Enpro Inc (NPO) 2016 Q2 法說會逐字稿

Good morning. My name is Kelly, and I will be your conference operator today. At this time I would like to welcome everyone to the EnPro Industries' second-quarter 2016 results conference call. (Operator Instructions)

Thank you. And I will now turn the call over to Chris O'Neal. Please begin, sir.

Thank you, Kelly. Good morning and welcome to the EnPro Industries quarterly earnings conference call. I remind you that our call is also being webcast at enproindustries.com, where you can find the slides that accompany the call.

Stephen Macadam, our President and CEO; and Milt Childress, our Senior Vice President and CFO, will begin their review of our second-quarter performance and our outlook in a moment. Also joining us on the call today is Ken Walker, who is our Senior Vice President and COO.

But before we begin our discussion, I will point out that you may hear statements during the course of this call that express a belief, expectation, or intention, as well as those that are not historical fact. 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 other risks and uncertainties, in our filings with the SEC, including the Form 10-K for the year ended December 31, 2015, and our Form 10-Q for the quarter ended March 31, 2016. 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 from which such statements are based.

Our earnings release and conference call presentation materials contain additional disclosures regarding non-GAAP financial information, collective references to EnPro and our subsidiaries, the de-consolidation of Garlock Sealing Technologies or GST, and pro forma illustrative financial information presented as if GST were reconsolidated for financial reporting purposes. These disclosures are important to understanding comments we will make on today's call, and we urge you to read them carefully.

Just as we did last quarter, we are providing pro forma segment sales and pro forma segment profit information in conjunction with the ACRP settlement agreement announced on March 17 to provide investors with additional pro forma information, illustrating each segment's results as if GST had been re-consolidated with EnPro, based on confirmation and consummation of the joint planned reorganization as described in our earnings release. Given where we are in the bankruptcy process and due to requests from investors for this type of information, we believe a focus on pro forma operating result is instructive to investors, as it reflects the performance of all of our subsidiaries. Until the ACRP process is completed, however, our published GAAP financials and Forms 10-Q and 10-K will continue to reflect GST on a deconsolidated basis.

Also, throughout this call we will be using the terms normalized sales and normalized segment profit. Normalized sales refer to consolidated or pro forma sales adjusted for year-over-year differences in foreign exchange translation and the impact of acquisitions and divestitures. Normalized segment profit refers to consolidated or pro forma segment profit adjusted for foreign exchange translation, the impact of acquisitions and divestitures, acquisition-related expenses, restructuring charges, and the impact on earnings as if the multiyear EDF project were accounted for on a percentage of completion basis. The intent of providing normalized results is to provide greater clarity of results in the current period compared to the prior period.

And now I'll turn the call over to Steve.

Thanks, Chris. Good morning, everyone. Before I begin my comments, I'd like to take this opportunity to formally introduce Chris O'Neal, whose voice you just heard as he opened the call.

Chris joined EnPro nearly 8 years ago and had served in a variety of corporate and divisional roles before succeeding Milt as head of EnPro's strategy and corporate development function when Milt assumed his position as CFO about a year ago. Chris added investor relations to his responsibility a couple of months ago. He knows a lot about our businesses, and we are pleased to have him engaged in investor relations. I expect you'll enjoy working with Chris.

I also would like to take this opportunity to formally thank Dan Grgurich, our prior head of investor relations, for all of his contributions to EnPro.

Now let's begin. As an opening comment, I want to share that I'm pleased about what our team accomplished during the second quarter, despite overall market conditions that continue to be quite challenging. Our total normalized pro forma segment profit for the quarter increased by 7.8% despite a 4.3% decline in normalized pro forma sales.

This improvement was driven by a combination of cost reduction, restructuring, production efficiency improvements, a record aftermarket parts sales quarter for power systems, and lower input costs as a result of supply chain optimization. Total pro forma sales for the quarter increased by 2.8%, and pro forma adjusted EBITDA increased by 3.1%.

The market environment in the second quarter, as summarized on slide 5, can be characterized as more of the same. We've seen negative year-over-year trends in many of our markets. Despite some recent positive trends, commodity prices in general remain down significantly versus the second quarter of 2015. And we have yet to see an increase in demand for related products in most markets.

We're continuing to experience weakness in refining, nuclear, mining, gas turbine equipment, and general industrial. Heavy-duty trucking also turned down slightly during the quarter versus last year, while aerospace was relatively flat. Notwithstanding these market challenges, we are seeing modest positive momentum in midstream oil and gas and semiconductor, and our order patterns along with customer feedback suggests that momentum in both of those markets will continue.

Before Milt provides detail on our financial results, I want to give updates on several of our strategic initiatives, including progress on the ACRP, a major new engine program win at Power Systems, innovation programs, and our latest acquisition in sealing products. The ACRP is proceeding toward planned confirmation according to the expected timeline we shared previously.

