Business Context and Reporting Period
EnPro Industries, Inc. designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products, and Power Systems. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017. GST and OldCo remained deconsolidated during the reporting period because of their Chapter 11 proceedings.
Key Financial Metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $307.6 million | $313.2 million | $603.4 million | $608.1 million |
| Gross profit | $104.5 million | $107.9 million | $206.1 million | $205.5 million |
| Gross margin | 34.0% | 34.4% | 34.2% | 33.8% |
| Operating income (loss) | $27.3 million | $29.1 million | $54.7 million | $(43.3) million |
| Net income (loss) | $9.0 million | $3.6 million | $15.4 million | $(43.2) million |
| Diluted EPS | $0.41 | $0.17 | $0.71 | $(1.99) |
| Operating cash flow | Not separately provided | Not separately provided | $28.0 million | $(3.0) million |
Six-month segment sales were $370.6 million for Sealing Products, $150.8 million for Engineered Products, and $84.0 million for Power Systems. Six-month segment profit was $41.5 million, $17.7 million, and $12.4 million, respectively.
At June 30, 2017, cash and cash equivalents were $132.1 million, all held outside the United States. Total assets were $1.60 billion and shareholders’ equity was $373.4 million. Long-term debt and current maturities totaled approximately $492.6 million, while notes payable to GST totaled $309.3 million and short-term borrowings from GST were $33.2 million. The company had $237.9 million of available borrowing capacity under its $300 million revolving credit facility and was in compliance with its covenants.
Investing cash outflows were $61.3 million, including $39.7 million for the Qualiseal acquisition, $15.2 million for property, plant and equipment, and $1.9 million for capitalized software. Financing activities provided $49.3 million, including debt proceeds, partially offset by debt repayments, $9.8 million of share repurchases, and $9.6 million of dividends.
Material Changes Versus Prior Comparable Period
- Second-quarter sales declined 1.8%, while six-month sales declined 0.8%.
- Net income improved materially because the prior-year six-month period included an $80.0 million asbestos settlement expense. The 2016 period also benefited from a $31.2 million income tax benefit.
- Interest expense increased to $16.1 million in the second quarter and $31.0 million for the six months, primarily because of higher average indebtedness.
- Sealing Products sales increased 3.3% in the quarter and 3.7% for the six months, but quarterly segment profit declined 13.8% because of unfavorable mix and higher manufacturing costs. Six-month segment profit increased 5.6%.
- Engineered Products sales increased 2.2% in the quarter and 2.0% for the six months. Segment profit increased 51.9% in the quarter and 136.0% for the six months, supported by cost reductions and higher volume.
- Power Systems sales declined 23.9% in the quarter and 19.8% for the six months because of lower aftermarket parts and engine revenue. Segment profit nevertheless increased for the six-month period, aided by cost savings, pricing, lower warranty costs, and a favorable EDF contract adjustment.
- EnPro acquired Qualiseal Technology in June 2017 for $39.7 million. Qualiseal had approximately $11 million of annual revenue and operates within Sealing Products.
- Gross margin was broadly stable year to year; quarterly operating margin declined to approximately 8.9% from 9.3%, while the six-month operating margin improved to approximately 9.1% from a loss-affected 2016 period.
Guidance, Outlook, Risks, and Unusual Items
Management reported strength in semiconductor, food and pharmaceutical, metals and mining, and general industrial markets, partly offset by weakness in nuclear, industrial gas turbines, and heavy-duty trucking. Management expects improved Power Systems activity in the second half of 2017 and remains focused on cost control, organic investment, bolt-on acquisitions, dividends, and share repurchases.
Management expects a 2017 annual effective tax rate of 28% to 33%, excluding the gain expected from reconsolidating GST and OldCo. Pension expense excluding reconsolidation effects was expected to be approximately $5 million for 2017, with total U.S. defined benefit pension contributions expected to be approximately $3.6 million.
The Joint Plan resolving asbestos claims was confirmed on June 12, 2017 and consummated on July 31, 2017, after the reporting date. GST and OldCo contributed or are obligated to contribute an aggregate $480 million to an asbestos trust, with additional deferred contributions guaranteed by EnPro. The plan enjoins future asbestos claims against EnPro and its subsidiaries covered by the plan. GST and OldCo were reconsolidated effective July 31, 2017, and future financial statements will include their results from that date without restating prior periods.
As of June 30, 2017, GST and OldCo had recorded asbestos liabilities of $387 million and $110 million, respectively. Approximately $49.0 million of insurance coverage or receivables was considered available for asbestos-related payments, although collection timing and competing claims remain risks. The company also recorded a $60.8 million asbestos liability related to its keep-well obligation for OldCo.
Other significant exposures include environmental liabilities of $24.0 million, the Lower Passaic River and Onondaga Lake Superfund matters, the Mississippi groundwater and vapor-intrusion litigation, and a BorgWarner claim against GGB France with an estimated reasonably possible loss range of approximately €0.4 million to €6.6 million. The filing states that some environmental loss ranges cannot be reasonably estimated and that actual costs could exceed recorded reserves.
The company is subject to federal, state, foreign, and local tax examinations. Management does not currently expect resulting assessments to have a material effect, but final outcomes are not determinable.
Most Important Facts for Investors to Verify
- Post-quarter reconsolidation accounting for GST and OldCo, including the fair-value step-up, asbestos trust funding, deferred contributions, and any reported gain.
- The effect of reconsolidated GST and OldCo operations on revenue, margins, cash flow, debt, liquidity, and covenant calculations.
- Actual cash requirements and insurance recoveries associated with the asbestos trust, including the $60 million of deferred contributions guaranteed by EnPro and the $20 million Canadian settlement.
- Whether Power Systems’ expected second-half recovery occurs and whether the EDF contract achieves projected efficiency gains without additional loss provisions.
- Sustainability of Engineered Products’ margin improvement and Sealing Products’ volume growth in the face of unfavorable mix and manufacturing-cost pressures.
- Liquidity implications of the $309.3 million GST-related notes payable classified as current at June 30, 2017, the January 1, 2018 maturity extension, and cash held outside the United States.
- Potential increases in environmental, Mississippi groundwater, Superfund, product liability, and BorgWarner-related costs beyond recorded reserves.