SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | Quarterly report pursuant to Section 13 or 15(d) of the securities exchange act of 1934 |
For the quarterly period ended September 30, 2005
o | Transition report pursuant to section 13 or 15(d) of the securities exchange act of 1934 [no fee required] |
Commission File Number 001-31225
ENPRO INDUSTRIES, INC.
(Exact name of registrant, as specified in its charter)
North Carolina | 01-0573945 | |
(State or other jurisdiction of incorporation) | (I.R.S. Employer Identification No.) | |
5605 Carnegie Boulevard, Suite 500, Charlotte, North Carolina (Address of principal executive offices) | 28209 (Zip Code) |
(704) 731-1500
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yesþ Noo
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
As of November 1, 2005, there were 21,248,921 shares of common stock of the registrant outstanding. There is only one class of common stock.
PART I
FINANCIAL INFORMATION
FINANCIAL INFORMATION
Item 1. Financial Statements
ENPRO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Quarters and Nine Months Ended September 30, 2005 and 2004
(In millions, except per share amounts)
Quarters and Nine Months Ended September 30, 2005 and 2004
(In millions, except per share amounts)
Quarters Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Sales | $ | 199.6 | $ | 192.1 | $ | 631.5 | $ | 622.2 | ||||||||
Operating costs and expenses: | ||||||||||||||||
Cost of sales | 133.7 | 138.9 | 422.7 | 430.8 | ||||||||||||
Selling, general and administrative expenses | 44.4 | 44.6 | 141.1 | 138.9 | ||||||||||||
Asbestos-related expenses | 6.5 | 2.8 | 13.3 | 6.8 | ||||||||||||
Restructuring and other costs | 0.1 | 1.6 | 0.4 | 4.7 | ||||||||||||
Loss on sale of assets, net | — | — | — | 1.8 | ||||||||||||
184.7 | 187.9 | 577.5 | 583.0 | |||||||||||||
Operating income | 14.9 | 4.2 | 54.0 | 39.2 | ||||||||||||
Interest expense | (2.3 | ) | (2.3 | ) | (6.8 | ) | (6.9 | ) | ||||||||
Interest income | 0.6 | 0.6 | 2.1 | 1.4 | ||||||||||||
Other income | 2.4 | 11.2 | 14.9 | 11.0 | ||||||||||||
Income before income taxes | 15.6 | 13.7 | 64.2 | 44.7 | ||||||||||||
Income tax expense | (5.6 | ) | (3.6 | ) | (23.1 | ) | (14.8 | ) | ||||||||
Net income | $ | 10.0 | $ | 10.1 | $ | 41.1 | $ | 29.9 | ||||||||
Basic earnings per share | $ | 0.48 | $ | 0.49 | $ | 1.99 | $ | 1.46 | ||||||||
Diluted earnings per share | $ | 0.47 | $ | 0.47 | $ | 1.93 | $ | 1.41 | ||||||||
See notes to consolidated financial statements (unaudited).
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ENPRO INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30, 2005 and 2004
(In millions)
Nine Months Ended September 30, 2005 and 2004
(In millions)
2005 | 2004 | |||||||
OPERATING ACTIVITIES | ||||||||
Net income | $ | 41.1 | $ | 29.9 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation | 17.9 | 17.8 | ||||||
Amortization | 5.4 | 5.8 | ||||||
Deferred income taxes | 13.2 | 5.1 | ||||||
Loss on sale of assets, net | — | 1.8 | ||||||
Payments for asbestos-related claims, net of insurance proceeds | (16.7 | ) | (16.5 | ) | ||||
Change in assets and liabilities, net of effects of divestitures of businesses: | ||||||||
Receivables | (9.9 | ) | (16.3 | ) | ||||
Inventories | (10.5 | ) | (5.7 | ) | ||||
Accounts payable | (4.2 | ) | 3.2 | |||||
Other current assets and liabilities | (5.3 | ) | (3.3 | ) | ||||
Other non-current assets and liabilities | (0.9 | ) | 11.4 | |||||
Net cash provided by operating activities | 30.1 | 33.2 | ||||||
INVESTING ACTIVITIES | ||||||||
Purchases of property, plant and equipment | (19.0 | ) | (23.7 | ) | ||||
Proceeds from sales of assets | 0.3 | 9.6 | ||||||
Receipt (payment) in connection with acquisitions of businesses | (1.6 | ) | 0.3 | |||||
Net cash used in investing activities | (20.3 | ) | (13.8 | ) | ||||
FINANCING ACTIVITIES | ||||||||
Repayments of debt | (0.1 | ) | (5.4 | ) | ||||
Proceeds from issuance of common stock | 0.9 | 1.4 | ||||||
Receipt from (deposits into) restricted cash accounts | (41.7 | ) | 0.5 | |||||
Other | 1.3 | — | ||||||
Net cash used in financing activities | (39.6 | ) | (3.5 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (1.4 | ) | (0.6 | ) | ||||
Net increase (decrease) in cash and cash equivalents | (31.2 | ) | 15.3 | |||||
Cash and cash equivalents at beginning of year | 108.0 | 94.7 | ||||||
Cash and cash equivalents at end of period | $ | 76.8 | $ | 110.0 | ||||
See notes to consolidated financial statements (unaudited).
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ENPRO INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In millions, except share amounts)
(In millions, except share amounts)
September 30, | December 31, | |||||||
2005 | 2004* | |||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents (unrestricted) | $ | 76.8 | $ | 108.0 | ||||
Accounts and notes receivable | 121.0 | 115.8 | ||||||
Asbestos insurance receivable | 105.3 | 109.9 | ||||||
Inventories | 67.2 | 58.6 | ||||||
Other current assets | 34.1 | 31.3 | ||||||
Total current assets | 404.4 | 423.6 | ||||||
Property, plant and equipment | 142.9 | 146.7 | ||||||
Goodwill | 126.6 | 125.7 | ||||||
Intangible assets | 63.3 | 67.3 | ||||||
Asbestos insurance receivable | 384.3 | 336.2 | ||||||
Restricted cash | 45.1 | 3.4 | ||||||
Other assets | 71.9 | 78.1 | ||||||
Total assets | $ | 1,238.5 | $ | 1,181.0 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities | ||||||||
Current maturities of long-term debt | $ | 0.1 | $ | 0.2 | ||||
Accounts payable | 49.1 | 55.5 | ||||||
Asbestos liability | 83.3 | 74.0 | ||||||
Other accrued expenses | 69.7 | 60.5 | ||||||
Total current liabilities | 202.2 | 190.2 | ||||||
Long-term debt | 164.6 | 164.6 | ||||||
Deferred income taxes | 43.2 | 41.0 | ||||||
Retained liabilities of previously owned businesses | 34.6 | 44.9 | ||||||
Environmental liabilities | 31.0 | 32.2 | ||||||
Asbestos liability | 176.9 | 159.4 | ||||||
Other liabilities | 71.3 | 72.2 | ||||||
Total liabilities | 723.8 | 704.5 | ||||||
Shareholders’ equity Common stock — $.01 par value; 100,000,000 shares authorized; issued, 20,997,517 shares in 2005 and 20,811,798 shares in 2004 | 0.2 | 0.2 | ||||||
Additional paid-in capital | 415.8 | 411.6 | ||||||
Retained earnings | 100.4 | 59.3 | ||||||
Accumulated other comprehensive income (loss) | (0.1 | ) | 7.0 | |||||
Common stock held in treasury, at cost – 237,305 shares in 2005 and 240,655 shares in 2004 | (1.6 | ) | (1.6 | ) | ||||
Total shareholders’ equity | 514.7 | 476.5 | ||||||
Total liabilities and shareholders’ equity | $ | 1,238.5 | $ | 1,181.0 | ||||
* | The year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. |
See notes to consolidated financial statements (unaudited).
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ENPRO INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Overview, Basis of Presentation and Recent Accounting Pronouncement
Overview
EnPro Industries, Inc. (“EnPro” or the “Company”) is a leader in the design, development, manufacturing and marketing of well recognized, proprietary engineered industrial products that include sealing products, heavy-duty wheel end components, metal polymer and composite bearings, air compressors, and heavy-duty, medium speed diesel and natural gas engines. The Company was incorporated on January 11, 2002, as a wholly-owned subsidiary of the Goodrich Corporation (“Goodrich”) in connection with Goodrich’s distribution of its Engineered Industrial Products segment to existing Goodrich shareholders. This distribution took place on May 31, 2002.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair statement of results for the period presented, have been included. Management believes that the assumptions underlying the consolidated financial statements are reasonable. These interim financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto that are included in its annual report on Form 10-K for the year ended December 31, 2004.
Revenues, expenses, cash flows, assets and liabilities can and do vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for a full year.
All significant transactions between the Company’s operations have been eliminated.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Recent Accounting Pronouncement
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). The statement requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements and that cost be measured based on the fair value of the equity or liability instruments issued. SFAS 123R replaces Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”
The Company adopted the provisions of SFAS 123R as of January 1, 2005 using a modified prospective application. Under a modified prospective application, SFAS 123R applies to new awards and to any awards that are outstanding on the effective date which are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been
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rendered as of the adoption date will be recognized over the remaining service period using the compensation cost previously calculated for pro forma disclosure purposes under SFAS 123.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). Under FIN 47, the fair value of a liability for a conditional asset retirement obligation should be recognized when incurred. This Interpretation also clarifies when an entity would have sufficient information to reasonably estimate the obligation. This guidance is effective no later than the end of fiscal years ending after December 15, 2005. The Company does not anticipate that the adoption of this statement will have a significant impact on its results.
2. Other Income
In conjunction with the closure of a plant in the early 1980s, Coltec Industries Inc (“Coltec”), which is now a wholly owned subsidiary of the Company, was required to fund two trusts for retiree medical benefits for union employees at the plant. The first trust (the “Benefits Trust”) pays for these retiree medical benefits on an ongoing basis. Coltec has no ownership interest in the Benefits Trust, and thus the assets and liabilities of this trust are not included in the Company’s consolidated balance sheets.
Because of the possibility that Coltec would be required to make contributions to the Benefits Trust, Coltec was required to establish a second trust (the “Back-Up Trust”) to cover potential shortfalls in the Benefits Trust. Under the terms of the Benefits Trust agreement, the trustees are required to retain an actuary to assess the adequacy of the assets in the Benefits Trust in 1995, 2005 and 2015. Based on the valuation completed in 2005, the actuary determined that there were adequate assets in the Benefits Trust to fund the estimated payments by the trust until the next valuation date. As a result, $11 million of assets held in the Back-Up Trust were released to Coltec during the second quarter of 2005. This amount was based on a distribution formula described in the Benefits Trust agreement and was recorded in income upon receipt. This topic is discussed further in Note 10, “Commitments and Contingencies” – Crucible Materials Corporation.
During the quarter ended September 30, 2004, the Company received and recognized as other income approximately $10 million from one of its insurers to settle the Company’s claims for (1) reimbursement of past costs relating to certain environmental matters including fees incurred in pursuing the claim, and (2) estimated future claims for which the Company had previously booked reserves. Additionally, the Company recorded a $0.8 million reserve adjustment during the quarter ended June 30, 2004 based on a favorable legal settlement related to a previously divested business.
The Company owns call options on Goodrich Corporation common stock to provide protection against the risk that the cash required to finance conversion of Coltec’s 51/4% Convertible Preferred Securities – Term Income Deferred Equity Securities (“TIDES”) into Goodrich common stock could exceed the liquidation value of the TIDES. The call options are derivative instruments and are carried at fair value in the Company’s consolidated balance sheets. Changes in fair value are reflected in income. During the quarter and nine months ended September 30, 2005, the Company recorded a $2.4 million and $3.9 million increase, respectively, in the fair value of these call options. During the quarter and nine months ended September 30, 2004, the Company recorded a $1.2 million and $0.2 million increase, respectively, in the fair value of these call options.
3. Comprehensive Income
Total comprehensive income consisted of the following:
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Quarters | Nine Months | |||||||||||||||
Ended | Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in millions) | ||||||||||||||||
Net income | $ | 10.0 | $ | 10.1 | $ | 41.1 | $ | 29.9 | ||||||||
Unrealized translation adjustments | 0.4 | 0.9 | (7.1 | ) | (2.5 | ) | ||||||||||
Changes in minimum pension liability | — | — | 0.6 | — | ||||||||||||
Net unrealized gains (losses) from cash flow hedges | (0.2 | ) | (0.2 | ) | (0.6 | ) | 1.1 | |||||||||
Total comprehensive income | $ | 10.2 | $ | 10.8 | $ | 34.0 | $ | 28.5 | ||||||||
4. Earnings Per Share
The computation of basic and diluted earnings per share is as follows:
Quarters Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in millions, except per share amounts) | ||||||||||||||||
Numerator (basic and diluted): | ||||||||||||||||
Net income | $ | 10.0 | $ | 10.1 | $ | 41.1 | $ | 29.9 | ||||||||
Denominator: | ||||||||||||||||
Weighted-average shares — basic | 20.7 | 20.5 | 20.7 | 20.5 | ||||||||||||
Employee stock options | 0.6 | 0.7 | 0.6 | 0.6 | ||||||||||||
Weighted-average shares — diluted | 21.3 | 21.2 | 21.3 | 21.1 | ||||||||||||
Earnings per share: | ||||||||||||||||
Basic | $ | 0.48 | $ | 0.49 | $ | 1.99 | $ | 1.46 | ||||||||
Diluted | $ | 0.47 | $ | 0.47 | $ | 1.93 | $ | 1.41 | ||||||||
5. Stock-Based Compensation
Prior to 2005, the Company accounted for stock-based compensation plans using the intrinsic value method. Required pro forma information regarding net income and earnings per share for 2004 has been determined as if the Company had accounted for its employee stock-based compensation plans under the fair value method. As a result of adopting SFAS 123R, the Company recognized $1.9 million of share-based expense during the nine months ended September 30, 2005. The Company would have recognized $2.7 million during the same period had SFAS 123R not been adopted.
