Circor International Inc (CIR) 2003 Q1 法說會逐字稿

Good day, everyone, and welcome to the Circor first quarter 2003 conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. of . Please go ahead, sir.

Thank you very much. And good morning, everyone, and welcome to our first quarter earnings call. Our objectives today are to review the company's recent performance and provide an updated outlook for 2003 and guidance for second quarter.

David Bloss, the Chairman and CEO of Circor, Ken Smith, its CFO and Alan Carlsen, the Executive Vice President of Operations. After their comments, we'll then go to Q&A. Before we start, two administrative notes, first, the slides we will be referring to today are available on Circor's Web site at www.circor.com under the link of investor relations.

Second, today's discussion contains forward-looking statements that identify our future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors, we advise you to read about them in the company's 2002 Form 10-K, which also can be viewed on the company's Web site. Of course, actual results could differ materially from those expressed or implied from today's marks. Now, let me turn the call over to Circor's Chairman, David Bloss.

Thank you, Ed. Good morning everyone. In addition to this earnings call, today has added importance as we host the company's annual shareholder's meeting here at our Circle Seal Control's facility in California, two hours from now. And all but one of our group executives attending that meeting are also on this call, Carl Nasca, Vice President of the Instrumentation Products Group, Doug Frank, Vice President of our Thermal Fluid Products business, and Barry Taylor, who is Vice President of our Hoke Operations. If there are any questions at the end of our remarks that pertain to their markets, they'll be ready to answer you.

Now, regarding our first quarter results, all in all I have to say that we're pretty decent in face of a very difficult economy. Ken will take you through the detail, but the headlines are, revenues came in at about 87.2 million, up about 9 percent for the quarter, about 6 percent excluding acquisitions, and about one percent up sequentially. On the incoming order side we came in at about 93.8 million, up 4.4 percent for the quarter, about one percent excluding acquisitions and up 2.3 percent sequentially, which is good.

Our backlog came in at 81.3 million. It's a record for us. It's up about 5 percent versus last year, excluding acquisitions, and up about 9 percent sequentially. And our earnings at 3.8 million are $0.25 per share, are above our estimates slightly and about equal to last year.

Of important note is our free cash flow, which came in strong at 14.5 million. It's two times last year's first quarter, equal to 3.8 times net income. And we made good progress on working capital and inventory reduction this quarter.

Regarding our markets, the international oil and gas markets remain fairly strong. Equitation activity continues strong and you can see by our incoming order rates that we've done quite well this quarter. The Canadian oil and gas activity was seasonally better than Q4, but in North America the oil and gas industrial markets are still sluggish, although the red counts are going up, which is good, and we hope to benefit from that later on in the year.

On the Instrumentation and Thermal Fluid Control side, the steam orders were down a bit from last year's first quarter, but sequentially higher by 6 percent. On the Instrumentation side, aerospace orders almost up 40 percent from the first quarter of Q4 and rebounded from a very low post-9/11 activity from last year.

Industrial and Processing for the Instrumentation side was pretty flat overall, but still reasonable in Europe for Instrumentation. As far as our performance is concerned, the earnings, we feel, are respectable, given our sales increase came from lower margin segments of our business, which is the petrochemical side. And our net of unabsorbed manufacturing costs due to our inventory reductions, which generated the cash flow that I referred to, and the cash flow has improved dramatically and our balance sheet is extremely strong. We're probably about 8 percent to net debt to net capitalization.

Market trends in general are stable and improving slightly in certain areas and we remain optimistic about the second half of the year, but conservative in our internal prospects. I'll have other closing remarks, but Ken Smith and Alan Carlsen will take you through, further through the results and explanations of the details. Now, let me turn it over to Ken.

Thanks, David. To begin, slide number three and slide number four provide the reconciliation and segue from US GAAP results that were reported in our earnings release to the operating results Al and I will be discussing on slides 5 though 10. On slide number 4, there were special charges in the first quarter of 2002 amounting to $450,000 pretax or $300,000 after tax, which related to closing two small North American facilities and their consolidation within the petrochemical segment.

And now I'll speak to slide number 5 regarding worldwide orders. We had a solid quarter. Our October 2002 acquisition plus the large international oil and gas products were the primary increases from last year's first quarter. Sequentially, orders increased for steam applications and HVAC, plus aerospace and OEM medical markets. Our order rates from other end markets have generally continued to be lackluster, which continued softness in the general industrial markets including our generation. And as for orders for North American oil and gas MRO, it was a soft first quarter this year, but as they've noticed, there are encouraging uptakes in US rig counts, which, hopefully, may benefit our second quarter.

