Enpro Inc (NPO) 2004 Q3 法說會逐字稿

Good day and welcome to this EnPro Industries third quarter 2004 financial results conference call. Today's call is being recorded. At this time for opening remarks and introductions I'd like to turn the call over to Mr. Don Washington, please go ahead sir.

Good morning everyone and welcome to our third quarter earnings conference call. Today, hosting the conference call is our President and CEO Ernie Schaub, we also have Bill Dries, our CFO and Rick Magee our General Counsel who are present to participate in the Q&A should need be.

In just a moment, Ernie will make his remarks and then we'll open the line for your questions, but first I want to remind you that you may hear statements during the call that express a belief, expectation or intention as well as those that are not historical fact. These statements are forward looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements.

These risks and uncertainties are referenced in the safe harbor statement included in the press release and are described in more detail along with other risks and uncertainties in our filings with the SEC including the Form 10-K for the year ended December 31, 2003 and the Form 10-Q for the quarter ended June 30, 2004.

We do not undertake to update any forward-looking statement made on this call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based. I'll also remind you that the call is being web cast on our website Enproindustries.com. A replay will be available both by telephone and on the website.

If you want to listen to the telephone replay, the information for the dial is in the press release. If your questions aren't answered this morning during the course of this call or if you have any follow up questions or if you need a copy of the release, please feel free to contact me after the call at (704) 731-1527. And with that I'll turn the call over to Ernie.

Thank you Don and good morning everyone. Thank you for joining us today. In the third quarter we saw favorable market conditions for the first half of the year continue and the performance of most of our operations improved substantially compared to the third quarter 2003.

The only significant exception to our expectations for the third quarter was the results of Fairbanks Morse Engine where a combination of issues resulted in a loss provision of $7.5 million on several open contracts related to U.S. Navy shipbuilding programs. I'll discuss this in more depth shortly, but first let me discuss some other results.

Sales in the quarter were $192.1 million, a 14% increase over the same quarter in 2003. About three percentage points of the increase in sales this year can be attributed to foreign exchange. In 2003, sales also included the Haber-Sterling business which was sold earlier this year and contributed essentially no sales for the third quarter of 2004.

If you exclude Haber-Sterling from last year, the year over year improvement would have been about 17% which offers even stronger evidence of the rebound in our markets this year. Moving from the top line to the bottom line, our reported net income in the quarter was $10.1 million or $0.47 a share. This compares to net income of $7.3 million or $0.35 a share in the third quarter in 2003.

All the references I make this morning, per share amounts are based on diluted shares. As we noted in the press release, net income in the third quarter was impacted by several significant items. In total, these items increased earnings in the quarter by about $2.7 million, or $0.12 a share.

These significant items can be found in a table on the last page of the release. But I'll briefly describe each of them. First of all, we received an insurance settlement of approximately $10 million in the quarter for reimbursement of past costs related to environmental matters and for estimated future claims that have previously been reserved.

The settlement is reported in the other income line on our income statement. On an after tax basis, it increased net income by about $6.3 million or $0.29 a share. You should note that this is separate from the settlement with Equitas regarding asbestos claims. The next item is that our call options on Goodrich common stock increased in value by about $1.2 million during the quarter.

This created an after tax gain of $700,000 or about $0.03 a share. The third large item is restructuring and new facility costs associated with the relocation of France Compressor Products of Houston which were about $1.6 million. These costs decreased net income by $1.1 million or $0.05 a share.

We view restructuring as part of our normal operating expenses, but we call them to your attention in order to help you understand their effect on our earnings, especially when compared to last year when these costs are only about a penny a share. The fourth item is the loss provision of Fairbanks Morse Engine which reduced net income by $4.7 million after tax or by about $0.22 a share.

I'll provide more detail on this issue when I discuss the performance of our engineered product segment of our company. Finally, we reduced a tax accrual that we felt was no longer necessary. Reversing the accrual provided a benefit of $1.5 million, increasing earnings by about $0.07 a share and reducing the effective tax rate for the quarter to 26.3% compared to 34.8% last year.

In 2003, there were also a number of items that impacted third quarter earnings creating a net increase of about $0.06 a share. The most significant of these was a gain on the repurchase of our tieds, a portion of our tied securities which increased net income by about $1 million after tax or a nickel a share.

