Circor International Inc (CIR) 2005 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Circor International second quarter earnings conference call. Today's call will be recorded. [OPERATOR INSTRUCTIONS] I will now turn the conference over to your host Mr. Curhan McCann from the Company's Investor Relations firm.

Thank you very much. Good afternoon everyone. Welcome to our second quarter earnings call. Our objectives today are to review the Company's recent performance and provide its updated outlook on the second half of 2005. With David Bloss, the Chairman and CEO of Circor; Ken Smith, the Company's Chief Financial Officer; and Bill Higgins, the Company's Executive Vice President and COO. After the comments we'll then go to Q&A.

Before we start, two administrative notes. First, the slides we'll be referring to today are available on Circor's website at www.CIRCOR.com under the link 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 2004 Form 10-K which also can be viewed on the Company's website. Of course, actual results could differ materially from those anticipated or implied from today's remarks. Let me now turn the call over to Circor's Chairman, David Bloss.

Good afternoon, everyone. Well, we had a good quarter. There's lot of things going on here at Circor. We've started a number of initiatives designed to improve our operating performance. But unfortunately it costs money to do them and we've included that in our outlook. We'll take you through these items in detail in our discussion today. Our second quarter results were up nicely as you can see from our press release. Revenues were up 25% and earnings before special charges were up 56% with market conditions favorable across the board. The results were at the high end of our own expectations.

Pibiviesse was able to ship those unique new valves to ExxonMobil for their high pressure gas systems. If you recall they're the ones that held up production at our facility in the first quarter. Like I say, overall our markets are in good shape if you ignore the lumpy oil and gas business at our Pibiviesse operation in Italy, all of our other businesses show -- continue to show positive order trends versus last year and our backlogs are up as well. Our energy product segment showed a 40% revenue increase, and a 94% operating income increase with margins of almost 11%.

Those of you who are familiar with the oil and gas industry know that the quarterly order patterns are tough to follow because of the variability in large project activity. If you recall last year was a roller coaster ride for incoming orders with first quarter orders extremely low followed by a big second and fourth quarters making the full year a record for us in both orders and in backlog. This year we're seeing a more stable order pattern so even though the quarter numbers show a decrease on a year-to-date basis our energy segment is ahead of last year's orders by 8% globally coming off of a strong last year with North American markets up significantly and the international project activity remaining very robust. As indicated in the press release we have a number of letters of intent on hand for oil and gas project work, which included about 15 million euro at quarter end. But we will not record them as orders until the specs are done and delivery dates are established, which is our policy, which will occur in this third quarter.

Project shipments will remain rather up and down quarter to quarter but the trends are good and prospects for long legs to this cycle are look going right now. Our instrumentation and thermal flow control segment also did well with revenues up 15%, operating income up 22%, and margins at 12%. Margins could have been better but raw material prices climbed up some more and under absorption from inventory reductions at our instrumentation division affected this quarter's results. We expect some abatement of bar stock steel cost increases coming in August/September but inventory reduction and the resulting effect on absorption will continue as we apply Lean manufacturing techniques throughout the Company and drive our inventories down.

Most product lines within this segment had higher orders and we are up 10% in total excluding acquisitions as the aerospace, the steam industry, and the instrumentation markets are ahead of last year. Free cash flow was good. We generated 12 million net of an incremental 4 million in CapEx for new facilities which Ken will speak about, and our balance sheet remains extremely strong with very low leverage. Acquisition opportunities continue to come across our screen, at any time we have about three to four that we're looking at and today is no different than our history. We continue to be focused on moderate sized fold-in deals to existing businesses and have been patient and disciplined in our approach about evaluating them. Now let me turn this over to Ken and Bill who will provide you with a few more details.

Thanks, Dave. I'll start with slide 3. As David pointed out we had a very solid quarter, double-digit revenue growth both for the quarter and the first half compared to the same period last year. Our energy segment led the revenue growth with significant shipment volumes to large international projects notably in the Middle East. Our acquisitions of Mallard Controls in late April 2004 and of Loud Engineering in January 2005 also contributed to our results. Nearly all our other business units turned in higher revenues as their end markets continued to be healthy including the general industrial markets. Overall profitability significantly increased benefiting from the factors listed on the slide including leveraging our fixed costs on the higher sales volume. On free cash flow it's been reasonably good thus far in 2005 despite the working capital demands of fulfilling order -- fulfilling higher customer order levels and we'll discuss cash flow more when we get to slide five.

