Chris O’Neal - Vice President, Strategy, Corporate Development and Investor Relations Stephen MacAdam - President and Chief Executive Officer Milton Childress - Senior Vice President and Chief Financial Officer.
Ian Zaffino - Oppenheimer Jeff Hammond - Key Banc Capital Markets Joe Mondillo - Sidoti & Company Liam Burke - Wunderlich Justin Bergner - Gabelli & Company.
Good morning. My name is Candy, and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries’ 2017 First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.
[Operator Instructions] Thank you. Chris O’Neal, Vice President of Strategy, Corporate Development and Investor Relations, you may begin your conference..
Thank you, Candy. Good morning and welcome to EnPro Industries’ quarterly earnings conference call. I remind you that our call is also being webcast at enproindustries.com where you can find the slides that accompany the call.
Steve MacAdam, our President and CEO; and Milt Childress, our Senior Vice President and CFO will begin their review of our first quarter performance and 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.
We do not undertake to update any forward-looking statements made on this conference call to reflect any change in management’s expectations or any change in assumptions or circumstances on which such statements are based.
Our earnings release and conference call presentation materials contain additional disclosures regarding non-GAAP financial information, collective references to EnPro and our subsidiaries, and the deconsolidation of Garlock Sealing Technologies, or GST, and OldCo LLC or OldCo and pro forma illustrative financial information presented as if GST and OldCo were reconsolidated for financial reporting purposes.
These disclosures are important to understanding comments we will make on today’s call and we urge you to read them carefully.
Just as we did in the last few quarters, we are providing pro forma segment sales and pro forma segment adjusted EBITDA information in conjunction with the ACRP settlement agreement announced on March 17, 2016 to provide investors additional pro forma information illustrating each segment’s results as if GST and OldCo had been reconsolidated with EnPro based on confirmation and consummation of the joint plan reorganization as described in our earnings release.
Given where we are in the bankruptcy process and due to requests from investors for this type of information, we believe this disclosure of pro forma operating results is instructed to investors as it reflects the performance of all of our subsidiaries.
Until the ACRP process is completed, however, our published GAAP financials in Forms 10-Q and 10-K will continue to reflect GST and OldCo on a deconsolidated basis. And now, I will turn the call over to Steve..
Thanks, Chris. Good morning, everyone, and thanks for joining us. In the first quarter for the first time in a number of years, we experienced modestly improving demand conditions in several of our markets.
The modest volume strength along with significant year-over-year year-over-year cost reductions combine to produce very favorable year-over-year results.
For the past several years, we’ve invested in modernizing facilities, equipment and IT systems and also invested considerable time in money and our comprehensive operating system to improve talent, commercial capability, productivity and innovation, and it’s exciting to see the positive effects of those efforts in our Q1 results.
For the first quarter, pro forma sales increased 1% year-over-year from the same period last year. Organic year-over-year sales increases in sealing products and engineered products of approximately 3% and 4%, respectively, were mostly offset by decline in power systems due to lower engine sales.
Pro forma adjusted EBITDA increased 50% year-over-year due to a variety of factors, including these volume increases in sealing products and engineered products; the positive impact from company-wide cost reduction actions, including restructuring activities that occurred throughout 2016; the favorable comparison impact from the $3 million of legal expenses that power systems incurred in the first quarter of 2016; and the favorable effect of currency on power systems to EDF program.
In the first quarter, we experienced modestly strengthening conditions in several markets we serve. Demand in semiconductor, food and pharma and aerospace continued to be strong. Oil and gas, automotive, refining, steel and mining improved, while general – while industrial gas turbines, general industrial, and nuclear remain flat year-over-year.
The general positive market momentum was partially offset by modest weakness in heavy-duty trucking, particularly early in the quarter. Sales were down year-over-year in Power Systems segment due to lower engine revenue noted previously. The decline rate relates only to the timing of work performed and does not represent any change in customer demand.
The column on the far right of Slide #5 provides directional guidance on how we currently see our end markets performing on a year-over-year basis through the rest of 2017. As you can see, we currently expect continued modest improvement on a year-over-year basis in many of our key end markets.
Before turning the call over to Milt to discuss our financial results in more detail, I want to highlight some positive developments in the first quarter, including the strong performance of Stemco air springs and progress in the ACRP.
As you’ll recall in July of 2015, we acquired Continental Corporation to air springs business, which manufacturers air springs for heavy-duty truck suspension. The business is a natural fit with Stemco and we’ve outperformed our original investment case.
Much of this value has come from the successful integration of air springs and Stemco’s systems processes and facilities.
Major integration activities have included the implementation of the new ERP system in each of the air springs locations, reorganization of air spring distribution through Stemco’s distribution center in Berea, Kentucky; the negotiation of new supply chain agreements that significantly reduced product cost; and the relocation of air springs R&D facility into a newly constructed building in Fairlawn, Ohio.
Each of these activities is required a tremendous amount of time and attention from the Stemco team and those efforts are paying off. We expect adjusted EBITDA to nearly double from the run rate at the time of the transaction to the run rate in 2017, and we expect further growth over time.
Our Stemco team has done an outstanding job on this integration. The ACRP remains on schedule. I want to take a moment to remind you a few of the – the important milestones that we achieved since the end of last year.
As we discussed during our last quarterly conference call on June – sorry, January 30th of this year, we announced the successful merger of Coltec into a new indirect EnPro subsidiary, OldCo LLC and subsequent prepackaged Chapter 11 petition filing of that entity.
On February 2, we reported that we obtained final court approval for the settlement agreement previously reached with the Canadian workers’ compensation boards for each of the 10 Canadian provinces to resolve current and future asbestos claims.
