CIRCOR International, Inc. (NYSE:CIR)
Q2 2017 Earnings Conference Call
July 28, 2017 09:00 AM ET
David Calusdian – Sharon Merrill Associates, Inc.
Scott Buckhout – President & CEO
Rajeev Bhalla – CFO
James Picariello – KeyBanc Capital Markets
Charley Brady – SunTrust Robinson Humphrey
Adam Farley – Stifel Nicolaus
Good day ladies and gentlemen. Welcome to CIRCOR International’s Second Quarter Fiscal year 2017 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 prepared remarks.
I’ll now turn the call over to Mr. David Calusdian from Sharon Merrill Associates for opening remarks and introductions. Please go ahead, sir.
Thank you, and good morning, everyone. On the call today is Scott Buckhout, CIRCOR’s President and CEO; and Rajeev Bhalla, 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 & Presentation section of the Investors link.
Please turn to slide two. Today’s discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties, and other factors. For a full discussion of these factors, the company advises you to review CIRCOR’s Form 10-K, 10-Qs, and other SEC filings. 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, July 28, 2017. 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, and free cash flow. These non-GAAP metrics exclude any special charges and recoveries. The reconciliation of CIRCOR’s non-GAAP metrics to the comparable GAAP measures are available in the financial tables of the earnings press release on CIRCOR’s website.
I’ll now turn the call over to Mr. Buckhout.
Thank you, David and good morning, everyone. We closed the second quarter in line with expectations delivering revenue of $151 million and adjusted earnings per share of $0.39. Orders in our energy segment were up 8% organically due in large part to strong demand for Distributed Valves in North America. Including bookings from our Critical Flow Solutions business, which we acquired in Q4 last year, energy orders were up 32%.
In our Advanced Flow Solutions segment, orders were down for the second quarter of 2017 due to a difficult year-over-year comparison. When you look at the first half of the year orders were up 5% organically largely due to the ramp up of our major defense platforms like the Joint Strike Fighter, and the multi-mission maritime aircraft as well as commercial platforms like the A350. Overall, we’re optimistic about the outlook across the majority of our end markets. I’ll provide more context around the expectations [ph] later in the call.
Operationally, we continue to execute on our simplification and operational excellence programs reducing our manufacturing footprint and migrating more production into our low cost manufacturing centers of excellence. Earlier this month, we exited one of our two French factories, consolidated operations into our low cost facility in Morocco and completed the sale of our low margin build-to-print business. With this sale, we’re able to simplify our French business and remove low margin non-strategic product from the portfolio.
In addition, selling the build-to-print product line allowed us to avoid substantial cash restructuring cost. We expect this action will contribute to our margin expansion going forward. The reduction in revenue from the sales is about $2 million in the second half of the year, the improvement in our earnings will be about $1 million in 2017 and $3 million annualized. In addition we continue to ramp-up our new manufacturing facility in Monterrey, Mexico where we are currently producing approximately half of our Distributor Valve part volume.
Our Mexico factory essentially replaces our former manufacturing facility in China, but with lower cost and shorter lead time to supply our North American customers. On the new product development side, I’m pleased to report that CFS launched a new fractionator valve that is used in the refinery’s fluid catalytic converter unit, it has fewer moving parts than the competition and is cheaper to operate and maintain.
We’re already taking orders and expect to begin shipping the product in 2018. This new product comes on the heels of the new delayed coking process isolation valve launched earlier this year. Combined these two new products are off to a strong start with almost $2 million of orders received and $22 million of quotes [ph] outstanding. In addition we continue to make good progress on the CFS integration, both cost synergies and growth initiatives are on track.
With that I’ll turn it over to Rajeev to discuss the second quarter results in more detail.
Thanks, Scott. Let’s review the segment results starting with energy on slide four. Energy sales of $83 million increased 2% year-over-year, driven by shipments from our North American Distributed Valves business as well as contribution from the CFS acquisition. This was substantially offset by lower volumes in our large international project business. As we noted in the last earnings call, we experienced supply chain constraint in our Distributed Valve business.
