Enpro Inc (NPO) 2017 Q2 法說會逐字稿

Good morning. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries 2017 Second Quarter Results. (Operator Instructions) Thank you.

Chris O'Neal, Senior Vice President of Strategy, Corporate Development and Investor Relations, you may begin.

Thank you, Krista. Good morning, and welcome to 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. Steve MacAdam, our President and CEO; and Milt Childress, our Executive Vice President and CFO, will begin their review of our second quarter performance and our outlook in a moment.

But before we begin our discussion, I'll point out that you may hear statements during the course of this call that express the 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 our Form 10-K for the year ended December 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 on 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 deconsolidation of Garlock Sealing Technologies, or GST, and OldCo, LLC, or OldCo, during the periods ended June 30, 2017, and 2016 and pro forma illustrative financial information presented as if GST and OldCo were reconsolidated for financial reporting purposes during these periods. 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 in the last few quarters, we are providing pro forma segment sales and pro forma segment adjusted EBITDA information in conjunction with GST and OldCo's joint plan of reorganization, which was consummated and became effective earlier today to provide investors with additional pro forma information illustrating each segment's results as if GST and OldCo had been reconsolidated with EnPro during the reported periods. Given the consummation of the joint plan and due to requests from investors for this type of information, we believe this disclosure of pro forma operating results is instructive to investors as it reflects the performance of all of our subsidiaries.

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

Thanks, Chris. Good morning, everyone, and thanks for joining us today. We had an active second quarter with solid year-over-year demand in a number of our markets and an exciting new acquisition in our Sealing Products segment, and happily the courts final approval in the 7-year old asbestos claims resolution process.

I first want to highlight that our businesses performed very well on a year-over-year basis, despite a 1.5% decline in pro forma sales. If we just look at Sealing Products and Engineered Products on a normalized basis, which adjusts for year-over-year differences in foreign exchange translation and acquisition results, pro forma sales would have been up approximately 2.3% and 4.5%, respectively. The growth was offset by the expected sales decline in Power Systems that was driven by what were largely timing issues and tough year-over-year comparables related to record aftermarket parts sales in the second quarter of 2016; our recent investments in commercial, operations and innovation capabilities that helped us to capitalize on the improved demand patterns in Sealing Products and Engineered Products.

Pro forma adjusted EBITDA increased 1.9% year-over-year due to 5 factors: first, volume increases in Sealing Products and Engineered Products; second, the positive impact from company-wide cost reduction and restructuring activities that occurred last year and early 2017; third, favorable effect of currency on Power Systems' EDF program; fourth, contribution of our acquisition of Rubber Fab in April of last year; and finally, to a smaller extent, our acquisition of Qualiseal, which impacted the final month of the quarter.

In the second quarter, several of the markets we serve maintained the momentum that started in the first quarter of this year. We experienced strength in semiconductor, food and pharma, metals and mining and general industrial. The general positive market momentum was offset by lower engine and aftermarket parts sales and continued softness in nuclear, industrial gas turbine, and to a lesser extent, heavy-duty trucking.

The column at the far right of Slide 5 provides directional guidance on how we currently see our end markets performing on a year-over-year basis through the second half of 2017. As you can see, we expect continued strength in semiconductor and food and pharma and modest improvement in metals and mining and general industrial. We expect heavy-duty trucking to remain weak but stable, and nuclear and industrial gas turbines to be soft.

Before turning the call over to Milt to discuss our financial results in more detail, I want to discuss some positive developments from the second quarter including the exciting completion of the ACRP, positive developments from recent investments in our commercial and innovation capabilities and a brief overview of Sealing Products' recent acquisition of Qualiseal.

As you might imagine, we're extremely excited about the completion of the ACRP, and I want to take a moment to celebrate this important milestone in EnPro's history. As of this morning, the ACRP joint plan of reorganization was consummated and became effective. GST and related entities have been reconsolidated with Garlock for financial reporting purposes and will be reflected in our consolidated results starting in August of this year. This follows the bankruptcy court's recommendation and the district court's approval in the second quarter and represents the successful culmination of many years of dedicated effort to resolve the asbestos burden that has weighed on our company since our founding in 2002. We're thrilled to have this process completed and are looking forward to an asbestos-free future. We're grateful to all those, including our employees and our outside lawyers and consultants, who have worked so hard to achieve this outcome and to our board and shareholders who supported us throughout this effort.

As we've discussed before, improving our commercial and go-to-market processes has long been a significant focus across our segments, and we've maintained our commitment to drive growth through continued investment in these capabilities. I want to briefly highlight 2 initiatives that exemplify our efforts. First is an example of how we strive to create organic growth after we acquire a company. In the second quarter of 2016, we acquired Rubber Fab as a platform for Sealing Products' growth in the food and pharma market. The Rubber Fab investment case included Asia as a key area of focus for growth, and since the acquisition we've been working aggressively to expand our distribution network to reach the Asian market. We now have 40 additional authorized food and pharma product line distributors throughout Asia that are ramping up and contributing nicely to our growth in this market, and we expect this momentum to continue.