Each of these activities were the significant milestone in our effort to permanently resolve our legacy as best dispersed.
The confirmation hearing with the bankruptcy court is still scheduled to begin in two weeks, and absent any unanticipated objections or appeals we expect to reconsolidate GST and OldCo into EnPro in the third quarter of this year.
On March 24, we completed $150 million addition to our 5.875% senior notes and used the proceeds to pay down our revolver. While this was not directly related to the ACRP, we issued the additional debt to increase our liquidity in preparation for the anticipated settlement payment, trust payment, later this year. Now, I’ll turn the call over to Milt..
Thank you, Steve. As discussed before, the pro forma segment results that I will discuss are prepared as if GST and OldCo had been consolidated on the basis described in our earnings release.
As a reminder, most of the difference between consolidated and pro forma segment information is in sealing products, with only small differences in engineered products and power systems stemming from foreign operations of those segments included in GST foreign subsidiaries.
It’s important to note that the pro forma results do not represent a projection of the financials as of the expected future date of reconsolidation. Our pro forma first quarter sales of $337.9 million were up 1% from the same period of 2016.
Organic sales for the quarter were also up 1%, as the impact of the Rubber Fab acquisition, net of the small divestiture was offset by unfavorable foreign currency translation.
Solid organic pro forma sales increases in sealing products and engineered products of 3.2% and 4.1%, respectively, were offset by sales decline in power systems to lower engine revenue versus last year.
Pro forma gross profit for the quarter of $121.8 million was 5.1% higher than in the first quarter of 2016, and pro forma gross profit margins were up 140 basis points year-over-year to 36%. Total pro forma segment SG&A declined in the first quarter of 2017 by $14.3 million to $77.8 million.
Excluding restructuring costs, $3 million of legal costs in the first quarter of 2016 related to the AVL lawsuit. And SG&A costs associated with acquisitions and divestitures, pro forma segment SG&A was $8.5 million lower than in the prior year.
As previously mentioned, the company-wide cost reduction initiatives, including the restructuring activities that occurred throughout 2016 contributed to the year-over-year improvement. Corporate expenses were $7.5 million in the first quarter of 2017 compared to $9 million in the same period last year.
The year-over-year decrease was driven primarily by lower professional fees and administrative costs, and lower employee costs as a result of workforce reductions implemented in 2016.
Pro forma adjusted net income, which adjusts pro forma net income for items, such as restructuring, legacy environmental reserves, and tax effects associated with these items, all are shown in the reconciliation table in our earnings release was $20.1 million, up a $11.5 million from a year ago.
Pro forma sales in the Sealing Products segment were $219.4 million in the first quarter, up 3.9% over the first quarter of 2016. Excluding the impact of the Rubber Fab acquisition, the Franken Plastik divestiture and foreign exchange translation, pro forma sales were up 3.2% in the first quarter.
During the first quarter, we continue to experience strong demand in our semiconductor, food and pharma, and aerospace markets Additionally, demand in oil and gas, refining, steel and mining improved modestly, and demand in industrial gas turbines, general industrial, and nuclear markets remained relatively flat year-over-year.
Our positive momentum throughout the quarter was partially offset by a modest year-over-year decline in heavy-duty trucking. Pro forma segment adjusted EBITDA, which excludes the impact of restructuring and acquisition expenses was $39.9 million, up 17.7% from the first quarter of last year.
Pro forma segment adjusted EBITDA margins increased to 18.2% in the first quarter from 16.1% a year ago. Excluding the impact of acquisitions, divestiture and foreign exchange translation, first quarter pro forma segment adjusted EBITDA increased 16.3%.
The increase was driven primarily by the increased volume noted previously, the positive impact from restructuring activities that were completed throughout 2016, and a continued focus on managing costs. Pro forma segment SG&A costs were $49.8 million in the first quarter compared to $55.6 million in the prior year.
Excluding restructuring costs and SG&A costs related to the acquisition and divestiture, pro forma segment SG&A costs were $5.3 million lower in the first quarter versus last year. In the Engineered Products segment, first quarter pro forma sales of $75.2 million increased by 1.6% from the first quarter of 2016.
Excluding the impact of foreign exchange translation, pro forma sales were up 4.1% in the first quarter over the prior year. This year-over-year sales increase was due primarily the strength in the European automotive, North American oil and gas, and general demand in Asia.
Pro forma segment adjusted EBITDA of $14.1 million, was up significantly from $9.6 million in the first quarter of last year.
As a result of the combination of increased volume, manufacturing efficiencies, cost reductions, and the favorable impact of the restructuring efforts completed in 2016, pro forma segment adjusted EBITDA margins were 18.8% in the first quarter versus 13% in the prior year.
Pro forma segment SG&A costs were $21.6 million in the first quarter compared to $25.9 million in the prior year. Excluding restructuring costs, pro forma segment SG&A costs were $1.9 million lower in the first quarter of 2017 versus a year ago.
In the Power Systems segment, pro forma sales were $44.3 million, down 12.8% compared to the first quarter of 2016. The sales decline was primarily due to lower engine revenue versus last year. Pro forma segment adjusted EBITDA for the quarter was $8.2 million, up from $2.5 million a year ago.
Contributing factors to the higher pro forma segment adjusted EBITDA in the first quarter were decreased operating costs attributable to prior year cost-savings initiatives, lower warranty costs, and the positive year-over-year impact of the $3 million of legal costs recurred in the first quarter of 2016.
