Circor International Inc (CIR) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, welcome to the Circor third quarter earnings release conference call. (OPERATOR INSTRUCTIONS) Curin McCan, Investor Relations.

Thank you very much and good morning. Welcome to our third quarter earnings call. Our objectives today are to review the company's recent performance and provide updated outlook on the remainder of 2004. With Davis Bloss, the Chairman and CEO of Circor, and Ken Smith, the company's CFO. 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 website at www.Circor.com, under the link of quarterly earnings, From investor's relation page.

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 2003 form 10-K, which also can be viewed on the company's website. Of course, actual results can differ materially from those expressed or implied from today's remarks. Now, let me turn the call over to Circor's Chairman, David Bloss

Good morning, everyone. I want to first provide some color on our third quarter results and then talk about what we expect in the fourth quarter. Then Ken Smith will review the financials in a little bit more detail.

As you can read from our earnings release, our third quarter earnings came in at the top of the range of our revised guidance from our September 13, pre-announcement at 21 cents per share. We adjusted our outlook during the quarter, due the hurricane's effect on our Leslie controls business, part of our Fluid Controls product line, which is located in Tampa. And for a couple of other issues -- one relating to asset write-offs on the SSI product line that we moved from Canada, to the other item being some unanticipated workmen's compensation costs.

All these items hit the Thermal Fluid Controls business at about the same time in the third quarter. So we felt it appropriate to issue the pre-announcement on our earnings. On that note, let me begin with our instrumentation in Thermal Fluid Controls segment, where our third quarter orders were up 6% although they were flat without acquisitions. And backlogs increased 8% versus last year.

Within this segment, besides the items I've mentioned, the Thermal Fluid Controls business has been battling the effects of the cutbacks of the U.S. navy spending and the overall fleet reduction program. Together with higher raw material costs. So it has been battling some bad things here.

The good news is that first of all, second round of price increases has been implemented at about a 4 to 5% overall level for the product lines in North America. The HVAC steam loop activity in North America appears to be on track. It should be a good heating season for us this year.

Our SSI product line move in the integration was successfully completed and we see that business improving as well. And our European businesses are expanding and showing fairly good results in the eastern block countries where power and process applications are actually growing.

Our aerospace products business, also part of the instrumentation and Thermal Fluid Controls segment, has benefited from increased procurement in the military aerospace sector. While the overall commercial aerospace market remains relatively flat, with some individual OEM's being up while others down.

One other item to note in this quarter's orders versus last year is that, last year in the third quarter we received a large blanket order for switches that go onto the smart bombs for U.S. military. And that was a blanket order. Although we've continued to have nice orders in the military aerospace this year, that third quarter last year was exceptionally good when we received that blanket order. We don't see any meaningful change occurring in these aerospace markets during the fourth quarter.

The last piece of the instrumentation of Thermal Fluid Controls segment is instrumentation products business. Where late last year we moved the Tomco quick-disconnect manufacturing operation from its Cleveland facility to our major facility in Spartanburg, South Carolina. This move gave us some problems. The equipment didn't move well which caused start-up issues. It was more difficult than we anticipated to find good machinists and we experienced high turnover rates. This cause stockouts (ph) and overtime that affected our other product lines in Spartanburg. And here is our other businesses, we got hit with escalating steel costs.

But good news is on the way, we're hoping and I've got some good news to report today. First, the plant has now absorbed the Tomco line and the efficiencies and past-due orders have improved dramatically. Second, we've had one formal price increase plus an additional surcharge to our customers, to help offset steel costs. And we expect a leveling off of these costs from vendors in the fourth quarter. Third, business conditions have improved this year in certain areas. Our business was BASF, PMEX and other customers in the fine chemicals and refining markets, is expected to improve in North America, UK and Germany. And, lastly, the two sampling system businesses we purchased late last year are doing extremely well, both in Europe and in the U.S. market.

Now turning to petrochemical segments. Orders were up 19%, and backlog increased34% compared to last year. This was expected.

The third quarter revenue was very soft for this segment, due to project shipping schedules. But quotation activity remains strong internationally, particularly the Middle East, West Africa, Brazil and Indonesian markets.

North American markets are mixed. Canada had some pretty tough weather conditions with a muddy environment which limited equipment movement. Although September was relatively strong there. The fourth quarter is expected to be get better Canada.

