Circor International Inc (CIR) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Circor International's third quarter 2007 earnings conference call. Today's call will be recorded. (Operator Instructions). The floor will be open to 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, and welcome to Circor third quarter 2007 earnings call. Our objectives today are to review the Company's recent performance and provide an updated outlook on the full year 2007 with David Bloss, the Chairman and CEO of Circor, Bill Higgins, the Company's President and Chief Operating Officer and Kenneth Smith, the Chief Financial Officer. After their comments, we'll then go to Q and A.

But before we start, two administrative items -- 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 Investor Relations page. Second, today's discussion contains forward-looking statements that identify our future expectations, but these expectations are subject to known and unknown risks, uncertainties and other factors. And for a full discussion of these risk factors, we advise you to read about them in the Company's Form 10K, 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 morning, everyone. Let me begin with the highlights for the quarter and then Kenneth and Bill will take you through the details. As you saw in our earnings press release, our fully diluted earnings per share for the third quarter was $0.62 and included some unusual transactions, such as the non-cash charges connected with my pending retirement as CEO in February of '08, along with a gain of the sale of our interest in a small business in Denmark, and some European tax benefits. If you net these items out, our EPS was $0.59, $0.03 above the high end of our previous guidance.

Orders for the quarter were up $0.33 over last year and backlogs ended at $396 million, up about 39%, to reach another record for us. Our Instrumentation and Thermal Fluid Controls segment was a mixed bag again this quarter. The various markets served by this segment either remained strong, or improved. The General Instrumentation markets increased the most, followed by Thermal Fluids, primarily Steam, while Aerospace markets remained healthy, although our incoming orders for this market dropped, due to the timing of large annual orders for landing gear, which were received last quarter.

The operating (inaudible) for this segment took a step backwards to 7.1% this quarter, after showing improvement in the second quarter. Our actions to improve the operating performance of this group, particularly the General Instrumentation business, are beginning to take hold, but at a slower pace than expected. Our expectations for this business remain positive, as some price improvements in this market are beginning to be seen.

This segment's performance has also been negatively affected by our higher legal costs associated with asbestos litigation involving our Leslie-controlled subsidiary. Because of the increased activity of these claims, the average quarterly cost of defense and settlements incurred by Leslie has increased from approximately $600,000 per quarter in 2006 to a little over $1 million per quarter this year.

In spite of this cost increase, we continue to expect operating profits for the Instrumentation and Thermal Fluid Control segment to improve to around 9.5% in the fourth quarter of this year.

Our Energy product segment continues to enjoy a robust global oil and gas market, even though our North American distribution business was softer this quarter, as expected, because of distributor inventory adjustments and a slowdown of activity in Western Canada. The profitability of this segment of our Company was much better than expected, with a record 17.4% operating margin.

Now, I'll turn the call over to Kenneth Smith for further details on the quarter.

Thanks, David, and I'll be referring to our presentation slides, starting with Slide #3, which shows the consolidated results for Circor. We had a good quarter, with solid quarterly orders, near record earnings and a record backlog to start the fourth quarter of 2007. And we had strong growth in both revenues and earnings, showing nice margin expansion.

For the quarter, the revenue increase was led by our Energy products and Aerospace products. Each got (inaudible) from higher volume and price realization. Regarding operating income, we had very good margin expansion, particularly on our Energy products segment, which drove the majority of the improvement.

Regarding diluted earnings per share, we had significant double-digit increases compared to the 2006 period, and $0.03 of the Q3 2007 EPS came from the three special items that David described, and which are noted on the right side of Slide #3. This quarter's results, excluding the three special items, was $0.03 over the top end of our guidance that we had provided in our August 2, 2007, earnings call, essentially due to the timing of higher than expected project-related shipments by our Energy segment. And the related Energy segment product more than offset the lower margin in our Instrumentation and Thermal Fluid Products segment in the higher corporate expenses.

Free cash flow was a positive $11.5 million as working capital leveled out and profitability was strong overall.

