Greetings and welcome to the EnPro Industries 2019 Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Chris O'Neal, Senior Vice President of Strategy, Corporate Development. Thank you. You may begin..

Thanks, Donna. Good morning, everyone, and welcome to EnPro Industries quarterly earnings conference call. I’ll remind you that our call is also being webcast at enproindustries.com, where you can find the slides that accompany the call.

Steve Macadam, our outgoing CEO; Marvin Riley, our incoming CEO; and Milt Childress, our CFO, will begin their review of our second quarter performance and our outlook in a moment.

But before we begin our discussion, let me point out that we will be making statements in today’s call that are not historical facts and that are considered forward-looking in nature. These statements involve a number of risks and uncertainties that are described in more detail in our filings with the SEC, including our most recent Form 10-K.

We do not undertake to update any of these forward-looking statements. Also during the call, we will reference a number of non-GAAP financial measures. Tables reconciling these measures to comparable GAAP measures are included in the appendix to the presentation materials.

With regard to the guidance that we will share in this call, we have limited visibility into long-term demand as most of our businesses have relatively short order-to-shipment cycles and typical order backlogs range from a handful of days to a couple of months. Power Systems is the exception to this.

Additionally, many of our products, serve niche applications for which demand is not correlated well with macro end market indicators. This further complicates accurate forecasting.

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

The impact of foreign exchange rate changes subsequent to the end of the second quarter and environmental and legacy litigation charges. And now I’ll turn the call over to Steve..

Thank you, Chris. Good morning and thanks for joining us today. Knowing that this is my final earnings call, given my retirement as EnPro’s CEO yesterday. I’d like to kick off our time today by thanking our colleagues and shareholders for their support during my tenure.

It’s been my honor to lead EnPro over the past 11 years, and I’m confident that we have the right strategy, right people in place for the company to see continued growth and success going forward under Marvin’s leadership. Since the announcement of my plans to retire, we’ve received questions from investors about our succession planning process.

So, I’d like to spend just a few minutes discussing that topic. And I’ll turn the call over to Marvin and Milt for discussion of our second quarter results. Marvin has been with EnPro for nearly 12 years.

And during that time, he’s held various roles across our organization that have given him the strategic acumen and operational expertise necessary to lead EnPro into our next chapter. Marvin has developed through a number of very intentional steps that have helped him prepare to be EnPro’s next CEO.

This process included most recently his appointment as our Chief Operating Officer in July of 2017 and his increased responsibilities in that role since then.

Marvin’s focus areas include improving our cash flow returns, increasing margins, accelerating our growth, creating the capability center, which is composed of several resources that are deployed to areas of the company with the greatest need and opportunity.

Our goal at EnPro is and always has been to deliver exceptional performance, and Marvin’s focus on these areas directly supports that mission. Marvin has committed to our core values of safety, excellence and respect and will continue to drive our financial and strategic goals.

Marvin has the full support of the board, and we’re all confident in EnPro’s future under his leadership. I’m looking forward to my next phase at EnPro as Vice Chairman and as shareholder of this great company. I also want to note that we have an exceptional management team that will support Marvin, just as they supported me during my tenure.

Milt, Chris, Robert McLean, our Chief Administrative Officer and General Counsel, all of our division presidents have deep knowledge of the company and are well suited to support Marvin in implementing our strategy. And I’m confident that they will collectively create tremendous shareholder value. Now, I’ll turn the call over to Marvin..

Thanks, Steve, and good morning, everyone. Before I begin, I want to recognize and thank Steve for his leadership of EnPro over the past 11 years. Steve created significant value for our customers, shareholders, and employees by positioning the company for growth.

Most notably, he developed a strategy and led the successful process to permanently resolve the ACRP. He upgraded our company’s processes, facilities, and equipment to a world-class level, and he created our dual bottom-line culture. Steve’s impact on the company has been profound and will survive the test of time.

From me and on behalf of our board and our 6,000 employees, thank you, Steve. We’re all much better because of you. Now, let’s turn our attention to Slide 6 in our results. Overall, I’m pleased with our performance during the second quarter.

We experienced a substantial year-over-year increase in profitability that was primarily the result of strength in aftermarket parts and services in Power Systems, productivity improvements, and lower warranty charges due to unusual warranty charges in the prior-year period that did not recur in Sealing Products and cost control measures across the company.

