Enpro Inc (NPO) 2017 Q4 法說會逐字稿

Good morning. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries 2017 fourth quarter and year-end results. (Operator Instructions)

I would now like to turn the call over to Mr. Chris O'Neal, Senior Vice President of Strategy, Corporate Development, and Investor Relations. Please go ahead.

Thank you, Michelle. Good morning, everyone, and welcome to EnPro Industries' quarterly earnings conference call. I'll 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; Marvin Riley, our Executive Vice President and COO; and Milt Childress, our Executive Vice President and CFO will begin their review of our fourth quarter performance and our outlook in a moment.

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 our Form 10-K for the year ended December 31, 2016 and our Form 10-Q for the period ended September 30, 2017. 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 the following. First, non-GAAP financial information; second, collective references to EnPro and our subsidiaries; third, the deconsolidation of Garlock Sealing Technologies, or GST, and OldCo, LLC or OldCo, during the relevant periods until their reconsolidation effective as of July 31, 2017. And finally, pro forma illustrative financial information presented as if GST and OldCo were reconsolidated for financial reporting purposes throughout 2017 and 2016 and the fourth quarter of 2016. These disclosures are important to understanding comments we will make on today's call and we urge you to read them carefully.

Consolidated results in the periods after July 31, 2017 reflect a reconsolidation of GST, its subsidiaries and OldCo as a result of the completion of the Asbestos Claim Resolution Process. Given that the fourth quarter of 2017 was the first full quarter in which consolidated results reflected all of Enpro's entities, we believe that investors will find comparisons of consolidated results for the fourth quarter of 2017 to pro forma results for the prior year period to be the most illustrative of the year-over-year performance of all of Enpro's businesses. Pro forma results for the fiscal years ended December 31, 2017 and December 31, 2016 reflect the performance of all of these businesses for these periods.

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

Thanks, Chris. Good morning, everyone. Thanks for joining us today. I'd like to start my comments today with a high-level summary of the status of EnPro. We've had a number of developments that are very exciting and that bode well for our company in 2018 and beyond.

First, we're experiencing very healthy demand in nearly all of our markets. This momentum is driving growth in our sales and EBITDA across all of our segments. Second, we have a robust pipeline of product innovation projects in each of our segments. These new product commercializations are beginning to contribute to our results and that will continue to bolster our growth over time. The most notable of these programs is the Trident OP engine that we're developing in Power Systems. We received great customer feedback and interest when we officially launched the Trident OP at the POWER-GEN conference in December. The engine's industry-leading fuel efficiency will save customers significant costs on fuel.

Third, the fourth quarter was the first full quarter in which our consolidated results represent all of the entities that we own. As you are likely aware, over the past 7 seven years we were forced to deal with persistent confusion related to the complexity of our financial reporting, due to our deconsolidated businesses as part of the ACRP process. Being able to report all our entities in our consolidated results is a significant milestone in resolving any lingering market confusion about the true financial performance of total EnPro. We also completed the funding of the Asbestos Trust in the fourth quarter. And aside from a small contingent true-up payment that may be due in the third quarter of this year, we're completely free of future asbestos-related liability.

Finally, in the last 2 years, as we've previously announced, we won a number of large Navy and Coast Guard engine programs. We're now through the softness in the U.S. government demand in this 2015 through 2017 period and we have nice robust backlog of engine and related aftermarket sales. In 2018, we're starting production in many of these programs.

I feel great about the state of our company. So many of the efforts that we've undertaken in the past 5 and even 10 years are starting to bear fruit and the future of EnPro has never been brighter. Now let's move on to a review of our fourth quarter and full year results.

We had a strong finish to the year with year-over-year sales growth in each of our segments. Excluding year-over-year differences in foreign exchange translation and acquisitions and divestitures, consolidated sales were up 11% in the fourth quarter over pro forma sales in the prior year. Excluding those same items, for the full year our pro forma sales were up a little over 4% compared to 2016.

Consolidated EBITDA was $48.6 million in the fourth quarter, up approximately 20% compared to pro forma results from the same period in the prior year, primarily due to volume increases across all segments, the positive impact from restructuring activities that occurred in 2016 and early 2017 and the favorable year-over-year impact of currency on the EDF contract. For the full year, pro forma adjusted EBITDA was $214.5 million, finishing the year above the high end of guidance that we provided in our third quarter earnings conference call, even when adjusting for the benefits of currency that we had in the fourth quarter.

In the fourth quarter we continued to experience favorable conditions in many of our core markets. Demand was strong compared to the prior year in semiconductor, aerospace, automotive, food and pharma, metals and mining, general industrial, heavy-duty tractor and trailer builds, nuclear and oil and gas. This positive momentum was partially offset by significant year-over-year decline in the industrial gas turbine market.

Power Systems experienced increased sales versus the fourth quarter of 2016, driven by higher engine and aftermarket parts sales. As you can see on the right-hand column of Slide 5, we generally expect these conditions to continue in the early part of 2018.

Before I turn the call over to Marvin to provide an update on Power Systems and our commercial and innovation efforts across the company, I want to discuss some positive developments from the fourth quarter, including the asbestos-relate trust funding and an update on our addressable market growth strategy.

