EnPro Industries, Inc. — Q1 2013 Form 10-Q Summary
Business context and reporting period
EnPro designs, manufactures and markets engineered industrial products through three segments: Sealing Products, Engineered Products, and Engine Products and Services. The filing covers the unaudited quarter ended March 31, 2013, compared with the quarter ended March 31, 2012. EnPro operated 61 primary manufacturing facilities in 12 countries. Certain subsidiaries associated with Garlock Sealing Technologies, LLC (GST) remain deconsolidated following their June 2010 Chapter 11 filings.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $286.9 million | $311.5 million | Down 8% |
| Gross profit | $94.2 million | $107.2 million | Down 12% |
| Gross margin | 32.8% | 34.4% | Down 160 bps |
| Operating income | $20.7 million | $32.2 million | Down 36% |
| Operating margin | 7.2% | 10.3% | Down 310 bps |
| Income before taxes | $9.7 million | $21.6 million | Down 55% |
| Net income | $8.6 million | $13.8 million | Down 38% |
| Diluted EPS | $0.39 | $0.64 | Down 39% |
The first-quarter effective tax rate was 11.4%, versus 36.2% in the prior-year quarter, primarily because the American Taxpayer Relief Act of 2012 retroactively extended tax provisions. The lower tax rate partially offset weaker operating results. Comprehensive income was $1.0 million, compared with $21.3 million in Q1 2012.
- Sealing Products: Sales were $146.6 million, down 2%; segment profit was $21.3 million, down 5%, and margin declined to 14.5% from 15.1%. Motorwheel acquisition revenue partly offset lower volumes in semiconductor, heavy-duty truck, and European water and wastewater markets.
- Engineered Products: Sales were $91.8 million, down 9%; segment profit was $5.8 million versus $9.0 million, with margin declining to 6.3% from 8.9%. Weakness was concentrated in European and North American automotive markets and Canadian natural gas.
- Engine Products and Services: Sales were $49.4 million, down 20%; segment profit was $4.8 million versus $11.8 million, with margin declining to 9.7% from 19.0%. The comparison was affected by four completed-contract engine sales totaling $18.4 million in Q1 2012 and none in Q1 2013.
Cash flow, debt and liquidity
- Operating activities used $17.8 million, compared with $3.4 million of cash provided in Q1 2012. Management cited lower segment results, $7.2 million of pension contributions, and $5.4 million of taxes paid.
- Investing activities used $15.4 million, including $9.8 million for property, plant and equipment, $3.5 million for internal-use software, and $2.2 million for acquisitions.
- Financing activities provided $30.2 million, including $63.3 million of debt proceeds and $42.5 million of debt repayments.
- Cash declined to $48.5 million from $53.9 million at December 31, 2012. Approximately $47 million was held outside the United States and $1 million in the United States.
- The senior secured revolving credit facility had $56.0 million of borrowings, $3.8 million of letters of credit, and $66.3 million of remaining borrowing availability at March 31, 2013. Maximum facility availability was $175 million.
- Convertible debentures had $172.5 million of principal outstanding, mature October 15, 2015, and became convertible beginning April 1, 2013 through June 30, 2013 because the stock-price conversion condition was met. Their carrying amount, net of discount, was classified as current maturities.
- Notes payable to GST totaled $259.3 million, including $248.1 million long term. These notes bear 11% interest, with 4.5% capitalized as payment-in-kind interest.
- EnPro contributed $7.2 million to U.S. defined benefit pension plans during the quarter and expected approximately $12 million of additional contributions during the remainder of 2013.
Material changes versus the prior comparable period
- Revenue declined 8%, primarily from lower volumes in Sealing Products and Engineered Products and lower engine revenue in Engine Products and Services.
- Segment profit declined 26% overall, from $43.3 million to $31.9 million. Corporate expenses were unchanged at $9.1 million, while net interest expense increased by $0.4 million.
- Operating cash flow deteriorated from positive $3.4 million to negative $17.8 million, while capital spending and software investments increased.
- Goodwill declined from $220.4 million to $217.1 million, principally due to foreign-currency translation. Other intangible assets declined from $222.5 million to $216.4 million.
- Accumulated other comprehensive loss increased from $23.0 million to $30.6 million, primarily from foreign-currency translation losses.
- EnPro discontinued cash-flow hedge accounting for certain foreign-currency derivatives in Q1 2013 and reclassified previously deferred amounts into income. The filing identifies a $0.8 million adverse impact on Engine Products and Services segment profit.
Guidance, outlook, risks and unusual items
- Management expected seasonal growth in some markets during Q2 2013, with higher sales, profits and margins supported by increased volumes, cost reductions and efficiency programs.
- Management remained cautious longer term, expecting low growth in North America and little or no growth in Europe. The projected effective tax rate for the remainder of 2013 was 29% to 32%.
- Management expected approximately $19 million of U.S. pension contributions for full-year 2013, including the $7.2 million already contributed, and estimated full-year pension expense of $11.1 million.
- GST’s Chapter 11 asbestos process remained unresolved. GST had recorded $466.8 million of asbestos liabilities, while claimant representatives asserted that GST’s liability could exceed its value. A mesothelioma claims estimation trial was scheduled for July 2013.
- GST reported $468.4 million of liabilities subject to compromise and $141.1 million of remaining insurance coverage believed available for asbestos claims and related expenses. Collection timing and ultimate recovery were uncertain.
- GST’s proposed plan contemplated approximately $270 million of payments for present and future claims and a potential $30 million EnPro contribution, but the plan was opposed by claimant representatives and was unlikely to be approved in its existing form.
- EnPro carried a $236.9 million investment in GST and a $34.1 million GST-related income-tax receivable. The filing stated that a bankruptcy plan or other developments could materially change the investment’s carrying value.
- Environmental liabilities were accrued at $10.1 million for remediation at 14 sites. The filing did not provide a reasonably possible loss range in excess of the recorded amount.
- Key operating risks included cyclical markets, raw-material prices and availability, foreign-currency and interest-rate exposure, pension funding, acquisition execution, debt refinancing or conversion requirements, and discontinued-business liabilities.
Most important facts to verify
- Whether the Q2 seasonal improvement and margin recovery described by management occurred.
- The status and outcome of the July 2013 GST asbestos claims estimation trial and any competing reorganization plan.
- Potential cash funding, refinancing or dilution implications if the convertible debentures were converted.
- Actual cash generation after working-capital needs, capital spending, pension contributions and debt repayments.
- Whether GST’s $466.8 million asbestos liability, $141.1 million insurance coverage and $236.9 million investment carrying value remained recoverable.
- Progress in recovering segment margins, particularly in Engine Products and Services and Engineered Products.
- Changes in foreign-currency derivative accounting and their recurring earnings impact.