Nov 5, 2010
Executives
Don Washington – Director, Investor Relations and Corporate Communications Steve Macadam – President and CEO Bill Dries – Senior Vice President and CFO
Analysts
Ned Borland – Hudson Securities Todd Vencil – Davenport & Company Joe Mondillo – Sidoti & Company Steve Wortman – Lord Abbett Gary Farber – C.L. King
Operator
Good morning. My name is [Kavita], and I will be your conference Operator today.
At this time, I would like to welcome everyone to the EnPro Industries Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.
Mr. Washington, you may begin your conference.
Don Washington
Good morning, everyone, and welcome to EnPro Industries quarterly earnings conference call. In a moment, Steve Macadam, our President and CEO, and Bill Dries, our Senior Vice President and CFO, will review the results for the third quarter.
But before we begin, I will remind you that our call is being webcast at EnProIndustries.com, where you will also find the slides accompanying the call. You can access the presentation through the webcast link on our homepage.
A replay of the call will also be available on the website. You may hear statements during the course of this call that express a belief, expectation or intention, as well as those that are not historical fact.
These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements. These risks and uncertainties are referenced in the Safe Harbor statement included in our press release and are described in more detail, along with other risks and uncertainties, in our filings with the SEC, including the Form 10-K for the year ended December 31, 2009 and Form 10-Q for the quarter ended June 30, 2010.
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 and 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.
Finally, I want to remind you that comparisons to our financial results for the third quarter and first nine months of 2010 to the comparable periods of 2009 reflect the deconsolidation of Garlock Sealing Technologies LLC and its subsidiaries, effective June 5, 2010. GST and its subsidiaries are deconsolidated from EnPro’s results during the pendency of the Chapter 11 legal proceedings to resolve asbestos claims against it.
Accounting rules don’t permit the restatement of prior periods to reflect the deconsolidation. We will conclude the call with a question-and-answer session after Steve and Bill make their remarks, and if your questions aren’t answered on the call or you have follow-up questions, please contact me at 704-731-1527.
And now I will turn the call over to Steve.
Steve Macadam
Thanks, Don. Good morning, everyone.
Thanks for joining us. Our third quarter results continued the trend of improvement that we began to see late last year.
We experienced strong year-over-year organic growth in nearly all areas. Our segment profits and profit margins improved, net income was higher, our cash flow was strong and we continued to make strategic acquisitions in the quarter.
As Bill will explain, the deconsolidation of GST had a negative impact on our reported consolidated sales growth, as well as our segment profits. However, GST had a strong performance in the quarter, and even though they are not included on our consolidated numbers for reasons Don explained, we continue to own a 100% of GST.
Before the selected items we outlined in our press release, we earned $9.6 million in the third quarter and GST earned another $5.7 million of income on the same basis. Last year, our entire company earned $9.5 million, before selected items, and I think it’s interesting to note that our consolidated earnings on this basis were about the same this year without GST as they were last year when they included GST.
That provides some indication of the strength of the recovery that we’ve seen this year. Looking briefly at the performance of our operations, all the Garlock companies reported strong year-over-year growth in the quarter, and benefited from improved demand across a number of markets.
That includes both the consolidated Garlock companies and deconsolidated GST and its subsidiaries. Stemco continued to see increased activity in the heavy-duty truck markets, where demand has increased significantly from the low levels of a year ago.
At GGB, demand for bearing products grew, as both industrial and automotive markets remain stronger than a year ago. Fairbanks Morse was unexpectedly stronger in the quarter, with good success in increasing aftermarket sales and made substantial contributions both to sales and profits.
At Compressor Products International, results were mixed, and as Bill will explain, growth has been more modest as gas prices remain depressed, causing continued postponements of projects and maintenance in CPI’s gas-gathering and related markets. We completed four acquisitions in the quarter.
Three of those were completed just after the beginning of the quarter, and we discussed them in our second quarter earnings call. Those acquisitions are being integrated into CPI and add a line of lubrication products and services that will allow us to capture very nice revenue synergies as we expand our product line in this business.
Acquisitions have made CPI a significant competitor in the market for reciprocating compressor components and service, and we will continue to drive this type of growth at CPI. The fourth acquisition in the quarter was a company called Hydrodyne, a designer and manufacturer of machine metallic seals and other specialized components, used primarily in the space, aerospace and nuclear industries.
Hydrodyne is included in the Garlock companies’ high-performance seals group, and fits very nicely into our plans to expand our presence in aerospace and nuclear power markets. As you know, the high-performance seals group, while globally part of the Garlock family, is not included in GST’s asbestos claims resolution process or ACRP, as we refer to it.
Each of these transactions is consistent in size and strategic rationale with other acquisitions we’ve completed. Year-to-date, we’ve spent a little over $25 million on acquisitions, and with our current cash balance, we have substantial resources to continue this aspect of our growth strategy.
We have a number of prospects under due diligence review, and I expect we will complete additional transactions before the end of the year. I know you are interested in what’s going on with the ACRP, so I will take a few moments to update you.
As you know, the ACRP automatically halts any claims against GST, including asbestos, and in addition, early in the case, the court granted an injunction against the prosecution of existing or future asbestos claims against other EnPro affiliates, which prevents plaintiffs’ lawyers from trying to shift their allegations of liability from GST to another EnPro affiliate. Currently, the parties are litigating over the process the case will follow going forward.
