CIR (2019 - Q1)

Good day, ladies and gentlemen. Welcome to CIRCOR International's First Quarter Fiscal Year 2019 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. I'll now turn the call over to Mr. David Calusdian from Sharon Merrill for opening remarks and introductions. Please go ahead. David Ca

Thank you, and good morning, everyone. On the call today is; Scott Buckhout, CIRCOR's President and CEO; and Chadi Chahine the company's Chief Financial Officer. The slides we'll be referring to today are available on CIRCOR's website at www.circor.com on the Webcasts & Presentations section of the Investors link. Please turn to slide 2. 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, 10-Qs and other SEC filings. 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, April 26, 2019. 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 refer to; adjusted operating income, adjusted operating margins, adjusted net income, adjusted EPS, free cash flow and organic measures. These non-GAAP metrics exclude certain special charges and recoveries. The reconciliation of CIRCOR's non-GAAP measures to the comparable GAAP measures are available on the financial tables of the earnings press release on CIRCOR's website. I'll now turn the call over to Scott. Please turn to slide 3.

Thank you, Dave and good morning, everyone. We're off to a strong start in 2019 with $270 million of revenue, representing organic growth of 8%. All three businesses grew organically in the quarter. We delivered $280 million of orders in the quarter resulting in a book-to-bill ratio over one. While orders were down from prior year, much of that is attributable to the timing of project awards in our Energy segment, which we expect to rebound in Q2 and Q3. In Industrial, an increase in order volume drove sequential growth in Q1 while year-over-year orders were flat to a very strong Q1 2018. Aerospace & Defense orders were up 50% organically as that segment continues to fire on all cylinders. Adjusted operating margin in Q1 was 7.6% essentially flat with the first quarter of 2018 largely due to mix across product lines. We expect higher margins as we move to 2019 due to volume, price increases, ongoing productivity initiatives and transitions to low-cost manufacturing. The Fluid Handling integration remains on track. Our Industrial leadership team is virtually complete and we made some important changes to our sales force structure and compensation for 2019. Orders remained strong and we're raising prices again this year. We're still on track to deliver $23 million of run rate synergies by the end of 2020. We expect synergy actions in 2019 to deliver an incremental $7 million of savings, which would be $15 million of cumulative savings since 2018. In Q1, we successfully completed the sale of Reliability Services for $85 million in cash an 11 times multiple on 2018 EBITDA. Our low-cost factory in Monterrey Mexico is now the primary source of production for Distributed Valves in North America. During the quarter, we transitioned virtually all production from our Oklahoma City facility. The pace and quality of new product development continues to improve. We remain on track to introduce 35 new products in 2019. One of our latest new products is a pressure reduction system developed for virtual pipeline applications, whereby natural gas is delivered by truck to remote locations in developing countries. Our pressure reduction skids leverage technology used to manage high-pressure gas for submarine applications to quickly decompress extremely high-pressure CNG safely and efficiently. This system illustrates how we're leveraging our technology across businesses to deliver mission-critical differentiated solutions to our customers. We continue to make progress on our delevering plans. In Q1, we reduced our debt by $53 million largely resulting from the sale of Reliability Services. We're evaluating the sale of additional non-core assets to simplify the company, strengthen the portfolio and further delever the balance sheet. Overall, we're feeling good about the remainder of the year. The majority of our end markets are strong, new product launches are gaining traction, price increases are underway and our low-cost manufacturing facilities are ramping up. Now let me turn the call over to Chadi to discuss the first quarter results in more detail, before I review the outlook for our end markets.

