Circor International Inc (CIR) 2006 Q4 法說會逐字稿

Please stand by. Good day ladies and gentlemen. Welcome to the CIRCOR International's Fourth Quarter 2006 Earnings Conference Call. Today's call will be recorded. At this time all participants have been placed in a listen-only mode. The floor will be open for questions following the presentation. I will now turn the call over to your host Mr. Curhan McCann from the Company's Investor Relations firm. Please go ahead, sir.

Thank you very much and good morning everyone. Welcome to our Fourth Quarter Earnings Call. Our objectives today are to review the Company's recent performance and provide an updated outlook for the full year 2007 with David Bloss, the Chairman and CEO of CIRCOR; Bill Higgins, the Company's President and Chief Operating Officer; and Ken Smith, the Chief Financial Officer. After their comments, we will then go to Q&A.

But before we start two administrative items. 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 risk factors, we advise you to read about them in the Company's 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.

Thank you, good morning everyone. 2006 was a very good year for CIRCOR with revenues up 31% our earnings are up 42%. We ended the year in great shape with backlogs at about 286 million as orders for the year were up 60% over 2005.

The fourth quarter was an especially good one for our Energy Products Group with very strong market activity and profitability exceeding 15%. Although the fourth quarter included some large project shipments and one-time delivery bonuses as we explained in our release, we are expecting another banner year in 2007 for this segment.

We had some setbacks in our Instrumentation and Thermal Fluid Controls segment as I'm sure you have seen in the fourth quarter. Bill Higgins will take you through the details but the bottom line is that we are not coming off of our objective to improve the profitability of this business by at least 200 basis points but we need a little bit more time to complete the implementation of our various initiatives. We are confident that we now have the right talent on board to make it happen and that the right steps are being taken to restructure our internal processes and outsource components where appropriate to lower our cost structure and improve our delivery performance. With those few remarks I'll now turn the call over to Ken and Bill for further details for you.

Thanks, David and I'll be referring to slide number three to begin my remarks. Ask David stated we had an outstanding record quarter which contributes to a terrific record year. Both revenues and earnings were very strong for the quarter. The revenue increase was led by our Energy segment's organic growth and our latest three acquisitions, - the Industria acquisition in October '05 and two acquisitions in February of '06 Sagebrush and Hale Hamilton.

Both segments revenues benefited from the shipment of high margin projects. Particularly the large international oil and gas projects and also the aerospace customers. Regarding profitability we had a very strong margin expansion in our Energy Products segment as it delivered an operating margin in excess of 15% in the fourth quarter 2006.

We also benefited from a lower income tax rate that contributed $0.03 per share and even without that tax rate reduction we turned in earnings per share for the quarter that was just over the top end of our guidance provided in our November 2nd Investor call.

Free cash flow was positive for the quarter and the year, but the smaller source of cash in 2006, compared to the same period last year, is directly the result of higher levels of working capital in 2006 to support the significant growth in orders, that we had this year.

And now turn to slide number four which details the P&L. Bill will discuss the significant rise in the segment operating income in later slides so I'll add color on the special charges, corporate expenses, interest expense and taxes. First special charges. The full year 2006 amount is largely a pension curtailment charge incurred in connection with the freeze of our qualified US pension plan. This past July we froze future benefits under this plan and future retirement benefits will be provided under our enhanced 401k plan for our US employees.

The special charges in 2005 were for -- to fill the consolidations in our Energy segment's North American businesses plus down-sizing one French operation in our Thermofluids Group and as an aside, this small French business was ultimately sold in the fourth quarter 2006.

Second, corporate expenses rose and the primary reason in the quarter and the year was the new accounting rule requiring stock options to be expensed starting in January 2006. This meant an incremental expense of $300,000 pretax or $0.01 per share in the fourth quarter of '06 and for the full year it was $1.2 million pretax or $0.05 per share.

Regarding interest expense it was higher in 2006 because we borrowed more and it increased our leverage to approximately 20% step to cap during most of 2006. In late January 2006, we borrowed $61 million for the two acquisitions, Sagebrush and Hale Hamilton, and while during 2006 we used our cash earnings to fund substantial investment and working capital to support the order growth and high backlogs.