GST is arguing that proofs of claim and a deadline for filing claims, known as a bar date, both of which are normal tools for Chapter 11 re-organizations, should be mandated to allow a process for GST to examine and move to disallow inappropriate claims. And, as we expected, the committee representing asbestos claimants wants the court to skip those steps and move directly to estimating the value of the liability.
GST believes the steps are required, and that furthermore, they will result in the elimination of the vast majority of approximately a 100,000 outstanding claims against GST. GST intends to demonstrate that claims should be disallowed for one or more of several reasons.
Many of the claims are simply no longer active, even in the tort system, and have been dormant for years. Many of the claimants cannot demonstrate any exposure to GST products.
Many cannot prove that GST products could have been even remotely contributed to their condition. And most importantly, the vast majority of these claims have no legitimate medical basis at all, and they contain the diagnosis of doctors who have long since been discredited for their involvement in abusive claims recruitment practices.
We expect a decision by the court on the bar date and proofs of claim in the fourth quarter. We continue to believe that the case will likely take a few years to resolve, but we are also convinced that the ACRP was the right step for GST.
Now I will turn the call over to Bill for his financial review.
Bill Dries
Thanks, Steve. As Steve said, the third quarter was another good one and followed two strong quarters in the first half of the year.
As Don pointed out earlier, the year-to-year comparisons of our reported numbers are significantly impacted by the deconsolidation of GST. To help you understand how the deconsolidation impacted our results, we’ve included a schedule in our press release that presents pro forma results for this year and last year as if the deconsolidation was effective on January 1, 2009.
The schedule will allow you to make apples-to-apples comparisons for each of EnPro and GST so that you can measure the impact of deconsolidation. Looking at our results for the third quarter, reported sales were only 3% higher than in 2009, due to the impact of the deconsolidation.
Consolidated sales in the quarter were $194.5 million, while GST reported an additional $46.1 million of third-party sales. Last year, including GST, third quarter sales were $189.4 million.
Our growth was essentially all organic, since the beneficial impact of acquisitions was negated by a weaker euro. Unit volumes increased across all businesses.
I will talk about individual operations a little later. Reported gross margins were 37.6% this quarter, which was 2.4 percentage points higher than the third quarter of 2009.
GST’s gross margins in the 2010 quarter of over 40% are not reflected in the consolidated margins of 37.6%. Similar to what we’ve experienced all year, we saw strong margin improvements at GGB, FME and the Garlock companies, largely due to positive volume leverage on our fixed costs, particularly at GGB.
SG&A spending of about $56 million in the third quarter increased by 6%, or just over $3 million, compared to 2009. GST had SG&A spending was about $11 million.
The increase in total spending over 2009 was spread across most units and was consistent with the increase in our activity levels. Approximately half of the increased spending was attributable to higher incentive compensation, which is a function of increased accruals in 2010 based on our current outlook compared with decreased accruals last year, based on the outlook at that time.
Now, let’s take a look at our segment results. In the Sealing Products segment, where GST was previously reported, sales declined by 17% as a result of the deconsolidation.
The segment reported $82.5 million in sales, or about $17 million less than last year. Since GST’s third-party sales were $46.1 million in the third quarter of this year, the deconsolidation had a significant effect on the segment’s reported results.
Despite the deconsolidation, segment profits were $15.5 million, about the same as last year, and margins improved by nearly 4 percentage points to 18.8%. GST also reported a strong quarter, with a 23% increase in third-party sales and a 64% increase in segment profits to $8.7 million.
We’ve included a slide in the appendix to our presentation showing GST’s performance in the third quarter compared to its performance last year, when it was consolidated. The Garlock companies benefited from higher activity in most key markets, including oil and gas, power generation, nuclear, aerospace and semiconductor.
Geographically, activity levels in the US were ahead of Europe, as the US has experienced strong order in quota activity throughout the year, largely due to maintenance activities that were deferred in 2009, but that could not be postponed any longer. Stemco saw a big improvement as well.
Sales were up 26%, with increases in its core OEM markets and the aftermarket. OEM sales nearly doubled from last year, and Stemco also benefited from increased brake product sales.
Neither OEM sales or brake products sales are as profitable as aftermarket sales, but even so, Stemco’s margins improved as volumes increased. The improvement in Stemco’s markets is reflected by FTR, a trade group, which has consistently raised its forecast of trailer builds throughout the year, and MacKay, another trade group, which recently reported a double-digit percentage increase in year-over-year revenue miles for the sixth months in a row.
Although we won’t be surprised to see some seasonal softness as year-end approaches, these data points provide encouraging signs for Stemco going forward and as we look towards 2011. In the Engineered Products segment, sales were up 28% and the segment reported a profit compared to a loss last year.
Within the segment, GGB saw dramatic improvements with sales up over 40%, excluding the negative impact of foreign exchange. GGB reported modest profits this year after losing money last year.
European industrial production and North American car and truck production are both up strongly and contributed to the volume increases. At CPI, sales were up over 20%, excluding the negative impact of foreign exchange, with acquisitions accounting for more than half of the increase and organic growth accounting for the balance.
Costs associated with opening new service centers and implementing a new ERP system affected its profitability. Service centers are core to CPI’s growth strategy.
They have opened three new ones this year and are in the process of opening two more. CPI’s core petrochemical markets remain strong, and the units supporting these markets did well.
