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Circor International, Inc. (NYSE:CIR)

Q4 2008 Earnings Call Transcript

February 26, 2009 9:00 am ET

Executives

David Calusdian – Sharon Merrill Associates

Bill Higgins – President and CEO

Fred Burditt – VP, CFO and Treasurer

Analysts

Charlie Brady – BMO Capital Markets

Mike Schneider – Robert W. Baird

Operator

Good day, ladies and gentlemen, and welcome to the Circor International fourth quarter and year-end 2008 financial results conference call. Today’s call will be recorded. At this time, all participants have been placed in a listen-only mode. The floor will be open to questions following the presentation.

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

David Calusdian

Thank you and good morning, everyone. Welcome to Circor International’s fourth quarter and year-end 2008 conference call. On the call today is Bill Higgins, the company’s Chairman and CEO; and Fred Burditt, the company’s CFO. Slides we’ll be referring to today are available on Circor’s website at www.circor.com under the link Quarterly Earnings on the Investors page.

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 2007 Form 10-K and other SEC filings, including its most recent 10-Q. 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, February 26, 2009. While Circor may choose to update these forward-looking statements at a later date, the company specifically disclaims any duty to do so.

I will now turn the call over to Bill Higgins, CEO for Circor.

Bill Higgins

Thanks, David, and good morning everyone. During today’s call, I’ll start by providing you our financial highlights for the year and the quarter. Fred will then take you through our slide presentation to offer additional details on the numbers, and then I’ll discuss our segment performance and provide you with our perspective on what we see in our end-markets, and we’ll then go to questions.

Let me begin with a few comments on our full-year performance. 2008 was a great year in many respects. Revenue increased 19% to a record $794 million over the year 2007, driven by growth across our businesses. For the full year, adjusted operating income, which is operating income excluding special and asbestos charges, grew 63% to $109 million. This equates to a 370 basis point year-over-year increase in adjusted operating margins.

In addition, we ended the year with a strong balance sheet with 4% total debt to equity and $82 million in available cash, cash equivalents, and short-term investments, as well as $110 million available through our line of credit. Also important, we benefited from our continuous improvement programs and aggressive efforts to improve Circor’s teams, our processes, and our performance through our customers.

For the fourth quarter, we ended the year on a strong note, executing well. Adjusted operating margin for the fourth quarter grew 210 basis points to 12.9% on a 16% increase in sales compared to the fourth quarter of 2007. Adjusted EPS before special charges came in at $1.12, exceeding the high end of our guidance range.

Orders at year-end reflected the global slowdown. The company received orders totaling $143.1 million during the fourth quarter of 2008 and is down 16% from Q4 of ’07. 4% of the drop is due to the backlog revaluation from currency changes. Our backlog at the end of the fourth quarter was $342.7 million, down 12% compared to the fourth quarter of 2007, and down 15% sequentially from the third quarter of 2008. This reduction is the result of the worldwide economic slowdown primarily in the energy, HVAC, and industrial process markets. I’ll provide more detail on our markets later in the call.

So, with that, I’ll now turn the presentation over to Fred.

Fred Burditt

Thanks, Bill. I will be referring to our presentation slides, starting with slide number three, financial results, which shows consolidated results for Circor. As Bill discussed, we ended an excellent year with strong fourth quarter performance.

For the quarter, consolidated revenues increased 16%; 21% organic and 1% from acquisitions, partially eroded by a negative 6% currency impact. Organically by segment, instrumentation and thermal fluid controls grew 9% and energy grew 35% in the fourth quarter versus last year.

In our discussions today, we will be referring to adjusted operating income and adjusted operating margins. These metrics exclude pretax charges associated with open asbestos claims, affecting our company’s Leslie Controls subsidiaries. These metrics also exclude special charges, which for the fourth quarter included pretax noncash goodwill and intangible impairment charge of $141.3 million. This noncash charge was required by Statement of Financial Accounting Standards number 142, primarily as a result of the recent macro factors impacting global credit markets, as well as the slower industrial business conditions. This impairment represents about 81% of our total goodwill and as related to the instrumentation and thermal fluid control segment. Goodwill related to the energy segment was not impaired.

I’d like to emphasize that these non-cash impairment charges do not require any cash payments, nor do they impact our operations, liquidity, or compliance with debt covenants. There is a reconciliation of our adjusted non-GAAP operating income and net income to the comparable GAAP measures available in the financial tables within our earnings press release and available on our Web site.

