Circor International Inc (CIR) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Circor International's fourth-quarter earnings conference call. This call will be recorded. At this time all participants have been placed in the listen-only mode. The floor will be open to questions following the presentation. I will now turn the call over to your host, Mr. Dan Peoples (ph), from the company's Investor Relations firm. Please go ahead, sir.

Good morning everyone. Welcome to our fourth-quarter earnings conference call. Our objectives today are to review the company's recent performance and provide an updated outlook on 2004, including guidance for the first quarter with David Bloss, the Chairman and CEO of Circor, and Ken Smith, the Company CFO. After their comments we will then go to question-and-answer session. Before we start two administrative notes.

First, the slides we will be referring to today are available on Circor's website at www.Circor.com, and there's a link there called quarterly earnings from the investors page. Second, today's discussion contains forward-looking statements that identify our future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors we advise you to read about them in the company's 2002 Form 10-K, which also can be viewed on the company's website. Of course actual results could differ materially from those expressed or implied from today's remarks. Now let me turn the call over to Circor's Chairman, Mr. David Bloss.

Good morning everyone. Before we get started let me first apologize for our delay in releasing earnings. We needed some extra time to reverify consolidating entries for two European subsidiaries and wanted to make sure everything was correct before we released our numbers. To recap some important numbers and trends for fourth-quarter, excluding acquisitions that occurred in Q4 of '03, our revenues were up about 10.5 percent for the quarter and 8 percent for the year, and sequentially up 10 percent.

Also on that same basis, orders came in at about 11.4 percent up for the quarter and up about 10 percent for the year and sequentially our orders were up 22 percent. Backlogs were up 19 percent for the quarter and sequentially up 8.2 percent. These year-over-year and sequential trends are indicating some long-awaited strengthening of some of our markets. Looking at our bottom line results, net income was up 23 percent for the quarter and 15 percent for the full year. More importantly, free cash flow came in at $49.2 million for the year, 17 million for the quarter. That equates to about 2.8 times our net income and about 13.7 percent of revenues.

These numbers reflect records for Circor in all categories except for the quarter of cash flow. We had one other quarter that was up higher than that earlier in the year. But other than that, all the numbers look like records for us. Stepping back and looking at our major markets, within the petrochemical sector it is the same story of strong international project activity, the Middle East, North Sea and Asia.

North American activity is mixed. Orders were up 8 percent sequentially. Canada looks like it is picking up a little bit for us. Drilling activity and prices and other stats say that '04 should be a noticeable improvement in petrochemical, although we are waiting to see as that develops. The year end backlogs in the segment were at a record level of 34 percent and up sequentially over 16 percent. Within the instrumentation and thermal fluid control segment, the aerospace orders rebounded from very low levels last year.

We are up about 40 percent from Q4 '03 versus Q4 '02 and up 22 percent sequentially but still relatively weak but better. Our general instrumentation orders, the Circor Instrumentation Technologies Division, were up about 5 percent sequentially but relatively flat for the year. Some pickup is being seen in this sector. The steam group, the thermal fluid controls business, remains slow for the second year. Power, HVAC, Marine, all the same. Should mean that 2004 will require some maintenance spending later on in the year hopefully.

Looking at our overall financial performance, we are delighted with the profitability improvement shown by the petrochemical segment but in our instrumentation and thermal fluid controls businesses the lower sales volume and plant utilization affected it throughout the year and we have to remember that there are some pretty high incremental margins within this segment for the products that we sell here. And we have some year end accounting adjustments also that negatively impacted the fourth-quarter.

Overall, given the negatives we absorbed with market conditions, competitive pricing for a few projects that are out there, our plant consolidation activity and the effects of reduced plant utilization which was further aggravated by our drive to permanently reduce inventory. We feel that 2003 was a good year for Circor considering all that, record earnings, cash flow and best of all, record backlogs. Just to recap for you we've undertaken five separate actions to reduce our operating costs even further. First is Tomco.

We announced in Q3 of '03 that we are going -- we closed our Tomco facility in Painesville, Ohio. This is that quick disconnect business we bought about a year and a half ago. And we are moving its production of the quick disconnect productline to our Hoke Spartanburg, South Carolina plant. Number two was SSI Equipment up in Canada. We announced in Q4 and then nearly completed it in Q4, the closing of our SSI Equipment site in Ontario. Moving it to our Spence Engineering facility in New York State. Number three is Telford in Alberta, Canada. We announced in Q4 the consolidation of its manufacturing operations to KF Industries in Oklahoma City, leaving Telford to focus on sales and distribution.