For purposes of the required pro forma disclosures, the estimated fair value of the stock options has been amortized to expense over the vesting period of the options. The Company’s pro forma information for the quarter and nine months ended September 30, 2004, is as follows:
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Quarter Ended | Nine Months | |||||||
Ended | Ended | |||||||
September 30, | September 30, | |||||||
2004 | 2004 | |||||||
(in millions, except per share amounts) | ||||||||
Net income: | ||||||||
As reported | $ | 10.1 | $ | 29.9 | ||||
Add: stock-based employee compensation expense included in reported net income, net of tax | 0.3 | 0.7 | ||||||
Deduct: stock-based employee compensation expense determined under fair value method, net of tax | (0.4 | ) | (1.1 | ) | ||||
Pro forma | $ | 10.0 | $ | 29.5 | ||||
Basic earnings per share: | ||||||||
As reported | $ | 0.49 | $ | 1.46 | ||||
Pro forma | $ | 0.49 | $ | 1.44 | ||||
Diluted earnings per share: | ||||||||
As reported | $ | 0.47 | $ | 1.41 | ||||
Pro forma | $ | 0.47 | $ | 1.40 | ||||
6. Inventories
Inventories consisted of the following:
As of | As of | |||||||
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
(in millions) | ||||||||
Finished products | $ | 34.9 | $ | 37.4 | ||||
Costs relating to long-term contracts and programs | 30.8 | 28.2 | ||||||
Work in process | 17.8 | 14.5 | ||||||
Raw materials and supplies | 23.5 | 20.0 | ||||||
107.0 | 100.1 | |||||||
Reserve to reduce certain inventories to LIFO basis | (14.7 | ) | (14.1 | ) | ||||
Progress payments | (25.1 | ) | (27.4 | ) | ||||
Total | $ | 67.2 | $ | 58.6 | ||||
7. Intangible Assets
The gross carrying amount and accumulated amortization of identifiable intangible assets is as follows:
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As of September 30, 2005 | As of December 31, 2004 | |||||||||||||||
Gross | ||||||||||||||||
Carrying | Accumulated | Gross | Accumulated | |||||||||||||
Amount | Amortization | Carrying Amount | Amortization | |||||||||||||
(in millions) | ||||||||||||||||
Customer relationships | $ | 32.7 | $ | 11.6 | $ | 32.7 | $ | 9.3 | ||||||||
Existing technology | 16.5 | 2.2 | 16.5 | 1.8 | ||||||||||||
Trademarks | 24.5 | 2.8 | 24.5 | 2.5 | ||||||||||||
Other | 10.7 | 4.5 | 10.6 | 3.4 | ||||||||||||
$ | 84.4 | $ | 21.1 | $ | 84.3 | $ | 17.0 | |||||||||
The Company has trademarks with indefinite lives valued at approximately $16 million that are not being amortized as of September 30, 2005 and December 31, 2004, and that are included in the table above.
Amortization expense for the nine months ended September 30, 2005 and 2004 was $4.1 million and $4.1 million, respectively. Amortization expense for these intangible assets for 2005 through 2009 is estimated to be approximately $5 million per year.
8. Business Segment Information
The Company has three reportable segments. The Sealing Products segment manufactures sealing products, heavy-duty wheel end components, polytetrafluoroethylene (“PTFE”) products, and industrial rubber products. The Engineered Products segment manufactures metal polymer and composite bearings, air compressor systems and vacuum pumps, and reciprocating compressor components. The Engine Products and Services segment manufactures and services heavy-duty, medium-speed diesel and natural gas engines. The Company’s reportable segments are managed separately based on differences in their products and services and their end-customers. Segment profit is total segment revenue reduced by operating expenses and restructuring and other costs identifiable with the segment. Corporate expenses include general corporate administrative costs. Expenses not directly attributable to the segments, corporate expenses, net interest expense, asbestos-related expenses, gains/losses or impairments related to the sale of assets and income taxes are not included in the computation of segment profit. The accounting policies of the reportable segments are the same as those for the Company.
Quarters | Nine Months | |||||||||||||||
Ended | Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in millions) | ||||||||||||||||
Sales | ||||||||||||||||
Sealing Products | $ | 97.0 | $ | 91.7 | $ | 299.2 | $ | 283.6 | ||||||||
Engineered Products | 82.8 | 77.6 | 263.4 | 256.2 | ||||||||||||
Engine Products and Services | 20.1 | 23.1 | 70.1 | 83.3 | ||||||||||||
199.9 | 192.4 | 632.7 | 623.1 | |||||||||||||
Intersegment sales | (0.3 | ) | (0.3 | ) | (1.2 | ) | (0.9 | ) | ||||||||
Total sales | $ | 199.6 | $ | 192.1 | $ | 631.5 | $ | 622.2 | ||||||||
Segment Profit | ||||||||||||||||
Sealing Products | $ | 16.9 | $ | 13.2 | $ | 53.7 | $ | 45.8 | ||||||||
Engineered Products | 10.0 | 7.6 | 35.1 | 27.2 | ||||||||||||
Engine Products and Services | 0.9 | (6.3 | ) | 1.9 | (1.6 | ) | ||||||||||
Total segment profit | 27.8 | 14.5 | 90.7 | 71.4 |
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Quarters | Nine Months | |||||||||||||||
Ended | Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Corporate expenses | (6.0 | ) | (6.5 | ) | (19.9 | ) | (19.2 | ) | ||||||||
Asbestos-related expenses | (6.5 | ) | (2.8 | ) | (13.3 | ) | (6.8 | ) | ||||||||
Loss on sale of assets, net | — | — | — | (1.8 | ) | |||||||||||
Interest expense, net | (1.7 | ) | (1.7 | ) | (4.7 | ) | (5.5 | ) | ||||||||
Other income, net | 2.0 | 10.2 | 11.4 | 6.6 | ||||||||||||
Income before income taxes | $ | 15.6 | $ | 13.7 | $ | 64.2 | $ | 44.7 | ||||||||
9. Pensions and Post-Retirement Benefits
The components of net periodic benefit cost for the Company’s U.S. and foreign defined benefit pension and other post-retirement plans for the quarters and nine months ended September 30, 2005 and 2004, are as follows:
Quarters Ended September 30, | ||||||||||||||||
Pension Benefits | Other Benefits | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in millions) | ||||||||||||||||
Service cost | $ | 1.9 | $ | 1.5 | $ | 0.2 | $ | 0.2 | ||||||||
Interest cost | 2.3 | 2.0 | 0.2 | 0.2 | ||||||||||||
Expected return on plan assets | (2.4 | ) | (2.0 | ) | — | — | ||||||||||
Amortization of prior service cost | 0.7 | 0.6 | — | — | ||||||||||||
Amortization of net loss | 0.3 | 0.2 | — | — | ||||||||||||
$ | 2.8 | $ | 2.3 | $ | 0.4 | $ | 0.4 | |||||||||
Nine Months Ended September 30, | ||||||||||||||||
Pension Benefits | Other Benefits | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(in millions) | ||||||||||||||||
Service cost | $ | 5.7 | $ | 4.8 | $ | 0.6 | $ | 0.6 | ||||||||
Interest cost | 6.9 | 6.3 | 0.6 | 0.5 | ||||||||||||
Expected return on plan assets | (7.2 | ) | (6.2 | ) | — | — | ||||||||||
Amortization of prior service cost | 2.1 | 1.9 | (0.1 | ) | (0.1 | ) | ||||||||||
Amortization of net loss | 0.9 | 0.5 | 0.1 | — | ||||||||||||
Curtailment loss | — | 1.2 | — | — | ||||||||||||
$ | 8.4 | $ | 8.5 | $ | 1.2 | $ | 1.0 | |||||||||
The Company anticipates that there will be no required funding in 2005 of its U.S. defined benefit pension plans; however, it made a discretionary contribution of $5 million during the third quarter and plans to make a similarly sized discretionary contribution during the fourth quarter. The Company expects to make total contributions of approximately $2 million in 2005 to its foreign pension plans.
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10. Commitments and Contingencies
General
Various claims, lawsuits and administrative proceedings, all arising in the ordinary course of business with respect to commercial, product liability, asbestos and environmental matters, are pending or threatened against the Company or its subsidiaries and seek monetary damages or other remedies. The Company believes that any liability that may finally be determined with respect to commercial and non-asbestos product liability claims should not have a material effect on the Company’s consolidated financial condition or results of operations. From time to time, the Company and its subsidiaries are also involved as plaintiffs in legal proceedings involving contract, patent protection, environmental, insurance and other matters.
Environmental
The Company’s facilities and operations are subject to federal, state and local environmental and occupational health and safety requirements of the U.S. and foreign countries. The Company takes a proactive approach in its efforts to comply with all environmental, health and safety laws as they relate to its manufacturing operations and in proposing and implementing any remedial plans that may be necessary. The Company also conducts comprehensive compliance and management system audits at its facilities to maintain compliance and improve operational efficiency.
Although the Company believes past operations were in substantial compliance with the then applicable regulations, the Company or one of its subsidiaries has been named as a potentially responsible party or is otherwise involved at 19 sites at each of which the future costs are expected to exceed $100 thousand. The majority of these sites relate to remediation projects at former operating facilities that were sold or closed and primarily deal with remediation of soil and groundwater contamination. Investigations have been completed for 14 sites and are in progress at the other five sites. The laws governing investigation and remediation of these sites can impose joint and several liability for the associated costs. Liability for these costs can be imposed on present and former owners or operators of the properties or on parties that generated the wastes that contributed to the contamination.
The Company’s policy is to accrue environmental investigation and remediation costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. The measurement of the liability is based on an evaluation of currently available facts with respect to each individual situation and takes into consideration factors such as existing technology, presently enacted laws and regulations and prior experience in remediation of contaminated sites. Liabilities are established for all sites based on the factors discussed above. As assessments and remediation progress at individual sites, these liabilities are reviewed periodically and adjusted to reflect additional technical data and legal information. As of September 30, 2005 and December 31, 2004, EnPro had accrued liabilities of $32.7 million and $34.0 million, respectively, for estimated future expenditures relating to environmental contingencies. Of these amounts, $15.4 million represents the Company’s share of liability as a potentially responsible party at a former industrial property located in Farmingdale, New York. The amounts recorded in the consolidated financial statements have been recorded on an undiscounted basis.
The Company believes that its reserves are adequate based on currently available information. Actual costs to be incurred for identified situations in future periods may vary from estimates because of the inherent uncertainties in evaluating environmental exposures due to unknown conditions, changing government regulations and legal standards regarding liability. Subject to the imprecision in estimating future environmental costs, the Company believes that maintaining compliance with current environmental laws and government regulations will not require significant capital expenditures or have a
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material adverse effect on its financial condition, but could be material to its results of operations or cash flows in a given period.
Colt Firearms and Central Moloney
The Company has contingent liabilities related to divested businesses for which certain of its subsidiaries retained liability or are obligated under indemnity agreements. These contingent liabilities include, but are not limited to, potential product liability and associated claims related to the Company’s former Colt Firearms subsidiary for firearms manufactured prior to its divestiture in 1990 and the Company’s former Central Moloney subsidiary for electrical transformers manufactured prior to its divestiture in 1994. No material product liability claims are currently pending against the Company related to Colt Firearms or Central Moloney. Colt Firearms has been named as a defendant in 37 cases filed by municipalities seeking to recover costs arising from gun-related injuries. Many of these cases have been dismissed or are inactive. The current owner of Colt Firearms is seeking indemnification from the Company’s subsidiary, Coltec, for these claims to the extent they involve firearms manufactured prior to March 1990. The Company has rejected Colt Firearms’ claims for indemnification relating to the municipal gun cases in all instances on various legal grounds. As a result, Colt Firearms has filed a lawsuit in New York State Court seeking reimbursement of costs incurred in defending the municipal cases.
The Company also has ongoing obligations, which are included in retained liabilities of previously owned businesses in the consolidated balance sheets, with regard to workers’ compensation, retiree medical and other retiree benefit matters that relate to the Company’s periods of ownership of these operations.
Crucible Materials Corporation
Crucible Materials Corporation (“Crucible”), which is engaged primarily in the manufacture and distribution of high technology specialty metal products, was a wholly owned subsidiary of Coltec until 1985. Through Coltec, the Company owned approximately 45% of the outstanding common stock of Crucible until the sale of the entire interest to Crucible in October 2004. Coltec no longer has any ownership interest in Crucible.
In conjunction with the closure of a Crucible plant in the early 1980s, Coltec was required to fund two trusts for retiree medical benefits for union employees at the plant. The first trust (the “Benefits Trust”) pays for these retiree medical benefits on an ongoing basis. Coltec has no ownership interest in the Benefits Trust, and thus the assets and liabilities of this trust are not included in the Company’s consolidated balance sheets. Under the terms of the Benefits Trust agreement, the trustees retained an actuary to assess the adequacy of the assets in the Benefits Trust in 1995, another actuarial report was completed in 2005 and a third report will be required in 2015. If it is determined in 2015 that the trust assets are not adequate to fund the payment of future medical benefits, Coltec will be required to contribute additional amounts to the Benefits Trust. In the event there are ever excess assets in the Benefits Trust, those excess assets will not revert to Coltec.
Because of the possibility that Coltec could be required to make contributions to the Benefits Trust, Coltec was required to establish a second trust (the “Back-Up Trust”) to cover potential shortfalls in the Benefits Trust. The trust assets and a corresponding liability of the Back-Up Trust are reflected in the Company’s consolidated balance sheets in other non-current assets and in retained liabilities of previously owned businesses, respectively, and amounted to $18.4 million each at September 30, 2005. Based on the valuation completed earlier this year, the actuary determined that there were adequate assets in the Benefits Trust to fund the estimated payments by the trust until the next valuation date. As a result, $11.0 million of assets held in the Back-Up Trust were released to Coltec during the second quarter of
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2005. This amount was based on a distribution formula described in the Benefits Trust agreement and was recorded in income upon receipt. Until such time as a payment is required or the remaining excess trust assets revert to the Company, the trust assets and liabilities will be kept equal to each other on the Company’s consolidated balance sheet.
The Company also has ongoing obligations, which are included in retained liabilities of previously owned businesses in the consolidated balance sheets, with regard to workers’ compensation, retiree medical and other retiree benefit matters, in addition to those mentioned previously, that relate to the Company’s period of ownership of this operation.
