Circor International Inc (CIR) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to CIRCOR International's fourth quarter and year end 2012 financial results conference call. Today's call will be recorded. (Operator Instructions)

I will now turn the call over to Mr. Dennis Walsh from Sharon Merrill for opening remarks and introductions. Please go ahead, sir.

Thank you and good morning, everyone. On the call today is Wayne Robbins, CIRCOR's Chief Operation Officer and acting Chief Executive Officer, and Fred Burditt, the Company's Chief Financial Officer. The slides we will be referring to today are available on CIRCOR's website at www.circor.com on the webcast and presentation section of the Investor Relations link.

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 Form 10-K for 2012 and other SEC filings. The Company's filings are available on its website at CIRCOR.com. Actual results could differ materially from these anticipated or implied by today's remarks.

Any forward-looking information that only represents the Company's views as of today, February 28, 2013. 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, adjusted EPS and free cash flow. These metrics exclude any pretax special charges, repositioning inventory valuation reserves, intangible impairments, as well as historical asbestos and bankruptcy charges related to the Company's Leslie Controls subsidiary. The reconciliation of CIRCOR's non-GAAP adjusted operating income, adjusted net income, adjusted EPS, and free cash flow 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 Wayne Robbins.

Thank you, Dennis and welcome, everyone. During the call Fred and I will discuss our performance in 2012, and more importantly, outline our plans for the future. Our performance in the fourth quarter and the full year reflects our commitment to drive improved operating results and margin expansion.

Fourth quarter adjustment EPS exceeded our guidance range increasing 17% year-over-year. We also generated strong free cash flow in the quarter bringing our full year free cash flow to $42.4 million. For the year, we grew adjusted EPS by 22%. Results of the past year demonstrate that we are making progress on our margin improvement initiatives.

During Q4 we achieved key milestones regarding the repositioning actions in California, Brazil, and India. We continue to expect these actions, which include consolidating facilities, shifting expenses to lower cost regions, and exiting certain non-strategic product lines will reduce expenses by approximately $7 million on an annualized basis. In addition efficiency, improved product quality, and lower lead times are valuable by-products of these actions.

I will provide more detail on our progress when I discuss our markets and business segments after Fred provides a look at our financials.

Thanks, Wayne. And good morning, everyone. Due to the repositioning actions and the related impact on earnings I want to remind you that we often discuss and measure our performance using adjusted operating income, adjusted margins, adjusted EPS and free cash flow which exclude repositioning-related inventory, impairment and special charges, as well as historical Leslie asbestos and bankruptcy charges. As a note, in our financial statements we record the repositioning-related inventory charges in cost of goods sold.

Please go to slide three. Revenue for the fourth quarter was $201.6 million, down 7% from Q4 of 2011 with no currency impact. Backlog of $447 million was up 12% year-over-year and 1% sequentially from the third quarter.

Adjusted operating income was $15.6 million, up 4% from the fourth quarter of last year and AOI margins expanded to 7.8% compared with 6.9% in 2011.

Net income for the quarter was $9.2 million or $0.53 per diluted share compared with net income of $10.3 million or $0.59 per diluted share last year.

Excluding repositioning charges we exceeded our guidance by delivering adjusted EPS of $0.69 for the quarter, an increase of 17% from the fourth quarter of 2011.

Now, please turn to slide four for our Q4 repositioning related charges associated with the activities in Brazil, California, and India that we announced last quarter. During the quarter we obtained savings of $500,000 from these activities primarily in Brazil. Wayne will discuss some of our accomplishments on these initiatives later.

During Q4 we incurred $3.9 million in repositioning charges which was primarily all cash. The corporate item of $2.7 million which is not part of our repositioning plan represents CEO separation costs.

Now, I will turn to segment performance beginning with energy on slide five. Energy bookings were up 11% year-over-year from orders across nearly all of our businesses. Ending backlog of $211.3 million was up 25% year-over-year, primarily due to higher order levels within our large international project business which typically has long lead times.