On the other hand, natural gas prices are low and industrywide inventory levels are high. So the CPI operations that rely on these markets, primarily in Western Canada did not do as well.
In the Engine Products and Services segment, Fairbanks Morse Engine continued to perform well, and in fact, much better than we anticipated at the end of the second quarter. Sales were up 20% from 2009, and the increase was all attributable to strong demand for aftermarket parts and services.
The increase was partly driven by repairs to engines on one class of ships, and produced the second-highest level of aftermarket sales FME has recorded in the eight years then EnPro has been an independent company. Engine sales were flat for 2009, as we only shipped one engine in the third quarter.
Before we move on, I will point out the significant increase in interest expense, from $3.1 million last year to $9.6 million this year. As we have explained previously, the increase is principally the interest owed to GST on $227 million in intercompany notes.
Before the implementation of the ACRP, the interest was eliminated in consolidation. But now, it is reported as interest expense in our financial statements and as interest income in GST’s statements.
Adjusted for the intercompany interest expense and other selected items, our net income in third quarter was $9.6 million. GST’s net income, adjusted for the intercompany interest income, ACRP-related expenses and other selected items, was $5.7 million.
In the third quarter of 2009, when GST was included in our consolidated results, our adjusted net income was $9.5 million. Now looking at cash flow, we generated nearly $65 million of pre-asbestos cash flow from operating activities in the first nine months of 2010, as earnings increased and capital spending decreased.
We spent about $4 million more on asbestos claims and legal fees than we collected from insurance through June 5, when GST initiated the ACRP, but we spent nothing on the claims since then. We also received about $138 million, after tax, from the sale of Quincy Compressor.
We spent about $25.5 million on acquisitions, and $29.5 million of cash was reclassified in connection with GST’s deconsolidation. Capital spending through the first nine months of the year was $14.3 million compared to $16.5 million in the first nine months of 2009.
For the full year of 2010, however, we expect capital spending to be slightly more than the $22 million we spent a year ago. The combination of these factors gave us $135 million of total cash flow in the first nine months of the year and resulted in $212 million of cash on our books at September 30, not including almost $70 million of cash on GST’s books.
We expect GST’s cash balance to continue to grow as it generates cash from operations and continues to collect insurance receivables due for asbestos claims resolved prior to June 5. That concludes my remarks, so I will turn the call back to Steve.
Steve Macadam
Thanks, Bill. We’ve had three strong quarters so far in 2010, and we expect our operations to continue to perform well in the fourth quarter of the year.
Our year-over-year comparisons for the fourth quarter of 2010 versus 2009 will be affected by several factors. The deconsolidation at GST will have a negative effect on our consolidated reported results.
The comparisons of our segment results will be against the quarter in 2009 when the economy was recovering and many of our industrial markets were returning to health. And the sales and profits at Fairbanks Morse were near a record high a year ago.
Our adjusted results last year also benefited from the favorable adjustment of reserves associated with trailing liabilities and from the lower tax rate. While we expect continued strong results across most of our businesses, we anticipate some typical seasonal softness in Stemco’s and GGB’s markets as we get closer to the end of the year.
I’ll also point out that our full-year outlook for Fairbanks Morse hasn’t changed substantially from what we’ve described previously. As I mentioned earlier, we have several attractive acquisition opportunities that are in various stages of review.
The expected tax increase on capital gains at the end of the year appears to be motivating sellers, so we feel fairly confident we will close one or more acquisitions before 2010 is over. The first nine months of 2010 have been rewarding and exciting for us.
We’ve seen a number of positive changes in our markets and in our company, and we expect the trend to continue as we make progress towards our strategic goals. With that, we can open the line to your questions.
Operator
(Operator Instructions) Your first question comes from the line of Ned Borland with Hudson Securities.
Ned Borland – Hudson Securities
Good morning, guys.
Steve Macadam
Hey Ned.
Ned Borland – Hudson Securities
Just a question on CPI here. You mentioned the ERP system and I guess some costs with some service center expansion, could you maybe give us some color on that -- how long are these costs going to be with you and what the magnitude is?
Steve Macadam
The ERP system, we are in the first year of probably a two-year implementation, Ned. So we think that will continue through.
And I’ll let Bill speak to the magnitude here in a second. But we expect that to continue through the end of 2011.
The service center issue, we have a goal within CPI -- this is very important for that business to have a local presence in the major markets around oil refineries and where gas is used, moved, whether it’s extracted from the ground, transmitted, processed in a petrochemical plant or refinery, etc. So we’ve had a pretty aggressive, actually, strategy to open new service centers over the last several years.
So there are two impacts. It takes -- our view is it takes about three years for a service center, once opened, to get kind of fully up to its -- what we would call a good, steady-state revenue level.
So we are carrying a little bit more cost relative to the revenue we are generating for a couple of years. So we have like -- I think we opened three last year.
And so we are only in the second year of those three. We’ve opened three so far this year.
We will open -- we are literally in the process of opening one in China and one in Colombia. Those will be open by the end of the year.
And so going into next year, I think -- I’m not sure exactly how many will be in our plan for next year, but probably another three to four new ones next year, in which case we will be carrying the second year of the ones that we did this year. In total aggregate, I would say that the ERP and the service centers may be $1 million.
Bill Dries
A couple -- $1 million, $2 million.