Thank you, Scott and good morning, everyone. Let's begin by reviewing our segment results. Starting with Industrial on slide 6. The Industrial segment reported sales of $111 million up 3% organically compared with Q1 2018. It's worth noting that foreign currency headwinds reduced Industrial revenue by 6% in the quarter. Industrial segment operating margin was 9.7%, down 140 basis points from Q1 2018. The decrease was driven mainly by onetime expenses as well as discrete costs linked to the divestiture of non-core assets. We expect revenue to increase sequentially in the second quarter, as we execute on our strong backlog. We also expect to see a return to double-digit operating margin driven by higher revenue, price increases, the continued benefit of synergies and the absence of onetime expenses. Turn to slide 7. Energy sales of $98 million increased 14% organically year-on-year. Growth was primarily driven by increased shipments from higher project booking in Refinery Valves. Adjusted operating margin from continuing businesses was 7.1%, an improvement from prior year. Higher revenue was partially offset by an unfavorable project mix in Refinery Valves and cost associated with ramping up production in Monterrey. We expect ongoing margin pressure in Q2, as we completed the closure of Oklahoma City facility. In the second half of 2019, we expect margins to improve as we ship the high-cost inventory in Distributed Valves further ramp-up Refinery Valves production at our low-cost manufacturing facility in India and benefit from higher volume in H2. Turning to slide 8. Aerospace & Defense had sales of $61 million up 7% organically on strength across both our Defense and Commercial business sectors. Aerospace & Defense operating margin was flat versus prior year at 15.3%. The benefit of volume was offset by unfavorable mix. For Q2, we expect margins to improve sequentially and versus prior year driven by volume, better mix productivity and pricing. We expect revenue to increase through the year as we execute on our strong backlog. In addition, year-over-year margins should continue to expand for the rest of 2019. Turn to slide nine for Q1 selected P&L items. Our adjusted tax rate for the quarter was 15%, driven by foreign tax rate differential and higher R&D tax credits, reflecting a full year rate of 18%. Looking at special items and restructuring charges, we recorded a total pre-tax charge of $12 million. The largest component of this charge continued to be the non-cash acquisition related amortization expense totaling $13 million, a $2 million loss from the January operations of the divested business, a $4 million charge related to other restructuring activities, primarily the closure of our Oklahoma City manufacturing facility which will be complete in Q2. These charges were partially offset by $7 million gain on the sale of Reliability Services. Net interest expense for the quarter was $13.2 million, down slightly on a sequential basis, but up nearly $1.4 million compared with prior year. This is due to higher interest rate partially offset by lower debt balance. Within other income, we recognized pension income and both realized and unrealized FX gains of $1.9 million, a level similar to Q1, 2018. Turn to our debt position on slide 10. As expected, we had negative free cash flow in the quarter of $26 million which is consistent with the seasonally high level of annual disbursements related to our employee bonus program, insurance premiums and professional fees, among other expenses. During the quarter, we spent approximately $4 million on capital expenditures. We expect to invest approximately $20 million to $25 million for the year. We made further strides towards improving our working capital performance. Working capital was 26% of sales in the quarter, 300 basis points better than the same period last year. We continue to see opportunities to improve, particularly by further accelerating inventory turns. In Q1, as Scott noted, we reduced our debt by $53 million. By the end of 2019, we expect to reduce our leverage by one turn, excluding the divestiture of non-core assets. I will now hand the call to Scott to discuss our market outlook.

