Circor International Inc (CIR) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen. Welcome to the CIRCOR International's second quarter earnings conference call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode, and the floor will be opened to questions following the presentation. I will now turn the call over to your host, Karen McKean from the Company's Investor Relations Firm. Please go ahead sir.

Thank you very much, and good morning everyone, and welcome to our second quarter earnings call. Our objectives today, are review the Company's recent performance and provide an updated outlook on the remainder of 2004. With me today are David Bloss, the Chairman and CEO of CIRCOR; and Ken Smith, the Company's CFO. After their comments, we'll then go to Q&A. Before we start, two administrative notes. First, the slides we will be referring to today are available on CIRCOR's Web site, at www.circor.com, under the link of quarterly earnings from the Investor Relations 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 2003 Form 10-K. It can also be viewed on the Company's Web site. 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, David Bloss.

Thank you. Good morning everyone. The second quarter came out slightly better than expected from an orders and backlogs standpoint for CIRCOR. We saw a rebound in large project orders, for international oil and gas projects, which verified our view that this end market continues to be active, in spite of its choppiness quarter-to-quarter. The North American oil and gas and related petrochemical activity was up as well, year-over-year and our distributors are telling us to expect a fairly strong demand in the fourth quarter. We also saw improvement in our orders from the aerospace market. Particularly, in military applications. And also for our industrial instrumentation, those in fitting business. We expect that these markets and product sets, should continue to gain momentum as orders normally lag the recovery, in the general industrial market by about six to nine months. Unfortunately, there was no improvement in our Thermal Fluid Control or Steam markets.

US Navy spending continues to be very slow, but this maintenance business has to be spent at some time, and we think later this year or in early 2005, we should see this business come back. The rest of Steam primarily HVAC, is seasonally slow during the summer months. But, we expect it to be little better later this year after two years of high commercial building vacancy rates, and the related hold on maintenance spending on their HVAC systems. On other fronts, we implemented price increases basically across the board to help offset rising Steam's fuel prices. They keep going up, and we may have to hit prices again, and we are watching this very closely. We need additional progress on our cost reduction initiatives during the quarter, for outsourcing of components continues to increase as we qualify new vendors. In addition, we are in the final of the consolidation of three smaller North American Facilities. The SSI business in Canada moving to Spence in Walden, New York.

The US Para Plate move to Corona, California and the largest one is TOMCO moved from Ohio, down to South Carolina. It took longer and caused more inefficiency than we expected. But, these benefits are still there, and we should see those later this year and going forward after that. During the second quarter, we acquired Mallard Control a nice addition of regulators and control valves for our oil field applications. We are integrating Mallard into our Petrochemical segment, which broaden its product offering, and our search for acquisitions in the higher end fluid-control area is quite active. We are pursuing candidates aggressively, but obviously refusing to overpay. Cash flow came back this quarter, we remained in a net cash position. We now have over $60m in cash and investments after paying cash for the Mallard acquisition. At this point, let me turn things over to Ken Smith, our CFO, who will take you through the details of our second quarter.

Thanks David. And turning to slide number three, regarding revenues for the quarter, we had a net benefit from the factors listed on the slide. The oil and gas market in the US was also up versus second quarter 2003, as rig counts and commodity prices are up from 2003 levels. Aerospace, particularly military aerospace, has been stronger for the first half of 2004 and is expected to continue. Regarding profitability, the operating income change noted on slide three reflects the net result of the several cost reduction efforts that we've undertaken, such as the fixed costs for our three recent facility consolidations, discretionary and staffing reductions, and increased foreign sourcing for lower inventory costs, but we also experienced higher raw material costs for specialty metals such as stainless steel and related alloys. The expected lower volume of shipments in the second quarter to large international oil and gas projects, and we are working through the remaining inefficiencies in the integration of the three US facility consolidations in the US and thermal fluid segment, which involved optimizing shop floor scheduling in machining centers, plus the training, and in some cases retraining employees.

And finally, we have been experiencing from vendors less reliability in their deliveries in both quality and timeliness, plus the capability to ramp up to higher volumes. And these vendor supply issues have impacted us by additional cost and inefficiencies in our own shops. There also was the effect of higher inventory and working capital as we raised safety stock levels to buffer the less reliable vendor performance. Now, turning to slide number four, the slight year-to-date operating income decrease involved both segments and I'll discuss each segment in a few minutes. Corporate expenses rose, this quarter we had the expected rise in compliance cost for Sarbanes-Oxley for '04, and the full impact of implementing a New York Stock Exchange requirement for an internal audit capability. The higher Sarbanes-Oxley costs involved the use of outside orders by us to perform the testing of financial controls. And at CIRCOR, we will be testing all 16 of our business units, but nine of those businesses are tested in a much more significant and pervasive manner, which underscores the amount of the cost and effort that we put into the compliance effort. In the second half of 2004, we'll continue to incur these incremental professional fess for testing the internal financial controls. Net interest expense was lower this quarter due to our principal payment last fall, and the other expense income category, primarily consist of foreign exchange gains and losses. And 2003 experienced more significant gains from the strengthening of the Euro and Canadian dollar.

