Enpro Inc (NPO) 2013 Q3 法說會逐字稿

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries third-quarter 2013 earnings results conference call.

(Operator Instructions)

Mr. Don Washington, Director of Investor Relations for EnPro, you may begin your conference.

Thank you, Rob; and good morning, everyone.

Welcome to our quarterly earnings conference call. I will remind you that the call is being webcast at enproindustries.com, where you can also find the slides that accompany our call. Steve Macadam, our President and CEO; and Alex Pease, Senior Vice President and CFO, will begin their review of our third-quarter performance and our outlook for remainder of the year in just a moment.

Before we begin, I need to point out that you may hear statements during the course of this call that express a belief, expectation, or intention, as well as those that are not historical fact. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements.

These risks and uncertainties are referenced in the Safe Harbor statement included in our press release, and that 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, 2012, and the Form 10-Q for the quarter ended June 30, 2013. We do not undertake to update any forward-looking statements made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based.

You should also note that EnPro owns a number of direct and indirect subsidiaries. From time to time, we may refer collectively to EnPro and one or more of its subsidiaries as we, or to the businesses, assets, debts, or affairs of EnPro or a subsidiary as ours. These and similar references are for convenience only and should not be construed to change the fact that EnPro and each subsidiary is an independent entity with separate management, operations, obligations and affairs.

I want to remind you that our financial results reflect the deconsolidation of Garlock Sealing Technologies LLC, Garrison Litigation Management, and their subsidiaries, effective January 5, 2010. The results of these entities will remain deconsolidated during the pendency of the Chapter 11 legal proceedings to resolve asbestos claims against GST. We refer to this as asbestos claims resolution process, or ACRP, and you will you hear us use that acronym during the call today. GST's summary results are presented separately in our earnings release, and we will discuss those, as well.

Now, I will turn the call over to Steve.

Thanks, Don. Good morning, everyone.

I am going to start the discussion about the third quarter with a few comments about the ACRP, since I suspect that's a topic of high interest to many of you. As you may remember, I missed this call last quarter because I was actually attending GST's estimation trial, which was held in order for the judge to make an informed decision about the appropriate number and value of pending and future mesothelioma claims against GST. The courtroom portion of the trial concluded on August 22, after 17 days of live testimony.

Both GST's legal team and I were generally pleased with the way GST's case was presented. Significant evidence was presented on both sides of the science issue, but the GST team presented, what I believe, was compelling evidence that GST's products could not have been a substantial contributing cause of claimants' mesotheliomas. Moreover, GST's representatives presented, what I believe, a very convincing case on estimation of the liability.

The estimation case demonstrates that GST's settlements had little to do with actual legal liability, but instead were influenced by the necessity of avoiding high costs of litigation, which were further inflated by the unfair and abusive practices of the plaintiff's bar. In cases against GST, these practices included the suppression of evidence of their clients' exposures to many sources of highly friable, extremely dangerous asbestos products manufactured by large companies, mostly insulation, that had previously filed for bankruptcy relief.

Despite the substantial limitations placed on GST's ability to discover evidence of these abuses, the pervasiveness and significance of those practices, and their impact on GST, were well chronicled in the evidence presented at the trial. The case is now in the post-trial briefing stage, with final briefs due in late November. We are uncertain as to when the judge will render his decision, but we do not expect a decision from the court before the first quarter of 2014.

Even then, a court decision will be very important, but not determinative. There are many potential impediments to the adoption of a plan of reorganization, including appeals, which may make confirmation difficult in absence of a consensual resolution. In the meantime, both we and GST have indicated, repeatedly, that we are willing to find and accept a reasonable compromise that would bring finality and certainty to the situation.

However, we have also demonstrated that we are patient and that we are not going to accept a settlement that's not in the best interest of our Company and our shareholders. Even though settlement remains a possibility for the ultimate outcome of the ACRP, and is our strong preference, we can't be sure that the case will be resolved in that fashion. We are committed to preserving the GST business and the significant portion of its value for our shareholders, but we can't predict how much, if any, of GST's value might be preserved in an ultimate resolution.

Now, let's turn to our operating environment. Although our results for the quarter did not compare favorably to the third quarter of last year, there are some factors we should not overlook. First is the affect of the performance of Fairbanks Morse in the engine products and services segment on our total sales and segment profit.

If we exclude FME from the comparison, and look only at the performances of our Sealing Products and Engineered Products segments, sales in the third quarter this year were actually slightly better than they were in the third quarter of last year because of an increase in the Sealing Products segment. On that basis, segment profits were the same in the third quarter of this year, as they were a year ago, while segment margins were slightly less than a year ago because of a small increase in restructuring expense. The point here is that the performance of most of our businesses held steady from the third quarter of a year ago.

There are a number of positive developments in the quarter. The Garlock family of companies, including both the consolidated and deconsolidated operations, performed well. Despite generally soft market conditions and a slight reduction in sales, compared to the third quarter of last year, costs at those businesses were lower and operating profits and margins were strong.

The Technetics Group reported flat sales and profits, compared to the third quarter of last year, but experienced a noticeable improvement in the business climate as the quarter progressed. Semiconductor bookings strengthened in the last weeks of the quarter, and the book-to-bill ratio show in that segment, at the end of the quarter, was 1.7. And, it appears bookings will remain strong through the rest of the year and into the middle of next year. Technetics also reported improved bookings in its aerospace, nuclear, and oil and gas segments.