This transfer will begin in late Q1 of '04 or early Q2. Number four is a U.S. warehouse, which is now empty and held for sale by our KF Industries business. This was vacated as we consolidated operations. And number five, is U.S. Para Plate, an acquisition we did in 2002. They are located in California. We announced internally of January of '04 that it will be closing and its operations will relocate into our Circle Seal plant scheduled for Q1 of '04. Each of these facility closures have attracted paybacks, and together with a little wind in our sails from our markets coupled with these facility closures, we expect to boost our bottom line in 2004. I will have other closing remarks, but Ken Smith will take you through further explanations of our results. I will turn it over to Ken.

Thanks, David. To begin, slide number three and slide number four provides a reconciliation from U.S. GAAP results that were reported in our earnings release to the operating results I will be discussing on slides five through ten. Slides number five through ten excludes special charges which is a line in our P&L that historically is used to report the onetime external costs for facility consolidations and excludes certain income tax benefits recorded in the fourth-quarter of 2003 which I will also explain.

On slide number four there were special charges in the fourth-quarter 2003 amounting to $1.1 million pretax for the five consolidations that Dave listed generated those Q4 special charges. Of the 1.1 million pretax, 400,000 was for KF Industries' U.S. warehouse and that book value being written down to market value, and the remaining 700,000 was for Tomco and SSI severance and moving costs, plus severance accrued for Telford's closing.

The special charges for the full year 2002 were for closing two small North American facilities in our petrochemical segment and the pretax amount was $745,000. Also noted on slide four, we recorded income tax benefits in the fourth-quarter of 2003 of 1.2 million or 8 cents per diluted share, the majority of which related to tax credits for product development and research activities, a majority of which related to prior years.

And a related note, the IRS just completed its examination of our 1999 through 2001 tax years, which included reviewing our amended returns for the product development and research tax benefit. Now to slide number five. Regarding worldwide orders, our Q4 over Q4 results were from four general factors. First, favorable foreign exchange rate, specifically the stronger euro and Canadian dollar. Second, the addition of two acquisitions in mid Q4 2002, plus two acquisitions in the fourth-quarter of 2003. Third, the continued strength of large oil and gas international projects, particularly in the Middle East, Africa and Europe. And fourth, orders were positive from aerospace, domestic oil and gas, MRO and the general industrial markets in the fourth-quarter 2003.

Regarding backlogs, they re-established another all-time high as Dave mentioned, with a large international oil and gas project orders accounting for 48 percent of the totals company's backlog at the end of 2003. Regarding revenues for the quarter, three factors drove up our revenue results. One was the stronger euro and Canadian dollar, second were the acquisitions, and thirdly, shipments to large international oil and gas projects. Regarding profitability, the operating margin changes noted on slide number five reflect the net result of several items including the positive contributions of acquisitions, our success serving the large and international oil and gas project market, and it is both volume and price, plus the petrochemical segments cost reduction efforts. Yet these three favorable factors were offset by volume decreases and the product mix change in other markets. More specifically selling less of higher margin project such as those sold at the commercial aerospace, OEM medical, HVAC and short cycle oil and gas producers, plus the dampening effect of unabsorbed manufacturing costs that cannot be avoided as we again successfully lowered inventory levels.

Earnings per share increased its improving to nonoperating expenses such as interest expense and the fourth-quarter 2003 income tax benefits both improved EPS. And free cash flow was an outstanding quarter in an outstanding year and I will add more color when I discuss a later slide on that topic. Now turning to slide number six. Of note were the special charges this quarter which David and I explained earlier. Looking forward to the first half of 2004 we expect to incur special charges for some residual spending for two of those five closings, specifically Telford and SSI, plus new spending for the U.S. Para Plate consolidation into our Circle Seal Plant.

The special charges in 2002 related to our petrochemical segment, which closed two small facilities in North America and consolidated both of them into its KF facility in Oklahoma City. Net interest expense was lower this quarter and the year due to our principal payment of $15 million on October of 2002. And other income and expense category consists primarily of foreign exchange gains and losses and the minority interest in our Chinese manufacturing joint venture. On slide number 7 cash flow from operations and free cash flow. Just plain very good.