Our second quarter adjusted EBITDA was up 29% year-over-year. I’d also like to comment on our efforts to execute our growth strategy outlined during our Investor Day in March. As we discussed, we’re focusing on growth in the food and pharma, semiconductor, and aerospace markets.

In support of our growth strategy and our commitment to disciplined strategic investments, we recently announced the addition of two new businesses to the EnPro portfolio, one focused on pharma and the other on semiconductor.

On July 2nd, we announced the acquisition of The Aseptic Group, a privately held company that distributes designs and manufactures sterile fluid transfer products for the pharmaceutical and biopharmaceutical industries.

This acquisition represents a key part of the strategic growth plan for Garlock and our continuing commitment to invest in these industries. The Aseptic Group is a recognized supplier of single-use, high-purity fluid path components that has been serving some of the world’s largest pharma companies for over 20 years.

The company is at the forefront of designing solutions to integrate the largest manufacturing technologies, currently being adopted to produce next-generation biopharmaceutical drugs. The Aseptic Group will be part of the Garlock Family of Companies in the Sealing Products segment.

On July 22nd, we announced plans to acquire LeanTeq, a privately held Taiwan based company. LeanTeq primarily provides cleaning, testing, and verification services for critical components and assemblies used in state-of-the-art semiconductor equipment.

This equipment is used to produce the latest and most technologically advanced microchips for smartphones, autonomous vehicles, high-speed wireless connectivity, 5G, artificial intelligence, and other leading-edge applications. LeanTeq will be a part of the Technetics Group in the Sealing Products segment.

Upon completion, the acquisition of LeanTeq will strengthen and expand our existing $100-plus million presence in the semiconductor industry with a primary focus on the aftermarket. LeanTeq adds proprietary technology capabilities and a highly differentiated service offering for semiconductor manufacturing equipment.

This acquisition aligns with our growth strategy and fits our acquisition criteria with a focus on technical expertise, niche markets, mission-critical applications, and significant aftermarket contribution. LeanTeq has a compelling growth and margin profile with a consistent cash generation track record.

And the acquisition is expected to be accretive to adjusted EPS in the first full year following the closing. We expect to close the LeanTeq transaction in the fourth quarter of this year. Both of these businesses fit our acquisition criteria and strengthens the EnPro portfolio.

We’re excited to welcome The Aseptic Group and LeanTeq employees to EnPro and look forward to working together to create value for our partners, customers, and shareholders. Now, I’ll turn the call over to Milt to discuss our financial results for the quarter..

Thanks, Marvin, and good morning, everybody. Adjusted EBITDA was $61 million in the second quarter, up 29.2% compared to the same period in the prior year on overall sales that were relatively flat compared to the second quarter of last year.

The year-over-year adjusted EBITDA increase was primarily the result of strength in aftermarket parts and services in Power Systems, productivity improvements and lower warranty charges due to unusual warranty charges in the prior-year period that did not recur in Sealing Products and cost control measures across the company.

Excluding foreign exchange translation and the impact of foreign exchange on the EDF contract in both periods, adjusted EBITDA was up 17.6% in the second quarter compared to the prior-year period. Gross profit margin for the second quarter was 32.3%, up about three percentage points compared to the gross margin in the second quarter of last year.

The increase was driven by the year-over-year parts volume increase in Power Systems, productivity improvements and lower warranty charges in Sealing Products and cost control measures across the company. Sales in the Sealing Products segment were down 5.4% compared to the prior year period, excluding the impact of foreign exchange translation.

Strong performance in our aerospace and midstream oil and gas markets was more than offset by softness in the semiconductor capital equipment and heavy-duty trucking market and by last year’s exit from the industrial gas turbine business.

Excluding the impact of foreign exchange translation, segment-adjusted EBITDA increased 15.7% compared to last year, driven primarily by productivity improvements, cost control measures, the lower warranty charges that we’ve mentioned that resulted from the non-recurrence of prior year unusual charges, and the benefit from our exit from the industrial gas turbine market in 2018.

Sales in Engineered Products segment were down 3.5% over the prior-year period, excluding the impact of foreign exchange translation. The decline was driven primarily by weakness in automotive and general industrial markets.