Although we made significant progress during the second quarter, it did have an impact on shipments, while supply delivery performance has improved we don’t expect all the constraints to be resolved until the end of the third quarter.
Energy segment operating margin was 10.7%, a decrease of 80 basis points year-over-year. The decline was primarily due to lower shipment volumes from our large international projects business, $600,000 for startup cost in our Mexico facility, as well as the adverse impact from foreign exchange. This decrease was partially offset by higher Distributed Valve sales, the CFS acquisition and our continued focus on productivity actions and sourcing saving.
For Advanced Flow Solutions please turn to slide five. Advanced Flow Solutions revenue of $69 million was up 5% year-over-year, primarily driven by our defense businesses and industrial solutions offset in part by decline in our power and process business, foreign currencies had an unfavorable impact in the quarter. Advanced Flow Solutions segment operating margin was 12.5% higher by 20 basis points compared with the prior year. This was primarily due to increased sales combined with a benefit from our margin expansion initiatives.
Turn to slide six for selective P&L items. We recorded a $600,000 net charge for special and restructuring items. Let me give you the components of this net charge. First, we incurred $2.4 million of restructuring charges, mainly severance for reductions in force in our Energy segment. Second, as is customer, we adjust for the non-cash acquisition related amortization expense of $2.6 million.
Third, the net loss on the sale of the French build-to-print business was a $5.3 million special charge. Finally we adjusted the contingent consideration for the CFS acquisition based on the latest fair value assessment, resulting in a gain of $9.7 million. Given the higher debt levels and interest rates incurred approximately $1.6 million of higher interest expense this quarter compared with the prior year, or $0.07 per share. In addition the second quarter results reflect year-over-year FX headwind of approximately $0.07 per share as well.
Turn to our cash flow and debt position on slide seven. We generated approximately $3 million in cash from operations and $300,000 in free cash flow during the second quarter. The lower than normal free cash flow performance was driven primarily by an increase in inventory for our Distributed Valve business as we ramp up supply to meet increased demand. For the full year we continue to expect our free cash flow to exceed net income.
During the quarter we entered into a new five year secured credit agreement that provides for a $400 million revolving line of credit and a $100 million term loan that was fully funded at closing. This new agreement provides for additional flexibility as we pursue our organic and inorganic growth strategies.
This brings us to our guidance for the third quarter. Please turn to slide eight. Overall for Q3 we expect revenue in the range of $150 million to $165 million and adjusted EPS in the range of $0.35 to $0.50 per share. Scott will cover our market expectations in detail in a moment. Overall this guidance assumes sequential improvements in orders and revenue in our Distributed Valves and CFS businesses offset impart by lower revenues in instrumentation and sampling as well as a further softening in our long cycle Engineered Valves business.
The growth in our AFS businesses will be offset impart by loss in revenue from the sales of French business. Regarding special and restructuring charges. For the third quarter of 2017 we anticipate charges to be in the range of $3.3 million to $3.4 million or $0.13 to $0.14 per share. We expect our third quarter adjusted tax rate to be approximately 30%, which is higher than prior quarters due in large part to the shift of income to higher tax jurisdictions such as the U.S.
In addition you may recall that we recorded a $0.10 per share tax benefit in the third quarter last year as a result of the cash repatriation action.
With that, let me turn it back over to Scott.
Thank you, Rajeev. Let me provide you with an overview of the trends in our end markets starting first with Energy. Energy segment orders increased 32% year-over-year in the second quarter due to strong demand in our Distributed Valves business as well as the CFS acquisition. This growth was partially offset by a significant decline in engineered valves and a modest decline in instrumentation and sampling.
In our Distributed Valves business, North American activity remains robust with rig counts continuing to increase through the second quarter. Orders were up over 80% year-over-year as a result of continued strength in the Permian, Eagle Ford and Marcellus plays. Orders moderated a bit sequentially as the level of large stocking orders from distributors in Q1 did not repeat at the same level in Q2.
