Circor International Inc (CIR) 2004 Q1 法說會逐字稿

Good morning ladies and gentlemen. Welcome to CIRCOR International's first quarter earnings conference call. This call will be recorded. At this time, all participants have been placed in listen-only mode. And the floor will be open to questions following the presentation.

I will now turn the call over to your host Curin McCann from the company investor relations firm.

Thank you very much. Good morning, everyone, and welcome to our first quarter earnings call. Our objectives are to review the company's recent performance and provide an updated outlook on 2004 including guidance for the second quarter with David Bloss, the Chairman and CEO of CIRCOR, and Ken Smith, the company's CFO. After their comments we will then go to Q&A.

Before we start, two administrative notes, first the slides that we will be referring to today are available on CIRCOR's web site at www.CIRCOR.com under the link of quarterly earnings from the investor relation page.

Second, today's discussion contains forward-looking statement that identify our future expectations. These are subject o known and unknown risks, uncertainties and other factor. For a full discussion of these factors, we advise you to read about them in the company's 2003 form 10K, which also can be viewed on the company's web site. Of course, actual results could differ materially from those expressed or implied.

Let me turn the call over to CIRCOR's Chairman, David Bloss.

Good evening, everyone and thanks for being with us this morning. Today our call is originating from the Spartanburg, South Carolina, headquarters in our major manufacturing facility for CIRCOR instrumentation technology business.

They make miniature fittings and valves and sampling systems and other devices for the industrial, mechanical, pharmaceutical, petrochemical, and other applications worldwide. It has been a tradition to hold our annual share holders meeting and our first quarter board of directors meeting at one of our operating facilities. This year we selected Spartanburg and our annual stockholders meeting is scheduled to begin in about one hour.

So, now I will summarize our first quarter results with you, and then Ken Smith will provide the additional details.

To recaps of important numbers and trends, our revenues came in at $90.7 million about a 4% increase, which comes from acquisitions and the exchange rate changes. While our markets are improving, it mostly occurred late in the quarter. And the incoming order rates that we posted were 5% decline from last year with instrumentation and thermal fluid control up 13%. That's up 3% without acquisitions, but up about 8% sequentially with a strong March.

The key marketing gained momentum during the quarter. The steam of the HVAC business has been kind of depressed because of the occupancy rates in commercial building was up over 11% for the quarter. It was a fairly good season for them. However, the Navy and Marine and power sector of this steam market group still remains pretty slow.

In the aerospace business, it was a good highlight for us. We were up about 44% in March compared to last year, it is the best order rate we saw since 9/11. And on the instrumentation side, the CIRCOR instrumentation technologies North American organization here was up over 13% in the month of March. Even though for the quarter we were just about 3 or 4% above last year.

That tells you and gives you an indication of the momentum that was occurring during the quarter for us. And in the instrumentation sector, Europe still remains rather flat.

The big fluctuation that occurred in our orders was in petrochemical. They were down 27% versus last year. You have to recall that last year's record pace of international projects that our Pibiviesse operation booked. In fact, they booked over $72 million of orders last year. They came in about $6 million in the first quarter.

But the quotation activity remains high for the projects. And we've already booked $6.5 million in the month of April, compared to the $6 million Pibiviesse booked all in the first quarter. So things are still relatively strong there. And the types of projects, that's changed slightly. We'll get into that later on.

The North American activity for petrochemical is rather flat. The [inaudible] increase at the end of Q1 last year remained relatively flat since then, although we do expect some modest increase in activity for the remainder of the year in this sector.

Backlogs remained at near-record levels for us, at $87.3 million, it is up 7% from last year. Without acquisitions, it is down about 5% because of some shipments of the project on the petrochemical side. The instrumentation and TFC group was up 5% without acquisitions, and up 7% sequentially on their backlog.

Net income came in at $4.3 million. 11% increase over last year. We think that's a good result considering the slow start we had in the early quarter. And the $600,000 of pre-tax increase in corporate expenses which Ken Smith will review with you, which are primary audit fee, compliance, corporate governance, expenses with the 404 requirements. And then the recording of the stock grant that we issued.