Excluding the impact of foreign exchange translation, segment-adjusted EBITDA decreased 9.5% in the second quarter over the prior-year period, primarily due to lower sales volume. In the second quarter, sales in Power Systems were up 30% over the prior-year period.

The increase was due to strong aftermarket parts and military marine engine sales, partially offset by lower sales to the power generation market.

Second quarter segment-adjusted EBITDA of $11 million was up more than sevenfold over the prior-year period, driven by the increase in higher-margin aftermarket parts and service sales and reduced SG&A costs.

Excluding the impact of foreign exchange on the EDF contract in both periods, segment-adjusted EBITDA in Power Systems was up $6 million or 123% over the second quarter of last year.

The impact of foreign exchange on the EDF contract was $3.5 million unfavorable in the second quarter of last year, and $200,000 favorable in the second quarter of this year. The contract includes 20 production generator sets plus two spares.

We have shipped 14 sets to date and are on track to ship the remaining six production sets by the end of the year. The manufacturing of the production generator sets is now 88% complete. We expect to ship the two spares in 2020. Adjusted diluted earnings per share for the quarter of $1.32 was up 83.3% compared to the second quarter of 2018.

The second quarter increase was driven primarily by $13 million increase in adjusted segment EBITDA, a $2.9 million decrease in net interest expense and a decrease in diluted shares outstanding. Average diluted shares outstanding were 20.8 million for the second quarter of 2019, slightly down from 21.1 million shares for the same period a year ago.

Now turning to Slide 16, which summarizes our major uses of capital in the quarter. During the second quarter, the company invested $8.8 million in facilities, equipment, and software, compared to $14.5 million in the prior-year period.

While we expect capital spending to be higher in the second half of the year compared to the first half, the lower year-over-year spending in the second quarter is evidence of our focus on cash flow and return on invested capital.

And such lower capital spending is made possible by investments made in infrastructure and software across the company over the past several years.

Also in the second quarter, we paid a $0.25 per share dividend, totaling $5.2 million and repurchased approximately 195,000 shares for a total value of approximately $12.7 million under the $50 million program authorized by the board last October.

As a result of our recently announced acquisitions, we do not anticipate repurchasing additional shares for the remainder of this year. At June 30, our cash balance was approximately $124 million and our borrowings totaled approximately $428 million.

Net debt at June 30 is about $29 million lower than at the end of 2018, and our adjusted net debt-to-EBITDA ratio at the end of the second quarter was approximately 1.4 times.

When taking our two recently announced acquisitions into consideration, we will continue to have a strong balance sheet with pro forma and net debt to adjusted EBITDA leverage of approximately 2.7 times.

The second half of the year is typically a strong operating cash flow period for us and we expect our leverage to be lower than the pro forma – than this pro forma level by year end.

Before Marvin provides commentary on guidance, I want to provide you with additional information regarding the $5 million increase in our 2018 income tax provision that we announced last evening in our Form 8-K filing.

As we noted in the Form 8-K, we concluded that the errors in reporting book income taxes were immaterial to our previously issued financial statements. Nonetheless, we have revised our 2018 statements to reflect this increase in tax expense and the associated increase and balance sheet accounts on our year-end balance sheet.

We will be filing an amendment to our previously filed 2018 Form 10-K to reflect the tax expense increase. And we will also be filing an amendment to our first quarter 2019 Form 10-Q that will reflect the balance sheet changes related to the 2018 income tax revisions.

The revision to 2018 income tax expense has no impact on adjusted EBITDA, adjusted EPS or cash flows for either 2018 or 2019 and will also have no impact on 2019 reported results.

As also noted in the Form 8-K and evaluating the root cause of the tax provision errors, we identified deficiencies in our internal controls over the accounting for income taxes, which we determined to constitute a material weakness in such controls.

The specific internal controls to be enhanced are in two relatively narrow, easy-to-fix areas, and we’ve already begun implementing steps to remediate these internal control weaknesses. We expect such remediation to be completed prior to filing our 2019 10-K. Now, I’ll turn the call back to Marvin..

Thanks, Milt. We’ll close with a discussion of current market conditions and our outlook for the rest of 2019 and then take questions.

Given our performance in the first half of the year and our outlook for the remainder of the year, we’re tightening our full-year adjusted EBITDA guidance to a range of $225 million to $229 million, which represents an increase of approximately 3% to 5% over last year.

