Circor International Inc (CIR) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, welcome to the CIRCOR International first quarter earnings conference call. Today's call will be recorded. [OPERATOR INSTRUCTIONS]. The floor will be open to questions following the presentation. I would now like to turn the call over to your host, Mr. Curran McCann from the Company's Investor Relations firm. 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 its updated outlook on 2005 with David Bloss the Chairman and CEO of CIRCOR, Ken Smith, the Company's Chief Financial Officer, and Bill Higgins, the Company's Executive Vice President and COO. After their comments, we'll then go to Q&A.

Before we start, though, two administrative notes: First, in the slides we will be referring to today are available on CIRCOR's website at www.circor.com under the link Quarterly Earnings from the Investor Relations stage. Second, today's discussions contain 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 2004 form 10-K which can also be viewed on the Company's website. Of course, actual results could differ materially from those anticipated or implied from today's remarks.

Now let me turn the call over to CIRCORs chairman David Bloss.

Good morning, everyone, and thank you.

Well, as you can see from our first quarter earnings release, we're off to a good start in 2005. Our markets appear to be in pretty good shape, and judging from our increase in revenues, orders, and backlogs that we reported.

Within our energy products segment, the North American petrochemical and chemical processing spending activity has moved upward, although Canada is not as strong as we would like, but it has improved, as well. On the international project front, quotations remain very active, although our shipments this quarter from our Pibiviesse operation was a lower percentage of the company's overall total.

At Pibiviesse, we've been working on some rather unique products for an Exxon/ Mobil project. These products are the first of their kind in their high pressure large bore ball valves for gathering and transmission lines for high pressure natural gas applications in the Persian Gulf.

Just to give you an idea of what I'm speaking about here, the most difficult of these valves was a 28-inch 7,000 PSI ball valve, that's 28-inch diameter, 7,000 PSI ball valve that ended up weighing over 58 tons, and are is made of stainless steel with [inkinal] overlays. These took a lot of effort and cost for us to develop because they are unique, and we expect them to have far-ranging applications going forward in this region.

However, it delayed our ability to finish and ship other orders, which are now sitting in backlog, and which we hope to flush out over the next two quarters. Therefore, the mix of higher margin products out of this operation as a percentage of our total energy product segment was lower than recent levels during this first quarter of 2005, but its project activity and backlogs remain very strong, and we expect margins to balance out during this year, as indicated in our projections.

Within our instrumentation and thermal fluids controls segment, the general instrumentation markets have improved in North America and continue to be strong in Europe. Our steam markets are up slightly, as we've been able to secure U.S. Navy engineering contracts to help offset the decline in product sales to this particular application. In addition, the other steam markets, including HVAC and power gen are showing some improved strength.

Within our aerospace operations, commercial activity is moving up, offsetting the decline in the military switch revenues, which was better last year due to the Middle East conflict. Also, all results include the positive effect of the Loud acquisition for 2.5 months of the quarter. Loud contributed to our bottom line, and it's shipments are expected to increase in the second quarter.

Profitability for our instrumentation and thermal fluid control segment showed some strong incremental earnings on revenue growth and a favorable mix, as well as the realization of price increases implemented in mid-to-late 2004. We are expecting that margins in this segment will bounce around a little bit this year due to the mix of shipments and some additional cost increases, but over all, they should have a good year.

On a consolidated basis, we've had to continually absorb the high cost of compliance with Sarbanes-Oxley 404, which Ken will speak to in a few minutes. From a cash flow standpoint, we did use some cash this quarter, besides acquiring Loud, we had to bring in more inventory to match our rising backlog and order rates. Particularly our Pibiviesse operation had an increase in inventories due to a buildup of back log, and I refer you back to my previous comments on their delayed shipments.

We expect that these inventories will be brought down as the shipments are made in the next few quarters. Our lien initiatives are targeted to prevent inventory increases from happening, and to reduce our overall inventory requirements in the long run, but as you know, we're just getting started on our lien transition, which Bill Higgins, our COO is leading. So we expect decreases in inventory going forward as we ship our backlogs and implement new processing systems. At this points, I'll let Ken and Bill take you through the details of our first quarter results.

