CIRCOR International, Inc. Q2 2008 Earnings Call Transcript

Aug.26.08 | About: Circor International, (CIR)

CIRCOR International, Inc. (NYSE:CIR)

Q2 2008 Earnings Call Transcript

July 31, 2008 1:00 pm ET

Executives

Curhan McCann – IR

Bill Higgins – President and CEO

Fred Burditt – VP, CFO and Treasurer

Analysts

Charlie Brady – BMO Capital Markets

John Marr [ph] – Robert W. Baird

Alan Mitrani – Sylvan Asset Management

Eric Mintz – Eagle Asset Management

Jimmy Kim [ph] – RBC Capital Markets

Operator

Good day, ladies and gentlemen. Welcome to the CIRCOR International’s second quarter 2008 earnings conference call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode. The floor will be open for questions following the presentation. Now I would like to turn the conference over to your host, Mr. Curhan McCann, from the company's Investor Relations firm. Please go ahead, sir.

Curhan McCann

Thank you very much. And good afternoon, everyone, and welcome to CIRCOR International's second quarter 2008 earnings call. Our objectives today are to review the company's recent performance and provide an updated outlook on 2008 with Bill Higgins, the company's President and CEO, and Fred Burditt, the company's CFO.

After their comments we'll 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 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 2007 Form 10-K, which can also 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 CEO, Bill Higgins.

Bill Higgins

Good afternoon, everyone. As you saw in our earnings press release last evening and our updated guidance from July 8, we had a great second quarter, exceeding our initial expectations with fully diluted earnings per share of $1.08. Revenues and margins were up significantly compared to second quarter of 2007 and up sequentially compared to the first quarter of 2008. Most notable, our second quarter operating margins were at record levels for CIRCOR at 13.3%.

The company received orders totaling $198 million during the second quarter of 2008, down 13% from the second quarter of 2007 and down 17% from the first quarter of 2008. These reductions have more to do with the timing or lumpiness of large orders. Quotation activity and end markets remained strong, which we'll explain more during the segment discussion.

Our backlog ended the second quarter at $446 million, 19% over the second quarter of 2007 and down 1% from the first quarter of 2008. Revenues for the second quarter were $207 million compared to $166 million in the second quarter of last year, an increase of 25% with approximately a third of that due to FX. Nice revenue growth combined with other factors drove operating income of $27.5 million in the second quarter compared to $15.8 million in Q2 of '07, which is an increase of 74%, with record operating margins at 13.3% in the second quarter compared to 9.5% in the second quarter of 2007 and 11.0% in the first quarter of 2008. It was a real strong quarter for virtually all of CIRCOR. And now I'll turn the presentation over to Fred.

Fred Burditt

Thanks, Bill. And I'll be referring to our presentation slides starting with slide number three, which shows the consolidated results for CIRCOR. As Bill outlined, we had a great quarter with strong year-over-year revenue growth and record operating margins. For the quarter, the consolidated revenues increased 25%; 70% organic and 8% due to currency, primarily from the Euro appreciation versus the US dollar.

Organically by segment, Instrumentation and Thermal Fluid Controls grew 12% and Energy grew 22% in the second quarter versus last year. Consolidated operating income grew 74% over the same period last year, hitting $27.5 million versus $15.8 million for the same period. This equates to a record 13.3% operating margin with contributions from both segments. Instrumentation and Thermal Fluids came in at 10.9%, up 210 basis points from last year. And Energy at 20.3% was up 400 basis points. We will elaborate later when Bill discusses the segments.

Regarding diluted earnings per share, the $1.08 for the quarter was up 80% versus 60% last year and 76% in the first quarter of 2008. The $0.60 from the second quarter of 2007 included special charges of $0.01 due to a small US facility closure in the Instrumentation and Thermal Fluids segment. Free cash flow was strong in the second quarter of 2008 at $31.6 million compared to the $5.4 million in the same period of 2007, due primarily to strong increase in net income and working capital changes. Year-to-date free cash flow was also strong at $26.2 million versus zero in 2007.