Additionally, power systems recorded a $0.5 million positive accounting adjustment related to the EDF contract during the first quarter of 2017. As a reminder, GAAP rules require that we evaluate the impact of the dollar to euro foreign exchange rate on the EDF contract each quarter.
Reflecting the total projected loss on the long-term EDF contract in proportion to percentage of completion of the contract, as is the accounting practice for positive gross margin long-term contracts and excluding the effect of the 2016 AVL charge. First quarter pro forma segment adjusted EBITDA increased 46.9% from a year ago.
Pro forma segment SG&A costs were $6.4 million in the first quarter compared to $10.6 million in the prior year. Excluding the $3 million AVL legal settlement charge, pro forma segment SG&A costs were $1.2 million lower in the first quarter versus last year.
As we’ve discussed in the past, disciplined capital allocation remains one of our top priorities for creating shareholder value. In the first quarter of 2017 on a pro forma basis, we invested $7.1 million in equipment and facilities, most of which was growth-oriented.
Additionally, we repurchased approximately 61,000 shares for $4 million, as part of the ongoing $50 million share repurchase program. Through the end of the first quarter of 2017, we had repurchased approximately 788,000 shares for a total of $39.6 million under the $50 million authorization.
Additionally, during the quarter, we paid a $0.22 per share dividend in March.
As in previous quarters, we outlined on Slide 15, our pro forma net debt and leverage ratio taking into account funding under the ACRP consensual agreement and reconsolidation and initial trust funding occurred at the end of the first quarter, our pro forma leverage ratio would have been approximately 2.3 times and in contrast to the 4.6 times EBITDA leverage ratio indicated by our consolidated results.
As we pointed out last quarter, this pro forma leverage calculation does not include tax benefits of the planned funding that we expect to realize over time. As Steve mentioned earlier, we completed a $150 million take on to our 5.875% senior notes.
The additional offering was priced at 101%, with a yield maturity of 5.66% compared to the 6% yield maturity of the original $300 million issuance. We used the proceeds to pay down our revolver.
And while this was not directly related to ACRP, we issued the additional debt to increase our liquidity in preparation for the anticipated settlement payments into the trust later this year. As we provided during the last three quarters, we are including an update of our pro forma valuation relative to earnings.
As shown on Slide 16, our pro forma enterprise value to pro forma adjusted EBITDA multiple at the end of the first quarter was approximately 9 times compared to a multiple of 14.5 times indicated by our consolidated results. Now, I will turn the call back to Steve..
Thanks, Milt. We’ll close with a discussion of the current market conditions and our outlook for 2017, and then take some questions. As we’ve discussed throughout our comments, demand in many of our markets showed signs of stability or modest improvement.
Our order pattern suggests that these encouraging trends will continue into the second quarter, and we’re cautiously optimistic about the balance of the year. It’s important to note that $12 million of our $18 million increase in adjusted EBITDA in the first quarter versus the same period last year was caused by a reduction in total SG&A.
SG&A costs in the first quarter of last year were the highest of the year, with costs moderating considerably in the second through fourth quarters of 2016, as we implemented the number of costs reduction and restructuring actions. We do not expect significant benefits from year-over-year SG&A comparisons for the rest of 2017.
And therefore, we expect that market growth, product mix, operating efficiencies along with continued cost discipline will be the key drivers of our performance during the balance of the year.
Given our first quarter results, current macro economic forecasts, order patterns and customer feedback, we are increasing our guidance for our 2017 adjusted EBITDA.
Excluding the future impact of acquisitions, changes in foreign exchange, and any litigation or environmental charges, we’re increasing our previous pro forma adjusted EBITDA estimated range of $188 million to $193 million to a revised estimated range of $193 million to $198 million.
I want to be clear that this guidance is based on our limited visibility into the second quarter and the demand levels that we’ve recently been experiencing. I’d also like to point out that we expect our second quarter pro forma adjusted EBITDA to be relatively flat compared to the first quarter of this year 2017.
While we expect improving performance in sealing products on a sequential basis and a stable but strong quarter in engineered products, pro forma segment adjusted EBITDA in power systems will likely decline sequentially in the second quarter compared to the first quarter, as a result of zero gross margin [Shaw MOX] [ph] in the EDF engine segments.
Lower aftermarket parts and service resulting from normally core – normal quarterly fluctuations related to customers maintenance interval and an increase in R&D related to the start of endurance testing of the OP2 engine.
Before I open the line to questions, I want to reiterate my excitement not only for our first quarter results, but also for the many growth and cost improvement initiatives that we have underway across our company.
We’re well-positioned to drive growth in value of our company as we move forward toward completion of the ACRP and the reconsolidation of GST and OldCo into EnPro. Now, we’ll open the line for questions..
[Operator Instructions] Your first question comes from the line of Ian Zaffino from Oppenheimer. Your line is open..
Hi, great. Thank you very much. Good quarter. Glad to see some of your end markets are trying to improve nicely there. Question, I guess, Steve, would be on the cost front. And maybe help me understand this a little bit more.
So you said you’re going to focus on costs, but there’s no more SG&A savings, or there is? And then what would be sort of the largest buckets of cost savings that you would be focused on? And then I have a follow-up?.
So I think our – we’re open to keep SG&A relatively constant of where we are, Ian. And what I was trying to point out is the year-over-year – the biggest year-over- year benefit that we’re going to see happened in Q1, because we started the cost reduction and restructuring actually we started it back in late 2015, carried over into 2016.
And then, as things declined last year even further, as markets deteriorated further, we have limited a bigger and more comprehensive cost reduction, and I think it was June – May or June of last year, or in late spring at some point, I don’t remember exactly. But it was another, it punctuated it. So we’ve been working hard on costs up until then.