Precash flow, $2.3 million. Below last year record levels that we accomplished. We're continuing to focus on our inventory and working capital reduction, even though it is becoming more challenging as we lower the pond of inventory. And we're still focused on that and expect good cash flow throughout the year.

Overall our performance is lumpy. It is because of the petrochemical projects, which are large in their individual sizes. But our operating profits are recovering for the instrumentation and thermal fluids control group as we absorb the consolidations that are still in process. The SSI in Canada was moved into the expense operation in Walden, New York. Tomco quick disconnects was moved into here in Spartanburg, South Carolina. And U.S. Para Plate out in California was moved into Circle Seal. So all of those are in transition.

We do have some costs that are being incurred as a result of start-up of those operations. But in spite of that, our operating profits are still recovering and should continue to improve for that group. The petrochemical group remains at 11%. They've done a good job improving their profitability. And we'll get into more about the steel prices. It is having an effect on us, we are increasing our prices in most of our businesses to try to offset that, doing what we can to minimize the effect of the rising cost of raw materials.

With that, I'll give it over to Ken Smith. He'll take us through more details of our first quarter results.

Thanks, David.

And now thinking about slide number three. Regarding worldwide orders, our Q1over Q1 results were the net results of several factors. First the addition of two acquisitions in late Q4 2003, those being Texas Sampling down in Texas and DQS International in the Netherlands. Second the weaker U.S. dollar versus the Canada dollar. And these two positive factors were offset by a significant decline in orders for large international oil and gas projects, as Dave quantified. And most of our businesses had a weak order intake in January 2004. As Dave mentioned, orders thereafter grew nicely in most of our businesses, in February and March of this first quarter.

Sequentially the decrease and the drop in orders from large oil and international project in 2003 was our best ever quarter for new orders from this particular end market . For backlogs stay stay positive because the receipt of orders this quarter were weighted toward the end of the quarter and could not be converted quickly enough into Q1 shipments and revenue.

Regarding revenues for the quarter, three factors drove up our revenue results. First, the Q4 2003 acquisition. Second, the stronger euro and Canadian dollar. Third, shipments to large shipments to large international oil and gas projects. And many of the ongoing businesses elsewhere in the company had revenue decreases, because orders in the first quarter were received later for shipment in Q2.

Regarding profitability, the operating market change noted on slide three reflects the improvement in our petrochemical segment. It grew over 300 basis points year-over-year. It was a combination of hire volume from serving this international oil and gas market. Both volume and price. Plus this segment's own cost reduction efforts combined to add over 300 basis points for this margin compared to Q1 last year. And I'll discuss each segment in more detail later.

Earnings per share increase improvements in operating income plus lower interest expense more than offset the higher corporate spending and lower effects. And free cash flow, as Dave mentioned, was satisfactory this quarter, not nearly as outstanding as last year. And I'll add more color when I discuss the later slide.

Now turning to slide number four, the operating increase all came from our petrochemical segment and our Q4 2003 acquisition. And we'll discuss each segment in a few minutes. Corporate expenses were on the rise. This quarter we had a significant increase in professional fees for external audit and for our Sarbanes-Oxley section 404 compliance work. And those two pieces combined to be an incremental $400,000.

In addition, we recorded $100,000 of expense for our restricted stock grants. And in future quarters we'll also incur incremental professional fees, most notably for the testing of internal financial controls, which is a requirement for all public registrants under the Sarbanes-Oxley act of 2002.

Net interest expense was lower this quarter due to our principle payment of $15 million in October 2003. And the other income expense category primarily consists of foreign exchange gains and losses. And 2003 experienced a more significant gain amount from the significant strengthening of the euro and Canadian dollar last year.

Income tax expense is up nominally on the increase in pre-tax income. I point out we are using a 35% effective tax rate, down 1% compared to Q1 of 2003. Net 1% point drop is due to a new tax credit for CIRCOR qualifying for the U.S. research credit.