Energy revenues of $96.6 million for Q4 decreased 12% year-over-year due to lower volume in our short cycle business from reduced North American rig counts and timing of large international energy and pipeline projects.

The segment's adjusted operating margin was 12.5%, up strongly from 8.4% in the fourth quarter of 2011. This increase was primarily driven by improved pricing, lower expenses, and productivity enhancements in both the large international projects business and in Brazil.

Now, let's move to slide six and the Flow Technologies segment. Year-over-year segment bookings were up 17% with strength across most end markets.

Revenue came in at $69.7 million, down 2% year-over-year with reductions in LED, Europe, and the unfavorable timing of projects partially offset by growth in power, HVAC, oil and gas, and petrochemical.

Gross fourth quarter adjusted operating margins were strong at 13.1% and up from 12.9% last year primarily due to productivity and pricing.

Now, aerospace on slide seven. Bookings were down 12% year-over-year due primarily to lower orders for commercial and military landing gear which are lumpy. We ended the quarter with relatively flat segment backlog compared with the prior year of $159.5 million.

Revenues of $35.3 million were down 2% from the prior year with a 1% negative foreign currency effect. Aerospace margins in Q4 were 3.5% compared with 8.6% in Q4 2011 and 4.2% in Q3 2012.

Margins were negatively impacted by approximately 400 basis points as a result of development and startup expenses on new programs including the A350, A330, and Blackhawk. In addition, the inefficiencies at our Sylmar facility during new program startup, the wind-down of overhaul product line, and repositioning activities impacted margins by an additional negative 550 basis points. The aerospace business is a major focus of our margin improvement initiatives.

We are consolidating two of our California landing gear facilities and exiting some of our non-strategic product lines. As we have discussed on prior calls, during the past few years we have won some large long-term programs for the A350, A330 and Sikorsky Blackhawk. These programs have required substantial investments in engineering, prototyping, and manufacturing readiness, and the costs have significantly impacted our margins.

In addition, the slowdown in military spending due to budget cuts and the wind down of operations in Iraq and Afghanistan has adversely impacted our volume, especially the CH-47 spares business and some other legacy programs. Finally the Sylmar acquisition which has helped us gain some new programs, has been more difficult to integrate than originally expected and dilutive to earnings as we have brought it up to CIRCOR standards.

We are addressing the Sylmar issues with the repositioning project which will generate savings in the range of $3.5 million annually beginning with Q3 this year. This project is on schedule. The large program investment and startup costs will continue through much of 2013 as all three programs are in the preproduction or ramp-up stages.

These important programs with Messier-Bugatti, Sikorsky, and Airbus, all have very long time horizons and our success should lead to further business opportunities with these global aerospace leaders. We expect to see some margin improvement in the second half of the year when the A330 and Blackhawk will be in full production. The A350 is not scheduled for production until late 2014 or 2015 and still requires investment including some anticipated specification changes. The remainder of this segment is performing at approximately 13% operating margin.

Slide eight includes highlights from our consolidated P&L. Corporate, general and administrative expenses for the fourth quarter of 2012 were $6.8 million compared with $6.4 million for the same period in 2011.

Our tax rate in the fourth quarter was significantly affected by the repositioning charges we recorded. If you remove the impact of repositioning our tax rate would have been 20.5% compared with a rate of 16.5% as reported.

The rate was improved over our guidance due primarily to a valuation allowance release for foreign source income, and section 162(m) adjustments. Looking ahead, we anticipate our first quarter tax rate on adjusted earnings to be approximately 36% which is negatively impacted by repositioning charges in Brazil. Excluding these charges, the rate is anticipated to be approximately 31%. For the full year 2013 we expect our tax rate to be approximately 30% and excluding repositioning charges the full year rate is anticipated to be approximately 29%.

Now, turning to slide nine, during the fourth quarter we generated a positive $25.6 million free cash flow compared with $15.2 million in the fourth quarter of 2011 primarily due to improved working capital. Our current cash position and our credit facility continue to provide us with the flexibility to invest in opportunities for organic and acquisition growth.

