Enpro Industries, Inc. — FY2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017. The filing is an annual Form 10-K, not a standalone quarterly filing, although it includes fourth-quarter data. EnPro designs and manufactures engineered industrial products through three segments: Sealing Products, Engineered Products, and Power Systems. The company operated 54 primary manufacturing facilities in 12 countries and generated approximately 43% of sales outside the United States.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $1,309.6 million | $1,187.7 million | +10.3% |
| Gross profit | $444.4 million | $394.7 million | +12.6% |
| Gross margin | 33.9% | 33.2% | +0.7 points |
| Operating income (loss) | $101.2 million | $(4.7) million | Improved |
| Net income (loss) | $539.8 million | $(40.1) million | Improved |
| Diluted EPS | $24.76 | $(1.86) | Improved |
| Operating cash flow | $46.6 million | $64.5 million | $(17.9) million |
| Capital expenditures | $41.0 million | $35.8 million | +$5.2 million |
| Cash and equivalents | $189.3 million | $111.5 million | +$77.8 million |
| Total long-term debt, including current portion | $618.5 million | $425.0 million | +$193.5 million |
Reported net income and EPS were substantially affected by a $534.4 million pretax gain from reconsolidating GST and OldCo. The reported net margin was approximately 41.2%, but this is not representative of recurring operating performance. Excluding the reconsolidation gain, operating results remained profitable but substantially lower than reported net income.
Segment Performance
| Segment | 2017 Sales | Sales Change | 2017 Segment Profit | Operating Margin |
|---|---|---|---|---|
| Sealing Products | $804.3 million | +14.0% | $90.9 million | 11.3% |
| Engineered Products | $301.1 million | +8.7% | $29.8 million | 9.9% |
| Power Systems | $208.2 million | $(0.1)% | $29.0 million | 13.9% |
Total segment profit increased 34.6% to $149.7 million from $111.2 million. Sealing Products benefited from GST reconsolidation, acquisitions, foreign exchange and stronger semiconductor, food and pharmaceutical, aerospace, and oil and gas demand. Engineered Products benefited from higher volume and restructuring savings. Power Systems benefited from a $3.9 million reduction in the EDF contract loss provision, partly offset by lower margins on engine contracts and higher projected costs.
Material Changes Versus the Prior Comparable Period
- GST and OldCo were reconsolidated effective July 31, 2017 after consummation of the Joint Plan resolving current and future asbestos claims. Post-reconsolidation 2017 results include $81.3 million of sales and $6.5 million of pretax income from these businesses; prior periods were not restated.
- The reconsolidation produced a $534.4 million pretax gain, including a $248.3 million revaluation gain and $286.1 million from eliminating net amounts payable to GST and OldCo.
- EnPro acquired Qualiseal and Commercial Vehicle Components for $44.6 million, net of cash acquired.
- Debt increased primarily because of a $150.0 million add-on issuance of 5.875% senior notes due 2022. Revolving-credit borrowings were $173.5 million at year-end.
- Operating cash flow declined because of asbestos-related payments, including the Canadian Provincial Boards settlement and funding of the asbestos trust, despite higher segment profit.
- Engineered Products profit rose sharply as restructuring costs declined and volumes improved. Sealing Products margin declined modestly, while Power Systems margin improved due in part to EDF contract reserve changes.
- EnPro recorded a $10.1 million impairment of ATDynamics definite-lived intangible assets and incurred $5.1 million of restructuring costs.
- The Tax Cuts and Jobs Act generated a provisional net tax benefit of $30.9 million, partially offset by a $51.5 million tax charge related to the GST and OldCo fair-value step-up. The 2017 effective tax rate was 6.5%.
Liquidity, Debt and Capital Allocation
- Cash and cash equivalents were $189.3 million, all held outside the United States at year-end. The company also reported a $113.2 million income-tax receivable, primarily related to carrying back the 2017 tax loss generated by trust funding.
- The $300 million revolving credit facility expires in August 2019. Borrowings were $173.5 million, letters of credit were $15.0 million, and availability was $111.5 million. EnPro was in compliance with its covenants, including a maximum net leverage ratio of 4.0 to 1.0 and minimum interest coverage of 2.5 to 1.0.
