Greetings. Welcome to EnPro Industries 2018 Fourth Quarter and Year-end Results Conference Call. [Operator Instructions]. Please note, this conference is being recorded. I will now turn the conference over to our host, Mr. Chris O'Neal, Senior Vice President, Strategy, Corporate Development and Investor Relations. Thank you. You may begin..

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 year ended December 31, 2017, presented as if GST and OldCo were reconsolidated for financial reporting purposes throughout that period.

These disclosures are important to understanding comments we will make on today's call, and we urge you to read them carefully. Consolidated results for the periods after July 31, 2017, reflect the reconsolidation of GST, its subsidiaries and OldCo, as a result of the completion of the asbestos claims resolution process.

Pro forma results for the periods prior to July 31, 2017, have been prepared as if 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 of those segments included in GST's foreign subsidiaries.

We believe that investors will find comparisons of consolidated results for 2018 to pro forma results for 2017 to be most illustrative of the year-over-year performance of all of EnPro's businesses. For clarity, throughout this call, we will compare consolidated results for the full year 2018 to pro forma results for the full year 2017.

Finally, I want to announce that we will be hosting an Investor Day on Wednesday, March 13, at the Parker New York hotel. During the meeting, we will provide a comprehensive overview of EnPro and each of our operating divisions, and we will share our strategy for enhancing the value of the company.

We believe that the day will be informative for anyone who wants to understand our business and our strategy better. The presentation will start at 9:00 in the morning and also be webcast at EnPro Industries.com. I hope you will join us. And now I'll turn the call over to Steve..

Thanks, Chris. Good morning, everyone, and thanks for joining us today. Before we jump in to the quarter, I'd like to kick off our time today by stepping back and reflecting on our full year results. I'll then turn the call over to Marvin and Milt for additional comments on our performance and a discussion of our fourth quarter results.

All in all, as I reflect on 2018, EnPro had a great year with many accomplishments. With the exception of 2 very specific and isolated problem areas in Sealing Products, namely our exit of the gas turbine business and challenges in our brake products group, our businesses posted strong sales and earnings growth.

Excluding those 2 business units, our total sales and adjusted EBITDA grew approximately 11% and 10%, respectively, over 2017 as a result of favorable market conditions, success launching new products, winning new customer programs and diligent cost control.

The semiconductor, food and pharma, aerospace, heavy-duty tractor and trailer builds, metals and mining, refining and processing, oil and gas and marine engines and aftermarket parts and service all performed strongly during the year. In Engineered Products, full year sales grew by 7.4% and EBITDA margins improved 120 basis points versus last year.

We introduced several new products in CPI, including a new emissions guard suite of products. We also advanced our development of new coatings technologies through our joint venture in GGB and achieved operational and SG&A cost improvements in the segment.

In Power Systems, despite being capacity constrained due to the production of the engines for the EDF program, our business delivered a record $37.2 million of EBITDA. This included $4.2 million of negative impact related to the EDF program and $7.3 million in R&D expense for the continued development of the Trident OP engine.

Given a robust backlog at the end of the year, we believe Power Systems is positioned for another year of strong results in 2019. In Sealing Products, the vast majority of business performed very, very well. As I mentioned, we had a couple of very specific issues that posed challenges for us, and Marvin and Milt will describe those in a minute.

The rest of the business, which represents nearly 90% of Sealing Products revenue, benefited from market tailwinds that drove strong sales growth, and EBITDA margins held steady at a healthy rate of approximately 19%.

Demand in semiconductor, aerospace, food and pharma, metals and mining, refining and processing and heavy-duty truck OE markets were favorable and we continue to win new programs in semiconductor, aerospace and food and pharma.

While we are beginning to turn the corner and recover from the challenges in our Brake Products Group, we anticipate that business unit will improve throughout the year. Now I'll turn the call over to Marvin to discuss some additional comments on our performance..

Thanks, Steve, and good morning, everyone. As we have demonstrated by our turnaround of Engineered Products over the past several years, the EnPro team has built the capability to take action when necessary to expand the operating margins of our segments.

As we began highlighting in Q2, we're taking swift action in the Sealing Products segment to reduce cost and expand our margins. Last quarter, I discussed that our ability to identify, isolate and resolve operational issues is a direct result of the robust and flexible operating system we have developed over time.

And we saw this in action during the year as we exited the industrial gas turbine market in the second quarter, which is now fully complete; and again in the second half of the year as we addressed the challenges in STEMCO's Brake Products Group.

We have previously discussed that we exited our industrial gas turbine business after a thorough evaluation of trends in that market. It became clear that our prospects with the business had fundamentally changed due to disruption in the OEM competitive landscape and end market demands.

Typically, exiting a business in similar circumstances results in large asset impairments and expenses. However, through diligent project management and partnership with our largest customer, we were able to minimize the impact to our P&L and actually generate a net cash gain from the restructuring.

I would like to thank our project team that led the effort, and congratulate them publicly on a positive outcome in a difficult situation. At STEMCO, we launched a campaign to significantly improve our Brake Products Group. Beginning in July, we asked one of our most seasoned leaders to take on the President's role at STEMCO.

Since then, we have been working collaboratively to put into place a comprehensive improvement program that has included talent upgrades within the business unit leadership team, pricing initiatives, should-cost analysis to support make-versus-buy decisions and a detailed review of the competitive position of our smaller business units.

