EnPro Industries, Inc. (NPO) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Marcella and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries 2018 Second Quarter Results Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Chris O'Neal, Senior Vice President, Corporate Development, and Investor Relations, you may begin your conference.

Thank you, Marcella. 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 CEO; Marvin Riley, our COO; and Milt Childress, our CFO, will begin their review of our second 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 expresses belief, expectation, or intention as well as those that are not historical facts. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements. These risks and uncertainties are referenced in the Safe Harbor statement included in our press release and are described in more detail, along with other risks and uncertainties, in our filings with the SEC including our Form 10-K for the year-ended December 31, 2017. We do not undertake to update any forward-looking statements made on this 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 material 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 relevant periods until their reconsolidation effective as of July 31, 2017. And finally, pro forma illustrative financial information for the three months and six months period ended June 30, 2017, presented as if GST and OldCo were reconsolidated for financial reporting purposes throughout those period. These disclosures are important to understanding comments we will make in today's call and we urge you to read them carefully. Consolidated results for 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. Pro forma results for the periods prior to July 31, 2017, have been prepared as the GST and OldCo had been reconsolidated on the basis described in our earnings release. 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 as those segments included in GST foreign subsidiaries. We believe that investors will find comparisons of consolidated results for 2018 period to pro forma results for the prior year period to be most illustrative of the year-over-year performance of all of Enpro's businesses. For clarity throughout this script, second quarter 2018 consolidated results to pro forma results for the second quarter of 2017. And now, I'll turn the call over to Steve.

Thank you, Chris and good morning and thanks for joining us today. We had a difficult second quarter with high level numbers don't tell the full story which we'll explain today. Four of our six divisions did well in the second quarter and all of our businesses generated year-over-year sales growth. In total, our sales were up 13% year-over-year and as noted on Slide 19 many of our core end markets continued to experience favorable conditions in the quarter, including semiconductor, food & pharma, general industrial, metals & mining and European oil & gas. Profitability was challenged this quarter by three primary items which collectively led to a 16% drop in segment adjusted EBITDA from the prior year. These items were: first, continued softness in the industrial gas turbine market which led to our decision to exit our facilities servicing that market; second, challenges in our heavy-duty truck brake products group including booking a large warranty reserve; third, a currency related drag in significant first half versus second half performance profile in Power Systems. With that backdrop, Marvin, and I will help you understand what's behind the weak headline including background on each of these three items as well as the positive momentum we're seeing in our businesses. Milt will cover our financials in more detail shortly. In Sealing Products, Garlock generated year-over-year sales growth led by volume gains in our food & pharma business which continues to perform above the expectations established in conjunction with the 2016 acquisition of Rubber Fab. Also last quarter, we highlighted Garlock's new product launches GYLON FX the next-generation version of our flagship GYLON product which is already generated sales above our full-year sales goal. In the second quarter, Garlock launched the EVOLUTION product which is the first fully encapsulated isolation gasket for oil and gas pipelines. Customer demand for EVOLUTION has been greater than anticipated and orders are exceeding our plan. In addition to these gains coming from innovation in the Rubber Fab acquisition, Garlock continues to execute very well and demand continues to be strong. Technetics Group also performed very well this quarter other than the impact of continued deterioration in the industrial gas turbine market. The semiconductor market continued to be strong leading to excellent year-over-year sales and profitability growth. We also had strong year-over-year sales and profitability increases in the aerospace and nuclear markets. We expect these favorable demand conditions to continue for the rest of the year. As we've discussed on past calls, our industrial gas turbine business has been a real challenge in the last 18 months which has partially offset strong growth and margins in the rest of the Technetics Group. Earlier this year in response to deteriorating conditions in this market, we conducted a comprehensive review of the business. We concluded during the second quarter that the structural changes in the industrial gas turbine market are permanent and that these changes greatly diminish the attractiveness of the business. As a result, we decided to exit our industrial gas turbine facility in Oxford, Massachusetts, and we expect to complete this exit by the end of the year. Excluding the results of our industrial gas turbine business from both 2017 and 2018 results, Technetics organic sales and adjusted EBITDA both increased to double-digit rates year-over-year. In STEMCO which as you know serves the heavy-duty truck market saw sales increase year-over-year in the second quarter but profit declined significantly due to several factors in the brake products group including higher commodity prices driven largely by tariff-related steel price increases, productivity issues in our friction factory, and unusual warranty costs totaling $4.4 million, a little over half of this expense relates to friction material quality problem caused by one of our past suppliers which we discussed during the first quarter call, but at that time had failed to understand the full financial impact. In response to the results of the first half of the year, we're taking action on a number of fronts to improve STEMCO's margins to its historical norms. Effective three weeks ago, one of our most seasoned leaders stepped in to run this business and we implemented a restructuring plan that eliminated 48 salary positions. We also implemented price increases that are now in place to address higher commodity costs. In addition, we're conducting a comprehensive review of the brake products group with a primary focus on addressing productivity issues in our friction facility. We believe the actions we're taking will lead to meaningful improvement in second half profitability. Our Engineered Products segment had another strong quarter with sales and adjusted EBITDA increasing at double-digit rates year-over-year. GGB generated strong year-over-year sales and profitability growth driven by solid growth in automotive markets primarily in Europe and strong demand in general industrial markets. CPI also generated double-digit sales and adjusted EBITDA growth in the second quarter over the prior year recording its highest adjusted EBITDA margin since 2011. As you will recall, a few years ago we embarked on a comprehensive review and subsequent restructuring of CPI that reset its cost structure and address other fundamental issues affecting its competitive position. As a result of the actions taken prior to the review, CPI's adjusted EBITDA margin has expanded by more than 10 percentage points. At this point, we believe that CPI has recovered with adjusted EBITDA margins comparable to GGB and with a positive outlook for the future including some exciting new products we've launched recently. Now I'll turn the call over to Marvin to provide an update on Power Systems.

