Circor International Inc (CIR) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the CIRCOR International third quarter 2006 earnings conference. Today's call is being recorded. [OPERATOR INSTRUCTIONS] Now I'd like to turn the conference over to your host, Mr. Curhan McCann. Please go ahead.

Thank you very much. Good morning, everyone. Welcome to our third quarter earnings call. Our objectives today are to review the Company's recent performance and provide an updated outlook on the full year 2006 with David Bloss, the Chairman and CEO of CIRCOR; Bill Higgins, the Company's Chief Operating Officer; and Ken Smith, its Chief Financial Officer. After their comments, we will then go to Q&A.

But before we start, two administrative notes. First, the slides we will be referring to today are available on CIRCOR's website at www.circor.com, 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 2005 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 the CIRCOR's Chairman, David Bloss.

Good morning, everyone. We posted numbers for the third quarter that show a number of positive trends. First, the market activity is healthy. Backlogs remain close to last quarter's record, up 70% over last year, excluding acquisitions. Orders increased 10% over last year, also excluding acquisitions with solid market activity across-the-board, even though our orders for large oil and gas projects took a breather from the torrid pace in the first half. But not to worry. Activity on projects continued to be good, but the order awards are lumpy. But the quoting activity remains strong.

Second, operating margins continue to climb. We are taking advantage of the strong demand in our Energy segment. It reported over 13% operating margins this past quarter and our Instrumentation and Thermal Fluid Controls segment came in at 9.5%. It's good to see sequential improvement, but as we indicated, more work is needed to get this segment back to the margins that we think it can deliver.

Third, our recent acquisitions are all outperforming our expectations. Sagebrush has been a homerun for us. Revenues are nearly double our initial expectations in the first year of ownership. Hale Hamilton had a strong quarter and year-to-date beat our original forecast, although the British Navy spending may be tightening a bit.

The Industria Aerospace business in France is doing well. Their delivery performance has been improved through our lean initiatives and their customer satisfaction index has improved as well. Loud's military helicopter landing gear business has a strong backlog given the high usage and demand worldwide for the Chinook helicopter platforms. With all these orders on hand and the 70% increase in backlogs, our inventories have increased as well impacting our cash flow. But we expect these inventories to come down as we ship and bring our backlog down to more normal levels.

I'd like to say a couple words more about our Instrumentation and Thermal Fluid Controls segment. In this segment we still have a lot of work to do to optimize our performance. The improvement we saw in the third quarter is marginal, but it was a sign of progress for us. Behind the scenes and not yet reflected in the numbers, we are seeing our production facilities running smoother and past-due orders being reduced. That means less overtime in expediting in the future. Meanwhile, suppliers are being qualified for outsourcing components to lower our costs and other cost reduction initiatives are being planned and implemented. Although the improvement in reported results is slower than we would like, we are making substantial operating improvements in this segment that should become realized as we make our way through 2007.

My last point before I turn it over to Ken and Bill is to congratulate Bill publicly. That's his recent appointment to President of the Company. Bill joined us about 19 months ago and has been leading our initiative into the lean implementation of our operations. Over that time he has given us great confidence in his abilities to continue that transformation and see us through that difficult transition that companies always go through in transforming themselves. We all wish Bill the best of luck. We'll support him tremendously as he moves forward now.

Okay, with that I will now turn the call over to Ken. He will take you through more details of the financials.

Thanks David. I'll begin by referring to our presentation slides starting with slide number three. We had an excellent revenue growth this quarter and also year-to-date. For the third quarter, the revenue increase was led by our Energy segment's organic growth and our latest three acquisitions -- Industria in October 2005; and two this year in February, Sagebrush and Hale Hamilton. Plus our Instrumentation and Thermal Fluids segment achieved a 10% organic increase in revenues. Regarding profitability, we had a very strong margin expansion in both of our segments and had additional contribution from our lower tax rate. The EPS for the quarter was just over the top end of our guidance that was provided in our August 2 investor call.

