Circor International Inc (CIR) 2003 Q3 法說會逐字稿

Good day, everyone, and welcome to the CIRCOR third quarter 2003 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 McDonald of Maconson Powell (ph). Please go ahead, sir.

Thank you very much and good morning, everyone. Welcome to our third quarter earnings call. Our objectives today are to review the performance and to provide an outlook of the remainder of 2003, including guidance on the fourth quarter, with David Bloss, Chairman and CEO of CIRCO, and Ken Smith, CFO.

After their comments, we will go to Q and A.

Before we start, two notes of administrative. First, the slides we will be referring to are available on our website at www.circor.com, under the link of quarterly earnings. Second, today’s the discussion contains forward looking statements that identify our future expectation. 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 them about in the company’s 2002 form 10K, which can also be viewed on the company's website. Of course, actually results could differ materially from those expressed or implied in today's remarks.

Now, let me turn the call over to CIRCOR’s Chairman, David Bloss.

Good morning and thanks for joining us for the call. Our results reflect our ability to grow earnings and cash flow while our markets continue to struggle along, although we have seen some very early signs of hope for 2004.

Our petrochemical segment was our star performer this past quarter with orders, shipments and backlog continuing to outpace last year's performance because of strong international project activity and an some increase in North America this past quarter, as well.

Operating margin reached almost 11% during the quarter. It has been quite sometime since we have seen it this high. We are getting some good pricing for our high end large size valves and our foreign sourcing program is taking hold on the more more commoditized products.

The instrumentation and thermal fluid control segment is still faced with weak markets for industrial instrumentation, aerospace and steam related applications, although orders were up versus last year, giving us some hope that things may improve as we move forward.

This segment’s operating margins dropped to 11.4% of revenues--its lowest in sometime, due to the difficult market conditions and the underabsorption we recognize due to lower sales volumes, coupled by our inventory reduction efforts. We think we are seeing the bottom of this earning cycle for this segment.

On a very positive note, cash flow continues to be strong. We have generated over $32 million dollars of free cash flow year to date, compared to $18 million dollars for all of last year. This $32 million equaled 2.6 times net income, or 12.3% percent of revenues. Our inventories have been reduced by 11%, and (inaudible) generated cash of $16 million since the beginning of this year.

Also during the quarter, we announced the closing of our Tomco facility in Ohio. We will be moving the production of the quick disconnect product line into our HOKE-Sparkbury , South Carolina plant, where a similar product is made.

About 65 people are affected by this decision, and we are helping them with the affects of this transition. Total costs of the move is estimated at $1 million approximately, with $300,000 of that recorded during this past quarter and another $700,000 of special charges expected in the fourth quarter, all pretax numbers. Annual pre-tax savings are expect today be close to $1 million. Going forward, we will continue to identify more opportunities to increase our productivity, including cob sol dating plants where it is feasible.

I have other closing remarks, but Ken Smith will take you through further explanations of our results. Let me turn the call over to Ken.

Thanks, Dave. To begin slide number 3 and 4 provide the reconciliation from U.S. GAAP results that were reported in our earnings release. For the operating results I will be discussing on slides 5 through 10. They exclude special charges, which is a line in our P&L that historically views the one-time cost for -- on slide 4, there were special charges in the third quarter of 2003 amounts to $271,000 pretax related today this closing of our facility.

The 2002 year to date special charges were for closing two small North American facilities in our petrochemical segment. I will now discuss slide number 5, regarding worldwide orders. Our results were net of 4 factors. First, payroll foreign exchange rates, specifically the stronger Canadian dollar, Second, the addition of two small acquisitions last October of 2002. And third, the continued strength of large oil and gas projects, particularly in the Middle East, Africa and Europe. And three of these factors more than off set the fourth factor, which is the continued soft economic conditions, such as general industrial, aerospace, HVAC, power gen, and the chemical industry.

Our order rates from these markets have been soft since during 2002. Regarding backlogs, they continue near all time highs with the large international and gas project orders accounting for 45% of the total backlog since September 30th, 2003.

Regarding revenues for the quarter, the same four factors also drove our revenue results. Regarding profitability, the operating margin changes noted on slide five reflect a net of several factors, including the following-- the positive contribution of last fall's acquisitions, our success serving large international oil and gas market in both volume and price, plus the petrochemical segment's cost reduction efforts via foreign sourcing.

But nonetheless, these favorable factors were off set by volume decreases in the product mix change in other markets, more specifically selling less of higher margin markets, those sold in the commercial aerospace, OEM medical, HVAC and short cycle oil and gas producers, plus the dampening costs of manufacturing costs that could not be avoided as we successfully reduced inventory again.