Now let's look at the performance of the operations of each of our segments. In the sealing product segment, sales in the third quarter were $91.7 million, an increase of $11.9 million or 15% from a year ago. This is the third consecutive quarter of double digit year over year improvement in the segment sales and is a reflection of the growth we have seen in the many sealing markets throughout the year.

Two percentage points of this year's increase are attributed to foreign exchange. Garlock Sealing Technologies increased sales by 13% compared to a year ago, primarily driven by higher demand from steel and nuclear power industries. Dry Lock also received some benefit from Pikotec (ph) which was acquired in the fourth quarter 2003.

Stemco remained very active in the class A truck market which has remained strong for several quarters. Like Garlock, Stemco increased sales by double digits percentage wise with increases in both original equipment and aftermarket sales. Profits in the sealing products segment were also higher, increasing by 12% to $13.2 million.

However, profit margins decreased slightly to 14.4% from 14.8% last year. The decrease in margin came mainly because of a loss at Garlock rubber technologies due to excess scrap costs and production inefficiencies. Profits in the segment were also effected by higher raw material costs, especially steel and by higher energy prices.

Garlock Sealing Technologies increased profits and profit margins significantly from a year ago as their markets strengthened and volumes increased. The unit also benefited from cost reductions and the addition of Pikotec. At Stemco, higher volume and selective price increases benefited profits, but profit margins declined slightly because of higher sales of less profitable products to original equipment manufacturers.

In the engineered products segment, sales increased to $100.7 million, up 13% from a year ago. Three percentage points are the increase attributed to the stronger Euro here. As I mentioned earlier, Haber-Sterling contributed about $5 million in sales last year, but essentially nothing in sales this year.

Within the segment, shipments of engines in the third quarter boosted Fairbanks Morse sales by over 30% compared to a year ago when there were no such shipments. The unit sales of parts and services however were somewhat lower than last year. GGB sales increased by 20% over the last year as it benefited from higher demand by industrial and automotive markets, both in the Americas and in Europe from favorable foreign exchange rate as well.

European sales at France Compressor products also benefited from favorable foreign exchange rates, although the units North American markets showed no year over year improvement in total sales were down slightly. Quincy Compressor continued to take advantage of improving U.S. industrial markets in the quarter and as a result, their sales were up about 13% in the quarter.

Turning to profits in the engineered product segments, the loss provision of Fairbanks Morse largely offset profits from other operations in this segment. And the segment's profits were substantially lower than a year ago, declining to $1.3 million this year from $1.8 million year, I'm sorry to $8.9 million last year.

The reduction is primarily because of the $7.5 million loss reserve at Fairbanks Morse Engine, but also because of the restructuring costs associated with the consolidation of France Compressor products as I mentioned earlier. Both GGB and Quincy Compressor benefited from higher sales volume and both reported strong improvements in profits, even though both experienced higher raw material and energy costs.

The improvement in Quincy was somewhat offset by expenses associated with the opening of a facility in China, which is now fully operational. With respect to Fairbanks Morse, the loss provision of the third quarter relate to two new engine models being built under several different contracts and scheduled for delivery at various times over the next three years.

Because the engines were new to Fairbanks Morse, they expected to experience learning curve operational improvements on these engines. What actually happened however was that they encountered unanticipated operational difficulties and other issues which impacted the profitability of all open contracts for these two engine models.

As you know, engines have been at modest profits so that we can create a more profitable service market later on. These issues were compounded by fluctuations in the value of the Euro, which increased costs for components purchased from our European based licensors.

Although hedges were put in place when each contract was awarded, the value of the Euro increased substantially between the time the bids were submitted and the awards were actually made to us. In summary, the operational difficulties and other issues combined with the currency fluctuations between bid and award turned modest profits on these contracts at the time of bid into losses today.

We move quickly to address the performance issues of Fairbanks Morse and to eliminate any further effects that they may have on these contracts. While we can't assure completely that we protect ourselves for every circumstance, we believe that we have adequately addressed the issues.

We're also exploring opportunities to recover some of the costs overruns on these contracts. Moving to cash flows, they were strong in the third quarter and the first nine months of the year. Operating activities have generated about $34 million of cash so far this year and our cash balance has improved by about $15 million.