In dissecting the amount generated from lower working capital, lower inventories generated $19.7 million of cash and Q4 alone inventories generated 3.9 million cash to (indiscernible) lower inventory levels by year end. Higher liabilities generated 14 million of positive cash flow for the year, which also excluded the pension payments which are shown separately on the slide. Accounts receivable increased and used 2.5 million of cash. DSO at the end of 2003 was 63 days, down five days from September 30, 2003 and equivalent to the 62 days at the end of 2002. And pension payments in 2003 to our U.S. plants helped keep the plan asset equivalent to our plant's current liability.

For CAPEX in 2003 we did invest nearly $2 million to expand our manufacturing capacity in our petrochemical segments Chinese joint venture, which is integral to our foreign sourcing initiatives. And now to slide number eight, the balance sheet. Our balance sheet continues to be underleveraged with net debt to net capitalization below zero. In October 2003 we paid the scheduled $15 million due on the Senior Notes and we now only have three annual installments remaining, which total $45 million. We have not pre-paid any of the Senior Notes due because of high make-whole requirements.

And other debt such as industrial revenue bonds carry some very low interest rates which are variable. And with $66 million of cash and investments as of December 31, 2003, our first priority continues to be putting that to work to purchase strategic acquisitions like we did with DQS and Texas Sampling in the fourth-quarter of 2003. Now to slide number nine, our instrumentation and thermal fluid segment results. Regarding orders, the two acquisitions in October 2002 and another two acquisitions in Q4 2003 provided an increase in Q4 over Q4 orders plus a stronger euro and orders from aerospace and general industrial markets helped, while thermal fluid products were equivalent to orders in the fourth-quarter of 2002.

Sequentially orders rose from aerospace and the general industrial markets. The backlog decreased in Q4 2003 from Q3 2003, which resulted from delivering key orders of thermal fluid products to HVAC power and maritime customers in the fourth-quarter. Revenues were net of good news from stronger FX rates and acquisitions, which more than offset the decline in sales by our ongoing businesses. In our ongoing businesses decreases for the quarter and full year were experienced in five key end markets, commercial, HVAC, maritime, aerospace, medical OEM and power generation plants. And for the quarter and full year comparisons, sales to these markets were down between 4 to 7 percent.

Separately, this segment's sales to the general industrial instrumentation markets decreased nearly 3 percent for the year while sales for the fourth-quarter of 2003 increased 7 percent. That increase in Q4 2003 revenues is consistent with a sequential rise in Q4 2003 orders from that market. Regarding operating income and margins, these have declined significantly from last year and we were impacted by factors which offset the two improvements of FX and acquisitions. And those offsetting factors were first, order weaknesses from end markets which have historically involved sale of products with higher margins. Second, unabsorbed manufacturing costs as we reduced production in order to help reduce inventories.

Third, severe pricing competition in certain product lines. Fourth, a rise in expenses for legal and insurance programs and pension expense. Fifth, year-end 2003 charges related to two small European subsidiaries in truing up the proper U.S. GAAP accounting from their statutory financial statements. Sixth, this segment also increased its inventory obsolescence provision for specific product lines in the fourth-quarter 2003. And seventh, we did have two facility consolidations in Q4 2003, the Tomco and SSI moves that Dave explained. We did incur extra internal spending for training, restocking and startup costs which were expensed in 2000 -- in the fourth-quarter of 2003, and these internal costs are not included in special charges because special charges where we only categorize our external incremental costs for those moves.

Looking ahead to the first half of 2004, the mild order strength in Q4 2003, both sequentially and year-over-year, is encouraging. Besides aerospace we are also expecting general industrial markets to slowly improve. So as we will describe later we are expecting this segment's Q1 2004 operating margin to be near 12 percent excluding special charges and that 12 percent reflects the absence of the nonrepeating Q4 2003 expenses and the beginning savings from facility closures. Now to slide number ten, our petrochemical segment. The order strength and the high backlog for this segment reflect the continuing global CAPEX spending for large international oil and gas projects. The Middle East and North Sea regions continue to release projects in our Italian business unit, Pibiviesse, is a premier global supplier of large sized ball valves which is installed in many of these projects.