Turning to slide number five, cash flow from operations and free cash flow were substantially less than last year. Last year was simply spectacular, when our businesses reduced working capital including inventory and further reductions in inventory will need to be more systemic across the order fulfillment processes of our companies, and Dave will speak further on this in his closing remarks. In working capital, accounts receivables was a source of cash, aided by more effective collection as evidenced by our decrease in DSO of three days to 62 days as of June 30, 2004, compared to the prior quarter end. Inventories, we actually used $5.5m of cash in the first half of 2004, as we increased safety stocks to mitigate the poor vendor performance and late deliveries, because we still want to deliver to our customers on time. Inventory value also rose from the increased metal cost that we're receiving from our vendors.

Now to slide number six, the balance sheet. Our balance sheet continues to very healthy with a net cash position even after the $14m Mallard acquisition this past April. And, this amount of dispersed cash from Mallard shows on the cash flow statement. There is $12m that is shown separately in investing activities, while the additional $2m, which is for a restricted escrow account as reported in the prepaids and other assets cash out flow -- I mean cash flow statement. The remaining portion of our debt consists of $45m of senior notes and another $12m of low-rate industrial revenue lines. And at this time I do not expect they will prepay for the senior notes due to the high prepayment penalties.

Now to slide number seven, our Instrumentation and Thermal Fluid segment results. Regarding orders, good news from several factors. The two acquisitions in Q4, 2003, and those were DQS in the Netherlands, and in Texas Sampling. They provided incremental orders, while key end-markets for us were positive, and markets that continued to be soft this year are power generation are maritime markets, and maritime includes the important end-user for us, the US Navy. Both of these markets purchased our Thermal Fluid Control products. Revenues were net of good listed on the slide. The customer price increases issued this past quarter had only a modest impact on second quarter revenues, as they are effective May 1 for new orders. We do expect the full impact of these price increases to be evident in our third quarter revenue results.

Regarding operating income and margin, the positive factors were foreign exchange and the fourth quarter 2003 acquisitions, and the fixed costs that we have avoided from the three recent facility closings. The negative factors were first and foremost the rising cost of raw material for inventory components, specifically stainless and related steel alloys, which we approximate to be a 100 basis point impact on the quarter compared to a year ago, and was particularly impactful on our general instrumentation products. The second negative factor was working through the integration of three facility consolidations in the instrumentation and thermal fluid segment, which involved manufacturing inefficiencies to reach optimal supply chain and manufacturing processes, and I estimate that to be a 100 basis point impact on the quarter. And third, the vendor performance, which I've indicated has been less reliable has required us to reperform, rework, locate quality and expedite alternate suppliers, which I think is all aggregated to be a 50 basis point improvement degradation.

Now, to slide number eight, our Petrochemicals segment the order increases in the petrochemical segment reflect the net effect of two order streams. One is the international market for large oil and gas projects. And the second order stream is the North American MRO order intake for oil and gas production and pipeline transportation. And this quarter, both order streams increased versus Q2 a year ago. The huge sequential increase came from the resumed strength from the international market for oil and gas projects after a very low order intake in the first quarter this year. The increase in revenues was the net result of several positive factors. The improvements from the acquisition and FX, and our US business were up nicely versus Q2 a year ago after a weaker Q1 2004. The higher domestic rig counts plus pipeline sales were good this quarter for our US business, particularly KF Industries. On the weaker side for this segment's revenues, there were declines in Western Canada due to the more wet and warmer spring weather, which softened the ground too much for drilling in that geography. And our Italian business segment had lower shipments to the large international projects compared to the second quarter a year ago, and also lower than our first quarter 2004 shipments to these large international projects. As our operating income and margin, this segment's strong Q1 2004 plus the positive impact of foreign sourcing and other cost reductions has pushed up the year-to-date profitability.

The lower second quarter 2004 profits and margins, principally reflect rising steel costs for raw materials, I estimate it to be 75 basis points. And less profitability on the lower volume of shipments to the large international oil and gas projects, which I estimate to be 200 basis points. And I'm sure you remember that last year 2003 was exceptionally an outstanding good year for us in serving the large international projects as it approximated 40% of this segment's revenues last year. Regarding our initial foreign sourcing program, we estimate that we are at 70% completion. We had it anticipated being finished with this initial program by the end of this quarter, June 2004, but there are two product lines that have been delayed by inadequate vendor quality in their initial samples supplied to us. We now expect to complete this remainder by October of this year.

Now lets turn to slide number 9, on this slide we point our assumptions for key-end markets somewhat that we expect serve and other markets that we expect along the degree of our success in the remainder of this year in the instrumentation of thermal fluid control segment, We feel that most markets that we serve are improving, even a chemical processing end market has improved for us and we expect it to continue through 2004. This summer gasoline refineries are operating full tilt so we do expect a mass improvement in orders when the summer driving season ends, and refineries can take time for maintenance. The general industrial markets we believe will continue a gradual recovery and that military aerospace will increase its capital spending on air hardware production. On the soft side, maritime has been weak as orders from the U.S. Navy have decreased, and what we believe is an effort by the U.S. Department of Defense to focus more spending over Iraq operations. Nonetheless we were upbeat for the segment.