I'll turn to slide 4. Which details the P&L in more -- greater length including the non-operating expenses. The special charges, although modest in amount, are the incremental costs for closing and moving facilities. The 2005 costs relate to the downsizing and relocation of a French business, and to closing and moving two small U.S. plants. In France we're transferring our manufacturing capability from France to another one of our European plants, and we've accrued the severance costs. The two U.S. plants are in our Mallard Controls business that we purchased in April 2004, and we'll be moving that production from Texas to our KF business in Oklahoma. The French and Texas/Oklahoma changes are expected to be completed in the second half of 2005 and reduce our facilities square footage by approximately 75,000 square feet and although they will have a cash use of approximately $2 million they will yield an annual cash savings approximating $1.5 million.

Regarding corporate expenses, the majority of the change for the quarter reflects increased compensation costs including variable compensation incentives. It also includes relocations for new employees and a small increase for professional audit fees. Of the year to date corporate expense difference, half of the 2.2 million is for higher audit fees for SOX 404, another 25% for variable incentive compensation increases, compared to last year, and the remaining 25% is for new hires, including our new COO, Bill who is with us today. Net interest expense was lower due to our annual principal payments of $15 million each quarter, which are on our senior notes, and income taxes continue to be accrued at 35% effective tax rate, the same rate as we had last year, for the comparable period.

Turning to slide number 5 in the cash flow from operations and free cash flow there are two notable items. First, we've used nearly $10 million in the first half of 2005 to increase inventory to support our record backlog which includes long lead time forgings for our -- the Middle East gas projects, and we've yet to gain some meaningful traction on our inventory reduction. However, Bill Higgins, our new COO, has certainly led to fast introduction of Lean manufacturing into our key plants and we believe we've only just begun to make some beginning sustainable improvements. Secondly, in CapEx, as David mentioned earlier, we have used $4 million for two facilities. One was in Rotterdam where we intend to consolidate three European businesses of our CIT division during the next 12 months, and a second facility is being constructed in China which we will expect to complete in the fourth quarter of 2005, and into which we intend to relocate our current Chinese plant. This new China facility is larger than our current facility and will enable us to expand its capabilities beyond the oil and gas products it builds today. Although not on this slide, number 5, because it's not included in free cash flow, we did invest another $6 million this past quarter to complete the purchase of the 40% minority ownership in our Chinese joint venture. So we now own 100% of it and we look forward to utilizing it and its new plant for expanding our thermal fluid controls and CIT product lines in Europe and in Asia.

Now to slide number 6, the balance sheet. Our balance sheet continues to be very healthy with a debt to capitalization ratio of only 13%. In 2004 we were in a net cash position and now at the end of the second quarter of 2005 we're in a net debt position after paying a net $35 million of cash in January of 2005 for the acquisition of Loud engineering. Now Bill Higgins will speak of our segment performance.

Thanks, Ken. I'll start with slide 7 and our instrumentation and thermal fluid segment results. Regarding orders, as Ken mentioned, our end markets are generally strong, military, aerospace, power gen, chemical, and general industrial markets are solid. Strength has been somewhat offset by continued weakness in our U.S. Navy business and softness in the steam related commercial HVAC business. In general the majority of our businesses have achieved solid organic growth both quarter over quarter and for the first half of the year.

In addition to the organic growth, we've benefited from our acquisition of Loud Engineering in January 2005. As you might recall Loud manufactures components and sub assemblies and provides after market repair and overhaul service primarily for the military helicopter market which has also been a strong market for us. Revenues have grown solidly in our instrumentation and thermal fluid businesses for the reasons I just mentioned. And as noted on the slide, the revenue growth has come from a combination Loud acquisition organic growth and a little benefit from foreign exchange. Operating income and margin have been improved both quarter over quarter and year to date despite some of the unfavorable items we noted on the slide. Our raw material steel costs have continued to rise in 2005 even ahead of our January 2005 levels. The rate of increase has been ahead of what we expected and what we planned for when we implemented price increases to our customers in 2004 so we're going to be watching the material costs closely and will consider further price increases factoring in our competitive price positions.