Steve Macadam
Yeah.
Bill Dries
Somewhere in there. And Ned, the other factor that comes in to play as well, we mentioned during the course of our remarks that particularly the Western Canadian operations have been fairly severely impacted by the weak natural gas prices and high inventory levels, and a couple of those units have actually lost money.
So, that’s weighing on the year-on-year, as well.
Steve Macadam
We are still pretty bullish about Western Canada and gas, really not just longer-term, but even in the medium term. Gas, natural gas is going to have to be a big part of the country’s solution to our energy issues.
And we think that CPI is very, very well-positioned to take advantage of that over the next five years. So that’s really the reason we are so aggressively opening service centers.
Ned Borland – Hudson Securities
Okay. And just a follow-up to that is are there sort of -- I mean is this a good way to think about it -- kind of revenue per service center, I mean, what is your average?
What has it been over the last couple of years of the ones you’ve opened up, as they ramp up to full capacity?
Steve Macadam
That’s really, really tough, because it varies widely, but I would say a general average would be about $3 million a year.
Bill Dries
Three to five.
Steve Macadam
Yeah. Three to five would be a larger --
Bill Dries
What we would expect so that –
Steve Macadam
Yeah.
Ned Borland – Hudson Securities
Okay. And then with Stemco, you mentioned the truck market and you alluded to the adjacent products, brakes being lower margin.
But is there -- is it lower margin because of you are kind of new to this business and you need the volume, or is it just structurally lower?
Steve Macadam
Well, friction is just structurally a little bit lower. It is still pretty decent margins.
And as you will recall, our friction program, we don’t -- we have a partner, a manufacturing partner in Brazil, a company called [Beralign] that makes the friction products for us and imports it and we sell it in the US. So we don’t have a lot of assets, our assets are basically working capital.
And there is just more competitors. It is just more competitive in the braking world.
So, I would say those are the reasons.
Ned Borland – Hudson Securities
Okay. And then in GGB, obviously very strong year-over-year growth.
The comparisons are probably going to get a little more difficult for you. Where -- are there any opportunities perhaps even outside of auto that you are excited about as you head into 2011?
Steve Macadam
Yeah. I mean, GGB has got a lot of exciting markets.
We launched -- we talked about it a year ago -- we launched a new whole product line within that company called -- the technology is called fluid film bearings, which are for higher-speed applications where the shaft literally turns on a thin film of lubricant fluid. And we are starting to get some traction there.
We’ve got a lot -- these are larger bearings, and they are pretty expensive -- pretty good-sized orders, when you get them, the sales cycle is long. So we’ve got a bunch of those in the pipeline and I would love to see some of those happen.
We continue to play in the hydropower business pretty significantly, and we’re excited about those prospects. We’ve got a lot of product development work that we do in GGB as our normal course of business.
And as you know about, that the half of that business, over half that is industrial, what we call industrial is just a wide range of end-use applications, from concrete pumps to gear pumps to scissor lifts and material handling equipment to wind energy, to ski lifts and snowmobiles and furniture -- I mean, just all kinds of -- anything that moves, turns, slides, that kind of things. So the potential addressable market for GGB’s products is huge.
So for us, it is all about application development. It is about commercial excellence and salesforce effectiveness.
And it is a big focus for us. So, I am very, very optimistic about GGB.
That business got hit harder than any of our other businesses in the recession, because 90% of what they do 90% plus, is OEM, because our products typically outlast the system or component or product that they go into. So there is really no significant aftermarket for that.
And as you know, the OEM business globally, in both auto and kind of equipment, just got creamed a year ago, which is why GGB’s top line dropped from first half of 2008 to first half of 2009 over 40%. And then we saw the recovery of that, so it kind of overreacted on the way down and then as the supply chain restocked starting in the second half of last year, it came back.
But the business is healthy. It took us a long time to get cost out in France and Western Europe last year, when things declined.
But the business is healthy, and I am actually very excited about the prospects.
Bill Dries
I would just, again, reinforce something that Steve said earlier in his answer. Auto accounts for well less than half of the sales, so the majority of the sales at GGB come from non-automotive-related areas.
And it is very, very -- as he went through, a very, very diverse group of markets and lots of, again, exciting opportunities.
Steve Macadam
We are growing in China with that business. We have a great team in China.
We’ve got a great team in Brazil. That’s a very, very good business, a strong organization.
We are recognized as the global leaders in solid polymer technology. So it is a really good business.
Ned Borland – Hudson Securities
Okay. That’s all I’ve got.
Great quarter.
Bill Dries
Okay.
Steve Macadam
Thanks, Ned.
Operator
Your next question comes from the line of Todd Vencil with Davenport & Company.
Todd Vencil – Davenport & Company
Thanks, guys. Good morning.
Steve Macadam
Hi, Todd.
Todd Vencil – Davenport & Company
Bill, real quick, just before we get into the details, I want to make sure I am thinking about this right. If -- as you know, we look at this with sort of the reconsolidation of GST, and I guess the way you’ve laid it out, if you make the adjustments that you guys make, that is $9.6 million of after-tax income, which is $0.46 a share.
And then by my math, GST was -- or you guys said it was $5.7 million after tax. By my math, that’s another $0.28 a share.
So if we added those together, that would be $0.72. Am I thinking about that the right way?