Since March 17 of this year, when we announced the comprehensive settlement, we've been working on the legal and administrative steps necessary to begin planned solicitation. During the second quarter, the parties filed all documents necessary to implement the ACRP settlement, including the plan itself, plan documents, disclosure statement, voting procedures, and formal plan ballots.

On July 29, so very recently, the bankruptcy judge issued an order approving the disclosure statement, solicitation confirmation procedures, and schedule for confirmation. The order established several key dates, including a deadline of December 9 for voting, a deadline of December 30 for completion of the tabulation and certification of the voting results, and a date of May 15, 2017 for the confirmation hearing to begin.

The solicitation period is scheduled to begin this month. So absent appeals, we would expect the Bankruptcy Court and the District Court to enter final orders confirming the plan and issuing the planned injunctions within 60 days of the confirmation hearing, leading to the consolidation under this timeline in the third quarter of next year.

As Fairbanks Morse announced on Monday of this week, Power Systems was chosen as the engine supplier for the main propulsion diesel engines on the Navy's new Lewis class of underway replenishment oiler ships referred to as TAO-205. This is a culmination of three years of intensive technical and commercial development efforts and, as you know, represents a typical cycle to win major Navy programs.

The program has a value to Fairbanks Morse Engine of approximately $240 million over the life of the program. The Navy has ordered six ships that will be built over the next six years. Each ship will be powered by two Fairbanks Morse MAN4860 engines. The engines meet the latest emissions requirements with exhaust aftertreatment systems. Fairbanks Morse received a $13 million order in July for the engines that will power the class's lead ship, the John Lewis.

Engine orders for additional ships are expected pending the normal appropriation process. This program will provide new engine aftermarket parts and service revenue for many years into the future. It also affirms Fairbanks Morse as the ongoing key strategic engine supplier for the US Navy.

Turning to slide 8, during past calls we have discussed the restructuring actions in both the sealing products and engineered products segments, and I'm pleased to share that we have completed all of these plants' major milestones. In sealing products, we discontinued all production and warehousing activities in Garlock's Elland UK facility and successfully expanded our distribution network there to support our existing sale. We also have made significant progress on our plan to exit a small facility in Brazil, which we expect to close by the end of the third quarter. These actions have already started to generate associated cost savings.

In engineered products, GGB completed the move of its Chicago operation to other existing GGB facilities. GGB also moved into and began production in a new owned facility in Suzhou, China. With these actions, we fully completed the four-facility footprint consolidation and modernization program that we began in early 2015.

CPI also completed its comprehensive restructuring plan, which included the exit from nine service centers and light manufacturing facilities. Five were closed, two of which were in South America, three in Canada; three were sold, one each in the United States, Canada, and Thailand; and one was consolidated into another facility. This restructuring resulted in a reduction of about 15% of the CPI workforce. This positions CPI as a much stronger company, and we've already started to see the impact of these actions on CPI's results.

In late June, as a result of continuing soft conditions across many of our served markets, we began the implementation of an additional initiative to reduce costs across all segments and the corporate office. Through this initiative, we expect to reduce pro forma operating costs by approximately $20 million on an annualized pro forma basis going forward. These actions will make us leaner now and more productive when markets recover. This cost reduction effort is additive to the restructuring of the past couple of years.

As a point of reference, our total headcount at the end of 2014 was approximately 6,000. Excluding additions from acquisitions since that time, we expect the total Company headcount to be approximately 8% lower by the end of this year. Even in the midst of challenging market conditions and cost reduction efforts, we remain committed to our new product development efforts and maintaining our leadership position in the markets we serve. We are also taking a long-term perspective and have increased our focus and funding for innovation. We believe this is vital to our future growth.

Two exciting projects underway are the development of the OP2.0 engine in power systems, which I have spoken about in the past, and a new next-generation hydrodynamic seal in sealing products that I'll discuss in a moment. We expect that both of these programs will create tremendous value for our customers by providing a step change in performance through both greater efficiency and lower lifecycle costs.

Fairbanks Morse is in the prototyping, design, and development phase of the new opposed piston engine or OP2.0, which is a medium-speed diesel engine that offers the unique combination of being fuel-efficient, highly reliable, and Tier 4 emissions compliant. The test results from the prototype engine have been excellent, and we expect that customers will find the value proposition compelling. Fairbanks Morse has a long history of powering municipalities, hospitals, universities -- which positions it very well to serve demanding needs of the distributed power applications.

While the total global addressable market for medium-speed reciprocating engines is approximately $10 billion, our initial focus will be on the 3.5 to 5 megawatt distributed power segment, which has an annual market size of approximately $1 billion. Technetics recently finalized the development of its next-generation hydrodynamic seal for aerospace main propulsion turbine engines, gearboxes, transmissions, and auxiliary power units. The next-generation hydrodynamic seal creates real value for customers by increasing operating efficiency and lengthening maintenance cycles.

Our test data shows that the seals -- our seals offer significant improvement in performance. And customer reactions have been very positive, leading to several application development projects. We believe we have achieved a competitive advantage through a unique combination of advanced design capabilities, including our proprietary finite element analysis to solve complex application requirements, combined with highly precise manufacturing techniques.

