Circor International Inc (CIR) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Circor International's second-quarter 2010 financial results conference call. Today's call will be recorded. At this time, all participants have been placed in a listen-only mode. There will be an opportunity for questions and comments after the prepared remarks.

And now I'll turn the call over to Mr. David Calusdian from Sharon Merrill Associates for opening remarks and introductions. Please go ahead, sir.

Thank you and good afternoon, everyone. Welcome to Circor International's second-quarter 2010 conference call. On the call today is Bill Higgins, the Company's Chairman and CEO; Fred Burditt, the Company's CFO; and Alan Glass, Vice President, General Counsel, and Secretary.

The slides we'll be referring to today are available on Circor's website at www.circor.com on the Investor Relations page. Please turn to slide two.

Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors, the Company advises you to review Circor's 2009 Form 10-K and other SEC filings, including the quarterly report on Form 10-Q for the 2010 second-quarter. All of the Company's filings are available on its website at circor.com.

Actual results could differ materially from those anticipated or implied by today's remarks. Any forward-looking statements only represent the Company's views as of today, August 2, 2010. While Circor may choose to update these forward-looking statements at a later date, the Company specifically disclaims any duty to do so.

On today's call, management will often refer to adjusted operating income, adjusted operating margins, and free cash flow. These metrics exclude any pretax special charges, as well as asbestos and bankruptcy charges related to our Leslie Controls subsidiary. The reconciliation of Circor's adjusted non-GAAP operating income and net income to the comparable GAAP measures are available in the financial tables of the earnings press release on Circor's website.

I will now turn the call over to Circor's Chairman and Chief Executive Officer, Bill Higgins.

Thank you, David, and good afternoon, everyone. Please turn to slide three. CIRCOR performed well in the second quarter from an operational standpoint. Our operating segments reported sequential improvements in adjusted operating income. This is a result of our focus on productivity across the Company through lean and continuous improvement initiatives.

Company-wide bookings increased 4% during the quarter, as our early cycle end markets continue to drive order growth. We saw particular strength this quarter from the short cycle energy, semiconductor and instrumentation markets. Mid-cycle end markets continued to improve and we're starting to see some positive signs from our late cycle end markets as well.

Our late cycle end markets, which take longer to emerge from the recession because of their dependency on capital spending, seem to have found a bottom, and particularly in energy products, they're beginning to grow sequentially off the bottom of the down-cycle. As sales emerged from the bottom of the cycle, our lean and continuous improvement efforts will position us to drive profitability improvements across the Organization.

The other highlight I'd like to mention was the filing on July 12 of a pre-negotiated Chapter 11 plan of reorganization for our Leslie Controls subsidiary. Fred will explain it in more detail in a minute, but the important point here is that the plan is intended to permanently resolve Leslie's asbestos liability through the creation of a trust, and permanently provide complete protection for Circor from Leslie's asbestos claims.

We believe that such a plan is the best solution for our shareholders, customers, and employees. To date, the legal process has gone as expected, and once complete, Leslie will be positioned to grow and contribute to Circor's profitability.

After Fred reviews our financial results for the quarter, I'll describe our end markets and provide guidance for the third quarter.

So with that, let me turn the call over to Fred.

Thanks, Bill. Please turn to slide four, if you've accessed our presentation. I'll begin with consolidated financial results.

Revenues for the second quarter were $168 million, up 2% from the second quarter of '09 and up 15% sequentially. The year-over-year increase consisted of 1% organic; 5% from acquisitions, partially offset by a 4% negative foreign exchange impact. With our guidance at $170 million to $180 million, we came in slightly below the bottom, but that includes a negative impact of approximately $4 million from FX.

We reported an operating loss in Q2 of $17.3 million, primarily as a result of charges associated with the Leslie bankruptcy filing and asbestos litigation, which I'll discuss further in a moment. Our net loss for the quarter was $11.2 million, or $0.66 per share compared with net income of $7.7 million or $0.45 per share in Q2 of '09.