Net cash outflows for asbestos in the first nine months, including expenses were about $23.5 million, slightly lower than the first nine months of 2003. Net outflow is reflected to $30 million we collected in the Equitas settlement during the third quarter of 2004, about a third of which, which was due from prior year billings.

As we previously reported, we're in dispute with other London insurers over documentation requirements and payments we believe are due to us and we are currently in arbitration with them. The amount of overdue payments in dispute is about $20 million. We believe we will collect the amount due to us, but probably not until early next year.

As a result, net cash outflows for asbestos should be modestly higher this year than in 2003. However, new settlement commitments remain below our insurance recoveries and we're on track toward our goal of aligning net cash outflows for asbestos with our annual insurance reimbursements within the next two to three years.

As markets improved and activities increased in the first nine months of 2004, we built working capital to $22 million. We normally see a decrease in working capital levels in the last part of the year as activity winds down and this year should be no exception. We also spent $24 million on capital equipment in the first nine months as we invested in our operations.

That's about double the amount spent through September of 2003 and relates largely to the initiatives at France Compressor and GGB. We continue to expect capital spending for the full year to be substantially higher than it was a year ago. We expect to begin achieving returns on these projects as early as next year.

Total costs on the initiatives at France Compressor and GGB are between $9 and $10 million. But they should generate annualized savings in the neighborhood of $5 million giving us a fairly quick return on our investment. We also received about $10 million from asset sales in the first nine months of 2004, or an amount roughly equal to what we expect to spend on restructuring during the year.

The proceeds came from the sale of France Compressor facility, a facility in Pennsylvania and the sale of Haber-Sterling business. Let's look for a moment at new asbestos claims now. The decline in new claims that began in the third quarter of 2003 has continued through 2004.

For the first nine months of the year new filings were more than 60% lower than the first nine months of 2003. We're encouraged by this trend which we believe is a result of effective local reforms, principally in Mississippi and Texas and may also indicated a declining number of potential claimants.

The reform efforts have been successful in some states including most recently legislation in Ohio and actions by the Mississippi Supreme Court. The outlook for federal reform is uncertain. There probably won't be any clearer until after the dust settles from the elections next week.

Because so many leaders in Congress have voiced support for the reform however, we are somewhat optimistic that it will be achieved at the federal level, but it's impossible to guess how far in the future. Although new claims have decreased, trial activities on the rise as we pursue our settlement strategy. Garlock began 13 trials involving 14 plaintiffs in the first three quarters of 2004.

This compares with seven trials in all of 2003. Ten verdicts were issued on these trials, five in favor of Garlock and five against Garlock. Most of the verdicts were either relatively small or offset by credits from other settling defendants. However, just last week, a jury in Los Angeles awarded $7.6 million in compensatory damages and $15 million in punitive damages against Garlock.

Each of these adverse verdicts is being appealed and Garlock has prevailed in the majority of its previous appeals, so we're confident of our success at the appellate level will continue. Turning to another item mentioned in our continuancy disclosures, we completed the sale of our interest of Crucible Materials Corporation in the third quarter.

As you may recall, we owned about 45% of Crucible shares. The sale of our interest rids us of an investment with little value but significant risk. We carried our interest in Crucible at zero, so the sale has no effect on our balance sheet and the proceeds will be nominal.

In review, our industrial businesses have responded well to increased market activity in the first nine months of 2004. Most of our businesses have seen double digit percentage sales increases this year with the exception of Fairbanks Morse, our largest businesses have capitalized on better markets to grow profits and profit margins.

We expect these favorable conditions to prevail for the remainder of 2004 and we're hopeful that they will continue into 2005. Most of our operations will benefit from these higher levels of activity and we should see year over year improvements in sales and profits compared to 2003.

Restructuring expenses this year will limit our ability to improve over last year, but we should begin to see a return on these investments in 2005. As we mentioned before, we expect total restructuring and new facility costs to be between $9 and $10 million this year, governing expenses for France Compressor, GGB and other initiatives.

Unfortunately, the contract loss provisions recorded at Fairbanks Morse the third quarter requires us to alter our outlook for profitability in 2004, and we now expect operating income for the full year of 2004 to be below the operating income we reported in 2003, although the amount will be less than the amount recorded at Fairbanks Morse.

You should also keep in mind that in addition to the Fairbanks Morse loss, the comparison will also be affected by about $7 million more in restructuring costs in 2004 and a $4 million swing in gains and losses on asset sales. All in all, we made a lot of progress this year and we'll continue to work hard to improve our performance in the future.