Moving to our petrochemical segment, large international project order rates during the past two years have been outstanding. And while orders thus far in 2004 had been lumpy, we expect orders for the remainder of 2004 to be decent, and we expect sustaining orders strength for North American short cycle in the roads. Status slide number 10; translating those market assumptions from slide 9 into our business and financial assumptions for the remainder of 2004 reflected in the following points. Generally order rates look good for the second half of 2004 as we were expecting mild order strengthening plus several of our business units have announced price increases to customers effective in April or May, so these will possibly effect the second half revenues. In the instrumentation thermal fluid segment we expect that we will have lower revenues in the third quarter predominantly from fewer project shipments to the Aerospace chemical and commercial HVAC customers. Operating margins in the instrumentation thermal fluid segment reduced and expected to improve in the second half, on customer price increases completing the facility consolidations and improving our supplier performances. Regarding customer pricing however we are watchful in the general instrumentation market, which is primarily the hope product line which - prices approximately 30% of the segments revenues as we are a price follower behind Swagelok and Parker-Hannifin.

Over our petrochemical segment, its strong backlog is awaited to the fourth quarter of this year and 2005. We do expect a third quarter of 2004 revenues in this segment to be lower and the second quarter sequentially and obviously then followed by a stronger Q4. Nearly half of the segment's backlog will be delivered in the first half of 2005. Speaking about the petrochemical revenues in the third quarter coming up, sequentially lower revenues are due to the extremely low order intake in the first quarter this year. In the first quarter this year, we received approximately one third of the order intake that we had in the previous and subsequent quarters for the large international oil and gas projects and, to repeat myself, which is 40% of this segment's revenue than all of 2003. And, since the delivery times of large products are anywhere from six to eight months, that is significant order shortfall in the first quarter this year for the long delivery times to projects becomes the third quarter 2004 revenue shortfall. Thus the revenue in the third quarter will be nearly half of the comparable sales in the third quarter a year ago for the large projects. But partially offsetting that is our North American businesses, which are expecting revenue, rises in the third and fourth quarters. The segment margin for petrochemical in the third quarter versus prior quarters reflect the net lower revenue volume and ore volume and continuing higher cost for stainless steel components.

Our second half outlook for the petrochemical operating margin is lower than our April assessment especially due to the competitive pricing environment in North America. Our certain key competitors have not raised prices or have raised them to a lesser degree than we did in May. And at the commodity marketplace that put pressure on our profitability. Speaking about corporate expenses in the second half, do you expect them to rise compared to prior years' periods? As I mentioned, professional fees are rising too for our compliance work and our surveying is actually 404 because we are using an outside firm to perform the testing, which is an obligation by the company to comply with this new legislation. And we also will be having our external auditors perform their own testing over this new law and I expect this surveying compliance to cost us a $1.5m this year, which will impact our EPS issue by $0.06. Although, as I indicated in a prior call at the end of the first quarter, I expect this to decline in our 2005 period by at least 25% to 50%. And also on corporate spending, we are amortizing the cost of our restricted stock awards over a two-year transition period. We're substituting our stock option awards with a restricted stock awards under our equity incentive program. In the current accounting treatment, it is that restricted stock awards are expensed? And this is an impact of $300,000 on 2004, which is an $0.01 EPS -- impact.

Working capital, we had a great 2003 as you know, and these are one-time improvements. So we can target to repeat those previous broad reductions. We do have further inventory reductions expected in 2004, but not as large as '03. As we continue to battle vendor performance and the rising metal costs for raw materials. And in the Q3, we do expect free cash flow to be a bit lower because of trade payments for increased inventory and higher income tax payments. So to summarize this slide and our outlook many end markets where we survive are improving. Metal costs for raw material are rising, but we have taken pricing action to help offset those. Deliveries in Q3 for the large international oil and gas projects will be lower in volume in profitability versus the second quarter of this year. Inefficiencies from prior facility consolidations will ease and diminish and our corporate expenses for compliance to Sarbanes-Oxley would be up. The near term, as indicated in our press release we are expecting third quarter earnings to be between $0.22 and $0.24 per share excluding any special charges, and we're not expecting any of those. And in the fourth quarter we're expecting $0.32 to $0.36 of earnings. And with that I will now turn the call back to David.

Thanks Ken. As you can see we're expecting a fairly good increase in earnings in the fourth quarter. We expect our markets to continue to improve. The oil and gas project orders are currently in our backlog and our schedule to ship. And the efficiencies from our planned consolidations should become fully realized. We are now preparing for the next stage of our development in CIRCOR. For those of you who have been following us during our first five years of existence, we have accomplished quite a bit. We reorganized ourselves in the Cohesive business groups, consolidated seven facilities, integrated six fold in acquisitions and reduced our working capital to generate a $140m of free cash flow paying down our debt and accumulating over $60m in cash.

