Enpro Inc (NPO) 2013 Q1 法說會逐字稿

Good morning. My name is Geralene, and I will be your conference operator today.

At this time, I would like to welcome everyone to the EnPro Industries first quarter 2013 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you. Mr. Don Washington, Director of Investor Relations, you may begin your conference, sir.

Well, thank you, Geralene, and good morning, everyone. Welcome to our quarterly earnings conference call. I'll remind you that our call is being webcast at enproindustries.com, where you can also find the slides accompanying the call.

In a moment, Steve Macadam, our president and CEO, and Alex Pease, our senior vice president and CFO, will review the results for the first quarter of 2013. But before we begin, I want to point out to you that you may hear statements during the course of the call that express a belief, expectation or intention, as well as those that are not historical facts. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements.

These risks and uncertainties are referenced in the safe harbor statement included in our press release and are described in more detail along with risks and uncertainties in our filings with the SEC, including the Form 10-K for the year ended December 31, 2012. We do not undertake to update any forward-looking statements made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based.

You should also note that EnPro owns a number of direct and indirect subsidiaries. From time to time, we may refer collectively to EnPro and one or more of the subsidiaries as we or to the business's assets, debts or affairs of EnPro or a subsidiary as ours. These and similar references are for convenience only and should not be construed to change the fact that EnPro and each subsidiary is an independent entity with separate management operations, obligation and affairs.

I want to remind you that our financial results reflect the deconsolidation of Garlock Sealing Technologies, LLC, Garrison Litigation Management and their subsidiaries, effective June 5, 2010. The results of these entities will remain deconsolidated during the pendency of the Chapter 11 legal proceedings to resolve asbestos claims against GST. We refer to this as the asbestos claims resolution process, or ACRP, and you'll hear us use that acronym during the call today. GST's results are presented separately in our earnings release.

And with that, I'll turn the call over to Steve.

Thanks, Don. Good morning, everyone. Thanks for joining today.

Alex will provide more detail on the first quarter shortly when he discusses our financial performance, but as you can tell from our earnings release, we continue to deal with soft market conditions, especially in comparison to the levels of demand that we saw in the first quarter of 2012.

Seasonal improvements provided a modest uptick in activity levels from the fourth quarter of 2012, but compared to the first quarter of last year, our earnings reflect decreased volumes, a less profitable mix as aftermarket demand softened, some accounting adjustments at Fairbanks Morse Engine, and costs at GGB in France associated with implementing and ERP system and qualifying a new raw material formulation.

The events at FME and GGB combined to create a net reduction in our first quarter pre-tax earnings of about $3 million. Of course, future volumes will depend a lot on market demand, but we do believe that the mix and cost issues are largely temporary and they don't indicate a shift in our long-term expectations for performance of GGB or FME.

Overall sales were down 8% from the first quarter of last year, excluding the Motorwheel acquisition, which was not in last year's first quarter. Sales were down 12%, or $37 million. About half of this organic decrease came in our sealing products and engineered products segments, where demand was much lower than the first quarter of last year.

The other half came at Fairbanks Morse Engine, which last year shipped four engines and recognized about $18 million in completed contract revenue on those engines. This year, no engines were shipped in the first quarter, and all engine revenues were accounted for under% of completion accounting. We currently plan to ship 22 new engines in 2013, or eight more than last year, and account for all the engine revenues this year under percentage of completion.

In our sealing products segment, sales were down 10% from the first quarter of last year, excluding the contribution of the Motorwheel acquisition. Sales of the engineering products segment were down about 9%. Conditions were softer in almost all markets served by these segments.

Profits and margin in all three segments reflected the effect of lower volumes, as well as reduced demand for some of our higher margin aftermarket products. In the engineered products segment, however, a portion of the decline was offset by the benefit of cost reductions that CPI implemented last year. In the deconsolidated operations of GST, demand in the US markets were stable compared to last year, but sales were down 2% as a result of lower demand in a couple of foreign markets. GST's profit margins improved over the first quarter of last year to 22.5% of sales.

Despite the fact that GST spent about $30 million last year to cover the expense of the ACRP and is on track to continue spending at a high rate, as the estimation trial date approaches, it remains a healthy and well-run business. I'll go into a little more detail about our outlook after Alex reviews the numbers, but currently we don't see any indication of a substantial change in the direction of our markets.

In this environment of soft demand and -- in this environment of soft demand, the continued success of our enterprise excellence program will be especially important to our operations. These programs enable us to continue to manage our costs effectively and to take advantage of our strong brands and strong market shares as opportunities arise in this challenging market environment.

As I'm sure you know, we're approaching the date scheduled for the start of GST's ACRP estimation trial. Discovery and trial preparations are rapidly moving forward and include the preparation and delivery of reports and rebuttal of reports from more than 30 experts, including 14 science and medical experts and six economic and legal experts working on behalf of GST.

Experts will be deposed in May and June in preparation for the scheduled trial date of July 22nd. We remain confident in the case and continue to believe GST will provide compelling evidence that its proposed plan of reorganization is feasible and fair. GST will demonstrate both that its products could not have been a cause of asbestos-related disease and that its settlement payments increased in the 2000s, not as a result or reflection of actual liability, as the claimant representatives allege, but because of temporary developments in the torts system, they substantially increased GST's cost of defense.