Thanks, Steve, and good morning everyone. As noted previously, and similar to last quarter, Power Systems has another quarter with strong sales performance relative to last year. We generated higher revenue across the businesses engine; aftermarket parts and service revenue were all higher during the quarter versus the prior year. Engine and aftermarket part sales in our marine segment were particularly strong as we continue to make great progress on several large marine programs, including ramping up some of the major programs serving just one over the past couple of years. Despite the strong sales momentum, Power Systems experienced a decline in segment adjusted EBITDA for the quarter as a result of the impact of currency on the EDF project. Excluding the impact of the small restructuring charge in foreign exchange on the EDF contract, Power Systems EBITDA was up 25% year-over-year. As discussed on the prior two earnings calls, we expect earnings to be up significantly in the second half of this year exclusive of the impact of currency charges. Our parts backlog is currently at a record level. In our marine, military marine parts order intake continues to be strong. We also expect a more profitable second half engine mix. This strong parts backlog and more favorable engine mix together with our continued focus on productivity improvements in cost control underpin our expectations for strong performance in Power Systems for the balance of the year. And now, I'll turn the call over to Milt.

Thanks, Marvin. Our second quarter sales of $393.6 million were up 13.4% over the second quarter of 2017. Organic sales which we define as excluding the impact of acquisition, divestitures, and currency translation were at 10.8% over prior year, up 9.3% in Sealing Products, up 7.2% in Engineered Products, and up 25.8% in Power Systems. Gross profit margin for the second quarter was 29.4% down about seven percentage points compared to the second quarter pro forma gross margin of 2017 resulting from year-over-year declines in Sealing Products and Power Systems as Steve and Marvin have just discussed. In particular, there were four main drivers to explain the majority of the year-over-year decline in the margins. The $4.4 million unusual warranty expense in the heavy-duty trucking Freight Products Group, a $2.5 million inventory write-down in our industrial gas turbine business related to our restructuring actions, improvement in the allocation of IT cost between cost of goods sold and SG&A that lowered gross profit by $3.2 million in the current quarter, and a year-over-year swing in EDF of $7.3 million related to fluctuations in the Euro. These items account for approximately four of the seven percentage point year-over-year decline with the balance attributable mainly to a combination of tariff-related commodity price increases and friction factory productivity issues and heavy-duty trucking and product mix in Sealing Products and Power Systems. In the Sealing Products segment, we experienced strong sales growth in the quarter with reported and organic sales up 11.3% and 9.3% respectively over the prior year period. This year-over-year sales increase was due to strength in semiconductor, aerospace, food & pharma, heavy-duty tractor and trailer builds, metals & mining, and nuclear while sales of the industrial gas turbine market continued to decline. Segment adjusted EBITDA which excludes the impact of restructuring and acquisition expenses was $38.6 million, down 15.5% relative to last year. Excluding the impact of acquisitions, divestitures, and foreign exchange translation, adjusted EBITDA decreased 17.4% in the second quarter versus the prior year. The year-over-year decrease was driven by continued softness in the industrial gas turbine business and the profitability decline in heavy-duty trucking brake products. As Steve discussed, the profitability challenge in brake products resulted primarily from three items: tariff-related commodity cost increases primarily in metals, unusual warranty charges, and low productivity in our friction factory. In the Engineered Products segment reported and organic sales were up 12.7% and 7.2% respectively over the prior year period. This year-over-year sales increase was due relatively broad-based demand strength in the segment. Segment adjusted EBITDA in Engineered Products was $16.2 million, up 20.9% over the second quarter of 2017. Excluding the impact of foreign exchange translation, segment adjusted EBITDA increased 13.4% in the second quarter over the prior year period primarily due to increased sales volumes. Segment adjusted EBITDA margins in the second quarter were 19% compared to 17.7% in the prior year period. In the Power Systems segment sales were $53.7 million in the second quarter, up 26.4% over the prior year period. As Marvin noted, the increase was primarily due strength across the marine segment with engine aftermarket parts and service sales increasing over the prior year period. In addition, we continued to make progress on the EDF contract. Through the end of the second quarter, we had shipped eight EDF production units and add 14 engines less complete and deliver. However we've already started work on all 14 of these engines and incurred approximately three-fourths of our total estimated cost to complete the contract. We continue to anticipate delivering the last engine for the EDF program in 2019. Additionally, we continued to work through our production launch of the U.S. Coast Guard Offshore Patrol Cutter and the U.S. Navy Tanker Oiler programs. Since we typically