This detailed work has led to the recently announced exit of our Brake Drum Friction Manufacturing. Our should-cost analysis and our competitive sourcing work demonstrated that it is cheaper to source this product than it is to manufacture in-house.

Our exit from Friction Manufacturing as swift, and while we have reliable sources of this product, we anticipate that it may take a few months for our newly established supply chain to reach maturity and cost efficiency. We are roughly 50% complete with our margin expansion campaign in the STEMCO brake products group.

Now shifting to the Power Systems segment.

As a result of our previously mentioned focus on expanding margins and the significant increase in demand for our military, marine engines and parts, we are prioritizing our marine engines and aftermarket parts business in addition to completion of the EDF production engines above the accelerated investment in the Trident OP.

This does not change our perception of the opportunity provided by the Trident OP engine; however, we are currently capacity constrained and must adjust the pace at which we bring the new product to market in order to meet the robust demand for our marine engines and parts.

We're currently in discussion with our Trident OP launch customer about adjusting the timeline for production and installation of the field test engine. Overall, we believe that the actions we have taken across the company will lead to take cost improvements as the year progresses.

These actions are evidence of how we leverage our unique operating system to address challenges and drive value in our businesses. We look forward to further discussing our operating system and improvement capabilities during our upcoming Investor Day in March. And now I'll turn the call over to Milt..

Thanks, Marvin. We continue to experience favorable conditions throughout the fourth quarter in many of our core markets.

Demand in aerospace, food and pharma, heavy-duty tractor and trailer builds, marine engines, parts and services and metals and mining were strong during the quarter, although year-over-year growth in sealing, products and Engineered Products was muted by strong prior year results, also about the company's exit from the industrial gas turbine market earlier in the year, and softness in the automotive, nuclear and U.S.

oil and gas pipeline construction markets. As we mentioned throughout the year, we expected Power Systems military, marine engine and aftermarket parts and service revenue to be heavily weighted to the second half of the year.

And during the fourth quarter, Power Systems achieved record levels of aftermarket parts and service sales as well as increased engine revenue.

In total, for EnPro, organic sales, which we define as excluding the impact of acquisitions, divestitures and currency translation, were up approximately 6% over the prior year period, driven primarily by a strong 32% growth in Power Systems. For the full year, our organic sales were up about 8%.

Consolidated adjusted EBITDA was $54.5 million in the fourth quarter, up 11.9% compared to results for the same period in the prior year, primarily due to year-over-year strength in Power Systems, offset by the previously noted challenges in our heavy-duty trucks Brake Products Group.

For the full year, pro forma adjusted EBITDA was $217.4 million, up 0.9% versus 2017. Excluding the impact of foreign exchange on the EDF contract, however, adjusted EBITDA was up 16.5% and 6.6%, respectively, in the fourth quarter and full year compared to prior year periods.

We finished the year within the guidance range provided on our Q3 earnings call despite an approximate $1.2 million negative currency impact in the fourth quarter. Gross profit margin for the fourth quarter was 30%, down about 4 percentage points compared to the gross margin in the fourth quarter of last year.

There were 2 primary drivers of the year-over-year decline. First and foremost, our margins were affected by the challenges in Sealing Products related to our Brake Products business, as Steve and Marvin has discussed.

Second, and to a lesser degree, margins were affected by an improved allocation in 2018 of IT costs, which resulted in moving certain costs from SG&A to cost of goods sold. We estimate that these 2 items explain 3.7 percentage points of the total 4 percentage point year-over-year margin decline.

In the Sealing Products segment, despite overall sales being down in the quarter, we were encouraged by strong sales performance in many of our core markets.

Sales were down 1.3% compared to the prior year period, driven primarily by the wind down of the industrial addressed driven production, and to a lesser degree, by reduced nuclear shipments due to the timing of customers maintenance cycles.

The softness was mostly offset by continued strength in the aerospace, food and pharma, heavy-duty tractor and trailer builds and metals and mining markets. Segment-adjusted EBITDA, which excludes the impact of restructuring and acquisition expenses, was $33.8 million, down 14.4% compared to last year.

The decrease year-over-year was driven primarily by the aforementioned cost challenges in the brake products business of STEMCO. A large portion of which pertain to an increase in friction material warranty costs.

At the end of the third quarter, we communicated that we believe we had adequately reserved for friction quality issues related to product sourced from a past supplier. The friction quality problems affected one specific style of friction material that is used in only a single niche market.

In the fourth quarter, we revised our estimates to cover all potentially affected products for this friction application, which led to an increase in our warranty reserve. Sales in the Engineered Products segment were up 1.9% over the prior year period, excluding the impact of foreign exchange translation.

Strength in the oil and gas and North American general industrial markets was partially offset by weakness in automotive and European general industrial markets.

Excluding the impact of foreign exchange translation, segment-adjusted EBITDA decreased 0.5% in the fourth quarter over the prior year, primarily due to increased raw material and manufacturing costs, partially offset by increased sales volumes.

Segment-adjusted EBITDA margins in the fourth quarter were 12.1% compared to 12.6% in the prior year period. For the full year, adjusted EBITDA margins were 17.4%, up from 16.2% in 2017. In the fourth quarter, sales in Power Systems were $90.7 million, up 31.8% over the prior year period.

The increase was due to record levels of aftermarket parts and service sales as well as increased engine revenue. Results for the quarter included $1.2 million of sales related to the EDF program. At the end of the quarter, we had shipped 10 production engines and expect to ship the remaining 10 production engines by the end of 2019.