I'll now turn to slide number four, which lists the P&L in more detail. Since we will discuss the segment operating income later, I will add color on the other category. First, asbestos-related settlement and defense costs. As the asterisk at the bottom of the slide describes, our Leslie Controls subsidiary has been and continues to be named as defendant in asbestos-related product liability actions. During the second quarter, our total expense for asbestos-related settlement and defense costs net of insurance was $2 million compared to the second quarter of 2007 of $1 million. The increase is due to an additional gross charge of $1.7 million or $0.9 million net of reserves for insurance recoveries for the increase in open claims accrual.

With regard to insurance, there is a clarifying point we need to be made here. To date, Leslie's primary labor insurance carriers had been paying 71% of both the indemnity cost and defense cost associated with the asbestos litigation. As of the end of Q2, we have now accrued an aggregate amount that meets the limit of our primary layer of insurance.

As a result, from a financial statement perspective, we will have to treat any future indemnity accruals as if the insurance has been exhausted. Therefore, we will no longer have the 71% benefit for indemnity charges. Defense costs, however, will continue to have an offsetting insurance recoverable until the insurance carriers have made cash payments that exceed the indemnity policy limit. Please refer to our most recent SEC forms 10-K and 10-Q for further information related to our Leslie asbestos litigation.

On a related matter, to clarify operating performance, starting this quarter in the press release and accompanying some supplemental information, we now present adjusted operating income, defined as operating income excluding the impact of special charges and asbestos-related costs. Now onto corporate expense, has increased from prior year driven primarily by two items. First is an increase in variable compensations, including share-based compensation. And second is an increase in professional fees, primarily legal.

Regarding net interest expense, it was lower in the second quarter of 2008 by $0.9 million, primarily because we have paid down a good portion of our revolving credit facility since the second quarter of 2007. Total debt was $23.6 million at the end of June 2008 compared to $55.2 million at the end of June 2007. In addition, interest income is up from an increased cash, cash equivalents and investments. Other non-operating expense for Q2 2008 is flat to Q2 2007. The $0.2 million for the quarter is primarily net foreign currency translation.

Regarding income tax expense, the increase is due to the rise in pretax income plus a 40 basis point increase in rate to 32.4%, primarily attributable to increased earnings in higher tax jurisdictions.

Now to slide five, cash flow. Cash flow from operations and free cash flow, as mentioned earlier, showed good improvement for the second quarter of 2008 and for year-to-date. On a year-to-date basis, the key drivers were $31.3 million of net income versus $17.4 million last year, and a reduction of working capital needs for the first six months of 2008 versus prior year. This was only partially offset by $2.3 million of increased capital expenditures supporting multiple areas including investments to support new products and lean flow.

And now Bill will speak about our segment performance.

Bill Higgins

Thanks, Fred. And now on slide number six, our Instrumentation and Thermal Fluid Controls segment results. Overall, this segment had very good quarter with good revenue, operating income, and margin growth versus the second quarter of 2007. Regarding orders and revenues, second quarter orders grew 2% compared to the second quarter of last year, even in light of the fact that Q2 2007 included some unusually large aerospace bookings. Instrumentation and Thermal Fluid Controls segment revenues increased 15% and virtually – improved with strength in virtually all areas, including aerospace, maritime, sampling and general industrial markets.

Second quarter and year-to-date FX favorably impacted our revenue by approximately 4%. The total backlog, we ended the second quarter in the segment with $164.3 million of backlog compared to $130 million last year for the same period, which is an increase of 26%. Regarding operate margin in this segment, 10.9% was 290 basis points over the second quarter of 2007.

And I'd point out, please note on the slide there is an error, incorrectly indicates 210 basis point improvement. It should be 290. So if you remove the impact of special and asbestos-related charges for all periods, margins improved 300 basis points in this segment. And these improvements have come from all areas, but particularly – with particular strength in aerospace and Instrumentation. And the key drivers being volume, price, mix, operational improvements, somewhat offset by material and other inflation costs.

In addition, the acquisition of Motor Technology, the aerospace acquisition we did in the second quarter of 2008, accounted for about $200,000 in gross profit. We had no special charges in the second quarter or year-to-date 2008 in this segment, but prior year includes $600,000 or $1.2 million for Q2 and year-to-date expenses associated with US facility consolidations.