Free cash flow was positive for the quarter and the first nine months of 2006. But the smaller source of cash this year compared to the same period last year are directly the result of higher levels of working capital in 2006 to support the significant growth in orders, which as the slide denotes, was a robust 66% for the nine-month period with similar growth in our backlog.

Now I'll turn to slide number four, which details the P&L. Bill will discuss the strong segment operating income in later slides. I'll add color on special charges, corporate expenses, interest expense, and income taxes. First, the special charges. The 2006 amount is largely a pension curtailment charge, which we incurred in connection with the freeze of our qualified pension plan. This past July we froze future benefits under this plan. Future retirement benefits will be provided under an enhanced 401[K] plan for our US employees. The special charges in 2005 were for facility consolidations in our Energy segment and downsizing of French operation in our Thermal Fluids Group.

Second, regarding corporate expenses, they rose this year and include the new accounting rule requiring stock options to be expensed, which was an incremental expense of 300,000 pre-tax in Q3 2006 or $0.01 per share and 900,000 pre-tax for the nine month period of 2006 or $0.04 per share. The remainder of the period, the period increases stem from consulting project and [variable] compensation.

Third, regarding interest expense, it his higher this year as we've borrowed more and we've nearly doubled our leverage in 2006 to 21%, debt-to-cap. In early 2006, we borrowed $61 million for the two acquisitions of Sagebrush and Hale Hamilton. And, as we've mentioned earlier, our large order growth and high backlog have meant a substantial investment in working capital.

Lastly, regarding income taxes, we reduced our 2006 effective tax rate by 200 basis points to 32%, which is a rate reduction we believe will be sustained.

Now to slide number five, cash flow. In the cash flow from operations and free cash flow, the most notable difference between the periods is the cash used for more working capital to support the near-record backlogs and the 38% revenue growth this quarter. Inside our working capital, we have continued to be effective in managing our DSO, which has been a very competitive 61days at the end of September 2006. This is particularly important to us since we have grown our international revenues where commercial terms average nearly 90 days to pay. For the full year 2006, we expect cash flow from operations to be in the range of $10 to $15 million and free cash flow to approximate around $5 million.

Now to slide six, the balance sheet. Our balance sheet continues to be very healthy. As I described earlier, the increased leverage in 2006 resulted from borrowing $61 million for the purchases of Hale Hamilton and Sagebrush earlier this year. Since the close of Q3 2006, we had a noteworthy milestone as we have paid the final annual installment on our original $75 million private placement, which carried a fixed-rate coupon of 8&2/3%. Although we borrowed some from our revolver this month to help pay off that private placement, it is certainly nice to have that high-rate debt gone.

Now Bill Higgins, CIRCOR's President, will speak about our segment performance.

Thank you Ken. Now if we look at slide number seven, our Instrumentation and Thermal Fluids segment results, starting with orders. As mentioned, the end markets served by this segment have been positive on top of strong contribution from our acquisitions. Organic order growth has been solid in the steam-related, HVAC, power-generation, and aerospace markets. We've seen mid single digit organic order growth from the chemical, general, and industrial markets. As David noted, the acquisitions of Industria in October '05 and Hale Hamilton in February of this year, performed well, both units exceeding our expectations in their first year with CIRCOR.

Revenues have grown solidly in Instrumentation and Thermal Fluid businesses, strongly aided by acquisitions. Sales of the steam-related products into the commercial HVAC and power-gen markets are strong as well as sales in aerospace and followed by increased shipments in the chemical, general, and industrial markets.

Regarding operating income and margin, we're not satisfied with the margin rate in this segment, particularly given the good performance in winning orders and expanding the top-line. We have put a significantly stronger and more experienced management team in place in these businesses. As they hit their stride, we're confident this segment's performance will be taken to a higher level. As we noted previously, this segment is challenged with the continued rise in stainless steel surcharges, capacity constraints at key suppliers, and lower productivity in some plants as we rebuild our operations and reengineer our supply chain capabilities. We are seeing visible signs of improvement from our lean manufacturing and six sigma initiatives on the factory floor, which initially shows up as higher output and improved performance to our customers. As David indicated, the sequential progress this quarter to 9.5% is encouraging and is a result of the improvement initiatives underway. But we still have a lot more work to do to sustain the double-digit bottom line results that we expect. So we continue to build out a more robust supply chain, both domestically and globally that will help us offset material cost pressures. We are expanding and enhancing our factory planning and supplier management capability to more efficiently use our existing production capacity and overcome the general tightness we see in capacity at some of our suppliers. That has been driving longer lead times for parts and causing expediting costs.