And lastly, regarding income taxes the slide shows large increases in tax expense both for the quarter and year. Unfortunately when you earn a lot of money as we did in 2006 we have to incur a higher expense. However, we did reduce our 2006 effective tax rate to 30.6% and did so in the fourth quarter from 32% that we had recorded in the first nine month of 2006. This full year rate reduction resulted from our recording US and French research tax credits.

Our tax rate for 2007 is expected to be 32%, which is an increase in the full of 2006 rate of 30.6% and this rate increase largely reflects the loss of the US tax reduction for export sales that expired at the end of 2006 for all US taxpayers.

Now to slide five, cash flow. In the cash flow from operations and free cash flow the most notable difference between the periods is the use of cash for working capital. We did invest a lot in 2006 primarily in receivables as we had a 41% revenue growth this quarter compared to Q4 '05.

Regarding receivables we have continued to be effective in managing our DSOs, a very competitive 58 days as of December end 2006. And this is particularly noteworthy to us since we have grown our international revenues where commercial terms typically average 90 days or more to pay.

Regarding inventories, we have invested in inventories during 2006 yet we have also been successful in receiving significant amounts of cash advances from project-related customers which helps fund our purchase of long lead time components, and we'll talk later about our expected increase in cash flow in 2007.

Now to slide six, the balance sheet which continue to be very healthy. During the fourth quarter 2006 we had a noteworthy milestone in that we paid off our final $15 million of our private placement notes which carry a fixed-rate coupon of 8.25%. And also in the fourth quarter 2006 we paid off a $7.5 million industrial revenue bond that had come due. The increased leverage in 2006 resulted from borrowing $61 million as I mentioned earlier for the purchase of Hale Hamilton and Sagebrush back in February. This borrowing against our revolver carried an interest rate of approximately 5.8% for most of 2006.

And now Bill Higgins, CIRCOR's President will speak about our segments performance.

Thanks, Ken. Good morning everyone. Now looking at slide seven our Instrumentation and Thermofluids segment results. This segment had a very mixed quarter. Regarding orders, the end markets served by this segment have been positive on top of strong contribution from our acquisitions so organic order growth has been solid in Power Generation and Aerospace markets with mid-single digit organic order growth from Chemical and General Industrial markets.

The steam-related HVAC product lines got off to a slower seasonal start due to the warmer weather. Q4 orders appeared flat year-over-year on chart for the -- a large aerospace order booked in fourth quarter of 2005 making for an unusual comparison. Although not shown on the chart were beginning 2007 with a healthy backlog in this segment. In fact the backlog entering 2007 is up 35% at $133 million including acquisitions that is up 18% if we exclude acquisitions in this segment compared to how we ended last year.

Revenues have grown solidly in most of our Instrumentation and Thermal Fluid businesses strongly aided by our acquisitions. Sales in steam-related products and for commercial HVAC was lower than expected due to the warmer seasonal weather. Our Power Generation and Aerospace markets are strong as well as sales into the Chemical and General Industrial markets.

Although it's not showing up on the bottle line yet, some of these revenue growth is a benefit from our lean manufacturing improvements that are yielding faster product throughput, better delivery performance and responsiveness to our customers. For example we were able to overcome supply chain constraints in Aerospace and shipped a large quantity of landing gear set that have been held up due to long forging lead times and supplier capacity constraints.

However, regarding operating margin we had a very unsatisfactory quarter with 8.2% in the fourth quarter of 2006. The third to fourth quarter decline from 9.5% is attributed to higher than expected costs in our Hoke Instrumentation business. In the past we have discussed the challenges in this product line which more than offset the revenue and margin improvements from our other businesses in this segment, namely our Aerospace and Simulated Product groups.

There are three main elements that comprise this segment's higher than expected costs. First in the fourth quarter of 2006 this segment incurred approximately 70 basis points worth of short-term costs for inventory-related charges and for relocation of new managers due to the acceleration and top grading of our leadership talent.