Now, to Slide #4, which details the P&L in more detail. Bill will discuss the significant rise in the operating income of this segment in a later slide, so I'll add color on the other items on this slide, beginning with Special Charges. The 2006 special charges were principally for a non-recurring expense for freezing our U.S. qualified pension plan in July of '06, and as you recall, since that freezing, we've now channeled our retirement money into our 401k program via higher Company contributions.

Our special charges in Q3 2007 are primarily the non-cash charges related to David's pending retirement. In the year-to-date 2007 special charge amount, there is an amount for Instrumentation and Thermal Fluid Products segment closing in the first half of 2007, a small U.S. plant in Connecticut, in which we manufactured components for the Hoke product line, and (inaudible) closing is one of the many actions we're taking to raise the operating margin in the Instrumentation and Thermal Fluid Products segment.

Next, corporate expenses, which increased. The Q3 2007 increase essentially represents higher litigation costs associated with a lawsuit that commenced five years ago in Canada and has now gone to trial. This suit is against a small group of former employees who, we believe, unlawfully took and disclosed proprietary information in order to commence a competing business in Canada. While we do expect additional costs in Q4 associated with this trial, we anticipate a favorable verdict, including assessment of monetary damages and recovery of some of our litigation costs.

Regarding net interest expense, it was lower in 2007 periods for two reasons --- first, we paid off in October of 2006, the fixed-rate debt, which carried an 8.25% coupon, and secondly, we paid down a good portion of our revolving credit line during 2007.

The other non-operating income of $1.5 million for the three months of September 2007, is essentially the (inaudible) sale of an investment in a small European business within our Instrumentation and Thermal Fluid Products segment, which became an investment for Circor when we acquired a [D2S] business in 2003, and this investment had remained unrelated to our other operations.

Regarding income tax expense, we had a 32% effective tax rate in the 2006 time periods, and a 32% rate in the first half of 2007. In this third quarter just concluded, we did record an effective tax rate of 23.3% and for the nine-month 2007 period, an effective tax rate of 29%. These rate reductions resulted from a (inaudible) tax benefit we recorded due to a change in Germany's tax law and a recently lowered statutory rate in the United Kingdom. And additionally, this quarter, we recorded a tax benefit of $250,000 after finalizing our 2006 federal tax return. That included a higher research and experimentation credit.

Now, Slide #5, cash flow -- in the cash flow from operations and free cash flow, we've had several sources and uses of cash for both periods, except for the marked increase in our profitability in 2007. Working capital continues to be a use of cash, as our order rate and record backlog have continued to require investment.

Now, to Slide #6, the balance sheet continued to be very healthy, and we had decreased debt in 2007, and our debt-to-CAP remains a very conservative 9%.

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

Thank you, Kenneth. And now, Slide #7, our Instrumentation and Thermal Fluid Products segment results. As noted on Slide 7, this segment again had solid order and revenue growth compared to the 2006 periods. Regarding orders, almost all end markets served by this segment continue to be positive. The one area we see continued weakness is in Maritime, the U.S. and UK Navy end markets. Compared to 2006, Q3 orders for this segment were led by chemical processing and general industrial markets, and year-to-date, order rates for all three product groups in this segment have been solid.

Regarding operating margins, this segment's result of 7.1% this quarter was lower than expected, principally due to our inability to meet a significant spike in orders, a shortage of savings we expected from outsourcing, and higher than expected litigation costs. And let me add a little bit here.

First, as we've improved customer service, on-time delivery and responsiveness, our order intake has increased. It's increased across the segment -- in fact, across the Company, which in most cases, we've been able to meet the --- our lean manufacturing efforts with improved capacity and productivity. In this segment, Instrumentation product group, however, we were not able to cost effectively respond to a 14% jump in order growth sequentially from Q2 to Q3 this year, which is 20% order growth year-over-year for the third quarter. As a result, we suffered higher overtime and material expediting costs and we expected to meet customers' commitments, and with that degraded operating margin in the short term. We are working to bring efficient capacity online and we expect to resume productivity and pricing improvements in the fourth quarter.

Secondly, we now expect the cost savings we anticipate from our low-cost country outsourcing initiatives will more notably be realized starting in the fourth quarter and into the first quarter of 2008, as the lower cost material works its way from (inaudible) our inventory and production, and the same will flow to the bottom line.

