Circor International Inc (CIR) 2002 Q2 法說會逐字稿

Good day everyone and welcome to the CIRCOR Second Quarter 2002 Conference Call. Today's call is being recorded. At this time, for opening remarks and introduction, I would like to turn the call over to Mr. Ed McDowell (phonetic) of Makinson Cowell.

Thank you. On the call today are David Bloss, the Chairman and Chief Executive Officer; Kenneth Smith, the Chief Financial Officer; and Alan Carlson, the Executive Vice President of operations. We will be referring to 12 slides during this morning's call. View these slides on CIRCOR's website, www.circor.com, under the link of investor relations. And in accordance with the Safe Harbor Regulations, we remind you that any forward-looking comments, we will be making our subject to a series of risks that may make actual results differ materially from our expectations. We advise you to read about these risks in our SEC filings. Let me now turn the call over to CIRCOR's Chairman and CEO, David Bloss.

Good morning everyone and we appreciate those of you who could make our conference call this morning. We know it is a busy time of earnings releases at this time of the month. But as usual, let me begin with an overview of our most recent quarter's result. Our operating results for the quarter were in line with our expectations, equal to first quarter's performance but lower than last year due to prevailing market condition. On the revenue side, we enjoyed positive effects from the international oil and gas projects plus the June 2001 acquisitions that we accomplished. But these factors were more than offset by the sluggish domestic markets for general industrial oil and gas, and aerospace valves and fittings. In addition, pricing has intensified which, in selected businesses, offset the positive effects of many of our cost-reduction initiatives. These factors coupled with higher insurance cost, primarily health insurance in particular, caused our earnings to be below last year's performance. Looking forward, we should continue to benefit from wins on projects for large oil and gas projects that have scheduled deliveries in the second half of 2002 and early 2003, which gives us some confidence of sequentially improved earnings projections for the rest of this year, assuming no further deterioration in our other primary markets. To that point, our backlogs at June end are CIRCOR's highest ever at nearly 79 million, up 25 percent from last year and up 3 percent sequentially. Again, reflecting the significant cap expending on large international oil and gas and marine projects, where we believe we are wining our share of the valve contest. Alan Carlson is here with us today, and he will provide the details concerning our operating performance of each of our segments in a few minutes. But let me say that we continue to be focused on raising returns, and we are well positioned for margin expansion when broader industrial investment activity spending rebounds. Our balance sheet continues to strengthen as well during the quarter. We generated over $16 million from operating activities in the first six months of this year and free cash flow was 1.8 times net income. Our net debt to total net capitalization ratio currently stands at about 10 percent, and our businesses are continuing their focus on efficiently managing their use of cash. At this point, Kenneth Smith and Alan Carlson will take you through the more detailed explanation of our financial results for the second quarter beginning with Ken. At the end of our remarks, we will have some time for your questions.