We expect adjusted diluted earnings per share to range from $4.45 to $4.59 for the year, or approximately 14% to 17% over last year.

For the sake of clarity, our guidance includes the impact of the recently closed acquisition of The Aseptic Group and excludes the impact of the recently announced acquisition of LeanTeq since that transaction has not closed. In Sealing Products, we expect sales in the second half of the year to be relatively flat compared to last year.

This outlook assumes continued softness in trucking through the end of the year and an improvement in year-over-year demand for semiconductor capital equipment during the fourth quarter.

We expect adjusted EBITDA in Sealing Products to be up modestly in the second half of the year compared to the prior year, primarily driven by the addition of The Aseptic Group, expectations of lower warranty charges and a continued benefit from productivity improvements and cost reductions.

In Engineered Products, we expect sales in the second half of the year to be relatively flat, compared to prior year, and adjusted EBITDA to be up meaningfully based on cost control measures implemented earlier this year.

Lastly, in Power Systems with a high backlog for aftermarket parts, we’re expecting adjusted EBITDA to be strong in the second half of the year and above first half results, although below the record level of the prior year. And now we’ll open the line for questions..

Thank you. The floor is now open for questions. [Operator instructions] Our first question is coming from Ian Zaffino of Oppenheimer. Please go ahead..

Hi, good morning, guys. This is Mark on for Ian. Thanks for taking our questions. So I think – first question would just be on the Engineered EBITDA improving.

Can you guys speak a little bit on the cost reduction measures that you’ve done already? How much there is to do and sort of the margin expansion opportunities there and how that translates into 2020 outlook, as well? Thank you..

Yes. Mark, we have – if you compare our performance in Engineered Products in the first quarter compared to the second quarter, you’ll see evidence of improvement overall, while our earnings were down more than our sales decline.

It’s a more normal pattern that we would expect in Engineered Products, compared to the – what you saw in the first quarter. And as you know in this segment, we have relatively high fixed cost. So we leverage on the downside. We leverage well on the upside, as well. So volume is a big consideration.

It’s impossible to solve the volume problem slowly through costs. However, in the first half of the year, our team has implemented a number of cost reductions. We saw some benefit of that in the second quarter but only partially.

We would expect to see – nearly all of the benefit that by the time we get to the fourth quarter and much of the benefit in the third quarter.

So as we look ahead to the second half of the year, as Marvin described in guidance, the real story for us is maintaining our focus on our sales, and we do have good projects that are under way that we believe will result in revenues in excess of what we saw in the second half of last year when performance really dropped off considerably from Q3 and especially in Q4.

So we’re expecting sales overall to be relatively flat, but to start the – to stop it down – the negative year-over-year comparison that we saw in the first half of this year and then have the benefit of the cost reductions that were implemented in the first half of the year.

And that’s the reason why we believe that if you look at our results in the second half in Engineered, compared to the second half of last year, that our earnings will be up meaningfully in that segment..

Okay. Great. Thank you very much, Milt. And then just a quick follow-up in Sealing and specifically heavy-duty trucking. You guys mentioned there’s going to be a little bit of a headwind. Just given where the stay of the market is, but where do you guys see in terms of market fundamentals from here on out and going into 2020, as well? Thanks..

Is that market fundamentals only in trucking?.

Yes, I guess, like, specifically more toward trucking?.

Yes. I mean, we – what we’re experiencing right now is just weakness in trucking. We anticipate that will continue. We did see that accelerate a little bit more toward the end of Q2. And our expectation is that we’ll have continued softness in trucking throughout the balance of the year going forward.

There’s not much more color than I can add more than that, quite frankly, because we don’t have much more insight than anyone else..

Okay. Terrific. Thank you, guys, very much..

Thank you. Our next question is coming from Justin Bergner of G. Research. Please go ahead..

Good morning, Marvin. Congratulations. Good morning, Milt. All the best, Steve..

Thank you, Justin..

I have a couple of questions here, just first some quick ones.

What is the current outlook for CapEx for 2019?.

It’s roughly, roughly $40 million, and that compares to over $60 million that we had in 2018. You may remember, we had a pretty heavy investment in Power Systems during 2018. So we’ve had a focus on reducing capital spending as I noted in my prepared remarks, and you’re seeing evidence of that.