Ken?

Thanks, David. And I'll start with slide number 3.

As David pointed out, we have had a very solid quarter. Double digit order and revenue growth versus first quarter of 2004. As for revenues, David cited the major factors, including favorable market conditions, and the customer price increases instituted in mid-2004. Our only noteworthy revenue decline was the lower shipments to Middle East oil and gas projects that Dave described. And overall profitability increased benefiting from the factors listed on that slide.

On free cash flow, we have invested in inventory to help support our record backlog, and in CapEx, we completed the purchase of a new facility in the Netherlands for nearly $3 million, and into which we plan to consolidate certain of our smaller European instrumentation businesses in late 2005 and then in 2006. Now turning to slide number 4, the Q1 change in segment operating income showed nearly a 25% earnings increase on incremental revenue of $12 million.

Regarding corporate expenses, the change reflect this considerable cost to comply with section 404 of Sox, and the testing of -- which involved testing of internal controls at nine of our business units. We learned a lot from the first year of compliance, and will most certainly be personally focused on reducing our cost of compliance in 2005.

Special charges were recorded for the accrual of severance at one of our smaller thermal fluid products businesses in Europe that will be downsized a bit later in 2005. Net interest expense was lower due to our annual principal payments of $15 million each October, and income taxes continue to be accrued at 35% effective tax rate, the same rate as we had in 2004.

Turning to slide number 5, cash flow from operations and free cash flow in the first quarter of 2005 were affected by an $11 million increase in inventory. The majority of which was purchased to support record backlogs, and included amounts related to the delayed deliveries on the large Middle East gas projects that will now ship in the second quarter. And in Capex as I mentioned, we spent nearly $3 million for a new European facility.

On slide number 6, the balance sheet, the balance sheet continues to be very healthy, with a debt to capitalization ratio of only 13%. In 2004, we were in a net cash position, and now at the end of the first quarter of 2005, we are in a net debt position after paying $36 million of cash in January 2005 for the acquisition of Loud. We still had nearly $30 million of excess cash and our first priority for investing it remains the funding of strategic acquisitions.

And now Bill Higgins will speak to our segment performance.

Thank you, Ken. I'll start with slide 7, our instrumentation and thermal fluids segment results. Regarding orders I have good news, most impact increase coming from Loud Engineering, our acquisition any January 14, 2005, allowed us the manufacture of landing gear systems and nose wheel steering assemblies and related components for military aircraft, including the Chinook 46-47 helicopters, F-16 aircraft and Loud presents out with a great opportunity to expand our aerospace offering.

It gives us critical mass on new platforms, and because of its location allows us to consolidate and leverage our support services with our Circle Seal business which is both located outside of Los Angeles. Apart from the Loud acquisition, most of our ongoing businesses had increases with the largest increase from our aerospace customers, reflecting good market conditions for our products.

Revenues were up nicely for the reasons listed on the slide, and regarding operating income and margin, a net change for the quarter reflects good margin expansion on the incremental revenue, includes the full effect of price increases to customers that we implemented in mid-2004, which were instituted to offset higher costs for steel and utility surcharges.

Now turning to slide 8, our energy products segment. Our order increases in the energy products segment benefited nicely from the continued orders for large Capex projects in the Middle East to expand liquid natural gas and new gas to liquid capabilities, and compares to a weak order intake in Q1 2004.

Orders from the North American market increased nearly 15%, while they also benefited from orders won by our Mallard Controls acquisition from April 2004. Increase in revenues was the net result of several factors, as noted on the slide -- a 5.5% net increase, essentially came from our North American businesses, while the gains from the acquisition in foreign exchange were offset by decrease in revenues to our Italian business unit which serves this large international project.