Another example is in the Engineered Products segment. GGB, which is our plain bearings division, developed a new commercial channel to market with the launch of its e-commerce platform, the GGB Webstore, at the beginning of 2017. The web store provides an improved customer experience and ease of ordering with 24/7 availability while lowering GGB's cost to serve customers. Initially, the website is targeting small industrial and distribution customers, but the platform will expand to serve as a channel for all customer segments. Since the Webstore's launch, GGB has experienced increased order volume, increased customer satisfaction and greater efficiency in its customer service groups. These are just 2 relatively small examples, but they're representative of the large number of investments across all parts of EnPro to build our commercial capability.

I also want to take a moment to highlight 2 recent initiatives that illustrate our continued commitment to innovation across the company. First, Sealing Products recently opened a new state-of-the-art facility to manufacture brake friction components for medium- and heavy-duty trucks. The 43,000-square foot facility, housed within the existing Rome, Georgia facility, is outfitted with the latest technology and highly automated state-of-the-art equipment that optimizes product consistency and significantly helps to eliminate air and waste in the production process. In addition, we've invested in the development of several new friction material formulations that increase the life of brake friction and reduce brake noise.

Second, our marquee innovation investment is, of course, the OP 2 diesel engine development in Power Systems. As you may recall from prior discussions, our Power Systems segment is developing an exciting next-generation opposed-piston engine that we had referred to as the OP 2.0. We recently chose a name for this industry-leading engine, which we will market as Trident OP going forward. The team made great strides in the second quarter in preparation to commercialize the product later this year. Recent performance testing validated our belief that Trident OP has the best fuel efficiency of any engine in its power class. Depending on a customer's usage requirement and prevailing fuel cost, this advantage results in a fuel cost savings of several hundred thousand to over $1 million per year, creating a very compelling value proposition for our customers. Endurance testing on -- the endurance testing phase on the engine has begun and is expected to continue for several months. We are confident that Trident OP represents a significant growth avenue going forward, and we're excited about the commercial launch later this year.

Finally, we completed a highly strategic acquisition in the second quarter to augment our aerospace business in Sealing Products. On May 31, we closed on the acquisition of Qualiseal Technology, a manufacturer of highly engineered mechanical seals and precision components primarily for aerospace applications. The acquisition expands our presence in the aerospace mechanical seals market and adds several attractive complementary product lines to the portfolio. This expanded product suite and the advanced manufacturing capabilities afforded by the acquisition will help us grow in the aerospace market. Qualiseal has an exceptionally strong team and I would like to publicly welcome them to the EnPro family.

Now I'll turn the call over to Milt.

Thanks, Steve. As discussed before, the pro forma segment results that I'll discuss are prepared as if GST and OldCo had been reconsolidated on the basis described in our earnings release. 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. It's important to note that the pro forma results do not represent the financials as of today's reconsolidation.

Our pro forma second quarter sales of $347 million were down 1.5% from the same period of 2016. As Steve noted, excluding the impact of foreign exchange translation and acquisitions and divestitures, pro forma sales in our Sealing Products and Engineered Products segments were up 3.2% and 4.5%, respectively. This strong performance was more than offset by pro forma sales decline in Power Systems due to lower engine and aftermarket parts sales versus last year.

Pro forma gross profit margin for the second quarter was 36.3%, up 30 basis points from the second quarter of 2016.

Total pro forma segment SG&A declined in the second quarter of 2017 by $3.3 million to $78.6 million. Company-wide cost reduction and restructuring activities that occurred throughout 2016 and early 2017 continued to contribute to year-over-year improvement in the second quarter.

Pro forma adjusted net income, which adjusts pro forma net income for items such as restructuring, legacy environmental reserves and tax effects associated with these items, all is shown in the reconciliation table in our earnings release, was $22.1 million, down slightly from prior year due primarily to higher interest expense.

Pro forma sales in the Sealing Products segment were $229.7 million in the second quarter, up 2.9% over the second quarter of 2016. Excluding the impact of the Rubber Fab and Qualiseal acquisitions, the Franken Plastik divestiture and foreign exchange translation, pro forma sales were up 3.2% in the second quarter. This year-over-year sales increase was due to strong demand in semiconductor, food and pharma, metals and mining and general industrial markets, partially offset by modest declines in aerospace and heavy-duty trucking and more significant softening in nuclear and industrial gas turbines.

Pro forma segment adjusted EBITDA, which excludes the impact of restructuring and acquisition expenses, was $45.6 million, up 2.5% from the second quarter of last year. Pro forma segment adjusted EBITDA margins remained flat with the second quarter of last year at 19.9%.

Pro forma segment SG&A costs were $49.9 million in the second quarter versus $49.6 million in the prior year.

In the Engineered Products segment, second quarter pro forma sales of $75.8 million increased by 2% from the second quarter of '16. Excluding the impact of foreign exchange translation and a small divestiture, pro forma sales were up 4.5% in the second quarter over the prior year. This year-over-year sales increase was due primarily to strength in the general industrial market and slight increases in aerospace and automotive. North American oil and gas demand increased year-over-year while European oil and gas markets softened.