Debt and Capital Lease Guarantees
As of September 30, 2005, the Company had contingent liabilities for potential payments on guarantees of certain debt and lease obligations totaling $11.2 million. These guarantees arose from the divestitures of Crucible, Central Moloney and Haber Tool, and expire at various dates through 2010. There is no liability for these guarantees reflected in the Company’s consolidated balance sheets. In the event that the other parties do not fulfill their obligations under the debt or lease agreements, the Company could be responsible for these obligations.
Other Contingent Liability Matters
The Company provides warranties on many of its products. The specific terms and conditions of these warranties vary depending on the product and the market in which the product is sold. The Company records a liability based upon estimates of the costs that may be incurred under its warranties after a review of historical warranty experience and information about specific warranty claims. Adjustments are made to the liability as claims data and historical experience warrant.
Changes in the carrying amount of the product warranty liability for the nine months ended September 30, 2005 and 2004 are as follows:
2005 | 2004 | |||||||
(in millions) | ||||||||
Balance at beginning of year | $ | 3.4 | $ | 5.0 | ||||
Charges (credits) to expense | 2.5 | (0.5 | ) | |||||
Charges to the accrual | (2.3 | ) | (1.6 | ) | ||||
Balance at end of period | $ | 3.6 | $ | 2.9 | ||||
Asbestos
History. Certain of the Company’s subsidiaries, primarily Garlock Sealing Technologies LLC (“Garlock”) and The Anchor Packing Company (“Anchor”), are among a large number of defendants in actions filed in various states by plaintiffs alleging injury or death as a result of exposure to asbestos fibers. Among the products at issue in these actions are industrial sealing products, predominantly gaskets and packing products. The damages claimed vary from action to action, and in some cases plaintiffs seek both compensatory and punitive damages. To date, neither Garlock nor Anchor has been required to pay any punitive damage awards, although there can be no assurance that they will not be required to do so in the future. Liability for compensatory damages has historically been allocated among all responsible defendants. Since the first asbestos-related lawsuits were filed against Garlock in 1975, Garlock and Anchor have processed more than 600,000 asbestos claims to conclusion (including judgments, settlements and dismissals) and, together with their insurers, have paid more than $1 billion in settlements and judgments and over $300 million in fees and expenses.
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Claims Mix. Of those claims resolved, approximately 3% have been claims of plaintiffs alleging the disease mesothelioma, approximately 6% have been claims of plaintiffs with lung or other cancers, and more than 90% have been claims of plaintiffs alleging asbestosis, pleural plaques or other non-malignant impairment of the respiratory system. Out of the 121,300 open cases at September 30, 2005, the Company is aware of only approximately 6,600 (5.4%) that involve a claimant with mesothelioma, lung cancer or some other cancer.
Product Defenses. The asbestos-containing products formerly sold by Garlock and Anchor were encapsulated, which means the asbestos fibers were incorporated into the product during the manufacturing process and sealed in a binder. They were also nonfriable, which means they could not be crumbled by hand pressure. The U.S. Occupational Safety and Health Administration, which began generally requiring warnings on asbestos-containing products in 1972, has never required that a warning be placed on products such as Garlock’s gaskets. Even though no warning label was required, Garlock included one on all of its asbestos-containing products beginning in 1978. Further, gaskets such as those previously manufactured and sold by Garlock are one of the few asbestos-containing products still permitted to be manufactured under regulations of the Environmental Protection Agency. Garlock discontinued all manufacture and distribution of asbestos-containing products in the U.S. during 2000 and worldwide in mid-2001. From the mid-1980s until 2000, U.S. sales of asbestos-containing industrial sealing products were not a material part of Garlock’s sales, and its sales of asbestos-containing products were predominantly to sophisticated purchasers such as the U.S. Navy and large petrochemical facilities. These purchasers generally have extensive health and safety procedures and are familiar with the risks associated with the use and handling of industrial sealing products that contain asbestos.
Garlock’s product defenses have enabled it to be successful at trial, winning defense verdicts in four of five cases that it tried to verdict in 2003, and five of eleven cases decided in 2004. In the successful jury trials, the juries determined that Garlock’s products were not defective and that Garlock was not negligent. In the cases decided by judges, the judges determined that the claimant failed to make a sufficient showing of exposure to Garlock’s products.
Recent Trial Results. During the first nine months of 2005, Garlock began ten trials. Three lawsuits in Philadelphia involving six plaintiffs, a Buffalo, New York lawsuit involving one mesothelioma plaintiff, and a New Jersey lawsuit all settled during the course of the trials. A Los Angeles trial involving a living mesothelioma patient resulted in an adverse verdict, but the claim was settled as part of a larger group settlement prior to the entry of judgment. A Baltimore jury returned a verdict of $10.4 million against Garlock and two other defendants in a mesothelioma case. Garlock’s one-third share is approximately $3.5 million. A Dallas jury returned a verdict of $260,000 in another mesothelioma case. Garlock’s share is approximately $10,000, 4% of the total verdict. A Kentucky jury returned a verdict of $5.0 million in compensatory damages in a lung cancer case in the second quarter of 2005, but this verdict was overturned by the judge in the third quarter of 2005, and a new trial has been granted. Another Texas lawsuit involving a plaintiff with mesothelioma settled during trial; however, the jury returned with a defense verdict in Garlock’s favor just after the settlement was reached.
During 2004, Garlock began seventeen trials involving twenty plaintiffs. Verdicts were rendered against Garlock in six cases. Garlock won defense verdicts with respect to three plaintiffs (in two trials) and the judge directed verdicts in favor of Garlock in two cases. There were two trials started in another case, both of which resulted in mistrials. Seven cases were settled during trial, and another case resulted in a hung jury.
Garlock is appealing each of the significant adverse verdicts against it. In some cases, appeals require the provision of security in the form of an appeal bond, potentially in amounts greater than the verdicts. The Company is required to provide cash collateral to secure the full amount of the bonds,
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which can restrict the usage of a significant amount of the Company’s cash for the periods of such appeals. As of September 30, 2005, the Company had $41.0 million of cash collateral relating to appeal bonds recorded as restricted cash in the consolidated balance sheet. The length of time for appeals can vary, and could be as long as two or three years. Garlock has a track record of success in a majority of its previous appeals, and the Company believes that Garlock will continue to be successful in the appellate process. However, there can be no assurance that any or all of Garlock’s appeals will be successful.
Settlements. Garlock settles and disposes of actions on a regular basis. Garlock’s historical settlement strategy has been to try to match the timing of payments with recoveries received from insurance, which are generally limited by agreement to an annual amount that is currently set at $86.4 million per year ($21.6 million per quarter). In 1999 and 2000, Garlock employed a more aggressive settlement strategy. The purpose of this strategy was to achieve a permanent reduction in the number of overall asbestos claims through the settlement of a large number of claims, including some claims not yet filed as lawsuits. Due to this short-term aggressive settlement strategy, and a significant overall increase in claims filings, the settlement amounts paid in each of the years 1999 through 2004 were greater than the amounts paid in any year prior to 1999. In 2001, Garlock resumed its historical settlement strategy. In fact, Garlock reduced new settlement commitments from $180 million in 2000, to $94 million in 2001, $86.1 million in 2002, $85.7 million in 2003, and $83.8 million in 2004. New commitments totaled $60.4 million for the first nine months of 2005. Because many of the commitments made in 1999, 2000, and early 2001 are being paid over a number of years, the settlement amounts that Garlock will pay in 2005 will continue to include some amounts for those settlements, but those amounts will be smaller than in recent years.
Settlements are made without any admission of liability. Settlement amounts vary depending upon a number of factors, including the jurisdiction where the action was brought, the nature and extent of the disease alleged and the associated medical evidence, the age and occupation of the plaintiff, the presence or absence of other possible causes of the plaintiff’s alleged illness, the availability of legal defenses, and whether the action is an individual one or part of a group.
Before any payment on a settled claim is made, the claimant is required to submit a medical report acceptable to Garlock substantiating the asbestos-related illness and meeting specific criteria of disability. In addition, sworn testimony or other evidence that the claimant worked with or around Garlock asbestos-containing products is required. The claimant is also required to sign a full and unconditional release of Garlock, its subsidiaries, parent, officers, directors, affiliates and related parties from any liability for asbestos-related injuries or claims.
Status of Anchor. Anchor is an inactive and insolvent indirect subsidiary of Coltec. There is no remaining insurance coverage available to Anchor. Anchor has not committed to settle any actions since 1998. As cases reach the trial stage, Anchor is typically dismissed without payment.
Insurance Coverage. As of September 30, 2005, Garlock had available $590 million of insurance and trust coverage that the Company believes will be available to cover future asbestos claim and expense payments. In addition, Garlock classifies $62 million of otherwise available insurance as insolvent. The Company believes that Garlock will recover some of the insolvent insurance over time. In fact, Garlock has recovered approximately $5 million from insolvent carriers during the first nine months of 2005, bringing total insolvent collections from 2002 through September 2005 to $15 million. In October 2005, Garlock collected $4.4 million from an insolvent London-based carrier. The proceeds will reduce the amount of expense that the Company will record in the fourth quarter by $2.8 million and satisfy a $1.6 million receivable.
Of the $590 million of collectible insurance and trust assets, the Company considers $508 million (86%) to be high quality because it is (a) written or guaranteed by U.S.-based carriers whose credit rating
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by S&P is investment grade (BBB) or better, and whose AM Best rating is excellent (A-) or better, (b) in the Equitas trust, or (c) in the London trust. The Company considers $82 million (14%) to be of moderate quality because it is with (a) other solvent U.S. carriers who are unrated or below investment grade ($69 million) or (b) with various other London market carriers ($13 million). Of the $590 million, $237 million is allocated to claims that have been paid by Garlock and submitted to its insurance companies for reimbursement.
Arrangements with Garlock’s insurance carriers limit the amount of insurance proceeds that it is entitled to receive in any one year. The amount of insurance available to cover asbestos-related payments by Garlock is currently limited to $86.4 million per year ($21.6 million per quarter). Because Garlock from time to time collects some insolvent insurance and because some of Garlock’s carriers pay as if there were no annual limit, Garlock receives amounts in excess of the limit in some periods. Amounts paid by Garlock in excess of insurance recoveries in any year that would be recoverable from insurance if there was no annual limit may be collected from the insurance companies in subsequent years so long as insurance is available, subject to the annual limit available in each subsequent year. To the extent that Garlock pays such amounts in a given year, these payments are recorded as a receivable.
In the second quarter of 2004, the Company reached agreement with Equitas, the London-based entity responsible for the pre-1993 Lloyds’ of London policies in the Company’s insurance block, concerning the settlement of its exposure to the Company’s subsidiaries’ asbestos claims. As a result of the settlement, Garlock received $30 million in payment of receivables in the third quarter of 2004, and another $88 million was placed in an independent trust. The funds in the trust are available to pay the Equitas share of future claims and the trust is billed monthly for that share, just as Equitas was billed. At September 30, 2005, the market value of the funds remaining in the trust was approximately $74.9 million.
In the fourth quarter of 2004, the Company reached agreement with a group of London market carriers (other than Equitas) and one of its U.S. carriers that has some policies reinsured through the London market. As a result of the settlement, which resolved a pending arbitration among the parties, in early 2005, Garlock received $22 million in payment of receivables and another $55.5 million was placed in an independent trust. The funds in the trust are available to pay the London carriers’ share of future claims and the trust is billed monthly for that share, just as the carriers were billed. At September 30, 2005, the market value of the funds remaining in the trust was approximately $52.3 million.
During the first quarter of 2005, the Company reached agreement with the parent of two of Garlock’s U.S. insurers. As a result of the agreement, Garlock will receive a total of $21 million of insurance payments in satisfaction of $26 million of total nominal coverage in three equal bi-annual payments of $7 million. The $5 million difference reflects discounting for present value and solvency and litigation risks. The first payment was received in May 2005, the second is due in May 2007 and the third is due in May 2009. The payments are guaranteed by the parent company of the settling insurers.
During the third quarter of 2005, the Company reached agreement with a U.S. carrier that is in receivership. Pursuant to this agreement, Garlock will receive $8 million by the end of the fourth quarter of 2005 in payment of an outstanding insurance receivable. Approximately $11 million of remaining nominal insurance coverage from this insolvent carrier will not be recovered.
During the third quarter of 2005, the Company reached an agreement with an insolvent London-based carrier. Pursuant to this agreement, in October 2005, Garlock received the $4.4 million described earlier.
In November 2003, Coltec received a letter and arbitration demand from one of its U.S.-based investment grade insurers claiming that the insurer was relieved of liability on a $40 million Coltec policy
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in connection with a 1998 settlement and payment in full by a related insurer of a $2 million Anchor policy. That insurer filed suit against Coltec in state court in New York in November 2004, making the same and other claims, and Coltec filed coverage litigation against the insurer in federal court in Pennsylvania in December 2004. The parties have agreed that the release question is required to be determined in the arbitration, which is ongoing. Coltec intends to vigorously pursue the insurance coverage. The $40 million policy is included in Garlock’s $590 million remaining collectible coverage. In addition, Garlock is in discussions with another significant U.S. insurer about the terms of the annual payment limit and the proper interpretation of provisions in the insurer’s policies relating to legal fees and expenses. That insurer is currently withholding payments pending resolution of the matter. This payment delay accounts for $30.3 million of the insurance receivables at September 30, 2005.
Insurance coverage for asbestos claims is not available to cover exposures initially occurring on and after July 1, 1984. While Garlock and Anchor continue to be named as defendants in new actions, only a few allege initial exposure after July 1, 1984. To date, no payments have been made with respect to these few claims, pursuant to a settlement or otherwise. Garlock and Anchor believe that they have substantial defenses to these claims and therefore automatically reject them for settlement.