Regarding backlogs, they are near an all-time high, and over 40 percent of total backlogs are for international oil and gas projects. The quarter-end backlogs without our business unit's large oil and gas order backlog, we're down 15 percent from March 31 last year, but up 3 percent from December 31, 2002. Regarding revenues for the quarter, the diversity of end markets really helped improve our top line. On the plus side, we're FX rates and the effects of last October's acquisition and the growth from large oil and gas projects while HVAX markets remain steady. These causes were partially offset by declines in sales and markets of commercial aerospace, Power Gen, OEM Analytical and the short-cycle MRO business for oil and gas markets in North America and other general industrial markets.

Regarding profitability, the operating results reflected a product mix change, selling less of higher margin products, such as those sold into commercial aerospace, OEM Medical and short-cycle owned gas producers. The second factor was the unabsorbed manufacturing costs that could not be avoided as we sold existing inventory and lowered our inventory levels this quarter.

And free cash flow, we had a very good quarter, in fact, one of our best quarters ever. Most importantly, working capital was reduced as our businesses regained some traction, reducing inventories this past quarter. And I'll add more color when I discuss slide number 7.

Turning to slide number 6, two items of note in the non-operating categories. First, the net interest expense was lower this quarter due to our principal payment Q4 of $15 million. And the other income expense rose. We did have favorable FX gains this quarter, particularly as the euro strengthened.

And now to slide number 7, cash flow. From operating activities and free cash flow, it was the highest of any quarter we've had since the spinoff in 1999. In working capital, receivables were lowered by 5 days this quarter to 57 days of sales. And in comparison, back in the early 2000, which was shortly after our spinoff, we had 70 days in sales and receivables. So, we've done a nice job in reducing the level of cash in that category of our balance sheet. And given our growing level of international sales, we're pleased with the current DSO levels.

And from inventories, we generated $5.3 million this quarter. Each of our businesses does have, do have targets this year for lower inventories and we had a nice increase here this quarter and we're aiming for additional cash to be generated in the quarters ahead.

Turning to slide number 8, the balance sheet, the numbers do tell the story. Our balance sheet continues to be under leverage, and the net debt to net cap ratio is under 8 percent and cash balances did rise again this quarter on the strong performance for Operations. And now, I'll turn this over to Alan, who will describe the performance of each segment.

Thanks, Ken. With slide number 9 regarding orders, it is helpful for me to begin by describing 2002 order levels in the Instrumentation and Thermal Fluid Control segment. Order strength in 2002 was highest in the first two quarters, with the second half of 2002 down approximately 11 percent in the first half of 2002.

So, our first quarter of 2003 ordered growth of 9 percent from quarter 4, 2002 is encouraging. And the end market that provided the majority of the sequential ordered growth were aerospace, HVAC and Medical OEM markets. Revenues were net of good news from FX rates, specifically the stronger euro and $3 million provided by the acquisitions of TOMCO and U.S. Para Plate. Revenue declined in the industrial markets, Medical OEM and Power Generation markets. Although not represented on slide number 9, first quarter 2003 revenues declined $1 million from the fourth quarter, 2002. The $1million decline was net of gains from FX and some market share gains in domestic industrial accounts that were more than offset by declines in revenue from HVAC, Marine Steam and OEM customers.

Operating income and margins declined. We were impacted by several factors, including the end markets that declined involved several products with higher margins. We also had unabsorbed manufacturing costs as inventories were reduced this quarter. And in addition, selected competitively big projects shipped this quarter carried lower pricing, and therefore lower margins. Looking ahead, we certainly are working every day to raise this segment's operating margin back to its more historical level, in the mid-teens, this year.

Now let's review our petrochemical segment with slide number 10. The relative order strength and the high backlog for this segment reflect the continuing strength of global cap ex spending for large oil and gas projects. The Middle East and North Sea regions are continuing to release projects and we are winning our share. And by historical measures, we are in year two of what could be a four-year upcycle. The cap ex spending is predominately for natural gas applications, for development of known resources, both on land and subsea, plus expansion of distribution pipelines and LNG production. Our Italian business unit is increasingly regarded as a premier global quality supplier in the largest ball valve sizes for these types of application. And as a result it is winning many orders.

Short cycle MRO orders from the North American market have been soft throughout 2002, and into the first quarter of 2003. Yet, it's mentioned earlier the US recount has risen a bit in Q1 and we're hopeful this will benefit short cycle orders in the second quarter.

Regarding revenues for this segment increased year-over-year. Apart from the positive effect from the euro rate, the additional revenue increase came from higher shipment of large international oil and gas projects. First quarter revenues compared to the fourth quarter of 2002 increased by $2 million. Half of that increase was from sales in western Canada, and the other half from a stronger euro exchange rate.