Stemco reported increased demand across all product lines, even though growth remained slow and likely to be tilted toward the OEM market for the rest of the year. We are enthusiastic about Stemco's product-line expansion and go-to-market strategy, and I am confident that strategy is proving effective in delivering very good results. At GGB, sales in Europe were up, compared to the third quarter of last year, because of better pricing, and we're encouraged that conditions may be beginning to improve in GGB's European markets, based on our order rate.

Offsetting those positives in the quarter, CPI and the engineered products segment continued to perform below our expectations. In the engine products and services segment, the combination of sequestration and the Navy's reduced maintenance schedule affected the performance of Fairbanks Morse significantly. Alex will help you understand the dynamics behind the results in those businesses, but in both cases, we're addressing issues that affect their performance, both for the short term and the long term.

At CPI, we named Ken Walker, who some of you have met, as president during the third quarter. Ken spent several years in charge of GGB's North American operations, before being named President at GGB in 2010, and has been leading GGB's turnaround over the past 3 years. While GGB continues to report to Ken, his current primary focus is to bring the benefits of his operating experience and strong commercial background to CPI.

He has been responsible for CPI since August and has begun a broad-based assessment of CPI's international markets, customers, operations, and commercial practices. However, as we have noted before, the results of our efforts at CPI aren't likely to be fully realized until market conditions improve.

At Fairbanks Morse Engine, we had anticipated softer demand for parts and services, primarily as a result of a reduction in the Navy's scheduled maintenance activity. However, the effect of sequestration was much more pronounced than we anticipated, and the combination of those two factors severely hampered government aftermarket parts and service sales in the quarter. Longer term, we're concerned over the prospects for new engine orders for Navy ship building programs. Based on the Navy's current ship building schedule, we see a drop in new engine orders in 2015, and they will remain at low levels for some time after.

To offset this decline, we continue to explore opportunities for FME in commercial markets and are taking steps to expand its product offering. On last quarter's call, we mentioned that FME had received a $21 million contract to supply five engines to an oil pipeline in South America. We're now pursuing other similar opportunities in oil and gas markets, and in power generation markets, there and elsewhere.

Power generation opportunities include a large life-extension product for several nuclear power plants in France and other smaller projects. Just last week, FME received a $6 million contract for supply of the state-of-the-art diesel generator system that will provide standby power to a large hospital. Unlike most of the engines we sell now to the US Navy, the proposed engine design for these projects is a proprietary FME design that is not subject to the restrictions of FME's licensing agreement with MAN.

Earlier this week, FME announced an agreement with Achates Power to improve the efficiencies and reduce emissions of FME's proprietary opposed-piston engines. The opposed-piston engine, known as the OP, is a highly reliable, extremely durable, and has been part of FME's historical offering for many decades. We believe these upgrades to modern standards will make the OP engine more competitive in oil and gas and power generation markets.

In addition to the agreement with Achates, FME also signed an agreement with Isotta Fraschini, an Italian manufacturer of high-speed diesel engines used for marine propulsion, power generation and other applications. This agreement gives us access to these engines for worldwide distribution.

At both CPI and FME, we're confident that we now have the right teams and are pursuing the right strategies to drive improvements in their performance.

Now, I will turn the call over to Alex to review our results in the quarter. Alex?

Thanks, Steve.

Our sales in the third quarter were $276 million, down $15.7 million, or 5%, from the third quarter of last year. Excluding foreign exchange and a small contribution from an acquisition, sales were 7% below the third quarter of last year. The most significant factor in the decline was a drop in sales at Fairbanks Morse, in part as the result of sequestration and the reduction in scheduled maintenance that Steve mentioned, but also because of lower engine sales.

The acquisition was a small Singaporean distributor of industrial seals that we completed in the first quarter of this year, as we continue to advance our Asia growth initiatives. Excluding FME, sales were about the same as in the third quarter of last year, as a decrease in sales at the Engineered product segment, primarily at CPI, offset an increase in the Sealing Product segment, where Stemco reported higher sales across all of its product lines.

By geography, sales were down in Europe by 4%, compared to the third quarter of last year, and flat in North America when you exclude FME from the calculation. I will discuss the performance of our individual businesses in more detail when I cover the segment results. At $29.4 million, segment profits were 22%, or $8.1 million, below the third quarter of last year, driven primarily by the drop in aftermarket parts and service sales by FME to the US Navy.

The loss of these higher-margin sales from Q3 2012 to Q3 2013 was the driving reason segment profit margins came in at 10.7%, more than 2 points lower than a year ago, when they were 12.9%. It is worth reiterating Steve's point that excluding FME, segment income was the same as in the third quarter of 2013 and segment margins were in line with the third quarter of last year.

We had about $1.3 million of restructuring expense, at the segment level in the third quarter this year, or about $400,000 more than in the last year's third quarter. Net income in the third quarter of 2013 declined to $5.6 million, or $0.23 a share, from $11.3 million, or $0.53 a share, in the third quarter of 2012, primarily because our operating income was lower. Excluding interest due GST and other selected items, net income was $13 million, or $0.53 a share, in the third quarter of 2013, compared to $17.2 million, or $0.81 a share, last year in the third quarter.