As I mentioned, to achieve double-digit operating margin in this segment, we've invested in much stronger leadership that is leading the transformation towards operational excellence and doing it in multiple facilities at the same time. This is no small task. It will take us time. We're fundamentally rebuilding how we run our operations. We did expect to see steady progress in most business units within this segment in Q3 2006. And we did. And we expect the progress to continue through Q4 and into next year.

Now turning to slide eight, our Energy Products segment, the oil and gas end markets served by this segment continue to be very healthy, for both large international products as well as domestic production and distribution. The total order increase as well as the organic increase were substantial, particularly for the nine month period supported by the robustness of the global oil and gas markets. Q3 orders were very strong in North America and lumpy, as Dave mentioned, from the large international projects. Sagebrush, as we mentioned before, has nearly doubled its revenues since we purchased it earlier this year. In general, the energy markets are very strong. Revenues are a mirror of orders. Our existing and acquired energy businesses have been very strong. With $165 million backlog at the end of Q3 2006, we expect a strong Q4 and a solid 2007.

As for profitability, we had outstanding operating margin expansion in this segment. It resulted from the benefit of a number of factors including the higher volume driven by market demand into which we've been able to increase prices. We've improved factory and supply chain performance with our lean manufacturing improvements in North America and China operations enabling efficient capacity expansion to meet the rising demand. We have the benefit of the consolidation of the Mallard and Hydroseal product lines from Texas into Oklahoma last year. And we have the benefit of expanding production in our new China manufacturing plant, which serves as a key supplier to our North American customers.

Now let's turn to slide number nine. On this slide we point out our assumptions for key end markets that we serve. Most are expected to be positive for the remainder of 2006. Looking beyond 2006, nearly all our businesses are expecting a positive 2007, although we're in the middle of our budget planning season right now and will provide an outlook for 2007 at our next investor call.

Turn to slide number 10, our expectations for revenue and margins in 2006 are cited. For revenue growth, we expect both segments to have double-digit growth over 2005. Regarding operating margins and in particular our Instrumentation and Thermal Fluid Products segment, it will take time to fix our supply chain issues, continue to strengthen management in key operations and material planning roles, and complete the improvement and actions I've described. As I've said earlier, this is no small task. The multitude of improvements underway will take time. We expect to see steady progress in most business units within this segment, including modest progress in Q4 2006 in Thermal Fluids and Aerospace. Our Hoke product line in Instrumentation will require more time and effort to achieve the levels of performance we expect. So looking into 2007 for the Instrumentation and Thermal Fluids Products segment operating margins, we expect to increase by 100 basis points every six months, which considers the longer term time needed to improve our Instrumentation product group.

Although not on slide 10, we have provided EPS guidance in our earnings press release for the fourth quarter of 2006 of $0.56 to $0.58 per diluted share, excluding special charges. The range of $0.56 to $0.58 is favorable to our fourth quarter of 2005 when we reported $0.33 per share, excluding special charges. For cash flow, we expect cash flow from operations of $10 to $15 million. This reflects continued use of working capital for most of the remainder of 2006, particularly in receivables and to a lesser amount in Q4 2006 inventories to meet the growing shipment plan.

So to summarize our outlook, we have good end market conditions, healthy backlogs. We've got stronger management teams in place. We're driving improvement on multiple fronts to grow the top-line and improve performance on the bottom line. We're deploying the lean manufacturing six sigma methodologies to develop a culture of operational excellence for the long-term benefit of our customers and shareholders. We are raising prices where we can, consolidating facilities to reduce fixed costs, and reengineering our supply chains, particularly globally to take advantage of the lower cost of foreign supply.