Looking forward into the third quarter, we anticipate many of these gains continuing. However, as the normal summer manufacturing shutdowns for vacation and maintenance as well as some unfavorable mix compared to the first and second quarter of 2008 will reduce margins slightly in the segment. Our plant consolidation activities within the segment are continuing. We successfully completed the relocation of our Southern California aerospace facilities from one site, which was a multi-building site into a new facility that we laid out for lean manufacturing flow. We completed that consolidation in July. And we continue activities in Instrumentation where we're combining two facilities into one in Spartanburg, South Carolina.

So now onto slide number seven, our Energy Products segment. Our orders were down 25% in the quarter. This was primarily due to exceptionally high order performance in the large international projects in the second quarter last year, 2007. We continue to see high quotation activity in the quarter for products around the world. And our distribution products portion of the Energy segment, our orders were up strongly in the quarter compared to prior year and at first quarter of 2008 as Energy prices and rig counts continue to be high.

Regarding revenues, at $107.7 million, were up 34%. Organic revenue increases were primarily driven by large international projects and fabricated systems in North America, partially offset by lower year-over-year revenues and standard products that are sold to the MRO market or through distribution. However, our distribution products were up double-digit sequentially from the first quarter of 2008.

Higher foreign exchange rates, primarily the Euro, accounted for 12% revenue growth in the quarter compared to prior year. Our backlogs in the Energy segment ended the quarter at $281.7 million compared to $243.5 million in the second quarter of 2007, which is an increase of 16% year-over-year. As for profitability, this segment turned in another outstanding quarterly operating margin at over 20%. This is up 400 basis points from the second quarter of 2007. And year-to-date, profitability is up 410 basis points from the same period last year.

During the second quarter, we shipped a very favorable product and project mix in our large international projects business. We also believe that we've been able to effectively price these projects despite long lead times. We continue to improve operational costs and throughput in the face of tight supplier capacity constraints. And these improvements have been partially reduced by higher material cost and unfavorable currency impact, which we get from the sourcing of materials from China, which especially affects our US distribution and fabrication businesses.

Now turning to slide number eight. On this slide, we point out our assumptions for our key end markets that we serve. In general, our markets have remained strong. We continue to see healthy global demand in general industrial markets, power generation, energy refining, emerging market infrastructure build-out. We are watching the commercial after-market portion of aerospace for weakness, particularly in the US where a number of airlines have announced older aircraft being retired as we finish the year in the fall of third and fourth quarter. This commercial aerospace part of our business is a small portion of our aerospace business overall. And on the other side of it, we see continued strength in the military and commercial OEM markets within aerospace. We expect to see and continue to see material increases in currency. China currency appreciation will continue to be a headwind.

So now let's turn to slide number nine. These are our expectations for revenue, and margins in 2008 are cited here. For revenue assumptions, we are raising our expectations for both the Instrumentation and Thermal Fluid Controls segment and the Energy segment. Based on our backlogs and the performance in our second quarter, we've generally increased the guidance across the board by approximately 2%. We enter the second half of the year in great shape. As I noted earlier, year-over-year backlogs are up 26% in the Instrumentation and Thermal Fluid segment and 16% in the Energy segment.

Regarding adjusted operating margins, as Fred mentioned earlier, we're using adjusted operating margins, which excludes special and asbestos-related charges. And this only affects the presentation of our Instrumentation and Thermal Fluid Controls segment operating margins. Now, based on our progress year-to-date, we've raised our Instrumentation and Thermal Fluid Product segment range from 10.5% to 11.0% to a new range of 11% to 13% for the year. In addition, we've raised the Energy range from 15 – what was 15% to 16% to a new range of 19% to 21%.

Corporate expense, our guidance is up slightly to approximately $20 million to $21 million. And the tax rate has increased 50 basis points due to confined mix – to our higher tax jurisdictions, as Fred mentioned earlier. We anticipate having another strong performance in the third quarter with earnings per share before special charges at $0.90 to $1.00, and this compares to $0.62 in the third quarter of 2007.

So if I can summarize our outlook, we currently have good end markets, particularly globally. While we continue to be cautious, our backlogs across the company are solid, our quotation activity continues high, we continue to make progress improving productivity and operational performance with Lean and Six Sigma helping to offset material inflation.

So with that, we'd like to open up the lines for any questions that you may have.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) We'll go first to Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

Thanks. Good morning, guys.

Bill Higgins

Hi, Charlie.