Additionally, we expect to ship two spare engines in 2020. Production of the 22 EDF engines was approximately 81% complete at the end of the quarter, and we had billed approximately 52% of the total contract value.

Due to the timing of billings, which is mostly after individual engines are delivered, we had a networking capital investment in EDF program at the end of the year of approximately $36 million. We expect to convert much of this networking capital to cash in 2019 as we complete and deliver the remaining production engines.

Segment-adjusted EBITDA in Power Systems was $20.1 million, up 97% over the fourth quarter of 2017. Results for the quarter include a program loss of $3.1 million for the EDF program. Foreign exchange on the EDF contract had a negative impact of $600,000 in the fourth quarter compared to a positive impact of $1.4 million in the fourth quarter of 2017.

Adjusted diluted earnings per share for the quarter of $0.98 was up 46.3% compared to the fourth quarter of 2017.

The fourth quarter increase was driven by a $3.4 million increase in adjusted segment profit, a $2.2 million decrease in corporate and other costs, a $1.7 million decrease in net interest expense and a decrease in diluted shares outstanding, partially offset by a $1.2 million increase in adjusted income tax expense.

Average diluted shares outstanding were $21 million for the fourth quarter of 2018 compared to 21.8 million shares for the same period a year ago. The reduction was primarily driven by share repurchases. For the full year, adjusted diluted earnings per share were $3.91, up 12.4% compared to the prior year.

As a reminder, when we refer to adjusted diluted earnings per share, we are adjusting for items such as environmental reserve charges and select legacy litigation, restructuring costs, impairment charges, acquisition expenses and normalized tax rates, all as shown in the tables attached to our earnings release.

Slide 17 summarizes our major uses of capital in the quarter. In the fourth quarter, we invested $25.6 million in facilities, equipment and software, driven primarily by spending in Power Systems to support military and marine programs. We also paid a $0.24 per share dividend totaling $5 million.

And yesterday, we announced a $0.01 per share or 4.2% increase to our quarterly dividend starting in March of this year. In connection with the legacy ACRP-related loss in 2017 and our subsequent filing of the 10-year loss carryback return, we received federal tax refunds of $97 million in 2018.

We have previously communicated expectations for receipt of an additional $32 million in the fourth quarter, but processing by the IRS was delayed by the federal government shutdown.

We have updated our estimate of the remaining refund to be $36 million, and we now expect to receive the refund in 2 separate payments sometime in 2019, although we do not have an estimate on timing of receipt.

At December 31, our cash balance was $130 million and our borrowings totaled $463 million, down from $189 million and $618 million, respectively, at December 31, 2017. The reduction in cash resulted from the repatriation of overseas cash facilitated by tax reform.

In total, we repatriated $11 million and $125 million of earnings from foreign subsidiaries during the fourth quarter and full year, respectively, without any incremental taxes. The reduction in borrowings is primarily a function of repatriation and a federal tax refund received in the second quarter of last year.

We outline on Slide 19, our net debt and leverage ratio at the end of the fourth quarter. As you can see, our trailing 12-month leverage ratio at the end of the fourth quarter was approximately 1.5x full year 2018 adjusted EBITDA.

Including the approximate $36 million tax refund that we expect to receive, the adjusted net debt to full year adjusted EBITDA multiple would have been approximately 1.4x, which is in line with the year end leverage estimate provided during our last earnings call. Now I'll turn the call back over to Steve..

Thanks, Milt. We'll close with a discussion of current market conditions and our outlook for 2019 and then take questions. As we've always explained, we have limited visibility of future demand.

With the exception of Power Systems, most of our businesses have relatively short order to shipment cycles, and typical 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.

Our guidance excludes changes in the number of shares outstanding, impacts from future acquisitions and acquisition-related costs, restructuring costs, incremental impacts of tariffs or trade tensions on market demand and costs subsequent to year-end -- the cost of the trades and tariffs.

The impact of foreign exchange rates as well from the year and numbers and environmental and select legacy litigation charges.

Given the current macroeconomic forecasts, planned improvements in STEMCO's Brake Products Group and anticipated weakness in semiconductor, automotive, and heavy-duty truck OE demand, we expect our 2019 full year adjusted EBITDA to be between $225 million and $233 million.

This translates to an adjusted diluted earnings per share outlook of $4.28 to $4.55 for the year. Now we'll open your line for questions..

[Operator Instructions]. Our first question comes from Joe Mondillo with Sidoti & Company..

Couple questions on the sealing segment and the brake sort of restructuring.

First off, how much was -- how much of the $15 million of sort of one-time expenses was cash as opposed to noncash?.

It was all noncash in the quarter, Joe..

Okay. And so just could you provide a little more color on where we are today? I think I heard you say that you're sort of 50% sort of complete in terms of the integration of the new supplier. Just walk us through how you are thinking about sort of the inefficiencies.

Are most of the efficiencies behind us? Or do we still see some inefficiencies in the first quarter as you sort of ramp up that volume with the supplier?.

Yes. So Joe, this is Steve. So here, we can -- and I might ask Marvin to build on this as well when I'm done. But if you reflect on the brake products group, right, so this is one business unit within heavy-duty trucking.

There were primarily 3 issues that we had to deal with last year, three cost issues, right? The first was the Duroline warranty issue. So let me explain this. So Duroline was the supplier from Brazil that we picked years ago to be our supplier, and supplied product over the course of time.