Now we look at slide number 8, our energy product segment. The oil and gas market served by this segment continue to be very healthy as Dave mentioned, both the international large projects and the domestic production and distribution. The Q2 order decline merely reflects on the large international project order pattern which is understandably fluctuating given the unevenness of spending for the multi-billion-dollar CapEx projects. As you know the CapEx project in the Middle East to expand LNG and new gas-to-liquid capabilities are being developed in Qatar, Kuwait, and the Emirates. The dramatic increase in revenues was the net result of several factors, as noted on this slide, largest of which was sharp rise in the volume of shipments made by our Italian business, the unit which has been successful serving the Middle East projects. Q2 2005 also includes revenues for certain large scheduled shipments that were pushed into Q2 from Q1, as we mentioned before, due to the lengthy customer testing inspections at our Italian business unit.

As for operating income and margin, the increase was predominantly due to the contribution margin from higher volume of shipments and including other factor of pricing as listed on the slide, slide 8 also contribute to the net rise in operating margin. As mentioned earlier we're now in the early stages of consolidating two small U.S. plants into our larger Oklahoma facility. Both were acquired when we purchased the Texas-based Mallard Controls company last year and this consolidation is well underway and will be completed this year.

Now if we turn to slide number 9, on this slide we point out our assumptions for our key end markets that we serve and factors we expect will influence the degree of our near-term success. Most of the markets we serve are expected to be positive in 2005. We did have some softness for new projects in the steam related commercial HVAC market and we continue to experience softness in the maritime U.S. market as the U.S. Department of Defense has directed spending to the Iraq war.

Now turning to slide number 10 as we translate the market assumptions shown on slide 9 into our business assumptions for the year 2005 on slide 10, we expect a healthy second half of 2005 compared to the second half of 2004, both in revenue growth and in earnings. Regarding just the third quarter 2005 we're providing EPS guidance of $0.28 to $0.31 per diluted share excluding the special charges and other facility consolidation costs. That $0.28 to $0.31 compares very favorably to the $0.22 we reported for the third quarter in 2004. The excluded special charges approximate about 300,000 for moved costs for the U.S. plants to Oklahoma and the excluded other facility costs would approximate about $200,000 for the overlapping new staff in Oklahoma before we released the Texas employees.

Our third quarter revenue projections include the fact that Q3 is typically the lowest seasonal quarter of the year, particularly with European vacations, plus the warm weather dampens our sales of steam related products and the fact that we had such a spike in shipments in Q2 2005. As for operating margins and earnings, our third quarter of 2005 excluding special charges and related facility consolidation costs include the following assumptions, we expect to continue lumpiness in the energy business due to the nature of the project business. We're expecting continuing higher raw material and energy costs from suppliers and we expect to see continued unabsorbed manufacturing spending due to our expected inventory reduction of 5 to $6 million resulting from our operational improvements focus on operational excellence and Lean manufacturing. Regarding the fourth quarter 2005 we're expecting sequentially higher revenues and earnings as key project orders in our backlog are scheduled to ship and Q4 is seasonally a stronger quarter for the steam related product in the oil and gas drilling activity in western Canada.

Also on slide 10 we show corporate expenses for the 12 months ending December 2005, corporate expenses are expected to be $2 million higher than 2004 to approximately $13 million. Half of that increase is for -- for 2004 is for variable incentive comp, or annual bonuses, of which they were next to nil in 2004. The balance of it is for higher corporate development and key staff additions, such as myself, driving the Lean implementation and operational performance improvements. Costs associated with our SOX 404 compliance and audit are expected to remain at last year's high levels but should be lower next year as we complete our restructuring and upgrading of our internal business controls and standardizing our processes. Regarding cash we have certain large cash outlays in 2005. Our 2005 CapEx will include $9 million for new facilities. The one in Europe that we just completed this spring to co-locate the consolidation of smaller facilities and our new plant in China to replace a current smaller facility. $4 million of the expected 9 million total for these two buildings was spent in the first half of 2005.

We announced in December 2004 an agreement to buy out the 40% majority -- sorry, minority owner in our Chinese joint venture and that purchase was completed this past quarter and used nearly $7 million and resulted in Circor having 100% ownership of our Chinese operations. This becomes an even more significant asset for us to expand our sales penetration into China, the Pac Rim region as well as increase our Chinese manufacture and foreign sourcing of components. To summarize our outlook we have solid end markets in general, healthy backlogs. We continue to focus on the implementation of Lean manufacturing across the Company to drive operational process improvement and we'll continue rationalizing facilities for improved efficiency. With that we would like to open up the lines for any questions that you might have.

Thank you. [OPERATOR INSTRUCTIONS] Our first question will come from Ned Armstrong, FBR.