The large CAPEX spending is predominantly for natural gas applications, for production from known reserves both land and subsea, plus expansion of distribution pipelines as well as liquid and natural gas production. Short cycle MRO orders from the North American markets continue to be soft yet some industry analysts are expecting North American rig counts to average nearly 12 percent higher in 2004 compared to 2003 which is certainly a positive indicator to us. Both Q4 revenues and full year revenues increased year-over-year in excess of the positive FX impact. This was the net result of a decline in our North American MRO shipments and lower sales to the Pac-Rim contractors, which were more than offset by higher shipments of large international oil and gas projects by our Italian business, Pibiviesse.

As for operating income and margin, our petrochemical segment continues to work hard to consistently deliver a minimum 10 percent operating margin. This quarter showed year-over-year and sequential improvement. A contribution from Pibiviesse's increased volume has been the principal reason for this segment's operating margin improvement. This segment's North American businesses have been actively increasing its foreign sourcing of products and components to lower its cost of sales. But quite frankly this foreign sourced inventory in transition also is concurrent to North American inventory being reduced dramatically in 2003, which meant more on absorbed costs in 2003 as the North American manufacturing levels were reduced.

Regarding this segment's foreign sourcing program we estimated 65 percent along in its initial program. As an aside, this petrochemical segment's inventories were reduced in 2003, generating nearly $11 million worth of cash. Now let's turn to slide number 11. On this slide we point out our assumptions for our key end markets and other factors that we expect will influence the degree of our success in 2004. In the instrumentation of thermal fluid control segment, we expect certain markets served by our steam products will be steady but remain below historical levels, that the general industrial markets will start a gradual recovery and that military aerospace will increase its capital spending and have higher production.

Within the petrochemical segment we noted the expected rise in North American rig counts in 2004 over 2003. Increased drilling will generally increase demand for such items as flowlines, tank batteries, metering separation and compression stations into which many of our products are sold. And from the large international project side of petrochemical we expect orders to continue at a reasonably strong level. And concluding with slide number 12, for my remarks, translating the market assumptions from slide 11 into our business assumptions for 2004 on slide 12, we factored in the following points.

Our Q3 2003 acquisitions are expected to aid 2004. While most of our end markets had been soft we expect gradual improvement. The petrochemical segment's operating margin is under pressure as pricing is more keen lately, particularly in North America. Both segments will have some pressure from rising metals cost, although our instrumentation and thermal fluid segment has been a bit, has a bit more exposure to this risk than our petrochemical segment. We will certainly be negotiating hard to avoid price deviations from existing contracts and we will be alert to what we can be adjusting in prices that we charge our customers. Inventory reduction remains a priority for us and that means some continued dampening effect on operating margins as we will have some continued unabsorbed manufacturing costs.

The income tax rate is expected to decrease to 35 percent. The new research tax credit should help. And I say new, that's new for Circor. The research tax credit has been allowable for U.S. taxpayers for several years. Working capital, we had a great 2003, but as you know these are onetime improvements and step downs in working capital so it gets harder to repeat those previous large reductions. We have further inventory reductions expected for 2004 but not quite as large as those that we realized in 2003. With that, I now turn the call back to David.

Thank you. Well, we feel that we've done the right things over the past couple of years to position ourselves for the future. Our major plant consolidations are either done or will be done by the end of the first quarter, as we finish up Tomco, SSI and U.S. Para Plate. A big chunk of inventory has been taken out of working capital and our foreign sourcing efforts are taking hold and being realized and our organizations are lean and focused by productline and market.

All we need now is the markets to give us a little boost and the owners of our acquisition targets to cooperate and say yes, both of which are difficult to predict. Right now, being almost two-thirds through the first quarter we are expecting only modest changes in end-user demand from last year because of a slow start in January that I think everyone experienced, although our expectations for 2004 remain positive and quotation activity continues to increase. We expect first-quarter 2004 earnings of between 26 cents and 30 cents per diluted share compared to the 25 cents per share reported in Q1 of 2003. Before I open the lines up for questions I would like to share with you an example of a new fluid control technology coming out of Circor that we are very excited about. It is pictured on slide 13.

This new product exemplifies the technical expertise and collaboration of two Circor companies, RTK in Germany and Pibiviesse in Italy. They secured a contract to supply two unique caged ball valves for one of the largest power plant projects in Germany. The Munich Utility Company is investing a total of EUR200 million in the expansion of its cogeneration plant, and an additional EUR1 millions to convert the Munich district heating network from steam to hot water. The plant has been producing electricity since 1899 and generating heating since 1969.