Bill Dries
Your calculator is working properly, although I get a slightly higher number when I add those two numbers together. But your calculator is working in the right direction.
Todd Vencil – Davenport & Company
Is there some change in my assumptions that I am making incorrectly that would allow me to get to the correct number that you are seeing?
Bill Dries
Yeah. Well, I’d go back and just redivide.
I think you are a couple of pennies short.
Todd Vencil – Davenport & Company
Okay. Fair enough.
Okay. Let me jump to the segments.
You talked about the strength in the aftermarket and the engine business. I think you said that was due to repairs on one class of ships.
Is that -- was that kind of a largish, one-time event? Is that done now?
How does that look?
Steve Macadam
The way -- this is Steve. The way aftermarket works, as you know, you’ve really got two kind of -- types of demand.
One type is planned maintenance items. A ship will come into port or a rebuild will happen in an engine that is on an industrial application.
And those, we have some visibility into those. As you know, it’s long lead time, parts and we will help customers prepare for big outages, overhauls or those kinds of things.
And then you have ones where something happens. These engines are in use a lot, right?
So sometimes you have unexpected issues that pop up in or around them. And when that happens, kind of by definition, it is unexpected for that particular situation.
But there is always some diet of unexpected things that happen. So it just so happened in the third quarter.
It was a pretty large one of the latter flavor. So there will be more, but that was particularly large.
Todd Vencil – Davenport & Company
Got it.
Bill Dries
Tough, but you can’t predict them.
Todd Vencil – Davenport & Company
All right. And you said, Steve, you said that your full-year outlook really hasn’t changed.
Can you just sort of restate that again so I can make sure that I remember that correct for the engine business?
Steve Macadam
Yeah. We think it is going to be about the same as it was a year ago.
Todd Vencil – Davenport & Company
And that is on a profit basis?
Steve Macadam
A bit both sales and profit. It will be a little bit more profitable, but the sales will be about the same.
Just because last year it was more -- the mix was more new engines than aftermarket. So we shipped, what, two more engines last year than we will ship this year?
Yeah, so the sales are going to be about the same. And then if you just mix adjusted aftermarket to new, so the profitability -- so our margin will be up a few points year-over-year, driven by that mix shift.
Todd Vencil – Davenport & Company
Got it. And then Garlock, you said you felt like a lot of that was driven by postponed maintenance from last year.
Steve Macadam
Yeah.
Todd Vencil – Davenport & Company
Does that imply at all that there was sort of some pent-up demand that maybe now is satisfied and not going to be drilled at the same ways?
Steve Macadam
That is a good point. But what it is really creating is really extended outage activity into the fourth quarter.
Usually, we see it pretty much wind up through the end of the third quarter. And we’ve actually seen it continue, at least thus far, in Q4 as well.
So I think what happened is there’s just a lot more outage activity that has to get done. So at some point, that will be caught up.
That’s correct.
Todd Vencil – Davenport & Company
Okay. So, but at least a fourth quarter event?
Steve Macadam
Yeah.
Todd Vencil – Davenport & Company
Okay. You talked about seasonality Q3 to Q4.
And I think you said normal seasonality in Stemco and GGB. I want to make sure that you’re not pointing to something more than normal seasonal declines in activity.
Steve Macadam
No. Absolutely not and in fact, Bill is going to kick me for saying this, but Stemco’s October was actually pretty good.
So we are still expecting -- I don’t want to mislead you. We are still expecting it will be slower in November and December.
It always is. But October was a little bit healthier than we had originally anticipated.
Bill Dries
2009, Todd, was somewhat of an aberration, obviously, with the economic woes that we experienced, things started to come together in the fourth quarter last year. So it ended up being our best quarter last year, but that is very atypical.
The normal pattern is for the fourth quarter is generally our weakest.
Todd Vencil – Davenport & Company
Got it. And then I guess final sort of category for me, you talked about maybe $1 million to $2 million of costs in Engineered Products from the ERP and from -- right from the new service centers.
Was that an annual number or a quarterly number?
Bill Dries
That’s an annual number.
Todd Vencil – Davenport & Company
Okay. And that one -- all the segments really -- or the other two segments look really great and obviously, I think, you beat the Street on the numbers.
But the margins were definitely lower than we were looking for in Engineered Products. How should we be thinking about -- if you wanted to look at the second quarter, which was a higher margin than the third quarter, is that between -- the second and third quarter, is that kind of the range of margins you would expect out of that business going forward?
Or which one should be looked at as being anomalous, if either one?
Bill Dries
And again, I think that we said before there are a number of issues that have impacted that segment. GGB is recovering from a deep hole last year.
They are not back to where -- their activity levels are not back to where they had been historically. And so as we continue to -- our volumes continue to grow, we will continue to leverage our volumes, our fixed costs.
I think, as Steve said, we’ve made a number of -- and continue to make a number of expenditures at CPI that will benefit us in the future. They are growth-oriented.
Not only the ERP and the service centers, but in fact, we made -- another factor that came into the play in terms of their margins this quarter. We made -- we’ve been fairly active in the acquisition front and we structured a couple of these transactions to give us a -- from a tax perspective, to give us a benefit, which resulted in the accelerated write-off of some of the intangibles.
But there will be real cash tax benefits to us and so we purposely made that decision to get that benefit. So there are a number of factors that have come into play, all of which, quite frankly, are pretty positive for the long-term health and trends of the business.