Well, early last year, we discovered that there was one particular type of friction. It happened to be a thinner type. So it's used in shipping container chassis only. And we only have 4 customers in that business, and unfortunately 1 of them of is pretty sizable. And so we started to incur warranty cost at an accelerated rate.

Basically, the friction was cracking in this application. Again, this is only one type. We didn't see any change in performance over anything outside of this particular type.

So when we took the -- so our team, our engineering team was trying to estimate, okay, how much of this friction in this particular application is failing, because when it fails, it's expensive. We have to not only replace it. We have to pay the cost of the labor that it takes to replace it. And so it cost us a lot of money.

And so over the course of the year, leading up to -- as you know, we had a lot of cost and a big reserve in Q2, and then we had another -- we added to that reserve in Q3.

We were always estimating the ultimate percentage of that application and that type of friction that could potentially fail over the life of the warranty, right? And so in Q4, we just concluded, I concluded, I'm just tired of chasing this problem, we're going to just reserve 100% -- we're just going to assume 100% of it fails ultimately during the life of the warranty.

So we took another warranty reserve in Q4, which kind of maxed this out, if you will, to 100%.

That warranty cost alone in Q4 was how much, Milt?.

It was over $3 million..

Another $3 million.

So for the full year, that was essentially $8 million of total warranty costs, of which obviously some is still on the books as a reserve, right?.

Yes. It was about a little -- roughly $6.5 million on the friction issue, if you want to highlight the reserve..

Yes. Okay, $6.5 million total, just on that friction problem. So that was one issue, and that is done. Now, that does not mean that, I mean, obviously, EnPro Industries in total has a lot of product out there, so I'm not guaranteeing to the investor community that we'll never see another warranty outside of that.

But we haven't seen any pick up and issues. We're just following our normal process. And this was all isolated, as I said, to this particular type of friction in this one application, which is now literally 100% reserved. Okay. So that's 1 of the 3. I'm sorry, this is going to be a long answer to your question, probably too long. But that's one.

The second one is in another brake products related product, early in the year, we started to have issues with one customer on a particular product. It was our brake adjuster product -- automatic brake adjuster product. We jumped into that and we figured out how to resolve that so forth and so on.

And we took a couple of million dollars reserve, I believe that was in Q2.

And we did that kind of -- we did, obviously, we tried to get our best number, but we also wanted to lean towards the conservative side because we didn't want the same thing to happen with brake products -- sorry, with friction, where we were continuing to chase an increasing warranty reserve.

So we got that reserve, we have not changed that reserved and in the second half of the year for all other customers other than one, which we're out of the woods there, but we haven't seen a change in the failure rate of this product in any other customer in the second half of the year so far.

Whether we see one or not, we still feel like we're easily adequately reserved because we haven't seen any other issues with that. So we actually believe at this point that issue was contained with one particular customer having a fair bit to do with how they installed the product in the factory, to be honest with you. But that's still disputed.

We still paid the warranty. So that's what led to that $2 million charge at STEMCO to the year. The third issue was productivity -- ramp up and productivity on our own friction manufacturing capability.

We spent over -- too many years and put in what we thought was a very automated, world-class line to produce this friction product ourselves in our existing Rome, Georgia facility. And we have struggled all year.

We struggled with the ramp up of that line, with the productivity was well below where it needed to be, the waste was too high, just on and on and on, with technical engineering issues associated with that.

So with the work Marvin led and described, we really got very deep on should-cost, we looked at a number of different suppliers that could produce our formulation of this.

And in Q4, we decided, you know what, even though we got a lot of capital invested in this damn thing, let's shut it down because we're can buy it -- we can basically buy it cheaper even if we get the line to where we now think or where at least in Q4 we thought we could get the productivity.

So we shut the line down in Q4 and took the restructuring cost that Milt just indicated, was a noncash charge, right? And we ended up, obviously, reducing the workforce there associated with that and whatnot. So that's done. So what we have left to do in brake products is to ramp up the supply chain.

We've got actually a couple of suppliers that are supplying us product now, and the one that is going to supply us most of the friction product is actually in India. We've got a contract that we've just recently signed with them. We've got them started.

But obviously, it takes a while for this product to get produced, on the water over to us and so forth, which is why we won't be at the full run rate with our new supplier and new supply base in total. We do have other suppliers, so we're meeting customer needs. It's just not the way we would like to be able to meet the customer needs.

And that will take another couple of months to get that ramped up. So that's what we mean by that. So that's the detail on brake products, which is why it leads us to have a fairly high degree of confidence that these issues in brake products are substantially behind us.

Marvin, you want to add anything to that?.

The only thing I would add to that is, as Steve mentioned, we are working pretty hard to focus on the productivity and quality improvements within the brake products group, and we do have a small team deployed there, providing them additional resources to accelerate the improvement.

So we do expect to see that start to show up in their P&L, starting actually in Q1, and it will improve throughout the year..

And that is basically the other products that we continue to produce, like drums and shoes and AVAs and so forth..

Okay. That was really helpful. I appreciate the color there.

Just a follow up, as you still need to ramp up the supply chain, like you said, does that weigh on productivity or margins a little bit?.

It weighs on margins, because we are basically trying to keep customers -- we're trying to meet and fulfill our customer commitments through contracts with high cost supply, Joe. That's the implication..

Okay. Okay. And by the end of the first quarter, is that something that we can expect in terms of ramping up? Or is that going to be....