Second this segment incurred approximately 100 basis points of additional costs that are personnel-related including costs of reorganizing management and the operations and the resulting higher labor and other employee costs.

Third, this segment shipped a mix of products in the fourth quarter of 2006 that had lower margin accounting for approximately 50 basis points.

All of these issues had action plans to be resolved in early 2007. Another actions underway include building low cost offshore supplier materials to offset material inflation, rearranging our factories for better flow of product and training our workforce in the tools of lean manufacturing, six sigma, and product line and facility rationalizations. This is no small task we have a lot of work underway, we have great teams in place that we expect to achieve double-digit bottom-line results in this segment. However we are going to remain conservative in projections until we demonstrate that the actions are taking hold.

Now turning to slide eight our Energy Product segment. The oil and gas and markets served by this segment continue to be very healthy for both large international project business as well as domestic production and distribution. The total order increase as well as the organic increase were substantial supported by the robustness of the global oil and gas markets. Q4 orders were very strong for large international projects and this segment's 2006 acquisition of Sagebrush has nearly doubled its revenues since we purchased it.

In short, the energy market continues to be very strong. Revenues are a mirror of the significant order growth, our existing and acquired energy businesses have been very strong this year and with it's $172 million backlog at the end of Q4 2006 we expect a solid 2007. As for profitability this segment turned in its highest ever quarterly operating margin, had outstanding operating margin expansion resulting from the benefit of a number of factors including higher unit volume driven by the market demand into which we have been able to increase prices and pull out some share gains. And with improved factory and supply chain performance with lean manufacturing in our North American and China operations enabling efficient capacity expansion to meet the rising demand. And we have set an high-margin shipments to international projects include a special bonus for early delivery in major projects in the Middle East. Plus we've had the benefit of the consolidation of the Mallard and Hydroseal product lines from Texas into Oklahoma in late 2005 and the benefit of expanding production in our China manufacturing plant which serves as a key supplier to our North American customers and provides us with a lower cost of goods sold.

Now let's turn to slide nine. On this slide we point out our assumptions for key-end markets that we serve. Nearly all our businesses are expecting a positive 2007.

Now turning to slide ten. Our expectations for our revenue and margin in 2007 are cited here. For revenue growth we expect both segments to have single digit growth over 2006 and for our Energy and Product segments is operating now at or near the peak of this current energy cycle and have already delivered nearly 20% organic revenue growth in each of the last two years. So we expect this energy segment to have high single digit revenue growth in 2007.

Regarding operating margins and in particular our Instrumentation and Thermal Fluids segment, they will take time to fix our supply chain issues and strengthen management, operations and materials planning and complete the improvement actions I've described. As I stated earlier this is no small task and the multiple of these improvements under way will take time. We do expect to see steady progress in most business units within the segment. Our Hoke product line and instrumentation require more time and effort to achieve the levels of performance we expect.

Although, not on slide 10 we have provided EPS guidance in our earnings press release for the first quarter of 2007 of $0.41 to $0.43 per diluted share excluding anticipated special charges. The range of $0.41 to $0.43 is favorable to the first quarter of 2006 when we reported $0.32 per share. This is lower than our fourth quarter because of the tax benefit high margin shipments in energy and taking a more conservative outlook in our Instrumentation and Thermal Fluid Control segment.

You recall our goal is to achieve 100 basis points improvement every six months in the Instrumentation and Thermal Fluids Control segment. While the progress is not sequential we still expect to see significant improvement in this segment starting in the second quarter. We still expect to exit the year at a run rate of greater than 10% operating margin which was our original goal. One of the actions underway will result in a facility closing later this quarter which will result in a special charge. Closure costs will approximate a $1 million in the first half of 2007 with estimated annual savings of $1.7 million per year.

For cash flow we expect cash flow from operations of $55 to $60 million. This reflects the slow rate of revenue growth compared to 2006 and some reduction in working capital particularly in receivables, [inaudible] amount in inventories.