Meanwhile, the U.S. is not as active as high oil and gas prices would normally predict. I will remind you that about 70% of our business relies on natural gas activities and major producers are investing in international projects, versus the more expensive environment in the United States.

Quotation activity for the chemical and refining application has improved. But these are for smaller size valves, where foreign competition is more fierce and pricing is very competitive. We continue to hold our share of the North American markets, but higher raw material costs are becoming more difficult to pass on. In fact, we are looking at a second round of price increases, but competitive environment is pretty tough.

Also, we're putting plans together to expand our Chinese manufacturing operation, to stay ahead of competition and defend our markets. And also to enable us to actively participate in the China market directly.

Our fourth quarter revenues are looking pretty good for us. Pibiviesse, their international product shipments are scheduled to be back to their recent high levels. Canadian activity should be stronger. And our Mallard hydro-seal acquisition that produces safety release and control valves is actually doing better than expected as we expand their distribution base. This expected revenue growth is offset somewhat by continuing higher steel costs from vendors and higher compliance costs for Sarbanes-Oxley Section 404 work. We've had a difficult time predicting these costs - - these areas of cost increases this year.

Our current estimates assume a leveling off of steel prices during the fourth quarter, and is updated for the most recent audit-fee estimates provided recently to us by our independent auditors. The bottom line of all of this is that we are lowering our previous guidance for the fourth quarter a bit, to between 28 and 32 cents per diluted share.

Ken Smith will now provide you with the financial details of our third quarter and talk more about what is included in the fourth quarter estimates.

Thanks, David. And to slide number 3, regarding revenues for the quarter, we had a net benefit from the factor listed on the fly. Aerospace, particularly military aerospace, has been stronger for us as David noted. Regarding the profitability, the operating income change noted on slide 3 reflects the net result of lots of cost reductions, such as - - the fixed cost for three recent facility consolidations, discretionary staffing reductions, increased foreign sourcing for lower inventory cost, and 2004 customer price increases. But all of these have been overshadowed by the expected lower volumes of shipment to large internation oil and gas projects this quarter. The continued higher raw material cost for specialty metals such as stainless steel and related alloys, this is affecting most of our business in varying degrees. And the corporate expenses for compliance activities for Sarbanes-Oxley Section 404.

Now turning to slide number 4. The Q3 segment operating income decrease, came from the petrochemical segments volume decrease, to large projects. And I'll discuss each segments in a few minutes.

Special charges this year were in the petrochemical segment. As we wrote down the net book value for unused warehouse held for sale - - and the sale of which is expected to close later today.

Special charges in 2003 were incurred in the instrumentation of thermal fluid segment for severance costs. In our previously discussed Tomco operation, which was closed late in 2003.

Corporate expenses rose. This quarter we had the expected rise in compliance costs for Sarbanes The higher cost involved the use of outside auditors to perform the - - assist us in testing the financial controls. And at Circor we are testing all of our business units, and nine of those in a major way.

Net interest expense was lower, due to our annual principal payment of $15 million in October of 2003. And the other expense income category primarily consists of foreign exchange gains and losses and 2003 experienced more significant gains than this year, from the significant strengthening of the Euro and Canadian dollar compared to the U.S. dollar last year.

Turning to slide number 5. Cash flow from operations and free cash flow were substantially less than last year. Last year was a spectacular period when our businesses reduced working capital. And specifically talking about working capital, accounts receivable was a source of cash this year. Aided by effective collections as evidenced by our DSO of 63 days in September-end 2004.

For inventories we generated $16 million of inventories in the first nine months last year. This year thus far we invested 12 million, as we've increased safety stocks to respond to higher demand, and due to increased steel and utility surcharges from our vendors. And CapEx, 2003 was higher than 2004 due to nearly $2 million purchase of C and C equipment to expand a manufacturing capacity of our Chinese plant.

Now, to slide number 6, the balance sheet. And continues to be very healthy as you can see. With an improved net cash position, throughout this year. Not reflected in our 2004 financials, because it occurred early this week, our net debt was reduced by another $15 million, specifically on October 19th, where we paid our next annual installment on the senior note. So our total debt today is not 58 million, but 43 million.