Quantitative Claims Information. Due to its uncertain nature, management’s estimate of the liability for early-stage and unasserted claims covers a range of possible values, and the Company believes that no single amount in the range is a better estimate than any other amount in the range. Therefore, in accordance with applicable accounting rules, the Company recorded a liability at September 30, 2005, for $260.2 million, which includes $96.2 million for advanced-stage cases and settled claims (inclusive of $7.2 million of accrued legal and other fees), and $164.0 million for early-stage and unasserted claims. The recorded amount for early-stage and unasserted claims is at the low end of the range of what the Company believes to be reasonably possible.
The Company’s outside counsel retained the expert claims valuation firm Bates White, LLC, to review Garlock’s product history, historical claims information and settlement experience and to assist and advise in connection with the management of Garlock asbestos claims and its estimation of Garlock’s liability for pending and reasonably estimable unasserted future asbestos claims. The Company received an initial opinion from Bates White dated February 17, 2005, which is updated quarterly. The most recent update is dated October 6, 2005. The updated report states that, “[b]ased on the range of events likely to transpire in the future, which are reasonably predicted for Garlock’s economically driven non-malignant claims over the next two to four years and for Garlock’s cancer claims and medically driven non-malignant claims over the next ten years, the reasonable and probable estimate of Garlock’s obligation for asbestos personal injury claims ranges from $253.1 million to $362.8 million.”
The Company has adopted the range predicted by its expert; however, it notes that Bates White also indicated a broader range of potential estimates of Garlock’s future obligation for the period of the estimation from $200 million to $622 million. The Company cautions that points within that broader range remain possible outcomes. Also, while the Company agrees with its expert that “beyond two to four years for Garlock economically driven non-malignant claims and beyond ten years for Garlock cancer claims and medically driven non-malignant claims, there are reasonable scenarios in which the [asbestos] expenditure isde minimus,” it cautions that the process of estimating future liabilities is highly uncertain. In the words of the Bates White report, “the reliability of estimates of future probable expenditures of Garlock for asbestos-related personal injury claims declines significantly for each year further into the future.” The Company also notes that the predicted range does not include legal fees and expenses, which add considerably to the costs. Plausible scenarios exist that could result in a total remaining asbestos liability for Garlock in excess of $1 billion, consistent with the high end of previous management estimates.
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The recording of a liability for early-stage and unasserted claims does not alter the Company’s strategy for managing its potential asbestos liabilities and insurance assets and has no impact on the ultimate amount paid for asbestos-related claims against its subsidiaries. However, the recording of that liability could, at some time in the future, accelerate the timing of the recognition of charges to income for future asbestos claims. That would happen in the event the amount of the low end of the Company’s estimate of the liability for pending and unasserted claims increases to the point where it, when combined with the amount of insurance receivables that it has recorded, exceeds the total remaining amount of insurance it has available for the payment of such claims.
The table below quantitatively depicts the number of pending cases, the liability described above, the amount that the Company expects Garlock to recover from insurance related to this liability, and asbestos-related cash flows.
As of and for the | ||||||||
Nine Months Ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
Pending Cases | ||||||||
New actions filed during period (1) | 11,000 | 15,400 | ||||||
Open actions at period-end (1) | 121,300 | 142,000 | ||||||
Remaining Solvent Insurance (dollars in millions) | ||||||||
Total solvent insurance available | $ | 589.5 | $ | 705.5 | ||||
Insurance billed but not yet collected (net of liabilities not covered) (2) | $ | (229.4 | ) | $ | (199.3 | ) | ||
Estimated liability for settled and advanced stage cases (3) | $ | (96.2 | ) | $ | (100.8 | ) | ||
Estimated liability for early-stage and unasserted cases (4) | $ | (164.0 | ) | $ | (148.2 | ) | ||
Remaining solvent insurance | $ | 99.9 | $ | 257.2 | ||||
Cash Flow (dollars in millions) | ||||||||
Payments (5) | $ | (107.3 | ) | $ | (97.6 | ) | ||
Insurance recoveries (5) | 77.3 | 74.3 | ||||||
Net cash flow | $ | (30.0 | ) | $ | (23.3 | ) | ||
(1) | Consists only of actions actually filed with a court of competent jurisdiction. Each action in which both Garlock and Anchor are named as a defendant is shown as a single action. Multiple actions filed by the same plaintiff in more than one jurisdiction are also counted as one action. Claims not filed as an action in court that were received and paid as part of previous settlements (approximately 4,100 in the first nine months of 2005; 7,300 in 2004; 10,300 in 2003; and 15,600 in 2002) are not included. | |
(2) | At September 30, 2005, the amount included $236.6 million representing cumulative payments made for which Garlock has not received a corresponding insurance recovery in large part due to the annual limit imposed under Garlock’s insurance agreement, but also due to some delinquent insurance payments. A reserve of $7.2 million has been established for asbestos liabilities not recoverable from insurance. | |
(3) | Includes amounts with respect to the estimated liability for settled claims and actions in advanced stages of processing (inclusive of $7.2 million of accrued legal and other fees at September 30, 2005), whether or not an action has actually been filed with a court of competent jurisdiction. At September 30, 2005, the Company classified $83.3 million as a current liability and $12.9 million as a non-current liability in its consolidated balance sheet. | |
(4) | Based on an estimated range of potential asbestos-related liabilities. The amount for early-stage cases and unasserted claims likely to be filed against Garlock in the future reflects the low end of |
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the range, less the amount allocated to settled claims and actions in advanced stages. The Company classified this amount as a non-current liability in its consolidated balance sheet.
(5) | Includes amounts with respect to all payments for claims settlements and expenses and recoveries made in the period. In the nine months ended September 30, 2005, and 2004, the Company added $16.7 million and $16.5 million, respectively, of the net cash flows to the asbestos insurance receivable in the consolidated balance sheets, and the Company recorded $13.3 million and $6.8 million, respectively, as an expense in its consolidated statements of operations. This expense relates primarily to uninsured legal fees and uninsured administrative costs, net of recoveries from insolvent insurance carriers. |
11. Subsequent Events
Sale of Debentures
On October 26, 2005, the Company sold $172.5 million in aggregate principal amount of 3.9375% convertible senior debentures due 2015. The sale was effected pursuant to the terms of a purchase agreement with certain initial purchasers, who received a discount of 2.75%. The debentures were sold to subsequent purchasers for cash at 100% and accrue interest from October 26, 2005.
The debentures bear interest at the annual rate of 3.9375%, with interest due on April 15 and October 15 of each year. The debentures will mature on October 15, 2015 unless they are converted, or the Company repurchases them, prior to that date.
Holders may convert the debentures into cash and shares of the Company’s common stock, if any, only under certain circumstances. The initial conversion rate, which is subject to adjustment, is 29.5972 shares of common stock per $1,000 principal amount of debentures, which is equal to an initial conversion price of approximately $33.79 per share. The debentures may be converted under the following circumstances:
• | during any fiscal quarter commencing after December 31, 2005 (and only during such fiscal quarter), if the closing price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading-day period ending on the last trading day of the preceding fiscal quarter was 130% or more of the then current conversion price per share of common stock on that 30th trading day; | ||
• | during the five business day period after any five consecutive trading-day period (which is referred to as the “measurement period”) in which the trading price per debenture for each day of the measurement period was less than 98% of the product of the closing price of the Company’s common stock and the applicable conversion rate for the debentures; | ||
• | on or after September 15, 2015; | ||
• | upon the occurrence of specified corporate transactions; or | ||
• | in connection with a transaction or event constituting a “change of control,” as defined. |
Upon conversion of any debentures, the principal amount would be settled in cash. Specifically, in connection with any conversion, the Company will satisfy its obligation by delivering to holders, in respect of each $1,000 aggregate principal amount of debentures being converted:
• | cash equal to the lesser of $1,000 or the Conversion Value, and |
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• | to the extent the Conversion Value exceeds $1,000, a number of shares equal to the sum of, for each day of the Cash Settlement Period (defined below), (1) 5% of the difference between (A) the product of the conversion rate (plus any additional shares as an adjustment upon a change of control) and the closing price of the Company’s common stock for such date and (B) $1,000, divided by (2) the closing price of the Company’s common stock for such day. |
“Conversion Value” means the product of (1) the conversion rate in effect (plus any additional shares as an adjustment upon a change of control) and (2) the average of the closing prices of the Company’s common stock for the 20 consecutive trading days beginning on the second trading day after the conversion date for those debentures (the “Cash Settlement Period”).
The Company used a portion of the net proceeds from the sale of the debentures to enter into convertible debenture hedge and warrant transactions, which are expected to reduce potential dilution to its common stock from conversion of the debentures by increasing the effective conversion price to $46.78. According to current accounting guidelines, the Company will treat the conversion option effect on earnings per share using the treasury stock equivalent method if and when the Company’s stock price exceeds the initial conversion price of approximately $33.79 per share. The entry into the hedge and warrant transactions will have the effect of decreasing the Company’s total shareholders’ equity by approximately $5.4 million. Total shareholders’ equity is impacted by the net cost of the hedge and warrant transactions, offset by an anticipated tax benefit. Future tax benefits are subject to various risks and uncertainties, including changes in the applicable provisions of the income tax code and regulations.
In addition, the Company intends to use a substantial portion of the net proceeds from the sale of the debentures, together with available cash, to redeem Coltec’s TIDES. On October 27, 2005, the Company gave notice to the holders of the TIDES that this redemption will occur on November 28, 2005. The aggregate redemption price of all outstanding TIDES, including TIDES held by Coltec, is $149,973,950, plus accrued interest. In connection with the redemption of the TIDES, the Company intends to terminate its call options on Goodrich common stock.
In connection with the Company’s issuance of the debentures, its primary U.S. subsidiaries entered into a new amendment to their senior secured revolving credit facility. This amendment permitted the Company to incur up to $172.5 million in debt under the debentures, so long as a portion of the proceeds of the debentures is used, together with cash on hand, to pay in full all amounts owing under the TIDES. The amendment also permits the Company’s subsidiaries to make distributions to it to pay interest on the debentures unless a default or event of default exists under the facility, and permits prepayments of the debentures or distributions from its subsidiaries to it to make principal payments or payments upon conversion of the debentures unless (i) a default or event of default exists under the facility, or (ii) the amount of the borrowing base under the facility, less the amount of outstanding borrowings under the facility, is less than $30 million.
Sale of Facility
On October 26, 2005, the Company sold a facility occupied by its former Colt Firearms subsidiary. The Company had leased the facility to Colt Firearms since its divestiture of Colt Firearms in 1990. Net proceeds from the sale were approximately $6 million.
Recovery from Insolvent Insurance Carrier
During the third quarter of 2005, the Company reached an agreement with an insolvent London based carrier. Pursuant to this agreement, Garlock received $4.4 million in October of 2005.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is management’s discussion and analysis of certain significant factors that have affected our financial condition, cash flows and operating results during the periods included in the accompanying unaudited consolidated financial statements and the related notes. You should read this in conjunction with those financial statements and the audited consolidated financial statements and related notes included in our annual report onForm 10-K for the fiscal year ended December 31, 2004.
Forward-Looking Information
This Quarterly Report on Form 10-Q includes statements that reflect projections or expectations of the future financial condition, results of operations and business of EnPro that are subject to risk and uncertainty. We believe those statements to be “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this report, the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “should,” “could,” “would” or “may” and similar expressions generally identify forward-looking statements.
We cannot guarantee that actual results or events will not differ materially from those projected, estimated, assigned or anticipated in any of the forward-looking statements contained in this report. In addition to those factors specifically noted in the forward-looking statements and those identified in the Company’s annual report on Form 10-K for the year ended December 31, 2004, other important factors that could result in those differences include:
• | the resolution of current and potential future asbestos claims against certain of our subsidiaries, which depends on such factors as the possibility of asbestos reform legislation, the financial viability of insurance carriers, the timing of payments of claims and related expenses, the timing of insurance collections, limitations on the amount that may be recovered from insurance carriers, the bankruptcies of other defendants and the results of litigation; | ||
• | the estimated liability for early-stage and potential future asbestos claims that may be received, which is highly uncertain, is based on subjective assumptions and is at the low end of a range of possible values; | ||
• | general economic conditions in the markets served by our businesses, some of which are cyclical and experience periodic downturns; | ||
• | prices and availability of raw materials; and | ||
• | the amount of any payments required to satisfy contingent liabilities related to discontinued operations of our predecessors, including liabilities for certain products, environmental matters, guaranteed debt and lease payments, employee benefit obligations and other matters. |
We caution our shareholders not to place undue reliance on these statements, which speak only as of the date on which such statements were made.
Whenever you read or hear any subsequent written or oral forward-looking statements attributed to us or any person acting on our behalf, you should keep in mind the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.
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Overview and Outlook
Overview. We are a leader in the design, development, manufacturing and marketing of proprietary engineered industrial products. We operate 29 manufacturing facilities in North America, Europe, and Asia, and employ approximately 4,200 people.
We manage and report our business as three segments: a sealing products segment, an engineered products segment, and an engine products and services segment. Prior to our annual report on Form 10-K for the year ended December 31, 2004, we reported our results of operations under two business segments, a sealing products segment and an engineered products segment. Our segment disclosures for prior periods have been reclassified to reflect the division of our former engineered products segment into two segments, our engineered products segment and our engine products and services segment.
For purposes of our segment disclosures, segment profit is total segment revenue reduced by operating expenses and restructuring and other costs identifiable with the segment. Corporate expenses, net interest expense, asbestos-related expenses, gains/losses or impairments related to the sale of assets, income taxes and other expenses not directly attributable to the segments are not included in the computation of segment profit. The accounting policies of the reportable segments are the same as those for EnPro.
Our sealing products segment designs, manufactures and sells sealing products, including sheet gaskets, metallic gaskets, resilient metal seals, compression packing, rotary lip seals, elastomeric seals, hydraulic components, expansion joints, PTFE products and industrial rubber products. These products are used in a variety of industries, including chemical and petrochemical processing, petroleum extraction and refining, pulp and paper processing, heavy-duty trucking, power generation, food and pharmaceutical processing, primary metal manufacturing, mining, water and waste treatment and semiconductor fabrication.
Our engineered products segment includes operations that design, manufacture and sell self-lubricating, non-rolling, metal polymer and composite bearing products, air compressor systems and vacuum pumps, and reciprocating compressor components. These products are used in a wide range of industrial applications, including the pharmaceutical, pulp and paper, gas transmission, health, construction, petrochemical and automotive industries.