So that summarize our outlook we have good end markets and healthy backlogs, with stronger management teams in place for driving improvement on multiple fronts to grow the top line and improve performance on the bottom line, we are deploying lean manufacturing methodologies to develop a culture of operational excellence for the long-term benefit for our customers and shareholders, we are rationalizing product lines and consolidating facilities to reduce fixed costs and we are re-engineering our supply-chain particularly globally to take advantage of lower cost foreign supply.

In summation this gets us to the full year guidance we've shown on slide number 10. So with that we would like to open the lines for any questions that you might have.

[OPERATOR INSTRUCTIONS]. We will take our first question from Michael Schneider from Robert W. Baird & Company.

Good morning, guys.

Good morning.

All right. Obvious topic is Hoke. David, maybe you can just give us a sense of, I guess, what changed during the quarter there are some new deployments of the lean initiatives or your pieces in this -- what ever I guess what was the setback during the quarter specifically.

Well, a couple of things, I think, Bill alluded to them in his discussion of the results, we have continue to upgrade the talent pool in that business and we started with a new group executive adding a new financial person to that organization and from then -- and a new HR person and they started digging through the organization and reassessing all the talent that was there for the future.

And they have come up with a number of positions that needed upgrading more than what we had originally anticipated so we are not going to stop them from making those types of changes we want to move that forward as quickly as possible and get it done. So that incurred us some costs in relocation and severance and so forth that's included in our normal operating results. And then they continue to dig through the numbers and the inventories, they take the physical inventory and number of locations and did a fresh look at volume activity by product category and part number and they felt more comfortable in obsoleting a bunch of inventory that was considered in the past to have a potential overtime to be sold. They elected to take a more conservative approach to that so we took the charge on that inventory.

So during the fourth quarter, though, did you actually have productivity and shop floor challenges because this all sounds sort of non-operational?

I think there was some challenges in the shop floor and operations. There -- about the middle of the quarter we landed a new operations team as well in addition to what Dave has mentioned. That's done some major re-organizing and relaying out of the factory and it has been a lot of work there and that has driven some cost.

Okay, and then just looking at the orders for the segment the Instrumentation segment. Even if you scrub it of the large orders last year in the fourth quarter, orders were still down 8%. Can you give us some insight as to what businesses are weakest in orders and I guess why you are not more concerned about that year end finish in orders.

Well, part of that sector includes Aerospace and what's new in that sector over the past couple of years is the Loud business and that is more a lumpy order pattern than we have traditionally seen in that segment of activity. And the orders in fact for Loud in the fourth quarter were low, but the full year was just about equal to the previous year so there has been no deterioration year-over-year, in fact the backlog is higher for the business.

And I will [inaudible] to that -- as I know the 2005 comparison and we had noted in the press release that it was by $8 million of orders in that one quarter at the end '05 and the other thing that happened with the lead times and [forgings] having gone out significantly, orders for the future were placed earlier so we took orders at an earlier pace and through this, through 2006 that are now in our very healthy backlog entering 2007.

So when you, I guess, exclude Loud then because I think my math does exclude that big order a year ago and the lumpiness of the orders and they are still down 8%, what I guess I'm driving at is their must be other businesses within Instrumentation that are down in orders as they close the year.

Circle Seal which had -- Circle Seal Aerospace had over -- was an $8 million of helicopter orders in the fourth quarter of '05. It had a good fourth quarter '05 as well, so unless I have some cyclicality to its order pattern as well so just looking at the two fourth quarters, Circle Seal product lines also had a bit of a down tick in the fourth quarter '06, but full year they were higher in '06 than they were in '05, for the full year.

Mike we may have to circle back because I just don't calculate the same number as you are coming up with a 8% decline Mike--

Okay, I will, and just final question and I will jump back in line, on energy, I appreciate the fact that you guys have been growing like crazy in that business and the margins are spectacular. I guess I'm a little cynical about your forecast though for 2007 being up just 7 to 9 especially given the backlog being up 150% organically. Can you -- I guess what do you see or is this just a gut feel given your [oil patches]?