incur higher costs on the first engines of the new program, these programs had a negative impact on profits in the second quarter. Segment adjusted EBITDA in Power Systems was $1.3 million, down $6.5 million over the second quarter of 2017. Excluding the impact of a small restructuring charge and foreign exchange on the EDF contracts which had a negative impact of $3.5 million in the second quarter of this year and a positive impact of $3.8 million in the second quarter of 2017, segment adjusted EBITDA increased 25% in the second quarter versus the prior year period. Total restructuring costs of $6.5 million were incurred during the second quarter, $6.2 million of which was for Sealing Products related to exiting the industrial gas turbine facility and restructuring an heavy-duty trucking that was completed in May. The restructuring of the industrial gas turbine business included a $26 million sales of building in Oxford, Massachusetts. As a result, our proceeds received from the sale of the building, the before tax net cash impact of restructuring for the quarter was a positive $24 million. Adjusted earnings per share for the quarter of $0.75 were down 25.7% compared to the second quarter of 2017. Adjusted earnings per share adjust 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 second quarter year-over-year decrease is a result of the items affecting Sealing Products and Power Systems as previously discussed and a $1.8 million increase in corporate and other costs, offset by $300,000 decrease in net interest expense, and a $4.4 million decrease in adjusted income tax expense. Average diluted shares outstanding were $21.1 million for the second quarter of 2018 compared to $21.8 million for the same period a year ago. As you all know, we are very disciplined and consistent in what we include in the calculation of adjusted EBITDA and adjusted net income. Our adjustments do not include one-time or unusual operating costs. Therefore items that affected our earnings in the second quarter such as the impact of currency on the EDF loss reserve and the unusual warranty cost in heavy-duty trucking are not adjustments included in our calculation of adjusted earnings. If you were to adjust of these two items adjusted earnings per share would be up at a double-digit rate over the prior year. Slide 13 summarizes our major uses of capital in the quarter. In the second quarter, we invested $16 million in our plant and facilities, including software. Consistent with our previously announced dividend increase, we paid a $0.24 per share dividend totaling $5 million. We also repurchased approximately 441,000 shares for a total value of $33 million under the $50 million program authorized by the board last October. Repurchases under the October authorization began in the first quarter of 2018 and through the second quarter we had purchased 665,000 shares for a total value of $49.9 million. We completed the remaining portion of the repurchase program in early July. With its completion the permitted share repurchases allowed under the indenture governing the senior notes have now been substantially exhausted. Since the beginning of 2015, inclusive of the final purchases in July under our current program, we have repurchased 2.8 million shares for approximately $177 million. As you know, we have taken action to realize the benefits of a loss created last year in conjunction with the ACRP related trust funding. On our first quarter earnings call, we indicated that we anticipated receiving federal tax refunds totaling approximately $128 million by the end of 2018. During the second quarter, we received $96 million of the federal tax refund and we estimate that we will receive the remaining $32 million in the second half of the year. In addition the carryback frees up approximately $31 million in foreign tax credits approximately $19 million of which will be used to offset the tax reform related toll charge and reduce 2018 taxes. The balance of foreign tax credits will be used to reduce taxes in future periods. On our first quarter call, we also indicated that we expected to receive approximately $17 million in 2018 from ACRP related insurance recoveries. We have received $12 million through June 30 and will collect an additional $5 million in the second half of the year. We anticipate another $29 million in insurance recoveries in future periods. At June 30 of this year, our cash balance was $93 million and our borrowings totaled $488 million, down from the $189 million and $618 million respectively at December 31 of last year. The reduction in cash resulted largely from the repatriation and use of $114 million of our overseas cash during the first half of the year facilitated by tax reform. The reduction of borrowings reflects credit facility repayments funded by the repatriation in federal tax refund which more than offset cash outflows in the first half of the year that were driven largely by seasonal working capital build, share repurchases, dividends, a $20 million pension contribution, and interest payments. We outlined on Slide 5 our consolidated net debt and leverage ratio at the end of the second quarter. As you can see, our leverage ratio at the end of the second quarter was approximately 2.0 times trailing 12-months pro forma adjusted EBITDA including the benefit of the $32 million federal tax refund and $5 million asbestos-related insurance recovery scheduled for the second half of the year, our leverage ratio at the end of the second quarter would have been approximately 1.8 times. Now I will turn the call back to Steve.