Turning to slide number five, cash flow from operation, and free cash flow were both substantially less than last year's outstanding quarter. Working capital, which is the largest swing from first quarter last year. Receivables this year in the first quarter were use of cash, as we did not collect effectively as we had in prior periods as indicated by DSO of 65 days here in the first quarter, compared to 62 days in our fourth quarter of '03.

Inventories were a use of $1.5 million. We had some businesses who have project shipments pushed into the second quarter 2004. Plus stocking for new product launches and some temporary increases to inventory to shorten customer delivery times. Prepaids were a use of cash of approximately $2 million. We pay in advance, at the beginning of a calendar year, most of our insurance policy premiums for the full year. Where some of the premiums at the beginning of 2003 were actually paid in the fourth quarter of '02.

Now to slide number six, the balance sheet, our balance sheet continues to be very healthy with a growing net cash position. The majority of our remaining debt consists of $45 million of senior notes and another $12 million of low rate industrial revenue bonds. I do not expect to prepay any of senior notes in 2004 due to the high prepayment penalties involved.

Now, to slide number seven, on instrumentation and fluid segment results. Regarding orders, the two acquisitions in Q4 2003 provided an 11% increase in Q1 over Q1 orders. So without [inaudible] orders the segment increased two points compared to last year. What is meant by the full quarter statistics is January 2004 orders were below what January '03 were, while February and March orders this quarter were much better.

So our business leaders feel very good about the momentum on orders exiting March into Q2 2004 for most of the general, industry and aerospace markets. The end market served by our thermal fluid products orders were equivalent to this quarter to last Q1 2003. The maritime end market declined Q1 over Q1. But that was offset by order growth experience from HVAC and the general industrial market it serves.

Revenues were net of good news. The two acquisitions in the fourth quarter of '03. Plus the weakening dollar combined offset the organic declines in most of this segment's ongoing business unit. In our ongoing businesses, revenue decreases for the quarter were nearly the same circumstance, that being incoming orders were low in the month of January '04, whereafter order rates picked up, therefore the order growth late in the first quarter was too late for us to convert in the shipments and revenue for the first quarter of 2004.

Regarding operating margin, it was favorably impacted by FX and the beginning savings from facilities closing in 2003. However, those factors were more than offset by two factors, the first being the rising cost of raw material and inventory. Specifically steel costs which was approximate 120 basis point impact, particularly for our general instrumentation products.

Second we had higher manufacturing costs for Aero space products as we instituted new measures to reduce our delivery elite times to customers. These investments has a negative impact on operating margin of 140 basis points. So all told, the good news and these two factors netted out to the 100 basis point decline the first quarter over last year.

Although not shown on slide seven, the sequential -- we had sequential improvement in the segment's operating margin by 170 basis point, a majority of which came from the nonrecurring charges in the fourth quarter of '03.

Now to slide number eight, our petrochemical segment. The orders decrease in this segment reflect the lumpiness of the international market for oil and gas projects. Last year in Q1 2003 we received a very high level of orders for the international projects business, particularly in the Middle East. While we only booked one-third of that level here in the first quarter of 2004.

While we continue to have very active quotation activity and expect international project spending to continue, it was the single factor producing that declined this quarter in orders in backlog that you see on the slide. New orders for short cycle MRO in the North America markets were equivalent to Q1 2003. The January 2004 order rates were a bit slower. While February and March were more robust which built the additional backlog at the end of the quarter of '04 -- of March 2004 for the MRO business.

The increase in revenues was the net result of increases from FX. And the higher shipments on the large international oil and gas projects by our Italian business, Pibiviesse. And those two factors partially offset by a decline in North American MRO shipments. And as I stated earlier, with so many of the North American MRO orders being received later this first quarter, it is difficult to convert those into shipments here in the first quarter of 2004. Which bodes well for Q2. As for operating income and margin, this quarter showed hard earned year-over-year improvement.