Charlie Brady – BMO Capital Markets

A question on pricing, I guess you alluded to it a little bit, but a major competitor of yours has put through some rate and price increases. Are you – I'm assuming you're doing the same, but are you fully capturing raw material price increases, or is there still a little lag there, a headwind?

Fred Burditt

Are you talking, Charlie, across the board or any particular segment?

Charlie Brady – BMO Capital Markets

I guess – yes, I'm sorry – I guess I was speaking more specifically to Energy with regards to the competitor. But I guess I'd look at that also broadly into Instrumentation business. The major competitor there has put through price increases last few quarters. Are they still doing that or has that kind of stopped out?

Fred Burditt

Okay. In the Energy statement, on the project side, obviously we quote different prices. So I think we're doing – we feel we're doing a pretty good job in that area. In the distribution side, yes, we are working on putting in – we're putting in price increases this year, which will help us to offset the – both currency and material inflation. And I don't know that we will totally offset that, but we'll certainly make a dent in it as we start into the second half of the year. On the other segments, and certainly in the Instrumentation part of business, we have seen price increases this year. As we mentioned in the first quarter and also in the second quarter, we've received some more. So we're beginning to get some movement there, which we had not gotten in the prior year.

Charlie Brady – BMO Capital Markets

Could you comment on – to what degree of sourcing are you doing from low-cost countries currently – and with particularly on the Instrumentation side?

Fred Burditt

For the Instrumentation side, really we are working – it's not a significant amount at this point, although we have a lot of activities in that area. We did close a facility in Connecticut last year, and we – a lot of that product was outsourced and some of it was moved to Spartanburg. We are currently working on a lot of across-the-board sourcing activities in both – many low-cost areas. But to date, we've not had a significant impact on our business, more of that will happen in the future.

Bill Higgins

And just to add to that, while we've been real strong with our plant in China for the Energy side of the business, the Instrumentation and Thermal Fluids segment, we're relatively new at sourcing. And as we've talked about in the last couple of quarters, we're putting the structure and the infrastructure in place to do more low-cost country sourcing. So we've still got a lot of work to do there.

Charlie Brady – BMO Capital Markets

Okay. Thanks very much.

Operator

(Operator instructions) We'll go next to John Marr [ph] with Robert Baird.

John Marr – Robert W. Baird

Good afternoon, guys.

Fred Burditt

Good afternoon.

John Marr – Robert W. Baird

Nice quarter.

Fred Burditt

Thank you.

John Marr – Robert W. Baird

Just starting with the Energy segment, thinking about the comments you made regarding the orders in North America. Sounds like North America is going to be a stronger contributor in the second half. Can you guys just talk a little bit about what you expect for the mix between the North American and international business in the second half and how that would compare to the first half?

Bill Higgins

Let me add a little color specifically around the North American MRO or the distribution products business portion of Energy. It was soft in the second half of last year and in entering this year, so our revenues were lower. I think that something that's different this year is we are building momentum there. Our orders have been real strong lately. We're just closing out the month. Our orders are strong and continue to be in North America, particularly if gas – natural gas prices are high and there's a lot of work going on in pipelines and rigs. So we expect as we go through the year that that will pick up and have a stronger second half of the year compared to the first half of the year, which is typically – I think the other way around, if we look back historically, the second half hasn't typically had been quiet as strong as the first half.

John Marr – Robert W. Baird

Okay. And then looking at your guidance for the full year and the third quarter – or at least your assumptions on the last page here, your business assumptions, as I put those into my model and try and do the math here, it seems to me that you're looking at a fourth quarter in earnings per share that would be higher than the third quarter. I guess, am I thinking about that right?

Fred Burditt

Higher than which quarter?

John Marr – Robert W. Baird

Fourth quarter EPS seems like it would be higher than the third quarter.

Fred Burditt

It is – generally speaking, they're relatively close, but slightly up, yes.

John Marr – Robert W. Baird

Okay. And then just finally on your facility moves, can you give us, I guess, just a little bit more detail on what you have planned there in the back half of the year? Is this – are the Spartanburg moves a third quarter event or a fourth quarter event? And I guess, do you have anything else planned here for the last half of '08?

Fred Burditt

We've just completed the aerospace consolidations in California. Those are done. The plant is up and running. It's running great, didn't miss a beat. The benefit of that will come a little bit longer as we are still going to have some of the costs associated with that this year. The Spartanburg moves are still underway. The goal is to be out of the second plant the middle of this year, which is now. It will take I think a little bit longer, as we mentioned in the last quarter, but we still believe we'll be completely out of that facility this year. After that, we haven't laid out plans to consolidate other plants, but we'll continue looking.