Thanks, Milt. We will close with a discussion of current market conditions and our outlook for 2018 and then take your questions. As we've always explained, we have limited visibility of future demand, with the exception of new engine production in Power Systems. Most of our businesses have relatively short order to shipment cycles and typically 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. As usual, our guidance excludes impacts from future acquisitions, acquisition-related costs, restructuring costs, the impact of foreign exchange rate changes subsequent to the quarter end, and any litigation or environmental charges. Given current macro economic forecasts a robust backlog in Power Systems and positive demand patterns in many of our markets, we believe our sales momentum will continue through the end of the year. We expect full-year sales to be up between 8% and 9% over last year's pro forma sale and full-year adjusted EBITDA to be between $214 million and $220 million. This represents a $10 million reduction from our previous guidance which is attributable to the impact of the stronger dollar from where it was at the end of the first quarter and the profitability shortfall experienced in the second quarter in heavy-duty trucking. This range reflects a slightly improved outlook for the balance of the year. Now we will open your lines for questions.

[Operator Instructions]. Your first question comes from the line of Ian Zaffino from Oppenheimer. Your line is open.

Hi, thank you very much. Question would be just on OP2, if you could touch on that or give us a little color on discussions there, launch partners, and your overall view of the market, given that work several months or three months since last summer we kind of heard about what's going on there? Thanks.

Let Marvin cover that, Ian.

Okay, yes. I mean we still feel extremely excited and positive about OP2 and we think the progress with OP2 is consistent with what we've expected to-date. Right now to give you a more granular view of that we are in sort of good faith conversations with two perspective partners that would be validation sites for us, we need to get through some major details as it relates to that but we do feel progress is progressing as we expected.

Okay. So when did it move here maybe like an announcement as far as a launch partner, size of a launch, more details around that?

Yes. So it's hard to tell you exactly when we will give you an announcement but the size of the launch will be fairly narrow right, we'd like to have a partner that takes one unit and we can run that unit for a considerable amount of time, so that we can see what the unit operate -- how the unit operates in field conditions and we could have sort of an opportunity to take a deeper engineering look once it's running in the field. So with the two individuals that we're speaking to, two companies that we're speaking to that is we'd like to target one maybe two units initially and then once we have confidence of the units performance in the field, we'd like to open it up to sort of broader customer acquisition.

Your next question comes from the line of Charlie Brady from SunTrust Robinson. Your line is open.

Good morning guys. This is actually Patrick Wu standing in for Charlie. Thanks for taking the question. Just wanted to delve a little bit deeper into STEMCO, I think you mentioned that about half of the warranty reserves is allocated to the supplier issue that you guys saw in the previous quarter. Just over the past three months or so, what has transpired that sort of cost of fund you got unexpectedly that you guys didn't see in the previous quarter and how should we think about that portion moving forward, most of these issues resolves at this point in terms of the warranty reserves? And then the STEMCO price increases that you guys talked about, when did that go into place and for the second half of the year did you anticipate these price increases to be able to neutralize the material cost inflation that you guys mentioned earlier in the call?

Yes, okay Patrick. Two good questions. First of all, let me cover the warranty charge in STEMCO. Of the total $4.4 million charge, $0.4 million of it was actually incurred in the second quarter for brake friction and we reserved another $2 million. This is a limited exposure because at this point, it’s just actually a couple of customers, so we know exactly what we're dealing with and we decided to go ahead and take a reserve for the whole amount. We were not aware that the -- at the first quarter at the end of the quarter and we didn't really have much of the reserve put up. So we feel like we've got that covered at this point. The remaining $2 million was for a product, another product unrelated to friction that we have discovered, we may have some exposure to that's already in the field, it's a defined period of time which is behind us, this is a product that we made and we're in the process now of notifying customers. So I can't tell you any more about that because we need to get the trade to understand exactly what we're dealing with. But that's essentially the other $2 million. Then on the price increases, there were -- there have been really three types of price increase, the first is steel prices pass-through the whole set of STEMCO products to the aftermarket that went in, in June. Then there was the steel impact for OE products, OE customers across -- again across the board for STEMCO that went in July 1. And finally, there's the increase to pass-through the tariff that's affecting our import of tapered roller bearings from China into the U.S. and we're fully recovering that and that basically is in went in yesterday so or Monday. So that's -- so they are all in place now, so we feel like we're going to be covering essentially the impacts that we've seen in both steel price increases as well as the specific tariff that targets tapered roller bearings is one of the ones on the list and that went, so that's where we stand on pricing. Does that answer your question?

Yes. More or less it does.

Okay.

Yes and then I would like to just switch gear a little bit to Engineered Products, obviously a solid quarter there on margins have been -- have done really well for quite a few number of quarters now. I just want to think of it, I just want to take a sort of a big picture stab at this segment when you take a step back, where do you think the segment margins can eventually move toward?

Patrick, this is Milt. We're running at a pretty good rate right now with the favorable conditions that we've had this year with the restructuring work the heavy work that we did at CPI that and most of our shareholders are well aware of. As Steve mentioned on the call, the most significant improvement we've had in margins in the segment over the past couple of years has come from the improvements in CPI. And now we're happy to say that our CPI margins are back out in the same neighborhood as good as GGBs which historically was the case if you turn the clock back a number of years. So I don't know I think the question on additional margin expansion is largely a function of volume and if we see additional volume in the oil and gas markets then that should and I think I could confidently say will accrue to the benefit of margins on the CPI side of the business. So I think it's all about volumes at this point.