And now we'll open the lines for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS).

We'll take our first question today from Seaver Wang at Sidoti & Company.

Hi, good morning.

Good morning, Seaver.

Just wondering if you could give us a little bit more detail on how long to get Fairbanks Morse back on track. I mean, I know you've addressed the issue, but in terms of maybe getting back to breakeven.

Fairbanks Morse isn't losing money. It's not a loss operation. It's just not making the margins we expect it to in the business, and we've taken the hits this year, so we should be back on track next year.

Bill, you have anything you think we ought to add to that?

No, I think that's right. We did ...

By first quarter next year?

I'm sorry?

You're saying next year, but can you give a little bit more detail? I mean, early next year, or just for the full year next year, that you'll have things back on track?

The issues associated with these contracts were dealt with and accounted for in Q3. We believe we have them behind us. As Ernie said before, though, you can't be guaranteed. We may encounter - from our perspective, we believe we have them behind us and that we should return to more normal levels of profitability for that business in 2005.

OK, but then in 2004 that's still going to affect the operating income, right?

Yes, I said respect - the operating income for the company overall, we expected a modest improvement, now we're inspecting that we won't make the improvement over 2003, but certainly the improvement will be less than the $7.5 million at Fairbanks.

OK, I see. OK. And can you just give me, again, a little bit more detail on the adjustment - hold on - on the tax accrual?

Bill?

Sure, obviously on the normal course, we make tax accruals based on our best estimates of what we'll end up paying, we review them periodically after we file our returns and we make assessments, and we will adjust normally those accruals either up or down, depending on the circumstances. In this particular case, we had an accrual for taxes associated with one of our foreign units, subsequent to the filing of our return determined that the reserve - the accrual was no longer needed.

OK, so the tax rate for this year and next year, can you give us your estimates?

Sure. I think that Q3 is an aberration. The 26% is not normal. Our normal rate is going to be in that 36%, 37% range.

OK.

We would expect to see getting back to that level in Q4, and we expect that to be the normal run rate in 2005.

OK, thank you.

And we'll take our next question from Justin Mayer (ph) at Lord Abbott.

Good morning, guys.

Good morning, Justin.

Ernie, I commend you on your attempt to wade through all the stuff. Very good to see - very good.

Thank you.

A couple things. First, on Fairbanks, just to follow up on Seaver's question. Can you give us some sense - I mean, I think you guys do a nice job of trying to explain each business and kind of direction and what's going on. Can you give us kind of a - take a step back, give us a 30,000-foot view of Fairbanks? Kind of in a normal year, how big is the business typically? I suspect as - prior discussions, you're talking more single-digit margins. Just trying to get your sense of satisfaction or lack thereof, if you will, where we should be entering a period of getting some nice shipments and therefore some decent cash flow out of this business and all of a sudden you get socked with a $7.5 million charge.

So just trying to gauge your level of interest in being more aggressive with this business.

That's a tough question. This is a fairly large business for us. It's one of our five largest, let's put it that way. And it has historically had margins near the 10% range, and we've been putting the programs that we've been putting across the corporation, the lean manufacturing, the total customer value programs into it, to make this business more competitive.

For years, it had been the business that relied on the fact that it was a U.S. manufacturing content business to gain sales and income, and that was sustainable. But in today's free market economy, they have to compete on cost and everything else, and it's been a big transition for them. We were getting there until this happened, and this is the first time that we've seen this happen in the business, and that's why it kind of came as a surprise. It was unexpected for all of us.

We had traditionally manufactured engines that were of our own design and we had had modest euro fluctuations when they weren't products of our own design. All of a sudden, we bid on these programs, and you know what's happened to the dollar in the past two years - euro. We bid on these programs, and the time between the bid and the time the contract was awarded was a lot longer, a lot more protracted, than we expected it to happen, and as a result, we were unprotected during that time period. So we lost some of it in that, and then we had the startup problems with some bigger, more complex engines than we normally have.

Now, I've given you a lot of information there, and you're asking me how we're going to get back. We believe we're back on track. We believe that we have the efficiencies built in the process. It's just a matter of getting the purchased material costs back in line, and that's what we're struggling with right now.

I'm not trying to put you on the spot ...