Market studies suggest that the market for these seals is approximately $40 million and that the market has the potential to grow to approximately $60 million as next-generation hydrodynamic seals displace legacy technology. These are two examples of the many development projects that are underway across our Company. I will continue to update you on these and others as they mature towards commercialization and we get a more refined sense of the revenue potential.

Finally, since December 14, we've completed four acquisitions in our sealing products segment. Each of these strategic bolt-ons enhance our position in the markets served and provide new products and capabilities. In aggregate, the companies are beating performance expectations.

Of note, Stemco's integration of the Air Springs acquisition, which closed in July a year ago, is proceeding very well. During the second quarter, we transitioned off the seller's ERP system to a new cloud-based ERP system that Stemco is adopting across the division. We also completed the relocation of the Air Springs research facility into a new location nearby. Our supply chain team has continued to negotiate new agreements with vendors to reduce costs and improve availability and quality. We're beginning to see the associated savings in our financial results and are expecting continued benefits in the second half of this year.

Garlock's acquisition of Rubber Fab is also off to a great start. While it has only been a few months since we completed the acquisition, we are pleased with the customers' positive reactions, how smoothly the integration has progressed, and our initial financial results. We see Rubber Fab as an attractive platform for expansion in the food and pharma hygienic growth market.

Now I'll turn the call over to Milt.

Thank you, Steve. As Chris mentioned in the introduction, this quarter we will continue to focus the rest of our remarks on pro forma results. The pro forma segment results that I will discuss are prepared as if GST had been reconsolidated on the basis described in our earnings release. It's important to note that the pro forma results do not represent a projection of the financials as of the future date of reconsolidation.

Also, as a reminder, most of the difference between consolidated and pro forma segment information is in sealing products, with only small differences in engineered products and power systems stemming from foreign operations of those segments included in GST foreign subsidiaries.

Our pro forma second-quarter result or sales of $352.3 million were up 2.8% from the same period of 2015. Net of divestitures, acquisitions contributed $25.3 million, and foreign currency translation reduced sales by $900,000. Excluding the impact of these factors, pro forma sales for the quarter were 4.3% lower compared to a year ago. The organic sales decline was driven primarily by continued soft demand we are facing in many of our end markets. And I'll cover each segment more detail in a moment.

Pro forma gross profit for the quarter of $126.8 million was 2.7% higher than in the second quarter of 2015, and pro forma gross profit margins remained constant at 36% year-over-year. Excluding the impact of the acquisitions made during the last year, which in aggregate have a lower margin profile, pro forma gross profit margin was 100 basis points higher for the quarter, reflecting improved results from previously completed restructuring actions, realized gains from recent cost control initiatives, and lower input costs as a result of supply chain optimization.

In total dollars, pro forma SG&A remained flat in the second quarter of 2015 (sic - 2016) at $87.2 million. As a percentage of pro forma sales, pro forma SG&A decreased in the second quarter 2016 to 24.8% from 25.4% in the second quarter of 2015. Adjusted for the impact of acquisitions made last year, pro forma SG&A was down 3.7% year-over-year.

Corporate expenses were $6.5 million in the second quarter compared to $3.4 million in the prior year. The year-over-year increase was primarily driven by a downward $5.5 million incentive compensation accrual adjustment in the second quarter of last year. Excluding incentive compensation costs, corporate expenses declined 3% in the second quarter of 2016 compared to the same period last year.

As Steve mentioned earlier, in the second quarter we began to implement an additional initiative to reduce costs across all segments and the corporate office. This effort is expected to reduce pro forma operating costs by approximately $20 million on an annualized pro forma basis. We did not realize any significant savings in the second quarter since we began implementation of this initiative in June. However, the majority of the actions have been taken and are complete.

With this program plus restructuring efforts that we previously initiated, we incurred $3.1 million of pro forma restructuring costs in the second quarter and expect to incur total pro forma restructuring costs of $11.3 million in 2016, leaving about $4 million in restructuring costs for the second half of the year.

Pro forma adjusted net income, which adjusts pro forma net income for items such as restructuring, legacy environmental reserves, and normalized tax accruals, all as shown on the reconciliation table in our earnings release, was $22.9 million, up $1.5 million from a year ago. Most of the year-over-year increase is attributable to improved profitability from the previously announced restructuring plan in the engineered product segment; lower input costs as a result of supply chain optimization; and record aftermarket part shipments in power systems, all of which more than offset the effects of lower volume in the quarter.

Pro forma sales in the sealing products segment were $223.3 million in the second quarter, up 3.1% over the second quarter of 2015. Adjusting for the impact of acquisitions and foreign exchange, pro forma sales were down 8.2%, reflecting weak demand in nuclear, gas turbine equipment, general industrial, refining, and metals and mining, slightly offset by increased demand in midstream oil and gas and semiconductor. Aerospace was relatively flat, while heavy-duty trucking was slightly down.