Two factors drove the income and margin increase. First was Pibiviesse continued sales volume and pricing improvement. And second was the cost reductions led by our North American businesses, KF Industries. Our North American business have been actively increasing their proportion of foreign sourcing of products and components to lower their cost of sales. And we estimate that we are now 70% in our initial foreign sourcing program.

Now let's turn to slide number nine. On this slide we point out assumptions for our key end market and other factors we expect will influence the degree of our success in the remainder of 2004. In the instrumentation and thermal fluid control segment, we now feel there are more markets improving. Even the chemical processing end market has improved for us. We expect it to continue to improve through the balance of 2004.

The general industrial markets we believe will continue a gradual recovery. And military aerospace we anticipate will continue to increase its capital spending. And require us to have higher sales to it. On the soft side of the slide, maritime is weaker, predominantly from the U.S. Navy which was decreased its orders in what we believe is an effort by the Navy to restrain its fares inventory. Yet overall we're upbeat by the segment.

Moving to the petrochemical segment, the large international projects order rates during the past two years have been outstanding. So given the lumpiness of orders thus far in 2004, we expect orders for the remainder of 2004 will not be quite as robust as 2003 truly a record year. However, we do expect a continuing rise in orders for the North American short cycle orders.

Now, in slide number ten. Translating the market assumptions from slide nine into our business assumptions 2004 on slide ten. We factored in the following points. And starting with a second quarter of 2004. A generally order rates look good for both second and third quarters as we're expecting a continuing order strengthening. Plus several of our business units have announced price increase to customers effective in April and May. So these will effect June and subsequent month's revenue.

We expect the instrumentation of thermal fluid products segment to grow its top line and operating margin over the balance of the year. And our petrochemical segment, it's strong backlog is weighted to deliveries later in 2004 and even 2005. In fact one-fourth of this segment's back log is scheduled for delivery in 2005.

Additionally current orders and backlog scheduled for the second and third quarter of this years deliveries, particularly for Pibiviesse are lower than what Pibiviesse had in the same period in 2003. It is the primary reason we're expecting lower revenue in margins in the second quarter 2004 as noted on slide ten.

Additionally pricing for large projects peaked last summer. So awards won by Pibiviesse last fall and winter, when shipped here in the second quarter, third quarter of 2004 will bring less margin.

We've also added a new row on slide ten, called corporate expense. Corporate expenses will rise from our historical levels, as I mentions in my remarks on slide 4. First external professional fees will be incurred by us or Sarbanes-Oxley section 404 compliance work. This entails testing internal controls and documenting those test results, for which we decided to use an outside firm for assistance. This work is then followed by our own external auditors performing their own test. Our first year expense to comply with section 404 of this law approximates $1.4 million pre-tax, which is 6 cents of an impact on EPS.

I do expect that amount to decline by at least 25 to 50% in succeeding years, or approximately $600,000 pre-tax or 2 cents on EPS. And the second factor on corporate expenses in 2004 is that we have on expensing the amortizationized cost of our restrictioned stock grant. In over a two year transition, we are replacing our stock option plan that we've had with a restricted stock grant program and the expected incremental 2004 expense is $500,000 pre-tax for the first awards in January of 2004. And on EPS, that is an impact of 2 cents a share.

Regarding the tax rate, we're expecting to be at 35% for the year, which is one percentage point lower than our rate used for most of the year since the spinoff. And this 35% reflects our continued use of the research tax credit for U.S. taxpayers. We did file last year, as you recall in the fourth quarter, we had filed an amended prior year return for the credit, and received a nice one-time recovery in the fourth quarter. Now we're continuing that for future tax periods.

Working capital we had a terrific 2003. As you know, these are one-time improvements. It gets harder to repeat those previous large reductions. As Dave mentioned, we have further inventory reductions we expect of ourselves. That's true for 2004. 2004 will not be quite as significant as what we benefited in 2003.

So to summarize this slide and end our outlook, first, any end markets we serve are improving. Second, metal costs and raw material are rising, but we're taking pricing actions to offset them. Third, the petrochemical segment's deliveries in the second and third quarter coming up will be less than the large international and oil and gas projects. And fourth, corporate expenses for the new Sarbanes-Oxley compliance are pushing our corporate expenses for professional fees up.