Looking at our consolidated results for the first nine months of the year, sales were about $869 million, down about 4% from what we reported in the first nine months of last year. Excluding the effects of foreign exchange and acquisitions, sales were down about 6%. Again, the change was primarily driven by lower revenues at FME, due in part to lower completed contract engine revenues, which we've described in detail in the past, and also a reflection of weaker parts and service sales. The remainder primarily reflects lower demand compared to the first nine months of last year, especially in Europe and in our semiconductor markets.

Segment profits were about 12% below the first nine months of last year. The decline was the result of lower volumes and a less attractive mix at most of our operations, but principally at FME because of increased sales of lower-margin environmental upgrades, a low-margin engine refurbishment contract, expenses related to an early retirement program, and weaker aftermarket demand. Segment margins in the first nine months of the year were 12%, compared to 13.1% in the first nine months of last year.

On a GAAP basis, we earned $0.96 a share in the first nine months of this year, compared with $1.64 in the first nine months of last year. Excluding interest due GST, an environmental reserve in the second quarter, and other selected items, we earned $1.94 from the first nine months of this year, compared to $2.48 in the first nine months of last year.

The deconsolidated operations at GST continue to perform well. Third-party sales in those operations were about $53 million in the third quarter, essentially flat with the third quarter of last year. Operating margins were 27.8%, as the business continued to benefit from price improvements and lower costs. In the third quarter of 2012, GST's operating margins were 22.6%. GST's EBITDA, before asbestos-related expenses, improved to $16.4 million, up 23% from the third quarter of last year.

Adjusted net income at GST, which excludes inter-company interest and ACRP-related expenses, was $9.2 million, an increase from $8.8 million in the third quarter of last year. GST recorded almost $16 million in ACRP related expenses in the third quarter, double the amount in the third quarter of 2012. These expenses increased significantly because of the estimation trial.

Through the end of September, ACRP-related expenses at GST totaled $40 million. As you know, GST is required to pay the expenses of all parties involved in the case. Although post-trial activity continues, we expect legal spending on the ACRP to moderate now that the testimony is complete. GST's cash and investment balance was $173 million at the end of the quarter, unchanged from the end of the second quarter.

Now, let's look at our consolidated third-quarter results in more detail. Gross margins were 33.9% in the third quarter of 2013, down about 0.5 point from the third quarter of 2012. The slight decline was mostly due to the performance of FME, although gross margins continued to benefit from effective management of our supply chain and raw material costs. SG&A expense of $71.4 million in the third quarter was up compared to the third quarter of last year by about $2.6 million. The increase reflects costs associated with the acquisition and investments to support growth in the pipeline market served by the Garlock family of companies. SG&A also includes $7.6 million in corporate costs.

I will also point out that we incurred about $1.1 million of ACRP-related costs at the parent-company level for GST's estimation trial. Those costs are included in the other operating expense line on our income statement and are the primary driver of the $1.2 million increase from last year to this year.

Now, let's look at our segments' operating performances, beginning with the sealing products segment. The segment sales were $157.9 million in the third quarter, up about 4% from the third quarter of last year, as Stemco recorded strong organic growth. Excluding foreign exchange and the contribution of the acquisition, sales improved by about 2%. Sealing products segment margins were up slightly from a year ago to $24.2 million.

Stemco's performance drove the increase, as profits were flat at Technetics and down at the consolidated Garlock businesses. Segment margins were 15.3% in the quarter. Excluding higher restructuring costs, segment margins were 15.4%, or about the same as in the third quarter of 2012 on the same basis.

Looking at the businesses within the segment, sales at the consolidated Garlock operations were about the same as the third quarter of last year. Although volumes were down, especially in Europe and in parts of the business that serve the US construction markets, sales benefited from modest price increases, the Singaporean acquisition, and favorable foreign exchange. However, these factors weren't enough to offset lower volume, costs associated with the acquisition, and increased SG&A, when the segment profits and segment profit margins were lower at the consolidated Garlock operations.

After several quarters of unfavorable year-over-year comparisons, sales at the Technetics Group were flat compared to the third quarter of 2012. Volumes were down in semiconductor markets in Europe, but a significant portion of the decline was offset by higher demand from nuclear markets. Technetics sales also benefited from price improvements. Segment profits and profit margins at Technetics were about the same in the third quarter of 2013 as they were in the third quarter of 2012.

Sales were up strongly at Stemco across all product lines. Although conditions remain somewhat soft in Stemco's markets, sales improved for core aftermarket products, suspension system components, and brake products. With higher volumes and significant operational improvement in cost control, Stemco's segment profits and profit margins also increased. As Steve mentioned, we're encouraged by Stemco's performance in a market that has offered limited opportunities for growth.

In the engineered products segment, third-quarter sales were $84.1 million, down about 3% from the third quarter of 2012. The entire amount of the decline came from CPI, where volumes were lower in Europe and North America. Excluding foreign exchange, sales were down 5% in the segment. Profits and margins were down in the segment, primarily as a result of lower volumes at GGB and CPI and continued restructuring expense at CPI.

The segment's restructuring expense in the quarter was $1.1 million, all at CPI. In the third quarter last year, restructuring was $900,000, with most of the expense at GGB. Excluding restructuring expenses from the third quarter of both years, segment margins were 4.8% in 2013, compared to 5% in 2012.