Yes, and I think the upside from new products that we're working on new technologies in GGB is a couple of margin points, if those are successful which obviously we hope they will be. Those will come more slowly over time because those are new product introductions that need to ramp up.

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

Just wanted to follow-up also on the Sealing segment, so as I understand that the change to your EBITDA guidance, I think about $4 million of that was related to Sealing but it sounds like and correct me if I'm wrong, I didn't hear the numbers correctly in terms of the warranty pricing, pricing headwinds in the second quarter and then on top of that the productivity and then the gas turbine, all of that added up to $4 million related to the guidance change? I'm just trying to…

No, no, no. The head in Q2 was bigger than the $4 million and so the $4 million is a net of the hit that we had again in brake products. We kind of anticipated the challenges in the IGT business, Joe, we had not made the decision to exit but we were certainly looking at it, we made the decision to exit in Q2. But then in STEMCO, we had a lot of headwinds, so the force net of that and then offsetting that in the second half of the year is the restructuring we did in STEMCO and the pricing increase and then the momentum we see in the rest of the business, so.

Okay. So what was -- can you quantify, is there a way to quantify the headwind that you did see in the second quarter related to all these headwinds that you saw?

Well, I guess directionally it's a pretty big number, if you just look at the Q2 and where we ended up compared to our expectations on the last earnings call when we gave the previous guidance and in heavy-duty trucking alone it was roughly $7 million swing and then on top of that we were dealing with industrial gas turbine which with some pluses and minuses during the quarter so that's directional not an exact number, Joe.

Okay.

Joe, you didn't ask us but if I could just spend one more second on the industrial gas turbine business, I mean you'll remember we bought this business, bought this facility in at the end of 2014 and for 2015 and 2016 it actually bought it for $55 million, $58 million and for 2015 and 2016 it actually did quite well, it was ahead of our expectations and the EBITDA just from this facility alone in two years into it, so that would have been 2016 was 10 little over $10 million. So we felt really good about it and then all of the sudden the market has died, I mean it's not a secret what has happened to GE's business, they were they missed this macro trend as well because they bought Alstom right and so everybody thought the gas would continue to replace coal globally and a bunch of stuff happened in the marketplace very, very quickly including renewable supply to coal went down, China stopped converting from coal to gas et cetera, and GE who is our big customer in that business, the volume just basically plummeted. So after some restructuring in math in 2017 and then looking at it hard in the last couple of months, we decided to get out and so there will be a little bit of a tail in restructuring costs in Q3 and Q4 but most of it is behind us and we actually have already sold the building for $26 million of cash. So even though on the books, it's a restructuring charge from an economic standpoint it was -- we were fortunate to get so much for the building because of where it's located. So hopefully and certainly our view is that the drag on earnings of that business is done and other than that, the Technetics Group is really doing quite well, so we're hopeful that that will shine through, shine through in the second half of the year right. In STEMCO, we have done our best to try to really get the best possible estimate of what the warranty costs could be, I'm not concerned about the price pass-through, I think we will cover most of those costs. We do have some productivity issues in the business but we're all over that. And we've got the right resources deployed, it will improve, it won’t improve in a step change way but it will improve. And we've got a new leader, one of our most seasoned guys, experienced been with the company a long time, he is a guy that has led Garlock for us for the last six or seven years and he's stepped in and he is now running STEMCO and is getting on top of all these things. So STEMCO still a good business, it's a healthy business, it historically it's been a good margin business and we've made some missteps but all of them were very fixable, it's not a fundamental issue that we have in STEMCO in my view. And it’s almost all centered into brake products group, so the core products, the seal, the Hubcaps Bearings, all the suspension products that's all still doing well. So I think it's a contained situation we have and we certainly expect through all of these things to have a stronger second half than we had in the first half.

Okay, great. Just a couple of follow-up questions, of the $7 million headwind in the second quarter at STEMCO, how much would you say is related to the productivity and it sounds like maybe that sort of lingers in the third and maybe even in fourth but maybe by the time we enter 2019 largely these productivity issues will be behind them, would you say?

Well first of all, you can start with the unusual warranty that we discussed so that's $4.4 million so that's the biggest chunk of that roughly $7 million number that I cited earlier and I have beyond that, I think Steve kind of covered generally what's happening that we got, we got to address the productivity in the friction facility, we’re getting on top of the tariff-related costs largely metals driven. So I really can't give you a precise breakdown there, Joe.

Okay. And just looking at this in hindsight, the environment right now economy is doing really well, truck miles are really good, I've been thinking that STEMCO should be actually outperforming, in hindsight what can we do to sort of prevent a kind of thing like this and it’s unfortunate because the environment seems to be really good for STEMCO?

Our volumes has been good and now we profits have been affected by mix because lot of growth on the OE side relative to the growth in the aftermarket although the aftermarket has been steady and solid as well. So yes not a question of volume and we're participating it, so we're not losing share, as Steve said we’re well-positioned in the industry, it is really some isolated incidents that we're dealing with, we've taken pretty quick action.