You see in the first six months of this year compared to the first six months of last year, and you’ll see it for the full year..

Okay, great.

And I mean, is there sort of a normalized CapEx rate or percentage of sales as we look out beyond 2019?.

Well, I think if you look at our current revenues and our current size, I think $40 million to $50 million, that range of an average diet – with the acquisitions, we’ll have a little bit more spending but those businesses will probably require on a percentage of sales basis, probably roughly the same level that we’re talking about on the core business based on a $40 million to $50 million diet..

Okay, that’s helpful. And then in terms of this tax issue, just to verify, there is no cash outlay associated with the $5 million income tax true, that’s purely a book income tax, true....

That’s correct..

Okay..

It’s purely the provision. The book income taxes has no impact on cash taxes..

Okay. And shifting to sort of more fundamentals.

As you look into the second half, what’s going to enable Sealing Products to be flat in the second half versus the negative growth in the first half? And does that include some contribution from The Aseptic Group?.

There is some contribution from The Aseptic Group since we included that in our guidance. And so that provides some offset to things like some of the headwinds that we talked about, the semiconductor capital equipment market this year, the heavy-duty trucking market, the exit from IGT last year.

One of the reasons it’s going to – year-over-year comp will moderate in the second half of the year is that when we get to the – by the time we get to the fourth quarter, you will no longer have the impact – year-over-year impact of the loss of the IGT sales, because that was pretty much wrapped up in the third quarter of last year.

We also are expecting, and Marvin mentioned this, we’re also expecting in the fourth quarter a better year-over-year comp in the semiconductor part of our business. We started to see in the turndown in that in our business in that market segment in the fourth quarter of last year.

So, the combination of expecting orders to pick up by the fourth quarter, as Marvin mentioned, plus last year being weaker in the fourth quarter in semi. So, those are a couple of highlights, Justin..

Just a little bit more color. I mean we expect aerospace also to be robust in the second half of the year in sealing, food and pharma to be robust second half of the year in sealing. And our Garlock business is showing quite a bit of resiliency, even though, the European industrial market is softening. It’s sort of holding up quite well.

So that’s really why we believe the second half would be okay..

Okay, great. And then one last one, if I may, then I’ll hop back in the queue.

The STEMCO and heavy-duty truck, I guess, end markets, could you maybe just compare sort of what you’re seeing in the truck versus trailer end of things and what you’re seeing in the OE versus aftermarket with respect to STEMCO?.

Overall, we’re starting to see – and this is sort of toward the end of Q2 here, we’re starting to see softness on the OE side and the aftermarket side, truck and trailer frankly. So, the degree of, obviously, OE is down more significantly than the others, but we’re starting to see sort of a macro slowdown.

I don’t know if I – this is one I’d sort of tap Steve since he’s still on the call.

Steve, do you have any additional color you think would be helpful here?.

Well, I think it’s important for everybody to always understand that we’re a lot more exposed to aftermarket activity than we are OE, both on the sales and particularly on the margin front. So, even as things slow in the aftermarket, it typically has much less impact on our EBITDA than sales. So that’s what I would say, Marvin.

And I think what we read and what we hear from our customers is that we’re beginning to have kind of order cancellations or they are, the fleets are beginning to cancel orders for both trailers and trucks, but the backlog is so – is still so strong that, that’s really pointing more toward three, four months from now, because the OEs that are producing the product now, they are still basically full.

So, it’s – that’s kind of what we’re seeing. And that’s very typical of the industry, that’s not a new thing. But I don’t think anybody would say we’re not through the peak of OE builds on truck and trailer..

And just one comment to add on just to quantify what Steve said. We’re – in the heavy-duty truck business; we’re roughly 70% aftermarket, 30% OE..

Okay. thanks for that detail..

Thank you. Our next question is coming from Jeff Hammond of KeyBanc Capital Markets. Please go ahead..

Hey, good morning, guys. Congrats to Marvin and Steve on the new positions..

Thank you, Jeff..

Just on Engineered Products, I think you said sales relatively flat in the back half. And I’m just trying to understand, it seems like first half was relatively weaker.

And I know Europe auto industrial has been a little bit more of a challenge, just some color on the confidence and where do you see that flattening out?.