At GGB, sales were flat with the third quarter of 2012, as better pricing offset the effect of lower volumes, mainly in North America. Excluding restructuring from GGB's segment profits in the third quarter of 2012, margins were about the same this year as last. Sales were down at CPI, as I mentioned, because of lower volumes in North America and Europe. Even though CPI benefited from price increases, lower material costs, and lower SG&A expense, the benefits didn't offset the effect of lower volumes and higher restructuring costs, and CPI reported a loss in the quarter.

A look at the results of the engine products and services segment will complete our review of the segments' performance. As we noted earlier, sales in the segment were down 34%, or $18 million. Lower engine revenues accounted for a portion of the decline. Last year in the third quarter, the segment recorded about $6 million in new engine revenue under completed contract accounting. There were no completed contract revenues in the third quarter of this year. And, lost production from the redesign of the manufacturing floor reduced percentage-of-completion revenue by about $2 million in this year's third quarter.

The segment also reported almost $10 million less in parts and service sales, as a result of sequestration and the timing of engine maintenance schedules. The drop in parts and service sales, which are much more profitable than engine sales, had a significant effect on profits and margins in the engine products and services segment. Profits were down about $8 million and profit margins declined to 6.6%.

FME's backlog was $137 million at the end of September, compared to $149 million at the end of June. As Steve mentioned, the team at FME is working aggressively to penetrate new engine markets, as we anticipate a decline in demand from Navy ship building projects in the coming years.

We reported GAAP net income of $5.6 million, or $0.23 a share for the third quarter. This compared to GAAP net income of $11.3 million, or $0.53 a share, in the third quarter of last year. Our effective tax rate in the third quarter was 22.2%. The tax rate shifted down, compared to the third quarter of last year, as a higher portion of our pre-tax income came outside the United States in jurisdictions where tax rates are lower. Based on our current expectations, our full-year tax rate should be in the range of around 30%.

Our adjusted EPS in the third quarter was $0.53, compared to $0.81 in the third quarter of last year. After-tax adjustments that increased our $0.23 of 2013 GAAP earnings to $0.53, are $0.03 of restructuring expense, primarily at CPI; $0.21 of interest due GST; $0.03 for other non-operating items; and $0.03 to adjusted tax accrual. I should also point out to you that our diluted share count was about 3 million shares, or 14% higher in the third quarter of this year than it was in the third quarter of last year.

The count increased because of the accounting for our convertible debentures as our share price improved. We have an option and a warrant hedge designed to reduce the potential dilution to the holders of our common stock from conversion of the debentures. Under GAAP accounting, our diluted share count at the end of the third quarter included about 2 million shares that would be required to satisfy the conversion of the debentures, plus about 1 million shares that we would be required to provide to a financial institution as part of the hedge. However, GAAP accounting does not allow us to record the benefit of the hedge, which would enable us to call the shares required for conversion and would reduce the net dilution to about 1 million shares.

Our free cash flow was lower by about $20 million, in the first nine months of 2013, than in the first nine months of last year. EBITDA was lower because of the decrease in our operating income. Compensation-related payments increased compared to last year, and we made a larger pension contribution this year. Lower working capital needs helped offset some of these increases. Through the first nine months of 2013, capital spending was about the same as last year, but if we complete all our plans for investment in 2013, CapEx could exceed $40 million.

We ended the first nine months of the year with a cash balance of about $75 million, up about $21 million from our balance sheet at the end of 2012. We continue to record our convertible debentures as a current liability because the gains we have seen in our share price triggered the conversion rights to the debentures. However, we have no indication that any holder is likely to convert prior to the maturity date in October 2015.

Now, I will turn the call back over to Steve for our outlook.

Thanks, Alex.

I'll close with a look at what we expect in the fourth quarter, and then we'll open the line for your questions. At this point in the quarter, certain of our industrial markets are beginning to show signs of improvement. Europe appears to be gaining strength, although activity is still at relatively low levels, and we typically see seasonal softness in the fourth quarter at GGB, where we have our largest European exposure. As I mentioned in my opening comments, our semiconductor bookings have improved, as have bookings in other high-performance sealing markets. Demand in our heavy-duty truck market is stable, although coming more from original equipment markets than the aftermarket.

Offsetting these positives, demand in our compressor products markets are softer than a year ago, and we expect demand for aftermarket parts and service from our US government markets to remain soft in the fourth quarter. Under those conditions, we expect sales in the fourth quarter of 2013 to be about the same as they were in the fourth quarter of 2012, but a higher proportion of the demand is expected to come from original equipment markets, where our profit margins are lower. In addition, we expect to see more restructuring costs in CPI. As a result, our segment profits and profit margins may decline from levels we achieved last year in the fourth quarter.

Before I close, I will reiterate our commitment to leveraging the strength of our brands, exploring the opportunities provided by new products and new markets that we've entered through acquisition and internal development, maintaining our cost discipline, our pricing practices, and executing the enterprise excellence initiatives that support our continued success. I am confident this commitment prepares us to operate in challenging markets and prepares us to capitalize on opportunities as our markets improve.

Now, we will open the line to your questions.

(Operator Instructions)

Your first question comes from the line of Ian Zaffino from Oppenheimer.

Two questions. You talked about the GGB order book being up. How much are we talking about being up? Over what period? Has any data changed recently, in the past couple of days or weeks? Or, if you could elaborate a little bit more that would be great. Thanks.