And so they started to be implemented throughout the year. So all I’m saying is, the comp gets tougher as we go through the year..
Right. Okay, I understood.
And then just sticking on that, I guess, there is any markets begin to improve? How much more room is there to take out costs versus of actually having to add costs back to take advantage of the stronger markets?.
Well, I mean, we’ll see, yes, we did pay much incentive last year, incentive comp. And so, one of the things that will drift or and that will be a little higher for SG&A will be more incentive comp for this year. We hope that things keep going well. And obviously, we give some merit increase that we do typically on an annual basis, that’s a little bit.
So we expect productivity gains and further improvements to work to offset those. And so we’re in a commodity – the raw material commodity market that is – it’s mixed at this point. It’s really kind of challenging to figure out. I’d say, in general, we’re seeing rising costs, but it’s not that extreme.
We’re in a good position to maintain our margin and continue improving our margin because of the nature of our products and our customer relationships and so forth. So we’re seeing some drift up in costs. If you look at the aggregate, but there are several large categories that we buy that actually are flat to modestly down.
So we don’t see a lot of cost squeeze coming from commodities. Look, the company is in great shape. I mean, I feel I’m very optimistically, you were at our Investor Day and so you saw we’ve made a lot of growth investments. Those growth investments are starting to hit, if you will, and will throughout the year.
So I don’t see us taking a lot of SG&A costs out going forward, but also don’t see a ton of SG&A costs in terms of structural costs, which is really driven by headcount. I don’t see a lot of that coming back either, because I think we can compete effectively in growth markets with the team we have.
Milt, do you want to add anything to that?.
No, I think that covers it well. As you know, when we talked in the past with volume, we leverage quite well those company, and you were seeing some of that with the modest improvement we had in the first quarter of this year..
Okay, great. Thank you very much..
Your next question comes from the line of Jeff Hammond from Key Banc Capital Markets. Your line is open..
Hey, good morning, guys..
Good morning, Jeff..
Hey, just – Steve, just a clarification on your, I guess, final comment about kind of the guiding color.
Was that 2Q you see similar to 2Q last year, or similar to this this 1Q we just put up?.
To this 1Q..
Okay. Okay, great..
Yes. We were talking sequentially in that case, yes..
Okay. Yes, that’s what I thought, I heard. Okay, if I wanted to really dig in on engineered products. I mean, you guys put up a 13% op margin, that’s a big outlier from what you’ve been putting up over a multi-year period. I know a while back, you had talked about higher margin targets.
So any aberrations within that? How should we think about that sustaining going forward?.
Yes, that’s a great question, Jeff. I think, believe it or not, it’s actually the elimination of aberrations that we’ve had in the past two years. So I would call this a much more normalized rate of margin with two caveats. One is Q1 and Q2, as you know, our GGB is strong, of course. The first quarter was strong.
It wasn’t a blowout quarter from a volume standpoint. I mean, we still haven’t seen, I think, I’d say, I personally I believe demand in general industrial in Europe will pick up throughout the year. We don’t really have that built in that much to our outlook.
But I think there’s a good chance that that will happen, because I think there’s some light and strength in Europe that we’re not yet seen that I think the market even called a little bit with the certainty that’s been resolved in the French election period that we’ve already seen and we’re going to see this weekend, I assume.
So I think that will help stabilize and Europe has been so weak for so long that I think there’s like potential there. And so, GGB, we didn’t – we really didn’t benefit from what I would call a hugely robust market. It was a decent market for them.
And then the other thing is CPI, I mean, we’ve been clearing the dust again, the smoke off the battlefield for two years, and the market has been in a freefall really until the first quarter, as I said, in – again in the Investor Day, it was – once we got back into this year, there were some renewed activity and our cost structure was in good shape.
Now we have in the first quarter exited two small service centers in Australia. We sold those to the operator there. So we’re still – those were marginal facilities, so we’ll still benefit from part sales over there. But we – but it will be – it will shrink the top line, holds the bottom line.
So that will help margins in CPI, and we have taken a little bit more just another, let’s call it, another nibble at SG&A costs in CPI this year as well. So cost position is great in both of those of businesses. Operationally, we’ve never done better.
Our on-time deliveries are better than they’ve ever been across the Board in all our operating facilities of both CPI and GGB, the teams have really, really worked hard to get those businesses competitive. We got some exciting things going on in GGB that will play out over the next few years.
So I think quite frankly, it’s the first quarter in a number of years that’s a clean look at engineered products based on the current – based on the current demand levels, which again are better than we’ve seen, but they’re certainly not back to the glory days of 2011 and 2012, you know when we were seeing tons of demand in those markets.
Milt, what do you want to add?.
All right, one of things Jeff, I mean Steve alluded to when he first started talking about the segment.
But just to remind you, Q1 historically has been our strongest quarter for the segment, particularly driven by the results in our bearings business, so – and then followed by Q2 and historically there has been a fairly noticeable difference in volume and margins in the second half of the year compared to the first half of the year, so I’ll just remind you of that, why that is driven by we have a heavy European exposure in both businesses and engineered products..
Okay, good, good color here, helpful. So Power Systems, I think the guide coming into the year was that you would get a decent amount of growth from the EDF contractor at low margins and then you’d have some margin pressure, that clearly didn’t play out.
So, is that how to think about that starts to normalize in the second quarter and beyond where you see may be better revenues, but lighter margins?.
Yes, let’s be clear that EDF is not low margins, it’s at zero, excluding any changes to currencies. So what we did get, if the dollar weakens right, if the euro strengthens, we would cover some of these reserves that we’ve been hit with in the past because dollar has been going – dollar has been strengthening right.