The decrease in revenues at our international business unit are expected to be recovered in Q2 as certain large scheduled shipments were forced into Q2 from Q1 due to lengthy customer testing and inspections. As David mentions we are machining and manufacturing emergency shut off valves for LNG and gas-to-liquid plants in Qatar, which are a first of a kind, and these 28-inch valves are for applications up to 7,000 PSI, and in that the unusually high pressure -- the wall thickness of these valves are 24 inches. It's solid steel, and perfectly machined, allowing no leaks.

The customers acceptance tests were lengthier than we anticipated, leading some key orders now scheduled for customer delivery in Q2. So as we expect our Q2 revenues for the energy segment for higher for those specific carryover orders worth an approximate $4.5 million to Q2 revenues, and as for operating and income and margin, the decline is predominantly due to the contribution from the postponed deliveries, which our Italian business will now ship in the second quarter. Separately, the Mallard acquisition continues to be accretive, and also we have positive contributions from our ongoing North American businesses.

Let's now turn to slide number 9. On this slide, we point out our assumptions for key end markets that we serve, and factors we expect will influence the degree of our near-term success. Most of the end marks we serve are expected to be positive in 2005, with order growth rates in the mid-single digits.

Now on slide 10, we are translating the market assumptions just referenced on slide 9 to our business assumptions for the year 2005 on slide 10, and we factored in the following points in instrumentation and thermal fluid segment. We expect steady revenues with strength from aerospace, chemical, commercial HVAC customers, expected contribution from Loud Engineering, operating margins in this segment are expected to improve on higher volume and higher price realization.

In our energy products segment, strong backlog is weighted to deliveries in the first half of 2005, particularly our second quarter and although the competition is excess capacity worldwide will keep pressure on our expected pricing and margins.

Corporate expenses are expected to be equivalent to 2004, as anticipated decreases in the Sox 404 costs will help us fund increases in selected staffing and anticipated bonus achievement. And as you know the effective date for expensing stock options has been delayed six months to January 2006 for calendar year-end companies like CIRCOR.

Regarding cash, we've had certain large cash outlays in 2005. 2005 Capex is budgeted at $17 million. There's 8 million for new products, cost savings, and equipment upgrades, plus another $9 million for two new facilities. One in Europe we just completed to colocate and consolidating a smaller facility, and a new plant in China to replace the current, smaller facility facility operated by our joint venture.

We announced in December 2004 an agreement to buy out the 40% minority owner in our Chinese joint venture, and that was nearly 7 million dollars and will result in CIRCOR's 100% ownership of our Chinese operation. As for as 2005 sources of cash, we expect to receive Chinese government relocation benefits of between $2 million, and $3 million to aid us in the relocation of our current facility to a new, larger site.

Although not on the slide, we expect some special charges in Q2, 2005, between $300,000, and $700,000 for two initiatives. One initiative is a continued severance and move costs at one of our smaller thermal fluid products businesses in Europe, and the second is the consolidation of our Mallard business in Texas, to be moved into our energy business, our KF Industries business in Oklahoma. That move will vacate 75,000 square feet of facilities, and have a net cash use of $1.1 million, and bring annual cash savings of $800,000. The move is expected to be completed by Q4 this year, 2005.

So to summarize our out look. Our many end markets we serve are healthy. We have a good start to 2005 with a record backlog, and the Loud Engineering acquisition, plus a much narrowed operating margin gap for the high metal costs and raw materials, because we've instituted customer pricing increases. So that I'll ton the call back over to David Bloss.

Thanks, Bill.

As you can see, we have some wind in our sails from improved market conditions, and healthy backlogs, we are continuing to focus on further facility consolidations, the implementation of lean manufacturing processes, and reduction of the excessively high Sarbanes-Oxley audit costs that we are incurring.

As we accomplish these objectives, we expect our cash flows to continue to improve, even beyond the rather healthy historical cash flow numbers that we've been able to post in the past. So with that, we would like to open the lines up for any questions that you may have that were not covered by our presentation.

Thank you, gentlemen. [OPERATOR INSTRUCTIONS]. And our first question will come from Charlie Brady from Hibernia Southcoast.

I got on the call a little late, so I apologize if you've answered this question on the Sox impact corporate expense in the first quarter. How much out of that 3.7 was a ramp up from Sox?