Our coding activity for midstream applications is up significantly. Additional pipeline companies continue to qualify our product and are optimistic about bookings in the remainder of the year.
In Q3, we expect our overall order intake to be in line with Q2 with a slight improvement in the quick ship orders out of inventory, and a consistent level of stocking orders with longer delivery times.
In the second quarter orders in our long cycle engineered valves project business were down 45% year-over-year. The market remains weak globally with the exception of the Middle East and certain countries in Asia. We are seeing a significant increase in budgetary quotations typical during the early stages of a project that normally result in project orders six to nine months later. We continue to experience intense competition and a difficult pricing environment, which we expect to persist throughout the remainder of this year.
Based on orders in the first half of the year, we now expect that revenues in the back half of the year will be down by more than 60%. We continue to take actions to reduce the cost structure in this business to mitigate the bottom-line.
Within our instrumentation and sampling business the market remains stable, bookings in Q2 came in slightly lower sequentially and year-over-year as some large projects were completed but not replaced. Based on recent coding activity, we expect a moderate order improvement in the second half of the year mostly driven by downstream refining demand for our sampling products and higher MRO order activity globally.
For our CFS business, the technical products have been performing well with strong bookings and healthy order pipeline for both MRO and capital projects. So the valve MRO orders were soft due to an unusually low number of refinery maintenance shutdowns in the spring cycle.
We anticipate an increase in fall of maintenance shutdowns resulting in higher MRO orders in the back half of this year. On the delta valve capital project side the pipeline is open and active quotes remains high so we have seen a number of these projected deferred in to the fourth quarter and next year as refineries manage their capital expenditures.
Turning to Advanced Flow solutions, where we serve the aerospace, power and process and industrial end markets. Our outlook for aerospace and defense remains positive given the growing market and our strong backlog.
Our position on key platforms such as the Joint Strike Fighter and the A350 combined with an increased focus on aftermarket is expected to drive solid revenue growth and margin expansion in the back half of the year.
In our power and process business, we’re seeing an improving outlook in the second half of this year as markets recover in Europe and North America. The majority of demand is currently driven by aftermarket repairs, replacement products, and upgrades as producers’ increased plant productivity and power output from existing infrastructure. Based on coding activity and anticipated award timing, we expect project orders to improve in the second half of this year.
Our Industrial Solutions business serves a number of end markets including the Maritime, industrial gases and HVAC markets. In the second half of the year, we’re expecting modestly higher order (inaudible) both sequentially and year-over-year and due to maritime defense orders and our focus on aftermarket applications across a variety of end markets. In addition, we’re expecting a near-term lift of increased coding activity for our cryogenic Controlled Valves for industrial gas applications. So overall for AFS, we expect the year-over-year revenue growth and margin expansion in the second half of this year.
In summary, we continue to be optimistic about the market outlook across most of our product lines in energy and AFS. We expect robust demand in our Distributed Valves business and an ongoing improvement in supplier delivery. We anticipate moderate improvement in our instrumentation and sampling product line and we’re expecting CFS capital project orders to pick up later this year and early next year.
Engineered valves will be slightly worse than we had originally expected. In AFS, all three product lines are well positioned to grow and expand margins through the remainder of the year. We’re staying the course on our simplification and low cost manufacturing strategy with the expectation that we’ll improve margins and working capital performance going forward.
In conclusion, we remain focused on delivering long-term value for shareholders by investing in growth both organically and through acquisitions, expanding margins, generating strong free cash flow and being disciplined with capital deployment.
With that, Rajiv and I are available to take your questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question today comes from James Picariello of KeyBanc Capital Markets. Please go ahead.
Hey, good morning guys.
Good morning, James.
So just looking at the rig and well count off late. It does seem that there is some leveling off. Just wondering are you seeing any deceleration in terms of growth for the Distributed Valves business at this point?