Yes. A lot of that is through – we got out and started our cost reduction efforts early in Q1, given what we saw in European industrial, Asian automotive and European automotive, right? So that’s sort of, first and foremost. So, we were aggressive there. Our oil and gas market is holding up okay, in Engineered.

So, we’re not seeing a lot of pressure in oil and gas, but we are implementing the same cost control measures in sort of the CPI business that we have in the GGB business. Those are some of the big ones. We are seeing – we do have a little sort of aerospace activity in Engineered, that’s helping quite a bit on the back end.

We are seeing some pickup in European automotive on the back end as well, in Q4. So that’s really what’s balancing out outside of the cost reductions..

And Jeff, just to remind you, I know you’ve got the information. But if you look at the second half of last year, there was a pretty noticeable difference in revenues between the first half and the second half. So that’s a factor too when we think about the year-over-year sales in second half being flat, relatively flat..

Good.

And then just on semiconductor in the core sealing business, what are you – are you hearing from your customers that that’s going to inflect positive in the fourth quarter? What kind of informs that the better 4Q?.

Well, we’re seeing better order intake for Q4. It started to show up here at the end of Q2. So that’s really what’s informing our decision..

Good. And then just on sealing, I know there’s a lot of moving pieces here, some FX, the IGT exit, Aseptic coming in.

I’m just trying to get like, on a full-year basis, how you’re thinking about like the core organic growth for the segment? If you kind of strip out all that noise and look at like STEMCO and Technetics and Garlock, and just so we can kind of understand kind of the true underlying trend..

Yes. If you look at the industrial gas turbine business, we can just quantify that one relatively easily. In 2018, we had sales of roughly $8 million that we will not have in 2019. It was – in the second quarter of last year, it was roughly $4 million of sales.

And Chris, I’m looking at you, I will pull you into this – was the $8 million an annual number?.

No, that was the first half..

The first half – sorry, first half of the year. So, we were running at about a $4 million per quarter pace, $4 million to $5 million pace last year through the first three quarters. So, let’s call that roughly $15 million of impact on sales in 2018. So, some of the decrease that you see is just that.

And then you can quantify the impact of translation, which we did indirectly with our prepared remarks, but I can give that to you, if you look at the first six months of the year in Sealing Products, currency hurt us by about $6 million. So, the first six months of the year, you had roughly $8 million of IGT, roughly $6 million of translation.

And then we had the regular pluses and minuses, what’s happening in the markets we continue to serve with semiconductor being down in the first half of the year compared to last year. Heavy-duty trucking being down a bit also year-over-year.

So, if you strip out the IGT, if you strip out translation, it’s a low – it’s probably, a low single-digit growth picture..

And then the second half, we don’t know The Aseptic revenues, but the underlying core would be down a little bit, and you get the IGT comp offset by Aseptic..

Well, if you look at year-over-year, we said sales, we expect sales notwithstanding. Some of the IGT noise would be relatively flat year-over-year, but that does include some benefit from Aseptic. It’ll – there’s one quarter, there’s a smaller impact on IGT, because it’s only one quarter essentially in the back half of the year.

So yes, it’s – I would still call it, net-net, relatively flat in the second half of the year. If you strip out Aseptic Group, you can strip out the impact of IGT..

And then just the last question on Sealing. I think you said, Marvin, in the second half, you expect profitability to be up moderately year-on-year, second half to second half.

And I just want to make sure I understand, like how you’re – I think you had a $4 million credit in 3Q 2018? Like, I’m just wondering how to think about that? Does that exclude from that comp or included? And if it’s included, kind of how do you make up that $4 million credit that hit?.

Yes. You’re referring, I believe, to the favorable settlement that we had last year on TrailerTail business in Q2. In Q2, that was in Q3 of last year. The warranty charge was in Q2..

Yes. We had some – also had some unusual warranty charges in the fourth quarter of last year, as you may recall. So, a part of the moderate increase is going to be Aseptic, a part of it is going to be the fact that we’re not expecting to have the recurrence of some of the unusual warranty charges that we had in the fourth quarter.

And some of it is some bounce back in the semiconductor business, where we actually think that we could have a stronger fourth quarter in semiconductor this year than we did last year..

Okay. That’s all very helpful. Thanks, guys..