With that, we'd like to open up the lines for any questions you might have.

Thank you. [OPERATOR INSTRUCTIONS]. Michael Schneider with Robert W. Baird.

Good morning. Congratulations, Bill.

Thanks, Mike.

Maybe first we could focus on Instrumentation and Thermal Fluid. Can you give us an update now nine months into the year as to what businesses are still probably most in need of margin improvement as we head into '07 so we can begin to understand the dynamics of the pluses and minuses in that segment.

I think as we indicated in the comments at the end, the Hoke product line within the Instrumentation Group is where we have the most work still in front of us. We've made some nice progress in other areas. But that is the one where we require the most work.

Are those more supplier issues or are they process issues?

It's a combination of material costs, supplier issues as well as our own process issues that we are working on.

Then if we go back, even earlier this year, there were other businesses, probably that were in most need. Who has made the most progress this year?

Who has made the most progress?

Yes.

I think our North American Energy business has done a nice job of improving. But in the segment we were just referring to, Thermal Fluids and Aerospace are both making nice progress.

As we go forward now, you've talked about getting this business back to the low double- and mid double-digits that we were at historically. Do any of the acquisitions either aid that margin or depress that margin from a mix standpoint, longer-term?

I think longer-term, the acquisitions in the segment, which were the Industria, Aerospace in Europe, in this past Q1 Hale Hamilton will assist that.

Anything about Hoke structurally now that, I guess, is lower margin going forward and would actually weigh on that business? Or do you believe you can restore the historical margins?

I think that depends on competitive environment as well. As we indicated before, we're a distant number three in that marketplace. There has been pricing pressure for some time now. If that changes, then obviously the numbers can return. That piece of it, we're not in control of. What we are doing is doing everything we can to get as near as our historic profitability by doing the things Bill elaborated on -- reducing our cost structure; consolidating some facilities; streamlining our approach in foreign sourcing to lower cost components. There is a lot of opportunity there for us. We're still machining -- screw machining products in North America. That, as you know, that's done on cost basis elsewhere. There is a lot of opportunity, even just on the cost side. But we are going to need some help on the pricing side to get us back to those traditional margins that we enjoyed three years ago.

I guess that is the ultimate question. If in these strong markets, you are not getting the pricing you need, as the US economy -- really global economy decelerates in '07 and '08, what makes you think you are actually going to get more favorable pricing?

We believe that the time will come when people will have to raise some prices. We're astonished that they haven't done it already, to tell you quite frankly. There have been a lot of stainless steel increases, as you know. People have chosen to absorb them. Don't ask me why or how. But they have absorbed them. Of course, they have the benefit of much higher volumes than we have. So that helps them a little bit to defray some of that cost.

But you are right. As I say, if they don't, then it is going to be maybe a couple of points lower than our historical averages.

Okay. And then the goal to improve margins 100 basis points every six months. Is that on a sequential basis or a year-over-year basis, Bill?

A sequential basis, every six months.

Okay, alright. I'll get back in the queue. Thanks again.

Ned Armstrong with FBR & Co.

Good morning. I think Dave, in your comments you alluded to a slowdown in big oil projects, which I think you believe will pick up again in subsequent quarters.

: Yes.

Is that based upon your experience in the business? Or is that what customers are telling you? Can you give a little bit of color?

Sure I can. It's based upon what customers are telling us and the heavy quotation activity that is going on continually in our operations, particularly at Pibiviesse in Italy. That is where the major project activity is for our Middle Eastern projects. Exxon Mobil, BP -- they are all spending -- continuing to spend large sums of money on long-term projects that spread out to 2010, sometimes 2012. Those are on the board being designed and engineered. We are assisting in the quotation activity. These are big projects. They could come in lumps of $5, $8, $10 million to us at one time. So if you get a couple of those one quarter and maybe one of those in another quarter, you'll see a big drop in incoming orders. But my comments were toned to reflect the fact that the activity levels continue to be strong.