So, we saw, as Milt articulated at Q1, we saw a lift in the euro that helps Power Systems, so that’s why we booked, I think it was a $0.5 million gain that covers through the – into the contract [ph]. But that still basically had zero margin, that’s the new zero margin number, right, because we’re still underwater.
I think the euro has to get back in the mid-to-high teens before we hit the breakeven mark and would stop recovering that gain, right, so still at zero margin. We will ship the number of engines as we’ve talked – the number of EDF engines that we’ve talked about this year, right.
So, it is just, as we’ve said before, let me just reiterate one more time is very, very difficult to draw any conclusions about Power Systems with one quarter. Because what we saw in one quarter was a fairly robust service volume and when we do aftermarket work and as you all know, the entire systems that’s where our higher margin stuff comes from.
So, and that just – that fluctuates quarter-to-quarter that’s not something that we can control, we’re responding to customer demand. So, Jeff, it’s just so hard to draw any conclusions with one quarter. We really have to look at it on a rolling average basis, so I think our guide for the segment for the year is still valid..
And Jeff just to – a follow-on comment, you might recall, if you go back and look at the second quarter of last year, we had a blow out quarter at Power Systems in terms of parts. Parts sales, it’s a very strong quarter.
And as Steve alluded to in our closing remarks, there will be a negative year-over-year comparison on parts and service, we already know that based on what we see coming up and that just ebbs and flows as you know and it’s not indicative of any changes in the business, and the fundamental drivers of the aftermarket of the business, but it’s timing..
And we’re finally going to get the Shaw MOX units shipped in the next two quarters. There’s two units and what do you say Chris, we signed that contract in 2009, so we’re eight years into this.
The engines are still there, it’s a complicated thing, because it’s going into nuclear fuel reprocessing station down at Savannah River that Shaw [ph] runs, right.
So this has been a bad deal for us from the beginning and I don’t even remember when it was 2012 or 2013 we wrote the thing down to zero, because we knew it was – we took a $2 million or $3 million hit because of the cost.
So they’ve been basically sitting there with a little bit more work to be done, but knowing that we’re kind of selling at zero margins and that’s about $10 million of revenue..
$10 million spread over the – over Q2 and Q3..
Yes, so finally we’ll get that out and then the other – obviously other big slug in there is the EDF issue rights, which we’ve talked about. So, and by the way the other thing about FME, let me just say, there is a few really exciting things.
The first is, as we said before, I mean we had a record year last year in landing new government contracts, that work really does, I mean, that work starts – I mean, I’m sure we’ll do some long lead time procurement this year, but it doesn’t really kick in until 2018, 2019 and 2020, but that’s very positive.
The second is obviously the OP2 engine which we’re extremely excited about. We shared some of the early performance data when we were in New York with that for the first time and we’re starting the endurance testing and every time we – every move we make forwarding in OP – in the OP development gets us more excited about the potential of that.
And the third is, the business has been working hard on selling into the power gen market. We signed a deal with MAN a few years ago to take some of it outside the government piece to take some of their technology into the power gen market in the U.S. and we’ve got some promising things in the pipeline there.
So, we’re not ready to announce anything, but we got a lot of things that are working towards the end of the pipe, so we’re – I’m very optimistic about FME, but again that’s not going to affect Q2, right. These are things that we’re building for the next several years and the future of the business..
Okay. And if I could just sneak one more in, you mentioned kind of weakness in truck and I think that continues, can you just – anything you’re seeing that would get you feeling better about that or any kind of inflection, where maybe that that market picks up with some of these other markets you are feeling better about? Thanks..
Yes, look, January and February, but January was really weak, February was a little less weak and March was decent. April has been slightly off of where we were in March, but not back to where we were in February and or January, right.
And a lot of our weakness going into the year was based on a lot of our projected weakness I should say was based on OE volume, particularly trailer kind of catching up with truck, trailer had a better year last year. And so we have not seen the weakness in orders for trailers and truck, it’s been much better than the industry had been forecasting.
So, I think it’s still too early to tell, the order books for trailers are looking okay, but they can slide those orders without really any penalties, so that’s just – it’s a rough indicator, it’s not a hard indicator.
And I think the aftermarket has been kind of cooking along, you know I wouldn’t call it really weak, but I wouldn’t call it robust either, so that’s what we’re dealing with in Stemco. So I don’t know if that’s helpful Jeff, but it’s kind of a non-answer to your question.
I don’t see any big inflection points coming, although I also don’t think the bottom is going to fallout either, it seems to be holding its own. I got to tell you, I told, Milt, this the other day is that, this quarter the demand level underlying the company broadly in Q1 feels solid to me.
It doesn’t feel like it was an aberration, it doesn’t feel like we’re on the verge of a grand slam home run either, but it feels like a much more solid foundation across many of our segments, across many of our geographies than we’ve had for three years.
So, and that has been maintained in our order book, so that’s why I think the company performance in Q1 was reasonably indicative of the environment that we’re in..
Okay, great, Steve. Thanks..
Yes..
Your next question comes from the line of Joe Mondillo from Sidoti & Company. Your line is open..
Hi guys, good morning..
Hi, Joe..
So, I just wanted to come back to engineered products and to sort of clarify, obviously a really good quarter and I appreciate the color Steve on that question. Just wanted to – so your long-term guidance seems like it’s – I think it’s mid-double-digit EBITDA type margins.