John Marr – Robert W. Baird

Great. Thanks, guys. Nice quarter.

Fred Burditt

Thank you.

Operator

We'll go next to Alan Mitrani with Sylvan Lake Asset Management.

Alan Mitrani – Sylvan Asset Management

Hi, thank you. I'm fairly new to the story, so I apologize if this is too elementary. But your outlook in terms of your business assumptions, your guiding for revenue for the year for each division, excluding FX, can you give us a sense of how much you think FX is going to impact the two divisions?

Fred Burditt

Sure. I mean, FX – the way we – we make an assumption that FX freezes as it relates – we don't try to project FX. So our projections are based – the second half are based on the rates that would have been existent at the end of June.

Alan Mitrani – Sylvan Asset Management

Okay. So can you give us a sense as to where they were year-to-date then for FX?

Fred Burditt

Sure, hold on a second. Okay. Year-to-date FX, it was about 7% across the company. That was about 10% in the Energy segment and 4% in the Instrumentation and Thermal Fluids.

Alan Mitrani – Sylvan Asset Management

Okay. 4% in Instrumentation and 10% in Energy, okay.

Fred Burditt

Correct.

Alan Mitrani – Sylvan Asset Management

Excellent. Can you talk about the raw material environment, whether you were able to get pricing to go above that and just how – do you hedge on raw materials and whether that's going to impact you strongly in the back half of the year and into next year?

Bill Higgins

We do not hedge on raw materials. We do purchase materials forward for our long-cycle businesses. So when we secure a quote in our – an order on our Energy Products business, which we're out 50 weeks, we are securing the material for that, a lot of times funded by a customer for the forgings, the castings, the long lead, hard to get items. But for the rest of the material, our cycles are shorter. So we're not at risk from a time standpoint, but we have to offset through price increases on a regular basis.

Alan Mitrani – Sylvan Asset Management

Okay. And maybe can you just give us a longer sense as to you guys haven't been running the business here for that long, at least as Senior Manager you made a lot of changes the last couple years. Can you talk to us about where you think the outlook is in the next couple of years for the business? What kind of changes – if we look back at CIRCOR a few years from now, what are the changes we're going to see? I mean, if we talk about acquisition changes, obviously doing a lot of manufacturing changes, but just how far to the goal of where you want this company to be are you?

Fred Burditt

Boy, that's a good one. We – I personally have been with CIRCOR since January 2005. We worked a tremendous amount on our operations in improving our business throughput and efficiency, in creating a scalable business model that we can continue to deal with acquisitions or on the existing base business. So our goal – our legacy is one of acquisitions and our future is one of growing the business both organically and through acquisitions.

Alan Mitrani – Sylvan Asset Management

And in terms of how far – I mean, where are you in terms of where your goals are? I mean I guess you haven't really made any acquisitions in a while. Can you give us a sense – just remind us what you're looking for, size, and what you're seeing in terms of competition for acquisition, because you are fairly small?

Bill Higgins

We haven't made any acquisitions of size. As we’ve sort of elaborated in our prior call, we did look at a number of acquisitions last year. And with the stronger management team that we have in place, we've looked at larger size acquisitions, but the pricing in the market last year was pretty hefty. The price premiums were very high. There were a number of good-sized deals that we withdrew from because of that. So we're continuing to look, we haven't changed that. That's been pretty consistent. And the right deals that fit within our core competencies, we'll still pursue them. For the longer-term picture, we have not published a specific set of goals of where we think we want to take CIRCOR. We haven't publicly stated that. We have said that on the Instrumentation side we have laid out a path over the past couple of years to get the Instrumentation profitability up. So the operating margins were up in the 11% to 13% range. We're getting into that range now, but we also said we want to get there and sustain that and then look at the strategy of our businesses to then determine how we get to the next level.

Alan Mitrani – Sylvan Asset Management

Okay. And then on the asbestos charges, because I'm not as familiar with this, just to understand what you were saying, you're saying that basically the carrier is paying 71% of your costs, indemnity cost, defense cost. You've accrued as much as they can cover for the year or this period? And now the expense charges for asbestos are going to be higher. Now these are cash costs that you're putting into your P&L, or they're not cash costs?