To begin, let me state that all of the P&L results reported on our earnings' press release were based on the inclusion of special charges and represented full US GAAP results. However, in these slides that we reviewed this morning, the P&L date is presented excluding the not recurring special charges directly related to flat closings, which were reported in our US GAAP income statements. If anyone has any questions regarding charges, we would be happy to respond at them at the end of our presentation. I also want to point out another adjustment made to the P&L results on this slide. This adjustment involved the accounting for goodwill amortization, the change beginning of this year. For CIRCOR, that meant goodwill amortization ceased with Q4 2001. Last year, goodwill amortization was $2.7 million, and in Q2 of last year, it amounted to $600,000. So for comparability in the attached slide, goodwill amortization has been removed from the 2001 results and footnotes on the slides quantified that improvement in earnings last year. I will now speak about slide number 3. Regarding worldwide orders, orders this quarter were equal in amount to one year ago at $84 million. The two European companies we acquired last June added to this year's second quarter by $4.4 million, but that increase was nearly matched by the order decrease in our other business units. Sequentially, orders decreased primarily in our petrochemical segment where Q1 has been seasonally stronger due to increased winner drilling in Western Canada. Also in the first quarter of this year, we booked more large international oil and gas projects than the second quarter. Elsewhere, general industrial markets and economic conditions remained soft in North America and Europe. Our backlogs continue to remain healthy. The strongest growth from last year was from large international oil and gas projects. And year over year, the two acquisitions added a smaller component of the backlog growth. Looking back over CIRCOR's nearly three-year existence, we began Q3 2002 with our highest quarter-end backlog since the spin-off. Regarding revenues, the decrease was a net change on lower sales to aerospace, general industrial, and oil and gas MRO markets, and higher sales to large international oil and gas projects and from the June 2001 acquisitions. Regarding profitability, the operating results reflected a product mix change selling less of higher margin products of the aerospace and general industrial markets plus MRO orders to oil and gas producers. Profitability also was negatively impacted by higher insurance expenses compared to last year and by selective short-term pricing actions in our petrochemical segment. Alan will talk about each segment's operating performance after I finish. In free cash flow and other reasonably good quarter, we did invest in an additional inventory this quarter as components were purchased for many of the project orders and backlog that we are scheduled for shipment in Q3 and in early Q4. We also invested in inventory in Europe and in the US where we have particular sales initiatives on their way to gain market share. And equating free cash flow to a per share statistic, Q2's free cash flow is 41 cents per diluted share. Now, I will turn to slide number 4, revenues. In the instrumentation on thermal fluid control segment, acquisitions accounted for a 4.3 million increase which more than offset a 6 percent decline in our other business units. The other business units declined particularly the instrumentation products reflected the continuing effect of the general industrial markets slow down. The decrease in the petrochemical segment stemmed from reduced oil and gas drilling and processing, which affected lower demand for valves or MRO with small projects. And the decrease in MRO sales offset the year over year rise in sales by our Italian business unit on large international projects. The decrease in both segment's operating margin was affected by the change in product mix where sales of more profitable products declined and by higher insurance cost. The petrochemical segment was further affected by selective short-term pricing actions in Q2, which Alan will describe shortly. Now turning to slide number 5, as I just described the decrease in segment operating income was broadly impacted by a product mix change, the petrochemical segment's pricing actions, and insurance cost. The special charges this quarter represent severence and moving costs to close two small petrochemical locations here in North America and consolidate into larger existing facilities. We also recorded special charges in Q1 for the related lease terminations and noncash asset write-offs related to the same two facilities. Net interest expense increased slightly due to debt assumed in last year's European acquisitions and some very low cost working capital borrowings in Italy. Other nonoperating income and expense improved predominantly due to foreign exchange gains on the rise of the Euro this quarter. Income taxes were favorable due to the lower earnings before tax plus certain tax strategies we implemented this year. And to refresh you on the tax rate decrease, last year the effective tax rate was 40 percent, and we are using 36 percent effective rate this year. Three points of the decrease to 36 percent were due to the nondeductible goodwill amortization ending last year. Turning to slide number 6, cash flow, as I described it earlier was satisfactory. We made selective investments and inventory this quarter to aid sales initiatives with readily shippable products and to fulfill orders scheduled for Q3. Also included in the second quarter and year to date 2002 cash flows was a contribution to our US pension plans. That April 2002, cash contribution was $2.7 million and that cash payment reduced the December 31, 2001 under funding by more than half. And accounts receivable were reduced DSO by another day, and thus, we now ended the quarter at 62 days of receivables. And in trade payments, we are heading closer to matching the timing of vendor disbursement to the timing of customer collections. For all of 2002, we are working to achieve free cash flow between one and two times (indiscernible). Turning to slide number 7, the short term debt includes the first of five annual payments of principle on our senior notes, which will begin this coming October 2002. And each annual payment is $15 million. Even with the principal payment this coming fall, our balance sheet is very strong and I believe sufficient to whether the current economic slow down and any double dip should one occur. And it is quite evident to me that we have ample leverage for future acquisitions. In fact, existing cash plus the unused revolver provides CIRCOR with $130 million to fund the right acquisitions. And for the foreseeable future, our goal for using this cash is to invest in the right and tactful acquisition or acquisitions. And now, our Executive Vice President of operations, Alan Carlson, will describe the financial performance of each segment starting with slide number 8.

