Keystone expecting to ride out new wave of lawsuits. (Corporate Focus).

JUST as Keystone Automotive Industries Inc. made its way back from a lawsuit-induced nightmare, a new class action over the use of its after-market auto body parts threatens to undo the recovery.

Executives of the Pomona-based distributor of replacement parts used by collision repair shops worked quickly to defuse the newer threat, posed by a Pennsylvania lawsuit against Erie Insurance Co. that was granted class-action status in March.

"Our feeling is this is not State Farm II," said Chief Executive Charles Hogarty in a May 16 conference call.

In October 1999, Keystone was bruised when State Farm, the nation's largest auto insurer, banned the use of after-market parts in repairs for its customers. The switch came after an Illinois court ruled that State Farm had cheated its policyholders by using them.

Keystone weathered the storm, but its business was hurt--State Farm writes 20 percent of the nation's auto insurance policies--and its stock remained depressed for a year, falling to below $5 at one point from the high teens.

Since late 2000, though, Keystone's stock has undergone a slow, steady climb, back to its mid-1999 levels. That climb was interrupted on May 15, with word that Erie had named Keystone and 43 other manufacturers and distributors as co-defendants in the more recent copycat lawsuit.

Keystone's stock got thwacked. It fell $2.35, or 11 percent, to $17.95, on the day Erie's "cross-joinder" complaint against Keystone and the others was disclosed.

The Erie lawsuit is different than the State Farm matter in a number of ways, Hogarty said. Erie is a minor policy writer, with less than 1 percent of the market--and unlike most of the major auto insurers, it stopped using after-market parts in 1999, when State Farm did, and never resumed.

Further, all the major insurers have been closely following the Erie case and several other similar cases, so the shock value is limited.

Trial is estimated to be a year off. If the plaintiffs prevail, the question of damages also comes into play. As a distributor of after-market parts, not a manufacturer, Keystone officials believe any damages awarded would simply pass through to manufacturers.

"I didn't see 7-Eleven get sued in the tobacco litigation. We're in the same position," said John Palumbo, Keystone's chief financial officer.

Keystone has $26 million or so in applicable insurance, and company officials said it appears to be well in excess of the company's potential liability.

Brett Hendrickson, an analyst with B. Riley & Co., agreed. "We can take the part of the State Farm award that wasn't punitive and then pro-rate it to the amount of market share that Erie has... and it's a very small number."

The big question isn't the legal costs, but whether the new wave of lawsuits will end up driving away an additional chunk of business. State Farm still doesn't use after-market parts. although virtually all of its big competitors do.

Surprisingly, Hogarty thinks the lawsuit will have the opposite effect: legitimizing the use of after-market parts. He speculates--based on what Keystone officials have heard about the case--that one reason Erie brought the other parties into the case was to bolster its defense.

In the State Farm case, no evidence was allowed to show whether after-market parts were, in fact, inferior. It was tried, essentially, on the question of whether State Farm broke the agreements it made with policyholders by using such parts.

In fact, after-market manufacturers have spent a great deal of time and effort on research, testing and certification to show their parts are equivalent to original parts. Some of this took place before the State Farm case, some later.

"I can't really argue with Erie's logic of bringing in people that can prove the validity of the whole concept," said Hogarty. "In the end, this might have a positive impact in reversing some of the damage the State Farm case had."

Erie officials did not return calls seeking comment.

Hogarty pointed out that some of Keystone's co-defendants, such as Modine Manufacturing Co., a Racine, Wis., maker of radiators and condensors, make parts that are used in new cars and also sold separately in the after-market.

"Their (parts) are going to meet all the original specs, because they're the guys who designed the original radiator, in some cases, for Ford."

After-market parts are measurably cheaper than original equipment parts sold through dealers. For example, a fender to a 1999 Toyota Camry costs $146 from the dealer, $56 on the after-market, according to a Keystone spokesman.

So far, investors remain cautious. The stock traded recently at $19.35, above its post-lawsuit low but below pre-lawsuit levels.

"While we'd prefer not to be involved, I do believe it'll be an opportunity," said Hogarty.

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224 or at [e-mail].

[GRAPH OMITTED]

Keystone Automotive Industries Inc.

Stock Prices

May 29, 2001  $10.20
May 29, 2002  $19.65

NOTE: Table made from line graph
YEAR (Mar. 30)                    2001    2000

Revenue (millions)              $351.8  $372.5
Operating Expenses (millions)    351.5   357.5
Operating Income (millions)        0.3      15
Net Income (millions)            (0.5)     9.8
Earnings Per Share             ($0.03)   $0.62

SUMMARY

Business: Automotive body-parts distributor

Headquarters: Pomona

CEO: Charles J. Hogarty

Market Cap: $285.5 million Dividend Yield: N/A *

* Total Liabilities: $30.7 million P/E Ratio: N/A

* Long-Term Debt: $0

* Company does not pay dividends

Surviving Another Attack

As government warnings about terrorist activity fly thick and fast, there are steps investors can take to hedge against the risks.

You'll never succeed in making your portfolio terrorism-proof unless you make it so defensive that it would perform poorly if there were no new major attack. You can, however, make your portfolio somewhat resistant.

The importance of defensive measures was driven home when the Dow Jones Industrial Average lost 14 percent in the first five trading days after terrorists destroyed American lives and property on Sept. 11. A second incident would be worse for stocks because it would leave investors feeling even more vulnerable and frustrated.

Here are several steps investors should consider.

* Reduce margins. Investors who use margins borrow money from a brokerage house so they can hold a portfolio that's larger than the amount of cash initially put up. The technique magnifies gains and losses. Since a terrorist attack would probably produce large and sudden losses, it would probably be a time when magnification is especially risky.

* Raise cash. Cash never declines. If a terrorist attack produced a 15 to 20 percent market decline, cash might be the best-performing piece of your portfolio. Since the market seems stuck in a trading range, the extra cash probably won't hurt your performance much.

* Buy bands. In times of political or military crisis, bonds often rise. They are perceived as a relatively safe investment, so they benefit from a flight to safety as investors flee stocks. The events that define a crisis usually pose a threat to economic growth. A slow economy usually implies lower interest rates, and falling rates raise the value of bonds. Finally, crises often impel the Federal Reserve to reduce short-term interest rates to offset threats to the economy.

* Defense stocks. In the week after the last attack, four of the six biggest gainers were defense stocks. It appears the U.S. will have to continue to deploy military force during the next two to three years and that the climate of public opinion will also be favorable to military spending.

* Energy stocks. While energy is not a sure hedge against a terrorist attack, stocks in this industry are likely to rise, Anything that heightens tensions in the Mideast raises the question of a supply cut-off, and that tends to make for higher oil prices.

* Short sales. In researching stocks, you probably come across some shares you think would be folly to buy. While you typically might avoid them, it might make more sense to sell them short. That's a technique for betting on a decline. If you have some short positions, at least one corner of your portfolio would probably rise, while most stocks were plunging. Be warned, however, that the technique is risky since you can lose more than the amount you initially invest.

These steps won't totally protect you against investment losses in the event of another terrorist incident. They may even reduce your return if no attack occurs. Nevertheless, these steps are a prudent form of insurance.

John Dorfman