Pro forma segment profit of $31 million was up 3.3% in the second quarter of last year. Pro forma segment margins remained constant at 13.9% year-over-year. On a normalized basis, pro forma segment margins were 120 basis points higher compared to the second quarter of the prior year. As previously mentioned, profitability improvements were largely due to lower input costs as a result of supply chain optimization, cost reduction initiatives, and realized savings from restructuring activities in this segment.

In the engineered products segment, second-quarter pro forma sales of $74.3 million declined by 5.7% from the second quarter of 2015. The year-over-year sales decline can be attributed to revenue reductions from restructuring activities that were completed during the past 12 months; weakness in the fluid power, oil and gas, and industrial markets; and a slight reduction in North American automotive shipments. All of these factors more than offset the growth in European compressor parts and service. Normalized pro forma sales declined 5.5% in the second-quarter versus the same period in 2015.

Pro forma segment profit of $5.6 million was up 30.2% from the second quarter of last year, despite the decline in sales, due to cost savings related to the restructuring activities that Steve described earlier. Pro forma segment margins were 7.5% in the second quarter versus 5.5% in the prior-year second quarter. Normalized pro forma segment profit was 29.2% higher than a year ago, and normalized pro forma segment margins were up 230 basis points despite lower sales as a result of the benefit of the restructuring and other operational cost savings.

In the power systems segment, pro forma sales were $55.5 million, up 14.7% compared to the second quarter of 2015. The increase was largely due to record aftermarket parts sales, slightly offset by lower engine and service revenues. Pro forma segment profit for the quarter increased to $7.3 million, up 14.1% from a year ago, primarily as a result of higher-margin parts sales.

Pro forma segment profit in the second quarter of 2016 was unfavorably impacted by a $1.7 million charge for the multiyear EDF engine contract. The charge for the quarter resulted primarily from a drop in the dollar-to-euro exchange rate since the end of the first quarter.

Excluding the impact of restructuring and adjusting the EDF engine contract loss as if it were accounted for on a percentage of completion basis, pro forma segment profit was 37.1% higher than in the second quarter of 2015. A more profitable sales mix, as just mentioned; lower purchased services; lower warranty costs; and relatively flat year-over-year SG&A expenses contributed to the increased profit.

We remain committed to our strategy of creating shareholder value through earnings growth and balanced capital allocation, including disciplined investments for organic growth and innovation, strategic bolt-on acquisitions, and returning capital to shareholders through dividends and share repurchases. We continued to execute on this strategy in the second quarter through the acquisition of Rubber Fab and investments in innovation, such as the ones Steve discussed in his comments.

We also repurchased approximately 200,000 shares for $9.5 million as part of the ongoing $50 million share repurchase program that was approved by the Board of Directors in the fourth quarter of last year. Through yesterday's market close, we have spent $26.5 million on share repurchases out of the authorized $50 million program. Additionally, we paid a $0.21 per share dividend in June and last week announced a $0.21 per share dividend, payable in September.

We get a lot of questions about our pro forma net debt position, particularly now that we have clarity on our asbestos liability. As you can see in the table on slide 18, upon reconsolidation of GST, we anticipate using the majority of cash on hand at GST, in addition to some incremental third-party debt, to fund the initial ACRP trust commitment of approximately $417 million. This includes $400 million for the US liability and an estimated $17 million for the Canadian liability. The final $80 million commitment for the US trust will be funded within one year of the initial payment.

As shown on this slide, if the settlement payment were to have been made at the end of the second quarter of this year, EnPro's enterprise value to net debt leverage ratio would be approximately 2.4 times -- in contrast to the 4.8 times leverage ratio based on our consolidated results. This does not include approximately $163 million of tax benefit that will be realized over the 3 to 4 years following reconsolidation, as we've discussed on previous calls.

This is the unique nature of the ACRP. We also get questions about our valuation relative to industrial peers. We believe that our pro forma financials are instructive, particularly now that we have a consensual agreement on the ACRP, as they reflect the performance of all of our subsidiaries.

Given our market cap of approximately $1 billion, pro forma net debt of $469 million, and our trailing 12-month pro forma adjusted EBITDA of $198 million, the resulting enterprise value equates to a 7.4 times multiple of trailing 12-months pro forma EBITDA, in contrast to the 10.8 times multiple indicated by our consolidated results without the benefit of GST. This pro forma multiple is well below the peer average of 12.7 times. We believe this valuation gap will adjust over time as the market gains confidence that the ACRP -- what we finalized through our plan, resulting in the permanent removal of the asbestos uncertainty that has been a part of EnPro since inception.

Now I'll turn the call back to Steve.

Thanks, Milt. We'll close with a discussion of the current market conditions and our outlook for the remainder of the year, and then take questions. As we have described in the past, we do not have much visibility to future demand for most of our businesses, and the current volatility in global markets makes the industrial demand picture extremely difficult to forecast. Most of the markets that we serve have continued to show weakness, and the strong dollar continues to affect our results. Only a few markets are showing signs of modest strength.