As you know, we permanently closed the asbestos chapter in our company in the third quarter of last year with a consummation of the joint plan of reorganization. At that time, our only remaining funding obligation under the terms of the plan were $80 million total deferred payments to be made on or before July 31, 2018. We negotiated a prepayment of $78.8 million that we made in the fourth quarter to fully satisfy our obligations to the joint plan, aside from a small contingent true-up payment that may be due in August. We are estimating that payment at $600,000 and this will complete our total obligation for trust funding.

We remain committed to creating shareholder value through profitably growing our company. Our legacy business has exceptionally strong positions in relatively mature and profitable market niches. We've been working hard to edge out of these markets to expand our addressable markets in ways that create value. We do this through innovation, product development which Marvin will discuss shortly, also organically expanding our geographic reach and through disciplined strategic acquisitions. It is this approach that has grown STEMCO from approximately $100 million to nearly $400 million in the past 7 years.

In 2017, we completed 2 strategic acquisitions, both of which were in our Sealing Products segment. The first was the Technetics Group acquisition of Qualiseal in the second quarter. As you may remember, Qualiseal manufactures highly engineered mechanical seals for the aerospace market. The acquisition added a complementary product suite that greatly enhanced our presence in the aerospace market. Since closing, the team has been focused on integrating the operations of the business and augmenting the existing management and commercial team to better position the business for future growth. We're pleased with the early commercial successes, including ramping volumes on several next-generation engine platforms and we're expecting continued growth in 2018.

The second was STEMCO's acquisition at the end of October of Commercial Vehicle Components or CVC. With a modest $5 million investment, this acquisition provides STEMCO a premium portfolio of air disk brake pads designed to exceed OE performance specifications. STEMCO will leverage its industry-leading commercial approach with CVC's differentiated brake pad portfolio to greatly enhance its presence in the growing air disk brake category. Initial post-close integration was completed without any issues and now our team is focused on accelerating our pipeline of opportunities with customers.

Given the strong performance trend in Engineered Products through extensive facility consolidation, organizational restructuring and disciplined process improvement; we're also able to look toward growth in this segment like we have been driving in Sealing Products. We are investing more in innovation and also actively looking at some exciting inorganic opportunities in that segment, particularly those that would be a strong strategic fit with GGB.

Marvin will also discuss our progress in the Power Systems reentry into the commercial power market. This effort is well underway and we're beginning to see real success. Now, I'll turn the call over to Marvin.

Thanks, Steve, and good morning, everyone. I'd like to start by sharing 2 brief updates in the Power Systems segment. The first is an exciting contract win with a major pharmaceutical company in Puerto Rico. This commercial power contract is our first win under the MAN agreement that we signed to distribute MAN's engines to the power generation market in the United States and its territories. Fairbanks Morse will provide a combined heat and power solution based on 2 dual-fuel reciprocating engines. Such a solution maximizes fuel efficiency by using the engine's waste heat for production processes that require thermal energy.

The first of these engines has arrived in Puerto Rico with installation to commence in the coming weeks. The second is scheduled to ship during the second quarter and should be installed by the end of the third quarter. The contract with the customer also provides for a 10-year parts and service agreement related to these engines. This is an exciting development for the Power Systems segment and we look forward to additional success with the MAN agreement in the power generation market.

I would also like to provide an update on our Trident OP program, which as you likely recall from prior discussions, is our next-generation opposed-piston engine that provides industry-leading fuel efficiency. During the fourth quarter, we made significant progress on fine-tuning the engine and we'll perform final fuel calibrations and endurance testing over the next several months.

On the commercial front, we officially launched the new Trident product at the industry-wide POWER-GEN conference in December. The industry interest and receptivity to the engine performance specifications was extremely positive. We're currently courting a variety of potential customers with applications that are ideal for our engines.

During the past few quarters, we have highlighted some of our ongoing innovation and commercial efforts to drive growth across our segments. I want to briefly highlight 2 initiatives from the quarter that exemplify our efforts. The first is a great example of our innovation efforts in the Engineered Products segment. CPI, which manufactures precision-engineered compressor components and lubrications systems, demonstrated its new Proflo EOS self-adjusting lubrication pump at the Gas Machinery Research Council show in October. The patent-protected Proflo EOS constantly monitors and adjusts the quantity of oil cycling through the compressor, ensuring optimal compressor lubrication. CPI's new solution was well-received at the GMRC show, resulting in multiple large customers field testing their product in their system. CPI has secured initial production orders from some of these customers.

Another example is in the Sealing Products segment. STEMCO, which manufactures and supplies high-quality components and solutions to the heavy and medium-duty truck and trailer market, was awarded standard position by Wabash National Corporation to supply Guardian HD Wheel Seals and STEMCO Hub Caps for its dry and refrigerated van trailers. This means the full range of STEMCO products will be specified into the trailer. These products are technologically advanced and offer a higher standard of performance through easier installation and longer life. We are excited to offer these products to Wabash, which is the leading producer of semitrailers and liquid transportation systems in North America, serving some of the largest U.S. fleets. Being awarded standard position further strengthens our long-lived partnership with Wabash and reinforces STEMCO's position as a market leader in wheel and product technology.

These are just 2 examples from our enhanced focus on new product development and commercial capabilities across EnPro. And now I'll turn the call over to Milt.

Thanks, Marvin. Before I begin, I want to note our consolidated results for the fourth quarter reflect the reconsolidation of GST, its subsidiaries and OldCo as a result of the completion of the Asbestos Claims Resolution Process on July 31 of last year.