That's all right.

In the prior quarters, there had been some slippage in the timing of some shipments, and one had a fear that you guys were kind of getting on track with that stuff, and this thing kind of comes out of left field, at least to us, probably not to you guys.

It did to us, too.

In that sense, though, what's your confidence in the management of that business? Any changes need to be made there, or are you just comfortable now that they've got all this kind of front-end work out of the way, that full-steam ahead, no pun intended.

We've changed - well, let me put it this way. In a very short order, we'll have had all new management in there in about the past year, just about. We have probably one or two, and you need some continuity in the business that has long-term activities. So we've made a significant amount of changes in the management in there right now.

And in addition, we put in new procedures, the calling for corporate review and oversight. We put in some policies with regard to the length of time a contract can be out on a bid basis, so that we won't have this long period in which we're vulnerable. We've put in many reforms and activities, as I mentioned in my statement.

Now, can we cover everything? I don't know. You hope you do and you expect you've done that. We think we've done it, we're confident we have. But, God, something could still pop up.

Sure, OK.

We think we've done all the right things with both people and policies and procedures. In fact, I just got another e-mail today from our guy out there about the organization change that's ongoing out there. So they're still going through the process.

OK, and just on that score, you talk about the guidance for '04 - operating profit '04 versus '03 for the company. Other than that delta, has anything changed? It seems like when you strip away all of the stuff from this quarter, you guys had a reasonably nice quarter, and you said last quarter, as you mentioned, that you expected '04 to be up over '03, so other than this $7.5 million hit, kind of fundamentals seems like it's still on track. Is that fair?

Absolutely. You know, most of the divisions, as I reported, had double-digit growth. Our profitability continues strong. Cash flow, we're investing exactly as we said we would. We're very pleased. Except for that hiccup, you're absolutely right. And that concerns us in reality, but we're right on track and the things that we expect to happen are happening. We expect 2005 to be a good year for us, so yes, we're right on track with that.

OK, and the $7.5 million, just so I understand, is that a cash set aside, too, or is that just merely ...

No, that's just an income hit.

OK, OK. And just a question for Rick on the asbestos stuff.

Sure.

Number of cases this quarter, since you guys had given us that, what do you see in the year, just on a - I know you gave the nine-month numbers, but ...

Yes, Justin. The number of cases for the quarter were down a little bit from the third quarter last year, but you remember the third quarter last year was when we started to see this new filing trend. So it continues with now a five-quarter run of lower new filings, and obviously we take a lot of comfort from that and feel good about it. The numbers, I don't have the numbers compared to last quarter in front of me, but we're a little bit down but fairly comparable to the third quarter of last year.

OK, I just - I see, I'd just written down 3,500 in the second quarter this year, just wondered if you continued to see it tail off from that.

Yes, it tailed off from the second quarter numbers, yes. We were lower for the quarter.

Could you talk a little bit about a comment that Ernie made about pursuing the settlement strategy? Is that just a function of the fact that some of these cases are actually now coming up for trial? I mean, this does not go back, obviously, to a couple of years ago when the company was trying to more aggressively settle stuff, correct?

That's correct. We continue to feel good about our strategy, our strategy of trying to hold the line, in essence, on our new settlement commitments and our settlement values, but because of this strategy, which is to work the cases up, to put the plans to their proof, we're going to be going to trial more often than we were in the days when we were paying the large inventory settlements. Because of that strategy, we're going to go to trial more often and there will be the occasional adverse verdict, as we've seen, but we still feel like that's the best strategy and it's a sound strategy, and it will continue to result in the improvements in our cash outflows.

OK, and just refresh, in terms of last year, the outflows were how much in total for the year?

They were $35 million, net.

And you expect it to be kind of in line with that for this year and then improving next year?

Yes, maybe a speck higher, but in that general ballpark, that's right.

They may be a speck higher because of the London - you know, we have this arbitration case still outstanding, Justin.

Yes.

We will settle that. We know we will. We'll get an agreement out of these guys and we'll get that thing going. As I said, we should have that wrapped by the end of this year and get money, January.

So you say, if it's 40 - I don't know the numbers, but if it's 40, less that 20 really for next year, the baseline should be 20 and any improvement you make on that. Is that true?

Yes, that's generally in the ballpark. That's right.