Consolidated adjusted operating income grew 38% to $26.1 million for the fourth quarter of 2007. Instrumentation and thermal fluids came in within 11.2% adjusted operating margins, down from 12.8% last year. Energy had a dramatic improvement to 20.1%, compared to 15.3% last year. Adjusted earnings per share was $1.12 for the quarter, up 100% from $0.56 reported last year, but down from $1.16 in the third quarter 2008. Please note that the adjusted earnings per share excludes after-tax impact of special charges, but includes asbestos charges.

Free cash flow for the fourth quarter was down $7.8 million year-over-year, as strong earnings improvement was offset primarily by growth in accounts receivable associated with a 16% revenue growth. Full year free cash flow was strong at $47.3 million versus $42.5 million for 2007. The full-year improvement resulted from the increase in growth and the profitability of our operations, partially offset by an increase in working capital needs and higher capital spending, primarily supporting our strategic initiatives and new products.

I will now turn to slide four, net income and EPS, which reviews the P&L in more detail. And since we will discuss the segment operating income later, I will add color on the other categories.

First, asbestos charges. During the fourth quarter, our expense for asbestos related to settlements and defense costs net of insurance was $1.4 million, compared to the fourth quarter of 2007 of $3.6 million. In the fourth quarter of 2007, we began to accrue for open claims, which resulted in a 2007 fourth quarter charge of $2.6 million. I encourage you to read our most recent SEC Forms 10-K and 10-Q for further information related to our Leslie asbestos litigation.

We have special charges of $141.3 million for the fourth quarter, which was the goodwill impairment charge that I discussed earlier. Corporate expenses increased slightly by $0.6 million due primarily to relocation-related expenses. Net interest was lower in the fourth quarter 2008 by approximately $0.3 million, primarily because we paid down a good portion of our revolving credit facility since the fourth quarter of last year. Total debt was $13.2 million December 31, 2008, compared to $22.1 million December 31, 2007. In addition, interest income was up as a result of higher cash, cash equivalents and investments.

Other non-operating income for Q4 2008 is up $0.5 million due primarily to foreign exchange impacts. Regarding income tax, the effective tax rate was 44.9% for the full-year 2008, compared to 31.1% for the same period last year. However, excluding the goodwill and intangible impairment charge, the 2008 effective tax rate would have been 30.3%.

Turning to cash flow in slide five, cash flow from operations and free cash flow, as mentioned earlier, was down $7.9 million in the fourth quarter versus prior year. As strong earnings improvement was offset primarily by growth in accounts receivable associated with our revenue growth. However, on a full-year basis, free cash flow was up $4.8 million or 11%. This is a result of an increase in net income partially consumed by an increase in working capital to support revenue growth. And finally, capital expenditures have increased year-over-year by $3.1 million, supporting multiple areas including investments to support new products and lean flow.

And now, Bill will speak to the segment performance in our markets.

Bill Higgins

Thanks, Fred. Please turn to slide six and I’ll review our instrumentation and thermal fluid control segment results. Overall, this segment performed well for the full-year 2008, driven by strength in aerospace as well as the process flow in refining end-markets. In 2008, revenues were up 10% and orders increased 11.3%. There was limited FX effect for the full-year in this segment.

Looking at the quarter, instrumentation and thermal fluid control segment revenues increased 3%, driven primarily by growth in the aerospace and instrumentation businesses. In the fourth quarter of 2008, FX negatively affected this segment’s revenue by approximately 7%, primarily as a result of the U.S. dollar appreciating against the Euro and the British pound.

Fourth quarter orders grew up 2%, 9% excluding currency over the last year with gains in aerospace, offsetting lower orders in thermal fluids and instrumentation. The segment’s backlog ended the fourth quarter at $169.8 million or 24% year-over-year growth. The segment’s adjusted operating margin for the fourth quarter was 11.2% compared with 12.8% in the fourth quarter of last year.

As a reminder, adjusted operating margin removes the impact of asbestos and special charges. And this decrease in the quarter within adjusted operating margin was primarily due to inflation of materials and wages, and by extent, is including acquisition activities, facility consolidation, and inventory adjustments. This is partially offset by favorable volume, price and productivity.

Now, moving to slide seven, where I’ll review our energy product segment. For the full-year, orders were down 17.5% due to a combination of capacity constraints mid year, some softening towards the end of the year in project markets, as well as a drop-off in short cycle North American business beginning in the fourth quarter. As expected, the downturn in the short-cycle business is a result of reduced rig counts and lower oil and gas prices. Full-year revenues were up 29% for 2007, including a 6% positive FX effect driven primarily by growth market segments.