In the instrumentation of thermal fluid control segment, the general industrial slow down continued to affect our businesses this quarter. Our orders decreased modestly year over year and sequentially due to commercial aerospace and general industrial markets which remained soft, while steam and cryogenic product sales remained steady compared to Q2 last year. We are optimistic that the bottom has been reached as orders were only down 2 percent sequentially, with aerospace orders in particular showing an increase sequentially. Regarding revenues, the Q2 increase was a net improvement from acquisitions that offset our decline in aerospace and general industrial markets. Regarding operating income and margin, previous cost reduction actions were not enough to maintain margins as the latest acquisitions did not have as yet earned the same higher margins as many of our existing business units. Also, higher margin products were among those product lines that had revenue decreases this quarter over Q2 last year, and insurance products this year had been increasing dramatically for the same reasons that we have read in the national press. Looking ahead, we expect the softness in the general industrial markets to continue. However, recent competitive wins should help mitigate market softness and continued cost improvement should help us sustain operating margins in the mid teens. When the general industrial markets improve, we also expect margin expansion based on past cost reductions. Now, slide 9. Regarding the petrochemical segment's performance, orders increased compared to last year on continuing international oil and gas project spending by major oil and gas companies, while at the same time demand declined for domestic MRO replacements and new oil and gas installations. Looking forward, we expect the near term demand for MRO to remain soft, although we have seen domestic recounts increased by the end of June, and hopefully, that trend will continue. With sequential decline for orders within both international projects and MRO orders, Q1 was stronger due to Western Canada's sequential drilling season. Our Italian business unit also secured more international orders in Q1 compared to Q2. Our backlog in the petrochemical segment remains high. Our Italian business unit in Pibiviesse, which manufactures the largest of our valves servicing the international projects, enters Q3 2002 with the highest backlog since 1998. Pibiviesse's delivery lead times for its largest valves on its international projects are generally six to eight months. So, there is a large portion of Pibiviesse's backlog that is scheduled for shipment in the second half of this year and new orders will turn into revenue in 2003. Revenues declined due to the weakness in the MRO orders from domestic oil and gas producers. The decline in MRO orders more than offset Pibiviesse's revenue increases in Q2 and the first half of 2002. The operating income in the petrochemical segment decreased due to several short-term factors. First, the net decrease in revenue from the prior period. Second, income deceased from selected short-term price inactions taken domestically to compete against new low price competitors, and these price inactions have ended. Third, we have actually lowered prices on certain industrial commodity valves to sell off existing inventories that will make room for lower cost foreign-sourced inventory arriving in Q3. And fourth, we decided to upgrade the existing seats in certain of our (indiscernible) valves and existing inventory. The repaying of valves with these new seats has been completed as expected to aid our sales to drilling and production installations in the colder climates. So, although the operating margin in Q2 was this segment's lowest in the last six quarters, we expect margins to rise sequentially that it had been in the second half from lower cost components, but curtailment of Q2's competitive price inactions and modest volume increases. And yes, this segment is still driving towards a 10 percent operating margin by year end. Let's turn to slide 10. In the first six months of 2002, revenues declined 5 percent which was net of our acquisitions adding in 5 percent while our other business units contributed to a decrease of 10 percent in both periods. The revenue decrease resulted from significant order softness across many end markets, although orders decreased a net 3 percent including acquisitions. If we excluded last year's acquisitions, orders were down 7.4 percent with the most softness coming in North America oil and gas, general industrial, and aerospace markets. And the backlog growth over June of 2001 is predominantly from the large oil and gas projects in petrochemical. The operating income change stems from the lower order volume from some of our key end markets on lower general economic conditions prevailing in North America and Europe, the decline in North American oil and gas revenues, and the general industrial instrumentation and aerospace sales impact, coupled with selective pricing moves and insurance cost with the primary factors that decreased worldwide operating income. Yet in the face of very difficult market conditions, our business units continue to market their products aggressively and reduce cost in order to rise our operating margins to the highest extent possible. This is particularly evident in our instrumentation and thermal fluid control segment, which maintained 16.7 percent margin in a difficult market condition of the first six months of 2002. Moving to slide 11. This shows certain of our key end markets and other factors that we expect to influence our performance in the second half of 2002. In the instrumentation of Thermal-Fluid Controls Group, the positive factors include the beginning up-turn in our commercial aerospace market as our sequential order rate from Q1 of this year to Q2 showed some improvement, the first since September 11th. We also believe our sales into military application plus our continued sales penetration in the OEM analytical market will bring added volume to the second half. We anticipate the soft markets and factors we have experienced in the general industrial markets during the first half of 2002 to continue to be unremarkable for the balance of the year. We expect the power generation market to remain soft for the next 2 years as guessed by our turbine (phonetic) producers such as Calpine (phonetic) as scaled back with sales prospects for 2003 and 2004. Within the petrochemical segment, North America drilling activity is expected to be weak because of the forecast of lower prices of crude oil and natural gas and a relatively high supply, although the mild increase in domestic recount is encouraging, but we expect our international revenues to continue to be strong. As several orders in our current backlog are scheduled for delivery in the second half, we also expect the large international order growth to continue, which will help us in the first half of 2003. In summary, while several of our markets are soft at the current time, we do not rely on predictions to manage our day-to-day business. Our business unit leaders monitor their markets closely and make appropriate adjustments to their production and spending levels as appropriate, and we continue to drive to raise our returns for shareholders in these difficult times. I now would like to turn the call back over to David.