It is also important to note that the record aftermarket parts sales that we enjoyed in power systems during the second quarter are not sustainable for the rest of the year. The increase in shipments in the second quarter was the result of the convergence of marine vessel maintenance schedule orders received late last year and early this year. Our current order backlog suggests that aftermarket parts sales will be approximately at historical levels for the remainder of the year.

We are now close enough to the end of the year that our backlog, order trends and customer feedback give us some level of confidence in providing the following guidance. We expect pro forma sales to be roughly flat on a currency neutral basis, with the growth attributable to acquisitions completed since early 2015, offset by general market-related weakness.

Excluding the costs associated with the AVL Powertrain Engineering lawsuit that we discussed last quarter, we expect flat to low single-digit decline in pro forma adjusted EBITDA compared to 2015. Both pro forma sales and pro forma adjusted EBITDA assume constant currency for the rest of the year. I want to emphasize that market developments and Company performance could cause our results to deviate either positively or negatively relative to this guidance.

Now we'll open the line for your questions.

(Operator Instructions) Ian Zaffino, Oppenheimer.

This is Dan Natoli in for Ian. Thanks for giving me the opportunity to ask a question. In terms of the oiler contract, can you just give a better sense as to what that might mean for EBITDA going forward and, ultimately, how that will affect some of the defense-related businesses? Thank you.

Yes. It's Milt. One of the things that's important to note is -- Steve mentioned this is a -- it's a significant win for us. We're very, very excited about it.

It is spread out over a long period of time. It's expected to be 17 ships over 17 years, so roughly 1 per year if you look at it. With our order, the contract that we have in hand, there's approximately $13 million in revenue. It will have a modest impact as we look year to year, but it's a very important win, because it does help solidify, as Steve noted, our position with the US Navy.

Our experience with new programs is that we typically see with the learning curve a ramp-up in margin as we go from the early engines in the program to the later engines in the program, and we would expect the same to be here. So we typically would see gross margins in the high single-digit to and low double-digit range initially, and then with some ramp-up over time. So that's little bit of guidance, and hopefully that helps you put this in perspective.

Great, thank you. And just as a follow-up, given where the stock price is and, clearly, a good quarter, any thoughts on capital allocation and buybacks and how that might look going forward?

We're committed to continuing with our $50 million authorization that the Board placed. We're roughly halfway through with that. We think that's working well. We're dollar cost averaging as we go, and we're doing it in a methodical way, without influencing the market. So we are committed to continuing that.

And then we'll step back with the Board and have discussions at the end of that program based on our balance sheet at the time and other opportunities we have for investment, keeping this balanced capital allocation strategy as our foundation and see what makes sense at that time.

Great, thank you very much.

Jeff Hammond, KeyBanc Capital Markets.

So on the sealing business, and I guess just looking at the legacy sealing ex-GST, you guys put up your best-margin quarter since 2013, really against the backdrop of declining sales. So I just want to understand better what's changed 1Q to 2Q to kind of drive that 500 basis points of margin improvement sequentially.

Yes. So, Jeff, your question is if you look at it on a consolidated basis as opposed to a pro forma basis. There are a couple of things. If you look at a lot of the volume, big part of the volume weakness we had in the quarter came from GST, which -- so you see a more significant year-over-year change in volume when you look at pro forma than if you look at consolidated.

But we had a pretty strong -- we've had a bright spot in the pipeline part of Garlock. So the part that is part of our consolidated results, the midstream oil and gas business, the project work has been stronger on a year-over-year basis. So we are benefiting from that.

Granted we did have a reduction in overall volume. We've worked hard, as you know, on cost containment. And while most of our restructuring to date, at least until the recent initiative, were focused on engineered products. We have had some restructuring activities in sealing products. And so we are seeing the benefit of that.

We did have one item where we benefited in the quarter this year from a settlement we received on a product patent infringement case that we were defending -- we were pursuing, actually, because the trailer tail business that we acquired -- we had a competitor in the marketplace who was infringing on our technology. And we did realize a settlement in conjunction with that case in the quarter.

And while I don't have the kind of the impact of what that would be on a consolidated basis on margins, if you look at the pro forma margin expansion for the quarter of about 120 basis points, that affected that. About a third of that pickup in margin expansion was related to this patent infringement outcome.

Okay, that's helpful. And then just back to power systems, you mentioned that the high mix of aftermarket, and you kind of had a low first-quarter on the margins -- how should we be thinking about the margin trajectory in that business into the back half?

Well, as Steve mentioned, we don't expect the record parts month and quarter that we had to continue. So we would expect the balance of the year for power systems on the parts side to be more in line with our typical average. So given that, we're not going to have same mix in the second half of the year that we had -- certainly than we had in the second quarter. So we would expect margins to be lower in the third and the fourth quarter than what you saw in the second quarter. So it's important when you look at the model to keep that in mind.