- The senior notes have $450.0 million of principal outstanding and mature in 2022. Contractual long-term debt principal payments total $624.3 million, including $173.7 million due in 2019 and $450.0 million due in 2022.
- Financing activities generated $118.5 million, including $149.2 million of net proceeds from the senior-note offering and $43.5 million of net revolving-credit borrowings. EnPro paid $19.0 million of dividends and repurchased $11.5 million of common stock.
- The board authorized a new $50 million share-repurchase program in October 2017. No purchases were made under the new program during 2017. The quarterly dividend was increased from $0.22 to $0.24 per share beginning in March 2018.
Outlook, Commentary, Risks and Unusual Items
Management reported strong demand in most served markets in late 2017 and early 2018, including semiconductor, aerospace, automotive, food and pharmaceutical, metals and mining, general industrial, and oil and gas. Industrial gas turbines remained weak, while heavy-duty trucking and nuclear markets improved in the fourth quarter. Management expected modest demand growth in 2018 and continued to pursue organic investment, innovation, acquisitions, dividends and share repurchases.
Management expected a 2018 global effective tax rate of approximately 30% to 35%, subject to discrete tax events and refinement of the provisional Tax Act accounting. The company expected to contribute approximately $20 million to U.S. pension plans before filing its 2017 federal tax return and approximately $0.8 million to foreign plans.
- Asbestos resolution: The Joint Plan permanently resolves covered current and future asbestos claims against GST, Garrison and OldCo and provides injunction protection for EnPro and its subsidiaries. EnPro and related entities paid $78.8 million in December 2017 to settle deferred trust contributions and exercise the option associated with the plan.
- Insurance recovery: EnPro reported approximately $44.4 million of remaining solvent insurance coverage or receivables related to asbestos claims, but collection timing and coverage remain subject to agreements and ongoing litigation with two insurers involving $15 million of coverage.
- Environmental contingencies: Environmental liabilities accrued at year-end totaled $27.3 million. Significant matters include the Lower Passaic River, Onondaga Lake, Arizona uranium mines and Water Valley, Mississippi. The company cannot estimate reasonably possible losses in excess of recorded liabilities for several matters.
- Water Valley litigation: The State of Mississippi filed suit seeking remediation costs, punitive damages and attorneys’ fees. EnPro stated that it cannot estimate a minimum loss or reasonably possible loss range for additional remediation costs or the lawsuit beyond existing reserves.
- BorgWarner claim: GGB France faces a claim with a reasonably possible loss range of approximately EUR0.4 million to EUR6.6 million, plus potentially undetermined proceeding expenses. The company retained a EUR0.4 million accrual and is defending the claim.
- Operating risks: Results are exposed to cyclical industrial markets, raw-material inflation, supply-chain disruptions, foreign exchange, international regulatory and trade risks, product liability, cybersecurity, intellectual-property and license renewals, government contracting, and dependence on U.S. Navy demand in Power Systems.
- Contract risk: The EDF engine-generator contract remains exposed to foreign-exchange movements, production costs, delivery penalties and execution risk. The 2017 loss provision decreased by $3.9 million, but projected total contract costs increased by $5.2 million.
Important Facts for Investors to Verify
- Normalize 2017 earnings for the $534.4 million reconsolidation gain, the related $51.5 million tax charge, Tax Act effects and asbestos-related trust and settlement activity.
- Review pro forma information for GST and OldCo, which presented 2017 sales of $1,402.5 million and pro forma net income of $53.7 million as if reconsolidation occurred January 1, 2016; the filing states this information is not indicative of actual or future results.
- Assess debt repayment and refinancing capacity, particularly the $173.7 million contractual maturity in 2019 and $450.0 million senior-note maturity in 2022.
- Confirm expected timing and collectability of the $102.5 million anticipated tax refund and approximately $44.4 million of asbestos insurance recoveries.
- Monitor environmental, Water Valley, BorgWarner and asbestos insurance litigation because several potential losses are not estimable or may exceed recorded reserves.
- Evaluate whether reported demand growth offsets weakness in industrial gas turbines, heavy-duty trucking and nuclear markets, as well as raw-material and contract-cost pressures.
- Consider the effect of the 2018 revenue-recognition standard on long-term engine contracts, performance obligations, service-contract timing and reported margins.