Late last quarter, GST won an appeal in the federal court in Delaware and will gain access to statements filed by plaintiff's lawyers in previous asbestos bankruptcy cases of prominent company defendants for filed Chapter 11 during the bankruptcy wave of the early 2000s. In those statements, the plaintiff lawyers disclosed the identities of claimants who claim injury from exposure to bankrupt defendants' asbestos-containing products.

We believe that those filings, together with the ballots cast in the bankruptcy cases, and claims made against the asbestos trust based on exposures to the product of these bankrupt former defendants, will demonstrate conclusively that certain leading asbestos firms were engaged in a widespread practice of concealing their claims' exposures to other products in order to drive up GST's litigation costs and inflate settlement demands made against GST.

As we have said in the past, we remain hopeful that GST and the claimant representatives can reach a settlement in 2013 that will provide finality and certainty to GST's asbestos-related payments and will allow us to reconsolidate GST's financial results. However, we have no assurance that the ultimate resolution of the case will come through settlement, nor can we anticipate when the case might be resolved or the ultimate value of GST that might be preserved.

Obviously, settlement discussions are a sensitive topic, especially in light of the approaching trial date. And as a result, we can't make any additional comments on them.

Now I'll turn the call over to Alex.

Thanks, Steve. As Steve noted, our reported sales declined about 8% from the first quarter of 2012 as we saw weaker demand across our markets and recognized lower engine revenues. If we adjust for the Motorwheel acquisition, sales were down 12%, with all of our businesses working in software market conditions.

Nearly half of the $37 million in organic decline year over year came from lower engine revenues at Fairbanks Morse Engine, driven by the transition to percentage of completion accounting, which we've discussed with you previously.

The remainder of the comparison is against the period when demand was much higher in our other businesses. By geography, excluding Fairbanks Morse, demand was down about 10% year over year in both Europe and North America, which together make up about 80% of our sales. Looking at measures of profitability, gross margins were 32.8% in the first quarter of 2013, compared to 34.4% in the first quarter a year ago.

The drop in gross margins reflects a combination of low volumes and a less profitable product mix, as demand remains soft in many of our aftermarket businesses. It also reflects accounting adjustments at FME, which I'll explain later.

Pricing discipline continued to offset a portion of the effect of weaker markets. SG&A expense of $72.6 million was slightly lower in the first quarter of 2013 than in the first quarter of 2012, although as the top line fell, SG&A increased as a percentage of sales. Corporate costs made up about $9.1 million of SG&A expense and were the same as in the first quarter of last year.

Now let's take a detailed look at our operating performance in the first quarter, beginning with the sealing products segment. Including Motorwheel, sales in the segment were $146.6 million, down about 2%, or $2.9 million, from the strong -- from the strong start that we saw in the first quarter of 2012. Excluding the $12.1 million that Motorwheel contributed, sales in the segment were down 10%, primarily because of less activity in our semiconductor and construction markets.

Sealing products segment profits were down 5%, or $1.2 million. The profits in the segment benefited from Motorwheel, which contributed $2 million, and the reversal of a $1.5 million earn-out accrual associated with an acquisition we made in 2009. Before the contribution of Motorwheel and a small restructuring charge, segment profits were down 15%, as volumes declined, particularly in some of our higher-margin aftermarket products.

Segment margins were 14.5%, a little more than half a point below the first quarter of 2012, when they were 15.1%. Both quarters included restructuring charges, which totaled about $100,000 this year and about $400,000 in the first quarter of 2012.

Turning to the businesses within the segment, sales at the consolidated Garlock operations declined on lower industrial demand in North America and Europe, delays in US construction markets due to harsh winter weather, and continued weak demand for products sold into European infrastructure projects. Profits and margins were also lower as modest price increases and cost reductions were not sufficient to offset the effect of lower volumes.

In the Technetics Group, sales a year ago benefited from very strong demand in the semiconductor market, which softened considerably after the first half of last year. Technetics sales to the market in the first quarter of 2013 were down sharply when compared to the high level a year ago.

In its nuclear markets, Technetics saw steady demand for products manufactured in its French operations, but little demand in the US, as consumers there worked from inventories built in previous quarters. Profits declined slightly at Technetics, driven predominantly by weak semiconductor volumes. Margins improved over the first quarter of 2012, primarily due to the reversal of the $1.5 million earn-out accrual I mentioned earlier.

At Stemco, excluding the contribution from Motorwheel, sales declined as it continued to deal with the sluggish aftermarket demand for its core wheel end products and low levels of demand for brake products. Based on current market indications, aftermarket demand at Stemco is likely to remain light for the foreseeable future.

A $2 million contribution from Motorwheel helped Stemco post improved profits compared to the first quarter of last year, but with weak demand for more profitable aftermarket products, Stemco's margins declined from those recorded in the first quarter of 2012. Because we acquired Motorwheel in mid-April of 2012, it will not have a meaningful effect on year-over-year comparisons of our first quarter 2013 results.

In the engineered products segment, sales were $91.8 million, 9% below the first quarter of 2012, as both GGB and CPI continued to deal with weak markets in Europe and North America. As was the case in the sealing products segment, the comparison is against significantly stronger markets in the first quarter of 2012, especially in Europe.

Although CPI's margin performance has improved according to plan, it was not enough to offset the effect of low volumes and higher costs at GGB, and profits in the segment fell by $3.2 million to $5.8 million. Segment margins were 6.3% of sales, compared to 8.9% a year ago, when high-margin industrial volumes at GGB were much stronger.