I think we were close to 19% here this quarter, and that that sort of guidance that mid-double-digit is sort of long-term guidance. We’ve already sort of suppressed that here in the first quarter, obviously, seasonally strong in the first quarter, and that’s going to trend down.
But even considering that, it seems like we’re close to that sort of long-term guidance, and you were even expressing that, it wasn’t really a home run of a quarter.
So how can we think about long-term profitability of that business? And in addition to that question in terms of aberrations and – do you see any risk of not seeing clean quarters going forward, or have things been cleaned up that that should be a small risk at this point?.
Let me – I’ll address the second-half of your question, Joe, and then let Milt talk about the margin targets and so forth. There’s always a risk of some aberration. I don’t want to sit here and say there’s no risk. We live in a risky world.
But I got it, but what I said, I hold to, which is, I mean, I’m not sure that our investors always appreciate the level of work and distraction that it takes to move factories – major investments in factories, build new factories, while we’re trying to run in an extremely weak environment and manage costs.
I mean, in engineered products, in the last three years, we have exited nine – now 11 locations in CPI, exited 11 locations around the world. We’ve laid off ahead to reduce the workforce by probably approaching 15% of that group at this point in total, maybe more, I don’t know from beginning to end, it’s been a big number.
We have – we’ve put a new President in there, he’s doing a great job two years ago. And the team has been upgraded, put people in the right spots, we’ve got organized, and we’re running very, very effectively. We had a fantastic focus in operational execution. We’ve raised on-time delivery across the board, which we measured very precisely.
We’ve raised on-time delivery from probably a low in the mid-80s to now in the high- 90s, and that’s solid stock improvement that is not going to go away, because our operating system is solid. And then in in the bearings business, we built a new plant in China and relocated what we have.
We built a new plant in Thorofare for the filament wound product and moved into that. We shutdown our Chicago operation, consolidate that into the new Thorofare building.
We shutdown a flailing facility that we bought before I got to the company in 2006 in Germany that we’ve been burdened with for years and we finally got that shutdown and consolidated into our existing Heilbronn facility.
I mean, every one of those is amazing, and that’s all happened in the last three years, right? And we finally through late last year and early this year got all that stuff done. And so, yes, those were all the issues, and we are not going to face a situation uncertain.
They were not going to face a situation similar to that in engineered products in the next three years, because I know what the footprint looks like, and we’re in good shape and we’ve invested in these facilities. That doesn’t mean there’s not improvement still to make there is.
But it’s not that level of disruption of trying to run a business and make all these fundamental changes it’s just night and day, right? So, Joe, I don’t think there’s a ton of risk that all of a sudden the wheels are going to fall off. And I think this is a better look at where the business is.
Now to your question of the margins and so worth, it is the strongest quarter. Q1 and Q2 is the strongest quarter. So we have to recognize that, that’s a structural issue with the demand profile of those businesses. So, Milt, I’m going to let you speak for that..
Yes. yes, Joe, as you know at our Investor Day – recent Investor Day, we had indicated that our margin target for this segment was 15.5% to 16.5%. So you’re correct. It is just like in Q1, you say, well, that 18.8%, we’re well north of that.
Part of the answer, Steve just emphasized again is the seasonality and the strong Q1, which is a seasonal high in the segment. Part of the reason is, we indicated in our Investor Day that the targets that we were putting out were targets that we expected to meet or exceed. So these were not aspirational targets.
And so I would expect if the year holds, that we’ll be in the first year of this three-year target range as the year holds, and we continue to see kind of modest improvement throughout the course of the year. I would expect this to be within this range in the first year.
So, the – once again, we were sparring to be the targets that we set forth during our Investor Day..
Okay, thank you. I appreciate that.
Also in addition to that, could you remind us sort of where incremental margins are with that segment at this point?.
Our contribution margin, it is – and this is general, this is directional, but it’s probably in the 50% to 60% range, or is that maybe closer to 50%. I don’t have the contribution margin chart in front of me, but that’s directional..
Okay..
Probably around 50%..
Okay. And then I – and I wanted to ask you about GST as well, because that was I thought somewhat of an out order – outlier in the quarter, very strong quarter.
It seemed like both on the top line, as well as on the margin side of things, I know steel production and maybe some refining more certainly a headwind over the last couple of years, and that seems like maybe that’s come back.
But could you could give – provide a little more color, is that sort of sustainable if we continue to see the trends that you saw in the first quarter? Any color there would be?.
Yes, I think so. I think it’s the first time we’ve had a, I would call, largely acceptable turnaround season in Garlock for – again, for a few years, right? We’ve always said and you all know that, there’s only so long you can put off maintenance work.
And again, it wasn’t a blowout quarter from that perspective, but it was, at least, a move in the right direction.
So and I assume when you’re saying, yes, you’re talking about the deconsolidated part, Joe, is that right?.
Yes, that is correct..
Yes, as I’ve said before, I’m sorry, I have trouble isolating, because we just don’t think about it that way. We think about Garlock as the total family of companies, particularly when we’re literally two weeks away from starting finally at the end of such a long journey our confirmation process – official confirmation process.
So I think about the whole things. If you look at all of Garlock, right, we had good performance in steel end markets, in oil and gas end markets, in the downstream. And the pipeline business was a little bit weak making Garlock overall now. That showed that the pipeline business is in the consolidated portion, so would show up in GST.
So, Garlock was ahead of our expectations. And in total, Garlock was ahead of expectations. And so the – all those non-pipelines that including the hygienic space that we’re in now after the Rubber Fab acquisition, all did well.