Good afternoon.

Hi, Ned.

With regard to margins and driving margin improvement, how high do you think you can get your margins and what type of time frame do you envision that occurring within?

We've normally indicated in the past that the -- that the two segments obviously have different margin capabilities. In the energy products business you have a mixture of high-end complicated high spec, high pressure, large bore valves along with smaller size valves that are more commoditized. In general we think we're running around 10 or 11% today. We think that we're in a good cycle right now and that probably 10 to 12% would be the range we'd expect that to be able to operate in.

On the instrumentation and thermal fluid control business it's a mixture of a number of product lines serving a variety of different markets, a lot of niche businesses. So it depends a lot on the mix of those, Ned, and in total, those tend to be, on average, higher margin than the energy products business. So we tend to think of those as 13 to 16% operating profit businesses throughout the various cycles. If all of the markets are kicking in at the same time, then you'll see us in the higher end of that. As we begin applying Lean and consolidating facilities with the additional floor space that's being generated and folding in the current platforms that we have, smaller plants into the larger facilities, we expect to be on the high end of both of those ranges probably within the next 18 to 24 months.

Okay. Do you -- what are the major impediments to achieving that, in your opinion?

Well, one thing that's currently been taking up a lot of our efforts and time is raw material prices and our ability to be able to pass those on in a lot of our markets we don't have leadership position in, and, therefore, we are -- in some cases, in many cases, we're leading the charge in increasing prices, which we've demonstrated in the past nine months. So that's one area. The ability to pass on continued high price increases. We're hoping to see some -- we've seen some leveling off and as we indicated there may be some abatement coming forward, at least in bar stocks deal in the next few months, at least that's what our vendors are indicating to us. But it also depends on the capacity of foundries and their ability to deliver on a timely basis as everybody knows, the capacity of domestic foundries shrank quite a bit during the last cycle. We've got to get on cue and be able to receive supplies from them on a standardized basis. That could be an impediment to our delivery lead times, and costs. Our ability to consolidate facilities. We've successfully done that in the past. I don't see any reasons that we should -- that should be an impediment to achieve the numbers I've indicated to you. Bill, anything else?

I don't have anything to add, Dave. I think we've got a pretty good pace started with our process improvement, Lean initiatives across the major businesses. It's going to take us a little bit of time to work through that. I'd make the space available for consolidations but I don't see that as an impediment. That's something we got to do.

Thank you.

You're welcome.

And our next question comes from Andrea Wirth with Robert Baird.

If we could just start instrumentation, just looking at market assumptions for the second half of the year the only thing that kind of moved was your commercial HVAC outlook. I guess maybe what's going on there? With commercial construction continuing to accelerate I would have thought that would have been a little bit better market for you. Is it more weather driven, or kind of what's the issue there?

Well, where our strongest market penetration is for commercial HVAC is for those project which involve steam, power heating and cooling, and there is a strong proportion of new products that are gas-fired for heating and cooling. So essentially installations that are steam powered, where there are going to be hospitals expand, their steam loops or university campuses, which are often fueled by steam-generated for heating and cooling, as well as municipal, the Con Eds, the Detroit Edisons when they have projects of new high rises that extend off of their, and tap off their under ground main steam lines that does benefit. But at the moment steam related new projects are few and far between at the moment. But that's not to say -- it probably says that what project are out there are more gas-fired.

Then a little bit on the profitability and instrumentation. You call it underabsorption and also raw materials. Could you give us an idea, as to what each of those -- rough idea as to what each of those actually in dollar amount impacted the margins?

Talking about year-over-year?

Yes.

Well, the year-over-year, we actually had margin improvement.

Right. But I guess, what was is the dollar amount, or the impact from the under absorption? Would you guess, you're talking a couple million -- $1 million? $0.5 million?

I'd say it's -- could be approaching 100 basis points.

100 basis points. And is that going to be a similar impact next quarter when you plan to take the inventory down 5 to $6 million, similar kind of underabsorption hit as well, or are we talking a larger number?

I think it's going to be similar, plus we'll have -- because we've had the other incremental piece of the third quarter will be that the -- some of these rising steel costs that we've born here in the 2005 first half will start to cycle through as we sell that product off, so that will be an incremental piece third quarter.

Okay. So I guess at this point right now there is a gap between price and cost? Right now your costs are running higher than your current pricing and instrumentation?