And now on slide 7, our instrumentation thermal fluid segment results. Regarding orders, good news from several factors. The two acquisitions in Q4, 2003. One was in Netherlands and other in Texas that provided incremental orders. The aerospace markets have improved and commercial HVAC has up particularly for our European business. And markets are continuing to be soft this year, up in the maritime. Specifically the end use customer with the U.S. Navy, as Dave mentioned. And the chemical processing industry which includes refiners which have pushed off maintenance spending until domestic summer driving vacation season ended. Revenue was another good news listed on the slide. Also customer price increases implemented on new orders received after May 1 of this year, also had a positive impact on the quarter.

Regarding operating income and margin, the net change in the Q3 margins, due to the factors David mentioned earlier. including unexpected cost this quarter in the thermal fluid group. For the hurricane disruptions and write-off of assets on the strainer business moved out of Canada. And the continuing higher cost of raw materials specifically steel costs and related utility surcharges from vendors. Our price increases to our customers have not fully offset the increased costs from vendors. And we also have key competitors who have not yet implemented price increases. In some cases not to the extent that we have.

Now, on slide number 8 our petrochemical segment. The order increases in the petrochemical segment benefited nicely from our acquisition in April, 2004 of the Mallard controls business in Texas. And for other existing businesses, two other principal order streams have had different strengths.

First, the North American MRO order stream is up 3 percent year to date over 2003. And, excluding our Mallard acquisition orders, our North American MRO orders have been softer this summer. Orders from U.S. gulf coast customers have declined because of lower day rates for renting rigs compared to prior periods.

Second, the international market for large oil and gas projects continues to be healthy. Which is most significantly served by our accounting business unit. And to that point, the order intake for large international CapEx projects, as you know, are quite lumpy. And for reference, our quarterly intake for this market segment in 2003 average $18 million per quarter for our Italian unit. The best year it ever had.

In 2004 we had a very low order intake in Q1, $6 million. Yet Q2 and Q3 of '04, have average $18 million per quarter order intake, back to the robust 2003 level. And we expect that the huge CapEx projects in the Middle East plus the L&G(ph) CapEx spending world wide, will continue to sustain a health order intakes going forward.

The decrease in revenues was the net result of several factors as noted on the slide. The most significant of which was our Italian business unit. And I just explained the lumpiness of quarterly order intakes. Our Italian unit normally takes 6 to 9 months to fulfill a typical order to these large projects. And just to give you an example, on a large ball valve that it ships, say 48-inch in diameter, which your 6-year-olds or 10-year-olds can walk through, just the ball to cool down from its molten state, takes one month. So it is just an indication of why the fulfillment time is so long.

Therefore, when we had a significant order shortfall in the first quarter this year, it really impacts the segment revenues in the second quarter and most notably in third quarter of 2004. So it's important to look at portion on a long term rather quarter to quarter comparison. As for operations income and margins, the lower third quarter 2004 profit margin principally reflect the lower gross profit on lower volume of shipments to international oil and gas projects and a continuing higher steel cost for raw materials.

This quarter, the domestic price increases the customers (ph) implemented in Q2 2004 have not fully offset the entire amount of higher raw material costs, but certainly have helped stabilize the segment's operating margin. For year-to-date profitability, this segment's strong queue on 2004 plus the positive impact of foreign sourcing, other domestic cost reductions, have helped offset the higher steel cost incurred in Q2 and Q3 2004.

Now let's turn to slide number 9. On this slide we point out the assumptions for key end markets we serve and other factors we expect to will influence the degree of our near term success. And David detailed many of these in his opening remarks.

On slide number 10, we translate the market assumptions on slide 9 into our business assumptions for the upcoming fourth quarter. And we factored in the following points - - The instrumentation thermal fluid segment is expected to have steady revenues, with sequential strength from aerospace, chemical and commercial HVAC customers. Operating margins of segments should improve on higher volume. And the absence of the unexpected costs we incurred in the third quarter not repeating.

In our petrochemical segment, a strong backlog has weighted the deliveries in the fourth quarter. And in the 2005 with scheduled shipments to large international projects coming in the next quarter from our existing backlog.

And corporate expenses will rise from historical levels. First because of external professional fees being incurred by us to help us assist in the Sarbanes-Oxley compliance. Where we are using an outside firm to help us with our testing. That work is also followed by external auditors, who will perform their own testing.