I don't know if I would comment on the last few days or weeks, but for the -- and I'm comparing it over a year ago. We track the pace of order intake, year over year, on a weekly and monthly basis. I would say, through July, it was certainly negative from last year, and beginning maybe in August, September time frame, it started to turn positive versus last year. And, that has continued, so we are seeing more orders in GGB, and that's continued even up until the current time.

Okay.

Do you want to add anything to that, Alex?

I was going to say, if you look at the trend for most of the year, it's been fairly flat year over year. In August, actually, the orders were up 35%, so that was a fairly substantial jump in that month. Obviously, it remains to be seen if that level sustained. The other thing that I would point out is, if you look at the German automotive markets -- across Europe, the new registrations are still pretty flat, but if you look at the German automotive market, which is where we play pretty heavily, sales are actually up. I think the number is something like 6%, predominantly for the export market, so both of those are some pretty good indicators for us.

Right. So, it's much more about the export market in Germany than it is about the domestic market, per se.

Yes, I think that's right. And, you know Alex is talking to the export of cars? Our bearings are consumed in Europe.

The other question would be on the FME declines. How much of that is, let's just say, baseline demand declines versus any type of destocking or burning off of spare parts that were hoarded before January 1, or if you could give us any color there?

Let me give you some color on that. This is obviously a big deal. We don't have visibility on what the stocking levels are, but let me see if I can give you a little bit more detail on what's happening. We sell spare parts and service, so aftermarket parts and service from FME, in three segments -- commercial; nuclear, we count as separate; and the government, which is basically the Navy. First, let me handle the easy one -- commercial has been actually up because we've been emphasizing that a lot, but that's the smallest portion by a pretty wide margin. The largest portion is the government.

In nuclear, we have actually had a difficult situation, only on a comp basis. This year, we anticipate to sell maybe 20% less than we did last year of aftermarket parts into the nuclear. We're a little bit under the three-year rolling average in nuclear, but last year was a stellar year for the year. Last year was a record year for us. We sold more than we had ever sold in any given year. That's just normal variability. So, in the nuclear side, we happen to be working against a difficult comp.

But then, the big one, which is the Navy, is really driven by preventive-maintenance schedules for Navy ships. And, of course, our engines aren't on every Navy ship, right. So, how it affects our demand is, are the ships scheduled for preventive maintenance -- they call it avails, for short, of availability, so it is when the ship comes in for some level of preventative maintenance. If that ship has our engines, there's work that are done on that engine. Now, there's three types of these preventive-maintenance projects, if you will. Minor, major, and then, big mid-life redos, that sometimes take a year or more with the ship in port. And, of course, major work is done on the engine.

Just to give you a sense, in 2012, we did -- the engines on ships that were worked on in these things, there were 30 engines affected in minor preventive-maintenance efforts, there were 40 in major, and there were 20 of these mid-life redos. And obviously, the mid-life ones are several times larger revenue for us than even a major, and a major is usually about 2x a minor. This year, we did about the same number of minors, half the number of majors, and none of the mid-life redos. And, that was just per the ships that were scheduled to be worked on and where our engines are.

Next year, we expect that to be back more to normal -- last year was a pretty good year, relative to the average. This year was a really bad year, compared to the average. Next year will be more about at the average, even when you look at that mix of minor, major, and these mid-lifes. We knew that was going to affect us, but it was kind of like the sequestration effort compounded that effect. So, not only did we see, then, broad-based reduction from sequestration, but these two things are related.

We do expect the effect of sequestration to continue, but I would say, we've had -- the total reduction in annualized government parts and service has been roughly 20%. And, we would attribute probably two-thirds to three-quarters of that to this avails schedule being off, and somewhere between 25% and 30%, or one-third, to be sequestration. Is that helpful?

Yes, that's actually really helpful. Appreciate that. Thanks a lot, guys. Take care.

Your next question comes from the line of Todd Vencil from Sterne Agee.

Staying with FME for a second, Alex, you mentioned a couple of things that I didn't completely get down. And Steve, by the way, that was a really good breakout of the sequestration versus the avail issue, so that's helpful. First of all, Alex, could you go through -- you mentioned an impact on the percentage of completion from factory rearrangement or something. Can you go through that again?

Let me take that. You can tell the impact. But what we did, the shop was a little soft with work anyway, Todd. So, what we did, and this is in the assembly shop, we changed the manufacturing floor configuration, so that the flow for how we build engines is different, to make it much more efficient for how we assemble engines. And that had -- basically that had the shop kind of offline for a couple of weeks while we moved, because it's pretty big -- it's a big shop, obviously, we're handling these big engines. And, they kind of go from stand to stand, depending on what steps in the assembly process are happening.

So, we basically lost -- we deferred some production time, and we still meet the schedules and so forth, but we spent a couple of weeks doing that -- preparing and doing that work. And that took out, or really moved, $2 million of revenue out of the quarter. Okay?

Got it. That's helpful. Was there -- how should we think about the profit impact associated with that $2 million of revenue?