Thank you. [Operator instructions] Our next question is coming from Joe Mondillo of Sidoti & Company. Please go ahead..

Hi, guys. Good morning. Just a follow-up on that last line of questioning.

Regarding Sealing and all the different issues that you had going on in 2018, our most of those issues in the past at this point, in terms of the warranties and friction, or are we still slow – are we still going to see a little bit of benefits in the back half of the year?.

Yes. We still have some issues; we’re working our way through. We’ve made tremendous progress in the STEMCO business, resolving the majority of those issues.

We do have, still some cost issues that we’re dealing with, just due to sourcing to try to meet customer demand, those kinds of things, where we might be paying a higher price than we think we should pay. And we’ll get that resolved going forward. But for the most part, the majority of the, I would say, cleanup has been done..

And we’re very comfortable on the warranty side, Joe. So, just to state that, we feel like we’re adequately reserved..

Okay. And then just at Engineered Products, just curious, sort of, it seems like if you were to sort of talk about sort of monthly trends, at least say, GGB, have those improved recently that gives you the confidence of a flatter second half of the year.

Could you just talk about maybe monthly trends or what you’re looking on day-to-day basis? And has anything indicated some improvement from three, four months ago?.

Yes. The word I would use is it’s stabilized, right? And so the beginning of the year, we saw what would look like a pretty aggressive drop-off in spaces like European industrial, Asian automotive, et cetera, et cetera. And now, we think those things are stabilized, and we’ve sized our business appropriately to deal with this level of order intake.

We do have some sense and some feeling, as I said before, that European automotive would pick up just slightly. We’d have to see how that shakes out, but that’s what it’s looking like internally that we’ll see some benefit in Q4. But Asia is still fairly soft for us, in general, in that business. And ConAg is still fairly flat.

So that’s the language I would use..

Okay. Great. I appreciate that. And then Power Systems, going into the year, you had a huge backlog and performance there has been great. But we still have the EDF. And so I’m just sort of curious looking into 2020, sort of what the order trends have been like, what the backlog looks like.

I’m not sure if it’s too early, but I do know that it’s a long lead time type of a business. Any sort of commentary or any color you can provide regarding that? That would be helpful. Thanks..

Yes. I mean, for right now, I expect Power Systems to have a solid year in 2020. The backlog situation looks good on engineering and aftermarket. We should be out of the EDF situation. We’ll have two spares that we’ll need to produce.

But just to give you a sense of the magnitude, at the end of Q2 2019 in comparison to Q2 2018, the aftermarket backlog was up over 50%. So, they’re going into the back half of the year pretty solid and should go into 2020 pretty solid..

Okay, great. And then lastly, just trying to think about free cash flow. In terms of the EBITDA guidance, could you give us any sort of guidance or how you’re thinking about free cash flow? I know there’s a lot of different moving parts related to how sort of your cash works out.

Could you just talk about that? And then if there’s any sort of – included in that, if there’s any sort of unusual items that you’re still expecting, whether it’s related to taxes or liabilities, receivables – I guess, tax of receivables. That would be great. Thanks..

Yes, Joe. A good question. We didn’t talk about the tax receivable on the call. Let me hit that one first. Earlier this year, we had expectations that we would receive the final payment from the IRS on the 10-year loss carryback that was in conjunction with the funding of the trust that concluded ACRP.

We expected that to be, I think, roughly – it was roughly $19 million that we expected to receive by the end of this year. We didn’t comment on at this time, because timing, and we stated it before the timing of that’s uncertain, because that’s subject to the final IRS audit, which is under way.

I don’t have confidence, right? Right now, that we’re going to get that this year. I’m not saying we won’t get it. So that’s a little bit of a question mark and a wild card. So, if we don’t get this year, we should get early next year, but that IRS audit is underway. We’ve talked about capital spending.

So, you can take the $40 million and get an idea of how much spending we’re likely to have in the second half of the year.

We – interest expense, I think you can get a pretty good read of that, if you want to look at the core business before the acquisitions, you can look at where we were for the second quarter and that’s a pretty good indication of what we do expect before the acquisition-related cost for the back half of the year, which is going to be a nice decrease year-over-year on cash interest expense, partly because of some of the cross-currency swaps that we put into place.