As we've mentioned before, we closed one U.S. plant in the first half of 2007 and sourced this production for low-cost Asian suppliers, and the savings from this closure and foreign sourcing benefit is expected to be approximately $1.7 million per year. We continue to expand low-cost country sourcing, as well as drive lean manufacturing initiatives deeply throughout our factories for productivity, capacity expansion and (inaudible) supplier management, better factory planning and execution.

Regarding this segment's margin decrease in Q3 of 2007, as David mentioned earlier, we've also incurred higher than expected legal costs associated with asbestos litigation involving our Leslie-controlled subsidiary.

On a positive note, the operational performance of the Aerospace products group and of the Thermal Fluid Products group in this segment, continue to make sustained customer and margin improvements, meeting or exceeding Q3 expectations. We're performing better to our customers and winning business as a result of the operational improvements. This is an ongoing year-over-year progression. With the great management teams we've put into place, and the efforts underway, we expect it to continue across the segment.

Finally, as we have fallen short of sequentially improving quarterly margins in this segment, we're forecasting a 9.5% operating margin in the fourth quarter, as Dave mentioned. We've challenged our management teams to higher levels and they have plans in place that (inaudible) get us to a higher level, but we'll remain cautious, however, until we demonstrate it. The great teams in place; they're working hard. The second and third performance has been two steps ahead, one back, and our goal is to achieve and then sustain double-digit operating margins in this segment and continue to improve from there.

Now, let's move to Slide #8, our Energy product segment results. The oil and gas end markets served by this segment continue to be healthy for both the large international project business, as well as the domestic, fabricated and distribution products. The orders comparison for Q3 is favorable, in part, due to a low order intake in Q3 of 2006. This segment's new orders were led by large international projects and for fabricated products at our Sagebrush business. Although not shown on the slide, Q3 of 2007 orders were 26% lower compared to the second quarter of 2007, due to the lumpiness of large projects and fabricated pipeline awards.

Order activity in North America has trended down due to the June and July wet weather conditions, and as distributors adjust their inventory levels, a condition that we expect to continue for the remainder of 2007. So overall, the Energy market for us continues to be very healthy and in particular, the activity on large, international projects.

Revenues are a mirror of significant order growth and this quarter's increase in revenues compared to Q3 of last year, 2006, was the net result of shipments to large, international oil and gas projects. And year-to-date revenue growth was also led by shipments to large international oil and gas projects, followed by strong shipments of fabricated pipeline packages. With this segment's record backlog of $260 million heading into Q4 of 2007, we expect to continue a solid Q4 into 2008 as well.

As for profitability, this segment turned in a record quarterly operating margin, higher than we planned when we issued guidance on August 2nd. Its margin over performance is a result of several things, starting with a beneficial mix of shipments to large international projects sooner -- shipped sooner than we expected with higher margins.

Additionally, this segment continues to benefit from previous and ongoing improvement actions, including increased prices, particularly for more highly engineered products, improved factory and supply chain performance from our lean manufacturing improvements in North America and China operations, which is enabling efficient capacity expansion, continued productivity improvement and faster response time to our customers. Plus we're benefiting from the expanding production in our China manufacturing plant, which serves as a key supplier to our North American customers and provides us a lower cost of goods sold.

Let's now turn to Slide #9. On this slide, we point out our (inaudible) for key end markets that we serve and nearly all our businesses are expecting a positive 2007. We've already described the expected strength of our oil and gas exposure, and our other segment, Instrumentation and Thermal Fluid Products, we're still anticipating solid order rates from Aerospace, power generation globally, and other general industrial sectors, with some (inaudible) softness in sales in the Maritime market.

Now, let's turn to Slide #10. Our expectations for revenue margins in 2007 are cited here. We've changed some of the numbers on this slide, compared to what the slide showed at our August 2nd earnings call, and we've raised the revenue growth for Instrumentation and Thermal Fluid Products segment. It had been 6% to 8% growth.