Margins in the segment also reflect about $800,000 in restructuring expense at CPI, as we move towards completion of our restructuring there. Last year, we spent about $900,000 on restructuring in the first quarter. Although GGB's market strengthened somewhat after a weak finish in the fourth quarter of 2012, GGB's first quarter 2013 sales were down sharply compared to the first quarter of last year. European automotive demand was well below the level of a year ago, while industrial demand lagged in both Europe and North America.

Despite the unfavorable year-over-year comparison in the first quarter, we expect modest growth in GGB's North American markets during 2013. The combination of declining volumes and an increase in expenses at GGB's primary manufacturing facility in France led to lower profits and a decline in profit margins.

The increase in expenses reflects costs associated with implementing a new ERP system and with producing product samples for customer testing using a new formulation of PTFE, one of GGB's most important raw materials. The vast majority of the expenditures for these items was recorded in the first quarter. We don't expect them to continue in any substantial way beyond the second quarter.

Sales at CPI were lower, as volumes were down in refinery and petrochemical markets in the United States and the natural gas market in Canada. CPI's European volumes were up slightly, as its operations in Germany and Holland benefited from export sales to markets in other regions of the world and as the service businesses continued to grow.

I'm happy to say that CPI's profits and margins improved significantly over the first quarter of 2012, even though restructuring costs were about the same in each quarter. CPI's SG&A expense was down by more than $2 million from the first quarter of last year. Adjusted for restructuring, CPI's margins were the highest they've been since the third quarter of 2011. Although CPI's performance is still not to the level we expect, the first quarter's results confirm CPI's cost initiatives are beginning to be effective.

Sales were down in the engine products and services segment by $13 million, or about 20%. As we mentioned earlier, Fairbanks Morse recognized about $18 million in completed contract revenues in the first quarter of last year, but none in the first quarter of this year. percentage of completion revenues were higher than a year ago, offsetting a portion of this decline.

FME also benefited from the increased sales of environmental upgrade packages which were quite small in the first quarter of 2012 and which carry lower margins than FME's traditional government aftermarket business. Profits in the engine products and services segment were down about $7 million to 9.7% of sales.

The decline reflects a number of factors, including the less profitable product mix I mentioned, higher than anticipated costs on a contract to refurbish several engines for the Canadian Coast Guard, and accounting adjustments primarily for the treatment of foreign exchange hedges.

These factors account for the majority of the year-over-year decline in margins that we saw in the first quarter. Although the product mix may continue to reflect increased sales of environmental upgrade packages and increased sales to commercial markets, we anticipate that FME's margins will return to higher levels in the second quarter and beyond.

As we mentioned last quarter, we believe some service revenue was pulled into the fourth quarter of 2012 from the first quarter of 2013 in anticipation of sequestration. But otherwise, we believe it has had no effect on the funding required to maintain the Navy's fleet. In fact, parts and service orders at the end of the first quarter were at normal levels.

FME's backlog was about $142 million at the end of March, about $8 million below the levels at the end of last year. Longer term, it's clear that FME's new engine sales could be affected by constraints put on the Navy shipbuilding program by Congress, as federal budget issues are sorted out. In the face of this uncertainty, FME is pursuing a number of commercial opportunities, both in the market for new engines and in the aftermarket. FME is also anticipating an early retirement program that will help to adjust the size of its workforce. We expect the program will result in a second quarter restructuring charge of about $2 million, but lead to annualized savings of over $3 million.

Looking at earnings for the quarter, we reported GAAP net income of $8.6 million, down from $13.8 million in the first quarter of 2012. On an EPS basis, that translates to $0.39 of diluted GAAP earnings compared to $0.64 last year. Two factors are important to understanding the comparison between the quarters. First is the effect of economic conditions and the other circumstances on our pre-tax income, which were substantial. Our markets were comparatively weak this year against the first quarter of last year, when demand was stronger than it was at any other time in the past year.

In addition, the issues I described at GGB and FME reduced our pre-tax income by about $3 million. The second factor is the low 11.4% tax rate we recorded in the first quarter of this year. Legislation passed early this year renewed certain tax provisions that had previously expired. The renewal was retroactive and created a significant tax benefit for us in the quarter. Although we expect to return to a higher tax rate in each of the remaining quarters of this year, our effective rate for the full year should be in the range of around 30%.

Our adjusted EPS was $0.56 in the first quarter compared to $0.91 in the first quarter of last year. After-tax adjustments that increased our $0.39 of first quarter 2013 GAAP earnings to $0.56 are $0.21 of interest due to GST and $0.02 for restructuring expense. This was partially offset by a $0.06 reduction to adjust the tax accrual.

As you can see, our free cash flow was lower in the first quarter of 2013 than in the first quarter of 2012. The reduction was the result of several factors. In addition to the effective lower earnings, we made sizable pension -- a sizable pension contribution in the first quarter of this year, but none in the first quarter of last year.

We spent more on ERP software this year. We paid cash taxes in the first quarter of this year, while we enjoyed the benefit of a tax refund in the first quarter of last year. And lastly, capital spending increased as we purchased a manufacturing facility that we formerly leased. We paid about $5 million for this facility, which was well below market price, and longer term, this investment will help us reduce expenses.