We're continuing to improve our results with a strategy based on a broad product offering across a large number of international markets and accelerating acquisition program, and the gross of cost cutting actions including facility consolidations, inventory reduction, and the movement of manufacturing to lower cost areas. We feel good about what we're doing here and the results. But in our view many of the actions we took to get to this point, we were the low hanging fruit. We're setting our targets higher for profitability and for return on invested capital. But we realize this is going to take systemic changes in order to achieve the higher targets. To accomplish this, we have concluded that we need to begin moving toward a culture of operational excellence, employing lean sigma's principles throughout our businesses.

We have over the past few months visited best-in-class companies, which have adopted these lean principles and interviewed a variety of consultants and are now planning our own implementation. It begins with education and training which will occur at the second half of 2004, followed by a detailed plan for each of our business groups with a launching of Kaizan early 2005. This is not a short-term project for us. We expect our employee teams to make major changes in the way we operate in the office, in the shop floor and with our suppliers and customers, to improve our efficiencies, reduce costs, shrink lead times, and increase asset turns. By the end of this year, I expect to be able to share with you our three-year targets for improvements in each of these categories. You maybe asking yourself why didn't we start sooner, or why don't we do it right now? Well, we want to finish the facility consolidations we started, and we need to get through the Sarbanes-Oxley 404 process, which by the way is another cost reduction opportunity if we can shrink the number of internal control centers we have. Then we can more fully concentrate our efforts on implementing unique process report. That's it for our prepared comments and we now will open the lines up for questions you may have.

Thank you sir. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touchtone telephone. If you are using a speakerphone please be sure your mute function is turned off to allow your signal to reach our equipment. Once again, if you would like to pose a question, please press the star key followed by the digit one, at this time. And we'll pause just a moment to give everyone an opportunity to signal. We will begin with Ned Armstrong of Friedman, Billings, Ramsey.

Yes, good morning, gentlemen.

Hi, Ned.

I had a couple of questions, the first was about your supplier issues. Were these suppliers typically larger companies that were putting you at low on their priority list or is it smaller guys who are overwhelmed. Can you elaborate on that some more?

Ned, it took several forms. One example was, we had some European foundries closed and we've moved to alternate foundries who are having difficulty in meeting with specifications and volumes that we need. In other cases, entire of our foreign sourcing, we've moved to alternate suppliers, both in Asia and in the Far East, which again are having, as far as our initial samples we are not a prospect and has caused us to use the short-term outsourcing here, domestically. In other cases, we had ramp-ups on certain new product lines that existing suppliers have been able to meet satisfactorily and surprisingly it became, it was pretty pervasive in this current quarter that we just finished that affected a number of our businesses. But, it came in different flavors

Yes, this is Dave. We are all taken aback by the one in Europe. They were bankrupt quite suddenly and closed their door. We had to go in and get our patterns out and get them into alternative sourcing and we had to pay a premium to get that expedited, as we saw it, eastern European qualified vendor sources which we now have, and we should see that improve as the year progress here.

Do you think, these problems -- you will still have some, but too much lesser degree, but they should be corrected by year end, is that a accurate assessment?

That's an accurate assessment. Yes.

Okay. My second question was regarding the lean Six Sigma initiatives.

Yes.

What type of cost do you anticipate for those, over the next 18 months, i.e., training, bringing in consultants, what have you?

We're -- I was little totally surprised that we're able to find a consultant group that we are still negotiating with. So, I won't say too much but that they offer quite extensive training documents and programs that are not that expensive and are willing to come in quickly and teach us -- teach the -- so that we can have our own lean Kaizan, if that operator is here with a --

Our own staff quickly. So, I expect us to be spending $50,000 to $75,000 this year for Executive training. I myself -- I'm going to -- a couple of weeks of Kaizon and one week of extensive operational excellence training along with all my direct reports. And then next year looks to be between $500,000 and $600,000.

And that's to train all the line personnel?

That's to get us implemented. That's to train line personnel and start Kaizon events throughout our organization. And we should then be at a level of maybe 50% of that in following years, because they'll be back to help us maintain and make sure that we're continuing to apply the principles correctly. So, I think the paybacks are quite extensive and easily recapture the cost of this during the period. So, I don't expect us to change our earnings projections because of the cost of this. It maybe one quarter to another as we implement one quarter and receive -- recognize the benefits another quarter, but the full year should -- at the minimum balance our force.

Okay. My final question regards to your remarks about the chemical industry. Was the increases that you saw there do more to MRO spending or more projects coming online. Can you characterize that a little bit more specifically?

The remarks in the chemical industry related to some new CapEx in Asia. There's a new capital spending going on that we're supplying. But, the more impactful remark in the chemical industry is that we're expecting order improvements once it's domestically on the summer driving season, once refineries get some chances to have some maintenance after its production this summer.

Great. Okay, thank you.

And we'll go next to Michael Schneider of Robert W. Baird.

Good morning, guys.

Hi, Mike.