Thank you, Chadi. Let me give you an overview of our end markets and the drivers that we believe will give us momentum as we move through the balance of 2019. Please turn to slide 11. Let's start with Industrial. We saw a 6% increase in order volume from Q4 to Q1. Year-over-year, orders were largely flat to a strong Q1, 2018 when we saw orders grow 19% on a pro forma organic basis. Demand for both new equipment and aftermarket product remains healthy. Our general industrial markets are favorable across most geographies, with strength in the Americas and Asia, partially offset by spots of weakness in Europe. We continue to see solid demand globally with particular strength in niche, critical service obligations across the general industrial space. In commercial marine, with IMO 2020 on the horizon, we're seeing strong demand for our scrubber pump business. This positive momentum is offsetting the ongoing weakness in new vessel orders. In power, our installed base of control valves continues to generate strong orders for aftermarket spare parts in both Europe and Asia. Pricing actions remains a focus for the business. At mid-year 2018, we raised prices 4% to 5% on approximately half the revenue. By the end of the second quarter this year, we will have increased prices by 2% to 3% on roughly half of the Industrial revenue, generating sequential margin lift through the year. For Industrial overall, we entered the second quarter with the largest backlog in at least two years, driven by strong OEM and aftermarket orders. For Q2, we expect higher orders sequentially and year-over-year as we leverage the breadth of our product portfolio and the strength of our brands to capitalize on high growth sub-segments within our larger end markets. Now let's shift our Energy segment. Overall, organic orders in Q1 were down significantly year-over-year, primarily due to a difficult compare with the timing of project orders in Refinery Valves and stocking orders in Distributed Valves. Refinery Valve orders were down in Q1, driven by timing of large project orders. As we've mentioned in the past, project orders in this business can be lumpy, with order timing difficult to predict. Having said that, the overall outlook for this business remains strong, with high levels of customer activity due to a few primary factors. The IMO 2020 regulatory change continues to drive downstream capital spending for our project. International customer activity is robust and showing signs of strengthening. Market demand is building for our recently launched new products. And finally, we're seeing continued success in building out our installation and aftermarket services business. In Distributed Valves, we saw softness in the U.S. upstream market as rig count and well completions declined in the first quarter. This softness led to a sequential decline in orders in Q1. In Q2, we expect a moderate increase in order levels sequentially as distributors prepare for an increase in Permian takeaway capacity in the second half of 2019. In Engineered Valves, the outlook remains unchanged. The Middle East and Asia remain our most active markets. While we're seeing a moderate increase in quoting activity, the market remains difficult. We do not expect an inflection point in the near-term. We expect orders in Q2 in line with recent run rates. For Energy overall, we expect orders to rebound in Q2 in line organically with prior year. We expect growth in the second half of the year driven by the anticipated increase in global upstream oil and gas investment and high activity levels in Refinery Valves, driven by new products and capital spending related to IMO 2020. Our Aerospace & Defense segment generated another strong quarter of orders which increased 50% organically to $88 million. The growth was driven by large defense orders related to the Joint Strike Fighter, the U.S. Navy DDG 51 class destroyer and the U.K. Dreadnought submarine program. Commercial aerospace orders continued their upward trend in the quarter. Narrow-body build rates of Boeing and Airbus remained strong in Q1, supported by strength in aftermarket spares activity. Boeing's recent decision to reduce 737 production amid the ongoing 737 MAX review will not have a material impact on Aerospace & Defense. We continue to raise prices in A&D, primarily focusing on OEM spot orders and aftermarket demand. For Aerospace & Defense overall, we entered the second quarter with the strongest backlog in at least two years. In Q2, we expect solid order growth year-on-year driven by naval defense orders, continued strength in commercial aerospace and aftermarket demand across the portfolio. The remainder of the year looks strong on both the top and bottom line. Now I'll give the call over to Chadi to discuss guidance.

Thank you, Scott. Turn to slide 12. Overall, we expect second quarter 2019 revenue in the range of $270 million to $280 million and adjusted EPS in the range of $0.40 to $0.48. We expect unfavorable FX impact of $6 million to $8 million compared to Q2 2018. In the quarter, we expect sequential margin expansion, driven by pricing, productivity initiatives and restructuring actions. We expect positive free cash flow beginning in Q2 and for full year 2019. We anticipate free cash flow in the range of $35 million to $50 million. Regarding special and restructuring charges for the second quarter of 2019, we anticipate charges for the following items, acquisition-related amortization expense of $0.49 per share and restructuring and special charges totaling $0.02 to $0.04 per share. We expect the second quarter adjusted tax rate to be approximately 18%. With that, let me turn it back over to Scott.

Thank you, Chadi. We're positive about our outlook for the remainder of 2019 as we expect to realize the benefits from favorable end markets, new product launches, pricing actions, manufacturing in low-cost facilities and integration synergies. We remain committed to driving long-term growth expanding margins, generating strong free cash flow and delevering the company. Now Chadi and I will be happy to take your questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Andy Kaplowitz with Citi. Please proceed with your question.

Hey good morning guys.

Good morning Andy. How are you?

Good. Scott and Chadi, can you give us a little more color on Industrial margin in Q1? How much of the year-over-year decline in margin was onetime expenses and the discrete costs you called out? And it seems, you're getting pricing in the business that you expected, but did you see any more inflation in Q1 that offset that? And ultimately, should Industrial margins go nicely in 2019 overall?