Let me just go through what I mentioned in the script, Todd. Basically, as Steve was going through, we had this lost production from the redesign of the manufacturing floor, and that impacted about $2 million of revenue. Our typical engine margins is in kind of the 5% to 8% range. Last year, in the third quarter, we had $6 million of engine revenue under the completed contract. This year, we had no engine revenue of completed contract. Again, if you use a proxy of, call it 5% to 8% operating margin on a new engine, that probably gives you about the margin impact. Does that help, or do want me to give you some additional color?

Yes, that's very helpful. That 5% to 8%, is that operating or EBITDA?

Generally, I'd call that an operating margin. It's a ballpark, because it very much depends. This engine that Steve mentioned, the $6 million engine to the hospital, is quite a bit higher margin than that because it's got a lot more bells and whistles on it. You have margins that are lower margin than that because they're much more plain vanilla, but I'd give you that as sort of a ballpark.

One thing, Todd, that I know you guys -- we'll talk more about this, probably in the first-quarter call, as we talk about 2014. When we shifted to percentage of completion, you guys will remember, we said any program -- this is not an engine -- we said any program that is already on completed contract, we're going to finish that program out, and a program is a particular ship program. And then, any new program we start, we're going do it as a percent-completion program. And so, what that did is that is going to cause a couple of years of really difficult period-over-period comparisons because of the number of completed contracts versus percent completion.

This year, for the full year, total percent completion will be 90% of our total new engine revenue, plus or minus. Next year, it's actually going to swing back, because we're going to be shipping and we are going to be finishing some engines that have been on programs that are multi-year programs. So, next year, it is more likely to be back to about 50/50.

So, even though, this year, we're shipping a total of 13 engines, next year we'll ship 22 engines. A little under half of those will be on percent completion -- sorry, a little more than half on percent completion, a little less than half on the old completed-contract method.

We'll give you more clarification on that as we get into next year. The total, I know you've got to strip away all that complexity, the total new engine revenue for next year is going to be probably about what it was for this year. Okay?

Got it.

The mix will change quite a bit. And, I'm giving you the estimate for full year this year, versus next year, when I'm making that comparison.

Got it. That makes a lot of sense. I appreciate that.

Now, that assumes, what I just gave you, also assumes that none of these new commercial efforts that we have launched actually get over the goal line, so that's a pretty conservative number. We're actually pretty optimistic that we're going to get more commercial engines. That's just kind of what's in the backlog today. Okay?

Got it. Looking at engineered products, gosh, we were moving so nicely toward Alex's double-digit operating margin there, and we took a step back, I guess, in the quarter. Was that -- again, if I'm hearing you right, it sounds like that was mostly driven by weaker business at CPI and -- A, am I right? And, B, how are we thinking about margins in that business from here?

It was all due to CPI. Look, GGB continues to perform very well, as a business, in spite of very weak markets. It's hard to estimate -- it's hard to understand. I know you guys probably cover a lot of European activity, but if you live in the US, and after all my time in Europe, it's hard to understand how they've been really struggling through this slow demand in Europe and the very slow recovery.

If you want look at the automotive registration numbers, I don't know where they're going to come out for year on average, but they're going to be, in some of those countries, numbers that you haven't seen for several decades. So, the year has been a dismal demand environment for our European business for GGB.

As you know, for GGB, it's two-thirds of the business, is Europe. We are very optimistic now that we've seen some improvement in that. It hasn't been a dramatic step change. I kind of wish Alex wouldn't have shared the August number because I think that was a bit of an anomaly. We're definitely seeing an improvement trend, but I wouldn't sign up for a 30%, 35% ongoing trend. But, I think I'd sign up for a solid 10% to 20% improving order rate, that we will have, going forward. If you were asking, that's just a prediction, that's not a forecast. But, I'm pretty optimistic about it.

As guys know, as we've said all along, GGB just leverages so nicely. I think we'll be in double-digit margins in GGB for next year. I feel pretty good about that, if we continue to see the improvement that we've seen in the European markets.

Now, CPI is tough to say. Ken has now been in place since August. We've made a number of people changes in that business. We've got another facility to consolidate, here in the fourth quarter, in western Canada. We've got -- he is doing a complete review of things.

We're going to try to get it so we start into next year with kind of -- so we get as much of this restructuring and big changes behind us as we can this year. So, you should not anticipate a good fourth quarter for CPI. They will lose money. It's never a strong quarter seasonally because it's cold in a lot of these regions. So, we're trying to get ourselves positioned to be on a pretty steep improvement curve next year for CPI.

At this point, Todd, I don't have enough visibility to give you a good sense of what our margin expectations are, but I can commit to doing that in the first-quarter call, the call we do the first of next year. We'll talk about where we see -- because by that time, Ken will have been in place long enough, they will obviously have a plan for 2014.

We'll know if we've been successful in getting the restructuring behind us, and we'll give you guys as much clarity as we have about engineered products margins. I know that's been a frustrating aspect of our Company for investors and the Street to understand. It's been frustrating for us. That's basically what I can tell you at this point.

That's helpful. Thanks a lot.

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

Good morning, guys. Thanks a lot for all the information. Everything's been very helpful on the call today. I just had a couple questions.

One, in terms of the FME, I was wondering if you guys have been seeing anything in terms of nuclear parts and services? Any improvement related to some of that Fukushima-related regulation, or any of that such, and should we expect that in 2014?

We haven't seen a huge impact on our domestic parts and service business for nuclear. This year it's been cranking along about like average. We sold, as I said, last year was a record year. That's in the US.