I think there's also -- Jeff, you know, we haven't really talked about this, so there's no way you would know it or anybody, and it's kind of so difficult to quantify we really haven't talked about it much. But yes, the EDF contract is extremely demanding. They are the most demanding customer we've ever served. And we -- as you know, we have sold a lot of engines over the years, both to the US Navy and to the domestic nuclear power industry.

But EDF really sets the global standard, to be honest with you, for rigor around the procedures, and inspections, and all the documentation required to put together an engine reliably -- far exceeded our organizational capability to do that in the beginning. And so as we have been working hard to deliver the first actual production unit for EDF, it has really been a significant drain on the organizational resource at Fairbanks.

Probably I would take it back to the second half of last year and, really, through the first half this year. And it's kind of -- we're now at the point where that engine has either shipped or is going to ship in another day or two, but it's ready to go. EDF has approved it, so forth and so on.

So we've been really climbing up a very steep learning curve at Fairbanks. And that has -- while, again, it's not necessarily -- it kind of affects the whole shop, because it affects the organization; it puts stress on the organization. So I'm really hopeful that -- and then, of course, on top of that, the stuff you do know about, which is we've had all this currency issue with respect to EDF and having to do the full contract accounting with -- anytime the damn currency changes, or our projection of the cost, frankly, to do the engine changes. We've got to look forward through the multiyear contract and bring that all back and book it now, because we are in a loss position really because the currency dropped so dramatically.

So it's been a challenge for the organization. And it's my view and hope that we're pretty much -- we've broken the back of that problem. As I said, we shipped the first engine or it's being shipped this week.

And from this point, only got 20 some-odd engines more to build there, and they're all exactly the same. And I think we're going to benefit from the learning curve going forward, hopefully. We're certainly not counting on this, but hopefully we might get a little bit of strengthening in the euro, which would obviously unwind some of that loss provision that we've taken, because the quarter ended at -- you know, EUR1.11 I think is what we finally booked the incremental loss at. So anything over EUR1.11 to the dollar, that provision would unwind a little bit.

That kind of might help you get a little bit more color on what's going on in power systems. But I've got to tell you, the EDF win was huge for us. It was a very big, high profile contract. And like many things in life and in business, when you really attack a very, very difficult problem, it really makes you better. It's made our organization at Fairbanks so much better and more capable; I can't even describe that -- which will position us very well for deeper penetration into the commercial market as the OP2 engine is beginning to hit the market.

While I'm on the OP2, nobody is probably going to ask me a question about that, so I'm going to talk about it. We actually were up there last week. We had our Board meeting in Beloit last week and saw the new engine running and heard the R&D team up there report on results.

It's going to be a winner. I'm just very excited about it. The Board is excited about it. This is going to really reshape the competitive profile of Fairbanks going forward into the future. And as we have talked to everyone about in the past, our intention in power systems is to strengthen our position with the US Navy and Coast Guard, with the US government marine market, which has been our legacy business. And I think the TAO program really solidifies that even further.

There is other major programs that we are working on winning as well, but we want to supplement that base, expand our addressable market, with aggressive pursuit of the commercial distributed power market. And we believe now -- we're gaining more confidence all the time -- we are actually going to have a product that is unique and highly, highly competitive in that space. So when you combine that with what we've learned organizationally, and the productivity improvements that the workforce has been able to put in place up there, really driven by the EDF requirements, I'm pretty excited about the future of Fairbanks. And that's not new. That's been a consistent theme I've been talking about for months now.

Okay. Very helpful. Thanks, guys.

Joe Mondillo, Sidoti & Company.

My first question I just wanted to ask you -- relative to some of your comments, Milt, regarding the multiple that you're getting on the stock and relative to sort of your thinking on the consolidation with GST over the next year and such -- just wondering what, if at all, risks are there with ACRP?

Well, let me address that, Joe. I'm closer to it than Milt. Now that the judge has issued the order approving the disclosure statement, the voting procedures and so forth, and setting the date, at this point the major risk would be if we had a third party that came out of somewhere that tried to enter this case as an objector, and they would have to do that also by the end of the year, essentially, to be valid. Now, nobody has done that yet. We've got no indication that anyone would do that.

And in past cases -- you know, W. R. Grace is the perfect example -- there were a number of legitimate objectors in that final confirmation, including us, including Garlock, as well as the city of Libby, Montana, and many, many others that were impacted by the Grace settlement. And during that time, the District Court essentially threw all those objectors out, basically said, I'm going to confirm this plan -- including us. Said Garlock didn't have standing in the case.

And so our view, our legal team's view, is at this point for an objector to come in -- first of all, we don't see where they would come from. A lot of times it's an insurance company that comes in and objects to these things. But in our case, we don't anticipate that, based on where we stand with our insurance companies.

And there's really no other debtors involved in this thing, or there's no other -- you know, there's no other -- we don't owe anybody else anything. So there's no -- this really not -- there's no other contentious party, I guess I should say. And if somebody did come in, they would be coming in so late in the game. There's been so much work done in cases you know that have been going on for years that it would be surprising if they were given much legitimacy in the process, to be honest with you.