Fred Burditt

These are non-cash costs. So we were talking about from a kind of GAAP perspective. And we have an open claims accrual on our books. And what we're saying is, at the end of the second quarter, if you take the aggregate of those open claims accrual for indemnity, we have now reached the insurance limits we believe we have. So, from a book perspective, not cash, book perspective, after the second quarter, we will no longer have the benefit of that 71% against indemnity. Now we will have the benefit of the 71% against the legal, which is our bigger of the two costs, because the insurance companies will continue to support that until we are actually on a cash basis pay for whatever claims or verdicts.

Alan Mitrani – Sylvan Asset Management

Is there any resolution that you could have to this asbestos situation, or there is none? There's no way – I mean, obviously you're not going to – you can't win, sense anything or there's no way to do, you just have to do what you're doing?

Fred Burditt

Well, it's actually an extremely complicated question you asked me and something that we are evaluating continuously. At this point, we have not made any decisions to take a change in course as to – from where we are today, but it is something we will evaluate annually.

Alan Mitrani – Sylvan Asset Management

Okay. Thank you.

Operator

We'll take our next question from Eric Mintz with Eagle Asset Management.

Eric Mintz – Eagle Asset Management

Hi, guys, congrats on the really strong results.

Bill Higgins

Thank you.

Eric Mintz – Eagle Asset Management

Just to drill a little bit into the operating margins, obviously we've got a pretty big step change here in your guidance. And I think you just referred to your target in Instrumentation having been 11% to 13%, which is where we are now. But I think you alluded that there could be more upside to that going out a few years. How should we think about that? Is there another step-up there potentially looking at thinking about maybe '09 a little bit?

Bill Higgins

Well, what we've said consistently while we'll continue to work internally is, we'll have stretched goals and we're driving for higher performance looking at the businesses. But we also have acquisitions to consider and how we roll those in and how they would affect the performance. We're going to continue to look strategically at the business and look at the portfolio of businesses that we have. But kind of looking backwards, we have put new management and strong operating teams in most of our businesses and done – and made a very large investment in capability around lean manufacturing, and giving the teams time to really work it to see what we could do with these businesses. And that's where we find ourselves today. So now our job as the executive team and what we're working on is the strategy of now where do we take these businesses. So, we do believe we can improve them. How much? It’s hard to say right now. And what the specific strategy will be? We haven't communicated that yet.

Eric Mintz – Eagle Asset Management

In terms of just like what inning we might be in on the lean manufacturing initiatives, has that played out here in this guidance or is there more upside from lean manufacturing?

Bill Higgins

We're very early – the discussion I have with the lean experts that we've been able to recruit in the company, they would tell us consistently across the board that we're in the first inning.

Eric Mintz – Eagle Asset Management

Okay, great. And then on the Energy, obviously a big step-up there. I think you guys, maybe two quarters ago, were thinking 15% was peak margin for Energy. Now we're looking 20%, is that – how do we think about that going forward? Is that going to come back in or is that sustainable here?

Bill Higgins

I think we had great debates internally about getting and achieving 15% and maintaining that and then going over it. So we have done better than we expected. We've had tremendous markets in the large project area. We've been in the right space. We are now quoting lead times out further now. So we're out 50 weeks on quotation activity. So there's general capacity limitations in the industry for supply of materials, for forgings, for castings, for purchase components. So we're working through that. That's where the operational improvement helps. We are also facing some headwind on the Renminbi, the Chinese currency appreciation affecting our supply chain, which has been a very effective supply chain for us out of China with our lean plant in China, which is a great – a very successful plant, has been a key supply chain to the North American markets as well as to the rest of the world. And we are facing some headwinds there on cost due to appreciation as well as general material inflation.

Eric Mintz – Eagle Asset Management

Could you maybe expand on the step change that we saw in your '08 outlook for Energy margins, if that was equal between I guess the land or – the land valves versus the project segment?

Fred Burditt

Yes. Actually the increase in the performance for the quarter as well as for our guidance is just all being driven by the large project business.

Eric Mintz – Eagle Asset Management

Okay. And then just to circle back on the Energy orders, I guess year-to-date down 4%, but you're indicating that you're seeing very strong quotation activity. Would you expect orders in Energy for the year to be positive?