Right now it's more of a gut feel but we've got to tell you the backlog is quite strong -- the project side of this business continues very strong . I was out in Italy just last week, they booked another EUR 30 million of PD Oman order so their business is continuing to be very good. So that part of the business is pretty solid. The risk that we have there is the its more of a short cycle business in North America, where you have -- we go through distribution and they are not long lead time project orders. These are day-to-day business and that -- if you look at different scenarios of projections out there that those in the industry have developed, you get a pretty broad outlook of the ups and downs so we have decided to take the most cautious outlook on that piece of the business going forward. And you're right, it could be much better than what we have -- we are projecting right now, but we will have a better sense of that in the second quarter.

Moving on. We will take our next question that will come from Charlie Brady from BMO Capital Markets.

All right thanks, good morning.

Hi, Charlie.

Good morning, Charlie.

I would like to dovetail on Mike's previous question on the Energy segment and in the revenue guidance there and the project business. It sounds like its becoming a little bit bigger than its historically been, and you look at your backlog and your order intake, are we correct to assume that the length of time to book and ship this -- some of the energy products business has maybe stretched out beyond say a 12 month-time period?

A little bit, not much.

Okay. That's fair--

Anticipating a [flat] they do have customers placing orders on them that are specifically asking for 2008 deliveries even though we may be able to fulfill it sooner if they so requested.

We are starting -- we are booking into '08 now obviously and they're still asking for more shipments in '07 and we are trying to find capacity to do that. But I don't think it has gone out more than what we have seen in the past substantially at this point. I will take another look at it though to make sure for you.

That really then is tied to what you said about the -- if the short cycle side of your business, and taking a conservative view because your time horizon in that business is limited by the very nature of the business.

That's right.

Okay. On the Instrumentation business are we done with the personnel changes there as far as the costs and sort of the disruption from bringing people in? It kind of seems like we're -- every quarter we say we're almost there, we are not, and I'm just trying to get a sense of how much further are we till that, kind of, we are done.

I know, I know. It looks like we got another quarter of hard work to do and we have got the plans in more detail than we have ever had before. As Bill indicated maybe we will have some color, Bill, but the improvements that we are projecting for the year are coming in second quarter and beyond so we probably have another quarter of some tough work to do here with people and we have factored in some disruption costs affiliated with a plant that we are going to be shutting down soon, within the next thirty days or so.

I know, I wouldn't say we are out of the woods yet but the action plan that we are working are underway, they are not action plans that we are planning on doing in the future, the ones that we are executing right now. The results from those after the benefits, we are not going to start seeing them until the second quarter.

We still, as Bill said, we still are looking towards that 10% or above operating profit as we exit '07. That means that we are going to be showing some nice high growth and profitability in this business starting in Q2.

Okay, I guess what I'm getting to is, your visibility when you are looking out towards the plan you have got in place and whatever you want to shut down or keep or move people around or move stuff around on the manufacturing floor, that visibility, that plan, is it fairly seating concrete that you can say okay, this is the actual steps we are going to do, and by the end of that first quarter if that's what you are saying.

Yes, that's what we are saying. The actual plans are very concrete right now, we tracking them in minutia detail.

Charlie, are you there? You seemed to have been cut off?

Sir, if you could please press *1.

The speakers to do that?

No, that is for Charlie. Please press *1.

I just got cut off there sorry, I guess what I'm asking is also that because you put people in place and they have gone through and done a deep dive on the business or a deeper dive and they found, okay, we need to do a little bit more than we really thought. Has that process kind of come to conclusion where you dived as deep as you're going to go and we know we are at the bottom here.

We have done a deep dive and I would say in 95% of the business. We are pretty thorough at this point in all major areas we've done it and so what they have now is they have the action plan set in motion or moving factory floors around, building the supply chains that we need to lower costs; that is all under way right now.

Okay, and just one final question and I'll be back on the queue, on the Energy products again, on the margin there, I mean obviously phenomenal margin Q4, and this is a business that we totally talked about in the mean 13% was kind of a peak margin we might get out of this business and given your guidance for '07 sounds like maybe that has moved up a ladder, what do you think is driving that, is it pricing? Is it just something operationally within that segment?