First, I guess, just on the Instrumentation segment, their consolidations that are ongoing. Where are you in this process now and indeed how much costs and disruptions are you anticipating in the second half and then is embedded in your guidance?

Mike, this is Dave. We are -- the US Para Plate and SSI moves are done. We're up the learning curve on both of those. We do have some as-do backlog that we're getting to as a last -- as everything else comes on board then you can deliver some of the accumulated past dues that occurred during this transition period. The Tomco, which was the largest one, we had to add 70 people down in Spartanburg and you've been there and that's quite a few people to add and we had a higher turnover rate than we have experienced in the past there for a variety of reasons. But, the bottom line is that to add 70 we have to go through probably a 100 people. And that hurt, that we didn't expect that. We're continuing to get through that piece of it now, in training the people -- the turnover has stopped. The training of the people is making progress, we're probably 80% to 90% through that. And then we'll start to see the efficiencies improve. One of the things that you get when you have that many people added is you tend to take the more experienced people on the shop floor off their job to help train the new people and that causes a double in efficiency and that's what we've experienced. We'll continue to see that in this upcoming quarter of that. But, in the fourth quarter, we're expecting that to be behind us and that's why we're upping our projection for that period.

Okay. And then in the same segment, the price increases you mentioned, can you give us orders of magnitude, maybe on both sides of the business or both sides of the segment?

Yes, certainly. I think on the Petrochemical segment, for the project side of it, it's all bid and speck. So it's hard for me to provide you with a percentage. On the MRO side, which is more less priced with discount sheets and so forth through distribution, that's about a 5% to 5.5% increase that was implemented. We've had our competition follow us in most cases, some have not. Those -- some of those that have followed, pulled back a little bit on it, we have not. But in the same time material and the fuel prices continue to increase. I'm sure you've seen that in other places. And we continue to try to find opportunities to even raise them again, but it doesn't look like anybody else in the market is going to be moving anytime soon, from what we gathered.

Okay and the instrumentation segment price increases?

Yes. In the instrumentation segment on the instrumentation -- saw a piece of that, it was about a 3.5% to 4% increase, by the way that's the first increase that they've had in probably three years, which I don't think was enough, but it was competitive. The majors -- we were following in that market, with Swagelok and Parker, and we're hoping to be able to increase that again soon because like I say, it wasn't enough to offset the continuing price increases that we're seeing in that category of the product. On the thermal fluid, it's a mixed bag both domestic and international. They were able to put probably a 3% to 4% increase through their markets.

Okay. And then when I look on the guidance on the petrochem side, you've reduced the margin expectations again in the second half, can you -- and as I understand you went through in the first quarter, and scrubbed the backlog, really got a better understanding as to what the embedded margin was in the backlog, but looks like you've reduced your expectations again. What was the change at the delta this quarter, that caused you to reduce your forecast again in the petrochem margin?

Mike, it's Ken. I was -- the predominant decrease driving at this quarter, is the volume shortfall on these large international projects and just to add a little color to the volume impact in these international projects, in this segment. A year ago, we had to this large international project in the third quarter of $16m. Fourth quarter was $18m. The best two quarters that they've ever had. The first quarter this year we did, I think was $15m; second quarter was $13m that we just finished. This quarter we're coming up to is $9m. That low amount of $9m of expected revenue to these large international projects this coming quarters, because we had a significant shortfall on order intakes this first quarter this year.

Sequentially we were kind of averaging almost $20m of orders intake last year, and we had $6m order intake this first quarter this year, for these large projects. Now we got back to almost $20m, here in the second quarter order intake, which drove that sequential order increase. Well when that order gap shortfall the first quarter occurs, it's going to leave a revenue gap sometime, and that sometime is the quarter we are now starting. Like these are generally six to eight months delivery times. These projects given the complexity and size of these products and that's significant of a volume drop. There's an -- to the amount of probability, that's not here in this quarter and that is essentially overwhelming, the improvement in orders here in North America and the pricing -- it's also been put through here in North America.

A couple of brighten notes for Mike, you'll be happy to note that the margins on the orders, that we booked in this second quarter, were equal to the ones that we enjoyed last year. So, that's not going to be an issue going forward. The other thing is that, there is a lot of fixed costs, not a lot, but a relative to their size. PPBSE in Italy has a cost structure that's relatively fixed. As you know it's not easy to fluctuate up and down, your employment cost in Italy. So, when you do have a shortfall in volume for one quarter, you are going to have to expect to see a reduced profitability level.

Okay. I guess I am still trying to understand now, what has changed, because back in April when you gave guidance, you knew that you had only 6m in shipments or orders in the first quarter. You had already seen the April orders and you gave guidance that petrochem margins for the year would be 10 to11, and it looks like the guidance now is something around 8.5% to 9%.

That two percentage, that 200 basis point decrease in our assessment for the second half now, versus our April assessment is largely driven off to North American pricing environment. As we've said, a little bit earlier in our prepared remarks, there are some notable competitors here in North America, that did not raise prices and we did.

Okay.