Yes. We actually exited 2004 and began 2005 feeling pretty good that we closed that gap for the 2004 cost increases on raw material. However, as we've described, the cost increases continue here in the first half of '05 and actually through where we are in the third quarter.

And your plans for price increases going forward you said you're looking at that right now?

Yes.

And what's your idea right now as far as soon as you can get those? Are we talking by the end of the year?

Well, w're taking a look at all of our individual businesses and now it's not as easy today as it was at the end of the fourth quarter to put blanket price increases across the whole product line. We have to analyze that selectively looking at product line by product line, and we're doing that currently. We've already instituted and are in the middle of announcing an add or two, some of the instrumentation products also within the energy products -- product line, the KF domestic pieces of that, we're looking and announcing some price increases there, too. So we're responding selectively now rather than our ability to just blanket the market with our full product line changing distributor price list.

A way to add to that, Dave, in some businesses there will be price increases occurring in the third quarter.

Yes.

For new orders.

And then I guess back to on KF, talk a little bit about the market there. How did that business perform? What's the overall view on the MRL market in general?

It's doing quite well. The only hesitation that we had was in the Canadian market where it's all weather-driven, as you know, and where everybody's pointing to a very strong second half from Canada. So it's gone up quite nicely for us North America. Let me see if I can split some trends out for you quickly here.

For the half year it's up 23% over the prior year.

The order rates are very strong.

I'm sorry, that was up 23% in North America?

Year to date.

Year to date?

Yes.

Okay. And then just on Pibiviesse, obviously that business is doing great. Can you give us an idea where capacity is right now? Are you guys running out of room?

No, we're anticipating, as I said in my comments, some legs to this cycle that it's in, and as you probably know we subcontract -- we've developed a business model at our Pibiviesse business to subcontract a lot of the machining so we don't have to go through the pains of down-sizing every time a cycle hits us so that benefits us. What we do need is more testing and assembling capability and we have the floor space to do it, but that floor space is currently being used by some machine and equipment which we will start sourcing some of those components from China once we expand, that's one of the reasons we're moving and expanding that Chinese facility. So things will move nicely, we'll be able to add assembly and test capability at our existing facility in Milan and move out some of that equipment to either subcontractor or to our Chinese joint venture which is being given more capability than it had in the past. It's a lot more -- we have a lot more flexibility in what we do with that Chinese operation now that we own 100% of it, and it's pretty nice.

One last question. Just on the corporate expense last quarter you guys had said it was essentially going to be in line with the prior year, now you've kind of bumped -- which was about, what, 10.3--.

About 11.9.

I'm sorry, what?

Almost 11 million last year.

Okay. So now you've bumped it up to 13 so what were the -- where did that incremental $2 million come from over the last three months?

It came from -- since that time we've had new estimates from our external audit firms on what their costs for 2005 will be. And we've got some -- that's the bulk of the rise although we also have some increases in some of our corporate development activities.

And that's the Lean and Six Sigma?

That but more in the acquisition investigation area.

Okay.

But still the bulk of that increase is where I had thought we were going to have some decreases in '05 for Sarbanes 404, and that's not turning out to be the case this year, year two.

All right. Great. Thanks, guys.

Thank you.

And we'll take our next question from Mark Grzymski with Needham & Company.

Hi, Mark.

How are you? Bill, I'm looking at the operational improvements, and you might have touched on this with Ned's questions, and I apologize if I use the wrong terminology here but as far as like low hanging fruit where you've gotten some consolidations underway here in the U.S. what percentage of the improvements that you've kind of estimated are low hanging and what percentage are going to take longer time and are going to be more of a challenge for you and your folks and -- well, the whole company? Excuse me.

Well, that's a tough question. It's hard to quantify that. We're in the middle of some current consolidation plans. We're also in the middle of our planning stage of our next phase of consolidation opportunities. I just haven't taken pencil to paper -- this is Dave, by the way. And I really haven't segregated the two for you.

I may make a distinction too, this is Bill, between low hanging fruit and accelerating our improvement. We're very early in the Lean activities and we're learning a lot across a number of businesses so it's not so much that there's low hanging fruit that we're going after as it we'll pick up momentum and it's going to take us time to get that momentum going. I don't look at it more on the front end as I do is it accelerating on the -- a little bit longer term.

Right. Okay.

Tough question.

Yes, I know. I'm hesitant to use the low hanging fruit, but--.

I'd love to find low hanging fruit.

And I thought we got all of it already.