So we would expect to see those margins continue to improve.
Todd Vencil – Davenport & Company
Perfect. By the way, Bill, I think I misspoke before.
I think I was looking at the wrong piece of paper. That walk on the reconsolidation gets me to $0.74.
I think I said $0.72 before, so…
Bill Dries
There you go.
Steve Macadam
There you go. Calculator works, Todd.
Todd Vencil – Davenport & Company
The calculator works great, it’s me that’s not working so well. So thanks a lot.
Steve Macadam
That’s your calculation, not ours. We just want to be clear on that.
Operator
(Operator Instructions) Your next question comes from line of Joe Mondillo, Sidoti & Company.
Joe Mondillo – Sidoti & Company
Good morning, guys.
Steve Macadam
Hey, Joe.
Joe Mondillo – Sidoti & Company
First question, I just wanted to talk a little bit more on CPI. I was wondering if you could just give a little more color in terms of what kind of factors you are looking at, Steve, that’s going to, get this business going.
Is it gas prices rising, or what are you seeing that is sort of going to drive that business going forward?
Steve Macadam
Well, one, it is the use and consumption of gas for energy. As you know, if you follow the gas and energy business industry at all, the country has really gone through -- is in the middle, quite frankly, has gone through a pretty significant transformation around that.
That oil to gas ratio is extremely gas favorable, has been for some time. And we’ve found reserves, as horizontal drilling technology has really allowed us to tap into shale formations and get the gas out of shale rock.
Many of the petrochemical companies and plastics producers and so forth are considering and in fact planning expanded capacity in the U.S. where as recently as six, seven, eight years ago, that was not contemplated at all.
There were many chemical industry experts that said you will never see another new or expanded petrochemical facility in North America, because we were so disadvantaged on natural gas. Literally, the natural gas we were -- in the U.S.
was at the top end of the cost curve. And because of the horizontal drilling technology and the shale discoveries and the ability to get the gas out of shale rock, we are now very competitive globally with gas.
And so what that means is gas is and will be in the future a lot more attractive in this country for the petrochemical producers as well as energy generation. And it is clean and it is available and it is domestic.
So obviously, you don’t just snap your fingers and start pulling it out of the ground. It takes a lot of drilling infrastructure, transportation infrastructure, etc.
And so our game plan as we have grown CPI really into a global -- really global powerhouse in this industry, is to continue to open service centers, both in the U.S. in those markets in Western Canada and in other regions of the world where gas will continue to become a more and more important feedstock for petrochemicals, as well as a carbon source for energy.
So that has been our game plan. So we identify those areas where we can do an acquisition.
We do an acquisition and integrate it. Typically, the owner, operator of those facilities comes to work for us.
And if we can’t find an acquisition in one of those markets, we will open a new service center. And so I would say there is a limit to how many of those there will be, because once you are in a number of geographies, you are kind of done.
But we’ve been doing this now certainly since I’ve been here, so -- and our diet will be to continue to open three to five new ones a year. And I see that happening for another few years until we feel -- and either open new or acquire, some combination of that -- until we are kind of fully penetrated into the market So that is our growth plan.
In addition to that, we are trying to expand our product line, which is why we bought the two lubrication -- we did the lubrication product and system companies in the last quarter. Those products are used and sold directly to the same customers and are installed on the same equipment that our rings and sealing products and valves are sold to.
And the interaction and interface, technically, between the lubrication system and the products that we put on the compressor are critical for both of them working and functioning as effectively as they can for the customer. And so it is a very, very natural fit and bolt-on, because the two really have to be optimized together as one system.
So that is why we did it. So it is a geographic expansion.
It is a product line expansion. And we think that gas, even if it is -- it probably will go up in price over time as demand increases, but we’re in a different game today domestically than we were even 10 years ago because of this technology shift.
Joe Mondillo – Sidoti & Company
All right.
Steve Macadam
Does that help, Joe?
Joe Mondillo – Sidoti & Company
Yeah. That was very informative.
Thank you. I’d just follow up there, I was just wondering it is primarily OE-related then, right?
Steve Macadam
No. It is primarily aftermarket-related, because these parts wear out on compressors.
So that business is probably 80% aftermarket and 20% OE, where we actually sell it to compressor manufacturers, usually because it is demanded by the end user who likes our materials or our products, our technology and says to the OE, don’t put yours on, put CPI’s on. But that is 20% of our sales.
80% of it is aftermarket replacement, because all this stuff wears out because they are literally wear parts.
Joe Mondillo – Sidoti & Company
Okay. Just to switch gears, I guess looking at the Fairbanks Morse, I’m wondering if you could give your opinion on why the aftermarket was so strong in the quarter.
Obviously, you pointed out to that one -- those ships that were demanding that. But is there -- what is the absolute value of your aftermarket sales in that segment look like trending over the last several quarters?
What I’m getting at is, is there a trend where these ships are getting to a point where they are all coming together and they need aftermarket and you are continually seeing stronger sales in that side of the business?
Steve Macadam
Bill, what do you think?
Bill Dries
I think that -- we’ve done a lot of work over the course of the last few years in terms of trying to beef up and grow the aftermarket side of the business. For a long time, they looked and focused primarily on just the engines that they had out in service.
And so we’ve been, I think, a lot more aggressive in terms of trying to move beyond and service engines other than our own. I think there have been some blips this year.