Thank you, Andy. So we've looked at our discrete and onetime costs of around $2 million. These costs are behind us. This had 200 basis point impact on the Industrial segment. And therefore we should see sequentially margin improvement for the rest of the year.

To follow up and get to the other part of your question on the pricing Andy, so we are raising pricing in Industrial right now. By the end of this quarter, we will have raised prices between 2% and 3% on about half the revenue in Industrial. And so you'll see that cutting in back half of the year. Regarding inflation...

Yes. Very helpful.

Okay. Regarding -- you also asked about inflation -- regarding inflation. For the company overall, we are seeing and anticipating net productivity on material, so we won't have net inflation, so some businesses of course will have net inflation. But in aggregate for CIRCOR, we'll have net productivity on material. And then of course we do have wage inflation, but you see some of that being offset with the synergies that we've been driving in Industrial.

Thanks for that Scott. And then just on the Energy orders, we know that you expected them to be down. You talked about sort of the timing issues in Refinery Valves. Can you give us some more color though how much of a difference versus your expectations was that timing in Refinery orders versus the sort of -- I guess it was destocking or tough comparison in Distributed Valves? And has oil prices strengthening here helped in terms of orders either late in the quarter and April as we're moving on here?

Sure. So the timing of orders the -- by far the biggest year-over-year swing in Q1 on orders in Energy was in our Refinery Valves business. So we happen to have a lot of project orders close in Q1. So we had a very strong Q1, 2018 and we had a lot fewer project orders close in Q1 this year. I wouldn't read too much into that to be honest. It's honestly impossible for us to forecast when these projects are going to turn into orders in a three-month window. What I would say is that, the activity levels and the amount of projects that we're quoting and managing right now is still very high. We expect order growth in 2019 versus 2018 in Refinery Valves. It's just hard for us to know exactly which quarter it's going to fall into. Right now, Q2 and Q3 look pretty good for this business, but things move around. So we feel -- still feel very bullish about Refinery Valves and that was more than -- that was about 60% of the year-over-year variance was the Refinery Valves business loan in the closure of project orders. About 25% of the variance -- of the $48 million variance was the Distributed Valves year-over-year and that was largely due to a lack of stocking orders. So we had some sizable stocking orders last year in Q1. This year, there's been I'd say hesitation as we entered the year in North American Distributed Valves in the industry in general. There's been hesitation in some destocking, I would say with our customer base as we enter 2019. We are anticipating it will improve through the year. The much-advertised takeaway capacity issue should start to resolve itself this summer. And we're hearing from our customers that things should to gradually improve through the year. But most of our customers were down here in the first quarter and so we saw the result of that in the stocking levels.

And Scott, I just want to ask you a quick follow-up on the MAX exposure that you sort of mentioned. It was good to hear that you don't expect any impact. Have you lowered production in line with Boeing's, lowering the production? Or is it just too small a percentage of your platform to really matter at this point?

So I -- yeah I wish we had more content on the 37. We don't have enough content that it's going to make much of a difference. We have between $10,000 and $15,000 per plane on this 37 MAX. So, the reduction in the rate that we're talking about here is relatively small for us in terms of top and bottom line impact.

Thanks guys.

Our next question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your question.

Hey! Good morning guys.

Good morning.

Good morning, Jeff.

Thanks. So just -- I don't know if I missed it did you give us a 2Q expectation for Energy revenues?

So, I don't know if we mentioned it in the prepared remarks or not, but as we look at Energy revenues from Q1 to Q2 more or less flat on revenue sequentially.

Okay. And then, just on the margins front for Energy, can just talk about how much the Mexico moves and disruption is costing you still on a quarterly run rate basis? And I think you said margins improve, it starts to improve in the second. Just if you can level set kind of magnitude of improvement from this level you had in 1Q and you'll likely -- looks like you'll see? Thanks.

Thank you, Jeff. This is Chadi. So, we expect in Q2 to see margin headwind in Energy driven primarily by DV as we flush through high-cost inventory. In H2, we should then see sequential improvement in margin, due to increase in volume and lower cost of manufacturing. We estimate the cost of this is around -- between $3 million to $4 million that we should see improvement from lower-cost manufacturing in the latter half of the year.