For the near term, as indicated in the press release, we're expecting second quarter earning of between 24 and 27 cents for diluted share, and that excludes any special charges. Which compares to 28 cents per share that we reported in the second quarter of 2003.

And with that I'm now turn the call back to David.

Thanks Ken.

That's our prepared remarks for the first quarter results and an updated insight on 2004. We're encouraged that some of our markets are recovering. Especially those areas such as chemical processing, HVAC, steam, aerospace, that makes up about 25 to 30% of our total business.

Other market areas such as Navy and the power remain at pretty low levels, but flat to last year. And the question mark we have in our minds are the petrochemical and general industrial, what direction they will go and how strong they can recover and the timing of that. But as in the past, we remain conservative and conscious about the balance of the year. Even though March was strong. But one month does not a trend make, as they say.

We also have a number of new product initiatives that should help us grow and we continue to invest in the future by focusing on new markets and new regions such as the Asian market which we're trying to establish a basin for our information technology. Some of these are highlighted in our recently published annual report. So, that's it. And now we'll open the lines up for questions.

Thank you. Today's question-and-answer session will be conducted electronically. If you are on a speakerphone, please make sure your mute button is turned off. It is star one on your touch tone telephone. We'll pause and allow everyone an opportunity to signal.

We go first to Michael Schneider are Robert W. Baird.

Good evening, guys.

Good morning Mike.

Maybe we can start start on the petrochemical side. It is curious to me while margins would be down in the middle quarters of the year. Especially given the fact that the backlog for those quarters was booked in '03. I'm wondering, is steel the incremental change that explains the decline in your profitability outlook? Or is it just putting finer numbers or refined numbers on what the back log holds in terms of profitability?

I would say yes to both of those. The steel prices have affected the margins and the type of projects they've been booking have changed. And the competitive nature of the pricing of those projects effected the margins as well. Some of that was booked in late '03 and didn't get fully reflected into our projections until we start putting finer pencil to it. So now we're realizing that in the projections that we're providing you now.

And there is no past capability or clauses for steel, nickle, whatever in these long-term supply contracts?

No, there are not. We protect yourself on those. Once we get the -- it is a prolonged quotation process, Mike. First, if you're up, you get the sheets from the project for the valve content. And then you go through the process of refining the engineering requirements, and the types of materials, so forth that you need to get into the specifics of the valves that are required on the project. And then you put a quote together. And when you approach the forgehouses for the raw materials, they only give you a short window of guarantee for the price. And then sometimes the end use customer takes longer than the protected time frame for them to get back to you, award the project, and then get into an even further refinement of the engineering specs which could change the material. So you can't place the order on the material until you're further along the project after you've been awarded it.

So what we do is as soon as we get an indication of an order, and as we're in discussions with them, we go back and make sure we lock in on those prices. But there is a period of a few weeks time that we're exposed, between the time the forgehouse has given us the quote and protected us for a period of time until the time we are prepared to order the material from that vendor. And in times of quickly rising prices in the steel markets, it hurts you, even a couple of weeks.

Right.

But in the past, it hasn't, because we haven't seen this type of a spike. We have seen it now.

In terms of revenue guidance for that segment, you've maintained the fact that revenue this year will be flat with last year. Yet you started in a hole, I guess, in the first quarter. So I guess that to me says you expect backlogs or bookings, more importantly, to pick up substantially from here. Is that just based on your April experience, or is there something else you know about the project pipeline?

Well, the project pipeline is still activity. We've got people working all hours of the night quoting a project. So we know that there is projects out there and it is still an active market. And as I indicated earlier, the mix of the products has changed. We were blessed last year with some nice L&G projects out of the Middle East that had exotic materials and hydrospecs. We are one of the few companies that are qualified and used. Probably number one in that category. Those projects have subsided. And now the projects we're working are more standard in their design and technologies. There is more competition on those.