I think it's into Q2, because the team has just, literally in the last few weeks, got this whole arrangement locked down, product qualified, et cetera, et cetera. My understanding is it takes a couple of months to get our -- probably 3 months to get the first shipments here and get the supply chain flowing.

It's big, heavy friction, so you got to bring it over the water. We can't fly it in or it's high cost..

Yes. Okay. Just last question, and I'll jump back in queue to let other people have a chance.

But just in terms of the sealing segment overall, looking at your guidance for 2019, is there anyway you can quantify how much the inefficiencies related to everything you just talked about with the brake products as well as the losses that you saw early in the year before divesting the gas turbine business? And then any other inefficiencies or costs? Is there anyway you can quantify what's not going to reoccur?.

Yes. So let me help you with that. You can figure this out. In my prepared remarks, right, so the brake products group in total and the IGT business in the year 2018 was a little bit around 10% of the revenue of the sealing products segment, okay? If you look at the 90% of sealing products, the margin was basically 19% what we've seen historically.

So other than kind of mix moving around, hey, we saw more semi last year than -- I'm talking about the rest of the business, et cetera, et cetera, there is no reason -- and we've still continued to see reasonable growth, although that gets down to the very specific end markets that we serve.

There's no issues in the rest of it, so there's no reason to believe that, that wouldn't continue to crank along at a reasonable level of improvement throughout the year. Obviously, a lot of it depends on the macros. And IGT is done, and we just described where we are with brake products. So that's pretty easy math to do.

Milt, do you want to add something to that?.

No. It's all puts and takes. There is no question, Joe, you are correct, and I think what your thinking is that if you look at a restated 2018 performance, assuming some of these problems are behind us, then obviously we would have finished the year at a higher level, but it's all puts and takes.

So the adjustments that would be favorable going into the year would be, we would not expect to have the year-over-year decline in earnings from the industrial and gas turbine business.

We would not expect to have with these warranty charges that Steve talked about, and then hopefully as the year progresses, we'll get some productivity improvements at our manufacturing. So those are all positive.

And then it's all, I guess, the macros of the year as Steve talked about, which is what's happening in semiconductor, what's happening in auto, what's happening in Europe and so forth..

China..

China. So our guidance takes all those things into account. And you also need to keep in mind as you're thinking about your adjusted '18 number that we talked about in our last quarter, a $4 million benefit that we received in semi products in connection with a litigation settlement that was a positive impact on our results in 2018.

It will not be recurring in 2019. So there are a lot of factors as you think about guidance, but hopefully that gives you a little bit of color to think through it..

Yes, it does.

And just lastly, the 19% margins that you sort of cited, that's an EBITDA margin, correct?.

Correct..

Yes..

Our next question comes from Charley Brady with SunTrust Robinson Humphrey..

I just wanted to go back to a comment on the Trident engine and talking with the customer about changing I guess some of the delivery schedule on that.

Can you just flesh a little bit more about what's going on there? And is there any potential penalty involved with changing that timing at all? Or what's happening there?.

No. Just the high-level is the Power Systems segment effectively, the Fairbanks Morse business, is in really, really good shape. And has seen significant increase in engine orders as well as aftermarket parts and services orders.

So the demand is extremely strong in that business, which puts us in a pretty precarious situation, in that we are effectively capacity constrained in totality.

So we've had to make some really difficult decisions in terms of what to do, and what we've decided is we obviously have to service the customers we have today, and that has to take sort of the resource considerations as a primary course of action.

And as it relates to Trident OP, we'll continue our development work, we'll work with the customer to resolve the customer delivery schedules. I don't anticipate that there will be any dependencies at all. We run the risk of a cancellation, but we don't run the risk of any cost..

The fact of the matter is, Charley, to get the first Trident in the field, we're not going to make any money on it, right? In fact, we're going to, I mean, we're going build the engine to get it out in the field because that was our plan. We really still want to do that.

But it's pretty hard for us to stomach the idea of using factory capacity to build something we're not making any money on, in fact, losing money on, when we can be building -- and need to, have to, really, build engines for the U.S. Navy. So that's our dilemma.

So we're working with the customer to try to see if we can maintain -- try to figure out how to kind of thread this needle. But again, it's nothing that's going to lead to any penalties..

Okay. I just wanted to clarify that. Can you just talk a little bit more about price/cost dynamics as you go into '19. Where you are on covering raw material increases and kind of tariff impacts et al.

Are you there now? Does it ramp as you go to '19?.

No, no. I think we're there. We're starting to see it go the other way where we get a little bit of relief on the raw material side, frankly, going into '19. Now, your guess is as good as ours on what happens with the next wave of tariffs. We're not making any -- I'm not making any comment on that. I have -- who knows what's going to happen.

But in terms of the status quo right now, we are adequately covered and we've started to see some moderation, particularly in steel prices, but in commodity prices overall.

Last year was a tough environment for industrials like ours, right? I mean, we were working throughout the year to catch up, not only -- it is just very, very hard for us to separate how much of it is "tariff impact versus other" because obviously, there was a huge ripple effect through other commodity prices that didn't have tariff directly on them, like steel and aluminum, but it was a tough raw material environment last year kind of just broadly right because the economy was doing so well.

And that has definitely leveled off and at least in the case of steel has begun to moderate..

I mean are you able to assess in any way that if the tariff was to go to 25%, what sort of impact that would have on your business, on your margin?.