That was offset a little bit by a weakness in pipeline, it’s not unusual for January and February to start slow on the pipeline side anyway. So but it was a little weaker than we had anticipated. So all in all, Garlock was – ahead was strong that was skewed towards what you would see in the deconsolidated portion..
It’s basic blocking and tackling and with some marginal help from the market. So, the costs, the restructuring, so all of the things that we’ve been talking about the big one on across the company here responsible for the GST results we saw in the quarter compared to last year..
Okay, I understand. Thanks. Just lastly, and I’ll jump back in queue here.
The environmental reverse adjustment that you seen in the last couple of quarters, it’s running at a $12 million annual rate the last two quarters, so at least, could you remind us what that is referenced to, and sort of what the outlook going forward to that is?.
Yes, the adjustments that we’ve had and you’ll see the details behind this when we release our Q.
But the primary adjustment that we had in the quarter is related to the Water Valley site and we’ll have more disclosure once again in our Q of what was happening at that particular location, this falls in the category of legacy liability that Goodrich put into EnPro with the time of the spinoff.
We as EnPro has not operated a business there, it’s a successor liability issue. And in the quarter we will have a $3.25 million adjustment increase in our reserve for that particular site. So that’s really the primary change that you’ll see this quarter in our environmental reserve..
And we think that that’s going to be – that represents the picture for the year, so we see it being relatively flat throughout the rest of this year, Joe..
So you were – when you were mentioning a three-point something number, Melt, you were referencing the first quarter or another one in the second quarter?.
It’s in the first quarter, it’s a reserve protecting in the first quarter. But as Steve just said, when we establish a reserve like that add to a reserve, we’ll look out over a future period of time to cover what we know of at the point and time we make the additional reserve.
So we would not expect an additional, absent some other pending developments that we don’t know of, and we would not expect an additional increase in that reserve..
Okay and your – and the guidance, the EBITDA guidance that you provided includes that reserve adjustment?.
We exclude environmental reserve adjustments in our calculation of adjusted EBITDA..
Okay, I appreciate it. Thanks a lot..
Because Joe, it’s not an ongoing recurring expense..
Right, right..
In response charges we take our response to specific situations that happens from time-to-time..
Right, I understand. All right, thanks a lot, I appreciate it..
You next question comes from the line of Liam Burke from Wunderlich. Your line is open..
Thank you. Good morning, Steve. Good morning, Melt..
Hey Liam.
Hi Liam..
You talked a lot about Garlock and getting back to sealant products, could you give us some color on how the other two businesses have done and we talked about end markets, but did one particularly standout this quarter?.
No, you know it’s three businesses as you know Liam, and Stemco is a trucking business that was a little under our expectations, driven by top line but we had that great, really great operating performance. The air springs businesses as I highlighted in my prepared remarks did very, very well. It’s generating great contribution to the business.
So, our Stemco business is just rock solid, it’s very driven by aftermarket miles in trucking, right. So the good news is most of it’s aftermarket, so even when there’s a weakness in OE volume, it doesn’t impact us near as much as many folks that compete in the trucking world.
So it’s a little bit behind our expectations, but certainly nothing to get too excited about. And they got a lot of really good things going on and operationally they’ve got a lot of the issues that we’ve been dealing with in the air springs integration behind them and so that feels pretty good.
And then in the Technetics Group, we did have some weakness in nuclear, some of the shipments we were hoping to have in Q1 got pushed further out into the year.
Again, that’s at customer request and that drives a lot of the fluctuation quarter-to-quarter, but we saw a really good semiconductor demand, good airspace demand and so forth, so that – the Technetics business is a little bit longer lead time, not quite as much day-to-day order fluctuation in terms of what we get.
It’s not like Garlock where you know we don’t really have much visibility, and a little bit more visibility in the Technetics Group. And a lot of the new work and new application work that we’re doing is spec-ed in, so we’re working with the design team and so forth. So hard to move demand in the near-term through any of our actions.
The demand that we move in Technetics is typically six, 12, 18 months in the future. Industrial gas turbines was still weak. GE is our main customer there, and their volume was weak in Q1. So, again, Technetics is a little bit behind our expectations in Q1, but we see them kind of recovering that throughout the balance of the year.
Milt?.
Yes, Liam, if you look at it year-over-year and you look at the segment broken down in sales and earnings, we had earnings growth year-over-year in all three businesses. It was driven more by year-over-year and Steve was making some comments relative to expectations for Technetics Group.
But even in Technectics Group if you look at it year-over-year, we had pretty significant growth in earnings, as we did in Garlock. We had more top line year-over-year growth in Technectics, and a lot of that was driven by the semiconductor market.
Strong sales we had in semiconductor of which we’ve seen a spike over the past few quarters, that’s been a really strong segment for us. Stemco on a year-over-year basis, our revenues were down modestly if we – as we talked about in the – in our prepared remarks, but with cost reductions and other things going on.
We still had a growth in earnings overall. That gives you a little bit more color year-over-year..
Sure. Yes, it does, thank you. And Milt, just quickly on capital allocation, you talked about the buyback. You do have growth capital projects better in your allocation – capital allocation plans.
Have those plans changed after the first quarter, or pretty much the same as it was as you ended the 2016?.
It’s always evolving. Things are deferred or occasionally some of these things come up overall, it’s directional for what we talked about during Investor Day.
And just as a reminder, we think that over time, our level of capital, given the investments that we’ve made over the past several years, because we’ve really stepped up some of our investment we talked about that it linked some things that we’re doing to prepare for the future, whether it’s investment in new facilities or new growth initiatives and we expect our investment to any of these systems and we expect our investments over time to moderate.