And others raised them less than we did, and in a commodity market place with commodity products, which is what the North America Market serves, because there are lot of competitors, including those from offshore, who want share, and want to keep their stackage busy. It is putting pressure on us and I don't think we are not covering all of the cost that we are receiving from our vendors and we can't pass all onto our customers because of our competitive pressure and we think, we are restricted at that from -- a bit moment there. So, that's the big change from where we thought we were going to be, last 90 days ago.

Okay, so the Delta from April to July, at least as far as the guidance goes, is not . It's KF in North America.

That is correct.

And the pricing environment there.

And the frustrating think for me Mike, is the fact that we -- that KF probably are -- the statistic side looked at, in the point to the where we raised our prices more than our competition of those who did raise the prices, let alone those who didn't touch their pricing. So, and steel prices continue to decline and I am anxious to see how things develop as the year progresses, with pricing from our competition.

Okay and let's see, I guess just a final question. For the second half, do you have a full understanding now, of the backlog in the petrochem segment and I guess, just give us some more color on the pricing of the existing projects. You mentioned Dave that they appeared to reflect last year's margins, but somewhat surprising given that last quarter, you have been talking that, margins were lower just because of types of projects have changed.

Yes.

May be just an update on that?

Yes, we have done more as we dive into, all these issues ourselves. You pickup more and more information and some of that margin decline I referred to last quarter, was also -- had mixed in it. The volume effects of the fixed cost structures of PBBS, which they did not break out separately, when in the analysis, that we are looking at. So some of that margin decline was because of lower volume expectations in future quarters. So, the pricing was less impactful, than I had indicated last quarter. So, that is helpful. That is good news, in my view. It is a matter of volume. The projects that we've quoted as I said and achieved, have done in the same realm of profitability as the ones we experienced last year and I think it is a matter of getting them out the door and absorbing the cost structure that we had at PBBS, is the profitability issue there, more than the pricing and mix of projects.

Okay, and I guess any relief in sight then, on the KF business that you can see? Is there anything you can do aside from waiting for your competitors to raise their prices?

Well, we're driving cost down as fast we can. We are finding ways, in fact we are probably going to be expanding our joint venture or maybe starting up another plant in China, or a wholly owned plant in China, to produce more and more components in products, under our own banner. We have to do that. That's just the market were in and we think we are ahead of the curve today and I think judging from some profitability numbers that we all have seen, I think people would agree that our profitability in the commodity market of close to 10% or around 10%, eight at that. I would to have it, higher and only we are going get there is to continue to drive the cost down.

Okay I will get back in line. Thanks.

Thank you.

We will go next to Jim Foung of the Gabelli & Company.

Hi, good morning.

Hi, Jim.

Yes, you had talked about the March projects you anticipate to ship in the third quarter about . How much do you think you'll ship in the fourth quarter, as you kind of get out the dips from the third quarter?

I think it is closer to $15m or so. It is a significant up but it's a significant portion of the sequential revenue rise and from third quarter to fourth quarter.

Okay.

It's probably two thirds of a 70% of it.

So would it be fair to say that starting the fourth quarter that would be a good base to kind of look at this I mean, Since that your orders are coming back in the petrochemical so it will be good base to kind of look at the petrochemical business, I mean this kind of a unusual dip in the third quarter.

That's certainly one way to look at it. But we certainly have an experience here in 2004 where the by order by quarters, it's lumpy. So we are hopeful, I think we continue to hear from our Italian management team that quotation activity is continued to be very active and strong and we read anecdotal information in the business press that capital spending particularly in the Middle East will be where our market and sales penetration is strong, that remarkable geography will be healthy going to the next years so we think 2005 could be a reasonably good year.

You don't season your order pattern is and you kind of low in order shipment like that you can be expensing your third quarter.

I didn't understand the question.

From your order pattern are you seeing any indication that you might have a shortfall in shipment in '05 in that to the third quarter this year?

Not this, not at this point. Not here on July 20.

Yes, toward .

Towards it, okay.

Yes, the order is that our ship in '05 are being booked as we speak so the third and fourth quarters order intake will set the tone for '05 for us in the project side. The MRO business in the Petrochemical side is up and down the you've all heard this story about the weather in Canada for years as they can get drilling rigs out there as in we can sell product but if the roads are muddy and it's a summer or wet fall that affects this as well so I can't try to predict, we're expecting some pretty good activity in the fourth quarter as all of these things come to bear.

Okay, could you just talk a little more maybe about the North America MRO business besides Canada I know you are guessing the US, are you seeing that kind of picking up of the quick in ship type of business.

We saw a pick up in the second quarter, third quarter, it's hard to tell, and you can't talk by a week and week and month to month. But generally the trend has been up, summer is usually slow for a lot of reasons but I think the trend for the balance of this year looks to be favorable for us.

You can't put a number on that anticipate what the year-over-year growth might be?

Not at this time.

That's a very high margin business for you as well.

Well, it has been historically but you know its because I've indicated fast, it becomes more and more commodities and we just talked about price increase a another sign that there's a lot of small or privately owned companies out there that have product producing capabilities and imports have becoming more accepted. We have to continue to drive cost down to maintain that kind of profitability level. Its one of the last five years that MRO businesses is changed dynamically.