And then just on the Crucible, is anything on the balance sheet - the environmental and/or the liabilities of the previously owned business, is that related to that at all, or was that all contingent off balance sheet?

Yes, we have - there are contained within both the environmental accruals and the retained liabilities of previously owned businesses, we do have some trailing liabilities associated with Crucible. We had no investment on our books, as Ernie mentioned, but we do have the accruals associated with those trailing liabilities.

OK, so those ...

Justin, that Crucible deal, we work on cleaning up and strengthening the company in a lot of the ways, and that's one of the kinds of things that you don't realize, you don't see it, it's on the surface. It was important to us because it reduced another potential long-term risk for us.

So the biggest thing that goes away is that the pensions, if you guys were forced to own the majority interest in the pensions, that that's the biggest piece that goes away now?

You got it.

OK, so the two amounts on the balance sheet then don't change. Is that ...

Right.

That's right.

And I'm sorry, last question, on the settlement for the environmental that ran through the P&L this quarter, that's obviously reflected, because just looking, since December, the environmental liability doesn't change, so I didn't know if the fact that it ran through the P&L should affect that amount at all or not.

No, as Ernie mentioned, a portion of that related to past expenses that have run through our P&L statements in prior years. Another portion of it relates to future claims that we already had reserve, so that reserve stays on the books. That's why there's no change there, so any money we got in associated with that also ran through the P&L.

Got you, got you, OK.

Yes, we'd want to put that in operating income, although there's some who said you could have.

Yes, yes, OK. Thank you very much, guys. Again, appreciate the detail.

OK.

We'll take our next question from Ted Wheeler at Buckingham Research.

Hi, good morning, all.

Hi, Ted. It's (inaudible).

Well, not so fast. Tell me the detail on the sealing sector. I think you noted that Garlock Sealing and Stemco margins are up this quarter. The sector margins are down. Would that delta from up to down be attributable to the Garlock Rubber comments you made?

No, let's clarify. Stemco was slightly ...

Yes, yes, I'm sorry. Yes, yes, you did say. I misread my notes.

Oh, OK.

But I would think that if you netted the two together, Garlock Sealing and Stemco's minor decline, the two of them, you'd be up for the year, year over year?

Yes, you're right.

So the difference between up and down, is that all Garlock Rubber, and if so, how do we play out the Garlock Rubber issue? When does that get back to where it should be, and how much pain was there?

Ted, you probably know Garlock Rubber as well as we do. Garlock Rubber is a business that's in very, very competitive markets and a business that's been under-managed for a long time, to be honest. We changed management at mid-year in that business, gave it a little bit more focus and put some emphasis on it, and in doing so, we ended up cleaning up some things, and we did some late last year and it wasn't adequate.

We did some more this year, and we've got the process controls now. We're trying to improve them. I don't know if that will ever be a strong business for us, because it competes with foreign businesses a lot in belting and sheeting and rubber products. But it has certainly been the issue in the sealing products organization right now. But because it's small and it's what I would call non-core to us, we haven't given it a lot of focus.

Bill, you have anything any want to add?

Sure, Ted, just back (ph) and answer the very first part of your question. Had it not been for GRT, if you looked at the remaining businesses in that segment, we would have had about a 30 or 40 basis point improvement in margins, instead of the 40 basis point decline.

OK.

The entire delta was due to that.

And I just thought there was some - while, obviously, the comments on the business structure are what they are, but I thought there were some one-time issues that you recognized in the quarter at Garlock Rubber.

I don't think so. They're more operational type. We took some last year, Ted.

OK.

Yes, we took fourth quarter last year.

OK, that's great. Thanks.

All right, thank you.

We'll take our next question from Farukh Farooqi at Jefferies & Company.

Actually, this is Mike Mitchell. Good morning, guys.

Hi Mike.

One question to follow up on Garlock. Can you elaborate a little bit about the production inefficiencies?

At Garlock Rubber?

Yes.

Yes. As I said to you, the business has been a non-core business, not only of us, but with Coaltech previously. And it had been undercapitalized, and a lot of the equipment and machinery and processes had been neglected, to be honest with you. And so we generated more scrap than really was reasonable in any business. And we continued to do so. We're fixing some of that, and in an effort, as I said to Ted, it was a very competitive business. In an effort to reduce costs, we went out to some lower-cost suppliers and continued to take some short-term measures, and these ended up only exacerbating the problem, rather than helping it.