So I guess the short answer would be yes, we’re seeing it start to flatten out. And we saw a moderation sequentially from Q1 to Q2 in order intake in DV largely driven by fewer stocking orders we had an extraordinary number of stocking orders in Q1 that didn’t repeat in Q2. The short — the very short cycle the book and build that we shipped out of inventory we’re seeing that continue to increase through Q2, but the stocking orders has started to moderate.
So it’s probably safe to assume the distributors have ordered what they think they needed at least through the medium term here and they’re being a little more cautious. So we aren’t seeing as many stocking orders.
Okay, fair enough. And then you mentioned pretty significant coding activity within the midstream portion. Do you have a sense for what the lead times might be on any orders that you do win when that might have?
It does depend on the order. Some of the quotes we’re doing right now are much larger than anything we’ve historically quoted in this segment. We typically would expect to see decisions on these quotes anywhere from two to six months’ timeframe.
Okay. And just the last one from me. Can you just sort of unfold the supply constraint, what went on there what actions are being taken now. And then I think you did provide some clarity by the third quarter you expect full recovery?
Correct. So yes that was probably the biggest constraint we had to driving the top-line in the second quarter. And if you look at where we ended up on the top-line relative to how we guided, clearly the constraint for us in the quarter was the supply chain in our Distributed Valves business. The orders are certain there.
We have a lot of different initiatives in place to manage this. I think I mentioned in the last call we have full time supply chain employees onsite at our top four suppliers. The user supplier based in China they are full time to make sure that we are getting the appropriate priority and the suppliers are shipping our product when they commit to ship it.
In parallel with that, we are qualifying duplicate suppliers for these parts some of these suppliers are making castings and forging so that takes a little bit of time to get the new suppliers up and running, but we do have that initiative on going as well.
So we are managing it as best we can, we are not alone part of the issue is many of our peers are out there fighting for capacity with some of the same suppliers that we’re fighting for capacity with, so it’s a bit of a battle happening right now.
We ended the quarter in a lot better position than we started Q2, so we feel much better about Q3 but we still have constraints it’s still going to we will say suppressed the revenue from what it could be in Q3, but we anticipate by the end of Q3 we will be done with the supply chain constraints in DV.
And let me just to add to that James, recognize that the flip side of the coin internally our factories are performing very well. And so the issue is not capacity issue within our four walls.
Got it, thanks a lot guys.
The next question is from Charley Brady of SunTrust Robinson Humphrey. Please go ahead.
Thanks, good morning guys.
Good morning, Charley.
Can we just dig into kind of margin expectations, given there in parts I mean it sounds like the DV valves is still coming in pretty strong maybe a little bit of moderating but still pretty good and the engineered stuff is obviously a little bit worse than expected and you have got some of this midstream mixed in. So I am just trying to understand your margin outlook picture particularly as it pertains to the Energy business?
Sure, Charley, let me take that. So let’s touch on what happen in Q2 and that I think will help put some color on what our expectations are for Q3 here. Q2 as I look at Energy, the fundamental delta here we were down 80 basis points the largest portion of that is frankly the Mexico startup costs that was about a 70 basis point impact. And if you look at the rest of the businesses our productivity and restructuring actions plus the lift we get from distributed valves and the CFS acquisition really helped offset the decline we see in the rest of the Energy businesses, primarily engineered valves.
So that’s the energy piece. And as I look ahead you are going to see that we do expect margin expansion as we look ahead here because the continued kind of productivity and restructuring benefits as well as the lift from DV is going to help us in the third quarter here and the Distributed Valves as well as some of the other business units will give us some lift here in the quarter.
Given your comment on the startup costs impact from Mexico in Q2 is it fair to assume then that obviously that doesn’t happen again in Q3 that we get a sequential lift in margin on energy in Q3.
It won’t happen to the same extent it’s probably going to be cut in about half in the third quarter, so you should get some lift there, correct.
Okay. And is it done by the end of third quarter or is there still more going into Q4?
It’s pretty done by the end of the third quarter, there might be some a little bit that dribbles into the fourth quarter, but it substantially done by the end of third quarter.