Fred Burditt

Yes, I think – actually on a year-to-date basis, I think we are positive, and we would – we do expect –

Eric Mintz – Eagle Asset Management

Just from Energy I think you're down – on slide seven.

Bill Higgins

The backlog is positive.

Eric Mintz – Eagle Asset Management

Okay.

Bill Higgins

Orders are down.

Eric Mintz – Eagle Asset Management

So, on orders for the year, would you expect that to be up year-over-year?

Fred Burditt

I think for the remainder of this year, we expect it to be similar to where we've been the first half.

Eric Mintz – Eagle Asset Management

Okay. Okay. Thank you. Great quarter.

Operator

We'll go next to Amit Daryanani with RBC Capital Markets.

Jimmy Kim – RBC Capital Markets

Hi, actually this is Jimmy Kim [ph] pinch-hitting for Amit. Question about your Q3 EPS guidance. It's going to be 10%-ish below where you guys finished in this quarter. And I was wondering could you comment on those dynamics? Is there a seasonality issue?

Fred Burditt

Yes. There's probably two important points to add to the issue, is we do have seasonality issues. We have – we typically have many of our plants have shut downed in the third quarter of the year, which impacts our profitability because of obviously the fixed cost without production, that's one factor. And the other is the – we talked about the asbestos issue and that will also impact it. If you took the first half of the year, the impact of that is probably somewhere in the range of $0.05.

Bill Higgins

With five manufacturing plants in Europe, we have the typical European shutdowns in a lot of our locations. So we do have to manage through that in the summer.

Jimmy Kim – RBC Capital Markets

Okay. Thank you very much.

Operator

And we do have a follow-up from Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

Thanks. Can I just kind of go to the last question and with regard to the third quarter guidance? And maybe you could help me out with some of your visibility. I mean, I understand you've got a third quarter seasonality and you've got plant shutdowns that obviously affect the overhead absorption. But doing the math on some of these numbers, it looks as though there is a pretty high degree of conservatism built in, at least that's what I'm coming up with. I'm just trying to understand that is it a fact of – obviously the project business is pretty high visibility if you are out 50 weeks, and the distribution business is maybe less visible. But can you talk maybe about visibility on some of the Instrumentation side and what degree of conservatism you do have kind of built in there? And then secondarily, your guidance excludes this asbestos charges, I'm assuming. Where is that – is that going to show up those charges in the individual segments or a separate line item?

Fred Burditt

Charlie, the guidance does not exclude the asbestos charges. Our guidance has always been our EPS excluding special charges, not – but asbestos is not – we do not treat asbestos as a special charge.

Charlie Brady – BMO Capital Markets

Okay. Understood.

Fred Burditt

As to the – our forecast – I mean, again, this is based on our information this is the best look we have at the second – at the third quarter, and I don't think there's any undo pessimism or conservatism in that number.

Charlie Brady – BMO Capital Markets

And can you give us some color on what sort of visibility you have just in broad terms on the Instrumentation business? How far out do you see things coming out to you? Obviously on the Energy side, the project business has a long visibility. What's it like on the Instrumentation side of your business?

Bill Higgins

Well, from the third quarter standpoint with the inclusion of one month of it and getting close to halfway through, I mean, we have pretty good visibility for the quarter, because we're out six, seven-week lead times, eight-week lead times maybe in some case. So we have visibility through the quarter. And we've done the backlog scrubs and looked at what's in the backlog so far and the run rates, and then looked at what kind of productivity we'll get, where the shutdowns are concerned and whatnot, and the mix changes.

Fred Burditt

One area that is always a quarter-to-quarter issue with us so that [ph] the large projects, which can – shipments can miss by a day or a week and have a relatively large impact on a quarter. It's not a long-term issue, but it can be a quarter-to-quarter issue.

Charlie Brady – BMO Capital Markets

Okay. Thanks.

Operator

And there appear to be no further questions at this time. I'd like to turn things back over to Mr. Bill Higgins for any additional or closing comments.

Bill Higgins

Well, I'd like to thank everybody for your support and your interest in CIRCOR. Our next earnings call is anticipated to be October 30, 2008 at 1 o'clock PM. So we thank you and we look forward to reporting good results next quarter. Thank you.

Operator

Again, that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.

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