As both Chris and Steve have mentioned, the fourth quarter of 2017 was the first full quarter in which consolidated results reflect all of EnPro's entities. In order to provide the most meaningful information about the fourth quarter, I will make comparisons of consolidated results for the fourth quarter of 2017 to pro forma results for the fourth quarter of 2016. For the full year, I will be comparing the pro forma results for both 2016 and 2017.

As discussed on previous earnings calls, the pro forma segment results that I will discuss have been 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.

Our fourth quarter sales of $362.5 million were up 13.4% over the fourth quarter of 2016. As Steve noted, excluding the impact of foreign exchange translation and acquisitions and divestitures, sales were up 11.1% over prior year; up 5.6% in Sealing Products, up 11.4% in Engineered Products and up 32.4% in Power Systems. Gross profit margin for the fourth quarter was 34%, up 85 basis points compared to the fourth quarter of 2016.

Adjusted earnings per share for the quarter of $0.67 were up 31.4% compared to the fourth quarter of 2016. Adjusted earnings per share adjusts for items such as environmental reserve charges, restructuring costs, impairment charges, acquisition expenses and normalized tax rates; all as shown in the tables attached to our earnings release. The fourth quarter year-over-year improvement is a result of the $12.1 million year-over-year increase in segment adjusted EBITDA as I'll cover shortly in the review of segment results, offset by a $4.1 million increase in corporate and other costs due in a large part to higher incentive compensation expense, a $2.4 million increase in net interest expense and a $1.8 million increase in adjusted income tax expense.

Average diluted shares were 21.8 million for the fourth quarter of 2017 compared to 21.7 million for the same period a year ago. For the full year, adjusted earnings per share were $3.45, up 25.4% compared to the prior year.

Before moving to a review of Q4 segment results, I want to highlight the estimated $24 million benefit incorporated in our fourth quarter tax provision in connection with the Tax Cuts and Jobs Act. This amount represents the net impact of the re-measurement of deferred tax assets and liabilities, the estimated toll charge on deemed repatriation of earnings and the estimated benefit of tax planning strategies in response to tax reform. Please note that the $24 million is subject to change as additional clarification on the Tax Act is provided and as we refine our estimates.

Also please note that this provisional tax benefit does not affect our adjusted earnings referred to previously. Going forward with the reduction in the U.S. federal rate from 35% to 21%, our adjusted earnings will be determined using an estimated 27% blended global statutory rate in comparison to the 32.5% rate used historically.

In the Sealing Products segment sales were $220 million in the fourth quarter, up 7.5% over the prior year. Excluding the impact of the Qualiseal acquisition, the Franken Plastik divestiture that closed in December of 2016 and foreign exchange translation, sales were up 5.6% in the fourth quarter versus the prior year period. This year-over-year sales increase was due to strength in semiconductor, aerospace, food and pharma, heavy-duty tractor and trailer builds, metals and mining, nuclear and general industrial; while sales to the industrial gas turbine market were down significantly.

Segment adjusted EBITDA which excludes the impact of restructuring and acquisition expenses, was $39.7 million, up 9.4% over the fourth quarter of 2016. For the full year, adjusted EBITDA margins were 18.8%, up from 18.4% in 2016. Excluding the impact of acquisitions, divestitures and foreign exchange translation, adjusted EBITDA increased 5.6% in the fourth quarter versus the prior year. Excluding the impact of acquisitions, divestitures, restructuring costs and charges related to the reconsolidation, segment SG&A cost in the fourth quarter were $50.9 million compared to $48.6 million in the prior year. The year-over-year increase was driven by higher incentive compensation expense.

In the Engineered Products segment, sales were $74.8 million in the fourth quarter, up 17.1% over the prior year period. Excluding the impact of foreign exchange translation, fourth quarter sales were up 11.4% over the fourth quarter of 2016. This year-over-year sales increase was due primarily to strength in the general industrial and automotive markets, with modest improvement in oil and gas markets. Sales were relatively level in the aerospace market relative to last year.

Segment adjusted EBITDA in Engineered Products was $9.3 million, up 14.8% over the fourth quarter of 2016, primarily due to increased volumes and the continued positive impact from cost-reduction efforts and restructuring activities that occurred throughout 2016 and early 2017. For the full year, adjusted EBITDA margins were 16.1%, up from 13.5% in 2016. Excluding the impact of foreign exchange translation, adjusted EBITDA increased 4.8% in the fourth quarter over the prior year period. Excluding the impact of restructuring charges, segment SG&A costs were $22 million in the fourth quarter, compared to $19.9 million in the prior year period. The year-over-year increase was driven primarily by higher incentive compensation expense.

In the Power Systems segment sales were $68.8 million in the fourth quarter, up 32.8% over the fourth quarter of 2016. This year-over-year sales increase was due to higher aftermarket parts and service sales and higher engine sales, largely driven by the shipment of the last zero-margin MOX engine that we discussed in the past, higher EDF revenue and increased activity on several naval programs.

Segment adjusted EBITDA was $10.1 million, up from $2.6 million in the prior year period. Excluding the fourth quarter impact of foreign exchange on the EDF contract in both 2016 and 2017, adjusted EBITDA increased 16% in the fourth quarter versus the prior year period. Excluding restructuring costs, segment SG&A costs in the fourth quarter were $8.6 million compared to $7.5 million in the prior year period. The year-over-year increase was due to higher sales and marketing expenses partially associated with the Trident OP commercial launch, slightly offset by lower incentive compensation expenses.