As for operating profit and margin, our petrochemical segment continues to work hard to consistently deliver its initial target of 10 percent. While this quarter shows improvement towards this critical objective compared to last year, we are in a transition period regarding the drive toward the higher proportions of inventory being foreign at lower costs. As the slide notes, the near-term effects of this transition is twofold. As we sell the proportionately greater degree of outside foreign-produced inventory, our domestic plants utilization is somewhat less and unabsorbed costs rise. Secondly, as we sell inventory on a first-in, first-out basis, the relatively higher costs of domestically produced inventory has temporarily lowered profitability.

Looking ahead for petrochemical segment, we expect further reductions of inventory, affecting under-absorption. This will dampen our profits somewhat in 2003, which is why we're expecting a range of 8 to 10 percent operating margin for the full year of 2003.

Let's now turn to slide number 11. Here I'd like to point out certain of our key end markets and other markets that we expect will influence the degree of our success in 2003. The Instrumentation and thermal fluid control segment, we expect that, while markets served by our steam products will be steady, many of our industrial markets served by our instrumentation products will be soft. Within the petrochemical segment, North American drilling activity has risen modestly due to the cold weather, declining natural gas inventory and higher crude prices. Bur for all of 2003, we are not expecting any significant rise from 2002 order levels from the North American market.

Looking at the international project side of petrochemical, we expect international revenues to continue to be solid, as several orders in our current backlog are scheduled for delivery in the first three quarters of 2003. We also expect international orders to continue at a reasonably strong level, however, not at the rate of increase we experienced in 2002. Of course, this is subject to how the international political issues also play out.

And concluding with slide number 12, translating our 2003 market assumptions into our update business assumptions for 2003, we factored in the following points: overall, most of our end markets of soft, in cap ex we are spending at maintenance levels. In 2003 we had some new product and cost-savings capital spending along with some planned IT investments. So, cap ex in total for 2003 will still be below depreciation. With that, I will not turn the call back to David.

Thanks Alan. As we indicated in our press release and our comments today, we are not looking for much improvement in our markets for 2003. In fact, with the continuing general economic uncertainty that exists today, our ability to see beyond a few months remains difficult. Our view of the second quarter of '03 is that we should come in at about $0.23 to $0.27 per share. Now we'll open the lines for any questions that you may have.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key, followed by the digit one on your touch-tone telephone. If you are using a speakerphone, we ask that you please make sure your mute function is turned off to allow your signal to reach our equipment. If, at any time, you do feel your question has been answered, you may remove yourself from the Q by pressing the pound key. Once again, to ask a question at this time, please press star, one on your telephone now. And we'll pause for just a moment. And just as a reminder, it is star, one if you have a question. We'll take our first question from Mike Schneider with Robert W. Baird.

Good morning, guys.

Hi, Mike.

Morning, Mike.

Nice quarter. I guess, just focusing on petrochem first, the inventory reductions that went on, maybe you could break out for use the $5 million cash source from inventory between the two segments, just to give us an idea of where the bulk of it came from.

Well, it was nice, Mike. It was pretty evenly split. 2 million of the 5 million was a reduction in petrochemical, and 3 was in the instrumentation and thermal fluid group.

OK. And given that 2 million came out of petrochem, can you give us some more insight into the margin this quarter, petrochem because sequentially our revenue was actually up $2 million, aided by currency, obviously, but up $2 million, the operating margins are down 250, almost 300 basis points. Certainly the underabsorption due to the inventory bleed is to blame somewhat, but is there anything else going on because it is a pretty precipitous drop.

Yeah. We tried to explain it in maybe too cryptic on the notes on the slide number 10, but in addition to the inventory reduction, we're also trying to sell off some of our more possibly domestically produced inventory as we're traveling over to this foreign sourced project. And so, not only are we getting a little bit higher cost of sale for that, we we've also, in elected emphasis trying to move it more quickly with some pricing, some targeted pricing actions. And the last factor, I would say is that, with this North American market being generally soft, continuing so. We're still not benefiting from that, generally the higher pricing that you get from off the shelf sales when someone is trying to hook up a weld today and they need, need either a checks ball and ball bells and needle bells. And so, it's really a combination of all those factors. But I'd say that the leading one would be the selloff of the higher cost domestic product, followed by the inventory reduction and the unabsorption there.

And Mike, this is Dave. We should be through that through the second and third quarters for that selloff and a full realization, maybe not, probably not full, but 80 percent to 90 percent realization of the foreign sourcing program that we started focusing on in earnest last year.

So, does the number this quarter lower your expectations for the margins for the lower end of the 8 to 10 percent range? I know you've kept that range in place for your operating assumption for the year, but I guess, in essence, was this margin disappointing to you this quarter?

No. It was not for the first quarter, and as Dave mentioned, we think this will start to rise up, but we put a particular focus to drive to move this older inventory and we have renewed energy around this table that are speaking to you about lowering our inventory levels and getting cash from that important source where know we're over-invested and we're making some very conscious decisions to move on those programs in some meaningful steps. And one of those results is that temporarily on the P&L we take some higher cost of sales.