Pro forma segment adjusted EBITDA of $13.3 million increased from $10.9 million in the second quarter of last year as a result of increased volume, improved manufacturing efficiencies and the continued positive impacts from cost-reduction efforts and restructuring activities that occurred throughout 2016 and early this year. Pro forma segment adjusted EBITDA margins were 17.5% in the second quarter versus 14.7% in the prior year. Pro forma segment SG&A costs were $21.8 million in the second quarter compared to $24.3 million in the prior year.

In the Power Systems segment, pro forma sales were $42.5 million, down 23.4% compared to the second quarter of 2016. As previously mentioned, the sales decline was due to lower engine sales, driven by the timing of production for several key programs, the timing of aftermarket parts orders and tough year-over-year comparables for aftermarket parts as Power Systems had record parts sales in the second quarter of 2016.

Pro forma segment adjusted EBITDA for the quarter was $7.7 million, down from $9 million a year ago. Pro forma segment adjusted EBITDA was impacted by the aforementioned sales declines, partially offset by lower SG&A costs. Additionally, Power Systems recorded a net $3.3 million positive adjustment related to the EDF contract during the second quarter of 2017, driven primarily by the strengthening euro.

As a reminder, GAAP rules require that we evaluate the impact of the dollar to euro foreign exchange rate on the EDF contract each quarter.

Pro forma segment SG&A costs were $6.9 million in the second quarter for the segment compared to $8 million in the prior year.

As we've discussed in the past, we're committed to a disciplined and balanced allocation of capital and maintenance of a strong balance sheet as we drive long-term growth and shareholder value. In the second quarter of 2017, on a pro forma basis, our capital expenditures for equipment, facilities and software were $9.2 million, much of which was growth oriented.

As mentioned previously, we acquired Qualiseal Technology, a manufacturer of mechanical seals for aerospace applications, as a strategic bolt-on within the Sealing Products segment.

Additionally, we paid a $0.22 per share dividend, totaling $4.7 million in May and repurchased approximately 86,000 shares for $5.9 million as part of the ongoing $50 million share repurchase program. Through the end of the second quarter of 2017, we had repurchased approximately 874,000 shares for a total of $45.5 million under the $50 million authorization.

As in previous quarters, we outline on Slide 17 our pro forma net debt and leverage ratio prepared as if reconsolidation and initial trust funding had occurred at the end of the second quarter under the terms of the joint plan of reorganization that was consummated earlier today. Prepared on this basis, our pro forma leverage ratio at quarter end was approximately 2.1x in contrast to the 4.7x leverage ratio indicated by our consolidated balance sheet. This pro forma leverage calculation does not include tax benefits of the planned funding that we expect to realize over time.

Subsequent to quarter end, on July 28, we used available cash and borrowings under our revolver to fund $400 million to the asbestos trust. We will also be paying $16.8 million to complete the Canadian settlement portion of the ACRP on or prior to August 12. Lastly, we anticipate funding the final $80 million payment to the asbestos trust in July of next year, but we may accelerate the final payment if it becomes more tax efficient to do so.

As we provided during the last few quarters, we are including an update of our pro forma valuation relative to EBITDA. As shown on Slide 18, our pro forma enterprise value to trailing 12 months pro forma adjusted EBITDA multiple at the end of the second quarter was approximately 9.2x compared to a multiple of 13.5x indicated by our consolidated results.

Now I'll turn the call back to Steve.

Thanks, Milt. We'll close with a discussion of current market conditions and our outlook for the remainder of the year and then take questions.

As we discussed many times in the past, we have limited visibility into future demand due to the short cycle and niche nature of most of our businesses. Most of our businesses have order lead times between a handful of days and a couple of months, and the component nature of our businesses largely obscures demand correlations with macro end market indicators. Notwithstanding this limited visibility, demand in many of the markets that we serve continues to show signs of stability, and demand in some markets such as general industrial and metals and mining has improved modestly. Accordingly, we remain cautiously optimistic that we will maintain our improved year-over-year performance through the end of the year. It's important to note, however, for Sealing Products and Engineered Products, we expect the second half demand to be lower compared to the first half of the year due to our typical seasonal patterns while Power Systems will have a stronger second half.

Given continued strength in a number of our markets, continued -- current economic forecast and customer order patterns, expected strength in the second half of the year in Power Systems and the recent Qualiseal acquisition, we're increasing guidance for 2017 adjusted EBITDA from our previous full year range of $193 million to $198 million to a revised estimated full year range of $200 million to $205 million. This revised range excludes the impact of further M&A activity, changes in foreign currency rates from the end of the second quarter, anticipated gain on the reconsolidation of GST and OldCo and any second half of the year litigation or environmental charges.

Just to reiterate, this guidance is based on our limited visibility into the second half of the year and demand levels that we've been experiencing recently.