Our engine products and services segment manufactures, sells and services heavy-duty, medium-speed diesel and natural gas engines. Government and commercial markets for marine propulsion and power generation, and applications such as pumps and compressors use these products and services.
Since our inception, we have focused on four management initiatives: increasing the efficiency of our operations through our Total Customer Value, or TCV, lean enterprise program; expanding our product offerings and customer base through our EnNovation initiative and a focus on new geographic markets; strengthening the mix of our business by strategic acquisitions and divestitures; and managing the asbestos settlements of our subsidiaries to minimize the impact on cash flows and enhance our liquidity.
Outlook. We expect sales to increase compared to 2004, primarily due to increased demand in selected markets, price improvements in various product lines, and new product introductions. The increase in volumes, price improvements, and the benefits of our TCV and restructuring initiatives are expected to result in improved operating margins and increased profitability in 2005.
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We anticipate net cash flows from operating activities in 2005 will benefit from lower net asbestos payments and improved operating income. Capital spending in 2005 is expected to be comparable to 2004 levels as a result of our strategy to improve manufacturing efficiency and a continued focus on new product development. Cash used by financing activities has increased in 2005, and we anticipate that it will remain higher than in 2004 as a result of cash collateral required to secure bonds associated with several adverse asbestos verdicts. We are appealing these verdicts. The collateral requirements will restrict the use of the cash during the periods of such appeals.
See our discussion regarding “– Forward-Looking Information” for additional information about factors that may cause future results or events to differ from those indicated in this section and elsewhere in this report.
Results of Operations — Third Quarter of 2005 Compared to the Third Quarter of 2004
Sales of $199.6 million in the third quarter of 2005 increased 4% from $192.1 million in the comparable period of 2004. Revenue in 2005 benefited from increased demand in a majority of the U.S. industrial markets, higher shipments to the heavy-duty truck market, and selected price increases at several business units. Fewer U.S. Navy engine shipments in the engine products and services segment negatively impacted sales in 2005, when compared to 2004.
Segment profit for the quarter increased 92% from $14.5 million in 2004 to $27.8 million in 2005. Segment profit in 2004 was negatively impacted by a $7.5 million loss contract reserve established for cost overruns on several engine programs at Fairbanks Morse Engine. Additionally, segment profits in 2004 were impacted by $1.6 million of restructuring expense, compared to $0.1 million in 2005. Higher volumes, a more favorable product mix and selected price increases favorably impacted segment profit in 2005. Cost reductions from our TCV initiatives and restructuring activities partially offset higher material costs and energy related expenses. Segment margins in the third quarter of 2005 were 13.9%, compared to 7.5% in the comparable quarter of 2004.
Corporate expenses in the third quarter of 2005 were $6.0 million, compared to $6.5 million in 2004. Asbestos expenses increased from $2.8 million in the third quarter of 2004 to $6.5 million in 2005 due to higher legal fees associated with trial defense and appellate activities.
In 2005, we recognized a $2.4 million gain on the fair value of our call options on Goodrich common stock compared to a $1.2 million gain in the third quarter of 2004. The call options are derivative instruments and are carried at fair value with changes in the fair value reflected in income. Changes in the fair value of the call options do not affect cash flows. We use the call options to protect against the risk that Coltec’s 51/4% Convertible Preferred Securities — Term Income Deferred Equity Securities (“TIDES”), which are convertible into Goodrich and EnPro common stock, could exceed their aggregate liquidation value if converted. For information about our notice of redemption of the TIDES, and our intention to terminate the call options, see “— Subsequent Events” below.
Results in 2004 benefited from the receipt and recognition of approximately $10 million from an insurer to settle our claims for (1) reimbursement of past costs relating to certain environmental matters including fees incurred in pursing the claim, and (2) estimated future claims for which we had previously booked reserves.
Our effective tax rate in the third quarter of 2005 was 36.0%, compared to 26.3% in 2004. The rate in 2004 benefited from the reversal of a previously established accrual of $1.5 million that was no longer necessary.
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Net income was $10.0 million, or $0.47 per share, in 2005 compared to $10.1 million, or $0.47 per share, in 2004. Earnings per share are expressed on a diluted basis.
Following is a discussion of operating results for each segment during the quarter:
Sealing Products. Sales of $97.0 million in 2005 were 6% higher than the $91.7 million reported in the same quarter of 2004. Sales at Garlock Sealing Technologies increased due to stronger demand in the upstream oil and gas production industries, higher shipments to the power generation and mining markets, higher volume in the European markets, as well as selected price increases across several product lines. Sales at Stemco increased as original equipment demand in the heavy-duty truck market continued to exceed the prior year requirements.
Segment profit increased 28% from $13.2 million in 2004 to $16.9 million in 2005. Profits at Garlock Sealing Technologies benefited from selected price increases, higher volumes in several markets, and cost reduction initiatives. Higher volumes and price increases at Stemco resulted in higher profits in 2005. Selected price increases and improved manufacturing efficiencies at Garlock Rubber Technologies favorably impacted 2005 profits. Operating margins for the segment for 2005 were 17.4%, compared to 14.4% in the comparable quarter of 2004.
Engineered Products. Sales in 2005 increased 7% from $77.6 million in the third quarter of 2004 to $82.8 million in 2005. Industrial requirements for compressors and aftermarket parts resulted in higher revenue at Quincy for the quarter. Sales at France Compressor Products were higher in 2005 due to increased demand across most of its markets. GGB sales were flat in 2005, when compared to 2004, as a result of soft demand in the European industrial markets, offset by higher shipments and price increases in the North and South American markets.
In 2005, segment profit increased 32% from $7.6 million in 2004 to $10.0 million in 2005. Segment profits in 2004 include $1.5 million of restructuring expenses, while 2005 results were not impacted by restructuring expenses. Profits at Quincy benefited from an increase in volume, a more favorable product mix and selected price increases. Lower restructuring expenses at France Compressor Products in 2005 resulted in higher profits when compared to 2004. Profits at GGB were negatively impacted by lower volumes and an unfavorable product mix in Europe, as well as higher expenses associated with the new Slovakian manufacturing site. Operating margins for the segment were 12.1% in 2005, compared to 9.8% in 2004.
Engine Products and Services. Sales in 2005 were $20.1 million, compared to $23.1 million in 2004. Lower engine shipments associated with U.S. Navy shipbuilding programs contributed to the decrease in revenue during the third quarter of 2005. This decrease was partially offset by higher parts and service revenue.
The segment reported a profit of $0.9 million in 2005 compared to a loss of $6.3 million in 2004. During the third quarter of 2004, we recorded a $7.5 million loss provision associated with cost overruns on several engine manufacturing programs.
Results of Operations — Nine Months Ended September 30, 2005 Compared to the Nine Months Ended September 30, 2004
Sales increased 1% from $622.2 million in 2004 to $631.5 million in 2005. Sales in 2005 were favorably impacted by increased demand in the heavy-duty truck market, increased requirements in the industrial markets served by Quincy Compressor and France Compressor Products, higher demand in the North American industrial bearing and seal markets, as well as selected price increases. This increase was partially offset by lower sales in the engine products and services segment due to fewer engine
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shipments to the U.S. Navy. The divesture of our Haber Tool and Sterling Die operations, which were sold in 2004, contributed $11.0 million in sales during the first nine months of 2004.
Segment profit increased 27% from $71.4 million in 2004 to $90.7 million in 2005. Segment profit in 2005 benefited from higher volumes in the sealing products and engineered products segments, selected price increases, and cost reductions associated with our TCV and restructuring initiatives. In 2005 and 2004, we established contract loss provisions of $3.5 million and $7.5 million, respectively, at Fairbanks Morse Engine for estimated cost over-runs on several engine manufacturing programs. Segment profits in 2004 included $4.7 million of restructuring expenses, compared to $0.4 million in 2005. Segment margins in 2005 were 14.4%, compared to 11.5% in 2004.
Corporate expenses were $19.9 million in 2005 compared to $19.2 million in 2004. The increase was primarily due to Sarbanes-Oxley compliance and benefit-related expenses.
Asbestos expenses in 2005 were $13.3 million, compared to $6.8 million in 2004. The increase was due to higher legal fees associated with trial defense and appellate activities.
Operating income in 2004 was negatively impacted by a $3.3 million loss on the divestitures of the Sterling Die and Haber Tool businesses in 2004, partially offset by a $1.5 million gain on the sale of a building in connection with the relocation of an operation to a new facility. The effect of these transactions is included in loss on sale of assets, net.
Results of operations in 2005 benefited from the receipt of an $11.0 million cash distribution associated with excess assets in a trust that was established for a divested business. Results of operations in 2004 include the receipt and recognition of $10.0 million from an insurer to settle our claims for (1) reimbursement of past costs relating to certain environmental matters including fees incurred in pursing the claim, and (2) estimated future claims for which we had previously booked reserves.
In 2004, we recorded a $0.2 million gain in the fair value of our call options on Goodrich common stock while the gain recognized on these options was $3.9 million in 2005. The call options are derivative instruments and are carried at fair value with changes in the fair value reflected in income.
Net income was $41.1 million, or $1.93 per share, in 2005 compared to $29.9 million, or $1.41 per share, in 2004. Earnings per share are expressed on a diluted basis.
Liquidity and Capital Resources
Cash requirements for working capital, capital expenditures, acquisitions, and debt repayments are funded from cash generated from operations. The Company has additional capital resources available for funding requirements, which are discussed under the heading of “Capital Resources.”
Cash Flows
Operating activities provided $30.1 million and $33.2 million of cash during the nine months ending September 30, 2005 and 2004, respectively. Working capital in 2005 increased by $29.9 million compared to an increase of $22.1 million in 2004. The increase in working capital was the result of higher activity in our markets. Payments for asbestos-related claims net of insurance were $16.7 million for the nine months ending September 30, 2005, compared to $16.5 million in 2004.
Investing activities used $20.3 million of cash in 2005, compared to $13.8 million in 2004. Capital expenditures in 2005 were $19.0 million, compared to $23.7 million in 2004. In 2005, we paid $1.6 million to purchase the minority interest of a shareholder in one of our foreign businesses. In 2004,
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we received payments of $9.6 million relating to the divesture of certain business units and the sale of a building that was no longer required as a result of our restructuring initiatives.
Financing activities used $39.6 million of cash in 2005, compared to $3.5 million in 2004. The increase in 2005 was primarily due to the posting of cash collateral required to secure bonds associated with adverse asbestos verdicts that we are appealing. We are required to provide cash collateral to secure the full amount of the bonds, which will restrict the use of the cash during the periods of such appeals.
Capital Resources
Our primary U.S. subsidiaries have a senior secured revolving credit facility. Any borrowings under the senior secured revolving credit facility would be collateralized by receivables, inventories, equipment, intellectual property, insurance receivables and all other personal property assets of EnPro and its U.S. subsidiaries and by a pledge of 65% of the capital stock of their direct foreign subsidiaries. The maximum available amount under the facility is $60 million. We have not borrowed against this credit facility.
A subsidiary of EnPro has outstanding approximately $145 million of TIDES due April 15, 2028. The TIDES are convertible at the option of the holders into a combination of Goodrich common stock and EnPro common stock. The value of Goodrich and EnPro common stock could increase to a level where the cost to acquire shares to fulfill a conversion could exceed, with no maximum, the $145 million aggregate liquidation value. To protect against this risk, we purchased call options on shares of Goodrich common stock expiring in 2007 in an amount that would enable us to purchase the Goodrich common stock at a cost equal to the liquidation value if all TIDES holders convert. The call options are derivative instruments and are carried at fair value in the consolidated balance sheets with changes in the fair value reflected currently in our earnings. Such changes may have a material effect on our results of operations in a given period, but should not result in any cash obligation.
We have recently issued $172.5 million in aggregate principal amount of 3.9375% convertible subordinated debentures due 2015. We expect to use a substantial portion of the net proceeds from this issuance to redeem Coltec’s TIDES. In connection with that redemption, we also expect to terminate the call options. For more information, see “– Subsequent Events” below.
Critical Accounting Policies and Estimates
Refer to our annual report on Form 10-K for the fiscal year ended December 31, 2004, for a complete list of our critical accounting policies and estimates. The Company adopted the provisions of SFAS 123R as of January 1, 2005, using a modified prospective application. Under this modified prospective application, SFAS 123R will apply to new awards and to any awards that are outstanding on the effective date which are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been rendered as of the adoption date will be recognized over the remaining service period using the compensation cost previously calculated for pro forma disclosure purposes under SFAS 123. The adoption of this accounting policy has not had a material impact on our financial statements.
Contingencies
General
Various claims, lawsuits and administrative proceedings, all arising in the ordinary course of business with respect to commercial, product liability, asbestos and environmental matters, are pending or threatened against us or our subsidiaries and seek monetary damages or other remedies. We believe that
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any liability that may finally be determined with respect to commercial and non-asbestos product liability claims should not have a material effect on our consolidated financial condition or results of operations. From time to time, we and our subsidiaries are also involved as plaintiffs in legal proceedings involving contract, patent protection, environmental, insurance and other matters.
Environmental
Our facilities and operations are subject to federal, state and local environmental and occupational health and safety requirements of the U.S. and foreign countries. We take a proactive approach in our efforts to comply with all environmental, health and safety laws as they relate to our manufacturing operations and in proposing and implementing any remedial plans that may be necessary. We also conduct comprehensive compliance and management system audits at our facilities to maintain compliance and improve operational efficiency.
Although we believe past operations were in substantial compliance with the then applicable regulations, we or one of our subsidiaries have been named as a potentially responsible party or are otherwise involved at 19 sites at each of which the future costs are expected to exceed $100 thousand. The majority of these sites relate to remediation projects at former operating facilities that were sold or closed and primarily deal with remediation of soil and groundwater contamination. Investigations have been completed for 14 sites and are in progress at the other five sites. The laws governing investigation and remediation of these sites can impose joint and several liability for the associated costs. Liability for these costs can be imposed on present and former owners or operators of the properties or on parties that generated the wastes that contributed to the contamination.