Now, I will turn the call back to Wayne.

Thank you, Fred. Please turn to slide ten.

Before I discuss what we are seeing in each of our markets, I would like to review our strategy so that you can put it in context with our efforts to grow sales and improve profitability in each of our segments. The core of our strategy is to target opportunities through both organic growth and acquisitions where there is substantial demand for valves and actuation control devices specifically in three large, global markets. Upstream and midstream oil and gas, car generation, and aerospace.

The key tenets of our margin expansion and growth strategy include improving our operational capability with lean and operational excellence to meet customer delivery and quality requirements at competitive prices and margins, establishing an optimum manufacturing footprint through repositioning and expanding supply chain capability to service our global customers and improve margins. Enhancing our sales and marketing capability to further penetrate global markets and attracting and developing talent to more aggressively execute our strategy.

As I walk through each of our three segments you will see how we are executing this strategy. Let's start with energy which comprises about 48% of our business. Regarding our North America short cycle business, recently there appears to be a flat to slightly declining trend in overall rig counts. However, rig counts for oils and liquids are still at good levels.

We are cautious but currently do not expect any major changes from current levels. To minimize the impact of the reduced rig counts we continue to expand our relationships with international distribution outlets, especially in the oil and gas hot spots of the Middle East, Southeast Asia, and Brazil. We continue to see strong quotation activity in large international projects in the first quarter especially as it relates to deep water offshore projects.

Our pipeline business which is primarily driven by capital spending also is experiencing increased activity. We expect this end market to improve with a need for pipeline infrastructure, particularly in the United States and Canada.

Let me give you a brief update on the repositioning actions in the energy segment. Our efforts to improve margins in this segment include shifting non-core manufacturing at our Brazil operations to low cost regions and exiting some non-strategic products.

During Q4 we exited the foundry on schedule and generated $500,000 in savings. We expect these actions will enhance profitability while positioning us to better capitalize on opportunities in Brazil.

Let me move on to the Flow Technologies segment which also derives a significant amount of our revenue from energy-related markets. Flow Technologies accounts for about 35% of our business and serves oil and gas, power generation, and other markets.

I will focus my remarks on the oil and gas and power generation markets. The commentary on our smaller end markets can be found on slide 10. In the oil and gas market we see strength in offshore platforms and expect this market to provide growth opportunities for some time. We are capitalized on a global opportunities in oil and gas as a result of our ability to deliver products with exotic materials and with short lead times.

The long-term outlook for the power generation market is positive and is a key target market for us. We believe there are significant growth opportunities in MRO for both efficiency upgrades and for conversion to natural gas-fired power plants in developed countries. In addition new construction in the emerging markets present CIRCOR with an excellent near and long-term growth potential. We are well positioned to capitalize on these opportunities.

Our repositioning initiatives for the Flow Group are on track. We recently reached a major milestone by opening our new constructed state of the art facility in India. Our new campus in Coimbatore, the result of consolidating three India-based facilities, provides sourcing, manufacturing and engineering services to our global business units.

Finally, let's move to our aerospace segment which makes up about 17% of our overall business and primarily serves the commercial and military aerospace markets. On the commercial side we are seeing continued strong production from OEMs such as Boeing and Airbus. Commercial aftermarket orders are expected to remain soft with continued maintenance deferrals and aircraft cannibalization being major headwinds. On the military side we expect to see continued lower spending globally with defense budgets shrinking and pending government cutbacks. OEM orders for the CH-47 remains at levels similar to 2012.

Aftermarket spare orders continue to be weak. As Fred mentioned our repositioning efforts in California continue to be on track.

Now, moving on to our guidance. Please turn to slide 11. For the first quarter of 2013 we expect revenues to be in the range of $199 million to $206 million. Compared with the prior year, revenues are expected to be lower primarily due to softer short cycle energy volume in line with anticipated reduced rig counts.