When you talk to your customers, do you detect any hesitancy or caution relative to the way that your conversations were say, a year ago?

Well, gee. No, I don't think so. North American distribution -- we go through distribution in North America. They are feeling pretty good about the near-term prospects. A year ago, obviously, there were different pricing mechanisms out there for oil and gas. But we saw our incoming order rates starting to climb starting about twelve months ago and climb nicely. They are sustaining it at good levels. You read and hear about a possible slowdown. We haven't seen it yet. Our customers also are looking at that closely. But they haven't given us any indication of a change. I think it is flattening out at pretty high levels. I have not heard of any anticipated decline.

Thank you.

Charlie Brady with BMO Capital Markets.

Thanks. Good morning. I apologize if my questions have been covered. I got on the call a little late. In your comments, you mentioned you had strong performance at Hale Hamilton as well as Industria. I am assuming that issues at airbus, particularly as it pertains to Industria, are really not having impact on that business at all?

No, really it hasn't. Any issues at airbus are future-looking issues. We have a pretty strong diversity of sales in aerospace in Europe through Industria. They are in good shape.

Having that business within CIRCOR now obviously [indiscernible] the European aerospace, has there been any leverage between that and the US side of the aerospace business? Do you see any significant advantage of having both in-house?

Yes. There is synergy that gives us a footprint in both key aerospace markets, if that is your question.

Also on the aerospace side, I think on the last call you mentioned that in the fourth quarter there were [indiscernible] for booking a number of aerospace shipments. Those are the higher-margin type of stuff. Is that still the case? Or did any of it get moved either forward or back?

I think the one everyone is watching is the A3-80, which is a little bit further out there. It has really been in the early stages of development. The other production on the A3-20 in Europe and the efforts at Boeing in the US, both on the 787 and the Loud Chinook helicopter program are pretty solid.

Thanks.

Mark Grzymski with Needham & Company.

Good morning and congratulations.

Thank you.

Are you seeing any order cancellations in the quarter? If so, has that been picking up?

The quick answer to that is no. We haven't seen any cancellations at all. No.

In regards to the Energy segment, are you seeing lead times push out? Is backlog going to go out as originally scheduled?

I think -- our lead times, are you talking about?

That's correct.

We've gone through this period of pushing out our lead times as we absorb this avalanche of activity -- increased activity. I think that has smoothed out now. Our lead times are starting to pull back in. We increased our capacity in China in our new expanded facility there, which is going extremely well, by the way. Bill was telling me the other day that we used to ship one container a week out of that factory. Now we're up to four containers a week. Or is it a day?

It's a day.

It's a day. So the flow of product coming out of China and the acceptance of our Chinese-made product into the North American market has improved dramatically. So that bodes well. That hits our sweet spot of our cost structure, lower cost environment, and our capacity ability. That allows us to shrink those lead times a little bit.

How about from the customer side? Are you seeing any of these larger projects that you mentioned being pushed back? Or do things remain on track?

Basically on track. You see some push-back sometimes because they can't get the ships into port to pickup our valves. If you've every seen those large-bore ball valves in Italy, they are crated in wooden crates and it looks like a mini-housing project going on in our parking lot. We're waiting for ships to come in or their inspectors to come out and give us final inspection approval before they ship them. Those are the only delays we're seeing. It is the result of probably shipping capacity and availability of transportation. And maybe there is just so much construction going on they are behind schedule. But that's it.

Two more questions. Ken, the 10% organic growth that you had in Thermal, what percentage of that specifically was related to pricing?

Probably a couple points -- two or three points. The majority of it was unit volume.

Lastly, I guess people's opinions on the general industrial environment domestically is up in the air. Dave, what is your feeling right now?