We ended the quarter with a cash balance of $48.5 million, down just over $5 million from our balance at the end of last year. On the balance sheet, you'll see a significant increase in current maturities of long-term debt to about $151 million. As a result of the gains we saw in our share price over the first month of 2013, the conversion rights to our convertible debentures were triggered on April 1st, which required us to move the debentures into current liabilities.

As long as the debentures meet the conditions for conversion, which are measured quarterly, they will be recorded as a current liability. We have no indication that any holder is likely to convert prior to the maturity date in October 2015.

Before I close, let's take a look at GST's results in the first quarter of 2013. Third-party sales at GST were down about 2% to $56.5 million because of softer demand in certain foreign markets served by GST. However, EBITDA-A and operating profits improved as GST benefited from lower costs.

EBITDA-A came in at 25.1% of sales, while operating profit margins came in at 22.5% of sales. GST reported adjusted net income, which excludes inter-company interest and ACRP-related expenses, of $8.6 million, an increase from $7.3 million in the first quarter of last year.

GST recorded a $10.4 million in ACRP-related expenses in the first quarter, an increase of about $3 million over the first quarter of last year. We expect those expenses will continue at a high rate, as parties prepare for the upcoming estimation trial. GST continues to generate cash and had about $150 million in cash and long-term investments at the end of the quarter.

Now I'll turn the call back over to Steve.

Thanks, Alex. I'll close with a few thoughts on our outlook for the second quarter and how we see the rest of 2013 shaping up. Then we'll open it up for questions.

Although 2013 is off to a slow start after the first quarter, we do see signs recently of the seasonal increase in activity that is typical of this time of year, as customers in the refining and petrochemical markets prepare for spring outages and as other industries ramp up their maintenance cycles. If these improving trends hold, we believe our sales in the second quarter of 2013 will return to the level we saw in the second quarter of 2012.

Our aftermarket businesses, with the possible exception of Stemco, should see higher seasonal volumes in the second quarter, which should benefit both profits and margins. Revenue at Fairbanks Morse should be in line with or slightly better than the second quarter of last year.

However, we expect demand from our European automotive and industrial markets and from our semiconductor markets to remain soft. The performance of all of our businesses should continue to reflect the cost reductions and efficiency improvements we've previously put in place.

For the rest of the year, we remain cautious. Our European markets show no sign of strengthening, and in North America, we see only the prospect of slow growth. Our expectations for North America are based on signs of modest improvement in industrial markets and in process industries. We also see indication, such as forecasts of freight movements and trailer builds, that our heavy-duty truck business may improve later in the year.

While this environment may support limited growth in our sealing products and engineered products segments, it's not likely to offset what we anticipate will be a full-year decline of approximately 15% in sales at Fairbanks Morse Engine for the year. As we've said, FME expects a significant increase in the number of engine shipments this year, but much of that revenue -- the revenue associated with these engines was recognized last year under percentage completion accounting.

In summary, our markets remain in challenge, but we're confident that we have the right combination of businesses and strategies to be successful even in these tough conditions. Now we'll open the line up for your questions.

Operator, could you instruct the participants how to log a question, please?

(Operator Instructions). And our first question comes from the line of Jeff Hammond from KeyBanc Capital Market. Your line is now open.

Hi, good morning, guys.

Morning, Jeff.

Morning.

I guess a couple questions on the margins. One, I mean, you mentioned CPI, you know, having kind of its best quarter since 3Q '11 and being up. I guess what that implies is that GGB decrementals were pretty ugly, if you could just talk about why decrementals were so challenged in GGB? And then --

Yes.

Oh, go ahead. Yes, go ahead.

Jeff, see, well, there's really -- there's really two primary reasons in GGB. One is just a really tough comp. I mean, last year's first quarter, we were doing quite well even in Europe. We thought we were, you know, really off to a great year last year, and as you'll recall last year, after the first quarter, we saw a slow decline throughout the year.

So when you look at the demand sequentially versus fourth quarter to first quarter, it's kind of about where we expected, to be honest with you. It's up a little bit from Q4, but we knew it was not going to even come close to returning to Q1 of 2012 levels. So that's -- that's the biggest factor, but then --

Okay.

-- the -- the second factor is -- is really two -- two cost things, one that kind of surprised us a little bit. We are in the middle of implementing an ERP system -- actually, we just started implementing an ERP system in GGB. And the first facility to go live was in Annecy, France, which is our largest facility globally in GGB. And so that happened in the first quarter.

And that, as you probably know, is a very difficult transition to make, and it affected operations. And so we were running more overtime and we had other issues as we sorted through this pretty significant shift in their system. That was completed in Q1 and is lined out now, but certainly had effect on the financials.

The other thing is -- and I think I've talked to you guys about this in the past, but, as you know, in GGB and in the rest of the company, but this mostly impacts -- almost exclusively, really -- impacts GGB, they're going to -- the PTFE industry -- so the folks that supply PTFE -- so this all the Solvays and DuPonts of the world -- they had agreed a number of years ago to change the formulation of PTFE, voluntarily, and remove a surfactant PFOA from that material.

Well, in -- that's a big deal in GGB, because that product goes into most of the bearings that we make. And as you know, most of that is in OEM business, so that all takes new qualification and PPAPs with our customers. And so they were making this transition in GGB in the first quarter. That will continue a little bit into the second quarter, but will be done by the middle of the year, but it's basically making a bunch of samples to send to customers so they can test the new formulation.