As Steve did, I want to reiterate our commitment to maintaining a strong balance sheet and to deploying our company's capital in a disciplined and balanced way as we drive long-term growth and the value of our company. Slide 17 summarizes our major usage of capital during the fourth quarter of last year.

First, we contributed $78.8 million to the ACRP-related U.S. asbestos trust, which satisfies our deferred funding obligations other than a contingent true-up payment estimated to be around $600,000. As Steve noted, we have no further asbestos-related liability.

Second, we completed the acquisition of Commercial Vehicle Components in October for a total investment of approximately $5 million. While this was a small investment, it underscores our commitment to strengthening our position in the markets we serve with proprietary technology.

Third, we invested $20.8 million in our plant and facilities, including software, which equates to about 40% of our total capital spending for the full year. The higher spending in the fourth quarter compared to the first 3 quarters of the year was driven by a number of growth and efficiency improvement investments across all 3 of our segments.

Finally, we paid a $0.22 per share dividend in the fourth quarter totaling $4.7 million. And this morning, we announced a $0.02 per share or 9.1% increase to our quarterly dividend starting in March of this year.

During the fourth quarter, we did not make any share repurchases under either the prior repurchase plan that expired in the fourth quarter nor under the new $50 million program authorized by the board on October 28. Through the duration of the prior share repurchase program, we repurchased a total of 898,060 shares for $47.2 million.

As in previous quarters, we outline on slide 18 our consolidated net debt and leverage ratio at the end of the fourth quarter. As you can see, our leverage ratio at the end of the quarter was approximately 1.9x trailing 12-month pro forma adjusted EBITDA. For those of you who have been reviewing this chart in prior calls, please note that we are limiting the asbestos-related insurance amount in this chart to the $17 million that we know will be received this year. We estimate the full benefit of the asbestos-related insurance receivable to be approximately $47 million, as will be detailed in our 10-K.

The leverage calculation in this table does not include the approximate $85 million tax refund related to ACRP trust funding that we expect to realize this year. Including this benefit, our leverage ratio at the end of 2017 would have been approximately 1.5x.

Before turning the call back to Steve to discuss our outlook for the year, I want to provide some closing thoughts on our balance sheet and liquidity. Our cash balance at December 31 was approximately $189 million, essentially all of which resided outside the U.S. In the coming months, we will be evaluating the implications of tax reform on this permanent overseas cash investment and how tax reform enhances our flexibility in the use of this cash.

As discussed on previous earnings calls, we also will be taking action to realize the benefits of the loss created last year in conjunction with the ACRP related trust funding. Based on our current estimates, net of the tax reform related toll charge, we anticipate receiving an estimated $85 million tax refund by the end of 2018 in connection with the filing of our 10-year loss carryback return. Beyond 2018, the carryback and deemed repatriation of foreign earnings combined generate an additional benefit of approximately $60 million in the form of reduced taxes in future periods through the use of foreign tax credits. Also in 2018, as mentioned previously, we expect to receive approximately $17 million from ACRP related insurance recoveries.

These items, which stem from U.S. tax reform and ACRP completion are significant, but they do not change the way we think about capital deployment. It will however allow us to be more aggressive within our framework of deploying capital in a disciplined and balanced manner through investments in our operations to drive growth and efficiencies, strategic acquisitions and partnerships and capital returns to shareholders. Currently we are pursuing a variety of growth and cost-reduction initiatives across all segments, including Engineered Products, where our focus over the past 3 years has been primarily on restructuring and other cost-reduction measures.

We also anticipate returning a measured portion of our capital to shareholders as evidenced by the increased dividend just announced and expectations for share repurchases as the year progresses.

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 2018 and then take questions. As we've always explained, we have limited visibility of future demand. With the exception of new engine product in Power Systems, most of our businesses have relatively short order-to-shipment cycles and typical order backlogs range from a handful of days to a couple of months. Additionally, the component nature of many of our products often obscures correlations with macro end market indicators. Notwithstanding this limited visibility, demand in most of our markets remains healthy, with the exception of the industrial gas turbine market, which we expect to remain depressed.

We're optimistic that we can continue with strong performance throughout 2018. As usual, our guidance excludes impacts from future acquisitions, restructuring costs, the impact of changes driven by foreign exchange and any litigation or environmental charges. Given current macroeconomic forecasts and continued strength in our end markets, we expect 2018 consolidated sales to be up between 3% and 5% over 2017 pro forma sales. We also expect adjusted EBITDA of between $216 million and $222 million for the full year, with stronger results in the second half of the year compared to the first half, primarily due to the timing of aftermarket sales and engine production schedules in Power Systems.

It's important to note that we received $9.1 million of positive foreign exchange impact related to the EDF contract during the course of 2017. When we normalize for this item, the difference in average exchange rates in 2017 compared to the current rates and for several smaller items, including the full-year effect of Qualiseal and the CVS acquisitions, our guidance represents a 5% to 7% increase in adjusted EBITDA.

Before I open the line for your questions, I just want to reiterate my excitement for all that we have accomplished over the past year and the strong current state of our company. We continue to be focused on our goal of building a first-class company that delivers superior value to our shareholders. Now we'll open the line for your questions.

(Operator Instructions) Your first question comes from Joe Mondillo from Sidoti & Company.

Joe, we can't hear you. Joe, we still can't hear you. Operator, I'm not sure if he's trying to ask a question or if he's on mute.