And second in 2004 we are expensing a corporate - - the amortized costs of our restricted stock awards. An over a 2-year transition period, we are substituting stock option awards with a restricted stock awards, under our equity incentive programs. In the accounting treatment today, calls for restricted stock awards to be expensed.

So to summarize this slide and our outlook, many end markets we serve are steadily improving. Metal costs and raw materials are rising but we've taken pricing action to help offset them and we're planning more. Deliveries in the fourth quarter for large international oil gas projects will be strong. And inefficiencies from prior facility consolidations are easing significantly.

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

Thanks Ken. As I mentioned during our Q2 earnings conference call, we are setting plans in motion to adopt lean sigma operating principals throughout Circor. Here's an update on where we are.

First, we're searching for a lean leader of operations for Circor. Someone with exceptional credentials and proven track record in a lean environment.

Second, the entire executive team at Circor, including myself, has gone through extensive hands-on training of lean principals including participation in a week long Kison (ph) event at one of our client consulting firms, TBM.

Third, presentations and training to our employees at our major facilities where we plan to initiate our lean efforts are scheduled for December, with lean assessment and first Kison events in January '05.

Fourth we're establishing our performance goals for our lean initiatives. These are generally what we will targeting during the first 36 months of business process improvements. At this point our targets are - - first to reduce lead times by 50 percent, second to improve productivity 25 percent per year, third 100 percent on-time delivery of products to our customers, and fourth ,and very important us, doubling our inventory turns from 2.5 to 5 times. In addition to our lean initiative, as part of our inventory turn improvement effort, we made significant progress during 2003 and it slowed down somewhat this year.

During our next quarterly review of the market value of our excess inventory we will determine whether a more aggressive market value adjustment is necessary, in order to allow us to expedite the sale of our remaining slow moving inventory. This determination should be made in the fourth quarter and could result in a non-cash charge to earnings, which obviously is not included in our estimates of EPS indicated earlier. By implementing the lean principles we also hope to free up space at our major facilities and then be able to consolidate further or add fold-in acquisition. That is the plan.

We've got a lot of work to do to build a lean culture and reate competitive advantage for ourselves and our markets we serve. We feel we are building a platform that will allow us to grow the company and create shareholder value. That's it for our prepared remarks and we now will open the lines up for questions you have.

(OPERATOR INSTRUCTIONS) Ned Armstrong, FBR.

Good morning. Could you comment a little bit on the Mallard acquisition and how that's benefited you not only from Mallard's business but how it may have helped you with any type of synergies?

Yes, I will. Mallard is - - had just acquired a small oil and gas, high-pressure safety release valve company called Hydro Seal, before we acquired it. And Mallard is also in the oil field but also some industrial process applications.

So that was a real benefit to us, having been a small privately owned company, it really didn't have a strong distribution base. And we saw opportunities to really grow the sales volume of that business. And also to apply some foreign sourcing of some of the components and so forth. We've started out those processes on both ends of the spectrum, and are doing quite well.

That product line is a nice and growing product line. They've got new products being developed as we acquired them, and we brought some new ideas to them as well. So it's small, but we think that business has capability of probably doubling its size in a short period of time through our distribution channel.

Is having the Mallard product as part of the Circor line enabled you to penetrate any additional customers?

Not yet. We first want to be able to supply them to our existing customers. And then as a package have a stronger package to offer to new end-use customers. Right now we're focusing on the first stages of that with the reps and distributors. The next phase will take us into the end users.

Okay. And then with regard to your sampling business, can you just give us a little bit more color as to how those businesses are proceeding?

Certainly. Two businesses, one in Holland, BQS (ph) , and the other in Texas, Texas Sampling. Both were - - we closed them quite near to each other and announced both of them simultaneous. They are doing quite well in that they were both privately held companies and the funding for growth was limited, and we've been able to provide them with the wherewithal to accept more orders and expand their breadth of quotation activity.

We've also been able to substitute our products into their sampling systems - - the fittings, the regulating valves, the control valves that are all integral part of the sampling system itself, have been converted to our products and they were our competitors before. So we're seeing the benefit of lower cost. We're maintaining their independence at this point because they both are very strong market shareholders in their respective markets and are doing quite well.

We are looking at more ways to introduce our higher-tech product lines to miniaturize the size of their sampling systems and to further reduce their costs and make them effective products. But that will come in the next 12 to 18 months.