And obviously, when we -- we've done that in thoroughfare. That was done last year, which is our US plant, and Annecy's the -- really the -- the next and last significant place we do it, because it's only in the GGB locations where we actually make the strip. And so, anyway, that -- that drove a lot of cost in Q1 for running that. Obviously, you don't -- you don't charge a customer when you send them samples that we need them to re-qualify.

So -- so those two cost issues, which were both kind of temporary or one-time things, combined with the reduction in volume, was -- was what affected GGB.

Okay, and then -- and then, can you quantify what you think of as higher margins in FME? And just in kind of this new environment, and as we kind of transition, I mean, how should we view, quote, "normal" operating margins for FME going forward?

Well, I think FME should be in the 15%, 16% range for the year. And that's what we kind of expect going forward. So, again, the effect in -- we had these accounting issues -- one was relative to how we manage FX -- FX hedges that we do, quite frankly, because we -- when we sell a contract to a customer in FME for a new engine -- so this would be for the government and -- as you know, we're a licensed manufacturer for MAN, so some of the key components for those engines actually are produced in Germany by MAN and shipped over to us, and then we make the rest of the parts and build the engine.

And, of course, that's -- so we're buying parts in euros and then selling to the US government in dollars. And so when we enter those contracts for delivery, we buy forward some currency to kind of protect the margin of those engines.

And as it turns out, when the date for actually delivering those engines moves around, which it does almost every time to some extent, it requires us to reset those hedges and move them around, and, unfortunately, we haven't changed how we've done it, to be honest with you, operationally, but our audit firm looked at that and said, gee, we're not sure you should be really doing the accounting the way you are, and so we shifted how we account for it. But from an operational and execution standpoint, we really didn't change anything. So that was a pretty significant number.

At FME, we had -- we had another accounting adjustment relative to the cost system that also impacted Q1 that will not repeat. And then the other thing that happened in FME, as Alex alluded to, is we had a pretty large for us aftermarket service contract for the Canadian Coast Guard that -- that was a fixed-price arrangement, and turns out it probably shouldn't have been, so we didn't make our normal margins on that -- on that deal. And so we did a bunch of work and didn't make a lot of money, which we normally do make good margins on service work and aftermarket parts.

So, anyway, that also was completed, that contract was completed, that work was completed in Q1, so that won't repeat. So unfortunately, FME, with the lower revenue, which was, quite frankly, driven by just the simple fact that last year we shipped engines in Q1 that were still on the completed contract method, so we had a big chunk of revenue a year ago.

You know, we're actually going to ship more engines in FME this year than we did last year by a pretty significant amount, but all the engines this year now are going to be -- are under the percent completion method, so we recorded a lot of that revenue last year, and then last year, we also did have several engines that we -- were still on the old completed contract method, all right? So it's a funny comp to do in FME, but with the volume being down and these cost issues coming up and biting us, we had a bit of an anomaly in FME margins in Q1.

Okay, thanks for the color. I'll jump back in queue.

Okay, thanks, Jeff.

Our next question comes from the line of Todd Vencil from Sterne Agee. Your line is now open.

Thanks, good morning, guys.

Morning, Todd.

Morning, Todd.

Hey, Steve, you've got to be careful with the Canadian Coast Guard, you know? You just do. So --

Are you Canadian?

I'm not.

Oh, well, you know, anyway, it's -- it was a good piece of work. We didn't execute it the way we should, so it's not the Canadian Coast Guard's fault. It's our fault. But, anyway, we learned from it, and it's behind us, so we're moving forward, so --

Fair enough. Fair enough. One clarification on the -- on the discussion on the engine margins -- and thanks for -- thanks for all of that -- you said you think FME is going to be in the 15% to 16% range for this year and that's what you expect going forward.

I mean, obviously, this year's going to be blended down pretty significantly by 1Q, so -- or, I mean, you think you're going to get a 15% to 16% this year, and then that's what next year looks like, as well? Or is next year more like whatever the last three quarters of this year look like?

Yes, that would be the -- it would be the latter.

Okay.

Next year would look like the next three quarters, yes.

So that -- just mathematically, given your 15% decline in sales comment for this year or something like that for FME, you're looking at like 17%, 18% margins for the rest of the year, if my math is right?

Yes, that's right. That's right.

Okay. All right.

And look -- look, the revenue for FME, I mean, we think is going to be down in the order of magnitude of 15%, so that's about -- it's about $35 million for FME -- for the -- for the engine segment, right? But, you know, we booked -- we booked $25 million last year of completed contract revenue. And all of the engines this year will be on percent completion.

Sure.

So, we -- as I think we told you guys in the call last time, 2012 was a funny year in FME, because we -- on the revenue side, right? For new engines only, right? We benefited from completing and shipping the number of engines that were still on the -- still on the completed contract method, right? So we got all the revenue, even though some of the work had been done in the previous years, and we also got the revenue for percent completion from work we did in the shop for engines that'll ship this year. So --

Right.

-- it's at tricky comp, so you got to be -- you got to be careful. So -- but we feel pretty good about -- unless -- but see, now, the shipment schedule for completed engines doesn't affect us near as much as it used to. If you remember, one of the -- well, we shifted because we had to. We now have the visibility and the ability to do it based on percent completion, but if you'll remember before -- you've been tracking us for a while -- remember, if we had an engine that was supposed to ship in Q2 and got moved to Q3, right, it would move all the revenue from one quarter to the next.