It's -- a ramp up? You mean compared to a year ago?

if you didn't have the Sox auditing experience, what would your normal corporate expense number been, about a million less?

Yes, that's what -- I was looking back at slide number 4, for the benefit of others, essentially all of that million-dollar increase from a year ago's quarter 1 of 2004 is Sox related.

Okay. So then going into the second quarter, you know, the -- you talk about corporate expense coming down to kind of the '04 level --

for an -- for the annual period

Is that really more second half weighted, though, so you'll probably still have some more Sox stuff going on in Q2?

Yes. It's now a -- to essentially comply with the regulations of that section, there's now quarterly responsibilities for management to be sure that controls are effective, and that they are being monitored, so it's not just an end-of-the-year phenomena anymore. So we have essentially now going forward, we'll have Sox expenses every quarter.

Can you quantify what you think in the ongoing quarterly number might be, above and beyond what it wouldn't have been without Sox? A couple of hundred thousand?

Without Sox?

Well, I guess how much is Sox on a quarterly business impacting the corporate expense line? Is it $150 now to $200,000 a quarter?

Well, it's a big number. It's probably close to $700,000 per quarter.

on an ongoing basis?

Well, for 2005. We spent a lot of money in '04. I hope to spend less than that in '05, and I still won't be good enough for my own standards, or management's standards in '05, and I expect to spend less in '06, and hopefully get better at it. You know, it's going to slow down like probably any other first-time project.

I think at least for Sarbanes, where we've got a multitude of facilities and control systems, that it's going to take us a two or three-year period of time to shake out the inefficiencies of what we have, and improve our standards -- our controls to where we're really testing on a very efficient basis.

Okay. Fair enough. On some of the top line growth, was there an extra week in this quarterly period versus a year ago, or am I just looking at that the wrong way?

There were a few extra days in this quarter, yes, there were, compared to a year ago.

And would that -- the way you guys recognize revenue over the quarter, would that have had a meaningful effect on your year-on-year growth?

No, because typically the first part of January in any given years it's -- at least from orders from customers, it's a relatively low period of the year. I would say on the quarter, no meaningful difference.

Okay. So we've got these energy orders now that have slipped into Q2. I would imagine that given that they're higher margin stuff, we should see a pretty good ramp on the energy margins in Q2, and then the second half of the year, to pull that down a little bit from what the Q2 number would be?

We're certainly expecting an improvement sequentially for the second quarter in the segment, aided in part by these -- these postponed and to-be-delivered orders in Italy.

All of those large international orders, will they go into Q2, or will some of that slip into Q3, Q4.

the majority will be in the second quarter, we'll probably have a bit of it that will go the third.

I think you're right, Charlie. This is Dave. I think you will see a bump up in the operating profits for that segment in the second quarter, and then maybe level off a little bit in the second half.

Okay. Did you discuss in the call, sorry again I got in a little late, what your '05 EPS guidance would be?

No, we haven't.

I'll get back in queue.

Okay.

Our next question will come from Ned Armstrong with Friedman Billings Ramsey.

Thank you, good morning.

Good morning, Ned.

With regard to the order levels during the quarter, did you see them getting progressively stronger, or tailing off, and how have they sustained themselves during April?

I think they've been pretty strong through the quarter. I mean, I wouldn't say that they were accelerating or changing. I think they have been pretty solid through the quarter.

We probably saw some nice activity throughout the quarter.

and more of the same in April, I take it?

Yes. Yes.

Okay. On your last call, you mentioned that you were a little bit behind in your price increases.

Yes.

and you mentioned that you got some through this quarter. Can I take that to mean that you're basically all caught up now?

Well, we're not caught up. We don't think we can get the rest of it, but we're as far caught up as we think we can achieve. We're probably about 85% of the way of recovering all of the cost increases. and the market just --

the market is not letting you go any further than you are?

No, we've pushed the limit on a couple of product lines and businesses to where some of our, markets just couldn't take anymore.