Consolidated adjusted operating income of $11.6 million, although down 19% from the second quarter of last year, was up 59% sequentially from the first quarter, and more on this later.

Focusing for a moment on our asbestos-related charges, please move to slide five. Although we reviewed most of this in our release and call July 12, I want to again run through our asbestos-related charges in detail due to their strategic importance.

On July 12, our subsidiary, Leslie Controls, filed a pre-negotiated Chapter 11 reorganization plan in the US Bankruptcy Court. The goal of the plan is the complete and permanent resolution of Leslie's asbestos liability, along with complete protection for Circor from Leslie asbestos claims. The key feature of the plan is a trust created under Section 524(g) of the Bankruptcy Code, through which all claims will be channeled and processed, and as appropriate, payments will be made to claimants.

This filing was the outcome of the strategy that we've been working on for some time. The plan was negotiated with both a committee of many key plaintiff attorneys representing Leslie's current asbestos claimants, and also with an independent representative of Leslie's future claimants. Most of these attorneys now only have extensive experience representing the claimants in Leslie cases, but like the future claims representative, they also have experience with asbestos-related bankruptcy trusts.

Because the plan was pre-negotiated with, and is supported by these attorneys, we have a high level of confidence in its success. In fact, eight of the nine members appointed by the US Trustee to the Official Committee of Asbestos Creditors were on the Pre-Partition Committee, which we negotiated. We believe the plan could be confirmed by the Court in the fourth quarter of 2010, at which point Leslie would emerge from bankruptcy and continue to operate as part of Circor.

The bankruptcy filed stayed all of Leslie's pending and future asbestos litigation claims; so while Leslie operates under Chapter 11, it will no longer be incurring asbestos defense or indemnity expenses as it has in the past. However, at this point, we do estimate that bankruptcy-related costs for completing the process will be approximately $5 million, which will primarily be incurred during the third quarter.

We established a $75 million liability in the second quarter, reflecting Leslie and Circor's contribution to the 524(g) trust. The total charge of this contribution, as well as the removal of our pre-filing asbestos and indemnity accrual, insurance-related adjustments, bankruptcy-related costs, and Leslie's ongoing litigation expenses prior to the bankruptcy filing, amounted to $28.9 million in the second quarter. This compares to $3.4 million in asbestos litigation costs for the year-earlier quarter and $4 million we included in our guidance for the second quarter.

Excluding the Leslie asbestos and bankruptcy charges net of tax of $1.10, adjusted earnings per share was $0.44 for the second quarter of 2010, compared with $0.58 in the second quarter of 2009. Our guidance for the quarter was $0.28 to $0.38, but that included $0.16 of asbestos. Therefore, without asbestos, our guidance was $0.44 to $0.54, and thus we came in at the low end of the range.

Two other factors affecting us compared to our guidance was approximately $0.02 from negative impact of FX in the quarter and $0.02 of transaction fees to close on the Mazda acquisition that we didn't forecast.

Now let's turn to our segment performance, beginning with Energy. Our Energy segment bookings increased 13%, due to very strong short-cycle business, partially offset by a lower number of large international and pipeline projects. Energy revenues for the second quarter of $77.3 million increased marginally compared to the $76.8 million in the last year's second quarter, but were up 20% sequentially. The slight year-over-year increase included growth from acquisitions of 10%, which was offset by an organic decline of 6% and the negative impact of foreign currency adjustments of 4%.

The segment's adjusted operating margin was 8.3%, down from [12.3%] in the second quarter of '09, but up from 3.5% in Q1 of 2010 and on track to double-digits in the Q3 of this year. Year-over-year margins declined primarily from -- primarily negatively affected by lower volume and unfavorable pricing in large international projects. Sequentially, the growth in margins was from volume and realizing productivity benefits from actions taken last year.