Our policy is to accrue environmental investigation and remediation costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. The measurement of the liability is based on an evaluation of currently available facts with respect to each individual situation and takes into consideration factors such as existing technology, presently enacted laws and regulations and prior experience in remediation of contaminated sites. Liabilities are established for all sites based on the factors discussed above. As assessments and remediation progress at individual sites, these liabilities are reviewed periodically and adjusted to reflect additional technical data and legal information. As of September 30, 2005 and December 31, 2004, EnPro had accrued liabilities of $32.7 million and $34.0 million, respectively, for estimated future expenditures relating to environmental contingencies. Of these amounts, $15.4 million represents our share of liability as a potentially responsible party at a former industrial property located in Farmingdale, New York. The amounts recorded in the consolidated financial statements have been recorded on an undiscounted basis.
We believe that our reserves are adequate based on currently available information. Actual costs to be incurred for identified situations in future periods may vary from estimates because of the inherent uncertainties in evaluating environmental exposures due to unknown conditions, changing government regulations and legal standards regarding liability. Subject to the imprecision in estimating future environmental costs, we believe that maintaining compliance with current environmental laws and government regulations will not require significant capital expenditures or have a material adverse effect on our financial condition, but could be material to our results of operations or cash flows in a given period.
Colt Firearms and Central Moloney
We have contingent liabilities related to divested businesses for which certain of our subsidiaries retained liability or are obligated under indemnity agreements. These contingent liabilities include, but are not limited to, potential product liability and associated claims related to Coltec’s former Colt Firearms subsidiary for firearms manufactured prior to its divestiture in 1990 and Coltec’s former Central
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Moloney subsidiary for electrical transformers manufactured prior to its divestiture in 1994. No material product liability claims are currently pending against Coltec related to Colt Firearms or Central Moloney.
Colt Firearms has been named as a defendant in 37 cases filed by municipalities seeking to recover costs arising from gun-related injuries. Many of those cases have been dismissed or are inactive. The current owner of Colt Firearms is seeking indemnification from Coltec for these claims to the extent they involve firearms manufactured prior to March 1990. We have rejected Colt Firearms’ claims for indemnification relating to the municipal gun cases in all instances on various legal grounds. As a result, Colt Firearms has filed a lawsuit in New York State Court seeking reimbursement of costs incurred in defending the municipal cases.
Coltec also has ongoing obligations, which are included in retained liabilities of previously owned businesses in our consolidated balance sheets, with regard to workers’ compensation, retiree medical and other retiree benefit matters that relate to Coltec’s periods of ownership of these operations.
Crucible Materials Corporation
Crucible Materials Corporation (“Crucible”), which is engaged primarily in the manufacture and distribution of high technology specialty metal products, was a wholly owned subsidiary of Coltec until 1985. Through Coltec, we owned approximately 45% of the outstanding common stock of Crucible until the sale of the entire interest to Crucible in October 2004. Coltec no longer has any ownership interest in Crucible.
In conjunction with the closure of a Crucible plant in the early 1980s, Coltec was required to fund two trusts for retiree medical benefits for union employees at the plant. The first trust (the “Benefits Trust”) pays for these retiree medical benefits on an ongoing basis. Coltec has no ownership interest in the Benefits Trust, and thus the assets and liabilities of this trust are not included in our consolidated balance sheets. Under the terms of the Benefits Trust agreement, the trustees retained an actuary to assess the adequacy of the assets in the Benefits Trust in 1995, another actuarial report was completed in 2005 and a third report will be required in 2015. If it is determined in 2015 that the trust assets are not adequate to fund the payment of future medical benefits, Coltec will be required to contribute additional amounts to the Benefits Trust. In the event there are ever excess assets in the Benefits Trust, those excess assets will not revert to Coltec.
Because of the possibility that Coltec could be required to make contributions to the Benefits Trust, Coltec was required to establish a second trust (the “Back-Up Trust”) to cover potential shortfalls in the Benefits Trust. The trust assets and a corresponding liability of the Back-Up Trust are reflected on our consolidated balance sheets in other non-current assets and in retained liabilities of previously owned businesses, respectively, and amounted to $18.4 million each at September 30, 2005. Based on the valuation completed earlier this year, the actuary determined that there were adequate assets in the Benefits Trust to fund the estimated payments by the trust until the next valuation date. As a result, $11 million of assets held in the Back-Up Trust were released to Coltec during the second quarter of 2005. This amount was based on a distribution formula described in the Benefits Trust agreement and was recorded in income upon receipt. Until such time as a payment is required or the remaining excess trust assets revert to Coltec, the trust assets and liabilities will be kept equal to each other on our consolidated balance sheet.
Coltec also has ongoing obligations, which are included in retained liabilities of previously owned businesses in our consolidated balance sheets, with regard to workers’ compensation, retiree medical and other retiree benefit matters, in addition to those mentioned previously, that relate to its period of ownership of this operation.
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Debt and Capital Lease Guarantees
As of September 30, 2005, we had contingent liabilities for potential payments on guarantees of certain debt and lease obligations totaling $11.2 million. These guarantees arose from the divestiture of Crucible, Central Moloney and Haber Tool, and expire at various dates through 2010. There is no liability for these guarantees reflected in our consolidated balance sheets. In the event that the other parties do not fulfill their obligations under the debt or lease agreements, we could be responsible for these obligations.
Asbestos
History. Certain of the Company’s subsidiaries, primarily Garlock Sealing Technologies LLC (“Garlock”) and The Anchor Packing Company (“Anchor”), are among a large number of defendants in actions filed in various states by plaintiffs alleging injury or death as a result of exposure to asbestos fibers. Among the products at issue in these actions are industrial sealing products, predominantly gaskets and packing products. The damages claimed vary from action to action, and in some cases plaintiffs seek both compensatory and punitive damages. To date, neither Garlock nor Anchor has been required to pay any punitive damage awards, although there can be no assurance that they will not be required to do so in the future. Liability for compensatory damages has historically been allocated among all responsible defendants. Since the first asbestos-related lawsuits were filed against Garlock in 1975, Garlock and Anchor have processed more than 600,000 asbestos claims to conclusion (including judgments, settlements and dismissals) and, together with their insurers, have paid more than $1 billion in settlements and judgments and over $300 million in fees and expenses.
Claims Mix. Of those claims resolved, approximately 3% have been claims of plaintiffs alleging the disease mesothelioma, approximately 6% have been claims of plaintiffs with lung or other cancers, and more than 90% have been claims of plaintiffs alleging asbestosis, pleural plaques or other non-malignant impairment of the respiratory system. Out of the 121,300 open cases at September 30, 2005, we are aware of only approximately 6,600 (5.4%) that involve a claimant with mesothelioma, lung cancer or some other cancer.
Product Defenses. The asbestos-containing products formerly sold by Garlock and Anchor were encapsulated, which means the asbestos fibers were incorporated into the product during the manufacturing process and sealed in a binder. They were also nonfriable, which means they could not be crumbled by hand pressure. The U.S. Occupational Safety and Health Administration, which began generally requiring warnings on asbestos-containing products in 1972, has never required that a warning be placed on products such as Garlock’s gaskets. Even though no warning label was required, Garlock included one on all of its asbestos-containing products beginning in 1978. Further, gaskets such as those previously manufactured and sold by Garlock are one of the few asbestos-containing products still permitted to be manufactured under regulations of the Environmental Protection Agency. Garlock discontinued all manufacture and distribution of asbestos-containing products in the U.S. during 2000 and worldwide in mid-2001. From the mid-1980s until 2000, U.S. sales of asbestos-containing industrial sealing products were not a material part of Garlock’s sales, and its sales of asbestos-containing products were predominantly to sophisticated purchasers such as the U.S. Navy and large petrochemical facilities. These purchasers generally have extensive health and safety procedures and are familiar with the risks associated with the use and handling of industrial sealing products that contain asbestos.
Garlock’s product defenses have enabled it to be successful at trial, winning defense verdicts in four of five cases tried to verdict in 2003, and five of eleven cases decided in 2004. In the successful jury trials, the juries determined that Garlock’s products were not defective and that Garlock was not negligent. In the cases decided by judges, the judges determined that the claimant failed to make a sufficient showing of exposure to Garlock’s products.
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Recent Trial Results. During the first nine months of 2005, Garlock began ten trials. Three lawsuits in Philadelphia involving six plaintiffs, a Buffalo, New York lawsuit involving one mesothelioma plaintiff, and a New Jersey lawsuit all settled during the course of the trials. A Los Angeles trial involving a living mesothelioma patient resulted in an adverse verdict, but the claim was settled as part of a larger group settlement prior to the entry of judgment. A Baltimore jury returned a verdict of $10.4 million against Garlock and two other defendants in a mesothelioma case. Garlock’s one-third share is approximately $3.5 million. A Dallas jury returned a verdict of $260,000 in another mesothelioma case. Garlock’s share is approximately $10,000, 4% of the total verdict. A Kentucky jury returned a verdict of $5.0 million in compensatory damages in a lung cancer case in the second quarter of 2005, but this verdict was overturned by the judge in the third quarter of 2005 and a new trial has been granted. Another Texas lawsuit involving a plaintiff with mesothelioma settled during trial; however, the jury returned with a defense verdict in Garlock’s favor just after the settlement was reached.
During 2004, Garlock began seventeen trials involving twenty plaintiffs. Verdicts were rendered against Garlock in six cases. Garlock won defense verdicts with respect to three plaintiffs (in two trials) and the judge directed verdicts in favor of Garlock in two cases. There were two trials started in another case, both of which resulted in mistrials. Seven cases were settled during trial, and another case resulted in a hung jury.
Garlock is appealing each of the significant adverse verdicts against it. In some cases, appeals require the provision of security in the form of an appeal bond, potentially in amounts greater than the verdicts. We are required to provide cash collateral to secure the full amount of the bonds, which can restrict the usage of a significant amount of our cash for the periods of such appeals. As of September 30, 2005, we had $41.0 million of cash collateral relating to appeal bonds recorded as restricted cash in the consolidated balance sheet. The length of time for appeals can vary, and could be as long as two or three years. Garlock has a track record of success in a majority of its previous appeals, and we believe that Garlock will continue to be successful in the appellate process. However, there can be no assurance that any or all of Garlock’s appeals will be successful.
Settlements. Garlock settles and disposes of actions on a regular basis. Garlock’s historical settlement strategy has been to try to match the timing of payments with recoveries received from insurance, which are generally limited by agreement to an annual amount that is currently set at $86.4 million per year ($21.6 million per quarter). In 1999 and 2000, Garlock employed a more aggressive settlement strategy. The purpose of this strategy was to achieve a permanent reduction in the number of overall asbestos claims through the settlement of a large number of claims, including some claims not yet filed as lawsuits. Due to this short-term aggressive settlement strategy and a significant overall increase in claims filings, the settlement amounts paid in each of the years 1999 through 2004 were greater than the amounts paid in any year prior to 1999. In 2001, Garlock resumed its historical settlement strategy. In fact, Garlock reduced new settlement commitments from $180 million in 2000, to $94 million in 2001, $86.1 million in 2002, $85.7 million in 2003, and $83.8 million in 2004. New commitments totaled $60.4 million for the first nine months of 2005. Because many of the commitments made in 1999, 2000 and early 2001 are being paid over a number of years, the settlement amounts that Garlock will pay in 2005 will continue to include some amounts for those settlements, but those amounts will be smaller than in recent years.
Settlements are made without any admission of liability. Settlement amounts vary depending upon a number of factors, including the jurisdiction where the action was brought, the nature and extent of the disease alleged and the associated medical evidence, the age and occupation of the plaintiff, the presence or absence of other possible causes of the plaintiff’s alleged illness, the availability of legal defenses, and whether the action is an individual one or part of a group.
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Before any payment on a settled claim is made, the claimant is required to submit a medical report acceptable to Garlock substantiating the asbestos-related illness and meeting specific criteria of disability. In addition, sworn testimony or other evidence that the claimant worked with or around Garlock asbestos-containing products is required. The claimant is also required to sign a full and unconditional release of Garlock, its subsidiaries, parent, officers, directors, affiliates and related parties from any liability for asbestos-related injuries or claims.
Status of Anchor. Anchor is an inactive and insolvent indirect subsidiary of Coltec. There is no remaining insurance coverage available to Anchor. Anchor has not committed to settle any actions since 1998. As cases reach the trial stage, Anchor is typically dismissed without payment.
Insurance Coverage. As of September 30, 2005, Garlock had available $590 million of insurance and trust coverage that we believe will be available to cover future asbestos claim and expense payments. In addition, Garlock classifies $62 million of otherwise available insurance as insolvent. We believe that Garlock will recover some of the insolvent insurance over time. In fact, Garlock has recovered approximately $5 million from insolvent carriers during the first nine months of 2005, bringing total insolvent collections from 2002 through September 2005 to $15 million. In October 2005, Garlock collected $4.4 million from an insolvent London-based carrier. The proceeds will reduce the amount of expense that we will record in the fourth quarter by $2.8 million and satisfy a $1.6 million receivable.
Of the $590 million of collectible insurance and trust assets, we consider $508 million (86%) to be high quality because it is (a) written or guaranteed by U.S.-based carriers whose credit rating by S&P is investment grade (BBB) or better, and whose AM Best rating is excellent (A-) or better, (b) in the Equitas trust, or (c) in the London trust. We consider $82 million (14%) to be of moderate quality because it is with (a) other solvent U.S. carriers who are unrated or below investment grade ($69 million) or (b) with various other London market carriers ($13 million). Of the $590 million, $237 million is allocated to claims that have been paid by Garlock and submitted to its insurance companies for reimbursement.
Arrangements with Garlock’s insurance carriers limit the amount of insurance proceeds that it is entitled to receive in any one year. The amount of insurance available to cover asbestos-related payments by Garlock is currently limited to $86.4 million per year ($21.6 million per quarter). Because Garlock from time to time collects some insolvent insurance and because some of Garlock’s carriers pay as if there were no annual limit, Garlock receives amounts in excess of the limit in some periods. Amounts paid by Garlock in excess of insurance recoveries in any year that would be recoverable from insurance if there was no annual limit may be collected from the insurance companies in subsequent years so long as insurance is available, subject to the annual limit available in each subsequent year. To the extent that Garlock pays such amounts in a given year, these payments are recorded as a receivable.