For the fourth quarter, the energy segment orders declined 37.5%, compared with the same quarter in 2007, and declined 23% compared with the third quarter of 2008. This sequential decline is the result of softening in both projects and short-cycle areas, although coding activities in the Middle East have continued at a fairly healthy level and we have booked some new projects in early 2009.

In the fourth quarter, energy segment revenues came in at $107.5 million, up 29% including the negative 5% FX impact. The 35% increase in organic revenue is driven by all areas, including large international projects, standard products sold through distribution, and fabricated systems in North America. Backlog at the end of the fourth quarter was $172.9 million, down 32% from the end of the prior year.

The segment’s operating margin hit 20.1% during Q4 2008, compared with 15.3% for Q4 2007. Margins benefited from a very favorable mix of large international oil and gas projects and increased unit volume, and partially offset by material cost inflation and unfavorable currency effects from China sourcing due to renminbi appreciation. Full-year operating margins were 20.2%, compared with 15.4% in 2007.

Now, let’s turn to slide number eight, which reviews our end-market assumptions. Let’s start with our largest end-markets in energy, which are the large projects who work on in the Middle East.

We are still seeing decent coding activity in the Middle East, however, with the delay or postponement of the release of orders. Thus from an order perspective, we do not have very good visibility. Large projects still seem to exist, but there have been delays, as I mentioned in the release of the orders, and in some cases, pressure on price improve [ph] re-quoting as engineering construction companies want to take advantage of decreasing cost and available capacity. This will likely put pressure on margins for future projects that do get released.

On our third quarter call, we mentioned that with lower gas prices and production outsourcing demand, we expected to see a downturn in our end-markets in North America in the short-cycle business first. Since that time, we have in fact seen a significant drop off in orders as a result of declining rig counts and lower oil and gas prices. Rig counts are down approximately 30% from a year earlier. While it’s difficult to estimate, we expect in the short-term that orders will be down by more than this level as inventory clears and until supply and demand are back in sync.

Moving to our aerospace business, which is generally positive, a little more than half of our aerospace business is military and defense, which looks solid for 2009. We ended the year with a strong backlog on the military side, including a follow-on contract for the Boeing Chinook CH-47 helicopter program that we announced on last quarter’s call. We also have good spares activity on military platforms in the aftermarket.

Looking at commercial OEM aerospace, we see the Boeing and Airbus build rates remaining on track for most of 2009 with a possible slowdown later in the year. The commercial aftermarket business of spares and repairs is significantly down in this environment, but it does not constitute a significant portion of our aerospace activity. Business aviation has dropped off recently and we expect that the economy will continue to be a drag on small jet business in 2009. However, the commercial helicopter market appears to be relatively strong.

Going forward, we expect that new products and the tuck-in acquisitions, such as those we have made during the past few years, will help us gain market share in aerospace in Europe and in the U.S., even in this difficult economy. For example, we are very pleased with our Motor Tech acquisition in Dayton, Ohio, which is added to our electronic systems capability.

Next, turning to the HVAC and steam-related markets, we continue to see building-related project delays in North America with a slowdown in commercial construction. However, this has been partially offset with growth in Latin America and Asia, which new markets for us where as we expand globally. We expect to continue to see maintenance and repair business from our installed base. And while capital projects may be delayed, our customers will continue to maintain efficient operation of their existing heating systems.

In general and industrial markets, we have seen a slowdown in North America and in Europe, although there are new growth opportunities in emerging economies in Latin America and Asia. While it's a small part of our business, we have also seen a significant slowdown in semiconductor capital spending.

In power generation markets, we have seen some projects delayed, such as in the U.K., where the economy has slowed significantly. On the other hand, we continue to see relatively strong demand for power generation projects in Asia. Similar to our general and industrial market customers, we also have a steady maintenance and repair business in power generation since up time and efficient operation of a power plant is critical.

Looking at chemical and refining, we expect weakness in the industrial gas industry due to a major gas company cutting back on plant projects in 2009. At the same time, we see compressed natural gas market as a growth niche opportunity going forward, although the rate of growth is slowing with the general economic weakness around the globe.

Our maritime business looks steady in the near term as a result of the new business that we won for the U.S. in international naval programs as well as continuing U.S. and U.K. Navy repair and replacement business. Our process end markets are largely driven by capital spending and maintenance and we are expecting that new project activity will slow down quite a bit due to the general economic downturn.