Regarding operating margins, and in particular, our Instrumentation and Thermal Fluid Products segment, we continue to expect to make progress, improving our supply chain issues and operations, materials outsourcing, low cost suppliers, as well as continue to rationalize product lines and facilities to lower our cost of operations. Our full-year expected margin for this segment is between 8% to 8.5%, with the fourth quarter expected to be around 9.5%, less than the 10% we had anticipated in the past.

As I stated before, we are making progress. It's so small task and it takes time. A stronger management team is in place and we expect to see continued progress in this segment.

We've raised the margin estimate for our Energy products segment to 15% to 15.5% this year, an increase due to the timing of shipments to large international oil and gas projects.

Regarding corporate expenses, a majority of the change in the estimate is due to the higher litigation costs for the Canadian lawsuit that Kenneth referred to earlier, and we ultimately do anticipate an award in our favor there. However, under accounting rules, we can't accrue anticipated awards until we actually recover it, which are not expected in 2007.

The income tax rate of 30.3% for the full year is a reduction from our prior expectations due to the tax benefits we recorded in Q3 2007. This also anticipates a Q4 2007 tax rate of nearly 34% due to the proportionately higher earnings from our Italian business with a higher tax rate than the U.S.

Although not shown on Slide 10, we have provided EPS guidance in our earnings press release for the fourth quarter of 2007 of $0.54 to $0.59 per diluted share, excluding any special charges. The range of $0.54 to $0.59 is unfavorable to the fourth quarter of 2006, when we reported $0.63 per share, which included a $0.01 special charge related to facility closures. The primary differences are expected to be higher litigation costs and a higher effective tax rate in Q4 2007.

Sequentially speaking, our EPS estimate for Q4 2007 is lower than the third quarter, primarily due to the higher tax rate in Q4, but also due to the unfavorable comparisons to Q3 of 2007, which included a $0.03 net benefit from the unusual transactions that we talked about earlier.

So, to summarize our outlook, we have good end market conditions and healthy backlogs. We are improving our performance to our customers and being rewarded with increasing orders as a result. With 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 lean manufacturing methodologies globally at all sites to develop a culture of operational excellence for the long-term benefit to our customers and shareholders. And we're rationalizing product lines and consolidating facilities to reduce fixed costs, re-engineering our supply chains, particularly globally, to take advantage of lower cost and foreign supply.

In summation, the effect from these actions expected in Q4 2007 get us to the full year guidance shown on Slide #10. So with that, we'd like to open up the lines for any questions you might have.

Thank you. (Operator instructions). And we will take our first question from Mark Grzymski with RBC Capital Markets.

Good morning, everyone.

Good morning.

Good morning. David, I wonder if you could just comment on the energy markets. It appears -- your backlog is strong. The bookings came off a little bit, but that's no different than it was last year. I'm just curious why your conservative comments in the press release, if on a year-over-year basis, business seems about as healthy as it was exiting 2006.

Let me take that, Mark. One of the things we have difficulty forecasting has to do with the lumpiness of the project business.

Sure.

And there's quite a big swing. It's just hard for us to forecast exactly what's going to get through all the approval process --- certification processes, get on the ship and be transported and turn into be revenue in the quarter. And the swing for us could be as large as, I don't know, $10 million, $15 million, possibly $20 million in revenue. So there's a large swing associated with the project business that is just too difficult for us to forecast.

Okay. But it's still a very healthy market. It almost comes off as some --- I know domestically, there were some concerns, but overall, international market is no different than it was last year?

It is a very healthy market.

Okay. All right, Bill. Looking at fourth quarter, it implies that your operating margins in the Energy product segment kind of falls a little bit. I'm just curious, if I'm doing my math right, but am I missing something there?

This is Kenneth. You're correct. We're expecting a margin decrease in this piece that we've recorded in the third quarter, essentially back to the timing of large projects, segueing off of Bill's previous remark, where we really benefited by some very -- the leverage of some of some of the sooner than expected shipments that we had in the third quarter, as well as some of the related margins that came with the pricing that was in some of those earlier shipments, which we don't think are going to be evident in our fourth quarter.