Okay. And its what's in the material cost increase at this extension outside your business, I guess can't give in kind of a?

The commodity prices have risen globally and its metal cost from the producers in the mines are up, there has been a significant rise in demand particularly from China as its our manufacturing basis is grown significantly which has put pressure back on producers to supply and when the demand exceeds supply the prices are rising and that's what happened over last nine months except particularly in last six months.

Okay, could you guys put a number on that and say how many percent increase were year-over-year that you have seen in metal prices.

I did quantify my prepared remarks. I said the instrumentation thermal fluids are estimated to be a 100 basis point. decrease and at your chemical for the quarter was at 75 basis point.

Okay. In some, let me be give very specific for you if you like. In the bar stock same as steel bar stock and to me exotic, they've gone up 30% from a year ago.

Right, okay.

So, it is just pretty dramatic when you look at a specific line item, but fortunately everything we produce is exotic in stainless steel. Well, we have a mix of that.

And point, there we have a number of contracts with vendors when we are stretched to the end of '05. And we have been successful in holding those costs from the suppliers, and so they are getting a lot of pressure, but they are not being successful in passing it on to us, but where we have not been able to hold the line on contract pricing, It is back to those basis points numbers that I quoted.

Right, okay. Well the last question, how big is your aerospace exposure and then what kind of active use in aerospace, other Companies are seeing a pick-up in the after-market businesses, in the commercial use is kind of coming back, or in the after-market gross?

Well, aerospace is about 20% of that instrumentation and thermal fluid segment revenues. But there is both after-market and new CapEx standing that is driving that both order streams up for us.

Military has been pretty good for us all along and a recent announcement by Boeing and Airbus that you saw on Wall Street Journal two or three days ago. They are predicting some good things happening in '05-'06. So, we have growing prospects for that business. In fact, that's one of our focused areas for acquisition growth.

Okay. Of the 20% in terms of instrumentation and thermal, what is the split up between military and commercial? Is that fifty-fifty, or?

I'd say it is just reasonably close to that.

Okay. All right great, thank you.

You are welcome.

We will go next to Charlie of Hibernia South Coast. . Mr. Brady, please check your mute button, your line is open.

On the pricing issue, can you guys just talk a little bit about how much of the cost increase of stainless steel you were able to capture on price increases? I know on the instrumentation side you said you had increases, but it wasn't really enough.

Well, it was enough at the time we announced them but unfortunately stainless prices continue to increase. So, as of today, I would expect that we are recovering a half to three-quarter of the price increases or cost increase through our own price increases. So, we are looking closely and watching our competitors for another move in some of our markets where we have the capability of doing that, that is in the non-commodity businesses. We are pushing and considering more increases.

Okay. And on the vendor issue when you talked about switching from vendors in Asia, is that, and that is going to mix around understanding that, is it that the initial samples your answer were okay and then when they got into more of a full production run, it wasn't up to expected quality?

On some cases, we have initial samples that are below quality standards. For example, porosity; too much porosity in the metal and so we have had probably more specification issues than we have had to wrap up from the Asian suppliers.

Okay, but if you are looking at, maybe I don't understand it, if you looking at the initial samples, you are obviously getting samples and running them through and testing them for quality controls before you do it for wrap-up. That is the same time you haven't, probably you have not switched suppliers until you know that the quality specks are passed. What piece is I missing here that will be, if the specks coming in on the sample is not good, why is there a switch over to full production run?

Well, we don't have, we just don't take one sample in and then give a green light if it was successful. So, many times it takes, three, four, or five.

No, I understand that, but it sounds, maybe I misunderstood that --

You know we are finding some of these quality problems on the samples on nearly the fourth and fifth. You know we are ready to give a green light, but it is in our most recent sample that we discover a new problem, and in the meantime, because we have been happy with the first and second developments, we have been starting to throttle back current suppliers in anticipation of the continued success from the new supplier.

Okay. So it's sort of an in-transition process, and then?

Exactly.

Okay. And could you just talk a little bit more in detail about the power generation market, a little more detail about the trends you are just seeing there? You mentioned it's over capacity, but a little more clarity on that?

Well back, we used to enjoy a lot of sales to the Calpines of the world and we have Siemens and GE's supply, GE Electric -- GE, I'm sorry, back in the late 90s and like 2000, 2001. But there was so much overcapacity that was essentially built and put in place. That now there is -- we are in a period of excess capacity, quite frankly. And therefore, those kinds of producers, the Calpines and GE and others have got decreased volumes for their market because there's quite a bit of depressed demand because of the excess supply -- excess capacity. And until that works out, which some believe will begin in 2006, suppliers those that are in market are going to have depressed orders and revenues.

But are you selling into the Asian market, where there seems to be a little bit more growth in the PowerGen market?

We are, but it's certainly not to the degree of what's been decreased here in North America.

Okay.