Well, its all of the above. Our estimation of the potential for this segment has steadily increased. I think in previous conference calls I've indicated that from a 12% to 13% peak we are probably looking at a 13% to 15% peak. Q4 was better than that obviously because of some good things that happened. We do have some good things happening once in a while in the business. We were able to deliver earlier as requested by one of our major customers and they let us have a nice little bonus as a result of that but moving forward I think what you are seeing is a trend of supply and demand especially on the higher end of the product line, the more exotic metals, the higher pressure environment that we are facing especially in the Middle East. We are a big supplier to Exxon Mobil and they have some big projects with high pressure gas coming out of the Persian Gulf and that requires a more sophisticated product. We've been trying to change our mix and not competing in the more traditional projects with traditional pressures and so forth, which carry or happen to carry a lower margin so supply and demand has allowed us to increase our mark ups a little bit, but also in the sectors that we are now competing in which is the -- which is the higher engineered side of the valve requirements.

Thanks very much.

You're welcome.

Moving on, we'll take our next question and that will come from Richard Glatz from Morgan Stanley.

Hey, guys.

Hi, Rich.

Could you maybe give us some more details and expand upon what we are doing, I mean Hoke's -- in particular with Hoke in instrumentation of Thermal Fluid. I mean you guys have given tidbits here and there, what is your plant savings going to be on closing the plant? This has been a continual problem and a continual drag for quite some time now and I think we'd like to hear what we're really doing here, and what the endgame is going to be. I mean, you are talking about things happening in the second quarter, and I kind of feel like well, we've heard this before. So you know if it's -- if you have plans in place let's hear about them. I understand that some things maybe you can't talk about from an employee point of view or -- but certainly there's some more detail that you can give us. That's my first question, want the second now?

No, let us handle one at a time Rich.

Okay.

That's a fair question, we'll respond as best we can. We haven't announced anything to the facility yet but we'll give you some idea of the range of savings that we are looking at here.

But I think from a top level of the plan, we -- as we mentioned before we felt like we've been there before but we do have nearly an entirely new leadership team that was put in place midway through the year and then follow on rebuilding of the operations and supply management teams at the end of the year. So what we're learning now in excruciating detail is the -- you know down in the deepest and widest levels of the business. So I feel confident that the team we have in place is a very, very strong team and has flushed out the major issues and has action plans underway to address them.

So it starts with building the people and the process capability to not only execute the day-to-day business, but also to rebuild the business and transform it and restructure it as we need to. So those are the actions that are underway from a high level plan, and they take us into -- well into 2007 and set a foundation for 2008 and the business will look significant -- significantly different than it did six months ago by the time we end this year.

Rich I think in the narrative I thought Bill indicated there's about $1.7 million a year of savings pre-tax in the closure--.

That's the one [inaudible] of the overall plan.

Yes, but I think Rich was looking for some concrete numbers so I can throw some out at him. I think the inventory issue that we referred to probably is between $3 and $500,000 that we incurred so that should not happen as we move forward. The foreign sourcing, we are the first try to that is going to be -- represent about 16% of the total production of nuts and ferrules and things like that. And then there's another 10% coming right after that that's going to be foreign sourced. So we hope within the next six months or so there'd be -- to be sourcing at lower cost about 25% to 30% of the components that that business is currently manufacturing today at a higher cost. So you factor in the cost savings of that and you're well in excess of $1 million to $1.5 million in savings easy. So those are the magnitude of the numbers we are looking at Rich.

Okay, which sounds great and also makes your 9% to 9.5% margin goal look modest and I can assume -- I can understand being conservative there given how this has gone, but--.

Yes, you're right

But as long as we characterize that as conservative I think I'll be satisfied. My next question gets down to really inventories and cash flow here. Your guidance for cash from operations looks good, however you know, I wasn't too impressed with your inventories and your inventory turns aren't really getting a whole lot better here. I have in my notes from about six years ago that we're going to be pulling cash out of inventories, and year-over-year certainly, they were up more than commensurate with some of the sales lines, and we've been in this lean initiative for a couple of years here, so I'm kind of wondering when we're going to get some traction on the inventories here and what the magnitude of that could be as well?