All right. And then, lastly, Bill, in the Instrumentation business, is the pricing problem that you're having there -- if you were to rank the issues on the margin side of business there -- I know there are some additional costs on the litigation side that aren't helping, but is that pricing problem that you're having there still a major headwind? Is there any update that you can give us there?

In a long-term perspective, it has been the major headwind associated with the rising cost of material, and we do expect to see some pricing improvement beginning in the fourth quarter, but most likely see most of it in the first quarter of 2008. So we expect to see it starting to improve at least slightly in the fourth, and then into the first quarter.

Great. I'll jump into the queue. Thanks, guys.

We'll take our next question from Mike Schneider, Robert W. Baird.

Good morning, guys.

Hi, Mike.

Maybe first, we can just stick to the large oil and gas project mix. Can you give us a sense of where your capacity is now, and what is the ability to stretch from here, given that the pipeline business does seem extraordinarily strong still, on a global basis?

Let me try that, Mike. This is Bill. The capacity in the North American market, with the growth that we've experienced there, is running very smoothly and as everyone knows, we've built a new facility in China about a year and a half ago, and we've been ramping up production there, as well as in our Oklahoma production facilities. So we've been meeting capacity there. In fact, we --- as things stabilize, it's not an issue about capacity. The capacity on the project business is one we are ramping up. The order intake is looking out further and further into the future, so as we're taking project orders, we're going out beyond 2008 into 2009 now. So we are full up on capacity as we look in the short-term for that business, but the planning for the projects is actually looking out longer term now. The capacity limitation is being recognized by the entire market.

And must you add capacity of [PVVSC] to meet the orders you've booked already for 2008?

We are adding --- we have plans in place and we are adding capacity to meet the orders we have in 2008.

And is it increasing your outsourcing percentage or is it actually adding bricks and mortar in Italy?

No, it's not adding bricks and mortar. We have increased our outsourcing and we have launched a lean manufacturing there last year pretty aggressively on the shop floor to free up capacity in assembly and tests, but we're not adding facility.

Okay. And I guess, just looking at the pace of orders, if you're already booking in '09, you've got a pretty good idea for what '08 holds in the project business. Can that business, based on what you see today in your backlog, be up double-digits again in '08?

We're going through our budget planning process right now, so I can answer that question better on our next call, but it looks pretty good for next year.

Okay. And what is the --- if you could just go to the quarter specifically, what were the growth rates within the Energy business on the international business versus the MRO, so we get a sense of the mix.

Year-over-year, most of that percentage for the segment improvement was largely driven by the large international projects. The strongest --- our distribution product stream was strongest in the early part of 2007, and because of weather conditions here domestically, and distributors adjusting their inventory levels, that kind of flattened out; also, the year-over-year -- (inaudible) giving the quarter comparisons, the project business.

Okay. And then on the project business, the type of projects, it's clear --- well, let me ask the question. I guess it's not clear. The margin benefit you showed during the third quarter, would you attribute that to, again, a favorable mix of types of valves and sophisticated projects that we've seen in the past? Or indeed, is this almost all a function of just the pull-ahead of some large shipments and the benefit you get on the absorption?

I would say both of those, and we've also had in the distribution part of our business, their margins have improved, even though their revenue levels have kind of stabilized sequentially. Their margin, we're having nice margin expansion in our distribution business because of the lean efforts that Bill has described on this call and previously enacted.

Yes, Mike, this is Dave. You're also getting the benefit domestically of a better mix of product coming from our Chinese operations. It's becoming more and more accepted there, so that carries a better margin for us as well.

Okay. So I guess what I ---

Let me add a little bit, too, to the growth and looking forward. When we look at the North American inventories being adjusted, our (inaudible) less or moderately engineered product businesses are seeing more activity in the international projects.

Okay. And what I guess I'm setting you up for is just now a view on 2008 because if margins domestically are rising, you're getting the benefit out of the Chinese operations, the mix of project activity is weighted towards the more sophisticated and higher margin products. You're going to enjoy double-digit growth in '08, or at least something close to two in the project business. Why wouldn't margins be up again from this 15% to 15.5% range in the Energy business? What's the countervailing trend?