In the second quarter of 2004, we reached agreement with Equitas, the London-based entity responsible for the pre-1993 Lloyds’ of London policies in our insurance block, concerning the settlement of its exposure to our subsidiaries’ asbestos claims. As a result of the settlement, Garlock received $30 million in payment of receivables in the third quarter of 2004, and another $88 million was placed in an independent trust. The funds in the trust are available to pay the Equitas share of future claims and the trust is billed monthly for that share, just as Equitas was billed. At September 30, 2005, the market value of the funds remaining in the trust was approximately $74.9 million.
In the fourth quarter of 2004, we reached agreement with a group of London market carriers (other than Equitas) and one of our U.S. carriers that has some policies reinsured through the London market. As a result of the settlement, which resolved a pending arbitration among the parties, in early 2005 Garlock received $22 million in payment of receivables and another $55.5 million was placed in an independent trust. The funds in the trust are available to pay the London carriers’ share of future claims
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and the trust is billed monthly for that share, just as the carriers were billed. At September 30, 2005, the market value of the funds remaining in the trust was approximately $52.3 million.
During the first quarter of 2005, we reached agreement with the parent of two of Garlock’s U.S. insurers. As a result of the agreement, Garlock will receive a total of $21 million of insurance payments in satisfaction of $26 million of total nominal coverage in three equal bi-annual payments of $7 million. The $5 million difference reflects discounting for present value and solvency and litigation risks. The first payment was received in May 2005, the second is due in May 2007 and the third is due in May 2009. The payments are guaranteed by the parent company of the settling insurers.
During the third quarter of 2005, we reached agreement with a U.S. carrier that is in receivership. Pursuant to this agreement, Garlock will receive $8 million by the end of the fourth quarter of 2005 in payment of an outstanding insurance receivable. Approximately $11 million of remaining nominal insurance coverage from this insolvent carrier will not be recovered.
During the third quarter of 2005, we reached an agreement with an insolvent London-based carrier. Pursuant to this agreement, in October 2005, Garlock received the $4.4 million described earlier.
In November 2003, Coltec received a letter and arbitration demand from one of its U.S.-based investment grade insurers claiming that the insurer was relieved of liability on a $40 million Coltec policy in connection with a 1998 settlement and payment in full by a related insurer of a $2 million Anchor policy. That insurer filed suit against Coltec in state court in New York in November 2004, making the same and other claims, and Coltec filed coverage litigation against the insurer in federal court in Pennsylvania in December 2004. The parties have agreed that the release question is required to be determined in the arbitration, which is ongoing. Coltec intends to vigorously pursue the insurance coverage. The $40 million policy is included in Garlock’s $590 million remaining collectible coverage. In addition, Garlock is in discussions with another significant U.S. insurer about the terms of the annual payment limit and the proper interpretation of provisions in the insurer’s policies relating to legal fees and expenses. That insurer is currently withholding payments pending resolution of the matter. This payment delay accounts for $30.3 million of the insurance receivables at September 30, 2005.
Insurance coverage for asbestos claims is not available to cover exposures initially occurring on and after July 1, 1984. While Garlock and Anchor continue to be named as defendants in new actions, only a few allege initial exposure after July 1, 1984. To date, no payments have been made with respect to these few claims, pursuant to a settlement or otherwise. Garlock and Anchor believe that they have substantial defenses to these claims and therefore automatically reject them for settlement. However, there can be no assurance that any or all of these defenses will be successful in the future.
Quantitative Claims Information. Due to its uncertain nature, management’s estimate of the liability for early-stage and unasserted claims covers a range of possible values, and we believe that no single amount in the range is a better estimate than any other amount in the range. Therefore, in accordance with applicable accounting rules, we recorded a liability at September 30, 2005, for $260.2 million, which includes $96.2 million for advanced-stage cases and settled claims (inclusive of $7.2 million of accrued legal and other fees), and $164.0 million for early-stage and unasserted claims. The recorded amount for early-stage and unasserted claims is at the low end of the range of what we believe to be reasonably possible.
Our outside counsel retained the expert claims valuation firm Bates White, LLC, to review Garlock’s product history, historical claims information and settlement experience and to assist and advise in connection with the management of Garlock asbestos claims and its estimation of Garlock’s liability for pending and reasonably estimable unasserted future asbestos claims. We received an initial opinion from Bates White dated February 17, 2005, which is updated quarterly. The most recent update
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is dated October 6, 2005. The updated report states that, “[b]ased on the range of events likely to transpire in the future, which are reasonably predicted for Garlock’s economically driven non-malignant claims over the next two to four years and for Garlock’s cancer claims and medically driven non-malignant claims over the next ten years, the reasonable and probable estimate of Garlock’s obligation for asbestos personal injury claims ranges from $253.1 million to $362.8 million.”
We have adopted the range predicted by our expert; however, we note that Bates White also indicated a broader range of potential estimates of Garlock’s future obligation for the period of the estimation from $200 million to $622 million. We caution that points within that broader range remain possible outcomes. Also, while we agree with our expert that “beyond two to four years for Garlock economically driven non-malignant claims and beyond ten years for Garlock cancer claims and medically driven non-malignant claims, there are reasonable scenarios in which the [asbestos] expenditure isde minimus,” we caution that the process of estimating future liabilities is highly uncertain. In the words of the Bates White report, “the reliability of estimates of future probable expenditures of Garlock for asbestos-related personal injury claims declines significantly for each year further into the future.” We also note that the predicted range does not include legal fees and expenses, which add considerably to the costs. Plausible scenarios exist that could result in a total remaining asbestos liability for Garlock in excess of $1 billion, consistent with the high end of previous management estimates.
The recording of a liability for early-stage and unasserted claims does not alter our strategy for managing our potential asbestos liabilities and insurance assets and has no impact on the ultimate amount paid for asbestos-related claims against our subsidiaries. However, the recording of that liability could, at some time in the future, accelerate the timing of the recognition of charges to income for future asbestos claims. That would happen in the event the amount of the low-end of our estimate of the liability for pending and unasserted claims increases to the point where it, when combined with the amount of insurance receivables that we have recorded, exceeds the total remaining amount of insurance we have available for the payment of such claims.
The table below quantitatively depicts the number of pending cases, the liability described above, the amount that we expect Garlock to recover from insurance related to this liability, and asbestos-related cash flows.
As of and for the | ||||||||
Nine Months Ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
Pending Cases | ||||||||
New actions filed during period (1) | 11,000 | 15,400 | ||||||
Open actions at period-end (1) | 121,300 | 142,000 | ||||||
Remaining Solvent Insurance (dollars in millions) | ||||||||
Total solvent insurance available | $ | 589.5 | $ | 705.5 | ||||
Insurance billed but not yet collected (net of liabilities not covered) (2) | $ | (229.4 | ) | $ | (199.3 | ) | ||
Estimated liability for settled and advanced stage cases (3) | $ | (96.2 | ) | $ | (100.8 | ) | ||
Estimated liability for early-stage and unasserted cases (4) | $ | (164.0 | ) | $ | (148.2 | ) | ||
Remaining solvent insurance | $ | 99.9 | $ | 257.2 | ||||
Cash Flow (dollars in millions) | ||||||||
Payments (5) | $ | (107.3 | ) | $ | (97.6 | ) | ||
Insurance recoveries (5) | 77.3 | 74.3 | ||||||
Net cash flow | $ | (30.0 | ) | $ | (23.3 | ) | ||
(1) | Consists only of actions actually filed with a court of competent jurisdiction. Each action in which both Garlock and Anchor are named as a defendant is shown as a single action. Multiple |
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actions filed by the same plaintiff in more than one jurisdiction are also counted as one action. Claims not filed as an action in court that were received and paid as part of previous settlements (approximately 4,100 in the first nine months of 2005; 7,300 in 2004; 10,300 in 2003; and 15,600 in 2002) are not included. | ||
(2) | At September 30, 2005, the amount included $236.6 million representing cumulative payments made for which Garlock has not received a corresponding insurance recovery in large part due to the annual limit imposed under Garlock’s insurance agreement, but also due to some delinquent insurance payments. A reserve of $7.2 million has been established for asbestos liabilities not recoverable from insurance. | |
(3) | Includes amounts with respect to the estimated liability for settled claims and actions in advanced stages of processing (inclusive of $7.2 million of accrued legal and other fees at September 30, 2005), whether or not an action has actually been filed with a court of competent jurisdiction. At September 30, 2005, we classified $83.3 million as a current liability and $12.9 million as a non-current liability in our consolidated balance sheet. | |
(4) | Based on an estimated range of potential asbestos-related liabilities. The amount for early-stage cases and unasserted claims likely to be filed against Garlock in the future reflects the low end of the range, less the amount allocated to settled claims and actions in advanced stages. We classified this amount as a non-current liability in our consolidated balance sheet. We caution that future asbestos liabilities remain highly uncertain. | |
(5) | Includes amounts with respect to all payments for claims settlements and expenses and recoveries made in the period. In the nine months ended September 30, 2005 and 2004, we added $16.7 million and $16.5 million, respectively, of the net cash flows to the asbestos insurance receivable in our consolidated balance sheets, and we recorded $13.3 million and $6.8 million, respectively, as an expense in our consolidated statements of operations. This expense relates primarily to uninsured legal fees and uninsured administrative costs, net of recoveries from insolvent insurance carriers. |
New Filings. The number of new actions filed against our subsidiaries in 2004 was much lower than the number in 2003 (17,400 compared to 44,700), and the lowest for any twelve-month period since the early 1990s. As the chart shows, that trend continued in the first nine months of 2005 (11,000 new filings compared to 15,400 in the first nine months of 2004). Possible factors in the decline include, but are not limited to, tort reform in some high profile states, especially Mississippi, Texas and Ohio, actions taken and rulings by some judges and court administrators that have the effect of limiting access to their courts for claimants without sufficient ties to the jurisdiction or claimants with no discernible disease, acceleration of current year claims into past years, uncertainty about the potential for national asbestos reform legislation, and declining incidence of asbestos-related disease.
Strategy. Garlock’s current strategy is to focus on trial-listed cases and other cases in advanced stages of processing, to reduce new settlement commitments each year, to carefully manage and maximize insurance collections, and to proactively support legislative and other efforts aimed at asbestos reform. Garlock believes that this strategy should result in the reduction of the negative annual cash flow impact from asbestos claims, as previous settlements work their way through the payment process. However, recent trial results and the threat of large verdicts impact the implementation of the strategy, and therefore it is likely that Garlock will continue to enter into settlements that involve large numbers of cases from time to time when it believes that the risk of a large adverse verdict outweighs the benefits of the strategy. Garlock believes that, as predicted in various epidemiological studies that are publicly available, the incidence of asbestos-related disease is in decline and should continue to decline steadily over the next decade and thereafter, so that the level of claims activity against Garlock will eventually
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decline to a level that can be paid from the cash flow expected from Garlock’s operations if Garlock exhausts its insurance coverage. However, there can be no assurance that epidemiological predictions about incidence of asbestos-related disease will prove to be accurate, or that, even if they are, there will be a commensurate decline in the number of asbestos-related claims filings.
Considering the foregoing, as well as the experience of our subsidiaries and other defendants in asbestos litigation, the likely sharing of judgments among multiple responsible defendants, recent bankruptcies of other defendants, and legislative efforts, and given the amount of insurance coverage that Garlock expects to be available from its solvent carriers, we believe that pending actions against Garlock and Anchor are not likely to have a material adverse effect on our financial condition, but could be material to our results of operations or cash flows in a given period. We anticipate that asbestos-related actions will continue to be filed against Garlock. Because of the uncertainty as to the number and timing of potential future actions, as well as the amount that will have to be paid to settle or satisfy any such actions in the future and the finite amount of insurance available for future payments, those future actions could have a material adverse effect on our financial condition, results of operations and cash flows.
Reform Legislation. The outlook for federal legislation to provide national asbestos litigation reform continues to be uncertain. We are supportive generally of proposed legislation that would set up a national trust fund as the exclusive means for the recovery of asbestos-related claims. We are not certain as to what contributions we would be required to make to such a fund, although we anticipate that they would be substantial and that they would continue for a significant number of years. While we are cautiously optimistic that reform legislation ultimately will be adopted by the U.S. Congress, there is no assurance that proposed legislation currently under consideration by the Senate or any other asbestos legislation will ultimately become law.
Subsequent Events
Sale of Debentures
On October 26, 2005, we sold $172.5 million in aggregate principal amount of 3.9375% convertible senior debentures due 2015. The sale was effected pursuant to the terms of a purchase agreement with certain initial purchasers, who received a discount of 2.75%. The debentures were sold to subsequent purchasers for cash at 100% and accrue interest from October 26, 2005.
The debentures bear interest at the annual rate of 3.9375%, with interest due on April 15 and October 15 of each year. The debentures will mature on October 15, 2015 unless they are converted, or we repurchase them, prior to that date.
Holders may convert the debentures into cash and shares of our common stock, if any, only under certain circumstances. The initial conversion rate, which is subject to adjustment, is 29.5972 shares of common stock per $1,000 principal amount of debentures, which is equal to an initial conversion price of approximately $33.79 per share. The debentures may be converted under the following circumstances:
• | during any fiscal quarter commencing after December 31, 2005 (and only during such fiscal quarter), if the closing price of our common stock for at least 20 trading days in the 30 consecutive trading-day period ending on the last trading day of the preceding fiscal quarter was 130% or more of the then current conversion price per share of common stock on that 30th trading day; | ||
• | during the five business day period after any five consecutive trading-day period (which is referred to as the “measurement period”) in which the trading price per debenture for each |
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day of the measurement period was less than 98% of the product of the closing price of our common stock and the applicable conversion rate for the debentures; | |||
• | on or after September 15, 2015; | ||
• | upon the occurrence of specified corporate transactions; or | ||
• | in connection with a transaction or event constituting a “change of control,” as defined. |
Upon conversion of any debentures, the principal amount would be settled in cash. Specifically, in connection with any conversion, we will satisfy our obligation by delivering to holders, in respect of each $1,000 aggregate principal amount of debentures being converted:
• | cash equal to the lesser of $1,000 or the Conversion Value, and | ||
• | to the extent the Conversion Value exceeds $1,000, a number of shares equal to the sum of, for each day of the Cash Settlement Period (defined below), (1) 5% of the difference between (A) the product of the conversion rate (plus any additional shares as an adjustment upon a change of control) and the closing price of our common stock for such date and (B) $1,000, divided by (2) the closing price of our common stock for such day. |
“Conversion Value” means the product of (1) the conversion rate in effect (plus any additional shares as an adjustment upon a change of control) and (2) the average of the closing prices of our common stock for the 20 consecutive trading days beginning on the second trading day after the conversion date for those debentures (the “Cash Settlement Period”).