Maybe I'd say -- simply I'd just add on to that a little bit. The extraordinary cost that we're absorbing per quarter is around what we said in Q4 last year it was around the same in Q1 around $3 million of higher costs in the quarter in Q1. We'll still see some of that headwind here in Q2, something similar in Q2. And then, in the back half you'll see that that will probably have roughly a $4 million improvement based on the lack of extra costs in the P&L. We're also expecting to see a volume improvement in the back half as well in DV.

Okay. Great, so, really the contrast in view of kind of the order declines you see in the last couple of quarters really is a function of the Refinery lumpiness. And maybe some of the Distributed Valves and you got a lot of confidence on the Refinery Valves visibility into 2Q, 3Q?

That's right. We have a lot of confidence. We don't know the exact timing. But yes we have a lot of confidence in order rates for the remainder of this year.

Okay. And then, just back on the discrete item, I think it relates to the divestiture. I just want to understand like what exactly those costs were. And why not exclude those as onetime, if they're true one-timers? Thanks.

Well, it would...

Do you want to take it? So the discrete costs are largely stranded costs that we have in the business that were allocated to this business. So we're essentially taking those costs out. So it's hard to say that it's a special cost. We didn't keep it in special we took it. But we're removing those costs and you won't see them in the remainder of the year. So, we didn't get them out right away. We didn't get them out at the same time we sold the business it takes -- it'll take us a few months.

And Jeff this is Dave Mullen. I'd add. Some of them are shared costs, and we need to deal with that. We've got pretty high bar for what we call special. So, if it's not crisp and clean we try to keep it out of -- or keep it in an operation that was the measure there.

Okay. Thanks guys.

[Operator Instructions] Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Good morning, everyone.

Good morning, Nathan. How are you?

Good thanks. Scott you started talking a little bit there about the plant savings from the move to Monterrey. I did note in the press release that there was talk about moving some of the Industrial stuff to India moving some of the Aerospace to Morocco. Maybe you can give us some more details on, how you see the cost savings progressing in those other segments from move to low-cost facilities?

Sure. So when you say the other segments you mean not Monterrey?

Yeah. I mean not Energy yeah

…which are not Monterrey, yes.

Right.

Right, so the -- so I'll talk about the India piece which is substantial. So this is in our Refinery Valves business. And I'd say lower volume in other parts. But the main volume that we're moving to India now is in Refinery Valves. We -- when you look at the Refinery Valves revenue in total, the savings will be in the say 3% to 5% range of margins over time. So, we will be doing this for the remainder of this year. We'll be ramping up volume in India for the remainder of this year. And the margin impact should be in the 3% to 5% range on the Refinery Valves business.

And when should we start realizing those savings?

We'll start realizing those savings in -- we're ramping up it now Nathan. So we'll start realizing those savings in the Q2, Q3 and Q4. We're ramping up through the rest of this year.

Okay. And the Aerospace stuff to Morocco?

That's also happening in the remainder of this year. So, we've already started that in Q1. And we'll be fully up and running in Q3.

And any quantifications around the saving there?

It's going to be smaller Nathan. These are smaller programs. So, I would not -- it's not going to be -- we're going to continue to spend margins in Aerospace & Defense this is a piece of it. I wouldn't break this out as a special number for you.

Okay. Fair enough. I guess my next question on the Aerospace order rates. They've been extremely good the last few quarters. Can you talk about the sequencing of those? We're yet to see that pickup in the revenue number obviously. Are these like five year blanket order kind of things that'll drip out over time? Or just any help you can give us on how that kind of sequence is coming up?

Sure. The most direct way to answer the question is you'll see high-single-digit growth on revenue for us the remainder of this year in Aerospace & Defense. So the longer answer is a lot of these orders that we're getting are large multi-year orders, particularly on the Defense side. And so you'll see this flush out over the next couple of years. So they tend to be two-year orders up to three-year orders.

Okay. That helps. I’ll pass it on. Thank you.

Okay. Thanks, Nathan.

Our next question is a follow-up question from Andy Kaplowitz with Citi. Please proceed with your question.