That won't happen going forward, but we got to be careful of this year-over-year comp just because 2012 was the main year where we had both methods kind of underway, if you will, because when we decided to make the shift -- you'll also remember this -- we didn't decide to just drop the curtain and change engines that were already -- had work going on.

We said we're going to change it prospectively on all the engines that were starting from that date forward and were going to finish the accounting and the engines that were already underway under the old method. So as a result of that, in the back half of '11 and all through 2012, we had this hybrid of both going on, if that's clear.

Yes, no, absolutely, thanks. Thanks a lot.

Todd, one other -- one other thing on the margin question you asked. Don't forget, we did mention in the remarks that we anticipate $2 million of restructuring charge next quarter, which will blend down --

Okay.

-- the -- the second quarter margins that -- end of the year should finish in the -- in the order of magnitude of what Steve mentioned, but the second quarter will be slightly lower than that high-teens number we quoted.

And 2Q, if you factor out the restructuring, which -- as we do -- should be in that range, as well?

Right, exactly.

Back to that restructuring? Okay, good.

Yes, exactly. Hey, Todd, just so you don't miss it or no one on the call misses it, there was some good news buried in Alex's comments on FME, actually, because at the end of last year, we were -- we were very concerned about this -- the effect of -- impact of sequestration on our parts and service business.

And we were very sure that some of the demand for parts got pulled into the end of last year because the Navy guys, they've got to keep the ships running, and they were worried that their budgets were going to get cut, right? So we saw some artificial orders, if you will, or some pull-forward orders.

That hit January and February, but once we got to March, things were kind of back to normal and our backlog actually looks decent for that. I think it's, quite frankly, what's going on with -- with North Korea, and so this is not the place that the Navy needs to get -- to cut on. We've got to keep these ships running.

So we feel actually -- and based on what we've been talking to the customer about and so forth, we feel that the core aftermarket government demand for FME is going to be solid for the rest of the year. So I didn't want to make sure -- I just wanted to make sure that wasn't kind of lost in the conversation.

No, I appreciate that. And we get that question a lot, so it's good to have the update. So thanks for that.

Yes. Yes.

Hey, Alex, corporate expense outside of the segments, which you mentioned was in line with a year ago, it was, though, higher than it's been run in the past probably three other quarters the last year. So is there something seasonal in there or something else going on?

There shouldn't be anything seasonal that I can think of off the top of my head.

The expectation should be right on top of last year, though.

It really -- yes, we really aren't increasing -- annually our budget is to not increase. Actually, I believe annually we're going to take it down just slightly. So there may be something related to timing, but -- but, yes, there's no real dramatic change in the corporate expense line.

Good. Good. Okay. And then maybe putting it all together -- and maybe I missed it -- if I did, I apologize -- but, Steve, if we kind of roll all this up -- and given all your comments about the fact that we're getting slow growth in North America and not really seeing any improving trend in Europe, how should we be thinking about sort of the full year comparison on the top line of margin, I mean, if we can sort of think about the whole thing rolled up together?

Yes, I mean, I think -- I think our expectation is for the year, so I'm going full year over full year, that sealing and engineered products both would be up a few percentage points on the top line.

Okay.

Now, you know, that includes four quarters of owning Motorwheel versus three quarters last year, so I'm not stripping out the acquisition effect. So we think sealing will be up 2% or 3%, and we think engineered will be up 3% or 4%, so that's our -- that's our current look at it, even with -- even with the first quarter. I mean, we tried to give the street a heads-up about the difficulty we saw coming in Q1 of the comp, both in -- primarily because of GGB, and then also we knew what was going to happen in FME on the top line.

So when you look at our first quarter actually relative to our internal plan, which we don't share with you guys, it's pretty close. We were a little bit behind top line, but, quite frankly, not very much behind, certainly within the margin of error of our ability to look at things, so it was pretty darn close.

And then -- and then even on the operating income line, if you -- if you take out the net effect of these -- of these one-time issues that Alex articulated, net meaning you offset with the $1.5 million gain we had on unwinding the -- the earn-out money for acquisition we did a couple years ago, which was a benefit to us -- and when you net all that out, even our OI was more or less right at our internal plan. Unfortunately, we had these one-time things come up and bite us, and in a relatively weak top-line quarter, that has a big impact on our earnings. So that's really what happened.

But in terms of the underlying business, I mean, you know, it's rare. When Q1 is a stellar quarter for GGB -- it happened to be last year -- but, you know, as we look at GGB, they're still -- they're still running fine. We got the cost things behind us in the first quarter. Europe, while it won't be a huge rebound, is also -- you know, it's stable, and in the US, we can -- we believe we'll see a little bit of improvement.

CPI is off to a decent start, actually, and we're seeing a little bit of optimism in some of those markets, because we've got a decent order book going into Q2 that we feel decent about. I mean, it's not stellar, but it's certainly better than where we've been, and the cost improvements we made last year are in place.

We had a lot of disruption in the CPI business last year, because all the facility consolidations and restructuring that we did last year, that's now behind us, and the team is now very, very focused on the commercial activity and the business is executing, you know, reasonably well. So I -- as Alex mentioned again, you guys don't get to see it at the CPI level and our internal plan, but as Alex mentioned, we're tracking against what we expected CPI to do. Q1 is always weak for CPI.