I think that's a fair point, one of the things that we've learned as we've dug into this is with really rebuilding the operations, the supply, planning and execution processes is more than we -- more work than we thought. But another thing to consider, with the amount of orders that we've taken particularly in a couple of areas where the lead times for materials gone out we've actually brought inventory in earlier for work that maybe we needed to. So we're working through alignment and synchronization of that planning, but we wanted to make sure that particularly in aerospace and some of the project businesses that we had the material to put the project together and ship them on time. We also built up some inventories as we've started to do the outsourcing program, and we built up inventory for the cold seasonal start that came later than we thought so we ended the year with a pretty warm heating season, we had done a pretty nice job I think of demand forecasting and analysis to see what inventory we would need so we could respond quickly to customer demand and the heating season just came later, it's not really until the middle of January. So we still got some more work to do there, I think our goals on inventory inside the company are fairly conservative and we'll make much more progress as we continue to rebuild the fundamental processes we've run the business [inaudible].

So then from that statement I take it that there's not a whole lot of inventory reduction built into your cash from operations guidance that you gave?

That's correct, although we've budgeted more this is another area where we've taken a little more conservative approach on what our estimates are that we're providing.

Alright, so then you guys could have -- after CapEx guidance as well obviously, $45 million of free cash flow here basically, and -- well minus the dividends I guess, but that's not all that big. And you know, it's a pretty damn large free cash flow yield. Your debt is down -- your net debt is down to 9% here, and I realize we probably want to do some more acquisitions along the way if we find things at attractive prices. But what are we going to use the cash for here?

Well I think we continue to look at that, we've got to generate it first Rich and I think in that light we are looking at acquisition opportunities. Bill has taken on more and more and all of the operating responsibilities here at the Company giving me more time to focus on acquisitions and hopefully we will see some benefit from that in the transactions for this year. So we've - we'll pay down some of the revolver with it and do some acquisitions, and the Board will continue to look at other ways to use that cash.

Alright, well good luck beating the hell out of your conservative numbers then.

Okay.

Thanks guys.

Thanks

Moving on, we'll take your next question from Mark Grzymski from RBC Capital Markets.

Good morning.

Hi, Mark.

How're you doing, thanks for taking my calls you could always increase the dividend I guess, but anyhow. Just to clarify on the -- you're talking about guidance for the Energy products segment and would you characterize your thoughts as international project business being strong and possibly the North American market kind of tapping it -- you know, topping off here?

Well what I characterize this as, as risk I mean with the backlog we have on the international projects I think '07 -- as we look at '07 there's not much risk that we can see in that piece of our business, if there is risk it'd be in North American markets. And there is -- you know there is some risk there that we are at a possible peak in the drilling activity and so forth in North America. And that's short cycle business and that could affect us within 60 day period. So that's why I wanted to make sure that people were aware of -- that represents a even though as a percentage of our total business with more and more project activity representing our backlogs and so forth, it's still a meaningful piece of that business. And there is -- I think if -- it's pretty close to its peak in this cycle.

Okay, so upside could definitely come from that market being stronger than--.

Yes, yes.

I guess with the markets already -- you know, in the North American market that is.

It could be -- it could get better. We've seen better days than what we've experienced right now in North American short cycle business but it could be down as well. It has more risk -- what I'm saying is it has more risk to it in our forecast than obviously the project business does.

Okay, and then my last question relating to gross margins. Is it fair to I guess assume that with raw material environment that we saw in the back half of 2006 that you'll also get some incremental gains from more stability there on the gross margin line? Ken maybe you--.

Well I -- you know, we're pausing because it's a mixed bag, we've got a number of different markets and product lines that we serve, they each have different competitive environments, they each use different types of materials--.

Right

So it's hard to answer that question in just one sentence.

I think we've seen a little bit of ease-in in some of the capacity constraints that we saw, like in Aerospace we've still seen some increases in the stainless side. I wouldn't say it's stopped completely, but it's a mixed picture and I think that's why we're driving really hard on global sourcing to lower our costs.