Now turn to Aerospace on slide seven. Within our Aerospace segment, bookings decreased significantly as a result of timing related to several large, multi-year military landing gear orders in prior periods. We ended the second quarter with a segment backlog of $117 million, relatively flat for the second quarter of '09 and down 3% sequentially.

Revenues were down 8% year-over-year, driven by an organic decline of 6% and 2% decrease from foreign currency adjustments. Adjusted operating margins were 14.6%, down year-over-year from 16.2% but up from 13.2% in the first quarter of 2010. Year-over-year adjusted operating income margins were down as a result of declining organic revenues and associated loss operating leverage, as well as increased expenses for engineering and new product development supporting future programs. Favorable product mix and productivity gains contributed to the second sequential increase in margins.

Now let's move to Flow Technologies segment on slide eight. We ended the second quarter with segment backlog of $75.7 million, up 24% versus the second quarter of '09 and up 2% versus the first quarter. Revenues increased 10% year-over-year due to organic growth of 13%, the result of strength in semiconductors and instrumentation, partially offset by a negative foreign currency adjustment of 3%.

The segment's adjusted operating margins were 10.1% compared to 9.5% in the second quarter of '09 and 10.2% in Q1 2010. Year-over-year increases resulted primarily from higher sales volume and productivity gains.

Slide nine shows highlights from our P&L, most of which we've already discussed. I'll point out that we had a high tax rate, though, of 48.6% in the quarter due to the Leslie bankruptcy filing. Our tax rate would have been 27% without asbestos, and we expect a 27% effective tax rate for the remainder of 2010.

The balance sheet, which you can see on slide 10, continues to be strong. It provides us with the flexibility to complete the Leslie bankruptcy, invest in organic growth, and pursue strategic acquisitions. During the quarter, we generated $11.9 million in free cash flow compared with $17.9 million in Q2 of '09. Our total debt was $5 million versus $12 million at the end of the second quarter of '09, which reduced our debt to equity ratio to 2% from 3%.

Now let me turn the call back to Bill.

Thanks, Fred, and please turn to slide 11. I'll be covering our end markets. Let's start with the international energy projects.

It appears that project activity in the Middle East and Asia for large engineered valve projects may have found a bottom in the first quarter of 2010, since March of this year orders have improved sequentially each month, and our sales and marketing people are hearing from large international construction companies that they are optimistic that activity will increase in the second half of the year. We're still seeing some pricing pressure, but it may be starting to improve slightly as volume in the industry resumes.

Our short cycle business remains strong, driven by a very healthy North American rig activity and we do not see any overstocking by distributors.

Turning to the pipeline markets, global quotation activity is at high levels for new projects and services around the world.

Turning to Aerospace, I recently attended a Farnborough International Air Show where the mood was surprisingly optimistic, at least more optimistic than I had expected, considering that Aerospace may be at or near the bottom of the recession. Large orders were awarded at the show, including those by leasing companies, and we're hopeful that this is a sign the market has bottomed and would begin to improve in late 2010 and into 2011.

The key issue right now in the commercial side of the market is the financial health of many airlines, which are not ready to consistently take delivery of new planes. On the positive side, where passenger travel is up, reaching pre-recession levels in May, and cargo traffic is also up significantly. These trends have contributed to a strengthening commercial aftermarket. The business jet aviation market remains at a low level.

On the military side, demand continues to be steady for us. We expect overall military demand to remain flat for the near-term and are watching for any longer-term changes in defense budget allocations.

Moving to Flow Technologies end markets, HVAC and steam-related markets continued to be weak as a result of soft new construction activity in North America. MRO business is steady as customers opt to repair and upgrade systems instead of making new investments, and we are seeing some growth opportunities in emerging markets around the world.

Turning to the industrial and process markets, the momentum and demand that we saw in Q1 continued throughout the second quarter. Semiconductor sales have been robust, driven by capacity expansion and LED production in Asia. Base industrials are improving, and maintenance and repair orders are steady. We're also seeing continued growth from European equipment export markets.