Go ahead, Joe.

Can you hear me?

Yes, now we got you, Joe.

Sorry about that. I was wondering, my question that I was trying to ask, I apologize for that. But the $214.5 million of adjusted EBITDA in 2017 that you pro forma; that includes the adjusted foreign currency related contracts with EDF? Is that correct?

Yes, that's correct. That's our number as we report the adjusted EBITDA?

And how much did you realize, how much income was realized in the fourth quarter related to that?

It was about $1.4 million in the fourth quarter.

Okay, I also wanted to ask related to the Engineered Products segment, the incremental margins there were in the single digits it looked like. Usually you talk about sort of 40% to 50%. Was there a product mix issue or what was going on in the fourth quarter why you didn't sort of see the operating leverage that you have seen in the past?

Yes, overall, Joe as you know, it's a really good story in Engineered Products for the year for '17 with significant margin improvement on a full year basis. The fourth quarter margin differential year-over-year is a little bit misleading for two reasons. One, in 2017 our incentive compensation expense was significantly higher than it was in 2016 and the trend and as we've gone throughout the year in '17, the incentive accruals have been increasing along with our performance. We had the opposite happening in 2016, where incentive accruals were declining. So that's one reason.

Another reason is in Engineered Products we had a fairly significant year-over-year increase in medical costs and so that had an impact on margins in the fourth quarter as well. We did experience some pricing pressures in raw materials. And so there were other factors. But the incentive compensation and medical costs were drivers as well.

Okay, and just looking at 2018, should we anticipate sort of on a percent of sale basis that incentive comp and health expenses sort of more normalize? So do you anticipate sort of the historical 40% to 50% incremental margins there at that segment?

Yes, we would. We would.

Yes, when you strip those out, we were in that neighborhood for Engineered in Q4.

Okay, just to go back to Power Systems, of the EDF contract, how much of that contact is left to be recognized as revenue going forward, if it still a big chunk?

Yes, give us?

Give us a second, Joe.

I guess in addition to that, also I would be interested to hear your thoughts on sort of-- you mentioned that just in terms of by quarters it's going to be back-end weighted at Power Systems. But just on a revenue and margin outlook for the year, relative to the backlog of engine deliveries as well as sort of timing on aftermarket demand; how do you look at the segment overall for 2018 relative to revenue growth and then also on a margin perspective compared to 2017?

Yes, let me give just a little bit of color and Milton you can share those specific numbers. First of all, Joe, we have shipped as of today, 6 of the EDF engines. That's as of today. 4 of those were out last year, 2 have been shipped out this year. And our plan this year is to ship an additional 10 engines, roughly. Now that may move around a little bit. Now first all, as you know, those are at zero margin, since we have been historically in a loss position in that contract because of the rapid decline of the euro from when we set it. What the true-ups we see every quarter as a result of that engine are primarily due to currency. Obviously we benefited a lot last year in Power Systems for the impact of that currency on the entire contract. So by the end of '18, we'll be through pretty much all. But we will carry some of these engines going forward into '19, probably about 5 more in '19. Now that's if the schedule doesn't change. The schedule could change. But again the only real impact on the bottom line for the segment is really depending more on what currency does versus more on how many engines we ship, okay? Now we've talked to the public about for years we've been talking about this U.S. government engine shipment. We used to call it the Fairbanks cliff that was coming. Because we knew that in '15, '16 and '17 we were going to be not producing many government engines, just as a result of how the Navy and Coast Guard shipbuilding program worked. And over the last 2 years, we've announced-- really 18 months, we've announced significant wins with the military with the U.S. government. And so those we've got a lot of programs going on now. Those programs have started with long lead time procurement items. We'll be building a number of those engines in the shop. And so that work will continue to accelerate throughout the year. But keep in mind, based on what I shared, Fairbanks or Power Systems has to earn $9.1 million more of EBITDA if currency stays exactly the same just to make up for the benefit we got on the EDF front last year. We expect to do that actually. Fairbanks is going to have a really good year. It's just hard to sort that out with all the currency impact within EDF. But as long as currency doesn't drop significantly, as long as the euro doesn't drop significantly from 1.2 to the dollar, Fairbanks is going to have a good year and that year will be improving as we go forward. Now to answer your specific question of how far we are along on a percent completion basis in that program, do you have that, Milt?

On revenue percentage it's roughly, we'll come back to you. It's roughly about 40 remaining, Marvin? So out of $105 million roughly total contract, about $40 million or $45 million of revenue remaining.

Okay, so if we exclude the effects of currency in 2017, it looks like the operating margin were roughly around 11%. Then it sounds like the volume and the production work that you have going on for 2018, at least relative to engines-- I don't know if you were combining aftermarkets into your comments there or not--

I was, Joe. I was, yes.

So it sounds like revenues definitely should be up relative to the 11% sort of op margin ex the foreign currency adjustment to EDF that we saw in 2017. Do you think that should be sort of comparable in 2018 just given the amount of new work of higher profitability type stuff and that should offset the increased engine shipments for EDF? Or could that slightly be under that 11% adjusted 2017? How do you think about that?

Yes, hold on one second, Joe. Okay, I'm going to have to do some calculating just to give you some direction.