I think the short answer is, we're more ready now. So last year, everything happened so quickly that I think we got caught a little bit behind the eightball in terms of anticipating. But we know that if it happened, it would have $1.2 million immediate impact, and then the question would be, would we -- how quickly could we got that covered as well.

But the mechanics and many of the customer conversations, and this has become such a visible issue in the industry that I think that we'd be able to get that covered much, much quicker than we did last year, which we really, really struggled to do, primarily in the STEMCO business, which is where we consume a lot of steel..

Our next question comes from Justin Bergner with Gabelli & Company..

I wanted to start off by revisiting Trident OP. I just want to make sure that the customer in question is a formal launch customer.

And why would you take any risk if they are a firm-launch customer in pushing back the timeline such that they could see reason to not continue as the launch customer potentially?.

That's a really good question. We do feel like if we ended up in a bad situation with this particular customer, we have other options. That would be the easy answer that we could pursue. We feel fairly confident that we can solve that problem if we ever ran into that problem.

As you know, as we mentioned in the last call, we did signed an LOI with this customer and establish an arrangement or sort of conditions of satisfaction to conduct this launch testing. But we have alternatives that we can pursue. Feel fairly confident about that. And we also are fairly confident as it relates to the penalty situation..

Okay.

But they are a firm-launch customer or is it still at the LOI stage?.

Well, we did not want to sign a firm contract because we knew what we were facing in terms of our ability to execute..

Okay. Understood..

Well that's a conversation, Justin, that's ongoing. They've got a project to do, I think, what was it, 4 or 5 total engines at which we had 1. It was going to be side-by-side with a competitor's engine. And we're just trying to work out now is that timing still going to work with them, it still make sense for us and so forth.

Now remember, we were still -- the development work for the engine is still ongoing too.

We were really trying to close the gap as tightly as we could of kind of putting the complete bow around the development and getting the first one out in the field, right? And so the fact of the matter is the development team would love to have a little bit more time to make sure that everything is fully complete and done.

So this is not -- that's why it's not a real problem. It really just indicates more how busy we are in the shop, quite frankly..

Okay. Understood. As we look into 2019, I just sort of wanted to make sure I understood that the puts and takes versus '18 were the $8 million warranty expense, the small expense in IGT before you shut that polystyrene product business down and then the $4 million litigation benefit.

Those -- that's it in terms of the sort of one-time nonrecurring puts and takes?.

That's in terms of the one-time. Obviously, we've been hurt by the price/cost issues that we talked about, which relate to tariffs. That was early in the year. We got hurt obviously about these productivity issues that Steve and Marvin discussed around our friction manufacturing. But those are....

Those are big movers..

Yes, but the ones you noted are really the ones that we could circle, and say, yes, we shouldn't have those items in 2019..

Okay.

And then are any mix impacts going to be beneficial or negative of note as we look into '19, either OE versus aftermarket or different end markets?.

I mean, that's a very complex question, Justin. I mean, it's as we said, with the short cycle that we've got, it's very, very difficult to predict how mix is going to move because we don't know what Q2 and Q3 have in store, much less the full year. So semiconductor, we know has shown signs of weakness, that's not one of our higher margin businesses.

We do know that the nuclear demand for both '18 and '19 is kind of the bottom, if you will, of the long-term trend in scheduled refueling and maintenance cycles of our customers. So we do have a visibility on that. '19 will look about like '18, it shouldn't get any worse, but it won't get any better.

We do think it will really start getting better in '20 and '21. Fairbanks is in, as Marvin said, in very, very good shape. There's more ship avails planned in 2019, and we've seen recently and that drives aftermarket demand.

We've also, based on what we've communicated to you all over the years, the new programs that we won two years ago, last year, et cetera have kicked in a bit. It drove a big capital spend, as Milt said, in 2018.

A lot of that was for test and capacity and expansion and modification because these, the Navy has high requirements for how much of testing needs to be done on each engine just because of the nature of the application. And so we had to spend a fair bit of capital in 2018 just on those tests and modifications to get ready for these programs.

Again, that capital spend is behind us in Power Systems. So anyway, on balance, we feel pretty good about the year with the caveat that there still feels like there's a lot of uncertainty just in general. But in terms of the direct communications we've had with customers, the orders that are on the books right now, which again is not huge visibility.

Yes, it's pretty good, it feels better than Q4. So who knows what's going to happen..

Our next question comes from Ian Zaffino with Oppenheimer & Co..

This is Mark on for Ian. So I guess just looking a little bit more in detail at Sealing. Aerospace demand has been a fairly consistent strong driver for the segment. We think that indications are for a slight, I guess, year-over-year slowdown beginning in 2019.

Can you just speak to what, I guess, like some of those drivers there? What's the expectation for the balance of 2019? And how can we expect this sort of to impact the segment?.

Yes, once again, I'd like the same comment -- Mark, it's Milt, that Steve made earlier on general market demand. We know the programs that we're on, and so we have some visibility on aerospace. But I think our view right now is that we're probably in the kind of the upper part of the cycle. And we are not expecting a lot of growth.

We think it's going to be -- continue to be a good market for us, but we're not expecting strong growth year-over-year, I would call it relatively flat, small, low single-digit growth in that market. But that's based on somewhat limited visibility. Steve, I don't know if you or Marvin have anything else on aerospace..