I guess that's why I threw it out there. Well, thank you. Thanks for the color there. Also, you talked about the Sarbanes Oxley, but looking past '05, you're indicating that you're not going to see that much improvement there, but do you think looking at SG&A in '06 that you could get back to a run rate that you saw in '04 or similar or are we going to see -- how are you seeing that? Or how are you guys looking at it in '06?

Well, the Sarbanes piece, which is a significant portion of corporate expenses, I do expect, in year three, to be a decrease for us, because this year not only -- year two, which is 2005, we're bearing a cost -- an increase -- as you know, we had to take advantage of the extra time period for small cap firms. We were afforded some extra time to file our Sarbanes reports here for 2004, which we did. And it took us a lot of effort to wrap that up with our auditors and some of the -- actually the -- because we learned of it, in late Q1, actually some of our 2004 compliance costs is in our 2005 P&L, as well as realizing that the decreases that I was hoping for in 2005 are not going to be realized. So when I get to -- and when the Company gets to 2006 and we've gotten two years of learning from this process and the compliance effort, plus the positive steps we're taking to standardize controls, combine and reduce some of the ledger sites and commonize many of our processes, I do expect to have a noticeable improvement/reduction in the spending for '06.

This is a real priority item from a management standpoint our operating unit managers are on task to ingrain these business controls and improve processes throughout the organization so as to reduce the amount of errors and testing and so forth, make the whole process much smoother and easier to do, and I will be personally upset if we don't see some significant decreases in that cost in '06.

There are some other aspects, just to speak about other portions of corporate expense. 2006 will provide for many who have not chosen to expense stock options. I believe the new rule comes into play, beginning January 2006 companies like Circor where we've only merely footnoted the impact, will be required to expense stock options. So that will be an element of the 2006 plan that we've got to be constructing here in the next several months. But apart from stock options and apart from SOX 404 costs, I would expect our other staffing and compensation costs and shareholder spending and director fees and all the other things that go into our corporate expense bucket will probably be comparable to what we've -- and has been comparable largely to 2005.

Well, we've got some recruiting costs in there in '05, they'll go away, too, and relocation costs for a few people, so you'll see some decline.

That was very helpful. I appreciate it. Just finally, David, you were talking about the legs of the cycle that you're seeing and the energy side in Europe, for example. I was wondering if we can kind of change gears, and looking at the industrial cycle here domestically and the legs that you're kind of envisioning here, I know you talked earlier about the light commercial construction market being very strong, hospitals, universities -- well, not so much that, but other parts of that. Could you just give us a little color there?

Yes, I can give you some color for that, I'd be glad to. There's two pieces of our business that address the industrial market, commercial market. One is contained within the energy products business. It's the smaller size ball valves. We do some check valves and butterfly valves that go into the commercial industrial markets. That's been moving along pretty well. The downside there is a lot of that stuff has been commoditized over the past eight -- five to eight years and we're now very selective in the higher end severe service side of that but still that's probably a $20 million piece of business for us and it's up nicely year-over-year.

The other piece is a part of the instrumentation business that goes into process, analytical equipment and other devices that go into industrial process environments. That business is doing quite well. That was a later cycle pickup than what we normally see with industrial production indexes. It started to show some good growth here in '05, and a lot of people were seeing that sector increase late '04 so it was -- it was a little behind in us seeing that. I can't figure out why it was. But it is healthy for us now, it's up nicely year-over-year and quarter to quarter. We're talking maybe -- probably 12%, 13% or so quarterly recorder so that's a nice increase for us but that includes some pricing as well that we instituted to offset some of the material costs. That's about all the flavor I can add to the North American industrial market for you.

All right. Thanks guys. Very nice quarter.

Thanks.

And now we'll take a follow-up question from Ned Armstrong.

Yes. With regard to the Loud acquisition, how much in earnings per share do you anticipate that will add to this year's number?

Ken's got his calculator out.

I can hear the gears turning.

I thought we were in the $0.09 to $0.10 range.

$0.09 to $0.10 Ken?

Yes.

Great. Thank you.

We'll go next to Mike Schneider with Robert W. Baird.

Good afternoon, guys.

Hi, Mike.

First, I guess, just trying to assess the puts and the takes here on the instrumentation business you've got the inventory reduction that's going on here in the third quarter, 5 to 6 million. That ill cause some underabsorption, you've got the steam unit. You're obviously lowering your expectations there. And you've also reduced your margin outlook for the year from the range of 13 to 14 down to just 13. I'm curious, I'm curious if those are the two items driving the reduction and we will see presumably once we get beyond the inventory reduction impact another resurgence of the margins there or is there more going on? Because as you probably even see in my note this morning that the margin there just seem to be frustratingly lagging the rest of business.