Earnings per share increases improvement to non operating expenses and improved upon the operating earnings factors. In free cash flow, We had another good quarter in free cash flow. Inventories continue to be reduced. I will add more when I discuss a later slide.

Now turning to slide number 6 of note were the special charges this quarter. We announced in September we will be consolidating this operation to South Carolina, in this special charge was for accrued severance. The physical move to South Carolina will occur during the fourth quarter with an additional special charge of $700,000, as Dave mentioned earlier. And the pay back on this cost is approximately one year.

The special charges for year to date 2002 related to the petrochemical closing two small facilities in North America which were consolidated to our KF industry facility in Oklahoma City.

Interest expense was lower this quarter and year to date, due to our principle payment of $15 million dollar in October of 2002. And the other income category, has been favorable this quarter and year to date primarily due from FX gains. -- turning to slide number 7, and cash flow from operations and free cash flow were again very good. In dissecting the $21 million dollars generated from lower working capital, lower inventories generated nearly $16 million, year to date, and Q3 alone was nearly $6 million. Higher liabilities generated nearly $9 million of cash, and that excludes the pension payment shown separately on slide 7, while accounts receivable increased and used $4 million of cash. DSO was 68 days at the beginning of September 30th, 2003, up 10 days from June 30th, 2003, and factors for this temporary increase included a UK post tall strike and higher international sales of longer payment terms.

For our U.S. pension plans, this slide indicates the amounts contributed year to date. And an additional $1 million this month of October, with the intent to keep the plans equivalent to the plan's current liability, which is where it is currently. For CAPEX, we now expect this year's total investment will be approximate $[78 million], the year to date amount includes a Q3 increase of the manufacturing capacity of our petrochemical segments Chinese joint venture, which is integral to our foreign sourcing industry.

Now turning to balance sheet, the balance sheet continues to be underleveraged with net debt to net cap nearly level. Last week, we did pay the scheduled $15 million due on the senior notes and we now have only 3 annual installments remaining totaling $45 million due on the senior notes. We have not prey paid any significant amounts of debt due to the high May Coal (ph) requirements on the senior notes. And other debt, such as industrial revenue bonds that carry very low variable rates.

With the $75 million cash on hand, as of September 30th, our first priority to put that to work continued to be acquisitions. And now slide number 9, our instrumentation and thermal fluids segment results.

Regarding orders, the acquisitions in October 2002 provided a 6.9% increase Q3 over Q3 For orders. Plus a stronger Euro and OEM orders helped, while most other end markets had leveling to Q3 of 2002.

The backlog change resulted 23R us having delivered key orders for commercial aerospace customers this quarter. Rev (inaudible) were net of good news, from stronger FX rates plus nearly $3 million provided by the acquisitions of Tom Co and Paraplate (ph) last October. These factors exceeded the decline in sales to general industrial commercial, HVAC and aerospace, medical OEM, and power generation markets.

Regarding operating income and margins, these have declined significantly from last year. We have been impacted by factors which offset the two improvements of FX and last year’s acquisitions. Those factors being order weakness from end markets, which have historically involved products with higher margins and we have also had unabsorbed manufacturing costs as inventories were reduced. This segment has reduced inventories this quarter by $1.8 million, generating cash of that amount, since the beginning of this year, the segments reduced inventories and generated cash of $8 million, year to date.

Looking ahead to Q4 in the first half of 2004, we have had some seasonal strength foreseen for the HVAC markets, for steam related products, plus Q4 will have projects shipping to key medical OEM's and power companies. And, we expect the general industrial market to slowly improve.

Now, to slide 10, our petrochemical segment. The order strength and high backlog reflect a continuing global capex spending for large oil and gas projects. The Middle East and North Sea regions are continuing to release projects and our Italian business unit (inaudble) is generally acknowledge by customers to be the premier global supplier of large site (inaudible).

The large project capex is predominantly for natural gas applications, for productions from known reserves, both land subsidy, plus expansion of distribution pipelines, plus liquid natural gas production.

The short cycle MRO orders from North American markets continue to be soft, yet the rise in rig counts during the past quarter, particularly in Western Canada, provides us with optimism for a seasonally higher Q1 and Q2 of 2004.