We had already seen some softness in North America in the third quarter and that has continued. European process markets began to decline in late Q4 and German exporters of industrial equipment that used our products also suffered a decline due to the drop in global capital investment. On a positive note, we expect to continue to see maintenance, repairs, and replacement business in our installed base.

So now, with that as background, let me discuss our outlook for Q1. We are providing guidance only for the first quarter of 2009 based on what we believe today. These are unprecedented economic times however, and visibility is limited and market conditions are changing rapidly. As we discussed in our news release, we currently expect revenues for the first quarter of 2009 in the range $170 million to $176 million, and earnings excluding special charges to be in the range of $0.56 to $0.68 per diluted share.

So now, let me talk a little about how we are better prepared for the down cycle than we have ever been in our history. We entered the year with a very strong balance sheet and certainly being nearly debt free with a substantial under-used credit facility enabled us to compete from a position of strength. The term cash is king has never been more true. Therefore, we can and we will continue to invest in lean productivity initiatives, global growth, new product development, and acquisitions that add to our capability and provide enhanced value to our shareholders.

The great progress we have made in building a strong management team and our culture of continuous improvement will enable us to emerge from this recession a much stronger company. Our lean efforts have made us faster and more efficient company and able to adapt quickly to changes in our markets. Every business in Circor has been improving during the past few years and our results demonstrate that. This is because of our commitment to develop people, improve business processes, and we continue to drive a relentless focus on lean and continuous improvement.

Going forward, we have a plan. In fact, each of our business units has developed a multi-tiered contingency plan with detailed actions and timelines based on potential sales volume levels. We are closely monitoring orders, backlogs, customer activity, in order to take action as needed to adjust our operations and cost structure in line with anticipated customer demand.

We’ve already begun to implement reductions in workforce at those sites where we see future reduced demand. We expect the workforce reduction to amount to approximately 10% by the end of the quarter. In addition, we have cut down on spending. We have frozen merit increases across the company beginning with the executive team.

As I mentioned, we have a plan. It was developed with leadership across Circor and communicated company-wide, so that each and every employee understands our objectives during these challenging times. Specifically, the plan has three goals. First, to maintain a high quality of earnings; second, to protect cash flow; and third, to emerge from this recession much stronger than our competitors.

I’d like to emphasize that we will continue to invest in critical strategic initiatives that we believe will enhance our productivity and make us more competitive. For example, we are investing in our global supply chain in India, China, and other low-cost countries to improve our cost structure and expand our global market reach.

And I’ll leave you with what I believe is our most important area of focus right now and that is maintaining great communications and increasing connectivity with our customers. We believe this customer connectivity, our talented leadership, and a passion for lean by which we’ve demonstrated significant improvements across Circor, will enable us to emerge from the current economic down-cycle as a stronger company.

So, with that, Fred and I will take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is coming from Charlie Brady with BMO Capital Markets. Please state your question.

Charlie Brady – BMO Capital Markets

Hey, thanks. With respect to the backlog, can you give us a sense of how far out each of the segments had to stretch? I mean, are we stretching out full-year of ’09? And then, I guess, if you can give us a sense of – within that backlog, particularly on energy, the mix of that business, have you seen a change with some of that mix as you go into ’09 and what that might do to margins?

Bill Higgins

Well, let me point out on the backlog that we have, due to the makeup of the various businesses we have across Circor, we have a mix of what I think of as short-cycle, medium-cycle, and long-cycle backlog elements. So, if I focus on energy, that applies as well to the segments. From a standpoint of the large projects, which are longer-cycle orders and backlog, we have a pretty good run at the first half and going into the third quarter of this year. In the shorter-cycle business or the gas – let me try the medium-cycle business, which might be the fabricated business we manufacture in North America, we also have a pretty good backlog going into the first half of this year. The shorter-cycle business, by definition, within a quarter is all the visibility we have. That applies as well to some of the other business units where, for example, in our navy business as well as in our aerospace applications, we have backlog that goes at least through the first half of 2009.

Charlie Brady – BMO Capital Markets

Can you give us a sense of how much of that backlog is the longer business, long or medium-term backlog?

Bill Higgins

Most of it is the longer-term backlog. We have a percentage breakout, but it’s – by definition, the short-cycle backlog turns over very quickly.

Charlie Brady – BMO Capital Markets

Okay. In terms of mix that’s in there, in terms of the specific product, has there been any meaningful mix that might impact the margin now? The margins in Q4 and Q3 were pretty stellar, and I guess I’m trying to look at sustainability aside from just absorption issues, just on a mix issue, what that margin impact might be.