You're a good tennis player; you just spiked the ball. Yes, I think the answer comes down to, as I said earlier, is what the final mix of the products that actually get shipped at the very end of the quarter. There are some large projects in the pipeline, but they've got to go through the whole process, the whole certification process, and get on the boat for us to recognize the revenue and the income with it.

Yes, in the project business, there's a variety of margins there in backlogs and so forth, and we really haven't taken an in-depth study. We will during the budget review process of their current backlogs and what their prognosis is for next year. But I certainly can't argue with the point you raised.

Okay. And then just switching now to the Instrumentation businesses, the U.S. and UK Navy business, it's been down for quite some time. The explanation has been a lot of just reduced naval budgets and less ships in port, but that seems to have kind of run its course now. Are you confident that something structurally hasn't changed in the markets, and you guys have either lost platform, lost after-market pricing? What is it? It just seems like this has been going on ---

No, it's not the latter, Mike. In fact, we have a very, very good reputation with the Navies. What we're seeing is, there's a piece of the after-market business with the Navy that's very profitable that has come in lower than we anticipated. And we think that's there's some delayed service due to activities, and we just don't understand it all, but we're digging into it. But the net result has been sort of this gradual decline in the base business, primarily the after-market maintenance service upgrades that we would see on these Navy ships.

There is the bigger picture here, that all the monies have been shifted into Afghanistan and Iraq and into other Armed Force services (inaudible) our helicopter business, but we also look forward --- there are new programs that we're winning, and as we look out a few years, we're positive on that business. It's just we're kind of in the trough. The question is, have we hit the bottom of that trough, or is it going to go a little bit lower? And it is very high profit after-market type business that's hard to make up with a mix of other products, even if we could make up the revenue, the profitability (inaudible).

And then we have --- there's another point. There's a number of engineering projects that we're looking at and we're pursuing and winning in both the U.S. and the UK.

To add to that point, our relationship and our activities with the Navy are actually increasing. You don't see it in our financials, but the engineering work that we're doing on the design of the next fleet --- and we're actually gaining, in certain cases, some market share, as the Navy is bringing to us some other valve opportunities. So we're hoping to capture some of that as well.

Okay. And then, I guess --- one more question back on the MRO business in North America. What's your view now, as the inventory has been settled again in the channel, as to North American drilling activity, gas, oil, Canada, et cetera. What's your thoughts as we head into the next season now?

I think what we're watching right now is just the (inaudible) of inventory in the system. A lot of people have brought up capacity, including us, in the system to become in line with the demand of [recount] and [recounts] aren't going down, from what we can tell. They look pretty stable in the U.S. Canada has been soft here for a while. So we're expecting that to stabilize. It hasn't quite stabilized yet, but probably in early 2008, we'll see that leveling off, I guess. And then the question is, can we win some market share?

Okay. And can --- a new one for the tax rate. The guidance for the year is 30.3. You said the fourth quarter is 35, I believe?

Oh, 34.

34. So how can the annual tax rate of 30.3 be lower than any quarter of the four quarters?

It's not. Our third quarter tax rate, that we just ended, is 23%.

Okay. I'm sorry, I was using the extra charge, okay. So on a GAAP basis, it would be 30, not three. Okay, thank you.

We'll take our next question from Ned Armstrong, FBR Capital Markets.

Yes, thank you. Good morning.

Hi, Ned.

Hi, Ned.

Hi, Ned.

With regard to the Instrumentation business, you noted that some of the challenges in the operating margin, dealt with productivity issues. Is that productivity related to some of the steps that you're taking to improve operations, or is it something different from that, and something else has cropped up that needs to be addressed?

Well, it is very much related. In the Instrumentation business part of the segment, we focused heavily on outsourcing and really rebuilding the whole planning, manufacturing and execution process. In the middle of that, as we've improved our performance to our customers, we got a pretty large spike in sales and order intake that caught us unexpectedly. So it wasn't a high single digit. I think I said the numbers were --- or at least looking at the order intake for the quarter is 20% up compared to last year, same quarter. So we sort of got hit because we're leaning out the lines and taking product out to outsource to improve our cost picture and we got hit with a large stock of orders that we worked hard to deliver. Some of that's gone in the backlogs, but it's cost us in the short term here.