So our view is that at this point, we feel pretty darn confident that we're going to be able to march through this. The date has been set. We've been ordered by the Court to start the confirmation hearing, as I said, in May of next year. So that should be relatively straightforward. And once we get that, then the district judge has to overall approve the whole thing.

But I just -- I think we're going to get it done. There's no other bankruptcy case that we can point to, asbestos-related bankruptcy case that we can point to, that got bogged down at this stage, other than -- Grace was most bogged it down of all of them. It took more time to march through it, but it still got done. So we've a high degree of confidence that it's going to get done.

That's why we've really shifted all of our tone in reporting and communication to be around pro forma numbers, because we believe that that's -- I know that's the Company we've got, right? There will be rounding error in terms of what the final -- what we get from the Canadian thing is not 100% set yet and different things. That's going to be rounding at the edges. We know what we're facing here.

So I feel as confident as I could be at this stage, particularly with the judge's order essentially last Friday. Took us a little bit longer to get back over the goal line than we had hoped. But now that that's in and the scheduling order has been issued, I think we're pretty much locked and loaded.

Okay, great. Thanks. That's very helpful, thanks.

Yes.

Regarding the $20 million of restructuring, I'm just wondering -- if you could quantify it, that would be great. But at least maybe you could steer us in the right direction of the weighting of where that's hitting amongst the three segments in the corporate line?

Hold on. Let's get a piece of paper here, Milt. That's a good question. We hadn't anticipated that, Joe.

We have -- I can give you kind of a rough approximation.

And while you're looking for that, was there any restructuring being done in the second quarter that you didn't realize fully the benefit from? Other than this new $20 million of --?

No, I think the vast majority of restructuring from programs that we've been working on, like the CPI deal, the GGB deal we talked about, other ongoing cost reductions in Garlock, and so forth and so on -- you would see pretty much the full benefit of that in Q2. But then, likewise, on the $20 million, we actually implemented it -- implemented the actions. Our goal was to get as much of it done and in place by the end of June as we could.

And so the lion's share of the action by far are in place, but the benefits didn't happen and, frankly, won't be fully in place even in Q3. That will be through the end of Q4. As you know, we when we did restructuring in the European markets and other locations where we operate, it's -- A, it's more expensive; and, B, it takes a longer time. There's more of a legal process to go through. It takes more time to get it done in Europe. And so that's really what will cause it to spill into Q3 and Q4 in terms of the restructuring charge that Milt indicated, right?

Okay.

So none of the $20 million is in. And that $20 million is on a run rate basis. In Q3, I would guess we'll see 70% of (multiple speakers) do you think?

70% to 80%.

Yes, maybe 80% of it. And then Q4, probably 90%, and -- or maybe even higher in Q4.

What remains -- this is Ken, Joe -- what remains is really the European piece. All the other actions have been completed. So it's really just working through the European parts of our business, which is GGB and CPI for the most part.

Okay. I assume you're still trying look for that number?

I can give it to you kind of roughly. This is directional. We'll see a big chunk of it -- 45%, roughly, somewhere in that range, in sealing. Then engineered, roughly 20%; roughly 20% in power systems, a little bit more than that. And there's kind of 14% or 15% of that amount at the corporate office. I don't know if those add up to 100%, but that's almost.

Okay.

I hope it's good enough.

All right, no, that's good enough factor, thank you. Lastly, I wanted to ask you, regarding sort of the year-over-year comps in terms of revenue for the sealing and engineered products segment -- just wondering, do the -- I mean, I know the comps do get a little easier in the back half of the year, but then you're also talking about how maybe, you know, heavy-duty trucking it seemed like got a little weaker sequentially in sealing.

So I'm just trying to get an idea of how you are thinking about revenue in the back half of the year in terms of the year-over-year comps? Mainly at the sealing segment and the engineered products segment, because it seemed like in the sealing segment, things did get worse sequentially year-over-year at sealing as well as, I guess, engineered products. But do they get better? Do the year-over-year comps start to get better in the back half, or how are you thinking about that?

This is all on a pro forma basis. I think if you look in the second half of the year, what we expect to see this year compared to the second half last year, we're going to be down. Our volumes are going to be down.

It'll be some of the same factors that we've discussed this year, because, remember, the second quarter of last year we were starting to see weakness in our markets. So in the second quarter of this year, even though Q2 2015 was weak, we saw some further deterioration, as we've been talking about throughout this year. So I expect we're going to see that.

And I believe a chunk of it will be in heavy-duty because there's some of the trends we're seeing there. But we'll see. So that is sealing. And then engineered -- engineered, we believe we will be maybe flat to slightly down compared to the year ago. And the dynamics are just a little bit different in that segment versus sealing. So that is a general direction there.

Okay. No, that's exactly what I was wondering. Thank you. Appreciate it for taking my questions.