We used a portion of the net proceeds from the sale of the debentures to enter into convertible debenture hedge and warrant transactions, which are expected to reduce potential dilution to our common stock from conversion of the debentures by increasing the effective conversion price to $46.78. According to current accounting guidelines, we will treat the conversion option effect on earnings per share using the treasury stock equivalent method if and when our stock price exceeds the initial conversion price of approximately $33.79 per share. The entry into the hedge and warrant transactions will have the effect of decreasing our total shareholders’ equity by approximately $5.4 million. Total shareholders’ equity is impacted by the net cost of the hedge and warrant transactions, offset by an anticipated tax benefit. Future tax benefits are subject to various risks and uncertainties, including changes in the applicable provisions of the income tax code and regulations.
In addition, we intend to use a substantial portion of the net proceeds from the sale of the debentures, together with available cash, to redeem Coltec’s TIDES. On October 27, 2005, we gave notice to the holders of the TIDES that this redemption will occur on November 28, 2005. The aggregate redemption price of all outstanding TIDES, including TIDES held by Coltec, is $149,973,950, plus accrued interest. In connection with the redemption of the TIDES, we intend to terminate our call options on Goodrich common stock.
In connection with our issuance of the debentures, our primary U.S. subsidiaries entered into a new amendment to their senior secured revolving credit facility. This amendment permitted us to incur up to $172.5 million in debt under the debentures, so long as a portion of the proceeds of the debentures is used, together with cash on hand, to pay in full all amounts owing under the TIDES. The amendment also permits our subsidiaries to make distributions to us to pay interest on the debentures unless a default or event of default exists under the facility, and permits prepayments of the debentures or distributions from our subsidiaries to us to make principal payments or payments upon conversion of the debentures
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unless (i) a default or event of default exists under the facility, or (ii) the amount of the borrowing base under the facility, less the amount of outstanding borrowings under the facility, is less than $30 million.
Sale of Facility
On October 26, 2005, we sold a facility occupied by our former Colt Firearms subsidiary. We had leased the facility to Colt Firearms since our divestiture of Colt Firearms in 1990. Net proceeds from the sale were approximately $6 million.
Recovery from Insolvent Insurance Carrier
During the third quarter of 2005, we reached an agreement with an insolvent London-based carrier. Pursuant to this agreement, Garlock received $4.4 million in October of 2005.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks as part of our ongoing business operations, including risks from changes in interest rates and foreign currency exchange rates that could impact our financial condition, results of operations and cash flows. We manage our exposure to these and other market risks through regular operating and financing activities, or through the use of derivative financial instruments. We intend to use such derivative financial instruments as risk management tools and not for speculative investment purposes. For information about our interest rate risk and foreign currency risk, see “Quantitative and Qualitative Disclosures about Market Risk” in our annual report on Form 10-K for the year ended December 31, 2004, and the following section.
Foreign Currency Risk
We are exposed to foreign currency risks that arise from normal business operations. These risks include the translation of local currency balances of our foreign subsidiaries, intercompany loans with foreign subsidiaries and transactions denominated in foreign currencies. Our objective is to control our exposure to these risks through our normal operating activities and, where appropriate, through foreign currency forward contracts and option contracts. The following table provides information about our outstanding foreign currency forward contracts and option contracts as of September 30, 2005:
Notional Amount | ||||||||
Outstanding in | ||||||||
Millions of U.S. | ||||||||
Transaction Type | Dollars (USD) | Maturity Dates | Exchange Rate Ranges | |||||
Forward Contracts | ||||||||
Buy USD/sell euro | $ | 24.4 | Oct 2005 – Dec 2006 | 1.2105 to 1.235 USD/euro | ||||
Sell koruna/buy euro | 17.2 | Oct 2005 | 38.87 koruna/euro | |||||
Buy USD/sell Canadian dollar | 11.8 | Oct 2005 – Dec 2006 | 1.206 to 1.327 Canadian dollar/USD | |||||
Buy euro/sell USD | 9.2 | Oct 2005 – Feb 2008 | 1.207 to 1.312 USD/euro | |||||
Sell euro/buy Australian dollar | 5.3 | Oct 2005 | 1.594 Australian dollar/euro | |||||
Buy koruna/sell euro | 4.3 | Oct 2005 – Dec 2006 | 39.024 to 39.880 koruna/euro | |||||
Buy euro/sell pesos | 1.5 | Oct 2005 | 13.115 peso/euro | |||||
Buy USD/sell pounds | 1.3 | Jan 2006 – Dec 2006 | 1.745 USD/pounds | |||||
75.0 | ||||||||
Option Contracts | ||||||||
Buy euro/sell USD | 5.4 | Jan 2006 | 1.305 USD/euro | |||||
$ | 80.4 | |||||||
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Subsequent Event
On October 26, 2005, we used a portion of the net proceeds from the sale of our convertible subordinated debentures due 2015 to enter into convertible debenture hedge and warrant transactions. See “Subsequent Events” under Item 2 above.
Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The purpose of our disclosure controls and procedures is to provide reasonable assurance that information required to be disclosed in our reports filed under the Exchange Act, including this report, is recorded, processed, summarized and reported within the time periods specified, and that such information is accumulated and communicated to our management to allow timely decisions regarding disclosure. Our disclosure controls also include components of our internal control over financial reporting.
Management does not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with polices or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Based on the controls evaluation and subject to the limitations noted above, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified, and that management will be timely alerted to material information required to be included in our periodic reports filed with the Securities and Exchange Commission.
During the third quarter of 2005, we implemented a new financial consolidation software application from Hyperion called “Hyperion Financial Management.” Prior to the third quarter of 2005, we used Hyperion’s “Enterprise” financial consolidation software application. We believe this migration will strengthen our internal control over financial reporting; however, there can be no assurance that we will not have a material error in our financial statements. No other change has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
OTHER INFORMATION
Item 1. Legal Proceedings.
A description of environmental, asbestos and other legal matters is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contingencies.”
In addition to the matters noted above, we are from time to time subject to, and are presently involved in, other litigation and legal proceedings arising in the ordinary course of business. We believe that the outcome of such other litigation and legal proceedings will not have a material adverse affect on our financial condition, results of operations and cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(c) The following table sets forth all purchases made by or on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during each month in the third quarter of 2005.
(d) Maximum Number | ||||||||||||||||
(or Approximate | ||||||||||||||||
(c) Total Number of | Dollar Value) of | |||||||||||||||
Shares (or Units) | Shares (or Units) | |||||||||||||||
Purchased as Part | that May Yet Be | |||||||||||||||
(a) Total Number of | (b) Average Price | of Publicly | Purchased Under the | |||||||||||||
Shares (or Units) | Paid per Share (or | Announced Plans or | Plans or Programs | |||||||||||||
Period | Purchased (1) | Unit) | Programs (1) | (1) | ||||||||||||
July 1 — July 31, 2005 | -0- | — | — | — | ||||||||||||
August 1 — August 31, 2005 | -0- | — | — | — | ||||||||||||
September 1 — September 30, 2005 | 901 | (2 | ) | — | — | |||||||||||
Total | 901 | (2 | ) | — | — |
(1) | Shares were purchased by a rabbi trust the Company established in connection with its Deferred Compensation Plan for Non-Employee Directors, pursuant to which non-employee directors may elect to defer directors’ fees into common stock units. The rabbi trust purchased these shares from Coltec, which is a wholly owned subsidiary of the Company. The Company does not consider the purchase of shares from Coltec in this context to be pursuant to a publicly announced plan or program. | |
(2) | Coltec furnished the 901 shares to the rabbi trust in exchange for management and other services provided by the Company. The number of shares was calculated using a price of $33.32, the average price of the Company’s common stock on September 30, 2005. |
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Item 5. Other Information.
In addition to its obligations under the Retirement Program for EnPro Industries, Inc. and Affiliated Companies (the “Pension Plan”) and the EnPro Industries, Inc. Defined Benefit Restoration Plan (the “Restoration Plan”), which pays benefits to employees otherwise payable from time to time under the Pension Plan that may be limited as a result of Sections 401(a)(17) and 415(b) of the Internal Revenue Code, the Company is currently obligated to four named executive officers (Ernest F. Schaub, William Dries, Richard L. Magee and Richard C. Driscoll) for supplemental retirement payments under a non-qualified Supplemental Executive Retirement Plan (the “SERP”) and for death benefits under death benefit agreements (the “Death Benefit Agreements”) providing benefits in the event the executive officer dies while employed by the Company. The SERP was put in place as part of the compensation packages developed to recruit these executives to the Company at the time of the Company’s spin-off from Goodrich Corporation, and the Death Benefits Agreements were put in place to provide benefits otherwise payable under the Restoration Plan and the SERP in the event of the executive officer’s death while employed by the Company. In order to fund its potential obligations to the executives under the Death Benefits Agreements, the Company purchased, in December 2002, life insurance policies on the executives covered by the agreements.
In order to fulfill the commitments made to these executive officers and on the recommendation of the Company’s Compensation and Human Resources Committee and approval by the Board of Directors, on November 8, 2005, the Company entered into Supplemental Retirement and Death Benefits Agreements with the four executive officers relating to the retirement benefits payable under the Restoration Plan and the SERP. Each of the agreements provides for the delivery to the officer of:
• | a life insurance policy having a net cash value equal to the single sum present value of the officer’s aggregate accrued benefit under the Restoration Plan and the SERP as of December 1, 2005 in the case of Messrs. Schaub and Driscoll, and January 1, 2007 in the case of Messrs. Dries and Magee; and | ||
• | each year thereafter, through termination of employment, a life insurance policy having a net cash value equal to the additional aggregate benefits accrued under the Restoration Plan and the SERP since the prior year. |
Delivery of these life insurance policies to the officers will be in lieu of any retirement benefits that the executive would have otherwise become entitled to receive under the Restoration Plan or the SERP. In addition, the amount of the death benefits payable to the officers’ beneficiaries under the Death Benefits Agreements will be reduced, dollar-for-dollar, by the amount of the death benefit provided under each policy distributed under the new agreements. The Company intends to use the life insurance policies previously purchased on these officers’ lives to deliver the benefits earned under the new agreements.
As part of the agreements each executive will also receive, with each policy, a tax gross-up payment in cash in an amount sufficient to provide cash to the executive sufficient to pay all applicable federal and state taxes on the benefit payment represented by the policy. The Company has the right to delay delivery of any policy or related gross-up payment to the extent its deduction with respect to such payments otherwise would be limited or eliminated under Section 162(m) of the Internal Revenue Code. It is estimated that the value of the existing policies will be sufficient to fund the policies required under the new agreements and reimburse the Company for the tax gross-up payments.
This description of the agreements is qualified in its entirety by the terms of the agreements, which are filed as Exhibits 10.1, 10.2, 10.3 and 10.4 hereto and are incorporated herein by reference.
Item 6. Exhibits.
The exhibits to this report on Form 10-Q are listed in the accompanying Exhibit Index.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Charlotte, North Carolina on this 9th day of November, 2005.
ENPRO INDUSTRIES, INC. | ||||
By: | /s/ Richard L. Magee | |||
Richard L. Magee | ||||
Senior Vice President, General Counsel and Secretary | ||||
By: | /s/ William Dries | |||
William Dries | ||||
Senior Vice President and Chief Financial Officer |
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EXHIBIT INDEX
2 | Distribution Agreement between Goodrich Corporation, EnPro Industries, Inc. and Coltec Industries Inc (incorporated by reference to Exhibit 2 to the Form 10-Q for the quarter ended June 30, 2002 filed by EnPro Industries, Inc.) | |
3.1 | Restated Articles of Incorporation of EnPro Industries, Inc., as amended (incorporated by reference to Exhibits 4.3 and 4.4 to the Registration Statement on Form S-8 filed by EnPro Industries, Inc., the EnPro Industries, Inc. Retirement Savings Plan for Hourly Workers and the EnPro Industries, Inc. Retirement Savings Plan for Salaried Workers (File No. 333-89576)) | |
3.2 | Amended Bylaws of EnPro Industries, Inc. (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-8 filed by EnPro Industries, Inc., the EnPro Industries, Inc. Retirement Savings Plan for Hourly Workers and the EnPro Industries, Inc. Retirement Savings Plan for Salaried Workers (File No. 333-89576)) | |
10.1* | Supplemental Retirement and Death Benefits Agreement dated as of November 8, 2005 between EnPro Industries, Inc. and Ernest F. Schaub | |
10.2* | Supplemental Retirement and Death Benefits Agreement dated as of November 8, 2005 between EnPro Industries, Inc. and William Dries | |
10.3* | Supplemental Retirement and Death Benefits Agreement dated as of November 8, 2005 between EnPro Industries, Inc. and Richard L. Magee | |
10.4* | Supplemental Retirement and Death Benefits Agreement dated as of November 8, 2005 between EnPro Industries, Inc. and Richard C. Driscoll | |
23.1* | Consent of Bates White, LLC | |
31.1* | Certification of Chief Executive Officer pursuant to Rule 13a — 14(a)/15d — 14(a) | |
31.2* | Certification of Chief Financial Officer pursuant to Rule 13a — 14(a)/15d — 14(a) | |
32* | Certification pursuant to Section 1350 |
* | Filed herewith |