Before I open the line for questions, I want to reiterate my excitement not only for our second quarter results, but also for the many growth initiatives that we have underway across our company. We are well positioned to drive growth in the value of our company as we emerge from the ACRP, and we look forward to an asbestos-free future.

And now we'll open the line for your questions.

(Operator Instructions) Your first question comes from the line of Ian Zaffino from Oppenheimer.

I guess the question would be given the better outlook, how has that sort of affected your maybe your view on kind of capital returns? And then also, M&A, are there some areas that you could go into now versus what you were thinking maybe 6 months ago?

Well, let me start with the second part of your question, Ian, and then Milt, maybe you can address the capital -- the use of capital. Yes, things are pricey in the M&A world, Ian, as you know and everybody knows. I mean, it's hard to find -- it's hard for us to find deals that are both strategic and reasonably priced. We did with Qualiseal. It's a great fit for us. Aerospace has been a key area of growth within Sealing Products of recent years. This fits literally hand in glove for us. I mean, it is almost the ideal product line for us to buy with a lot of synergies on product lines that we already have serving adjacent and similar applications, but not direct swap-outs for what we bought. So it's a really, really nice product line extension for us. So we still have other stuff in the pipeline. It's still too soon to call in the pipeline of what we will complete through the back half of the year. We have one smaller deal in Sealing Products, which we will close in Q3 most likely, but it's small and it's really more of a -- kind of a start-up plant acquisition. And so rather than us building the plant and starting up a line, we're kind of buying a plant that has a product line that we want, but it's not enough to move the needle one way or another. But other than that, we don't have anything that I would say is imminent. And I don't think our posture has really changed given the outlook of markets. We're kind of looking at it the same as we have in the past, which is we want really good strategic fits, and we don't overpay for them. So that's basically how we think about it. But Milt, why don't you pile onto that?

Yes. Ian, with our improved earnings, we obviously are seeing a corresponding improvement in our return on invested capital because our investment profile remains fairly consistent with what we had planned for the year. So to your question about returns, we would expect to see some improvement that's consistent with our improving earnings outlook. Just to add on one other thought, we outlined in our Investor Day earlier this year what our plans are for the business, our approach on capital allocation. And now that we're reconsolidated and we have the asbestos chapter behind us, our intent is to continue to proceed along the path that we have for a very strategically oriented -- we are a very strategically oriented team, and we'll have more capital. So we hope to, over time, to increase the level of investments we're making, both internally in our innovation programs as well as strategic bolt-on acquisitions. So we're very excited about the reconsolidation and the additional flexibility it gives us going forward.

Your next question comes from the line of Jeff Hammond from KeyBanc.

So just on Power, just want to understand the moving pieces a little bit better there that maybe impacted 2Q. And then how should we think about second half growth, either by first -- versus first half or year-on-year and kind of where the margins shake out?

Yes. Milt, I'm going to let you address the outlook. Let me give you, Jeff, just a little bit of flavor for it. Even though we are percent completion, so it levelized it somewhat, just to give you a sense, we're going to ship 4x more engines in the second half than we did in the first half, maybe more than that. I mean, it's a dramatic increase. Now we are percent completion, so it dampens that somewhat. But we've got a lot of programs underway in the shop and we will -- and it will be less dominated by EDF in terms of the percent completion in the second half as the first half. So the change in the top line we tried to guide you all to that for this quarter was kind of exactly what we expected, maybe a little bit under on aftermarket parts. But again, we had a record in Q2 of last year, so nothing concerning -- our service revenue was actually up. So it was a very solid quarter for Fairbanks. It's always going to be very kind of -- variable from quarter-to-quarter from our stance because of the volatility of shipments of new engine. So we're really confident in the second half outlook for Power Systems. But Milt, let me let you add to that.

Yes. Okay, just to kind of set the playing field a bit. Jeff, as Steve has said, we do expect higher revenues on engines in the second half for 2 reasons: one is the percentage of completion of additional revenue that we expect, plus the shipment of the MOX engines. We've talked about that in the past. We did not recognize any revenue on the MOX engines in Q2. We expect to recognize about $10 million of revenues. Those were accounted for under completed contract in the second half of the year. And as you'll recall, those are at 0 margin. So the fact that we will have $10 million of revenues in the second half of the year, it'll show up in the top line, but it'll obviously have a negative impact on our margins in the second half of the year for that part. And so kind of the real key for us in terms of your question about margins for the second half of the year is going to be where we end up with aftermarket parts. We have a pretty good read on the engines side, as Steve noted, and as I just mentioned, both with MOX as well as percentage of completion on a number of new engine programs that we have underway. The aftermarkets, obviously, is a big driver of our margin that we end up with in the second half of the year. So we're expecting, as Steve mentioned earlier, the second half of the year in Power Systems to be stronger than the first half of the year. We had the benefit in the first half of the year, so when you look at margins, we had the benefit from currency going with us in the first half of the year. We had indicated on the first quarter that, that had a positive impact of, I think it was roughly $1.5 million in the -- $0.5 million excuse me, $0.5 million increase in the program in the first quarter and it's about $3.3 million increase in the second quarter. So in our reported segment margins in the first half recognized the benefit of that. In the second half, given the outlook that we're providing, since it's based on exchange rates in effect at the end of the quarter, there's no assumption, up or down, on how currency might affect the EDF contract. So independent of that, we're going to expect margins, EBITDA margins, overall to be lower than they were reported in the first half of the year. But keep in mind, part of the reason they're higher in the first half of the year is because of currency, as I've explained. So revenue is up and margins down.