OK. And then could you then update us as to where you are, Alan, on the move to foreign sourcing within the petrochem group? I think the target you're looking for is about 40 percent across the sales being foreign sourced than you had been at 10 to 15 percent. How dramatic has the needle moved at this point?

The needle continues to move very nicely. We're going to see a major uptake at the beginning of the quarter this year with foreign source product coming in. That's what Ken has been mentioning is, the selloff of this point in time. So, the real move, we're taking ourselves into that 40 percent category of foreign source material in general in the petrochemical business net real uptake comes in the first part of third quarter.

OK. And then what does that imply, then, for the utilization here in the U.S. facilities, Alan, because presumably, you've got less need for production capacity in the U.S. What are the plans to address that?

We are moving toward certainly less productivity out of the facility. However, we are, which is our main facility in Oklahoma City. That facility, however, will be utilized for other things. We have a second facility in Oklahoma City, which would potentially put into the main facility in Oklahoma City and reduce the other city. So, we have, we definitely have plans to use the plant.

We're also, Alan is modifying the staffing levels accordingly and we're also decommissioning equipment that's no longer needed and re-deploying that. And so, there's a number of steps being taken , you know, to start out.

OK. And in fact, did you reduce the head count during the first quarter, in petrochem?

Yes, we did.

I'd say it was in, I'd say it would be somewhere in the 15 to 30 range. OK. All right. I'll jump back in line. Thanks.

operator. And as a final reminder, to ask a question today, please press star, one on your touch-tone telephone, and then once again, we'll pause for just a moment. And we will take a follow up from Mike Schneider.

If the lines at the ballpark went that fast. OK. And then switching gears to instrumentation. I guess, just to repeat a number, Dave, you mentioned that steam orders were up sequentially and aerospace was up 40 percent. Was that sequentially or year-over-year.

That 40 percent was year-over-year. You know, the effects of 9/11 really hit us during the fourth quarter of '01 and then the first quarter or '02. And we're finding now that the OEMs have gone through their inventory, used that up, salvaged what they could out of other places and are now ordering at low levels, but compared to zero, it's good news to see orders coming back to us.

OK. And then does that raise your confidence? Presumably that benefits Circle Seal.

Yes.

Does that raise your confidence then, in the margins going forward in instrumentation as those orders come back and obviously benefit the mix or is there something else?

Yeah. We should get a better mix as those orders will be shipping out throughout the year. So, maybe Carl has another few comments for you on that.

Yeah, Mike, Carl Nasca. The aerospace orders are coming in very strong. The issue with aerospace, as you know, is that lead times are extended. So, we will see some benefit to those orders this year, but really you're going to see them next year as these, as we start shipping on these longer-term orders.

OK. And then the Hoke benefit, presumably their oil and gas exposure is still a negative at this point, but we heard speculation in call yesterday and a number of other calls. People, at least, are trying to determine whether the turnaround season was good, bad or indifferent this quarter and what the outlook is. Could you give us a sense of what your guys in the field are hearing about maintenance projects and smaller upgrade projects?

Yeah. We'll let Barry Taylor respond to that since he's here. We'll give him an opportunity to let you know what's going on.

As far as how the orders in the oil and gas declaration in the North Sea has remained a positive and actually increased. But in the United States, in the coast and all, we've not seen uptake. It remains pretty much flat as far as compared to last year.

So, as far as you're concerned, there wasn't any unusual spurt of turnaround activity in the U.S.?

Not at this time, there has not been.

OK. And because the first quarter is the seasonal peak in turnaround activity, does that mean that the year is unlikely to show any robust activity either?

I guess I found my forehead on your premise of the first quarter being the peak of turnaround activity. Could you...?

Well, it's just my understanding that the bulk of the turnarounds do go in, do occur during the first quarter, as these guys kind of move from the distillates to the summer gasoline season. So, most of the turnarounds do go on during the first quarter. And if we haven't seen any recovery in that activity yet, does it pretty much imply that the year is as we see it and we shouldn't anticipate any material increase?

I think that's fair to assume that there won't be any material increase in that segment of the business.

OK. I think that's it. I appreciate the time. Thank you.

OK, Mike. Thanks.

And there appears to be no further questions at this time. Gentlemen, I'll turn the call back over to you for any additional or closing remarks today.

Well, don't have any closing remarks, but we gave you an overview of what happened this quarter. We're pleased with the results, especially in the cash flow. Overall, the order rates and backlogs appear to be fairly strong cross relative to the weak periods we just came through in the last 18 months. And we appreciate your being on the call. Look forward to talking with you next quarter. Thank you.

And that does conclude today's conference. We thank you for your participation, and have a great day.

Thank you very much.