Okay, great. And then in terms of the outlook on 2019, that launch. Can you guys speak a little bit on the M&A pipeline and areas of interest? And any details on capital allocations with buybacks and capital investments would be great..

Sure. We have a very active look at strategic acquisitions. It's ongoing. It's not something we're start and stop, as you know. We've been very disciplined this year, you haven't seen us spend a lot of our capital on M&A this year in a pretty high-priced environment.

We communicated previously, and this remains to be the case, we're focused on select opportunities in the semiconductor space and the aerospace space, and food and pharma and our Sealing Products business if we can find opportunities to grow there. So that's taking priority as we look for inorganic growth opportunities.

Other uses of capital, Steve just mentioned, that we've spent pretty heavily this year on test ends to support the big wins that we've had in Power Systems. And we would expect our capital spending to be meaningfully lower in 2019. So year-over-year, that will be -- I think that you'll see another small change there.

I would guess, we'll probably end up, at least based on our plans, $15 million or $20 million below where we were in '18, probably subject though to order opportunities coming up that we say have a good return on investment that we might decide to invest in. But that's how we see it now.

And yes, we do expect to be repurchasing shares as the year goes on..

Our next question comes from Jeffrey Hammond from KeyBanc..

So just back on the drum friction, is there a revenue headwind that's associated with that in '19 that we should be thinking about?.

No, there's no revenue headwind at this point. Nothing we know about. It's still a healthy business, we just need to work on the cost side..

Okay. And then just on the drum brakes business, it seems like we've been hearing more shifts to air disc.

And just kind of speak to how you're seeing that play out and kind of reaction to that?.

Well, it's definitely a long-term trend, Jeff. We have that in front of us. It's on our plate of strategic things to look at. We did buy a company you may remember, just a small -- relatively small, but it's a factory in China, a business in China that we make air disc friction. And we've introduced through a supplier, we're introducing a rotor as well.

So we're going to be selling air disc brake systems as well, and our goal is to help customers do this migration. So I don't -- I think it will be a long-term thing just because, I mean, these tractors and trailers, as you know, have a long life and there is a massive installed base.

So what we've seen so far is the conversion mainly happening with very -- trucks that really carry a lot of heavy and dangerous stuff like tanker trucks. Those have been the first ones to shift over. So the fleets are, obviously, resisting it because they like -- they have an installed base and they're going to have to continue to service that.

So our hope, at least as we sit here today, this is obviously subject to ongoing review and change, but our hope is to have both types of technologies so that we can help our customers do that migration and transition over time..

Okay. And then just back on OP, too. I just want to make sure we're clear. So this is a kind of a short-term capacity issue.

I guess, are you thinking about the long-range opportunity any differently and kind of the R&D spend associated with it?.

Yes. I mean, the capacity issue that we're experiencing in the Power Systems business, my guess is going to be at least 18 months to 2 years. What I'm trying to be mindful and not super excited about how much demand we're seeing, but it is quite substantial in the Power Systems business. So their backlog is quite strong for this year and next year.

So what that means for us as it relates to the Trident OP is we have to really think through what the options are, whether we want to exercise other ways to get the product to market, those are the kinds of things we're experimenting with now. We know we have to get the product to market so we're looking at other alternatives on how to do that..

Okay.

And then just, Marvin, can you give us a sense of how you think the growth rates look in Power Systems in '19, '20 kind of big picture?.

Well, let's say for '19, it will be north of 8% for sure. It could be -- it's all based on shipments, but it's north of 8% for sure. It could be 10% or so. And then '20, I don't have that number in front of me right now for '20. We can probably get that to you..

And how does that growth fallout in terms of margin mix?.

Well, we have a fair amount of EDF to get out of the system this year. So once the EDF units come out of the system in its entirety, you will see that margins start to walk up from where we ended last year with that 14.5% EBITDA and Power Systems in 2018. I would expect to see some improvement in that as you go forward into '19 and '20.

High level, we'd like to start moving that business up to 18%, 19% EBITDA..

Our next question comes from Joe Mondillo with Sidoti & Company..

Just a couple quick -- hopefully quick follow-up questions.

Could you give us expectations on sort of working capital needs and CapEx for the year?.

Yes. On CapEx, Joe, as I mentioned just a little bit ago, we expect the CapEx to be $15 million or $20 million less in '19 than was the case in 2018. And that's because we won't have to repeat some of the heavy capital spending we had in Power Systems in 2019.

And on the working capital front, we had about $30 million, I think I said $36 million at the end of the year, tied up in the EDF program alone of working capital.

And with us expecting to ship all of the production engines, so that would be shipping another 10 production engines in 2019, and the shipment of those, the primary trigger for being able to invoice.

We expect to convert a big chunk of that $36 million to cash, not all of it, but a significant portion of the $36 million in cash and working capital to cash during the course of 2019. That's the biggest movement.

You also saw some pretty large increase year-over-year in accounts receivable on our balance sheet at year-end compared to year-end '17, and the largest part of that was just a very strong quarter and month of December that we had in Power Systems due to the aftermarket parts and service demand.

And parts and services have provided at the end of the year that were still on our books as receivable. So we would expect some of that to come down as well..

Okay, great. And then Steve, you sort of commented on sort of the visibility that you have, and I think you sort of mentioned that it seems like things currently or maybe you feel a little better than maybe going back to December.

Specifically, my question specifically has to do with Engineered Products, given sort of the exposure that you have to European auto and some of the GGB business that's exposed to, I think, some of the heavy capital equipment markets.