But we did indicate that we expect it still kind of a fairly high-level of spending in 2017 more in line with what you’ve seen over the past couple of years..
Okay, great. Thank you very much..
Your final question comes from the line of Justin Bergner from Gabelli & Company. Your line is open..
Good morning, Steve. Good morning, Milt..
Hey, Justin..
Hey, Justin..
I guess, I wanted to ask about sort of the embedded sales outlook in your guidance. I realize you don’t explicitly guide to organic sales growth.
But how much of the sort of higher EBITDA growth is related to a higher sales growth outlook versus other drivers?.
Yes, it’s – the growth year-over-year is going to be – you’re going to see it more in our manufacturing efficiencies, in our cost reductions, the results of restructuring. But as we mentioned earlier, across the board, not just in engineered products, but across the board, particularly in sealing and engineered. We leverage quite well with volume.
So the volume changes do have some outsized effect maybe greater than you might think on our – so if you look at our top line, it’s – we would expect a very modest year-over-year change if you exclude the impact of acquisitions, but much more significant impact on the – on earnings. So that’s generally, – that’s kind of general.
We could go through and talk about what’s happening in the individual segments. But I think that kind of covers it in general. Now, the power systems, that’s a different story, because in power systems, revenue there is going to be a function of new engine sales.
And we are going to have some pretty strong – expect to have some pretty strong revenue quarters on the top line in power systems due to getting the Shaw MOX into valve, that’s $10 million of revenues spread over the next two quarters. Now, that’s our last engine program that’s on a completed contract basis.
So we’ll be recognizing all the revenue when those are shipped. And then we’ll have the acceleration – some acceleration in revenues on AVL although where we’ve got to count it that on a percentage of completion basis. So we have had revenue recognition there.
So power systems, Jeff, kind of carved out some of my comments earlier pertain primarily to sealing and engineered..
Okay. As I think about sort of the implied first-half versus second-half EBITDA guidance for your annual guidance and your second – you view of the second quarter is going to be flat with the first quarter.
I mean, EBITDA would drop fairly materially even if we’re at the high-end of your range from sort of $105 million to $110 million in the first-half to something on the order of $90 million in the second-half. I realize that NGO product is less strong and then power systems might also taper from OE engine deliveries.
But are you expecting within that annual guidance sealing products to have a similar EBITDA cadence in the second-half versus the first-half?.
In sealing products. so we – well, within sealing products, we typically – the first-half is typically stronger than the second-half. We don’t see quite the pronounced difference in sealing as in engineered, but we still have the pattern. Historically, in sealing products, the second quarter has been our strongest quarter.
It’s typically the first quarter in engineered products, but in both cases, the first-half is stronger than the second-half..
And it’s a very, Justin, thanks. It’s very hard to call major seasonal patterns in our business. It really is, because within each segment, there’s difference in each markets that are following different overall cycles some of which have an annual nature to them and many of which don’t, they’re driven by like semiconductor.
There’s no annual cycle associated with semiconductor, there’s a long cycle effect and it’s a significant cycle beat the trough in semiconductor, we still just doesn’t have anything to do with the season of the year right.
And then you swing all the way from that over to businesses like trucking, which is always stronger in Q2, every – it doesn’t do as much in the winter. And so Q2, the first part of Q3 are usually the strongest in that business and then weaker in Q4.
So it’s really hard to step back and see what’s the overall seasonal pattern right, because when we get – when we give our guidance, we’re trying to look at where we look at it obviously below the segment level even below the divisional level to try to pick out what these different things are and then kind of roll it up.
So it’s not the kind of top down seasonal approach that I just don’t want anybody on the call to be misled by the fact that we have this big seasonal pattern, because it’s – as we studied it over the years, there are some conclusions that you can draw, but there’s exceptions to many of those conclusions..
Okay, that’s helpful.
I mean, another way to phrase the question is, I mean, excluding the seasonal variation in sealing products and engineered products, there is a new guidance basically embed through sales staying at current levels –first quarter levels that is as we go through the rest of the fiscal year?.
Yes, it basically assumes that the modest improvement that we’re seeing year-over-year in the first quarter relative to whatever seasonal impacts there might be remains about the same year-over-year as we saw in Q1.
Okay. Thank you.
And then just lastly, any updates on OP2.0, or through M&A initiatives versus what was communicated at the Investor Day?.
Not really, Justin. As I mentioned in my prepared remarks, we’re getting ready to start the enduring testing for OP2., which will reflect the last iteration of design. We’re still not quite ready to start it up, but that will definitely happen in Q2, if we maintain our schedule. So again, still very, very optimistic about that.
But we’ve got to have a little bit more time on the test stand before we really are able to talk any more – anything definitive about the commercial side of that program. And on the M&A front broadly for the company, we’ve got a good pipeline.
And we’re pretty encouraged that a couple of the things we’re looking at, not huge, but a couple of things we’re looking at might come through. So we’ve had, as you – everyone knows, we still have an active program.
Strategy is still the same in terms of really smart strategic bolt-on to have a lot to the business is one of the reasons we wanted to highlight air springs is to show you all we’re spending your capital affectively on acquisitions.
So we’ve got a couple of things that we might get over the goal line in the next quarter and a lot of things in the pipeline behind it. So we’ll see not able – not ready to announce anything yet, because we don’t announce them until we get it done. So but – yes, wouldn’t don’t be surprised if we have something that happens in Q2..
All right. Thanks for taking my questions..
Yep..
Thank you. I’ll now turn the call back over to Chris O’Neal for closing remarks..
Thank you, Candy, 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..
Ladies and gentlemen, this concludes today’s conference call and you may now disconnect..