We're watching it carefully. If you really analyze the niches that we serve, the aerospace market has its own unique characteristics, usually not affected by general industrial activity. The steam businesses are focused on power plants. Heating systems, that is more commercial construction in those heating districts and the US Navy, which we know has been reduced over the past two, two and a half years. In the Energy business, that is where most of the industrial -- two places that the general industrial activity affects us. It's in the Instrumentation business and in our Energy Products business. Within Energy Products there is about $20, $25 million business that focuses on general industrial valves for chemical processing and ethanol and those types of things. That would affect us to that magnitude. The Hoke business is so diversified. You have these small instrumentation analyzers, sampling systems, conditioning systems, through all fluid processes of any nature, that is affected. That's probably a $50 million business for us domestically. In that business, in particular, we haven't seen any slowdown at this point.

It sounds very positive. Thanks for taking my questions.

Richard Glass with Morgan Stanley.

Nice Quarter. And congratulations to Bill.

Thanks Richard.

I've got some softer, fuzzier questions than hard numbers. Can you talk about some of the management changes that have gone on in the past year in terms of, obviously not Dave and Bill and Ken, but below that level. How pervasive has that been? What have you been up to there essentially?

The second thing is, could you talk about the lean manufacturing efforts and where we are in that and how far we have to go and what kind of progress we've made. Thanks.

Be glad to. We worked hard and did a number of assessments, evaluations throughout the Company as we were deploying the lean program and looking at the talent that we have and the processes that we have. We're rebuilding in places where we need to. In some cases we've been able to find talent within. But we have recruited a large proportion of our management talent from outside. I have to say, I feel very good about the talent we've brought in -- what we call A players from the who's who of first class manufacturing companies to lead primarily the Thermal Fluids Instrumentation businesses. A little bit in the other businesses. But that is really where the bulk of the change has been made. There are different stages of forming teams and rebuilding their processes and procedures. There has been a fair amount of work there.

Regarding the lean manufacturing initiatives, we deployed primarily in North America when we started the first twelve months. We have now deployed lean initiatives overseas, really just getting going in Europe. We did a little bit of work in China last year with the new facility. When we constructed that we used lean techniques to lay out the plant. So it very flexible. We are using Kaizen techniques to set up the assembly operations there.

The facilities in North America have made nice progress. A number of them have had -- they are running multiple Kaizen events every month. More than half of the employee population at some of our larger facilities have been through lean training and lean Kaizen improvement activities. There are half a dozen facilities that, if you walked in today, would look different than they did last year.

It's still early in the process. We're still deploying techniques around visual factory management, around quality, around flow in the plant. It's still very, very early in the process. But the progress is good. We're building the capability to do that effort internally as well. When we bring in talent from outside, we're bringing in experts in six sigma lean manufacturing as well.

Thanks. Keep up the good work.

[OPERATOR INSTRUCTIONS] John Franzreb with Sidoti & Company.

Good morning. I want talk a little bit about capacity utilization in the Energy Products Group. I know you mentioned earlier that China has been a great help. What kind of rates are we running at? Are you constrained in any part of that business?

In the China operation, we're expanding capacity as we go. We're staying ahead of it in that it is growing very rapidly. We're still not even using 50% of the facility we constructed. The US/North American operations in Energy -- we're expanding that as we go primarily through the lean efforts, the kinds of activity on the factory floor. We've been able to put more throughput through with the same number or less people and square footage. So we haven't -- I don't think we've hit a barrier yet. I think we're in good shape.

Pibiviesse in Italy, that is a large borer. Big project activity goes on there. We've just launched lean there as well. We're hoping to see some improvement in capacity. But [aside from that], I think we're keeping up with the demand rate. The customers on these big projects know what the lead times are because of the sourcing of the forgings and so forth. We subcontract a lot of the machining over there. Our subcontractors have some depth. We don't see them running out of capacity. It's a matter of our capability to engineer, assemble, and test. We have that capacity to keep up with our present demand.

Fantastic. Regarding the outsourcing, can you talk about what kind of progress you've made in outsourcing and where you stand in that whole program.

It's different progress in different business units. Fundamentally we are developing the capability to manage a global supply chain. We have leveraged the China operation. We are using that across the Company to help us manage supply out of China, manage the quality of it if it's not something we make ourselves. That gives us a footprint in China. We are working in other regions of the world as well. Really building that capability, which maybe six or twelve months ago, we wouldn't have found in the Company.