Well, as indicated in our remarks and more importantly by our financial results, the management team of CIRCOR operates on a conservative basis and focuses on the fundamentals of strong customer service, cost control, and cash management. The employees in all our business units work hard to provide our customers with quality products that fit their fluid control needs. We serve a diverse set of end use markets which, in times like these, allows us to weather difficult economic conditions without lull on fluctuations in our operating performance. Our position in each of our major markets remain strong and, in may cases, is growing. Our record level order backlogs gives us some confidence that the remainder of this year should be somewhat better than the first half, but this also depends on the vitality of our day-to-day MRO and smaller project activity in each of our businesses which is difficult to predict in today's environment. But at this point, we expect third quarter earnings to be around 27 cents, the fourth quarter at 31 to 36 cents, and the full year at $1.10 to $1.15 excluding special charges. Our balance sheet is extremely strong. We have generated significant cash since our spin-off and have accumulated quarter bank account. We will continue to be very selective as we search for acquisitions and look for cash return on our investment, which meets our internal criteria. Given these uncertain economic times, we are scrutinizing all candidates even more closely than before, and we expect pricing to continue to decrease, so we are being patient in our acquisition search. And finally, before we open up our questions, I would like to say a few words about the impact at all the proposed changes in regulations concerning corporate governance we have and what we do here at CIRCOR. As you can get, this topic captured a lot of attention in time at our recent Board of Directors' meetings over the last couple of days, and we are still evaluating the internal actions that will be required by these new regulations. However, we are committed to complying with these new requirements as soon as they are finalized, and we are confident that our accounting practices and policies as well as our disclosures contained in our public filings have been appropriate, candid, and transparent. With that, I would like to thank you for being with this quarter's conference call. We will now open the lines for any questions that you may have.

Thank you gentleman. Our question and answer session will be conducted electronically. If you would like to ask a question, please firmly press the star key followed by the digit 1 on your touchtone telephone. We will come to you in the order that you signal, and if you find that your question has been asked and answered before you could ask it and you would like to remove yourself from the question roster, please firmly press the star key followed by the digit 2. Again, if you would like to ask a question, press the star key followed by the digit 1. And for our first question, we go to Michael Schneider (phonetic) with Robert W. Bare (phonetic).

(multiple speakers) Certainly interesting times in the market and the sector, may be you could give us a sense on the petrochem side, the Pibiviesse increase versus may be the balance in that segments so we can try and dig a little deeper into the order patterns.

Well Mike, we usually do not dig that deep into each individual business unit within a sector, but the order patterns for the North American operations, I am sure you are probably more interested in sequential versus year-to-year, is that correct?

Yes.

Are in North America, the order patterns declined less than the Pibiviesse change sequentially because Pibiviesse had one half of the first quarter. Obviously, it probably broke a lot of its own internal historical records in that first quarter and are still quite high. The second quarter orders for Pibiviesse were still higher than what I have seen in the last since 1998.

And I know that business is wealthy and a large project. Do you sense anything other than timing issues going on? Is courting activity slowed?