During the first quarter we expect to incur pre-tax repositioning-related charges of between $3 million and $3.7 million. Excluding those charges, we anticipated adjusted earnings to be in the range of $0.43 to $0.53 per diluted share.

We expect lower year-over-year profitability in Q1 due primarily to lower energy volume and aerospace margins. This guidance assumes that exchange rates remain at present levels. In summary, we anticipate improved top and bottom line performance over 2012.

We are aggressively executing our strategy with a continued focus on margin expansion including evaluating further repositioning opportunities. We believe that the markets we serve are attractive and provide opportunities for profitable growth both organically and through acquisitions.

So with that let's go to your questions.

Thank you. (Operator Instructions). Our first question comes from line of Charley Brady with BMO Capital Markets. Please proceed with your question. Your line is live.

Good morning, guys. This is Andrew on for Charley Brady.

Hey Andrew, how are you?

Hi.

First on the energy margin I was wondering how much of the improvement is from pricing and performance in Brazil?

The -- well, we had the $500,000 of repositioning savings in Brazil so that was part of it and the -- we don't break apart the total number so that is the biggest number in the quarter for Brazil.

Okay. And for energy orders, what -- how much of the energy orders were -- are large projects and how much are expected to ship in 12 months?

I'm not quite sure -- just to reiterate we -- our projects business does have a backlog typically of 9 to 12 months, or a lead time of 9 to 12 months. So of the orders in the quarter, those that are part of the projects business again will not primarily ship this year. Most of them will be -- being pushed into the following year. Does that answer your question, Andrew?

I was just wondering how much of the orders are large projects.

Well, we don't break it apart, but the -- typically about half of our business is short cycle. About 35% or so of that is the large cycle business. But from -- on a year-over-year basis we had growth in both of those segments.

Okay. And in Flow Technologies on the margin pricing volume and productivity?

I'm sorry, could you elaborate a little bit more on the question?

Yes, just on the Flow Technologies margin improvement, how much is pricing volume and productivity?

It primarily would be productivity on a year-over-year basis. Pricing tends -- we tend to -- are able to offset inflationary pressures with our pricing activity. So the read through is primarily on a productivity basis.

Okay. And there was some -- you mentioned some growth investment in power. We were wondering what the headwind was to that in the quarter and then also if you guys expect further investment and at what level?

Well, the power industry for example in India still remains somewhat slow. But China is continuing a robust investment and we are participating in, and we're also participating much more in the MRO business in North America that continues to be very active.

Okay. And do you guys expect any -- in the aerospace segment, do you guys expect any impact from sequestration on current or potential programs? And have you guys incorporated that type of scenario in your guidance?

Well, we have been reflecting for quite a while as we said in our comments, so we have had pretty weak spares orders and even some weakness in some of our OEM orders for at least a year now because of the wind down in budgets and activities overseas of our military. That has already been hitting us a lot. On the sequestration like everyone else we are still trying to evaluate what that all means but at this point I would say our -- we are anticipating that in 2013 because of the programs we are on we don't think there will be any really huge impact to us. But we don't know, we don't know all of the answers and it may have an impact as we look into 2014.

Okay. And I guess with -- you may have mentioned this on the R&D and production startup costs particularly in 1Q 2013 how much of that -- how much should we expect of the R&D and production startup costs?

Well, at this point, my comments earlier, we expect the new program investments in the first half of -- in the quarter, really Q1, will be in the range of where we have been spending as we -- second half of 2012.

Okay. And do you guys expect any more charges related to the operations in California? And if so, how much?

I think in the -- the total charges in the quarter $3 million to $3.5 million for the quarter. And some of that is in Brazil and some of that is in California.

All right. Okay. Thanks, guys. Appreciate your help.

Okay.

Thank you. (Operator Instructions). Our next question comes from the line of Matt Summerville with KeyBanc Capital Markets. Please proceed with your question, your line is live.