While he's doing that, Joe, do you have-- I mean the problem is-- not the problem. Operationally what we've been challenged with is a big portion of what the one facility, one manufacturing facility that we've had in Fairbanks, a big challenge has been the team has really been working through initially the startup of the first engines for EDF. And as we've shared in the past, we struggled a lot. It's a very demanding customer and the quality and tracking and part traceability requirements are even well beyond what the U.S. Navy requires. So it was a real challenge for us on the first 2 or 3 units. But since then, during last year, we spent a million dollars for a semi-automated welding cell up there. We can now weld almost half of the welds on all the blocks and oil pans for the EDF units. We've debottlenecked the production line and we've solved all the quality disputes and the design questions from EDF. And now we're doing something that we don't normally do at Fairbanks, which is we're making a lot of the exact same engines and it's flowing pretty well. So it's really hard to overestimate how much of the Fairbanks team, the engineering and operations team; was focused on EDF last year to get us to where we are today. I'm hopeful that we're going to begin to see a lot of benefit from that streamlining combined with now a reasonable but kind of returning to the norm, if you will, of much, much better margin government work.

Yes, for all of the reasons that Steve described, having profitable engines flowing through our facility and all of this is subject, of course, because our performance on the aftermarket side can swing our margins significantly. But we would expect for '18, Joe, for our margins to be north of that adjusted number that you calculated, excluding the EDF FX pickup from this year. I haven't checked your number. I think you mentioned 11% excluding that. And I would think that we would be more in the 13% to 14% range in 2018, still burdened a bit, of course, by EDF revenue that's going through, but a nice step up from where we were this past year.

Okay, that's good to hear, and relative to sort of the -- what kind of visibility do you have in '19 relative to the wins that you've made over the last 18 months and just the schedule? I don't know how far out you can see with the U.S. Navy relative to maintenance and aftermarket. Do you have any good feel, and I know it's 2 years out, but 2019, do you have any color there or is it just too early and you need to see how orders and things progress throughout this year?

On the engine side, we have a fair amount of color. And the way to answer that would be we'll see an increase for specific programs like OPC that we announced and the TAO program that we announced. So those programs start to flow into '19. They start to pick up here in '18 and definitely carry over into '19. We have good visibility into '19 and from where we sit, '19 looks pretty good from here.

Your next question comes from Ian Zaffino from Oppenheimer.

Question was just concerning OP2.0, what sort of cadence of this, how do we expect maybe the launch to occur, when will shipments start? And then after the initial launch partner, when should we expect to see maybe customer #2, customer #3, et cetera? So any type of cadence you can give us would be really helpful. Thanks.

Yes, I think the best color to provide at this time is we launched in December. So we're roughly 6 weeks or so beyond our launch date. And we look at few things internally to give us some perspective on whether we're getting traction or not. And the most significant thing that we look at is the sheer number of units quoted relative to our plan. And we're up relative to what we planned to quote in Q1. We're well past that number right now. Now the commercial operation dates for most of those projects are roughly 18 to 24 months out. So we'd have to back that up for you lead time and those kinds of things. But that's the best color I could provide now. The initial indication is really positive in terms of customer interest and the number of projects that we've quoted. But with commercial operation dates at 18 to 24 months, we'd have to work that out based on hit rates and specific projects. It would be hard to forecast in detail right now.

Your next question will come from Jeff Hammond from KeyBanc.

This is Brad Vanino filling in for Jeff. Just on the capital allocation side, with just tax refund kind of expecting maybe at the midpoint at the back half of 2018; does that change any of the timing of when the pipeline could heat up or is that just unrelated?

I think it's largely unrelated, because our spending on growth initiatives, strategic acquisitions is going to be driven by opportunities that we see and us having an ability to seize the moment and move forward when we find something that makes a lot of sense for us. So we're driven more by the specific opportunity than we are within the context of having a stronger balance sheet this year because of the combination of tax reform and the carryback related to ACRP.

So I mentioned in my comments it really doesn't change how we think about capital deployment. But it will allow us to be a little bit more aggressive when we find those opportunities that make sense.

Okay, and I mean it sounds like you're going to be disciplined in M&A and the balance sheet's in good shape and it looks like some moderation in growth investments in the year. So I guess my question is kind of, if we move throughout the year and nothing really intriguing pops up, does that suggest that maybe more activity in the new buyback program that was recently authorized or dividends beyond what is currently baked in? I'm just trying to get a handle on where capital allocation could end up if nothing of these materializes in the year.

Yes, we've indicated before that our goal is maintain net debt to EBITDA of 2x to 2.5x on average throughout a period of time. So if we find either this year or next year or whatever that we are going to an extended period of time are below that range, then yes, we have to consider our options. Of course, we could go through a period of being under-levered, based on that range if we're working on things. But if we find that we're in a sustained period of being well below that range, then yes, I mean we're going to be considering stepping up returns to the shareholders in one form or another.

Okay, then just quickly on GST; are there any legal or process overhanging or is that completely in the rear view? You mentioned at a conference recently that there was some things that were deterring kind of looking into bolt-ons in that business. Is that completely behind us now?

I'm not sure I understood your question. I thought I heard 2 in there. The first is the asbestos issue is done. There is no lingering litigation. There's no lingering liability. All of EnPro is protected by the deal, not just Garlock. So we are free and clear of asbestos-related issues. Now we negotiated a discount to the $80 million to pay it early. So we paid what I said, $78.8 million. And so it's a modest discount. But even to do that, we had to agree with the trust. This is not with the lawyers. This is with the trustees that the idea is if they earn that $1.2 million return on that incremental payment into the trust then we won't owe them anything. We're basically estimating it's $600,000 in August. That's the only thing. So it's kind of-- it's so small it doesn't really matter.