Third quarter revenues increased year over year, this was the net result of a decline in North American MRO shipments, and lower sales to Pac Rim contractors, which were more than off set by two positive factors-- the higher shipments of large international oil and gas project shipments, by our Italian business and the stronger Euro exchange rate. Our petrochemical segment continues to work hard to deliver a minimum 10% margin. This quarter shows year over year and improvement towards this objective, an increase in the proportion of lower costs, foreign sourcing has been a principle reason for the margin improvement. And we estimate that this is in the initial program for greater foreign sourcing. Again, operating margin improved on a net basis, affects and lower cost foreign components more than off set domestic order softness, and unabsorbed manufacturing costs as we lowered production to help inventory levels.

As an aside, this segment’s inventories have reduced since December 31, 2002 generating $8 million in cash.

Now let's turn to slide number 11. This slide we point out the assumptions that we expect will affect our degree of success in the last quarter of 2003 and the first quarter of 2004.

For the instrumentation and thermal fluid control segment, we expect certain key markets served by our steam products will be steady, while many industrial markets will continue to be soft. Yet, we are encouraged by the order increase we had in Q3, compared to Q2 of this year and the prospects of spending by customers in China and the military markets.

Within the petrochemical segment, the average number of North America the drill (inaudible) of rigs has risen over 20% thus far in 2003 versus the end of the calendar in 2002. So that particular fundamental is encouraging for us, and the increased drilling would decrease the demand for such items as flow lines, tank batteries, plus metering separation and compression stations into which many of our products are sold.

Looking at the international project side of petrochemical, we expect international orders to continue at a reasonably strong level.

Concluding with slide 12, translating the market assumptions from slide 11 into our business assumptions for the full year of 2003 results on slide 12, we factored in the following points.

FX rates and our October 2002 acquisitions are [aiding] this year, while most of our end markets are soft. We expect seasonal strength in Q4 for sales in HVAC and the domestic natural gas production applications. Inventory reduction remain as priority for us and that means an effect on operating margins as we will have some continued unabsorbed manufacturing costs. In capex, we have new product and cost saving spending at our Chinese plant that will raise this year's (inaudible).

We are also continuing to evaluate additional consolidations of small sized facilities, which could bear on Q4 and next year's results. With that, I now turn the call back to David.

Thank you. As we indicated in our press release and our comments today, we are not looking for much improvement in our markets for Q4 of 2003 beyond the seasonal uplift in the steam, HVAC business, and some specific project shipments. In fact, with the continuing general economic uncertainty in and the lack of momentum that we can see today, our ability to see beyond a few months remains difficult and our view of the fourth quarter of '03 is we should earn about 31 cents to 35 cents per share, excluding any special charges.

Now we will open the lines up for any questions you may have.

Thank you, Mr. Bloss. (Operator’s instructions) We will take our first call from Charlie Brady of Hibernia Southcoast Capital.

Thanks, on the consolidation, can you just talk a little bit, how much more of facility consolidation do you see out there in your business? I guess how far along in that plan do you go?

Well, we have a number of ideas that we are trying to finish our analysis on and make sure they are worth the effort and costs to consolidate. We still have a couple small facilities out there that could be consolidated into our other plants. Right now, we are sitting at about 17 manufactures facilities throughout our company.

We are hopeful to reduce that by a couple more as we move forward into next year. We are not at liberty obviously at this point to disclose anything further because it is still under analysis and we haven't announced anything.

Fair enough. Can you talk about the effect of currency on the quarter? What was the impact of currency on the top line, as well as earnings and also orders?

Well, as indicated on the slides, Charlie, the revenue and the impact year to date is 5.5%,. And that is fairly close numbers is what it would be on the orders. And -- what was your other question? On slide five, we try to quantify that each quarter.

That's all I have. Thanks.

Thank you.

Michael Schneider of Robert Baird.

The currency impact this quarter was larger than it has been year to date. Would you happen to have the order numbers for the quarter's?

I do not.

Okay. I will follow up on that later. I'm intrigued by your comments, Dave, about the encouraging signs, orders seem to be up, modestly year over year. Can you give us some color? What are the guys saying that gives you some of the encouragement?

I wish I could say it more strongly to you but we don't really see consistent momentum going, but our quotation activities seem to be picking up here at the end of the quarter.

We of course do have some seasonal effects coming through on the steam side. We have some project activity work being shipped this quarter.

But moving into next year, the quotation work for large projects in the oil patch is still very healthy. We just booked another $4.3 million order for natural gas field for 6 valves for 38-inch valves where the body thickness on the class five thousand valve is about 16 inches. Those seem to be continuing pretty good.