Courting activity has not slowed. I was discussing that same point with the management there last week and taking a sense for what they are seeing in preparation for this conference call, and they tell me that their quoting lead times may not be as competitive as they were before because their backlog is so high, but their courting activity is still pretty strong.

Okay. On the MRO side, there is this continued disconnect between the higher utilization rates within the chemical and energy sectors and what (indiscernible) going on on the daily maintenance.

Right.

Can you give us your thoughts on how long the disconnecting continue or is there something different about today's market than let say even 18 or 24 months ago.

I do not think there is anything substantially different from the market dynamics that we are seeing, and we are hoping that, by the end of this year, we will start seeing some (indiscernible) in capital spending in that sector and will take us into next year on a better basis than what we have seen in the last 18 months. But I do not see any dynamic change in the market structure or (inaudible) going forward.

In the chemical markets specifically for you, what is the latest read there? We have obviously got mixed signals out of your other competitors had reported already. Some say it is down hard and some say there is actually encouraging signs. What is your read on that market?

That was interesting. I read the same things, and we have one particular product line that we can look at orders, you know, on an individual basis that deals just in the chemical sector, mostly industrial and chemical processing, and sequentially that is flat for the first and second quarter. The declines that we have seen in that sector all occurred a year ago and that has been relatively flat since in the last 12 months for us. So, I am still studying the other information, may be they are serving a different piece of that chemical process and industrial markets. But we have seen it down steeply last year and then flat since then.

Okay, and including the MRO activity, it has not deteriorated?

Not on the chemical processing and industrial site. The MRO activity decrease that we have referred to in our remarks deal primarily with the petrochemical side of it.

Okay. And then on the selective pricing actions, Alan, you mentioned that in the petrochem side you have taken some pricing action within that segment. Is that what you mentioned David earlier about trying to gain some share or there are some other issues?

Well, it was maintaining our share and our markets, as you know, as markets get tougher you know how it goes. Everybody wants whatever is left, and they get pretty aggressive out there, and we were not going to stand by and watch others get our market share so.

And is that in the smaller MRO-type valves or is that in the large projects as well?

It was in the smaller MRO-type valves and very specific to product lines where we had a competitor coming in trying to look at our larger one-stop shopping kind of thing. We do not want to let them get in on any product whatsoever.

Okay. Let's see and then final question, Ken, could you give us the currency impact on the quarter top line and bottom line?

Yes. On the bottom line was negligible and on the top line, it was a million three positive.

Okay, and I know the Euro strengthened just in June, but if you extrapolate it out, presumably you have some sizeable gains in the third quarter sequentially?

Possibly, but I am not thinking of it at the moment.

Okay, and does your guidance assume -- what is your guidance assume about the Euro from here?

No improvement.

But over parity, from one -- you know, basically from one flat sequentially?

Well, we just assume that we fall back into the mid 90s.

Okay. Alright, great. Congratulations on a nice quarter (indiscernible).

Thank you.

For our next question, we go to Rich Glass with Morgan Stanley (phonetic).

A couple of questions that has kind of tie back the other here. You guys talked about returns a few times there, but if we take a look at your assets from the beginning of the year and pull out the cash even, the assets are up. I realize probably some of that have ties into the inventory levels for the second half. But what I think we need to may be talk about a little is the petrochemical cost structure in particular. You were talking about 10 percent margins at some point in the future and, you know, you want to drive the returns. Can you get the 10 percent margins and can you improve returns without either a big pick up in the economy or, more realistically, may be with downsizing some of that operations employing assets out, I mean, (indiscernible) to get to a higher returns and the earnings are not cooperating at this point.

But we had a little set back this quarter as Alan described which -- and I think, Alan and I both have been focusing on the performance of this business and feel comfortable that of the actions our employees, the sourcing of components offshore, some machining done offshore which we already have purchase orders launched and issued for, so that stuff is coming our direction be delivered in the third quarter and replace higher cost components that we are getting domestically before. That with its cost structure changes that Alan has implemented in the petrochemical business, we feel pretty darn confident that we will be able to get, if not 10 percent, very close to it by the end of this year. And then on the asset side, we are going to continue to bring down those inventories. What you see in this quarter is exactly what Alan said obviously that we had to build some inventory, get components in to meet the back log of requirements that we currently have with our record levels. So you will see those coming down in the second half as well. As far as other assets, we have closed that Houston warehouse. We have closed another facility in Pembroke, New Hampshire. Those are the special charges, and we got another little Canadian law operation that we are consolidating, so you will see those assets coming down as we move forward. Once we get finished with those, then we have got a plant (indiscernible) in the city, plant in Italy, and a joint venture in China, and we are as tight as we can be on facilities at that point.