Yes, we keep doing things to that segment like consolidating plants and causing some inefficiencies and it's just masking some of the incremental benefit that you'd expect to see because of the volume. I agree with you 100%. I think you outlined the major pieces. The only other piece I could add to that possibly is what's occurred in this first half and material steel prices continuing to escalate and our ability to pass those on. We're hoping to get some pricing -- additional pricing in the second half and we're seeing some decrease in the bar stock steel prices, so we're hoping that piece of it to come into the equation by the end of the year. I think you hit upon the major points.

Focusing on the revenue assumption as well for the year in instrumentation and thermal fluid, looks like you reduced your organic growth number from 7 to 9 down to 4.5 to 6.5. What does that reduction relate to? Is that steam only or is there more?

Predominantly steam only.

Okay.

We're expecting some recovery on this commercial HVAC, steam-related commercial HVAC, but a fair portion of this segment's revenues and it's a very profitable product line for us.

Okay. Then switching gears to pibiviesse, what's the status of pricing in that market? We talked last year about how most of the sophisticated alloy, high-margin projects have probably come and gone now. What's left?

I don't recall making that statement but if I did -- Ken is shaking his head telling me I did say it. There isn't a lot of -- we're seeing continued quotation activity and order activity on the severe service side, the exotic metals. Some of those -- that ExxonMobil order that held us up the first quarter, shipped to second, that was a stainless steel with an overlay of exotic metal on top of it which costs $1 million per valve. So -- and we're taking orders for more similar type valves as we move forward here. That market is strong. We continue to see it strong. I've heard other people refer to it as hot. It is a hot market right now and we're well positioned in that sector.

The material cost equation for Pibiviesse is held at bay because of our quotation, it's a project-orient business so as we prepare a quotation for a project we get fixed price for maybe 30, 45 days from the foundries and forging houses, and then we include that current cost in our quotation, and our quotation is subject to that same time limitation, and when we get notification of letters of intent, then we go ahead and lock in on -- with those vendors so that we have consistency in our raw material pricing in our quoted price to the customer so that's not an issue as much as it is for normal distribution type business.

Which quarter are you actually booking into right now for Pibiviesse?

Second quarter of next year.

Okay. And then the guidance, Ken, does it include charges now for the second half of the year?

Does it include special charges?

Yes.

No, does it not.

What type of special -- what's the range of special charges you expect in the third and fourth quarters?

I think in our prepared remarks we said in the third quarter was about 300 grand of the historical, what we'd call special charges and we've got about another millionish in the fourth quarter. Which is earmarked for some European consolidations related to that Rotterdam facility.

Just given the preference for GAAP accounting now, in'06 are you going to start running these through or are you going to continue to call them out?

It's a debate I'm having with myself and others here at the Company so we're -- we've not yet settled out on the answer there.

If you take a step back and look at the guidance now, it really looks like overall your operating income assumption really hasn't changed. Yes, you've boosted energy but you trimmed instrumentation by a commensurate amount and really the differential comes from corporate expenses. So my question is, that if you haven't really lowered your operating income assumption why are you now booking $1 million extra in variable comp against corporate expense? Were you simply underaccruing in the first quarter?

We had some underaccruals in the first quarter and the overperformance now that we think we'll have for the full year puts us well over our internal targets.

But if you haven't raised your guidance, Ken, does that mean presumably your target is actually higher than that? You've raised it internally?

The target for the comp plan has remained -- it was approved the beginning of the year so that's not changed.

I believe that is all. Thank you.

[OPERATOR INSTRUCTIONS] And at this time we have no questions standing by. I'd like to turn the conference back to Mr. Bloss for any additional or closing comments.

Thanks. Appreciate everybody taking the time to listen in on our call, and we'll be seeing you in early November to review the third quarter results.

I have one clarifying thought.

Okay.

To follow on to my answer to Mike.

Hang on, everybody.

That comp comparison of where we say we've got $1 million increase, that is compared to 2004 actuals. That's not a change in the guidance that we had. Does that help, Mike?

He can't respond now.

All right. We're done.

Thank you very much, everybody.

Thank you for your participation in today's conference call. You may disconnect at this time.