But overall, EBITDA -- overall, total dollars of EBITDA is up a fair bit, Jeff.

Okay. And then can you just talk about what...

Jeff, let me just -- let me clarify one point on that. If you exclude the EDF contract adjustments from the EBITDA in the first half of the year, then we expect the second half of the year EBITDA to be up considerably from the first half. I just want to make that one clarification.

Okay. So I guess, Qualiseal, can you talk about revenue and EBITDA, like what's the revenue run rate for that business? It looks like you paid $40 million for it.

Well, we haven't disclosed that yet at the time of the announcement. We indicated the number of employees to give some size. It's -- the revenues are under $15 million, so just to size it a bit.

Okay. Because it looks like you took EBITDA guidance up $7 million. It looks like, I guess, you would have had $3.3 million of the FX and then some contribution from Qualiseal.

Correct. And so our guidance, if you take those 2 things into effect, we brought it up modestly if you exclude those 2 items. And just as a reminder, our Q2 results came in slightly above what we had indicated on our Q1 call that we thought Q2 would be -- you might remember we had really strong year-over-year results in Q1. And we wanted to remind all of our investors on the call we had in Q1 not to expect the same year-over-year improvement in Q2 for a number reasons and we'd indicated that we expected our Q2 results to be about the same as Q1. And we ended up beating that a bit, and that's really the basis for bringing up our guidance for the full year a bit on top of the EDF contract and the Qualiseal acquisition impact.

Okay. Because if you look at the second half, it looks like you're calling for EBITDA to be slightly down year-on-year. So I just want to -- I didn't know -- I want to understand that a little bit better just because it seems like you've got pretty good momentum in Sealing and Engineered Products.

Well, Jeff, we do. We do have good momentum. We -- the order pattern seems the same. We've tried to be conservative in our guidance because we are such short cycle and things change pretty quickly in our world in terms of how order patterns look. But yes, we wanted to put a number out there that we're confident that we can achieve or beat, so that's what's reflected in the current thinking.

Jeff, if you look at what's embedded in our guidance currently, Jeff, we haven't talked specifically around corporate expenses. But if you look at our guidance, our segment EBITDA is up year-over-year. We're expecting some higher corporate expenses this year that offset and masked that a bit. So to Steve's point, our outlook does include improved performance segment EBITDA at the segment level.

Your next question comes from the line of Joe Mondillo from Sidoti & Company.

I just wanted to follow up just relative to the guidance and sort of focusing on the Sealing segment. Outside of the GST subsidiary, the Sealing segment sort of did a little weaker than I was anticipating. GST, the subsidiary, had huge margins, actually had a huge quarter. So if you take that out, the Sealing segment was actually a little weak and I'm just wondering what's actually going on there? I know you cited in the press release heavy-duty trucking, which shouldn't really be a surprise; nuclear, which, now that's a lumpy business, I think. But looking beyond that going into the back half of the year, the margins were sort of flat on the ex GST part of the Sealing segment in the first half of the year. Are you still expecting a seasonal -- why is it weak? And are you expecting a seasonal sort of drop-off still like you usually do in the back half of the year?

Yes, Joe, the reason that Sealing Products margins have been under a little bit of pressure and basically been flattish has been really 3 issues -- 3 markets, if you will. The first is trucking, as you said. The aftermarket, which drives the profitability, the aftermarket in our core wheel-end business has just been soft. I mean, we haven't lost position, but it's running a couple of percent below what it was a year ago. Other parts of the business are doing well. We're doing great in air springs. We're actually doing okay in OE, volume in all product lines. We're still struggling with the TrailerTail business, but that's not a whole different than it was last year. We've done a lot of stuff to try to right that. We're hoping to have a little bit better second half, but we still got a lot of work to do in that business. But most -- so trucking aftermarket has been just a little bit weak and the other 2 pieces in Sealing were nuclear. And anytime we see a drop in nuclear revenue, those are very nice margin products for us. So we don't see that improving a ton in the second half, might be a little bit better later in the year. We've got some orders that are due to ship before the end of the year, very significant orders of good margin nuclear stuff. That should be more helping next year than what we've seen this year. It varies a lot based on just nuclear facility refueling cycles around the world. So that's another one that has impacted that. And the third is actually the industrial gas turbine business where we sell parts into that. That has been week as industrial gas turbines have been under pressure globally. And then our largest customer, by far, our biggest customer in that business, is actually going through a major ERP conversion and so we believe that some of the orders might be a little bit bottled up there. But we're rightsizing that business. I don't expect the demand in the second half of the year to be that much better in that business, maybe a little bit, and our cost position will be a little bit better. So I don't -- the only thing that will happen second half in the core Garlock business is just the normal seasonal pattern, which as we approach the end of the year, gets a little bit slower. But if you look at what our demand patterns are for the limited visibility that we do have in Sealing, it's still, I would say, consistent with what we've seen the past, which is a few percentage points up on balance. But that explains a little bit more what's happening to those -- what happened to the margins in the first half of the year. These 3 areas that we've been hit with are all decent margins really so the mix, we get a little bit of a negative mix effect when that volume is down.