Okay. And just on your commentary on the refinery shut down activity picking up in the second half is that more anecdotal, is it stuff you are hearing from the customer base that’s giving you some confidence of that happening or is it just it hasn’t happen yet so eventually you got shut stuff down and fix it and that’s the expectation. Obvious level I guess what I am really trying to square up.
Yes so it’s what we are hearing from our customers. So we maybe should be careful about saying that that’s a global trend. So our customers we’re working closely with them are expecting have push up shutdowns into the second half. And then I would say we have some confidence in this logic because what you just said the delays can only happen for so long eventually they have to do the maintenance they have to drive the MRO.
The other piece of it Charley that there are if you look at some of the industry trade move, we do track these turnarounds or these shut downs they are also projecting improvement but we are seeing a bigger lift actually in the early part of 2018 if you read some of the trade publications attract this data.
Yes. Can you comment on raw material cost inflation or lack thereof. If you’re seeing any of that impacting the business.
We’re not seeing a lot relative to raw material inflation given the nature of our products Charley. Recognize also that a good portion of our spend is under long-term contracts we manage escalation with that process as well. So it is not a material driver to the numbers.
And Charley, we are able to — in aggregate we normally deliver net productivity on material costs and that’s not different this year. So we are generating productivity in aggregate on material.
[Operator Instructions] Our next question comes from Nathan Jones of Stifel. Please go ahead.
Hi, good morning. This is Adam Farley on for Nathan.
Hey, good morning Adam.
So following up on margins. You guys have done a pretty good job over the last few years, what are some of the major buckets of margin opportunity left and how do you go about attacking those areas?
There are couple of key areas that are important to the margin expansion story. And the key point here is that most of that is largely in our control. So if you put aside market growth and that aspect that helps lift the margins, we have a very focused simplification and operational excellence game plan that includes reducing the manufacturing footprint substantially that includes migrating production hours into a low-cost sourcing centers of excellence, that’s Mexico, India and Morocco.
And also looking at our Serco operating system driving operational efficiencies in throughout the enterprise. So there is good room for improvement for the margin expansion within our control. And I’ll have Scott elaborate a little bit more about that as well.
Couple of other comments. As I just mentioned material productivity is something that we’re pretty good at we drive that every year. So you should expect to see us continue to more than inflation on material and driving net productivity pretty consistently year-after-year. The other part that Rajiv didn’t mentioned that we’re spending a lot of time on its price. We are seeing success in a number of areas right now, net-net if you look at our AFS business in aggregate, we are raising prices versus prior year particularly strong price increases in aerospace and defense.
If you turn to the energy side, we’ve certainly had issues with price on Engineered Valves. But we’re having the opposite we’re driving the opposite on our Distributed Valves business right now. So if you remember our comments from the last quarter in Distributed Valves we mentioned that we were discounting less as appose to changing the price sheet or directly raising prices.
We’re still doing that, we’re still discounting less and we’re also in a very targeted way raising prices where it make sense in Distributed Valves. So there is a price component here going forward, but I certainly agree with what Rajiv said, we still have a long run way here on the structural cost side of Serco.
Okay, Great. And then turning to M&A, this has been a bigger focus for you over the last couple of years including transformational acquisitions. Are there any more development support in this area? And is this still an area of high focus for the company?
So, yes. We are still spending time on M&A. I mentioned in our Investor Day the majority of opportunities that we’re looking at right now are more on the AFS side of the business. So you should expect to see us get a little more diversified overtime. We are open to transformational opportunities. Those are — as you know those kind of rare the ones that make sense are kind of sense, but we are certainly open to that. But I wouldn’t try to predict anything like that happening in the short to medium term.
So yes, the short answer is we’re still spending time on M&A a bias towards the AFS side outside of the business. And we’ll see how things play out. We have quite a number of interesting proprietary relationships right now. And I think it could be just a matter of time before something happens.
Okay. Thank you for taking my questions.
Gentlemen, there are no further questions at this time. This will conclude today’s conference. You may disconnect your lines. Thank you for your participation.
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