And in Garlock we're fine. In Garlock, Q1 is not always a great quarter, just because of seasonal effects. It really depends on the maintenance outage schedule and so forth, and that really cranks up in Q2. So we've got to get really through the summer before we know how the full year for Garlock is going to look.

But, again the order book is okay. And even in Stemco, we saw certainly the March-April numbers and volume in Stemco was a hell of a lot better than January and February, so that's also a bit -- and, you know, if you read all the forecasting about freight and freight movement and new trucks and so forth, it does point to an improving trend throughout the year.

So we're not hitting the panic button on this end, to be honest with you. We've got to understand the FME difference. But, I think I've said this before in previous years, but I travel to the field a lot anyway, and that tends to be concentrated more in the first half of the year, because we give safety awards to those plants that have stellar safety performance, which we again set a record in our safety performance last year.

So I've been out in the field a lot, you know, since the beginning of the year. And I actually feel very good about our business. We got some great things going on in our factories. The teams are focused. We're doing some very, very important things to strengthen our business around the systems work and the productivity improvement and the commercial excellence program that we've got in place.

You know, but we got to deal with reality. I mean, Europe, it's going to take a while before Europe -- I mean, I think it'll take years before Europe will get back to any kind of reasonable growth, so we're going to have to gain share. We're introducing new products. We just introduced a new product in -- in GGB and just got our first -- just a couple of weeks ago got our first sizable order down in South America. So very pleased with the GGB's team, team's ability to bring in new customers, introducing new products.

We've got to get this PFOA-free PTFE conversion behind us. That's something we've been working on for two years, to be honest with you. And, it's now in the late innings of that, because we're running customer qualification, but we -- our development team had to do all the formulations with this new PTFE raw material that we're having to deal with. And for a while, it was hard to even get samples from the PTFE suppliers.

And so -- but yet they're still shifting to this. This is not something that we have the option to do. We really have to do it. And so it's been a huge burden for the GGB technology team and manufacturing team, which once we get that behind us, they can turn all that resource and attention to developing new applications and so forth.

So the GGB business is just -- is running very, very well operationally. I know it's hard for you to see that when you see the low margins. You don't get to go to the plants like I do. But I feel very good about GGB, and I feel good about the path that the CPI guys are on, after all the restructuring and work last year. So that's kind of where I am on the outlook.

Perfect. That's great. Thanks so much.

(Operator Instructions). Our next question comes from the line of Joe Mondillo from Sidoti and Company. Your line is now open.

Good morning, guys.

Hey, Joe.

Hey, Joe.

A lot of information so far, so I'll try to keep it brief. Just one question. In terms of the engineered products segment, what is the seasonality through the year normally? Because the last two years, we've seen quite a bit of a falloff in terms of the margin in the back half of the year, but I know there's been a lot of costs and restructuring costs and a lot of costs associated, so, you know, what is that normal seasonality? And I guess, what do you look for this year?

Yes, it's very hard to peel the seasonality from the publicly disclosed stuff, because you've got to look at every year is either in a -- throughout the year, a lot changes through those 12 months, Joe, as you know. So it's either -- you're either in a declining market, a growing market, et cetera.

But if -- if everything were stable, if everything were stable and you were -- if you could just -- it's impossible, but if you could take some snapshot of economic activity and levelize it throughout the year, from the broader economy, the engineered products group would be stronger in Q2 and Q3 and weaker in Q1 and Q4.

Q1, driven mostly by CPI, because they sell a lot of stuff into cold parts of the world where there's just not the level of maintenance and certainly not the level of project activity that CPI benefits from in Q2 and Q3, and then it begins to slow a little bit in Q4, and driven in Q4, but mostly by GGB, because at the end of the year, all the European auto plants shut down for -- for the holidays, and GGB's fourth quarter has always been weaker from a top-line perspective, right?

The first quarter, I would say, is not typically really weak. It's not really strong. It's kind of neutral, if you will, on average. Last year, it just happened to be kind of lights out in the first quarter. I mean, it was -- we were running -- we were running full out in -- in GGB globally in the first quarter of last year. It turned out that a lot of it was European guys thought things were going to recover quickly, and they kind of just petered out, as you know. So -- but in aggregate, engineered products, the strength is in Q2 and Q3, driven by those two factors.

Okay, perfect. And does that also go for the margin profile of that segment, as well?

Sure. Just from pure leverage standpoint, absolutely.

Okay.

And I do -- as you pointed out, Joe, fourth quarter of last year is when we took a fair bit of CPI restructuring costs, because that's when we did -- that's when we executed -- we've been working on it for a while and planning it, but it's when a lot of the cost hit of consolidating the facilities that we did into Houston.

Okay. Perfect. And then also, just looking at CPI, how does the backlog look at that business? And with natural gas prices climbing over the last several months, is it -- are you starting to sort of hear any word of projects or sort of warming up or -- how does that --

Yes, it's better than -- it's better than last year. In CPI, we don't have a long backlog. It's a short order -- it's a short cycle order business. However, we have a quote activity read, so when we get requests for a lot of quotes, we know that things are starting to pick up a little bit, and we have seen that late in the quarter.

Okay, great. And then just one last question. In terms of sort of the current volume that you're receiving just overall in the overall business, if we don't see any sort of improvement, how are you thinking about the overall footprint of the business and the cost structure?