Were any of those markets changing for the worse throughout the quarter? Or is there anything lumpy or anything? Because the first quarter, you actually saw year-over-year expansion in margins and then the second quarter here we actually saw year-over-year decline in margins. So I'm just wondering...

No, I would say it's just that -- Milt, you can pile on, but my sense is it's just a general quarter-to-quarter volatility in the mix that we've had. But no, we didn't see -- if anything, trucking is -- I think -- we still think it's soft, but we think it's stable. Might be a little bit better in the second half than the first half, but not -- again, not enough to really -- nuclear will be slightly better, but very flat and still very weak relative to our normal history. And then industrial gas turbines, I think, will be more or less the same. So we don't see anything that's deteriorating on us at this point. But Milton, you want to address Joe's question about Q1 versus Q2 margins?

Yes. Well, Joe...

Really, the year-over-year comparison that's what I was referring to. The expansion of margin in the first quarter and then you saw year-over-year decline in margins in the second quarter.

Well, actually, it was flat. I'm not sure exactly -- are you looking at EBITDA? If you look at...

Well, I'm looking sort of excluding GST -- I'm excluding GST because GST is a huge corner.

Okay, okay. Yes, we look at it as the entire business so you're right. I mean, our strength in the quarter was really in our core Garlock business, and that's where we saw the year-over-year increase in metals and mining and general industrial. So we had a very strong quarter there. And Steve has, I think, has hit all the high points for some of the softness that we've had in other parts of the segment. But we're performing well. We don't have any major concerns in the segment. And we typically do have a softer top line in the second half of the year than we do in the first half of the year in the segment, so that will obviously have some impact on margins in the second half.

All right. I might have missed sort of the outlook when you were talking about the Power Systems. But aftermarket, is that a question mark? Or do you have a idea compared to the first half of the year how aftermarket parts pan out in the second half?

Yes. Steve, you want to take that? Or do you want me to...

Yes. No, go ahead.

Okay. Joe, last year, we kind of had the opposite of what we're seeing this year. Last year, we had a strong first half of the year in parts in Power Systems, primarily we saw most of that in the second quarter. So we had an all-time high, as a matter fact. We referred to it on the call as a tough year-over-year comp in our prepared comments. It happened to be an all-time quarterly record for us in terms of parts shipments in Q2 of 2016. This year, we -- it's reversed. We had a soft first half of the year and we're expecting a stronger second half of the year on the parts side. We're not necessarily expecting and don't expect to see the same kind of record quarter or results that we had in the first half of the year. But nonetheless, we do expect an increase in our parts revenue in the second half of the year.

Okay. Also I wanted to ask you relative to the Engineered Products segment, should we anticipate a typical seasonal decline sequentially in the back half of the year compared to the first half?

The answer is yes, subject to some of the limited visibility we have. And Steve, maybe you want to talk a little more about this, but we've got stronger order patterns going into Q3 -- or into Q3 than we typically have. So we're optimistic that we could see maybe the first half, second half differential being a little bit smaller than we've seen in the last few years, and as you know, in this business, we leverage quite well. So your question about kind of margins relative to activity levels in the second half is going to be driven in large part by how the rest of this quarter plays out.

Joe, that's essentially what Jeff was kind of circling around earlier. That's what's not reflected in our guidance, to be honest with you. In the second half of the year, we're assuming that we see the normal seasonal pattern, while, again, nothing's going to go wrong, but we just normally see things slowdown in the second half of the year to the extent that, that we break from that -- we won't break from that pattern completely, but there's a strong possibility that we will end up the year with a little bit less of a seasonal curtailment than we've seen in the past in demand in Engineered Products. We did not build that into our guidance on purpose because of all of our businesses, that is extremely short cycle, the entire segment, and it's very, very hard to tell. So even though our order book is decent even going into Q4, it's not been unusual in the past to have some of those orders late in the year actually get delayed and pushed into the first quarter of next year. So we thought it would be prudent to not count on that happening, so that's basically what's embedded in our guidance.

Okay. And then also, relative to the guidance, do you still have $38 million roughly going from $30 million last year of R&D expenses? Is that still the budget there?

That -- I guess, if you look at where we are for the first half of the year, we're going to be running a little bit behind that, but our current plans would call for us to be in that ballpark, Joe. Now the big driver there is the level of R&D spending that we have in Power Systems for the new engine and some of the timing of that -- that timing can shift a bit. So we would expect to be in the ballpark of the guidance that we provided, perhaps a little bit less.