Okay. And and if the pipeline is still full but yet pricing seems to be sliding, is it just a function of the type of project, or is there something else occurring? Is there a new competitive change or something like that?

No, no change in competitive environment, Mike.

Okay. And then switching to instrumentation. I guess, what is your confidence that you didn't lose share, misorders, whatever in the January, February time frame. Because clearly sitting back now for a week and a half listening to every industrial company come out and report very strong orders, January, February and March, you guys seem to stand out as an exception to that strength. Is there any specific explanation you can offer?

I think I've seen companies like Parker Hanifen out there indicate some pretty strong orders. As you know, they publish their orders every month.

Yep.

We analyze those quite thoroughly. We're comfortable we maintained our market share and probably gained a little bit over the past 18 months as we gained [BASF] and the DOW contracts on a global basis from people like [Sledglock] and Parker Hanifen. I think what you're seeing and what we've concluded is that the majority of what those companies are showing is the hydraulic off highway construction vehicle market, which we've seen boom. But we don't participate in it. Ours is the -- if you were to dissect a company like Parker, we would compete with the fluid connector instrumentation side of their fluid connector business which is conglomerated with the other connector in fluid control devices, including those related to off highway vehicles and hydraulics.

So our markets are lost within their larger sector. So it is pretty hard unless you really dissect and have more detailed information to get comfortable with it. But we are very comfortable with the knowledge that we have not lost market share. We're maintaining and gaining in markets. We're introducing new products and new platforms and doing it quite successfully. In fact we're meeting here in Spartanburg and we're giving a presentation with the board yesterday about all of the market initiatives that are going on within this business. And we feel very good about it.

Okay. And I guess just taking a step back now, looking at the guidance for the second quarter, you've got it down year-over-year from the 28 cents reported last year. Yet in listening to your comments, both of you guys, that you ended the quarter on a strong note. Seems like April has continued the momentum. Why are you going to be down year-over-year? Is it more just the mix on the petrochemical side that is pressuring you or just the overhead expenses? What else is feeding it?

I would say there is three primary drivers to that. The answer. One being in petrochemical, the richness of pricing, it started to decline last fall and winter, are now being shipped out. And petrochemical in the second quarter, so the margins being dampened by that effect.

Second, the price improvements, price increases to the customers that are being put into place effective in April and May will effect new orders. Not existing backlogs. Therefore, by the time the new prices go out on shipments, that will largely be June, and lastly, we have an incremental $400,000 in corporate expenses. We had $2.3 million in the first quarter of corporate spending. I am anticipating that it will be around $2.7 million in the second quarter. Again focused on the Sarbanes-Oxley testing that we are rolling out. Those are the through key pieces.

Okay. And final question, just if indeed chemical processing is coming back, I assume KF is the biggest beneficiary of that.

The KF [inaudible] piece of that which is the industrial line.

Okay. What is the margin implication of that business being stronger? How does that affect the mix?

Well, that's a -- I'll give you an abbreviated answer to that. It is getting better. I guess. About the foreign sourcing program that we've targeted for the KF business has been mostly directed toward. But a lot of it is directed toward the KF, the industrial side. The valve industry is one that is mostly commodified over the past six, seven years. Over the past two years we've been focusing quite heavily on foreign sourcing of component based product and so forth to improve the margins and that.

So it is better. And today those margins should show equal to what you're experiencing in the other portions of our petrochemical business. So the mix shouldn't affect total consolidated margins.

Okay. All right. I'll get back in lines. Thanks, guys.

Once again, ladies and gentlemen, it is star one for questions. And Mr. Bloss, we have no more questions in our queue. I would like to turn the call back to you for concluding remarks.

Okay. I I think we've covered probably more in this conference call that we have in the past, more detailed information for you. And we appreciate your attendance. And we look forward to a growing and recovering market in most of our markets here. And we'll show that in future periods. So thanks for attending. And see you next quarter.

This concludes our conference call today. We thank you for your participation. You may disconnect at this time.