Now, I mentioned it in my part of the script, Joe, the French nuclear system is run by EDF, as you probably are aware. They have, I think, 56 or 58 nuclear power stations in France. It's still the predominant source of power generation in France. It's a huge share of their energy mix, and they continue to be committed to it. In fact, you may have seen, recently, it was announced that EDF was going to build and operate the new reactor in the UK. They just announced it a few weeks ago.

Anyway, EDF has decided to add, basically, backup power in each one of those nuclear stations. We are partnered with Westinghouse France, and we're bidding on, and have been for -- it's been a long selection process with a number of consortium companies, Electricite de France -- I'm sorry, Westinghouse France is our partner, because it obviously includes a generator set and controls and so forth. So, we would supply the engine; they would supply the installation, the generator, the controls, and they would be essentially the integrator.

We expect a decision, before the end of the year, on whether we win a portion of that work. We're doing pretty well in terms of hanging in there. I hate to predict it, because it's one of these binary things, where we're either going to get a decent chunk and several engines, or we're going to get nothing. But, we'll know by the end of the year.

We also have -- so that's the nuclear question. But that's clearly driven -- all that decision was driven by the Japan disaster and their decision to add additional backup power at each one of these sites.

Now, the US has not -- the NRC has not decided to do that. They also have not decided to not do that. There's a lot of activity at the NRC, looking at what should happen to nuclear safety in the US. So, that's how I would answer that question.

Okay, great, thanks. Just overall clarity on the segment, sort of what your outlook is, it sounds like the aftermarket parts and services, actually, will be, potentially, up next year and engines sort of flat. So, are you actually thinking about next year as actually being somewhat of a better year, and the effects of sequestration and such, more taking a toll in 2015 and beyond?

Well, a lot of it will be, obviously, dependent on whether we win some of these things I mentioned or not. If we don't, and we just go in with what we know we have now and the recovery to some extent of the service and so forth, we expect our year to be slightly better than this year, I would say, and margins to be a little bit better than where we're going to end this year.

Now, you may have noticed, and if you haven't noticed, I would encourage you to look at it, FME announced, a few days ago, a partnership deal that we signed with a company called Achates Power, which is a start-up company, technology company, that has really got an incredible amount of intellectual property and done a lot of work to improve the fuel efficiency, power ratio, emissions performance of opposed-piston engines. It's actually quite exciting. We're the only guys that make an opposed-piston engine in our size range.

And, of course, Achates is mostly focused on and they're partnered with a number of heavy-duty truck companies because they have been able to demonstrate in their facility, on bench-scale engines, improvement in fuel performance, fuel efficiency of, on the order of magnitude, of 15% to 20%, with better emissions performance than the current four-stroke diesel engines and to be able to make them cheaper because there are fewer parts and so forth.

So, this is a big deal for us, and we'll be spending some costs next year. We have already started with this, and we have been working with them for a number of months. We have an agreement with them, which gives us exclusive rights to this technology for OPs in our size range, which is obviously much larger than a truck engine. We will have some costs associated with R&D of that for next year.

I don't want to get you guys too excited because I'm really excited about this. It is a multi-year effort, though, because it would take us a couple of years to get the actual technology developed and incorporated into our engine, but it could be a game changer for us in terms of providing a product that is, far and away, better, from a fuel efficiency and emissions standpoint and cost standpoint, than comparable engines in our size range. And, we could be in the market with something like that in a few years. So, we're pretty excited about it. I think we announced it -- was it yesterday or the day before, Don? Two days ago.

Okay, thank you. Then, lastly, I want to finish with CPI. I was wondering if you could actually provide a little more detail, or update us, on the actual restructuring efforts that you're making there? Also, I thought North America refining was a market in that business that has really been struggling, but it seems like there could be signs that market could be improving down the line. Just wondering if you could comment on that?

Well, the restructuring activities have been, really, two. One has been facility consolidation to reduce our costs and become more efficient in how we operate, and the second has been in headcount changes for a number of reasons. So, those are really the two components, and that's what we saw in the third quarter and will see again in the fourth quarter.

We also have -- we're also reviewing some of the inventory that we have had in place in western Canada of kind of a spares program that we've run, and that may be included in some of our restructuring in Q4. We've got a team that's reviewing the quality of that. It's a spares program where we would take equipment out of the field and refurbish it, replace it, and refurbish the old, and then hold the old until it's needed again. Obviously, with the market being much slower, that the pace at which that moves in and out is also reduced.

So, we're reviewing that, and we'll have more detail on that. We are going to get that done by the end of the year. So, those are the components of the restructuring, Joe. And then, your other question -- other part of your question?

I was just wondering, I remember last quarter, I think Alex was referring to North America refining not being as strong as hoped, I was just --?

I think it's kind of where we've seen it. Obviously, we're hopeful, and the turnaround season we typically see is usually in Q2 and Q3, which drives a lot of this type of work.

Joe, I wouldn't change my comments materially from what I made last quarter. For the CPI business, that refining segment continues to be weak along with the natural gas.

Okay. Thank you.

Your next question comes from the line of Gary Farber from CL King.

Good morning. A couple of questions. When you speak about operating income being down year over year, does that include charges associated with CPI?

Yes, it would. It would include the charges with CPI, then when we give you the adjusted EPS numbers, we would back out, I think it was $0.03 of restructuring.