We also have been fortunate to do some engineering work and be involved with a number of military aerospace programs that are going into some production phases next year, so that should help us, although commercial aircraft production still is going to be soft through ’04, I think, although that has been noted by others in the field. And we are hoping that we do see some life in the general industrial environment itself, which gives us some hope in our instrumentation business, as well as in petrochemical on the industrial side.

Dave, maybe you could just spend a minute without getting too specific but just to give us a sense of where this market is heading. It seems the most economically sensitive businesses would be Holk Circle C and KF?

Yes. That's correct.

What are you seeing of those businesses?

the trends are, as I indicated, activity -- quotation activity levels seem to be increasing slightly. I don't want to read too much into that, but I'm hoping that that shows us some mow ten momentum.

How about just moving through the quarter? We have heard a number of industrials who have already reported say July was okay, August was terrible and September bounced back. What do you speculate might be the reason?

We can only -- we did all that. The same type patterns were experienced by CIRCOR. It seemed as though in August people were just at a wait and see period. I know Europe -- in our business, it was heavily influenced by our European activities, and every summer in August, it seems -- everybody seems to really shut down. So we were concerned, but not overly concerned because we have seen the patterns in the past.

We were glad to see September come back, and I'm hoping that that can carries us into some momentum.

When I look at your numbers being up and competitors like flow serve and the other people who have reported showing declines year after year, is it a case we may be mistaking your gains for another market?

I wish I could say that and it is hard to prove. As you analyze our markets, we are in different sectors than you see in some of those other businesses. In the petrochemical side, a lot of people say they are in the petrochemical markets, but that is such a diverse market and so many niches in it that we differentiate in the oil patch, and have great position in the large bore valve line for international activities.

In fact, our company has gained market share. I can say that with confidence, over the past two years, proving I'm time and time again they can produce very large, very high pressure valves that the end use customers are specifying more and more as they get into these liquefaction processes. And, with these high pressure wells that they are finding in these fields, very high press pressure deep wells and they need more severe service valves to support those fields.

So, then you get into aerospace . I don't think people like Flow Serve (ph) have an aerospace influence as we do. Steam is a specialty niche that we are very glad we have. I wish we had more. That seems to be a different market trend and profitability of products, as well. So I think as you dissect it, we are in different markets, we have gained some market share, and that is how we have been trying to portray ourselves to the public, as well--showing the different markets that we do serve.

And one question, I will get back in line. The military aspect that was high hopes of the fleet coming in and you having some rework business during the quarter, maybe the fourth quarter, was that on target or given that the fleet is still out to sea, is it still yet to come?

Yet to come. Not materialized.

Nancy, I do have a follow up answer for mike Schneider about the rates on orders. I would say the following statistics I'm going to give you would apply to both orders and revenue for both the third quarter and year to date period where, like I said, it was 5.5% for the total company. But for each segment, FX lifted quarters and revenue by about 3 percentage points and lifted petrochemical by 8 percentage points.

And we do have a follow-up question from Mr. Schneider of Robert Baird.

Guys, you just on the foreign sourcing element, could you update us as to where you stand in particular in petrochemical? Last time we talked you had about, by our estimation, about 70% of your goal achieved in the chemical side of that business and 40% in the oil and gas. Any moves in those numbers?

Things continue to increase in that regard for us. We are at 70% of getting the products sourced and we are probably at 50% to 60% of realizing the benefits of that, from a P&L standpoint at this point. Because we are ordering the product, getting it through the channel, and then selling it.

As part of either finished products or components, so the trend is continuing. We are on track. And we have added some capacity to our joint venture in China, to allow us to even increase that sourcing of components, and finished valves.

Is it a case where those foreign sourcing initiatives have opened up the capacity and what was spurred TOMCO and forthcoming consolidations?

in this situation, it was a different scenario. The TOMCO product line served the commercial, and other markets. And very little foreign sourcing is taking place there, because there is a lot of miniature parts and components and high pressures and so forth, where we have to control the quality.

No, the TOMCO consolidation was brought to us by improvements in HOKE and the fact we could reconfigure the shop floor and add some space on the second tier of the building and enough space to move that into our existing facility and save $1 million, so that was not impacted by foreign sourcing.

What we is moving forward as we look at the effects on our KF operations in Oklahoma City is we are including floor space, as we machine less ourselves, and we are able to hopefully consolidate some warehousing and things like that into our building and not have to lease excess space. So that is something else we are looking at.

And Ken, just switching gears to the impact of inventory reductions, do you have an easy at this mages as to what it has cost you in the year to date?