Hi, guys. So I just wanted to ask you about the Q2 guidance. In the sense that, again if I use consensus maybe it's slightly low 20% is consensus EPS. My question is do you agree with that seasonally sort of low? And is it really just the sort of Energy cost absorption that you talked about flipping around in the second half of the year? And is there anything else contributing to Q2 maybe being a little bit lower than usual seasonality?

And the question Andy is around the EPS guide for Q2? That's what you're...

Yeah. The midpoint, if I use the $0.44 I think it is.

Okay. Do you want to take that Chadi?

Yes. So I think here Andy, if we look at it and we compare for example versus prior year, we're looking at some headwinds when it comes to the Reliability Services, divestiture. We're seeing that around $0.08 for the quarter. We have also some pension income and FX that's contributing another $0.08. So these $0.16 are a key driver year-on-year when we look at the dynamic of the EPS.

Okay. That's helpful. And then Scott, just on Engineered Valves, you mentioned, it's sort of steady issue goes. I guess there's still pretty tough market. I think last quarter you talked about maybe an inflection in the second half of the year. We are starting to see final investment decisions ramp up again, I think in the EMC space. So are you seeing any of that yet? Or is it still too early to tell?

So, we are seeing an increase in activity. I'm being cautious here in what we project. Trying to project an inflection point is very hard here. So we are seeing an increase in activity. We are seeing what everybody is reading in the press that we're starting to see some more investment, particularly in the Middle East and a little bit in Southeast Asia as well. So I don't see a strong inflection point happening in the next quarter. It could happen in Q3. Maybe Q4 will be more likely if we were going to see a real inflection point for us in this business. So we continue to look at the whole picture here for our DV business. We're looking at leveraging India to address costs. We're looking at ultimate sourcing. We're still looking at further restructuring. So there are a lot of things that we're looking at holistically for this business. But I wouldn't -- I'm not getting excited about what we're seeing as an inflection point in near term yet.

Got it. And then, finally like you had mentioned last quarter, and I think you talked about it again this morning that you still have some non-core sales that you might be looking to divest. I think last quarter in answering to a question you talked about as much 20% of sales. Valuations have obviously gone up again since last quarter's report. So do you look at it as pretty likely that you would sell some non-core businesses this year, and get your leverage down faster than the one turn you've guided to?

I would say that assuming we can get a fair price -- and I agree with your point on valuations. Assuming we can get a fair price for the assets that we consider non-core then yes we will. We would make something happen this year. That's the goal.

Thanks guys.

Okay.

Our next question is a follow-up question from Nathan Jones with Stifel. Please proceed with your question.

Just wanted to maybe help us level set some of the expectations for Energy revenue here. I mean you guys said you're looking at something like flat year-over-year in the second quarter. We've had a couple of quarters in a row here of pretty down heavily organic order rates. Is there an air pocket at some point that investors should be expecting as those reduction in orders that timing in orders runs through the P&L? Is it third quarter, fourth quarter something like that?

I would -- yeah, you're right. Q2 we're expecting to be more or less in line sequentially, maybe slightly down year-over-year. Going into the back half depending on the business that we're talking about, I think you're right. We could some businesses drop-off, but some businesses will increase. So net-net on Energy, I would not project growth in the back half versus prior year, but I don't think you're going to see anything like the magnitude of the order drop that you saw here in the second quarter. I think that's just -- that's lumpiness in our project businesses more than anything else. So you'll probably see revenue fade in the back half, but we do have some businesses like Refinery Valves that we expect to deliver pretty strong growth in the back half.

Okay. And I assume that you would be looking at the DV valve business picking up in the back half as well, probably an anticipation of some stocking orders at distributors there as takeaway capacity in the Permian comes back online or come online, and well completions pickup?

That's correct. So I would -- that's correct. So we expect a moderate increase in revenue through the year in DV. We expect growth in Refinery Valves. Engineered Valves is probably not going to grow in revenue in the back half. Instrumentation and sampling is more likely to be flat.

Okay. Thanks very much.

Okay.

Thank you. We have reached the end of the question-and-answer session, and with that, the conclusion of today's call. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.