Referencing the previous caller, in terms of [indiscernible] the management talent, do you think you enough talent in place now. Are you still looking to improve in certain areas?

We have a strong team in place. We're going to continue to look at the talent. Our goal is to have sufficient talent, and bench strength of talent, so that we can continue to improve production and integrate acquisitions. We've got more room to go, but we are in real good shape right now.

One last question. What kind of charges are you expecting in the fourth quarter? Can you give us some kind of idea of what kind of hits we might be taking in Q4?

We think there will be approximately $500,000 of pre-tax of special charges that will relate to consolidation activities.

Okay, great. Good quarter. Thank you.

Ned Armstrong.

This also deals with some of your lean efforts at TFC. When you look at what needs to be done, what do you think the most challenging areas are?

You are referring to the whole segment -- Instrumentation and Thermal Fluid Controls?

Yes. As your lean efforts apply there, what do you think the most challenges will be over the course of this quarter and next year?

I think the biggest challenge, as we've noted, is in the Hoke product line and Instrumentation. There is a lot of hard work going on there. That is the single biggest single challenge. After that, it's a little bit different in each business unit. There are different places. There are different products. We're making progress with the lean and with the skills and the people. The Hoke product line would be our biggest challenge.

Just to elaborate on it a little bit more, are there cultural issues that are resisting the change? Or is it just that there is so much work to be done that it's overwhelming?

There is a lot of work to be done. It's not a cultural issue. It's just the multiple fronts we're working on.

Okay. Thank you.

Michael Schneider.

Could you address the Energy segment in Q4. If you look at the guidance you've given for the year, it implies that Q4 is going to be nearly a 14% margin in Energy. That is obviously a blockbuster and record number for that segment. Can you give some sense of why the mix is so strong. Is it just an unusual bucket of orders that are being delivered in Q4? Any color on that would be helpful.

I would provide a two-part answer to that question. First, on the top-line we do expect sequential revenue improvement for it -- I mean in the high double-digits, high teens. On the operating margin that we're expecting in the fourth quarter for it, as the slide points out, these are margins without special charges. That 500,000 expected pre-tax charge in the fourth quarter for special consolidation is in that segment. So I think if you stripped that consolidation fee out, we're expecting something in the 13.5 range for that quarter.

As you have begun to outsource and deploy lean throughout that segment, etc., and obviously a very strong market, have you raised your long-term expectations for profitability in this segment? Because going back even to '98 at the time of the spin, we used to talk about this business being no better than a 10,11% margin business in the peak. Now we've been running consistently between 11, 12, and now even 13%.

We continue to raise the bar for our operating manages in that segment. The whole dynamics of that business has changed. The volume activity gives you pricing opportunity. Competitively there has been some consolidation occurring. We are in a better position with people like Exxon Mobil on the higher end of the product range where you can get more profitability from the more technology that you put into the valves. There are a number of factors.

The answer to your question is yes. Next week we go on our budget review. I can hardly wait to see what they have in store for us as they put together their budgets for '07.

It's no longer just a mix issue. Because in some of the past two or three years when you've blow-out margin quarters, you have usually attributed it to more sophisticated alloy projects or something like that. It's no longer just that?

No. It's more than that now. It's -- there have been some structural changes in the landscape of that market.

Thanks again.

Charlie Brady.

On the back of Mike's question, did I hear you correctly on the Energy Products side in fourth quarter revenues that you are expecting that to be up sequentially high double-digit, high teens?

Yes.

Thanks. I just wanted that clarification. I appreciate it.

Gentlemen, there appear to be no further questions at this time. I will turn the conference back to you for any additional or closing remarks.

I think we've had a lot of good questions and I think a good summary as a result of these discussions for our current quarter. We look forward to seeing you at the end of our year. I think this one is February.

February 21, we will release.

So the 22nd is the call. So we'll you then. Thank you for calling in.

That does conclude today's conference call. Thank you for your participation.