Good morning. A couple of questions. You've talked a little bit about your North America footprint, Brazil, India. What is sort of the game plan with respect to your manufacturing footprint in Europe if anything? Do you see that evolving more towards low cost region manufacturing?

Yes, we have got several activities we are looking at to move -- as we opened up the India facility that provides us some additional opportunities to source some of our products from Europe there.

And then you talked about deliberately exiting certain product lines or businesses. How much revenue is left to come out of CIRCOR's overall top line as it relates to that effort?

It is about -- Matt, take Brazil for example, I think it is around $2 million on an annualized basis. So you will see, we've already started to do that in Q4. So there will be $1.5 million or so during 2013 that will come out. And the overhaul business was also I think a little bit north of that number. So and again that was -- we have wound a lot of that down in Q4 so probably another couple million on the overhaul side.

Okay. And then with respect to California, can we go back and talk -- when you bought that business a couple of years ago, remind me how profitable was it and how -- what happened that sort of got it in the position it's in where it sounds like it is fairly dilutive to the Company and how do you feel about your line of sight now to getting that business up to, say, the 13% average margins you are generating if you remove some of this noise, if we call it that?

Right, right. As you recall we bought that business for a couple of strategic reasons. One is to get much more growth in the landing gear business which has been very successful. The reason we have gotten some of these bigger programs is because of having that -- the capability but also in the overhaul and as we have said, the overhaul is an area that we have strategically after evaluating and having it for awhile have decided that that is probably not the place to invest.

So and we are, as we have talked, we are moving that facility into or combining it into our overall California landing gear so as an independent business unit as of the end of the second quarter it will not --it will -- won't exist and so we are -- but the programs that we were going to put through obviously all landing gear is where we are in these big programs are going to be so long-term we expect to get good returns.

If you look at your energy margins we will call it up 400 basis points year-over-year in the fourth quarter, backing out the charges, can you talk about how much improvement of that how much of the improvement was driven by the long cycle business or the large international projects versus whether you saw expansion or contraction in the short cycle piece?

I would say it is primarily the long cycle business and Brazil. Those are the -- those are the drivers that were -- are changing the margin in Q4.

Is the long cycle business now in a sustainable profit contribute -- is it sustainability contributing to operating profit now?

Yes. Several things happened last year. One, obviously we had better pricing going into the backlog. That is going to be shipped this year. In addition, we have also improved our productivity and production in Pibiviesse last year as well. We do anticipate it will be sustainable and continue to improve.

With respect to aerospace, I don't know if you guys have been, but I have been a little surprised by how much RD&E related expense you continue to incur in that business. I guess -- can you talk about some of the design changes that have been thrown at you, how much of that burden is hitting your P&L versus the customers, whether or not you have recourse back to that sort of lost profit if you will and characterize really, do you have any visibility into your RD&E spend in 2013?

Yes, Matt, we do. I just want to be clear the customer changes are not really the driver of the investment and most of our investment as we said in the past, we are expensing, it is not something we are putting on the balance sheet. And we have got three, as we have talked about, three large programs Blackhawk, the A330 and A350. Timing wise, I think we would have -- two years ago would have thought it would have been more spread out, but all three of them are actually hitting us now and so that I think is contributing to some of the increased spending into the second half of this year and as we go into 2013.

Thank you.

Thank you. Our next question comes from the line of Steve McNeil with Jennison. Please proceed with your question. Your line is live.

Good morning. So one of the things that is very attractive about CIRCOR in my mind is the unutilized, or under-utilized balance sheet. You guys have a fair amount of liquidity. And then I look at -- I'm a little nervous though when I look at what you have done with the California deal and then the Brazil, you guys took some write-offs last year. What lessons have you learned from those transactions so that we are not repeating ourselves sometime in the future with write-offs and everything? Just want to get some comfort around your capital allocation strategy that it is going to create some shareholder value.

Good question Steve. And we would agree with you. You know, I think we need -- we didn't do a good job on a couple of those situations. However, since that time we have completely relooked at our whole acquisition process from ideation all the way through execution. We have put a significant amount of effort in the last 18 months to being sure that the next actual transaction that happens will be done at a very accretive basis and we will get out of it the strategy and the earnings that we want.