Okay. And you have $38 million in the guidance?

Correct.

Okay. Also -- is there any way you can -- do you have any idea on the amortization related to GST yet? Or is it still too early?

I'm sorry, can you repeat that?

The purchase accounting amortization relative to the consolidation of GST, do you have any idea how much that is going to be quarterly? Or is it too early to put on that?

Yes, it's too early. We'll be recording with our -- the requirements of this reconsolidation, which is consistent with a large acquisition. We'll be filing, I think, it's within 75 days information. At that time, we'll have the final step-up of our PP&E and intangibles and goodwill and all that so -- and you'll see it by the time we report Q3 and our balance sheet in Q3 will fully reflect the final step-up in basis as well as indicate the final gain on the reconsolidation.

Your next question comes from the line of Ian Burke (sic) [Liam Burke] from FBR Capital.

Steve, can I ask just sort of follow up on your R&D discussion? How has the new product pipeline been in -- vis-à-vis the R&D budget?

Could you just clarify that for me, Liam?

Well, typically, on the R&D side, you come out with a series of product innovations, adjustments and changes and that drives, a, your pricing; and b, your competitive position. So just the sense you've had a lot of activities, so to speak, especially on the M&A side. How has that been going?

Well, R&D and -- did you mean R&D or M&A?

R&D, please.

Yes. No, we had been -- we've been -- if you -- I don't know if you want to look back at the Investor Day material, but the key is that our company, for the 20 years that preceded about 2 or 3 years ago, didn't spend much money on product development and R&D. We didn't really have a process. We didn't have the cash to fund it. A lot of the reason, since we've been EnPro, has been the asbestos lability. And before we were EnPro, it was driven by other issues. And so we have had to essentially prime the pump with our own R&D activity. And so when you look at the actual revenue that we're getting today from the level of spending that we've had in the last few years is very, very minor including OP 2, which is our largest investment, we haven't sold any and we're going to commercialize that engine later this year, and by the way, it's a winner. We -- I was with the team recently in Q2 where we actually showed the performance data of the engine to some customers for the first time. And again, we haven't broadly broadcast this to the industry yet. We're going to do that at the POWER-GEN show later in the year once we get more -- once we get some endurance testing under our belt. But some of our better customers, we actually showed the actual performance data that we've seen from the test stand on the OP 2.0, and I've got to tell you, this engine -- this is a big deal. Our customers referred to this as a "game changer." I mean, this is the most fuel-efficient engine in its class and the savings that customers can get is frankly phenomenal in fuel savings, right? So we're very excited about it, but then that's OP, so we've got no revenue for it yet. And then we've been also investing in a number of products in Sealing Products, a number of new products that will hit the market very, very late this year, early next year that we're excited about. And even the stuff that already is in the market is still very, very much in the ramp-up phase. So there's a lot more value that's going to be generated. In addition, I got to tell you, have everybody on the call still that the Power Systems segment is actually doing very, very well if you don't look at the current year financials because we're so bogged down with EDF and the MOX units and the development of OP 2 on the P&L. But we always knew it was going to be this way, right? When you look forward at 2019 and '20 and '21, this business is going to be doing phenomenally well because we have a fantastic backlog of government work. We're still working on additional backlog items of new engines. We're going to have the OP 2 in the market, and that's going to be a very, very exciting segment for us over the next 5 years. So I would say what you see in terms of the positive impact on the financials from the new products we've developed is very, very minor today compared to what we expect it to be in a few years.

Okay. And Steve, on the pricing front, is pricing relatively stable?

Yes.

Your next question comes from the line of Justin Bergner from Gabelli & Company.

I just wanted to follow up on the last line of questioning around OP 2.0 or the Trident OP. I just wanted to sort of understand what was incremental in terms of the development for the program in the second quarter versus sort of what was shared at the investor event earlier in the year.

Oh, nothing, just more confidence that, that's all real performance. And frankly, Justin, this feedback from the marketplace, when we came to the Investor Day, no customers had seen what we showed you guys. And so I don't know what it was, 6 or 8 weeks ago, we had a session where we had a number of customers in the room and we actually chose to share that and get some feedback on how we're thinking about going to market, their level of interest, so forth. And so our confidence really gained -- really grew in the commercial kind of viability of this engine platform. So that's really what changed. We're continuing to do development activity and run the engine. In the second half of the year, we will see more of the endurance testing activity that we talked about in the Investor Day.

Okay, great. That's good to hear. On the EBITDA guidance, you mentioned sort of the major changes, namely, Qualiseal better-than-expected performance in the second quarter and the EDF contribution. Are there other sort of second order effects, be it stronger Engineered Products margins, changes in your Power Systems outlook, the benefit of currency June 30 versus March 31? Are any of those factors playing a role?

No.