Okay, so we can get to that 10 percent operating margin without a big pick up here, that is what you are saying?

I believe we can. We are working hard toward it. We have got detailed actions, assignments, time tables, and it is moving forward on schedule.

Okay, and then tying back to that, I mean, your great free cash flow and you have for some time near the net debt is down to -- close to zero for (indiscernible) purposes. Have you given some thoughts to buying back your own stock? I mean, you have talked about acquisitions for a while. You have done a couple of small ones. But it seems like your stock is straying pretty cheap enterprise to free cash flow basis, that is for sure.

Yes, right now it is. Let me respond to that. We have thought about it but decided not to pursue that at this point, although things changed with the stock prices going the direction they have been going. So, we keep that on the top of our table. But right now, we want to follow our long-range strategy and going through acquisitions and that means we are going to need that cash. We are a small company, and the size of deals and the size of growth that we would like to accomplish could very well utilize that if we hit on a couple of transactions, so I would hate to loose that gun power right now. And I think we are entering into a very attractive time where companies with cash will find some very attractive acquisitions in our market areas in the next 12 months.

A lesser consideration, Rich, is that we have got this first of the principal payments coming up this fall $15 million to?

You got the 57 million in cash in the (indiscernible).

Yes, we have got that covered.

Yes, (indiscernible) it is covered.

And if you are going to be producing free cash flow of any things sort of like this magnitude looking out to the future, it seems to me like you should be able to buy back stock and do some acquisitions? (indiscernible) just a statement there.

Well taken.

Thanks guys.

Thank you.

Thank you and if you would like to ask a question, please firmly press the star key followed by the digit 1. For our next question, we go to (indiscernible) with Robinson Humphrey (phonetic).

Thank you. I have two questions. First, you talked previously about the chemical business. I guess yours has been flat so far this year. Are you seeing some talk in chemical and general industrial and those rounds of volumes really dropping off over the next couple of months?

I have to be honest that, no, we have not heard dropping off comments. We felt the impact, like I said, 12 months ago and it has been depressing for us to listen to our sales people over the last 12 months, see how bad it is out there with nothing happening. So, we have been living in a very very depressed market for some time already, and that is why I found it curious that other companies in the fluid control industry are now just talking about it. I cannot reconcile that right now.

Alright. A second question, on acquisitions the past six months, it seems as though, not just your comments but other industrial companies are talking to, an on-again and off-again depending on where people think the recovery is. Have you seen a marked change with the move and equity marks over the last month or two and your targets? I guess approached to being willing to sell. Have we got into that point yet or is that still somewhere down the line?

I think we are nearing that point. Our knuckles are bruised from knocking on doors and what we are persistent is heck to continue that dialogues. But you have to remember that we are looking for high-engineered content valve businesses and product lines to acquire, and those are the ones that generate cash and profitability for companies in times of (indiscernible), and it is just hard to convince them to let go of those businesses. They have to become a little more needy of cash and may be make some strategic decisions as far as direction of the company, when I am talking about larger companies with divisions that we are interested in. In small private owners, they are tending to look at it and tell themselves that they do not want to sell off in today's multiples their earnings because they are down a little bit. But this (indiscernible) in my view that and I think it is getting closer that their cash needs. They are going to see just the desire. They want to just sell and move on with their lives on the private owner side.

Okay, thank you.

Your welcome.

Gentleman, we have no further questions on our roster, therefore, Mr. Bloss, I will turn the conference back over to you, Sir.

Well, just thanks again for those of you who attended this conference. I know it is a very busy time and a lot of earnings are coming out and the markets are very active, so we appreciate the time you are giving to us and we will see you next quarter.

Ladies and gentlemen, this thus conclude our conference call for today. You may disconnect at this time.