Clearly, our market position has been in North America. And we are following GE as they sell turbines into China and so forth. The second tier suppliers where we supply components to, and we'll follow them. We are starting representation in sales activities in the China market for the power industry, as we speak. So, we are going to establish ourselves there and then later on, either through acquisition or our own investment, our strategy would -- in the next, I believe, 24 months, may be to start our own production there.

Okay. Then my last question, I'll get back in the queue. On the foreign exchange impact, I guess it was about 1% in the quarter. Is there an expectation for Q3, Q4? Obviously if you get the year-on-year, comparisons would become less and less. Similar comparisons for the second half?

Yes. Expect these numbers - -

Assuming there's no fluctuation, obviously, in the exchange rates.

Correct. There will be no change in this next two quarters to what the numbers we've put out.

Thanks very much.

You're welcome.

We'll go next to Rick D'Auteuil of Columbia Management.

I guess, my question involves the acquisitions you have done to date. I know there is a lot of moving parts here, with the restructuring and everything. But if you kind of do a postmortem on what you have done, and go back and re-evaluate the impact. Have you gotten what you hope to get out of those, in sort of a rear-view mirror look and what have you learned from that pet process because, to be honest, unfortunately we have been a long-time shareholder here, the IPO, and you guys have a tendency to miss more than you meet and I'm just wondering if that part of the equation is working or not working?

Well, it's obviously any company goes through a series of acquisitions, and the number we do especially small-sized ones as a mixed bag. And we are no different. I think one of the things that we are focusing on are those that have not gone the way we had expected. We changed our attitude towards that industry in particular, not in the specific acquisition that we did. The cryogenic business is one of those. We made a couple of acquisitions in the cryogenic field, and as we got more and more involved with it, we changed our view, our long-term view of that business with it's limited end-use customers limited to six or so major players in the world, and the effect that they have on the pricing of the products. So we've changed our attitude towards that market, and that was the lesson learned. As far as the other acquisitions that we've accomplished, we feel that they have been good ones for the long-term and short-term. We established as a budget, the financial justifications that we've made for these acquisitions to our Board, and that becomes our budget for the following years and we then track the performance to those numbers. And we've been within 80%, 90%, sometimes 110% of our initial expectations for these deals.

When you guys communicate to the street, usually when you make an acquisition even though many of them are small. I might think if you also put out its impact at least on earnings over some time period. When you go back and review that I don't know if it's easy to separate it. But are you in fact achieving those, the accretion from those deals? I guess with the exceptions, sounds like the cryogenic ones, perhaps not.

The exceptions for the cryogenic being stated, I would say within a reasonable attainment of the numbers that we had originally expected. Yes.

Okay. Thank You.

You are welcome.

And we will take a follow up from Michael Schneider of Robert W. Baird.

Could you address just Europe generally, we seem to be getting mixed signals, it may be outside of Petrochem, that is could you just address, what you have seen in Europe year-to-date?

Well I saw there are some pockets Mike, France and Germany in particular at least for our coverage's have been soft, particularly France, we had good success continued order intakes in the UK. Up in our analytic business that we purchased in DQS and Netherlands last fall. They had very robust first half and their sales penetration is hardly western Europe and the . So, I have some different answers, if I had to sum it all up, its probably neutral to slightly up with the donors being the French geography and economy. And German to it, a lesser extent.

Okay. Then just on PowerGen, I know you have walked through us some stuff already on that but it seems like your incrementally negative on that market, I am wondering what you have heard from your customers, your public reports that made you more cautious on that market?

I wouldn't say we are more cautious. We are sustaining --- this is lower than -- as it is a contrast to what we were three years ago. It's a market that we serve and to market that, does not, we don't see any up-tick here in the short line.

Okay. Fair enough.

There is been no change in our attitude or the market conditions that we see.

Okay.

I tried to, on that slide, to list all the significant markets that we do serve and say whether they are hot are cold.

And Ken just on Petrochem. It looks like if we added up your expecting $43.52m out of this year. How would that compare to last year in total?

They were not less than $60m last year.

Okay. And I am trying to get a sense of what the market potential of this Petrochem segment is in '05, if we assume in a back to rate of call its $60m to $65m, might get a stronger KF presumably with center margins due to the pricing pressures. Can this business get back to 10% margin next year or we fighting to sustain this 8.5% to 9.5% range because of KF's drag?

Well, our target is 10% and we have not changed that target and I think it is achievable next year, in spite of the pressure we are seeing in the pricing of North American in relation to the cost increases that we have experienced. Where we have sort of a anomaly right now with raw material prices and we are hoping and lightly so, I think that to see those raw material prices start to come down later on this year. All the pundits are indicating that and we hope the intendance come true. And we continued to drive through foreign sourcing our cost down and we think 10% is good number stop.

Okay. Thanks again.

And gentlemen at this time there are no further questions in the queue.

Okay. Well I take that it does for this quarter and again thank you for being on the second quarter earnings call. We look forward to updating you in October in our Q3 2004 results. Thank you very much for attending.

And that conclude today's conference call. We thank you for your participation. You may disconnect at this time.