The current projects involved a high-efficiency generation plant achieving an extremely high level of efficiency or heat rate. The system combines a gas turbine operation with temperatures of over 500 degrees C. with a steam turbine process. The waste heat from the gas turbine is used to generate steam. This steam turbine produces electricity as well as helping to generate district heating and results in reduced emissions of air pollutants and lower heat loss. As an example this process makes it possible to reduce annual Co2 emissions by 500,000 tons.

Two valves like the one pictured here were deliver by the Pibiviesse and RTK in Q4 of 2003, to cope with the large volume of steam involved in this process. The two 15 ton 36 inch by 56 inch valves using our proprietary caged ball technology replaced conventional control valves and are installed after the steam turbine. Using these valves, the volume of steam discharged from the turbine can be regulated over an exceptionally wide range of steam volumes while maintaining a noise level of between 77 and 86 dBAs which is very difficult given the volume and pressure going through these large valves.

Overall the valves represent a technical innovation for this particular type of application. The Munich cogeneration plant project represents the first implementation of this kind of valve solution. The interest that it has generated among other operators of power plant turbines is very high; in fact negotiations on a new project are already taking place with the turbine manufacturer. We feel that the future for our new caged ball productline is very bright. So at this point, we will open the lines up for your questions.

(OPERATOR INSTRUCTIONS). Mike Schneider with Robert W. Baird.

First, congratulations on a real nice year. Great performance. Focusing on instrumentation and thermal fluid for a second, in the quarter I know you guys were wrestling with some the accounting at RTK and SART. Ken, maybe you can give us an indication of what type of adjustment was actually run through the P&L in that segment for the quarter.

Well of that list of seven that I described from the segment of impacting the reduction to the operating margin, the RTK SART, we did have some adjustments to correct the U.S. GAAP adjustments that we have those two subsidiaries plus the obsolescence charges, plus the internal costs for moving Tomco and SSI, and the aggregate of those three factors is about 2.5 percentage points down on the operating line, on the operating margin line.

So it's a good million, probably 1.2, 1.3 million?

Yes. And we feel it's one of the reasons why we point to the first-quarter 2004 where we think this segment will be able to, even with reduced volume, be able to achieve a 12 percent operating margin.

Well, that's encouraging because it means even the 30 cent adjusted number is several, three to four cents higher, if you scrub it of those items.

That's correct.

Special charges in '04, you laid out the activities. Can you give us some rough numbers of what you respect?

I think it will be the neighborhood of $600,000 to $700,000 pretax.

And that's everything you have planned today for '04?

Substantially. We think we have a small warehouse to take care of in the second half of '04, but that won't be more than maybe a hundred, 150,000 pretax.

The full six, seven hundred comes in the first-quarter?

First half. I would say since you are probably going to be near three or 400,000 in the first-quarter, as we start to incur charges for the Para Plate move out of Sacramento into Corona, California.

The guidance you gave for the first quarter includes or excludes those charges?

Excludes.

Okay. And just another question on KF specifically. You mentioned severe pricing, I am presuming it is in that business line. Could you give us some color as to what has changed there other than just a tough market?

Well, I think nothing has changed there. It has been a tough market and it continues to be, but I think the severe pricing comment came when Ken was talking about the instrumentation and internal fluid control segment. There we've got a strainer line that tends to be more commodity, that is the SSI products that we are moving down from Canada. That one has really been -- more competition has popped up out there and really down and dirty pricing, as we call it in that productline. Some of these strainers are welded and fabricated, the larger sizes. Others are by resale, smaller size strainer as they go on a number of different types of fluid lines, and those by resale items are really getting lower margins.

On some of these items, guys, just coming from a more macro sense, the distributors I talked to both here and in Europe are beginning to talk more about sourcing directly from Asia, slapping the distributor label on it and in essence co-competing with their branded products. How much of this have you guys seen and how do you deal with it or is it just an eventuality that you've got to accept?

It's an eventuality in certain product categories, like we see it in the stuff we tended to buy and resell on the strainer side which tend to be more industrially oriented. On the -- within the petrochemical segment we are seeing that on the small side ball valves and see that continuing. But that -- in total if you take a look at our other businesses, they tend to be more upscale, more engineered, more brand recognized and more regulated with industry standards that create barriers to that happening.