Justin Bergner, Gabelli Company.

Thank you all for taking my questions following a pretty good quarter. First question -- I have a couple of quick questions here. Within your pro forma sealing products business, it might be helpful just to remind us the breakdown within oil and gas between upstream, midstream, and downstream?

There's not much upstream, and there's certainly not much left. We had some product lines that we sold into upstream that, I mean, it's off over 50% from its peak a year and a half ago. I think the amount that we have left in upstream -- upstream has got to be very negligible for the segment. And then I would say kind of midstream and versus downstream, I'd still say it's kind of 50%/50%.

Our overall direct oil and gas exposure, I think, for the segment was roughly -- for the Company was roughly 12% or 13%.

Right.

I don't know if Ken or Steve -- I don't have the data in front of me -- have it. Justin, you could follow up with either me or Chris after the call, and we can give you what that percentage exposure is specifically for sealing products segment. I just don't have it in front of me right now.

Yes. I was giving you my estimate, Justin, for sealing products. Because in engineered products, it's all CPI, and that is probably more 20% midstream and 80% downstream.

Okay. That's helpful, thank you. Different dynamics for different parts of the oil and gas market these days.

No question, no question.

I know that you don't want to specifically quantify what the raw materials benefit was to the second-quarter sealing products margins, but when we look at sort of the first quarter and the second quarter combined on a first-half basis, is it safe to assume that the margin level in sealing products will look similar in the second half to the first half?

Yes, I think that's a reasonable estimate.

Okay, great. And then switching to power systems, did any of the business in this new contract supplant existing business in your Fairbanks Morse business? Or is this all incremental?

You're talking about the new engines -- the TAO program?

Yes, the new engine contract.

Oh, it's all replacement. We benefited in -- if you go back to the period of, let's call it, 2008, 2009, 2010, 2011, and 2012, we benefited by a large wave of new engine builds for the Navy. They were building a lot of ships.

And then I think we shared with folks that have been following us for over -- consistently over a long period of time that that kind of -- we were going to have a lull in that, a significant lull, in new ship for the Navy engines in the 2015, 2016, 2017 kind of window. Really 2016 and 2017, primarily.

And that, in fact -- I mean, we saw that coming because the next wave of new ship programs that the Navy was working on, like the TAO program, like LXR program and others, and the new offshore patrol cutter for the Coast Guard and so forth are all things we're working on. We obviously won the TAO program. But those are the -- that's the next wave of government ships that will happen beginning in 2017, 2018, 2019, in that time period. So it's important for us to win these programs, to have that base of business that we have enjoyed in the past.

Now, obviously we have the aftermarket parts benefit for all the engines that we put in the field in the -- you know, earlier in the time frame that I mentioned. But the way -- the nature of this business works in the government is we get on a program. And however many -- typically, however many ships that are built in that program, you know, they don't redesign the ship and engine and power propulsion system for every -- they just build multiple ships that are the same configuration.

So once you're on the program, you pretty much stay on the program through the life of it. But once the program is over, that's it. The volume is gone. And you've got to win the next one that follows on behind it.

And that, of course, is lumpy. It's not a constant -- the Navy is going to spend so much on -- you know, the Navy budget remains relatively constant, but how much of that money spent on new ships, and what type of ships, and whether the ships take our engines or not are all up in the air. So I would say all of the Navy stuff will be replacement, depending on what period you look at. Obviously, it's new and incremental relative to last year and where we are today.

And as I think Steve -- well, Steve said this, but I just want to reiterate one point, and it goes back to Dan's comment earlier, a question earlier about the profitability impact. When we win the programs, we are really seeding the future aftermarket. And that is -- that part will have in future years a significant impact on our business and profitability.

Great. Thank you for that perspective. One more which I think will be of benefit to people on the call, and then I'll follow up offline with respect to other questions. But you mentioned that the guidance for 2016 excludes the legal costs associated with the power systems lawsuit. I just wanted to verify that was the case and understand where those costs show up in your financial reporting?

That was in our segment results in Q1, and it was about a $2.7 million charge that we recognized in conjunction with that. And that was in power systems.

Okay, and there won't be further charges as the year progresses?

No.

Not for that. Nothing that we know about, Justin. There's always the stuff we don't know about, but we don't see anything on the horizon.

And the reason we separated that out is because I was referring to adjusted EBITDA. And as you know, we don't adjust out for these legal things, even though that was a big one. We don't normally see things of that size.

But we wanted to stay consistent with how we've always reported adjusted EBITDA, which only adjusts, really, for restructuring and legacy environmental stuff and discontinued ops-related things. So that's why we called that out special, to be consistent, because it's not normally in the adjustments we make.

Got it. Okay, thank you for taking all my questions.

Okay.

And there are no further questions at this time. I'll turn the call back over to Mr. O'Neal.

Thank you, Kelly. And thank you all for joining us this morning. If you have any additional questions, please give me a call at 704-731-1527. Have a good day.

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