In the power generation markets, international demand continues to be strong and domestic OEM orders are also picking up as a result of MOR activity. Exports of equipment to emerging markets are healthy. For example, we provide valves on steam turbines that are exported to China. Petrochemical and refining end markets continue to be weak. There is little major project activity right now and we expect a low demand level for the near-term. MRO activity, on the other hand, has stabilized domestically in the European markets.

Turning to our Navy/Maritime business, we expect orders to be steady throughout 2010 and overseas defense projects continue to appear firm.

So, this brings us to our expectations going forward. We are cautiously optimistic as we move forward in the second half of 2010 and are encouraged by positive signs in many of our end markets. In energy, demand in our short cycle business is steady. And while the large international project market is still challenging, we're hopeful that demand is coming up off the bottom and pricing is slowly beginning to improve.

Our Aerospace segment will continue to be soft for the remainder of the year, although we're starting to see some positive trends in the commercial aerospace market and a growing sense of optimism. We expect Flow Technologies semiconductor orders to remain strong, and most other businesses in that segment are stabilizing except petrochemical, refining, and commercial construction.

With that said, please turn to slide 12 and we'll review our guidance for the third quarter of 2010.

We expect revenues for the third quarter of this year in the range of $170 million to $180 million, and earnings, excluding special charges and excluding charges related to Leslie's bankruptcy process, to be in the range of $0.50 to $0.60 per diluted share. Let me point out this is different from the past when asbestos estimates were included in our guidance. And, finally, as Fred noted earlier, this guidance assumes a tax rate of 27%.

Before we go to your questions, I'd like to leave you with a few key thoughts. First, permanently resolving Leslie's asbestos issue will enable us to focus on growth without the costs, the risk, and the distraction of ongoing litigation.

Second, we've been making great strides and great progress in building our emerging market capabilities, particularly in India, where we've built engineering sourcing and the sales organization, and we believe we have opportunities for lower cost sourcing, manufacturing and growth there.

During the quarter, we acquired the Valves division of India-based Mazda Limited, which manufactures severe service control valves and vacuum systems. This acquisition provides us with greater access to the steadily-growing Indian power generation industry, and broadens our product offering with a suite of [spheres] service control valves. The integration of Mazda into our Flow Technologies segment is well underway and proceeding on track.

And finally, we're executing our long-term growth strategy, which includes growing by investing in new products and systems, and through acquisitions; leveraging lean to improve performance and profitability; and expanding our global supply chain and business presence in emerging markets around the world.

So with that, we'd like to take your questions. And, Operator, we'd like to go to questions now.

(Operator Instructions). Charlie Brady, BMO Capital Markets.

With respect to the energy products, the orders there sequentially were up pretty nicely. And I'm wondering, as we go into the back half of this year, particularly given the nature of a good part of that business being short cycle, would you expect the revenues in that segment on a growth rate to track where they were coming in? Or was there anything in particular in the second quarter that maybe bumped it up -- you know, the 30-plus percent sequentially you saw?

Well, I think, Charlie, we actually had a pretty good -- as you -- as we said, we had a good quarter there. From a sequential basis, what we saw primarily was a rebound to some extent sequentially in our large project business. So that was encouraging for us.

You know that's -- a lot of that, though, is going to be built into backlog, so I don't think that -- at this point, as Bill said, we think that market is hopefully stabilizing, but it's tough at this point to see how much that's going to grow significantly beyond.

Yes, a portion of that is probably going to be delayed into backlog for two or three quarters.

Right. But the short cycle business has held up pretty steadily, so.

Have you seen an acceleration as you went through the quarter and even into the first part of Q3, on the short cycle business?

The short cycle business has held up. I think if you went back a quarter, some people are saying they expect it to sort of peak and start to trail off. And it's held up pretty steadily so far. And then the sequential increase has been in the project business.