Okay. Could you comment a little bit, too, on how you're seeing your European business? Is it still fairly strong for you, or --

Yeah, I'll break it down a little bit for you. In the steam and instrumentation businesses, within our -- within that segment of the company, they've been pretty good. They've been strong even last year. You know, we've read the same things you've read and heard, things that, you know, that are softening in nature in the European markets, but they've been holding up pretty well, and they continue to be fairly -- fairly good for us.

I've heard recently there's some downward momentum in the German markets, the economy there is getting a little bit tougher, and that may affect us going forward, but overall, we're in pretty good condition. You know the story, we've talked enough about the Pibiviesse operation we have there, and that's mostly Middle East and North Sea activity, so that really isn't the European market.

Right, but within Europe, itself, would you attribute that more to just solid markets in your niches, or are you taking share from competitors?

It's tough for us to really gauge the market share increases, but we think based upon the statistics we're seeing, we may have gotten some market share. Okay. Great. Thank you. Thank you.

Our next question will come from Needham & Company, Mark Grzymski, please go ahead.

Thank you. Good morning.

Hi, Mark.

How are you?

Good.

Just a couple of questions regarding the instrumentation thermal fluid group. How much of that, the incremental growth there, was from the pricing as opposed to the unit growth? Is there any way to break that out?

They had a 360 basis point improvement.

Yes?

I would say probably at least a couple of points, probably 200 points of that is probably price.

Yeah, at least.

Okay. Great.

They've also benefited -- well, Ken, with the balance of that difference, we also had facility consolidations going on last year, even though we excluded special charges from this calculation of operating margin. I know we had some inefficiencies in the plant, as training and other activities were going on, to absorb those -- those operations being combined, which we don't put into special charges, so that's another aspect of the improvement.

Okay. And from the -- regarding the Loud acquisition, do you -- how much revenue did that contribute in the quarter?

Well, about 20 million for the year, and we only had it for a little over two months for the first quarter, so it was probably around 3.5 million, something like that.

and the margins on that business, the growth margins for quarter?

We generally don't dive that low. It was certainly a contributor.

Okay. Great.

Nice contributor to the segment

Okay. Great. And would that -- would your positive outlook in the aerospace market -- how much -- because of the loud acquisition, has that given you more confidence, or is it just overall fundamental shift in the business, whereas you're seeing a lot of stuff in the news about that market, or is the Loud really giving you a lot of confidence?

Well, that's -- both Loud has a very nice back log, even when we bought it, and it continues to now, as they're one of the prime suppliers to the Chinook programs that Bill spoke of, but also our ongoing aerospace businesses have had -- have certainly had nice revenue improvements, and really good order strength themselves.

Great.

so a combination of both of those pieces are making us feel good in that market

Okay. And just quickly and briefly. The Capex, are you still looking at about 17 million this year?

Yes.

Okay. That's it for me. Nice quarter, guys.

Thanks.

[OPERATOR INSTRUCTIONS]. We'll take a follow-up question from Charlie Brady.

Thanks guys. On Loud, does Loud do any civilian aerospace work, particularly Boeing?

No it's specifically the Chinook program, and the F-16 program, takes up about 90% --.

We, our aerospace business would be out of Circle Seal, not out of Loud.

and looking at instrumentation and thermal fluid on your guidance for the year, the high ending 14% and you did 14.8 in Q1, I guess what was the -- you know, you just talked about some of the pricing being a good bit of that, which obviously out to stick for the rest of the year as a facility consolidation, I guess I'm just trying to understand why the margin ought to back down for the next nine months, or was was there one thing in the first quarter that really drove the margin above average that isn't going to be repeated the rest of the year?

Yeah, this is Dave. I can respond to that. You know, one quarter does not a trend make, so that's part of our thinking there. We're -- we would love to see these continue on. The other thing in the back of our minds is that we keep seeing inching up those metal prices, even though, you know, people -- the brunt of them have -- have been absorbed, they continue to inch up slightly every month. Our bar stock quotations from the month of May, are higher than they were for the month of April, for example, so we're buying ahead some of that stuff, and that's part of the reason for inventory change.