Okay. All right. What is the savings on exiting of the gas turbines on a quarterly basis?

Well we we've lost year-to-date, year-to-date we've lost 2 million bucks roughly plus or minus.

Yes, and it varies a little bit on the question, it’s a little bit new last year --

Yes.

Because we have to -- when we're spending time together if you want to dig in the details, we have got all the details, we're happy to do it. But the answer to your question depends really on the specific question because what we've seen is an acceleration of the decline, if you go back to the first quarter of 2017, it was still a pretty good quarter for us in IGT, we are starting to sense that things are slowing down. We saw a pretty significant drop in Q2, but it just continued to worsen since then, so if you look at the volumes that we had in the second quarter of this year compared to the second quarter of last year it's almost half and that’s after a soft second quarter in 2017. So it's directionally, if you want to look at full-year, I think the couple of million dollars as Steve cited is a good one but.

But would have been worse in the second half than that, Joe, that's going well, yes.

Understand. Just last one and I will jump back in queue, I just wanted to ask about Power Systems, could you update us on sort of your thoughts on this is very lumpy and it’s tough for us to tell but just wondering, I know earlier in the year you thought that margins could be sort of comparable to a year ago, do you still think that for the full-year any outlook that you can provide for the second half on revenue and margin as well as we enter 2019 that would be helpful and then on top of that, I was hoping to get, how much of the EDF revenue was booked in the first half of the year?

Yes what is the first half, Milt? We -- as we mentioned in the prepared remarks Joe, we’re three-fourths roughly three-fourths of the way through on a percent completion basis of the EDF contract. By the end of the year that will probably be I don't know probably close to the 90% because we'll probably ship -- we shipped 8 so far we've got one going out in the next week or two and we will probably ship three more by the end of the year, so I would guess when you say Marvin, we are probably going to ship four more this year.

Four more this year after the one next week.

After the one, yes so we will call it that would be 13 that would be shipped and through, and as Milt said, the way the production process works, we've started -- essentially started all of them at this point, so they're all somewhere in the shop. So that rack is slowly moving through the pipe out as they say, we're getting closer and closer to seeing the end of that and as you know I want to also clarify one thing, I think everybody knows this but in some of the notes that you guys published this morning, I saw a little bit of a language difference that I just wanted to clarify, we don't make a projection on currency going forward. The only thing we do as it affects our guidance is take the currency at the end of the quarter and whatever that is, we adjust our guidance by that number, now it's more complicated now because obviously a big chunk of that is EDF because it is the fact that it’s in a loss position, we have to book the impact of that as if it we’re not changing through the balance of the deal right and that's why as Milt mentioned in his remarks, the period over period last year to this year for EDF had a huge seven million bucks or plus swing because we had a big gain last year because the dollar was weakening. And then, in this year, we had a significant loss because the Euro went from €123 to €117 during the course of the second quarter. But I just want to make sure everybody knows we're not taking a position on what currency does, on a prospective basis, we simply kind of mark our guidance if you will to market what was -- whatever the currency is, most of it's Euro but it does it is obviously we have other foreign operations. So I just wanted to make that clarification now Milt can address the rest of your questions.

I think you had asked about revenues in the second quarter were EDF related.

For the first half actually?

For the first half it’s roughly, roughly $14 million.

Okay. Okay and I think you said earlier this year you were looking at about $30 million of revenue, so we're looking at about $16 million of revenue in the back half of the year with about 25% of the costs that's your margin is that the way to way to look at that?

Definitely this is looking two things here. So the second half of the year, second half of the year, I think you’re maybe a little heavy and so according to our best estimate right now might be more in the neighborhood of $11 million to $12 million.

Okay.

In the second half of the year.

And then just overall sort of outlook of margin in the back half of the year and do you still I think the environment should say that maybe margin gets a little better in 2019 because EDF is largely behind you but any early thoughts on 2019 and how things look?

Yes. And even in the second half of the year, we should have a better engine mix that will help profitability marginally and then yes it should improve in 2019.

Yes, just to add a little color to that, I think it's important to note that on the back half of this year currently the business, the Power Systems business is sitting with sort of a record aftermarket backlog today, right. So the coverage for the balance of the year in terms of the backlog, we already have enough in the backlog to cover the second half of the year forecast, so we're in a very, very strong position. So I would expect the back half of the year to be much better.

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

Hey guys, this is Brad filling in for Jeff. Most of my have been answered here but just one on capital allocation, when you assess your M&A pipeline, anything at all there and may be a little bit more color of when buybacks can return to the table it sounds like you have to go through some debt pay down first and then what is the appetite to pay down debt now you’re at roughly two times? Thanks.