We have now changed management, as I said, changed some practices and policies, got some outside help to give us some expertise in the area, and it's showing a difference. Scrap rates are coming down to more normal rates. We've still got some investment to do there, but most of the - most of the costs have been associated with scrap and rework type of costs. Bill, is that about it?

I think that's a good summary.

Yes.

And just one more question. Can you break down the FX gains by segment for me?

The FX gains - I thought we did - didn't we ...

You mean in the sales?

Yes.

Yes, we ...

In total, a couple of percentage points and, in fact, it was about - it was a couple of percentage points in each segment.

Yes. About the same.

Great. That's all I had. Thank you.

OK, Mike.

And again, ladies and gentlemen, it is star, one for your questions. We'll go next to Kareem Dupey (ph) at Lehman Brothers. Sir, your line is open. We'll take our next question from Kevin Stark (ph) at Imperial Capital.

Good morning.

Good morning, Kevin.

On the $7.5 million charge, does that have the effect of improving gross margin over the next several quarters or is that more retroactive?

It's probably both.

What quarters would you say it covers and what do you think the impact is on gross margin?

Well, the entire 7.5 million is gross margin and these particular ships, they - we're talking six contracts that cover 26 ships that would be shipped over the next three years.

... mid 2007.

... 2007. So, this effectively would improve the gross profits associated with the shipments of those engines over the next three years.

OK. Second question. The outsized verdict in Los Angeles. Is that in the case with - was it Robert Treget (ph).

This is Rick. Yes, that was the case.

Is there anything specific about the case that argues why it would get this outsized verdict compared to other cases? Anything unusual about it? Aside from the jury.

You know, I guess, no, there wasn't anything unusual, in particular, about the plaintiff himself. It was - because we're on appeal, I won't comment much on the trial itself, but there were lots of unusual things in the trial. We were obviously very disappointed in the verdict, but we are confident about our prospects for success on appeal. It was a case involving a mate on a Navy ship.

Unfortunately, most of the Navy-related suppliers are no longer with us, who supplied asbestos. So we were targeted because there weren't a whole lot of other defendants to target in that case. The evidence clearly showed that (inaudible) is accounted for less than 1% of all the asbestos on the Navy ship, yet we were allocated a 40% share of the judgment. So, there are lots of things there, going on there. Again, we are confident in our defense and, in most cases, are able to convince the jury that there's a big difference between raw asbestos fibers and the fibers from an encapsulated non (inaudible) product like ours. In this particular case, the sympathy for the plaintiff overcame the judgment of the jurors and that's going to happen from time to time.

Kevin, it points out the need for reform in the asbestos situation here. As Rick said, we were a small player in that whole scenario and yet to be allocated 40% of the cost only because you're the last man standing points out the inefficiencies and the injustice in our system.

Yes. Let me follow up on that. You know, as Ernie told you, we had five verdicts in our favor and five verdicts against us. It just - it points out what we've called and what others have called jackpot justice that we see out there. And it underscores our contention that the tort systems ill equipped to dispense justice and match torts like this. As a result, we continue to work diligently with others in Washington in support of reform legislation. And that legislation would redirect hundreds of millions of dollars - billions of dollars - that's being spent on lawyers and experts and other administration - administrative costs in the system to a fund that would pay people who are truly sick with disease from asbestos.

You know, clearly, as Ernie said, people on both sides of the aisle recognize that that's the best solution and that we need that solution. And we're confident that, ultimately, probably not this year, maybe not next year - but that ultimately, we're going to get reform at the federal level. And our two-prong strategy, one of those strategies is to continue to support that reform and work hard to try to get it.

But if this is a plain vanilla (ph) mesothelioma case and you've got 12,000 potentially plain vanilla (ph) mesothelioma cases that could go this badly for you, it just arguably would make an investor fairly worried.

Well, the good news, I guess, Kevin, is that this is the only one that we've had go badly - go this badly - and we've been in litigation, in trial since 1978. And we believe that we're going to get this verdict overturned on appeal and that it's an outlier and we don't expect to have this kind of verdict again. And if we do, it will be because of things that happen at the trial that we believe will enable us to get the result overturned on appeal.

Kevin, let me also assure you if we thought that this was the norm in the ongoing circumstances, we'd be taking some different actions than we're taking today.