Have the sampling businesses enabled you to sell some of your products to some of their customers, as opposed to utilizing your products within the sampling products?

Not yet. They deal through a different channel of distribution, and OEM's, and we haven't gone to that step, yet. We hope to be able to be address that in the next quarter.

Okay. Thank you.

You're welcome.

Richard Glass, Morgan Stanley.

Hi, guys.

Hi, Rich.

You guys have not exactly performed consistently. We haven't grown earnings in quite some time. Even after your $15 million payment, you're sitting on 53 million in cash for producing free cash every quarter. You're talking about taking down inventories further in the fourth quarter, whether that requires a charge or not, which would produce more cash and your stock has done absolutely nothing.

How can you possibly justify sitting on all that cash and not either buying back stock or returning the cash to stockholders in some form?

Well, our board consistently reviews the alternatives to use our cash and we've got a pretty firm goal strategy here through acquisitions that we're continuing to make progress on. And we feel, as a company, and as a board, that the funds are best used in that growth arena.

Regarding your earnings comment, we're frustrated, as well. We've done a lot of consolidations. We've foreign-sourced a lot of our components. We've expanded our joint venture in China. We've done all the right things but unfortunately corporate governance requirements, new additions to our staff to fulfill those requirements, Sarbanes-Oxley work, and then these steel price increases which caught us off guard. We're embarrassed about those. We should've reacted sooner and we're trying to recover from that. But competition is tough in our markets, and we're doing the best we can. These are not excuses, but I'm just trying to put it in proper perspective here.

Dave, those are excuses, actually.

Well, I don't think they are. We are attacking our cost consistently.

The truth of the matter is then given the size of your company, if you can't ride out some of these issues, which, you know, in a larger company they can. Maybe you guys shouldn't be an independent company at this point?

Well, I can't address that in this form.

Well, you guys have no produced no return for shareholders here.

I disagree with you. I think if you take back to our spin, we spun off at $10 a share. We've appreciated the stock quite nicely. There's been some bumps in the road recently, but we are planning to get back on track and grow this company and improve our earnings position. That is our plan.

All right. Thank you.

(OPERATOR INSTRUCTIONS) Michael Schneider, of Robert W. Baird.

I want to focus on petrochem. Obviously, or at least in my opinion, that's the huge swing factor in '05 now. You're targeting eight eight (ph) per margin in Q4 in petrochem. Yet revenues are going to be up, call it 1 to $3 million year-over-year.

So despite a 1 to $3 million growth in revenue, year-over-year in the fourth quarter margins will be down approximately 350 basis points. And is that indicative, Dave, of the issues at KF on pricing? Is it indicative of the margins in the Pibiviesse backlog, both? And then I guess I want to talk about what that implies for '05.

Yeah, I think it's partially both, but mostly it's the Pibiviesse mix of projects and competitive environment they're facing. We had a wonderful experience last year in the projects that they were able to capture with the types of alloy materials, exotic materials, high-pressured, difficult environments. Those projects were nice to us and hopefully they'll come back.

But right now our backlog consists of more normal types of projects and stainless steel without the stellite(ph) overlays and ink analysis (ph). And that's a more competitive environment. There is more competition out there. And things are happening to our competition, as you know, the growing business is repositioning itself, trying to gain back share that is quite frankly we took a piece of. And they're being aggressive in the market, as well. So that - - for next year, then, we're looking at probably more of the same.

And we're going to be looking at ways to reduce our costs in that business by expanding our joint venture in China. And doing more product expansion there, so that it can produce components that go into the Pibiviesse type product. That's a big step for that market, because those end-use customers, we will have to, you know, convince actually, that the quality of products coming out of our operations in China, is acceptable to them. And we feel that we can do that. And it will be a big cost savings if we can.

So, you know, to summarize, we're working on ways to reduce our costs to address the issue of the margins, but the margins go up and down in that business depending upon the type of projects that are out there. We're glad that there is a nice healthy activity of projects, to keep that operation growing for us. But, you know, we can't choose the types of materials that the end-use customer wants.

And having no further questions, Mr. Bloss, I'd like to turn the conference back over to you for any additional or closing comments.

I would like to thank everybody for attending the third quarter conference call. We've got a lot of work to do here, as we explained. And we'll get back to it and talk to you at the end of the fourth quarter. Thank you very much.