So in total I would say probably 10 to 15 percent of our total revenues seem to be exposed in those areas. And we are able to effectively compete with on-time deliveries and good customer service and a competitive price in a full line of products, whereas the lines that some of these distributors are trying to import themselves and putting their own label on are really commodity stuff. And that is why I have said for the last five years that we are not going to be acquiring or moving into those lines, those types of product categories.

We are tending to focus our attention and resources on the engineered product, the aerospace, the steam businesses, the Navy and Marine, the powerplant applications and the exotics and the bigger size classes and the full product offering in the petrochemical side.

Just switching to energy for a second, Pibiviesse, the capacity there, I got to believe given the orders and the revenue you guys are bursting at the seams. What is the plan to try and address further growth?

Two things, Pibiviesse has done a great job over the years of subcontracting machining operations in Italy. You know the Italian market. It's a wonderful area for subcontracting of some pretty exotic machining of components. So we do some machining of the larger size. So we have additional capacity of outside sourcing of machining. We are running up into a little bit of assembly test capability. The other area we are looking at is we need to accommodate this new caged ball technology at Pibiviesse and that is going to require us, and we are looking right now to additional facilities in the Milan region, near our current Pibiviesse plant. You will be seeing some capital spending. We will probably lease the building and land and add some machine-tools to cover some of the more complex machining and welding that is required for that caged ball, and that will relieve some capacity out of Pibiviesse.

On that same note, the guidance, can you walk through for energy -- for calendar '04 you've got equivalent revenue projected for petrochem. Candidly, that seems overly conservative and almost difficult to accept given you are running at 52 million at backlog. It would imply you are expecting a second half decline.

It has been so good. We thought we would continue to be conservative until we saw another few months of activity for the petrochemical business. It has been so good for Pibiviesse. You almost have to stop and wonder how long it will continue. But it is continuing. If we see what we are seeing today through another couple of months, you will probably see a stronger projection in the fourth quarter. We still don't know what is going to happen in North America.

Canada seems to be picking up the last few weeks, good order rates. The North American markets haven't kicked in yet. Although our distributors are telling us all signs are positive for '04 for them, we haven't seen it. We have some Pac-Rim activity that should pick up for us, as well. We really don't know how to quantify that at this point because it is early stages. It is a pretty lumpy business, as you know. And we are just not comfortable and being more aggressive than the current projection. But I hope you're right.

Me too. Thanks again.

(OPERATOR INSTRUCTIONS). Mike Schneider with Robert W. Baird.

Center stage again. I do want to address the first quarter. We are, in essence, two-thirds of the way done now with the first quarter. What have you seen in orders, and in particular on the industrial side? Has the strength there continued?

As I said in my comments, Mike, January was just a very soft month for everybody across the board. And as we talk to people out in the field that are distributors and so forth, they experienced the same thing. So that kind of set us back a little bit, but February has come back nicely. And we expect March to be getting back on track to where we thought it would be. So if it wasn't for January, I would respond to you very positively.

Again, the February strength applied to general industrial as well?

Yes.

And secondly, we have all been waiting for this military kick for you guys in the Marine space. Any, not that I follow the fleet around, any indications the fleet is coming in, due to come in, etc.?

We will get some small activity -- not small, but medium-sized activity probably in the second half of the year, Mike. In our (indiscernible) -- one of the reasons we are showing a little slowdown in orders from Q4 to Q1 in our thermal fluid control business is that they shipped a lot of catapult valves to the Navy in the fourth quarter. Now we've got one set going in the first quarter, but I think we shipped about six sets in the fourth quarter. So we've seen some pretty good spending in the catapult area. But you're right, when those ships start rolling back in there should be a lot of maintenance backed up on those ships.

Finally in acquisitions, you guys have cleaned the balance sheet up incredibly, 60 million in cash now. I know you guys are looking actively at acquisitions, but is there anything you believe is, let's characterize it as probable in the acquisition pipeline that is 20, 25 million or greater?

I'd have to say yes, but again you would have to take that with a grain of salt because the deal business is -- it ain't over 'til it's over. But we have a lot of prospects we are looking at and very attractive ones that we have developed relationships with and I'm hoping to move those along. I've got a couple of small ones that should come across the table relatively soon.