Let me start with the share repurchase question first and then we can back up and talk about M&A and pipeline of how we’re thinking about that. Yes, we're running into the maximum permitted under the indenture agreements of our senior notes as I mentioned on the script. So it's unlikely that we will proceed with any further share repurchases until such time that we make a decision of what we want to do with our existing senior notes. There is a builder basket that over time based on the income that we generate will rebuild our ability to repurchase shares but any amounts under the builder basket will likely be pretty small, if you're looking at the near-term. So that's the situation with our share repurchases. So we do expect that will be generating pretty strong cash in the second half of the year, we typically are much strong cash generator in the second half of the year than we are in the first half of the year. We anticipate the additional refund coming in by the end of the year. We got a small amount of the extra fee collections, so we think the second half will be a good cash flow year for us asset yields, yes at this point will be paying down debt. So on the question of the M&A pipeline, we're looking at a lot of things, over the past quarter we -- our team has spent considerable amount of time working at a number of opportunities that are in some of the markets that we've identified that we are targeting for future growth. We’re maintaining our discipline, so it's -- we've gone pretty far down the road on a couple of deals but given price and some of other considerations we haven't pulled the trigger on anything to-date, this year as you know. So we continue to look and so our filter is we're looking for businesses that are either kind of strategically debt and actual tuck-in or fit with existing business and we're looking at some larger adjacency moves that serve the markets that we're interested in and have attractive business and market characteristics.

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

I first wanted to ask a little bit more on the cash flow front, so you got $96 million of the tax refund in the first half, you repurchased $50 million of stock and paid $10 million of dividends, that’s $60 million now, so there are sort of $35 million call from non-operating activities and your net debt went down by about $35 million versus year-end, so sort of free cash flow in the first half seems to be about flat. Is that sort of where it would normally be in the first half if not sort of what's the drag and any sort of projection as to where sort of free cash flow can end the year outside of these tax refunds and other non-operating factors would be helpful?

We do Justin back to the question previously. Our working capital is fairly seasonal, it’s fairly predictable. We typically see it build in the first half of the year and then we typically see a work down of that in the second half of the year, so the first half of the year we've had a combination of two things as we've talked about today, our sales are up nicely this year and we're expecting our revenues for the year to be up 8% to 9% and on top of that is what's happening in the Power Systems with the revenue recognition there but even outside of Power Systems still pretty good organic growth that we’re expecting this year. So there's some additional working capital is needed to support that growth, in addition we have the second quarter, first quarter and second quarter working capital build that historically has been in the neighborhood of $30 million or so. And so we would expect some of that working capital build to come down by the end of the year and then in addition to whatever cash we generated from our operations.

Okay, that's helpful. And then any sort of comments on free cash flow conversion, I know it’s not something you typically guided to?

Yes, well our definition of free cash flow conversion internally is what percentage of EBITDA do we generate to take EBITDA less capital spending, changes in working capital what is that as a percentage of EBITDA, that's how we think about it internally, I’m not sure what exactly what is your definition is. But on that basis, we’re targeting and it depends and varies by business but we’re targeting something like 70% to 80%. Now one of the outflows in the first half of the year that I have mentioned in the comments earlier is we did made $20 million pension contribution in the second quarter so --or in the first half of the year I should say. That was a use of cash and one of the reasons why you're saying the flat cash performance in the first half.

Okay. Was that in the first quarter or the second quarter?

That was in the mostly in the second quarter we had a little bit, we had $2 million to $3 million I think in the first quarter.

Okay. And just I think you ran by a little bit quickly, your definition of free cash flow conversion again, could you just state that again, sorry I couldn’t hear?

Essentially what percentage of EBITDA do we return after capital spending and after changes in working capital.

Okay, including tax effects?

In that definition no.

Okay.

I’m happy to spend more time with you on looking at our underlying cash flows including the tax rate differences, the cash taxes which vary they are significantly different than our statutory tax rates given the refunds and so forth.

Okay, good, that's helpful there. I will just switch gears to guidance quickly, two quick questions there, is the second half view of EBITDA any lower than it was in your sort of guidance that was given in the first quarter, it seems like it's more or less the same second half few years before?

Yes, it would be -- it would be more or less the same, if you considered in total, if you take what's happened with heavy-duty trucking how the picture as Steve said slightly improved in our other businesses.

Okay. And then the bridge sort of amidst the benefit from the sales guidance increased to 6% to 8% to the 8% to 9%, is there really sort of a slight benefit there from the increased sales guide that's being offset by sort of $7 million hit in heavy-duty truck that you referred to earlier versus the $4 million number on the waterfall side?

I’m not sure I am following your question.

I mean the increased sales guide would normally your EBITDA outlook now that you’re forecasting 8% to 9% sales growth and then you also mentioned earlier there was really a $7 million hit to heavy-duty truck in the second quarter, so really that receipt sort of $7 million hit to heavy-duty truck but then we’re offsetting part of that from the increased sales guide to inform sort of your new EBITDA guidance?

Yes, but there are some other -- there are other factors too. I mean one of the reasons that we’re having pretty good sales performance this year is we’re seeing a new engine revenues in Power Systems which don’t carry the same margins that the aftermarket does and we're expecting to have a strong second half aftermarket performance as well. In Sealing Products, we’re having a pretty strong volumes in semiconductor which on average our margins in semiconductor are lower than the average in the semiconductor, in heavy-duty trucking lot of our revenue increase is being driven by the OE business. So there is a nexus use of plan to but I do agree with your comment, I think that’s part of it.