We mentioned the one class of ship that is having some issues, the oil contamination issues, that are driving a little extra part sales this year. But as I look -- as we look at this year, we are probably running 10% to 15% higher on the aftermarket side than the typical year.
Some of which relating are discrete, but some of which we hope is a reflection of the fact that we’ve been more aggressive and we will continue to be more aggressive on the parts side.
Joe Mondillo – Sidoti & Company
So that is about 60%, 65% aftermarket this year? Is that?
Bill Dries
It is roughly in that neighborhood.
Steve Macadam
And Joe, it is one of the key focuses of that business. So it is certainly one of their top two sales priorities, the other of which is penetrating the resurgence of nuclear power plants, because as you know, these engines are also sold as backup power generation for nuclear power plants.
And as we see those -- that is a market that we are aggressively going after. And then obviously, we want to maintain our position and share with the U.S.
Navy.
Joe Mondillo – Sidoti & Company
All right. How much was the aftermarket in the third quarter in that segment?
Bill Dries
It was the bulk of the sales in the quarter. We only shipped one engine and engines generally run in the kind of $4 million to $5 million range.
So most of the sales in the quarter were aftermarket.
Joe Mondillo – Sidoti & Company
Okay. And how many engines are you planning on shipping in the fourth quarter?
Did you say that?
Bill Dries
We didn’t say it. We generally don’t forecast, but it is going to be roughly comparable to the first quarter or to the third quarter, I’m sorry.
Joe Mondillo – Sidoti & Company
Okay. And then I guess just looking at GDB, I know that business was hit pretty hard in the downturn, profitability, I believe was unprofitable at one point, I think.
You can clear that up if I was wrong there. But how was the profitability looking at that business and I guess looking forward?
Steve Macadam
We’re still not happy with it. Yeah, when we were at the depths of the recession, the first half of last year, we were losing significant money in that business every quarter, because demand dropped almost half.
And as we’ve said before, our cost base was centered in Western Europe, primarily in France. And you don’t just -- you are not allowed legally to lay people off in that country.
A lot of people in the U.S. who don’t do business in Europe don’t fully understand that.
So it takes a long time to negotiate with the government and put social plans in place to be able to downsize the workforce, even when they have nothing to do. So we didn’t start seeing the labor leave our French operations until really the August timeframe of 2009.
And that is when we were able to stem the bleeding and get the costs in line. And then we also started to see in the second half of last year the recovery start and we started to get a little bit more volume.
And then we were able to return to profitability again. We are certainly not happy with the margins that we are seeing in GGB now, because their volume is still, while a lot better than it was a year ago, is still far from what it was before.
And I would say still not robust. So we still -- as everyone on the call knows we still have a long way to go in this recovery globally.
So that’s not a comment about what the pace will be, but just in terms of long-term growth, we’ve got a long way to go in GGB to get it back to where it was. So we’ve done a good job on the cost side.
We are doing a better and better job penetrating new markets and new applications. And so I would expect those margins to continue to trend up going forward from where we are today, almost certainly.
You want to add anything, Bill?
Bill Dries
No. No.
I think you summarized it well. I agree.
Joe Mondillo – Sidoti & Company
Are there any further initiatives that you can take on the cost side, or is it more just a factor of demand and volume coming back?
Steve Macadam
In GGB, it is more a factor of demand and volume coming back and us gaining share and penetrating with new products and new applications and that kind of thing.
Joe Mondillo – Sidoti & Company
Okay. How about raw material prices?
Is that significantly affecting you anywhere in any of your businesses? And if so, how does the pricing environment look?
Can you increase prices or anything like that?
Steve Macadam
Well, first of all, commodity prices are increasing, depending on what commodity you are talking about, at a pretty significant clip. Copper is up 11% year-to-date.
Tin is up over 60% year to date. Steels are up a few percentage points.
Aluminum is up. Nickel is up.
So yeah, these are all raw materials that are coming in. We do not have an environment where we cannot pass on price increases.
We do that, because we have to. And in some cases, when the commodities are going up like that, it creates an environment where the competition does that, too and it is kind of expected.
So I don’t have any huge concerns about us being able to maintain our gross margin levels as a result of commodity price increases. The other input costs are not going up like the commodities.
They are more. I would say inflation, which is very low based kind of things.
So it is really just the commodity inputs that are a challenge. So much of it is being consumed in China and I think we are going to continue to see that.
Joe Mondillo – Sidoti & Company
Okay. And then just last question, just has to do with the court case on the asbestos.
I was wondering in terms of that bar date that you mentioned, what are the chances that you get an unfavorable decision of that in the fourth quarter? And then, granted you get the decision that you’re hoping for, how long does that period before we start going through the claims last?
Steve Macadam
We are confident that the judge will set a bar date. But we don’t really have a view of how long -- what that date will be, whether it will be six months or nine months or 12 -- can’t imagine it would be more than 12 months.
And that bar date will require that a proof of claim be filed by the claimants and once those claims start to be filed, we will be going through the synthesis of them and analyzing them and make motions to disallow some of those categories that I went through.
Joe Mondillo – Sidoti & Company
Okay. Great.
Thanks a lot, guys.
Steve Macadam
Yeah.
Operator
Your next question comes from the line of Steve Wortman with Lord Abbett.
Steve Wortman – Lord Abbett
Good morning.