Plus there is some pretty key projects with nice margins in Q1 that we hope will continue, but you're never guaranteed that you continue to get those kind of orders coming through on some specific product lines and projects. So the combination of that told us, look, we should probably, be a little on the conservative side, but realistic in going forward, that maybe, we couldn't sustain those same margins for the entire year.

What sort of price increases on like bar stock, or if you want to get in more general terms, are you seeing on input prices, commodity costs. I mean, it's not in double digits, I wouldn't imagine.

No, they're not double digits, but they're keeping up 3%, 4%, 5%, and last year they were increasing that much every week. So we've seen the rate of increase decline substantially, and we're hoping it starts going the opposite way. We're hearing rumors, and while we haven't seen it in our supply chain yet, but --

Your guidance on operating margins assumes higher cost inputs is that correct?

Yes, it assumes some creeping up of material prices, yes.

Great. Thanks very much.

You're welcome.

And we will now hear a question from Andrea Wirth of Robert W Baird.

Morning, guys.

And hi Andrea.

Could you just talk about the pricing environment maybe on both side of your businesses? I know you've been able to put in as many price increases as you can, to kind of offset raw materials, but just talk about what your competitors are doing. Are they still raising prices enough as well, or just kind of talk a little bit about the environment.

I would say it's a mix -- mixed environment. I think a number of competitors are raising prices. In the particularly the end of last year and beginning of this year, looking at material price increases that we all suffered, but not across the board.

I guess who is being more aggressive on pricing, and where are you sewing that, versus, who is staying in line?

I think from what we've heard and seen from our operations, of course, they're telling us we're the most aggressive in the marketplace, but, in some of our businesses, major competitor hasn't yet matched our December price increase of 5%, but fortunately they were higher than us to begin with, so, we don't -- we're not suffering from being -- being excessively high in that particular product line.

So that tells us that, until we see somebody move forward and match our price increases, in some businesses, or go forward with additional price increases in others, that we have limited upside potential in additional price increasing at this time.

Okay. And then one last question. Could you guys give us what internal growth was for both backlog and orders for both of the businesses? Was it the same amount as -- I guess did acquisitions contribute the same amount to orders are as it did revenues, or is there a little bit of different mix?

No, I think if our price press release, we excluded acquisitions in the percentages that are in the bullet up on top. I'm trying to find that press release right now. We said before acquisitions orders increased --

Oh, I guess I meant by segment.

by segment?

Yes, please.

Oh, I think we can -- Ken, do you have that?

Yeah, energy without acquisitions grew year-over-year by -- let's see here --

I've got 31% without -- without the acquisitions, Ken, for the orders year-over-year quarter change? Yeah.

Yeah, 31% I have.

31?

Yes.

In energy and then do you have backlog.

Instrumentation and thermal fluid control without the acquisition of Loud came in about 4.2%. Is that what you have, Ken?

Yes.

Do you have the similar numbers for backlog?

Take another question, and I'll compute.

Yeah.

That's actually all I had, guys. I can follow up afterwards if you want.

Ken can -- let Ken compute, bit the numbers have year-over-year quarter charge in backlog of energy products without acquisitions is 78%.

Okay. So near about -- they're flat in instrumentation and thermal fluid controls, the backlogs, without acquisitions. Okay.

Yeah, which would make sense, because there's for the not a product business, so the backlog would be --

Yeah, we're all getting stuck on energy with or without the acquisitions is nearly the same, but when I looked at the Mallard, backlog, it's relatively small.

It's small.

Okay. You've got it.

Thanks.

You're welcome.

[OPERATOR INSTRUCTIONS]. And Mr. Bloss, it does appear that there are no further questions. I'll turn the conference back over to you for any final and closing remarks.

Okay. Short and sweet. Thank you for being on the first quarter earnings call. We look forward to updating you in early August on our Q2 2005 results. I'll see you then. Thanks.

That does conclude today's teleconference, and thank you all for your participation. At this time, you may disconnect.