Again concentrated primarily in instrumentation?

Yes, but we are also looking at some petrochemical, the higher end in the petrochemical markets. As we really focused on our strategy in the petrochemical business, we've challenged ourselves to look for product lines and extensions of our capabilities, not just in the on/off valve area, but other types of fluid control devices, that we could service through our current distribution and our current capabilities engineering-wise. And we've identified some interesting areas.

Okay, thanks again.

So we may have something in that arena yet this year.

James Foung with Gabelli & Company.

Can you guys talk a little bit about material costs? I know that has been going up in pretty much all the basic commodities. How much of material costs is your total cost and what kind of increases are you seeing and what are the things you are doing to try to mitigate that?

I would say in our total cost of sales material across the whole company, is around 40 to 50 percent of material cost, maybe hovering closer to the 40 percent range across the whole company. And each of our business units have contracts that vary in length from generally a year to some cases three years and longer. And where certainly much like we did, hopefully like we did three years ago when tariffs went up here in the states, we were able to block off and not be charged for those tariffs because of existing contracts that we were able to hold firm to with our suppliers. And we are certainly keeping our eyes keen to what our vendors are doing now or experiencing because we certainly don't want a flow down from having any price increases. So we are actively talking to our suppliers and trying to stick with our contracts.

How much of your materials are covered by contracts?

I would say the vast majority of them.

The vast majority?

Sure because we certainly want to -- we try to lock in supplies, you want to lock in a quality supplier who has got not only efficient operations and a best price to you, but also has got flexibility in how they deliver and when they deliver. And to secure those preferred suppliers we arrange, in most major cases, supply contracts with them.

So in 2004 what kind of net material costs increase are you seeing over '03 given your contracts and the other things you are doing there?

At this point, here we sit at the end of February beginning of March, we have seen very little. The fact is we have some spot, barstock purchases where we are close to some cost-sharing thresholds but it's a relatively modest piece of an impact on the operating margin for the company. So it is something we just have to keep alert to as we go along through 2004.

Okay.

(OPERATOR INSTRUCTIONS). Tom DeMore (ph) with the State of Wisconsin.

Just a couple of quick questions. In terms of the tax rate I think you stated that you expected the tax rate to be 35 percent in '04. I just calculated that your taxes were 7.8 million on a pretax of twenty-five seven which is about 30 percent in '03. So I wanted to make sure I heard you correctly. Your effective tax rate is going up 5 percent in '04?

I said the tax rate is going to be 35 percent in '04, and that is going back to write my remarks. When I talked about that during the prepared portion of the call, I said we had one million two as seen on slide three, one million two of tax benefits, the majority of which apply to prior years, multiple prior years.

Okay. If you adjust for that, what was the effective tax rate in '03?

Thirty-six percent.

Okay, I'm sorry. I missed the first part of the call. And then secondly, in terms of your debt the company has very good free cash flow. Could you just comment on what kind of debt paydown you might be able to achieve in '04?

In '04 we have a scheduled $15 million principal payment to be disbursed in October of '04. And thereafter, the bulk of the other existing debt is less than 2 percent variable interest rates on some IRB rates, IRB borrowings that don't have scheduled payments until four or five years out. So right now I'm only planning to disburse the scheduled Senior Note payment of $15 million. To be any more aggressive and prepay a larger piece of that would require us to pay some very high prepayment penalties, (indiscernible) whole payments. And right now it is an uneconomical trade-off. So right now, $15 million.

Okay. Were rates to rise 1 percent, overnight rates, how much would that affect the rate on the 25 million in debt that you expect to have outstanding at the end of the year?

I expect to have more than 25 million outstanding at the end of '04.

You do?

Just on the Senior Notes, we'll go from 45 million at the moment down to 30, and there is another $15, $14 million of variable-rates stuff out there that we have right now on the balance sheet.

Okay.

Back to your question, what would a one percentage point increase in overnight rates do? Our variable rate debt would be a modest amount, 1 percent on about $14, $15 million.

Okay. Thank you very much.

We have no further questions. Mr. Bloss, I would like to turn the conference back over to you.

Thanks everybody for being on our fourth-quarter earnings call. We look forward to updating you in April on our Q1 '04 results. Thank you very much.

Thank you, and that does include today's conference. We do appreciate your participation. You may now disconnect.