Can you give a sense of -- do you have a sense of how big or small it will be?

In Q4?

Yes.

Well, we're not exactly sure, Gary, because of this inventory thing, so I'd rather not make an estimate.

Okay. Another question was on -- obviously a lot of things going on with the Company. Just the acquisition market, is that even on the plate right now, and if it is or it isn't, just your sense of the market?

We continue to look at opportunities to strengthen each of our businesses. So in each -- not each, not every one of them, but in Stemco, we're looking at a couple of opportunities. In Technetics, we've got a couple of opportunities that we're looking at. I would say our strategy, there, has been consistent.

As we said, going into the year, we probably would take a bit of a pause this year -- one, to digest what we've got; and two, to try to get this ACRP behind us, so we could take a clean look at where we stand. We're still hopeful that will be the case. We have continued to cultivate these relationships along the way.

So it wouldn't -- we did one small deal earlier. We're probably going to get -- I don't know if we've got another small distributor in Asia, for Garlock, that we may get done by the end of the year, or early next year. Next year, we should be back at more of the pace that you saw over the past four years, excluding this year.

Right. And, just for modeling purposes, share count should be consistent going forward with the share count reported this quarter? And, also, how you think about the tax rate going forward?

It depends, Gary. The share count is driven by the share price related to the convertibles. So, right now, diluted shares are at $23 million, but you should -- I'm sorry, 23 million shares, but you should basically back out 2 million shares from that number because of the impact of the hedge that we have in place. So, you essentially get double dilution related to the hedge, and I can talk you through the mechanics of how that works. Obviously, as the share price goes up, the shares outstanding increases as long as we have the convertibles on the books.

In terms of the tax rate, for the full year, we're anticipating 30%, but that will be low. That will be sort of anomalous, driven by one-time effects that went into place. This year -- well, they went into place retroactive to last year, but we booked them this year. A more normal rate, I think, is in the 35% range.

Okay. And then, just one last one. You made some comments at the beginning regarding the ACRP, that a court decision, if it goes that route, would take awhile. It sounded like there was an appeals process beyond that. Is that the case? And, can you talk about what the process is even if the court did end up deciding this?

Gary, Rick happens to be in the room, Rick Magee, who is leading that effort, as you know. So, I am I'm going to let Rick address that question.

Hi, Gary. Obviously, dependent on the judge's decision, either the Company or the committee can appeal that decision. The positions taken in the estimation trial by the parties were, as you know, dramatically different. So, dependent on where the judge comes down, assuming we get to that, the party that doesn't like the decision has lots of grounds for appeal that have arisen throughout the case. We believe our appellate rights are very strong. It's hard to predict whether there will be an appeal and what that appeal will look like, until we know what the judge is going to do. But an appeal -- if a party is not pleased, an appeal is almost a foregone conclusion. While we'll have an estimation decision at some point, and that will move us a long way toward a resolution, there will be appeals that will follow that, just depending on how people feel about that decision.

Right. Okay. Thanks.

Your final question comes from the line of Jeff Hammond from Keybanc Capital Markets.

This is James filling in for Jeff. Could you elaborate on what's driving GST's strength? Also, how you might be outpacing recent trends in the truck market, given that heavy-duty build schedules in North America have come down recently, while you guys are still crediting OEM activity as a tailwind? Are there share gains implied? Any color would be helpful. Thank you.

That's a great question. Let me handle them in reverse order. In Stemco, there's no question that we have had share gains because what we've done -- if you've studied the history of Stemco, you know that our core products are the wheel-end components oil seals and bearings and hubcaps and so forth. Over the past five years, we have systematically added other product lines to the Stemco portfolio of products, including some suspension components, king pins, spring pins, urethane bushing components, and braking systems. We have added friction, brake shoes, now, brake drums through motor wheel, automatic brake adjustors -- all those are new products.

We've gained share from the position, when we bought or partnered with a company to have those products, we have been consistently gaining share every year as we have incorporated those products into our go-to-market strategy. That will continue. So, even though we've seen a relatively weak aftermarket truck environment, we have been able to continue to grow sales pretty substantially. What we just pointed out before is, we continue to believe that aftermarket demand, which is driven by ton miles and truck loadings and so forth, will be about where we've seen in the past, which has been fairly weak, from a market standpoint. The mix is likely to be a little bit more on the OE side than the aftermarket side. We play predominantly in the aftermarket. But, yes, we've been gaining share pretty consistently in those product lines.

On the Garlock side, the business is doing well. We're the leader in sealing science globally. We have had pretty significant success in growing our presence in other markets, moving some of our technology and some of our products that have been successful in one region to other regions. And, I believe we're continuing to chip away at market share.

Also, even though sales have been slightly better, the costs this year have been very good. We've managed costs effectively in that business, so margins have been better, even better than gains we've had. So, I feel very good about Garlock, both the deconsolidated and consolidated portions.

Got it. Thank you.

Yes.

I will now turn the call back to Don Washington for closing remarks.

We appreciate all of you dialing in today. I know there are a few of you who are still in the queue for the Q&A. I apologize that we have to ring off, but both Steve and Alex have other obligations that take them away. However, if you would like to give me a call later today, you can reach me at 704-731-1527. I will be glad to help you as I can. Again, we thank you all for dialing in today. We look forward to talking to you soon.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.