And then the second half of the year is typically a good cash flow period for us from a working capital standpoint. And in particular, we still have a fairly sizable investment working capital related to the EDF project. And so we should work that down partially this year.

We had about $30 million tied up in working capital in EDF, and I would expect $15 million to $20 million of that, we should be able to pull in this year. And then we also have some other contracts in Power Systems, where we may get some prepaid, some cash advances.

So all in all, we’re expecting it to be a really strong second half of the year from a cash flow perspective. We also didn’t comment on this call about the asbestos-related insurance receivable that we have on our books, and we’re expecting to get $7 million or $8 million that come in this year from that.

So that’s some additional cash from kind of non-operating sources that we would expect. So, all in all, it’s good. I mentioned earlier with the acquisitions on a pro forma basis, we were at about 2.7 times, if you look at our balance sheet at June 30.

So, by the end of the year, I expect because of the cash flow and what we’re talking about to be considerably below that level. I think we’ll be well below two and a half times by the end of the year. And I think I’ve got a margin of error, when I mentioned the two and a half times..

Okay, great. Appreciate that..

Yes, yes..

Thank you. Our next question is coming from Justin Bergner of G. Research. Please go ahead..

Thanks, guys for the follow-up. Just some quick clarifications.

The Sealing Products growth being flat in the second half that is excluding currency rate?.

It is..

Okay.

And then just any more commentary on what the drivers of the engine aftermarket strength are and how sustainable they are into the midterm?.

Well, the engine aftermarket strength, I mean, a lot of it has to do with just units getting out into the field – in the field, meaning into the water. From all of the programs that we’ve won, and those ships are now being commissioned and provided to our end customer. And they are now hitting the water.

So, we’re seeing a pretty meaningful increase in the number of cylinders that’s out there. And that’s really the primary driver. We also have started to do some really nice work in power gen as well to recapture some business.

But for the most part, the bulk of it is coming from just all, then if you go back and look at the programs the LPD, TAO, CVN, there’s a long list of programs that we won the offshore patrol cutter, a number of those units will be making their way into the field and providing a steady stream of aftermarket business..

Okay. And is there any – I mean, I guess, it seems like the aftermarket strength has not just surprised us analysts and investors, but it somewhat surprised your team internally.

So maybe – I mean, what about the aftermarket strength has surprised you versus just been sort of a predictable consequence of delivering more on the OE side?.

Well, one of the sort of changes – first of all, I’m not surprised. I’m quite excited, but not surprised. One of the changes is that there was a big sort of contract that we were working on with the U.S. Navy, that’s an IDIQ contract to provide sort of aftermarket parts and services to their Sealift Command vessels.

Now, they had reduced their spending, because of sequestration for a number of years. And when sequestration was lifted, because we were able to get a budget, they’re able to spend a little bit more, but spend to appropriate levels, not go through what they were going through before.

And so I think that’s how I would think about it is that they now have a budget that they can operate to, they’re no longer subject to sequestration. So, they can order appropriately and do what they would normally do to keep the vessels appropriately maintained and we’re taking advantage of that..

That’s very helpful. And then lastly, call wouldn’t be complete without an update on Trident OP.

Anything to share there?.

No, the team is continuing to do their work. We had a number of technical experts in to visit with our R&D team here lately, I mean, within the last four weeks. Just to make sure we had a different set of eyes to confirm what we were seeing, just words that we got was you guys have a great intent; you’ve done an excellent job in your development.

We agree with you on its best-in-class performance, et cetera, et cetera, et cetera. So that gives me more and more open inspiration that once the team is finished with their endurance testing, we’ll go into the field and have some success. So, we’re still pretty excited about OP Trident.

We maintain our focus on what we’re doing as a disciplined sort of developers of engines, and that’s the update. I’m pretty excited about it. The team is pretty excited about it. We still have the appropriate level of focus. We’re still having regular updates and we’re working hard..

Great. Thanks for the follow-up questions..

Thank you. At this time, I would like to turn the floor back over to Mr. O’Neal for closing comments..

All right. Thank you, Donna. And thank you all for joining us this morning. If you have any additional questions, please feel free to give me a call at (704) 731-1527. Have a great day..

Ladies and gentlemen, thank you for your participation. This concludes today’s teleconference. You may disconnect your lines at this time and have a wonderful day..