Just wondering sort of what your sort of take is on that segment and sort of where we are and how the outlook looks?.

Yes. I mean, I'll be very honest with you, Joe. The bookings that we have, the orders that we have look very, very good.

Now that said, the way that business works in particular, I'm speaking of GGB, and this is across the board, automotive and industrial customers, right, that's the one that can turn very, very quickly because it's mostly OE demand, almost all OE demand.

And so the way that market behaves is there's an order on the books for delivery in March or April. And if the world changes, they will push the order out or reduce the quantities or anything else. So barring that from happening, the orders are there. They have been placed, they're on the books.

But like I said, since we have in most -- many, many, many of the GGB applications, we essentially have 100% of the business on any given platform, whether it's an automotive platform or an equipment platform.

If we are selling to a particular pump style or gearbox style or whatever, wherever it's going, we typically -- that part is typically engineered into the product and we have 100% of the demand.

So if the customer starts selling less cranes or less whatever, it's going -- less cars, less cranes, less snowmobiles, less whatever it is, that ripples through to our demand and we don't have a lot of visibility into it, that's why it is hard to predict.

But right now, if you look at the actual orders on the books, we're above where we were a year ago. So hopefully it will be real and it's not just phantom orders..

Right. Sure. And so the revenue ex currency over the last several quarters has slowed significantly, it was under 2% in the fourth quarter. When you say very good, is that defined as improved from the 2%? Or sort of low-single digits? Is that sort of the outlook? I was just trying to get a sense of....

No, no, no. I think we're still looking at low-single digit outlook for sure..

The comp, as you know are pretty tough, because we've had a couple of a strong years..

Yes..

Yes. Okay. Just wanted to make sure there. And then lastly, Milt, I just wanted to clarify the sort of tax receivables and asbestos insurance receivables, what you have going forward? I think there was 3 different buckets that you mentioned last quarter. And I know you mentioned this in your prepared commentary.

But just wondering if you could sort of just work that out for me going forward..

Well, on taxes, let me just talk about the cash part, okay? That's probably what you're most interested in. We expect to receive about $36 million in the tax refund in 2019. It's likely going to come in 2 different payments, so that's probably not relevant. You probably don't -- that doesn't matter.

But I think we should get roughly $17 million relatively soon. And whenever things go back to normal, the IRS with all their processing and so forth. So that's why we don't know for sure. We would have expected that, were it not for the government shutdown.

There's another $19 million piece that we also expect to get in 2019, and that part is subject to some additional final auditing, sign-off procedures by the IRS. That's $36 million. On asbestos-related insurance receivables, we expect to get about $10 million in cash in 2019.

And that's, I guess, beyond 2019, yes, we have a little bit of additional amount on our balance sheet. But the additional amount we expect would come in over quite a few years as the trust starts to make payments over a period of time..

Our next question comes from Justin Bergner with Gabelli & Company..

Just had one clarification question. On EDF, I think you mentioned a $600,000 FX loss and then a $3.6 million, I guess, operating loss.

Can you just clarify, if I heard that correctly, and what the $3.6 million exactly refers to?.

Yes. The true-up on the P&L, the P&L impact every quarter, is a reflection of 2 things, primarily. It's, one, what's our estimated cost to complete the contract at the end of the quarter as well as what the euro-dollar exchange rate is. So in the fourth quarter, we had $600,000 of an earnings hit related to the change in currency.

And we had an additional, call it, $2.5 million, it was a little bit above that, but $2.5 million or so increase in our estimate of the cost to complete the program. So that's the reason for the -- or that's the difference between the $3.2 million that was cited and the $600,000 for currency..

Okay. But when you talk about meeting your guidance despite the FX hit, you were also absorbing a $2.5 million increase in the cost to complete.

Did you anticipate that cost being incurred in the fourth quarter? Or was that an additional headwind?.

No. No. At the time we provided guidance in Q3, we do not anticipate that..

And Justin, it's important to understand, not all of the $3.2 million was cash cost in Q4. I don't even know if we have that split. But we certainly would have had some increased cost, but we didn't do a ton of EDF work in Q4.

That is a P&L basically reserve -- I mean, I don't know if you can count it as reserve or how we count it, but it's basically a cost that we have to book at the end of the quarter, because that's our -- because the whole contract is essentially every quarter mark-to-market, if cost don't change and if currency don't change, we make 0 margin.

And so as soon as our cost -- as soon as our view of the cost to complete the rest of the engines goes up, we have to book that in the current quarter, even though we didn't incur those costs in the quarter, those costs will be actually incurred through the balance of fabricating the engines.

You follow?.

Yes..

We'll all be very, very thrilled when we get the last d**n EDF engine on the water, trust me. And we're getting very, very close. We're halfway done, and we're halfway done with the shipments. We're 80% of the way done with the actual work associated with it in terms of hours.

Well, #11 goes out any day now and yesterday went out, 11, and then 12 will be on the test end and 13. So hopefully, well before the end of the year, we'll be able to say sayonara to the last one. And I'm going to celebrate, trust me..

Ladies and gentlemen, there are no further questions at this time. I will now turn the call back over to Chris O'Neal for closing comments..

Thank you, Diego, and thank you all for joining us this morning. If you have an additional questions, please feel free to give me a call at 704-731-1527. Have a great day..

This concludes today's conference call. All parties may disconnect, and have a great day..