I had an assessment yesterday for our board members to review the quarter before releasing it, for the instrumentation of they are mow group of about 200 basis points. And

and that that is year to date or Q3?

Year to date. They have been pretty steady on their decreases, so I would say that is equivalent statistic for both periods of time. And I don't think I had an assessment for the fourth. Just petrochemical.

But it is certainly an important number, but it has been more than off set by these issues and the volume of the large project sales and the pricing improvement that PBS has been able to achieve over the last several quarters.

Can you take in roughly $8 million year to date out of instrumentation inventories? Give us some color as to how you have done it because foreign sourcing has been a big player in that segment. Is it a case where these are shop floor improvements or literally taking production off line and trying to learn to live with less?

They have accelerated their use of faster flow through the shop floor through staging less at each machine center and assembly outposts. We have altering our purchasing habits by asking vendors to deliver smaller quantities, but more frequently on more of an as-need bases basis.

Many of the units have reduced in the MRV systems the safety shock levels, which can have a pretty traumatic effect in your fast moving items. KF in particular has been pretty nimble in substituting particular components on their shelf for new orders that come in, where we may give them a better valve because we have got some existing inventory and it avoids us going off and buying new components for the same price as the less specified valve that the customer wants. So we are working off some of the excess inventory.

So it has been a combination of those efforts and others, from purchasing, to how we deal with vendors, from how we move through the shop floor and changing our stock levels that have all contributed to this decline this year.

Okay. And one final question on acquisitions, the balance sheet becoming pristine here, would you give us a sense of how many properties you are looking at and realistically what you think the odds are of doing a meaningful acquisition?

I wish I could give you those odds. I wish they were 90-plus%, but you just can't tell. We are very active, continue to be very active in looking at deals. We have a number of small to medium size, couple larger size ones we are looking at, as well, but it is just hard to tell, Mike.

We get involved with some recently, we spent a lot of time and effort and found some issues with the environmental or other areas that just -- the size of the deal didn't warrant us taking that kind of a risk moving forward on it. We are trying to also be very picky about the type of businesses that we want to acquire.

As you know, there have been a number of businesses up for sale in the commodity sector of the valve industry, and we just haven't wanted to pursue those, and looking for a niche, higher margin that fit or existing product lines for our strategy of focusing on the higher end of the segment of the fluid control industry. So we are selective. We are going to continue to be selective, and I just hope that we do -- that our balance sheet, you are right, is ripe for a good size acquisition for us. And we do certainly want to do that.

Kind of another way, if you look at deals over say $20 million, Dave, if there been bidding you have bid on and not been successful just in terms of price?

No.

Again, over $20 million, to make a meaningful random line, how many deals have you actually signed on say in the last 12 months roughly?

I'm afraid we just don't go into that kind of detail with the public.

Appreciate it again. Nice quarter, Thanks.

Thanks.

Our next question comes from Don Taylor from Franklin advisory.

following up on Mike's last question, I just wonder if there is really enough of the kind of deals out there that you could potentially make given the strength of your balance sheet and your cash flow and whether we need to rethink some of the other uses of cash?

No. The well flow of potential acquisitions continues to be pretty healthy. Most of the deals that we get involved with are ones that we initiate ourselves rather than an auction occurring where we are invited to participate. So our efforts to knock on doors and be able to dialogue with owners of these smaller size companies continues to be pretty favorable. So we are not in a position to want to give up our strategy of using our leverage to grow the company and give our shareholders a superior return on investment.

Okay. Thank you.

A follow up question from Charlie Brady, Hibernia.

Follow up to one of Mike’s questions about the order trends and a clarification on August. I know it is seasonally weak but would you characterize it as seasonally or unusually weak?

Well in today’s environment I don’t know what is unusual. Compared to last year’s August? Yeah, it was weaker than last year’s.

Normally you would expect a seasonal weakness in August with Europe on vacation. I’m wondering if it was weaker than you expected?

Well the answer is yes, with a caveat. Surprisingly, maybe is too strong a word. We were concerned because of slowness in orders during the August. Not in the areas where we traditionally see slowness, but other areas as well. We were glad to see September bounce back. I wouldn’t characterize it as shock or surprise.

It was a broad based slow down?

Very broad based. Across the board.

Okay. Thank you.

Gentlemen, there appear to be no more questions. I will turn the call back over to David Bloss.

I’d like to thank everyone for being on our third quarter earning’s call. We look forward to updating you again at the end of the fourth quarter. Thanks.

You may disconnect from the call. Thank you.