Yes. Do you - I don't have a lot of history with the EnPro story, but do you have any sense - any statistics on how well you've done on appeal, historically?

Well, in front of me I don't have the specific statistics, but we - in well over half of the appeals, we've had new trials granted and often in the (inaudible) and then, if you added that, where we settled a case at very favorable numbers while it's on appeal, our statistics would be, you know, clearly impressive in terms of how well we've done in appeal (ph) prospect.

This verdict was handed down on October 20. Do you have to post any kind of bonds in the fourth quarter?

Well, at this point, the post-trial motions have not even been heard by the judge. And as part of that process, the judge will determine whether a bond's necessary or not. So that's - it may well be that we have to post a bond, but that termination has not yet been made.

OK. Thank you all.

OK.

We'll now go to a follow-up from Justin Mauer (ph) at Lord Abbott (ph).

Staying on the legal course here, Rick, could you give us a little insight on this Crane announcement, relative to, you know, their "agreement" and, you know, set asides and they're going to run the division through the 524? Just trying to understand, you know, how does that - to me it doesn't seem like, even though they're attempting to quantify like you guys did last quarter, kind of the broad-based liability - how that puts them in any better stead than you guys, for example. You know, could you explain that and just to the extent that, you know, is it an option for you guys to go that route? You know, I'm sure you've looked at it. Why not? Those type of things.

Right. Yes, Justin, let me just comment on - you know, that announcement came on October 21, so we - like you, we are studying it and trying to understand exactly what is going on there and what the numbers mean. As a result of both that announcement and the Quigley announcement that came back in September, it does appear that there's a new dynamic in these - 524(g) Chapter 11 cases and that, for some reason or the other, the futures representatives in those cases are demanding less for the future cases and only for disease cases and non-malignancy cases. Obviously, that's important to us and we'll study it and see what it means for us.

We continue to think the best result for us by far is legislative reform and we'll continue to support that and push for that. But we're going to understand this and know what it means for us and know what this potential would be for us, just like any other potential avenue for us. For Crane, if this - if it gets ultimately approved, I think it's a very good settlement for them. It gives them finality and it gives them certainty. And whether or not it will or not, as you've seen in all the other Chapter 11s, most of which are unconfirmed and still in various stages of challenge and litigation. It's a long process. So, we'll have to see how it comes out.

Justin, this is Ernie. The same kind of question, by the way, our board asked yesterday. And I'll tell you what we told them. We continue to look at every option all the time. You have to. Because, as Rick said, the dynamics change, whether they're the trial cases, whether they're the 524(g) options or the legislative efforts. The dynamics do change and we have to keep constantly on top of them.

Yes. I mean, I suspect, given your insurance position relative to most, that your insurance companies would encourage you to do that to the extent that you could quantify all right. But it's just - it's the big unknown as to whether it holds over time. Right?

Right. But, Justin, you probably know that the insurance companies, in a lot of cases, are the ones who object to these settlements because often it accelerates the payment of the insurance into the bankrupt estate, to get that paid out more quickly.

Got you. OK. Thank you, gentlemen.

OK.

We'll take another follow-up now from Seaver Wang at Sidoti and Company.

Hi. Just wondering if you had an update on what we can expect in terms of the restructuring and new facilities costs line item for '05. I think you said 10 million for '04. And last quarter, Ernie, I think you said that that was abnormally high, but that, you know, there's a possibility for another large project. So, I was wondering if you had kind of budgeted anything yet.

We're still reviewing the budget process for 2005, as you might expect, and we do have one rather large potential in front of us. But we haven't finalized on it yet and I don't - I can't comment on it. The magnitude could be significant. But it's the last of the major projects that we would have. Bill, anything else, you think ...

I think that summarizes it.

Yes.

As Ernie said, we're evaluating one and we expect the management team to be coming forward shortly with a recommendation.

When you significant - similar to this year or possibly larger?

Similar. Maybe a little larger.

OK. Thank you.

Mr. Washington, having no further questions at this time, I'll turn it back to you for additional and closing remarks.

We thank everyone for joining us this morning. I think it was a good call and if you have any further questions, please let me know. You can reach me at 704-731-1527. Thank you.

Ladies and gentlemen, thank you for joining us for our conference. We do appreciate your participation and ask that you now please disconnect.