So what have you specifically done?

We have had a -- through our CIRCOR business system we did a series of, I don't know, probably around 10 kaizen events over a period of 18 months with a cross functional team across the whole corporation. Also using outside help to make sure we have the right processes in place, evaluation, toll gates so that we are making the right decisions at the right time or deciding not to go forward with transactions so that we feel very confident that our next, as I said, our next acquisition will be very positive and accretive to the corporation.

All right.

Given the changes that you have made behind the scenes, do you feel like the organization is ready for a transaction this year?

Yes. We have got -- we are pursuing a set of acquisition targets. Of course, timing is always difficult but we are better prepared and have identified specific people that would be involved in any kind of due diligence and integration process.

Okay. And then just changing gears for a minute. In terms of the new CEO search, can you just give us a flavor for the type of person you are looking for? What sort of characteristics -- are you looking for somebody who is more of an ops person or somebody who has done a lot of deals for example? Just try and give us a rough flavor for that please, thanks.

I think obviously the Board is the one that is directing that search, but clearly we understand that one of the focuses for CIRCOR going forward is margin expansion as well as take advantage of our cash situation for growth, for acquisitions.

So a little bit of both maybe?

Yes, sir.

Okay. Thanks, guys.

Thanks, Steve.

Thank you. (Operator Instructions). Our next question comes from the line of John Moore with CL King and Associates. Please proceed with your question. Your line is live.

Good morning, guys. Can you hear me all right?

Yes.

A question on the energy division. The rig counts have been flat for the last several quarters so I guess I'm curious what do you think has enabled the energy business to hold up until now? And what is your read on how much inventory is in the channel?

There was a consolidation in Q4 on some of the distributors and they have taken down some of their inventory as a result. We feel that that is pretty much behind us so we anticipate a more normal flow the second half of (technical difficulty)

Okay. So when the rig count does reaccelerate you wouldn't expect there to be any lag in terms of your short cycle energy business and the orders you would receive there?

No, I think some of that inventory positioning has been adjusted to some degree already.

Yes, and we (technical difficulty) there is always distribution, John, so it's always going take some time for us to fill the customer demand.

Okay, great. And just margins in energy. It seems like (technical difficulty)get to your guidance you've got to assume the energy margins decline sequentially in the first quarter. I guess is that -- is that right? And is it (technical difficulty) the short cycle business and do you think the long cycle business can continue to see margin expansion going into the first quarter?

You're correct that there is in our overall guidance for the first quarter there is some drop-off in energy margins on a sequential basis and a lot of that is due to the (technical difficulty) project mix in Q4 and so that has come off a little bit. And then there is again just some weakness in the short cycle business that is driving the change.

Okay. And just lastly, I know you said the tax rate for the year, but can you say it one more time? I think you said 36% third quarter and then 29% for the next three?

Yes, for the year, 29% is the yearly rate without repositioning.

Got it. Thank you.

Thank you. Our next question comes from the line of Matt Summerville with KeyBanc Capital Markets. Please proceed with your question. Your line is live.

Just one follow-up. It sounds like you guys are absolutely moving forward here in the near term with the, sounds like, forthcoming selection of a new CEO. Can you talk about the decision making process that you guys were perhaps part of or the Board used for presumably the intention of the Company is to stay independent how the Board would have arrived or believed to arrive at the correct decision in moving forward in that manner?

Yes. Matt, I can't obviously speak for the Board but I know the Board obviously went through all their due diligence as to why and when the change was made and they are certainly evaluating all the angles as it relates to we would go forward. They have reiterated that we -- our strategy is sound and we are continuing on that path. I think that is beyond that I think that is the Board's responsibility.

Thanks.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Robbins for any closing comments you may have.

All right. Thank you very much. And we look forward to the next conference.

And this concludes our conference call. Thank you for joining us today.