Well, as Alex mentioned, we have already implemented or we're in the middle of implementing, really, an early retirement at FME. And so that will happen in Q2. We'll take a $2 million restructuring charge. That will lead to a little over $3 million of annualized savings. So for the year, we should be relatively neutral on that. We'll be a little bit -- take us a little longer than the rest of the year to make up the $2 million, but it's still -- still the right thing to do.

In GGB, we had a lot of temp and contract labor and worked a lot of overtime because of the ERP conversion that I mentioned and running the PPAP samples alongside our regular volume. So that will also happen.

So far, in the rest of the businesses, we have not seen demand to be weak enough to do any kind of -- what I would describe as major downsizing. We'll continue to manage overtime and contract labor, but we do not see at this point -- again, things change, but at this point, we do not see going back to the mode we were in a few years ago in Europe, where we were doing all the short workweeks and all that kind of stuff. We don't -- we don't -- our demand is still strong enough so that we don't need to do that.

Okay, perfect. Thanks a lot.

Yes.

Our next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Your line is now open.

Hey, guys. Just a couple follow-ups on the asbestos litigation. One, can you just kind of update us on where you're at with the questionnaires? And, two, just on these bankruptcy trusts that you can now see into and the ballots, I mean, how does that make you think about current and future claim trends?

Well --

Or is that just simply to show how that impacted your settlement amounts?

Yes, that's what it's for, Jeff. It's to -- it's to prove -- see, the other side -- the other side wants to use the most recent history of GST settlements to size the overall liability, okay? And, remember, the liability is for pending and future claims. So all those claims that have already been resolved going backwards, those are done anyway. So when we filed the company, when they filed Chapter 11, there were a set of claims that were still unresolved. And then the difficult thing in these cases is projecting forward what would -- what do claims look like going forward?

But -- so that's the pot we're talking about. The other side would like to use the most recent year's settlement history, right? Which, of course, they would, because it's been higher than -- than any other time, in Garlock's history, right?

Well, why? Why was it higher? It was higher for -- we believe higher for the reason that, when the other companies filed bankruptcy in the early 2000s, like Owens Corning, and many were already bankrupt, like Johns Manville and all the -- all the other major asbestos companies that actually did produce dangerous products all filed for Chapter 11, well, when -- as you know, when you're in Chapter 11, you -- all the claims are stayed, okay? So these guys were all offline.

So what do the plaintiff lawyers do to go get their money, right? They go, they turn to these peripheral defendants like us, who really didn't make anybody sick, didn't have a dangerous product, right?

And, oh, by the way, they coach their clients to not -- to not mention all the insulation companies that they were exposed to and all -- et cetera, et cetera, even though subsequently they've got claims with them, they vote in their -- they vote in their company's bankruptcy proceedings, they've signed 2019 statements for them, and then subsequently, they -- we believe they seek money in the trust system while they're denying exposure to those companies in -- you know, when they're suing Garlock, when they're suing GST.

So what happened in that time period is, our defense -- our litigation costs went up, because we had to prove that these -- that these claimants, in fact, did have these other exposures, while the lawyers -- their lawyers coaching them to deny it, and it raised the settlement demand, because there -- the truly culpable companies weren't in the courtroom with us, right?

And so that's what the whole -- our whole strategy of getting all the ballots which we've got, getting the 2019s, which we now have a ruling to be able to get -- we're in the process of getting those -- and some additional evidence that we've been allowed to get, which is still subject to a confidentiality order by the court, around actual trust payments, we believe all this will prove to the court that this is what, in fact, inflated the settlement numbers for GST, not the fact that their -- why would their liability go up? Nothing changed on the GST side. It changed in the tort system environment, because there was all this evidence concealment going on. That's what changed the game.

Okay, perfect. And then just update on the questionnaires and what that has done to the current claim number?

Well, when we went into the bankruptcy, we -- when we went into the bankruptcy, we had, I think, 5,800 open mesothelioma claims or something like that. And through the process of reviewing all those and pulling out those that weren't relevant or those that weren't legitimate, et cetera, et cetera, it was down -- it was reduced down to about -- there's about 3,500 active pending claims, on the -- on the day of the filing, okay? You with me?

Yes.

Yes.

Okay, and then --

Now, that doesn't mean -- by the way, that doesn't mean they're all legitimate, by any stretch, but we at least know it's down from 5,800 to 3,500. Most of the 3,500 aren't legitimate, either.

Okay. Okay, that's helpful. And then just a quick question on Stemco, I mean, you said aftermarket weak, you know, and should be weak for the foreseeable future, but I guess it -- you know, the weather was kind of more normal this year or worse after a mild winter. And I think we're seeing at least stable, you know, decent freight trends. I mean, why -- why such a subdued outlook?

Well -- no, well, let me clarify. I think that -- we believe that Stemco's levels of demand will look like last year. So when I say -- so the first quarter, they were down substantially. We think they'll go back to tracking at the levels of last year, so sequentially, it'll be a fairly decent pop. But it won't -- year over year. I just meant, year over year, we're not expecting the aftermarket to be a lot stronger the rest of this year than it was last year. You with me?

Okay, yes.

It will be stronger than Q1, no question.

Okay, thanks, guys.

Yes.

And there are no further questions in queue at this time. I turn the call back over to the presenters.

All right, everyone. Thank you very much for dialing in. Of course, you know if you have further questions, please don't hesitate to contact me, 704-731-1527, and we'll look forward to talking to you next quarter. Thanks.

This concludes today's conference call. You may now disconnect.