Bill Higgins

We did ship a number of project-related valves and other equipment to very high-profit mix projects in the second half of the year of 2008, and we don’t expect that necessarily to continue in 2009. The mix will probably shift to a more normal mix that we’ve seen in prior years for the project business.

Charlie Brady – BMO Capital Markets

Thanks. I’ll get back in queue.

Operator

(Operator instructions) Our next question is coming from Mike Schneider with Robert W. Baird. Please state your question.

Mike Schneider – Robert W. Baird

Good morning, guys.

Bill Higgins

Good morning, Mike.

Mike Schneider – Robert W. Baird

I’m just trying to really determine, like the previous caller, just where we end up in energy for the year. I'm looking back kind of at your historical book-to-bill ratios, your historical backlog bills and drawdown, and I’m just – I know this is a crystal ball you don’t have or anybody has, but if we assume the energy markets in large-project activity remain at the current rate, I think you got a backlog of $172 million. You did $331 million in orders in 2008. And it strikes me, if you cut it a couple of different ways, either matching your backlog plus some orders as your revenue for this year or matching total orders of $330 million to revenue this year, your energy revenue is going to be plus or minus in the $300 million range, down from the $408 million you did this year. Is that the right way to think about it or are there other moving parts that we should bear in mind?

Bill Higgins

I think the difficulty, as you mentioned, is making the assumptions that the current rates hold. We’ve had a lot of discussion, we’ve talked to a lot of customers, we’ve had teams in the Middle East, and there is quite a bit of quotation activity out there. It’s very difficult for us to determine what that will translate into as we get into the second and third quarter. We do have the ability if we book quotes in the first and second quarter, the capacity and the throughput to convert those quotes in the second half of the year. So, it’s a real wildcard right now.

Mike Schneider – Robert W. Baird

So, what is your utilization rate in the Italian plant right now for large ball valves?

Fred Burditt

Well, it’s still fairly high because we entered the year with pretty strong backlogs from the first half.

Mike Schneider – Robert W. Baird

Okay. And to the pricing question again, you mentioned you’ve got re-quoting going on within the backlog. What type of deflation rates are you seeing on existing backlog?

Bill Higgins

It’s not within the backlog, it’s new quotes. So, these are quotes that are out for bid today, which would fill in the second half of year and go into 2010.

Mike Schneider – Robert W. Baird

Okay. But I did not hear you correctly, Bill, did you mention it was re-quoting going on?

Bill Higgins

Yes, re-quoting or quoting? This would be activity that we’ve had out there that has not been released orders, that has been quoted a second time.

Mike Schneider – Robert W. Baird

Okay. Well, same question. If you take quote A versus quote A1, what type of deflation are you seeing in the quoting?

Bill Higgins

I don’t have any answer to that question, Mike.

Mike Schneider – Robert W. Baird

Are we talking 3% or 30%?

Fred Burditt

Definitely more towards the former.

Bill Higgins

But it would be speculation at this point.

Mike Schneider – Robert W. Baird

Okay. When you mentioned there is project delays, we’ve heard that across the energy space, have you seen specific cancellations within your backlog that would’ve flowed through this quarter?

Bill Higgins

It’s in more delays. We have not in the – even in the gas pipeline markets, we haven’t seen it in our specific applications.

Mike Schneider – Robert W. Baird

Okay. And then, just in the HVAC space, I’m curious about the comment that made your building and commercial construction to slow down. I guess I didn’t appreciate that steam projects or steam products are being used in many of these new commercial towers. I had thought your business at Leslie and expense [ph] on these companies where it's primarily aftermarket for the existing municipal heating systems.

Bill Higgins

Most of it is. The lion share of it is, what I call, the install base model. But when you think about the capital spending that’s gone on in university campuses in the last ten years or hospitals or other buildings where they’ve added on wings or new buildings onto the steam loop system, we would have sold products into those buildings. So, there’s a project element of it that was pretty robust up until about the middle of last year.

Mike Schneider – Robert W. Baird

Okay.

Bill Higgins

But that would be on top of, I don’t know, 60%, 70% base business.

Mike Schneider – Robert W. Baird

Okay. Thank you. I’ll get back in line.

Operator

Gentlemen, there are no further questions at this time. I’d like to turn the conference back over to management for any closing or additional remarks.

Bill Higgins

Thank you, everybody. We appreciate your support and interest in Circor, and we look forward to speaking with you on our next call, which is scheduled for April 30. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect at this time. Thank you again for joining us and have a wonderful day.

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