But going forward, the only thing we'll do is continue to benefit from insurance receivable collection over time. So as the trust starts paying out claims, so as people claim into the trust; then we'll get an insurance recovery associated with that. Just the timing of it is the claims have to be paid by the trust before we get the insurance money. So that will continue. This year it's 14, 17?

Well, it's $17 million that we know will be collected this year. It could be more, Brad. But $17 million is scheduled. And then in addition to that there's another $30 million that we believe we will collect over time.

A few years, yes, as those claims are paid by the trust. That's the only thing. And we're independent of the trust. The trust is managed by separate trustees. We're kind of, thank goodness, out of the asbestos liability game. So yes, that's 100% behind us and again, going forward all of our results obviously will be the full company results.

Okay, yes. I was just referring to more the M&A side of that where I think you said there was parts of the legal process that required you to kind of divulge any M&A plans within GST and that kind of?

Oh, right, right, right. Yes, yes, yes. No, I'm sorry. I did misunderstand. Yes, look, while we've been frozen in bankruptcy in the ACRP while GST has been frozen there, it was just way, way too problematic to try to buy an acquisition related to that part of our company, simply because the other side-- the court controlled the estate at the time. And that's all done. So yes, we've got, in fact we're looking at something. It's small, but we're looking at something right now that will be a nice little-- again, it's small, not enough to move the needle. But it's a great little premium product add-on that we think we'll get done in the first half of the year for that part of Garlock. Yes, so to answer your question, it does open up a new avenue for growth for GST.

The next question comes from Justin Bergner from Gabelli & Company.

A couple clarification questions here. On the EDF contract which was called out as a $9 million tailwind to OP in 2017, if I add up the amounts called out in each of the quarterly press releases for EDF, I get to about $4.5 million, not the $9 million. So I can follow up offline, but if there's any clarity you can provide here.

Yes, we can follow up offline, Justin. But in a nutshell, the differences in the prior quarters we've communicated the impact on EDF in full, which was a combination of currency-related impact and changes to estimated cost to complete the contract. And so both of those things are always running through our P&L from quarter to quarter, since we're on this kind of mark to on a full contract basis. Because we're in a loss position. So every quarter we look at the estimated cost to complete the contract and we had this currency-related adjustment as well.

So in the past, in the prior 3 quarters when we've talked about the EDF impact on the quarter, it's been in the context of the combination of currency and changes to estimated cost to complete.

Okay, thank you. That's very helpful. And then the income tax receivable that you have on your balance sheet at year-end 2017 is pretty sizeable. I guess it's about $123 million, which transcends the $85 million from the deferred tax asset look-back recovery. What else is in there just so I can sort of understand what cash would look like without this insurance tax receivable?

Well, our income tax provision is very complicated this year. And we had a lot of things going on. We had a big gain on the reconsolidation of GST. We've had tax reform to build in. We can sit down with you and kind of walk through those details. But I think the easy way to do it is to look at our adjusted earnings per share that we showed that provide a ballpark, and for '17 we used a tax rate, a kind of a normalized tax rate of 32.5%. And I had mentioned that going forward we'll be using in that adjusted calculation, about a 27% tax rate. So there's a lot of details, a lot of the gives and takes that went into the tax provision this year.

Okay, but the $123 million, I mean that's going to be cash that's coming in the door over the course of the 18?

Repeat your question. I'm not sure if I'm following you.

Okay, I might have misspoke at one point. I guess the $123 million income tax receivable at year end '17, I assume that consists of the $85 million plus an additional amount. I mean should we basically treat that as money that's going to increase the cash and cash equivalents by $123 million when it's all recovered?

Well, let me just tell you that with tax reform, the amount that we booked which would include the line item that you're pointing out on our balance sheet are all provisional. There have been almost day-to-day explanations and refinements and changes that are coming down from the IRS which affect how we monetize the carryback and how the toll charge factors into it. So the short answer is you can go by what I commented earlier on the call in my prepared remarks that for the carryback for the refund, we expect about $85 million to come in this year. Now we are going to have additional benefit in the form of foreign tax credits which we'll be able to monetize over a number of years. But if your focus is on the near term, on the income tax receivable, the $85 million as of today, is a better number than what you see on the balance sheet.

Okay, that's very helpful, and then should I assume that there will be a repatriation liability of some magnitude that affects the $189 million of cash that's mainly overseas and I don't know if there are undistributed foreign earnings on top of that that could be taxed at the 8.5% rate. Any comments there?

The information that I've provided when I talked about our liquidity, just comments on liquidity earlier, all of that was net of the toll charge that we would otherwise have to pay. So no, I mean if you go back to my comments on we ended the year with $185 million roughly or $189 million in cash. We expect to get $85 million in the form of a tax refund. We'll have the additional foreign tax credits to use in the future. All of that is kind of a net-net as we see it today of the impact of both tax reform including the toll charge and the impact of the carryback related to the ACRP trust funding.

So said another way, we could bring back some portion, up to that foreign cash amount without paying any incremental to what Milt shared.

Okay, but the $60 million, is that $60 million, is that net of expected repatriation taxes or is that gross?

Yes, it is. No, it's net.