Right, right. Okay and then what about pricing going into 2007 are you -- what's really baked into the top line growth numbers there?

Actually, not a lot.

Okay.

But as you compare '06 to '07, that's where you know we had price increases occurring during the year in '06 that would have a full year effect so if we had a -- let's say a 10% price increase in '06 maybe half-year so you naturally get 5 points of '07 effect just because of that price increase of last year so there's probably what -- three, maybe three points of total price at most right now.

Okay fair, fair. Alright well thank you guys.

Okay you're welcome.

Moving on, we'll take our next question from Andrea Worth from Robert W. Baird.

Hi.

Hi Andrea.

Just want to dig a little more into your more conservative comments on the North American side, on the MRO side. Just curious, can you give us some color as to what you've seen so far, the first call it seven weeks of the year. Have you seen any hesitation at all, any signs of flattening out yet, or are things still running pretty strongly?

No, things are running pretty smoothly. We would look at our order -- we can talk now but not later about the first quarter activities so far, and they are hanging in there right at our budgeted level so we don't see anything at this point that would make us nervous.

Is there any difference between what you've seen in the US and Canada? We've heard some things like Canada's been weakening a bit. Have you seen that or--?

A little, a little bit I'd say, yeah.

I would say Canada has never gotten at the level that the US has gotten to, I mean that was our learning last year, it's -- it's not okay but it's not nearly -- hasn't been nearly as strong as the US activity.

Okay, and could you give us an idea roughly you know, if you look at -- you had about 34% organic growth in energy overall this quarter. What's really the split between international projects and MRO? I mean is MRO growing at roughly the same rate right now or is it close to something like 10%?

Okay that's a tough one because you know, as our breakdowns internally don't allow us to easily do that but while I'm blabbering along here I'm trying to look at the numbers we have. It -- I see it still looks like year-over-year the North American business was up in orders for the year I would say around 25%. Part of -- some of that may be some project work too so I hesitate a little bit, but it looks as -- looks as though it's still above 20%.

And could you remind us roughly what your mix is between MRO and project in Energy?

It varies. Our backlog right now is about a 30% MRO backlog and 70% or so project.

Okay, okay that's helpful. And then just you mentioned you had that little bonus benefit in the quarter. Do you know roughly how much that was the benefit on the basis points?

Approximately it's approximately 90 basis points.

90 basis points. [inaudible]. Okay, okay--.

That was a nice bonus.

Yes, definitely. And then just a couple of clarifications, on the guidance, does that include the facility closure charges you are expecting for the first quarter?

Restate the question again Andrea?

Your guidance for the first quarter of $0.41 to $0.43 does that include your facility closure?

No, it excludes it.

It excludes it?

Yeah, the press release said it's a "excluded anticipated special charge" -- is what the closure would be.

Okay [inaudible] is that going to happen in the first quarter?

A good piece of it. There's got to be some recording of that $1 million gross number that we quoted in Bill's remarks that will fall in the second quarter. So in the first half we'll have that million but there'll be some portion of it for first quarter.

Okay, and then just one question, just want to clarify when you're talking about the foreign sourcing in [inaudible] roughly about 16% of the components being sourced here, expect to increase that by another 10. Was that by the end of the year or what was the target there?

It was probably by the middle of the year, rough time frame.

It's all because when we have that second phase schedule--,

Yes, let's say it's through three quarters.

Getting up to 25% roughly?

Yeah, it will be phased in.

Okay great, thanks guys.

Thank you.

And at this time that will conclude our Q&A session. I would like to turn the conference back over to Mr. David Bloss for any closing or additional remarks.

Well thanks. As we end this year we are feeling pretty strong about our results and our markets as you can tell, we are working hard to show changes, improvements in our instrumentation business, which we are spending all of our time focusing on at this point and we hope to be able to give you a better outlook for the rest of the year as we talk to you at the end of our first quarter which will be on May 3rd, so we'll see you then. Thank you.

Thank you that will conclude today's conference. We thank you for participation. At this time our phone audience may disconnect.