Justin, just to clarify on Power Systems, we were expecting this -- the first half/second half phenomenon so that's not -- we talked about that we're expecting a stronger second half of the year in Power Systems than we had in the first. That's not a change from where we were a quarter ago. It's just a matter of the patterns that we expected this year. So just to clarify that point.

Okay. But would there be a slight benefit from using sort of June 30 currency exchange rates versus March 31 in your new guide?

That's not -- no, the guidance clearly has baked into it June 30 currency levels. So yes, that is in our guidance number. What's not in there is the difference between the end of Q2 and today because, as you know, the euro has continued to strengthen from where we ended the quarter. So it's not -- the guidance does not include anything that's happened since the end of Q2. It's all reflected -- it's all based on what we saw at the end of June.

Okay. And so the organic sales guide seems relatively unchanged then versus prior?

That's a good assumption.

And we have no further questions in the -- I'm sorry, we do. We do have one more question. Your last question comes from the line of Joe Mondillo from Sidoti & Company.

I just had 2 questions. Number one, the legal expenses related to GST and such, where is that -- is that hitting the P&L right now? And...

It's excluded from our EBITDA numbers that we talked about. We've taken out everything that's related to the asbestos case.

And Joe, the majority of those had been, obviously, in GST. There has been some [impro-level] expenses if you look over the history. But as Milt said, most of those pieces are adjusted out when we give the adjusted number. But they're certainly in the real number -- I mean, in the reported consolidated number.

And are they in the GAAP operating income segment margins? Where do those hit?

Could you repeat that question, Joe? And specifically...

I'm just wondering what line item they hit on a GAAP basis.

Yes, let me check here. I don't know...

I can follow-up on that, that's fine.

Can you follow up with us on that? I just need to check.

Yes, not a problem. I just wanted to also ask -- yes, not a problem, I'll follow up. Just lastly, I just wanted to ask on the EDF contract, how much -- can you quantify how much left of that contract we have? The euro is at 1/18 now. If we keep appreciating, is there just going to be a consistent quarterly adjustment like we've been seeing? Or is there anything else in that contract that you'll see a positive benefit beyond the quarterly adjustments that we've been seeing the last couple quarters that will benefit if the euro keeps appreciating?

Well, where we end up on the contract can be a function of 2 things. It's currency, as you pointed out as well as our cost and efficiencies. And we're kind of working on that. We're getting into -- starting to get into fuller swing. So it's entirely possible that our production efficiencies could improve as we accelerate into the program. But those are the 2 drivers. So we're always looking at cost changes and currency.

So relative to the currency, though, I believe going back a year or 2, whenever that was when you wrote down the contract, the contract going forward was really not profitable. If the currency continues to appreciate, does that make the contract profitable? Or is that not how it works?

I'll tell you what, given the exchange rates right now, it's kind of hard to envision getting back into the profitability level for this contract. It becomes -- it would require a stronger and stronger euro as we go on because of fewer revenues that are left in the program.

Yes. But Milt, on a percent completion basis, remind me, we're about 1/3 of the way through the program. That's different from engine shipments, but on a -- a little less than 1/3, correct?

Yes. Cost-wise, Steve, we're over halfway just because...

All on the cost.

Yes, because of all the...

On the cost. Yes, okay. So -- but Joe, as you know, the reserves with the currency hit from a year ago, we're through the complete -- through the end of the contract. So you are right in the regard that any appreciation in the euro over time will be a positive adjustment like it was in Q2.

Right. Okay, okay. And then just lastly, related to EDF and more so sort of Power Systems, looking out to 2018, if I recall, I mean, you have 50% of this EDF. At the end of the year, I'm not sure where you're going to be at, but I was always thinking that 2018 was going to be sort of another maybe tough year compared to 2017. But do you expect maybe that 2018 could actually be a better year on a margin profitability...

You mean, for the -- are you talking about for the whole segment or for EDF?

For the whole segment, really.

Oh, yes, it'll be better. Next year will be better for the whole segment because we'll be, one, we'll be the line down on the EDF. Keep in mind, we've only shipped 2 engines. We got 27 to ship even though the costs were halfway where. So as Milt said, these are all the same kind of engines and so the factory, the team, is getting better and better at producing them in a consistent basis. We've got all that -- we've got 99% now of any of the very challenging requirements for EDF built into our system in terms of how we operate and so forth, right? So once we get to the end of the year, we'll be through that now. What could change also, which is likely to change is the schedule for delivery of EDF engines because the facilities that EDF is working on in France are not going to be ready as soon as the original or as the current engine schedule that we have. So there's a chance we'll make less engines next year and deliver them, although we're still cranking along as if we've got to ship them on the current time line. But EDF will be a smaller portion of the impact on Power Systems in '18 and '19 and we will see the beginning of the ramp up of some of the normal base of government engines that we've enjoyed historically. Basically, we won't be out of the cliff fully until '19, but we'll be coming out of the cliff in '18 so...

And Joe, to answer your previous question, we can go ahead and knock it out now. The ACRP cost would be in other expense -- other operating expense.

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

Thank you, Krista, 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 does conclude today's conference call. You may now disconnect.