Thanks. I'll hop back in the queue.

Matt Summerville, KeyBanc.

I just have a couple follow-up questions -- again, just sticking with Energy. Bill, I think you'd mentioned a quarter or two ago that the backlog within Energy had been, from a quality standpoint, I guess, hurt a little bit by some price competitiveness. You mentioned that you might be starting to see pricing ease in terms of the large international projects.

I was hoping maybe you could put some numbers around that in terms of what you were seeing, what you're seeing now. And then, I guess, at what point do we have all of those less-advantageous, we'll call them, kind of deals work their way through the backlog into revenue?

Well, first, let me kind of remind everyone it is a long cycle business that plays out over three quarters -- anywhere from half a year to a full year in lead-time. And last year, we had a very, very competitive price environment where the gross margin and profitability in our backlog came down severely with that competition.

So, I wouldn't say we're out of the woods yet. We're cautiously optimistic we're seeing a little bit of improvement in that pricing environment; but it's probably too early to call it a trend, but it's moving in a better direction that it had been. So I guess -- I mean, Fred could maybe comment on -- the effect last year, we had quoted some numbers on the impact on the backlog and the pricing in the backlog.

Yes, well, we said it's probably -- it had [300 to 600] basis point impact on our business as we went into this. And as Bill said, really, up and through the first quarter, we had not seen any change in that pricing; in the second quarter, we've seen a slight improvement. But, of course, that's again -- it was not going to impact our revenues until the end of this year or (multiple speakers) starting into next year --

Yes, it's really going to be probably the first quarter of next year by the time it works through.

But we did see some slight improvement.

With regards to then how we should think about the back half of the year, if you still kind of have some of this lower-price business working through backlog into revenue, how do we bridge going from 3.5% margins in the first quarter to [8], up to double-digits in the back half? What's going to drive that additional improvement on the margin and energy from here, near-term?

Well, there will be continued improvement and profitability in the short cycle business because, again, the orders have been strong -- were continued strong in the quarter.

We are going to see some improvement in profitability in the project businesses; some volume in PE; our pipeline business, as we anticipate some improvement there and profitability also. So it's really a combination of all of those, plus we'll see the final leg of some of the cost reductions we made at the tail end, the beginning of this year, we'll get the full benefit of those as we get into Q3.

Thank you.

(Operator Instructions). Jamie Sullivan, RBC Capital Markets.

A question on the pricing side, on the short cycle business. I was wondering if you're seeing any improvement there as well?

We've seen a little bit of improvement on some of the projects -- we actually have some projects in the -- not to confuse the world -- we do have some project or bid pricing in the short cycle and we've seen a little improvement there. But the bulk of our business or a lot of it is through the catalog. We've not seen a price increase at this point.

Okay. And then is there any update to your macro view on where rigs are trending and where you think they might shake out for the year?

I think at least -- you know, it is a short cycle business by definition, so it can change pretty quickly; but so far, it's held up really well this year.

Okay. And then moving to the restructuring side, most of the activities are complete at this point -- correct me if I'm wrong. I was just wondering, can you tell us any sense of volume that you're sourcing through low-cost countries today versus, let's say, 12 months ago?

I don't know if you want to take that first -- just let me add a comment on the restructuring completion. The restructuring Fred was just referring to in the Energy business, we still have activities going on in the other groups. So, we'll keep working those.

We consolidated Aerospace plants at the beginning of this year, and we're continuing working to move things to lower-cost sites, so that work will go on. Maybe not as major restructuring, but continue to help on the cost sourcing side.

Yes, the biggest move on the sourcing side across all of our businesses, we're doing that; but the biggest move we made was really during the fourth quarter last year, where we completed almost all of our machining and casting business from -- on the short cycle energy business, it's all to China, which we've been doing over years, but we really finished up the last large leg of that.