So just to make sure I understand that, because of some of the efforts that you were undertaking to get manufacturing processes to your desired level of efficiency, this spike of orders created a disruption in those processes of your regular manufacturing process, which was costly?

It did and additionally, we didn't have the machine flexibility and the capacity to meet that rise.

Okay. My other question was more of a detail. I noticed that in your guidance for CapEx, that you took about $2 million off. Is that a timing issue or is that $2 million you decided not to spend? And if the latter, what was the underlying rationale for that?

It was more timing, Ned.

Timing, okay. Good, thank you.

Welcome.

(Operator instructions.) We'll go next to Richard Glass, Morgan Stanley.

Hi, guys.

Hi, Rich.

Hi, Rich.

Hi, Rich.

Nice quarter. Apparently, someone doesn't like it, but (inaudible) guidance, really. But again, as someone you guys know who is selling stock close to 50 and I'll be happy to buy it back at 40. On the other hand, can you maybe tell us why you have confidence, or point to some actions or things that are happening that we don't see, that are going to lead to the higher margins in the first half of next year in Instrumentations and Thermo Fluids? You're talking about it, but there's been kind of a manana, manana, issue. So what do you guys see that's going on internally that we don't get to see because you've kind of had --- your earnings have been saved on the energy side, but that can't go on forever, either. So it's going to have to start working.

Within the segment, there's three product groups --- the Aerospace, the Instrumentation, and Thermal Fluids (inaudible) steam, and each one of them has multiple facilities. And what we can see that you don't see internally is that each of these operations is improving, and there are different stages of improvement. It may be that they're at an earlier stage and we can walk the factory floor and see the materials moving through more orderly, more organized, more linear, as I call it, on a daily basis. So we're starting to put systems in place that we can plan and execute to daily, versus sort of historically maybe pushing more at the end of the week, end of the month or end of the quarter.

What that does is, it frees up capacity. It frees up capacity of people and time and cost, and the lean efforts also frees up space and people and capacity. And as we're capturing more orders, we're building a set of processes in these businesses that we can execute more efficiently than we would have in the past. So each of the businesses is seeing pretty decent quarter growth, and we're seeing improvements --- not in total inventories, but work in process inventories. And we've added some price increases and we've got a significant effort underway to outsource. So if you look back at the pricing that we had in the past, that will (inaudible) add as we go forward a little bit, as has the efforts to utilize our China facility for the other groups and outsource into Asia through that as a platform.

So significant improvement, I think, in most of the factories from a (inaudible) standpoint and then outsourcing, and then we'll get a little bit of benefit from pricing. And I'm thinking generally across all the businesses. It's different in each one, different locations.

Okay. And getting back to the Energy segment, though, getting back to what Mike was talking about on the growth for next year, given your backlog stretches out to '09, is it safe to assume that you guys are getting some pricing, as well as just the volume increases as well? And what are those looking like?

This is Dave. There's still a lot of competition out there in the large (inaudible) of business, especially in Italian markets. So we still have to remain competitive out there and there are still a couple of what I call "irrational players," that just like to have a lot of volume. So that keeps us a little bit constrained in the upside on those margins, but we have, over the past couple of years, as you know, moved that business into the higher end of the range of higher margins, but obviously, on big projects, there's a mix of products in a package that we bid on. And some of those then tend towards the lower end of the line. So it just depends, project by project, the mix of the higher versus lower margins and technology of products within that project. And there's really a --- it's not what you would consider a normal distribution product where you have a stable price and then you can look to volume to leverage.

All right. I'd also like to find some time to sit down with you guys next week in Chicago, which I had not scheduled, so if you could work that out, that would be great, too.

Okay.

Richard Glass. Thanks, guys.

Thank you.

And there are no further questions at this time. I would like to turn the call back over to our speakers for any additional or closing remarks.

Well, I don't have any closing remarks, except thanks, and we're looking forward to talking with you at the end of our year. That would be in February.

The end of February.

The end of February. Thank you very much.