently convertible $172.5 million principal amount of debentures.
- Actual cash generation relative to pension contributions, capital expenditures, debt maturities, and potential acquisition spending.
- Changes in the environmental reserve and the ultimate remediation cost for the Trent Tube site and other environmental locations.
- Whether the expected second-half decline in Engine Products and Services and limited market growth affect full-year earnings and margins.
- The collectability and timing of GST tax receivables, insurance recoveries, and other related-party balances.