Steve Macadam
Hey, Steve.
Steve Wortman – Lord Abbett
How much better was the aftermarket engines business in Q3 than you thought? Because you had indicated that your full-year expectations hadn’t changed.
So I was just curious how much was pulled forward, if you even know.
Bill Dries
We were probably $5 million, $6 million more than we had anticipated on the aftermarket side.
Steve Wortman – Lord Abbett
Okay. And second, was the -- did you guys expect to just ship one engine?
Was that within your expectations?
Steve Macadam
Yeah. Well, it was the expectation going into the quarter.
Steve Wortman – Lord Abbett
Right.
Steve Wortman
Because as we said in the last call, what happened to us is we had them planned out for the year and we actually moved a few engines -- pulled him forward and shipped them in Q2. They were originally programmed in for Q3.
But this is a customer-controlled thing, not an FME-controlled process.
Steve Wortman – Lord Abbett
Sure. So how many engines have you shipped year-to-date, if you can remind me?
Bill Dries
I think it’s 11.
Steve Wortman – Lord Abbett
Eleven. And just directionally, so you are talking one in Q4.
I mean, directionally, should we expect much change next year?
Bill Dries
We generally -- I mean, our engine shipments move a lot from quarter-to-quarter obviously, but we generally are in kind of the 15 plus or minus range on an annual basis. Some years will be higher or lower.
It just depends on the Navy’s schedule. I wouldn’t -- so we were at 14 or 15 last year.
We will be 12 this year. At this point, I think directionally it may be about the same.
But again, a lot of it is just out of our control.
Steve Wortman – Lord Abbett
So the big swing factor for profitability there next year is the aftermarket?
Bill Dries
Yeah. The aftermarket is where -- I mean, yeah, the engine business is a profitable business, as opposed to historically it has been a breakeven business.
We are actually making decent margins on our engines now. But the aftermarket side of the business is where we continue to make the most of our money.
Steve Wortman – Lord Abbett
But you had indicated it’s running 10% to 15% higher than typical. So is there any way for you to gauge what your internal execution or trying to expand the business is providing?
Is there any way that you guys are tracking that?
Steve Macadam
Yeah. Steve, look, it is our expectation that we are going to continue to grow sales into the aftermarket business year-over-year.
Bill is saying it was higher than it had typically been in the past, but a lot of that is because of our efforts to grow share and penetrate more customers and have better leadtimes and everything else. So we certainly are working hard to try to make our aftermarket sales and FME bigger every year.
Steve Wortman – Lord Abbett
Okay. Thanks a lot.
Bill Dries
As Steve said, it is a number two right after the nuclear side. It is very much of a focus for that business.
Steve Wortman – Lord Abbett
All right. Guys.
Thank you.
Steve Macadam
Yeah.
Operator
Your next question comes from the line of Gary Farber with C.L. King.
Gary Farber – C.L. King
Yeah. Good morning.
Just a couple of questions. The SG&A number in the quarter, is that sort of the going forward run rate you would say?
Steve Macadam
Hey, Gary, good morning. By the way, this is going to have to be our last question.
So you asked whether SG&A was at its current -- the same run rate?
Bill Dries
Yeah. I think it is probably a little higher than what its run rate will be, primarily because -- we said during the call that it is -- about half of the year-on-year change is attributable to just the timing on the incentive compensation.
Again, that is something you estimate during the course of the year and you update those estimates as the year goes on, depending on what the current outlook is. And we did the same thing a year ago.
So it was kind of an aberration in terms of the size of the impact on a year-to-year basis. But we would to expect to kind of annualize the run rate to be a little lower than that.
Gary Farber – C.L. King
Okay. And on the gross margins, given you had the aftermarket benefit in this quarter and the prior quarter, I think you were less, would you expect -- you can have the seasonal effect in Q4.
Would you expect sort of gross margins to sort of come in somewhere between Q2 and Q3 in Q4?
Bill Dries
Yeah. I mean, it is a -- we’ve been running pretty consistently in the kind of highish mid 30s.
And I would expect -- I don’t expect Q4 to be markedly different from what we’ve been experiencing. I don’t think it will -- we won’t hit the Q3 level.
Gary Farber – C.L. King
Right.
Bill Dries
But I think, yeah, somewhere between Q2 and Q3 is probably a pretty good estimate.
Gary Farber – C.L. King
Okay. And then just two last ones.
DNA -- normalized D&A for the company would be running about $38 million?
Bill Dries
36, 37ish.
Gary Farber – C.L. King
Okay.
Bill Dries
Actually, we did about -- we had about $9 million in Q3 and I think that, on an annualized, 36, 37, something like that.
Gary Farber – C.L. King
Right. And then just lastly, on the cash balances you had, all that cash -- well, how much of that -- most of that cash is domiciled in the U.S.
or elsewhere?
Bill Dries
Most of it is domiciled in the U.S.
Gary Farber – C.L. King
Okay. All right.
Thanks.
Don Washington
All right? Okay.
Thanks, everyone. That has to conclude our call for today.
I know that others of you may have questions and please feel free to call me at 704-731-1527 later on in the day. I will be around all day and be happy to take your calls.
We appreciate you all being with us this morning. It has been a long and hopefully informative call.
So thanks again and we will talk to you next quarter, if not before.
Operator
This concludes today’s conference call. You may now disconnect.