So almost all of that production is now in China. That was the biggest move, and that's what you saw some of the benefit coming through in Q2 and we'll finish that off in Q3.

Okay, thanks. And then one last one on the M&A strategy. Just wondering how the pipeline of deals looks there? And is there any trend to how it's weighted in terms of segment or geography?

The activity out in the market seems to feel pretty good. I mean, I've been traveling a lot recently, and at least the people I talk to, the consensus seems to be that activity has improved, increased on the M&A front -- a lot more discussions, more people willing to talk about buying and selling.

From our standpoint, we continue to work it. We're talking to as many people that we can that fit within our strategy. We're taking a very focused approach. So, as we've said before, there's specific areas we like. We like upstream oil and gas and we like certain parts of the Aerospace industry, where we've [built] core competencies, and we like the power gen space in our TFC group as well. So we're working those and there's one or two areas in each group that we're putting our efforts into.

Okay, thanks a lot.

(Operator Instructions). Marty Pollack, NWQ Investment Management.

In page 5, when you describe the post-quarter of costs for Leslie, you mentioned $5 million. I'm just wondering, is that all actively -- is that distributed evenly through to fourth-quarter? Or is that essentially in your guidance, as you go into third-quarter guidance, is that $5 million impact (multiple speakers) [in every] quarter?

Yes. Okay, Marty, this is Fred. Of the -- maybe we weren't quite clear enough. That $5 million, first of all, we think most of that will happen in the third quarter but some will be in the second -- fourth quarter to complete it. And we have neither one -- we do not have that expense in our guidance. So, you'd have to add that expense to our guidance if you wanted to get the two combined.

I see. So effectively, the [50/60] would be assuming we've already gone through the settlement and your future expense will be fairly nominal?

Right.

Okay. Just the other question on the Flow Technologies side, your comments on HVAC -- and I'm just wondering, that particular segment of the market still remaining very weak -- what is that in terms of entire mix for flow? And is there some other exposure you have outside of commercial, not residential there? (multiple speakers) remind me what that is.

Yes, Marty, it is -- we don't have any residential business. It is light construction and steam-related systems, municipal systems, like when steam loops in cities and universities and campuses. So it's -- when we talk about the capital spending part of HVAC and steam, it's that new construction part that's dried up in North America since the downturn.

We have solid business in the spares and parts and MRO portion of that industry, where a hospital may not build a new wing on the hospital because of capital, but they're certainly going to keep their systems up and running. So we do have the aftermarket service business or the parts business, but not the new construction -- dried up two years ago.

It's -- [I don't know if] this is part of your question too, Marty. It's the low teens part of that total segment.

Okay. Thank you.

Charlie Brady, BMO Capital Markets.

With regard to the backlog, I know the Energy products is certainly longer lead-times and it's [mostly in] the project [bids], but for the other two -- the Aerospace and Flow Technologies, can you just remind us -- how much of that do you think you're going to recognize in the balance of the rest of this year? How much flows into 2011?

The portion that -- as I just think qualitatively, the portion that would flow into 2011 would be in our longer-term Aerospace and Maritime defense-related activities around aircraft carriers and airplanes, helicopters. So I don't know, Fred, if --?

But there's -- in the Aerospace group, there's a significant part that's beyond this year. We have a lot of large orders that are beyond this year. So it's about $117 million in the backlog. Of that, there's probably over -- about half of that's probably -- over half of that's outside of this year.

And the Flow Technologies Group, it's much more -- it's much different. Most of the backlog we have in the Flow Group is in this year. The one exception to that is probably the Navy, so there's several million -- maybe even $10 million, $15 million of that would be in follow-on years. And there's a little bit of that in some of the other businesses. But most of it's in the current year.

Great. Thanks. That's helpful. Thank you.

Thank you. At this time, we have no further questions. I'd like to turn the call back over to Bill Higgins for any closing comments.

I'd just like to thank you for your continued support in Circor and we'll see you next time.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.