[Operator Instructions]. Your next question comes from the line of Matthew Fields from Bank of America. Your line is open.

Hey everyone. Just you were talking a lot about how you’re just sort of limited on buybacks because if your bond indenture but I'm sure as you're well aware they're currently callable and their call steps down on September 15th to 102.9 which is not so much above where they're trading now. So I mean with a 30-day notice you could announce two weeks from today that you're refinancing those bonds and giving yourself more flexibility under your fee basket. So what's your thought on just terming out refinancing that debt?

Yes, we're considering all those options.

Your next question comes from the line of Andy Reamer [ph] from [indiscernible] Management. Your line is open.

Couple of questions from me, one on the pension. How does that plan look right now after that $20 million contribution should we anticipate seeing no additional contributions going forward? And then I hate to harp on this again, but just on STEMCO and the issues there, I guess, at what point during the quarter that it became evident that there was some productivity issues and then what specifically are those issues, if you could give a little more context behind your comments? Thank you.

Okay, I'll take the pension and then we'll move from there to talk about STEMCO. The -- we're in great shape on pension, by the way. We are nearly fully funded, so we don’t anticipate any a need to make any future contributions to the pension. Certainly not in the near-term, not the market goes crazy on us, maybe that’s a different story down the road but we're pretty fully funded and we're matching up how the pension funds are invested so that we don't have a lot of risk at this point. So that’s a good story. I will mention this I didn’t talk about it in my prepared remarks. It was referred to in a footnote on one of the slides but during the quarter we annuitized a significant portion of the retiree pension obligation. It will have -- it will be a Q3 event. So you'll see it more in our disclosure in the third quarter. It will have a non-cash non-operating charge but it's really a positive; we're basically annuitizing about 75% of the retiree obligations under the pension. And so we're de-risking a plan. We can -- we consider to be a NPV positive move for the pension and also it just insulates us from changes that might happen in the future if the PBGC continues to increase per participant fees as has been the case over the past few years. By the way, the 75% that I cite was based on headcount as opposed to dollars because we did annuitize a -- have a lower dollars participants in the plan.

And then, Andy, on your question on productivity, so we entered the friction production business -- or the, sorry, the friction business within heavy-duty trucking a number of years ago, and our plan which we did, which the plan was to partner with a Brazilian supplier. This is going back, gosh, I want to say seven years -- six or seven years now. And bring that friction into the United States and then also put in one of our existing facilities in Rome, Georgia a friction line to be able to run the high end friction products that demand a higher premium that is how we want win in STEMCO, right, selling better products that last longer and so forth. So we went down that path and we actually -- our engineering team designed a friction line that we have installed and it was a different approach; we thought obviously a much better approach to producing friction, better quality, better throughput, et cetera. And so it was -- I won't take you through the technical details of it but they were some technical risk associated with it. We started that out last summer and we have struggled with the new equipment and that production configuration. And we struggled from the beginning, well, for the first six months it was kind of like normal startup issues that we thought we would overcome and we continue to struggle with those issues. So that's the productivity issue that we're referring to. We just have not yet got any output that we need from that facility. Obviously our supplier from Brazil is a big part of this warranty whereas all of this warranty exposure that we have, we've also obviously moved away from that supplier a couple of years ago, we now have a good supplier but the warranty that we're incurring, the warranty cost that we're incurring is stuff was already in the field. So that's where we're struggling within the brake products group.

Okay. Just a quick follow-up then on that. I mean you talked about the problem being relatively contained. So what specifically needs to be done to improve the production? Is it something where the equipment is faulty and you need to be switch out, why continue to struggle, I mean, why you're still struggling there? What's -- why they're talking all of the [indiscernible]?

Well, I think I would best -- I don’t think we need to swap things out, I don’t think we would do that. It's a technical problem, it's equipment that we procured, put in place obviously the run out but it's just there's some steps in the process that probably need to be decoupled and all of its needs to be debottlenecked, and we're working in it. We are making some progress but it's a technical -- it's an ongoing technical problem. So I still believe a lot if it is startup issues that have just have been persistently caused; it's a relatively unique way to produce friction. We still have hopes that it will be -- that it would be affected. But that's a big part of what we're looking; Marvin is spending a lot of times trying to help team sort out of the where we go with this and make sure we have all the right resources supplied and negotiating with the suppliers of the equipment and so forth. So it's really that's how I would describe it some engineering and technical problem. Do you want anything to that, Marvin?

Yes. The only thing I would add is that in the near-term the cost drag that we'll have is that we do have to meet customer demand. So we have engaged another supplier and we are buying what's required to meet customer demand as we come up to speed on the line, right. So you have a little redundancy there relative to cost as we attempt to meet customer demand and improve the line at the same time. So as we get better productivity out of the line obviously that will come down. So that's what we're experiencing here in the near-term.

There are no questions at this time. I turn the call back over to the presenters.

Thank you, Marcela, 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.