Okay, and then lastly on the waterfall chart in the EBITDA guidance, what is the other bar that's about $2 million positive for your '18 EBITDA outlook?

Give me a second. Let's see if I can figure it out.

It's $1.8 million.

Yes, we scrubbed it to really try to provide an apples-to-apples and not just to point out the year-over-year difference in the EDF FX, but to scrub it for other items. I think it picks up, and I don't have the details in front of me. We can follow up with you. I think it's things like LIFO, the impact of LIFO may have been one of them. And that's probably the most significant in the other bucket. We can follow up with you.

That's also, by the way, the full year effect of the acquisitions we made in '17.

And your final question for today comes from Joe Mondillo from Sidoti & Company.

Just a couple of follow-up questions. I just wanted to confirm the purchase accounting amortization related to the reconsolidation of GST, is that still trending at about $8.6 million annually? Is that what you annualized? Is that what you saw in the fourth quarter and was that what the 2018 trend should be?

That's about right.

Okay, and then just looking at the Sealing segment, what would you say your typical incremental margins that you have realized in the past there? And then looking at 2018, it seems like -- and correct me if I'm wrong -- that the heavy-duty STEMCO is maybe the one business that is potentially going to continue to show year-over-year improvements or at accelerated rates anyways just given sort of the new truck builds and trailer builds rates that have been going on, and then maybe even the acceleration in truck miles with aftermarket and such? Correct me if I'm wrong with that. But if that's the case, I always thought STEMCO was maybe a little lower margin. So relative to your historical incremental margins there, should we see maybe an unfavorable product mix potentially in 2018 just given the strength in STEMCO?

If you look at overall margins, relative margins in the segment, Joe; the STEMCO margins, yes, are among the 3 businesses in the segment, the STEMCO margins are the lowest of the 3 overall. But it's not by much. It's a relatively small difference certainly between Technetics and STEMCO. Our highest margin performer in Sealing is Garlock. It has been for quite some time. So I don't think that it's going to be noticeable enough that if we were to have more growth in STEMCO than the other businesses that it would be a significant factor on the margin side.

Yes, and I don't know if I would even agree, Joe, with your overall assumption that that business within that segment is going to grow faster this year than the other two. I think they're all kind of pacing about the same. Remember in STEMCO, most of what we like to sell is aftermarket parts. The equipment that's on the road today is relatively new, because of all the new truck and trailer builds in the last few years. And so even if aftermarket miles go up, yes, that does have an effect. But it will better as the equipment ages down the road. So we don't see, at least in our planning, we don't see STEMCO outpacing Garlock and Technetics in Sealing. We think they're all going to be relatively healthy. The only market that we sell to in that whole segment that's weak is industrial gas turbines. And while I mean the drop-off last year was significant. So we don't think it will weaken further. But we certainly don't think it will strengthen. We think it will kind of stay about where it was last year. I mean it's so weak it's hard to imagine it going down anymore. But we're taking some actions in that business to try to at least have it be more profitable than it was last year. But we're continuing to feel decent demand across the entire segment.

Okay, and what would you say? I mean is that segment, is that pretty much typical of sort of a 30%-ish kind of incremental margins?

I think that's a good estimate, yes.

Okay, and then just one last question regarding cash and you took on a little debt to finance the negotiated roughly $80 million or so of the rest of the asbestos resolution. How were you looking at the debt and the cash that you're going to be receiving in 2018? Are you thinking about paring that down at all since you increased it in the fourth quarter? If not, where do you see the interest expense? I'm just trying to think of like the interest expense and how you're thinking about use of cash.

Yes, we have a lot of moving pieces coming in on cash, as we've discussed. We're evaluating this permanent overseas investment in cash that we've had historically and now with the tax reform looking at the flexibility of using that cash. We have the refund that we're expecting. We have the ACRP insurance receivable collection that we've discussed in addition to the cash that we generate from operations. And so I mean clearly absent some large growth investment, acquisition or otherwise, as we generate cash we'll be using it to pay down the outstanding borrowings we have on our revolver at the end of the year. You can see it on our balance sheet roughly what that was.

Okay, so do you anticipate maybe the interest expense is a little higher than the fourth quarter early in the year and then maybe it falls down a little bit?

Yes, absent growth investments. I mean if we're not investing in M&A or other relatively large growth investments, we will see a reduction in our revolver balance, which will translate into reduced interest payments on the revolver payment. Now keep in mind, we did the $150 million tack-on in our senior notes last year and we didn't start the year with $450 million in senior notes. So we will have the full year effect of that interest expense, offset in your scenario or in the scenario I just painted, offset by lower interest expense on revolver borrowings. So just how it nets out, I wouldn't be projecting a large decrease in interest expense this year. Keep in mind a lot of the cash that we have coming in on the tax refund is not going to happen immediately. It's going to take some time for us to realize that and also for us to do our final planning related to tax reform.

Great, I guess one thing that I'm just trying to clarify is that you drew the revolver I think in December. So the interest expense in the fourth quarter relative to sort of the annual rate that you're sort of running at, at the end of the year, that interest expense should probably be higher than the fourth quarter considering that you drew that revolver in December. Is that correct?

Yes, no question, if you're zeroing in or isolating on the interest expense related to the revolver debt.

As there are no further questions, I'll turn the call back over to the presenter for closing remarks.

Thank you, Michelle. 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.

Thank you, everyone. This will conclude today's conference call. You may now disconnect.