CIRCOR International, Inc.
Q1 2018 Earnings Call Transcript

Published: 2 May 2018

[Operator:]

Good day, ladies and gentlemen and welcome to CIRCOR International's First Quarter Fiscal Year 2018 Financial Results Conference Call. Today's call will be recorded. At this time, all participants have been placed in a listen-only mode. There'll be an opportunity for questions and comments after the prepared remarks. I'll now like to turn the conference over to Mr. David Calusdian from Sharon Merrill for opening remarks and introductions. Please go ahead.

[David C. Calusdian:]

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 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. 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, May 2, 2018. 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, organic measures and pro forma amounts. 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. Please turn to slide 3.

[Scott A. Buckhout:]

Thank you, David. Good morning everyone and thank you for joining us. The CIRCOR team got off to a strong start in the first quarter as the momentum we saw across many of our end markets at the end of 2017 continued in the first quarter. We reported adjusted EPS of $0.40 on revenue of approximately $276 million, both slightly better than we expected as we entered the quarter. We booked over $325 million of orders representing a book-to-bill ratio of almost 1.2. This is the first quarter under our new segment reporting structure and the first full quarter including the acquisition of Colfax's Fluid Handling business which we completed in December of last year. Our three reporting segments are aligned with our primary end markets, Industrial, Energy, and Aerospace & Defense. Industrial orders of $137 million were up 19% on a pro forma organic basis. Order strength in Industrial was largely driven by general industry globally and commercial marine markets in Europe. We saw strong year-over-year orders in both new equipment and aftermarket parts. Energy orders were up 2% on a pro forma organic basis reflecting growth in refinery valves and engineered valves. Orders were up 30% overall due to the contribution from Reliability Services, a business we acquired as part of the Fluid Handling acquisition. In Aerospace & Defense, orders were down 11% on a pro forma organic basis due to a difficult compare to last year when we recorded large orders for the Joint Strike Fighter and the Multi-Mission Maritime Aircraft programs. Overall Aerospace & Defense orders increased 6% year-on-year with the addition of the defense pumps business that was part of Fluid Handling. Rajeev will discuss our segment financial performance in a moment. But, first let me touch on the key operating and strategic highlights since our last call. Although we've owned the Fluid Handling business for less than five months, we're excited about the potential of this business and the progress on integration. The acquisition positions us as one of the world's leading suppliers of diversified flow control products in a $6 billion market. It significantly enhances our overall scale and ability to deliver severe service flow control solutions across a complementary set of end markets. It provides us with a more balanced mix of valves, pumps and other motion controlled products and services, significant sourcing, manufacturing and engineering synergies, access to highly differentiated severe service technology products, and robust new equipment and aftermarket growth opportunities supported by a large and growing installed base. With respect to synergies, we're confident in our ability to realize our committed cost synergies of $23 million by year four. We also expect this transaction to be cash EPS accretive for the year. The integration of Fluid Handling is on track, the end market aligned organization structure is already surfacing growth synergies across the portfolio. We've operationally integrated the Fluid Handling businesses into CIRCOR; the organization structure now reflects our philosophy of clear accountability with consistent metrics and processes largely in place. We're making good progress on the sourcing in G&A synergy actions. We've largely exited the transition services agreement with Colfax. And we haven't had any meaningful business disruptions as a result of the integration; order intake has been strong. For CIRCOR overall we continue to make progress on our margin expansion and simplification program having largely completed the three restructuring programs we announced on our last call. The restructuring of our engineered valves business in Italy is complete, the reduction in force in our German industrial business is on track, and the rationalization of our Reliability Services network will be completed this quarter. As you may recall, these actions will cost approximately $11 million in aggregate and are expected to generate annual run rate savings of approximately $8 million. We expect to realize $5 million of these savings in 2018, primarily in the second half of the year. I'm pleased to announce that we received a top performer award from Airbus as part of their Supply Chain and Quality Improvement Program. Airbus grants this prestigious award to only four suppliers each year. We're proud of our Aerospace team in Corona, California for their dedication and commitment to high quality products and top notch customer service. I'm also pleased to report that the American Petroleum Institute has granted API certification to our new Monterrey, Mexico facility. This significantly expands the breadth of product we can manufacture in Mexico and will support the continued growth of our distributed valves business. We recently inaugurated the expansion of our manufacturing facility in India. We're ramping up production for our DeltaValve and TapcoEnpro product lines for customers globally. We expect to realize significant cost savings from sourcing and manufacturing these products in India. Before I review our end market outlook, let me turn it over to Rajeev to discuss the first quarter results in more detail.

[Rajeev Bhalla:]

Thanks, Scott. As a reminder, given the organizational realignment, we've provided the revised quarterly income statement segment data on both historical and pro forma basis which includes combined information reflecting the Fluid Handling acquisition as though it occurred on January 1, 2016. This information is available in our SEC filings and in the tables attached to our press release. In addition, we adopted the new pension accounting standard at the beginning of the quarter. This standard requires the reclassification of certain components of pension cost between operating expense and other income or expense. As a result, service costs remain in the operating results, while the remaining components are reflected in other income. This change had an adverse impact on our Q1 adjusted operating margins of 60 basis points on a consolidated basis. From a segment perspective, the impact is primarily in the Industrial Grou; there is no impact to earnings per share. With that backdrop, let's review the segment results starting with Industrial on slide 5. The Industrial segment had sales of $117 million reflecting the addition of the European and North American pump businesses acquired last year. The European pump business saw a significant increase in demand especially for the commercial marine market offset in part by lower deliveries to North American pump customers. On a pro forma organic basis, sales in the segment were down 5% versus prior year, reflecting lower demand from the power generation market combined with fewer shipments to the U.S. Navy out of the North American valves business. Industrial segment operating margin of 11.1% was strong in North America and EMEA pumps benefiting from carry-over restructuring savings from last year. This was partly offset by the impact of lower volume in the European valves business. For the second quarter, we expect moderate margin expansion sequentially as the benefit from our restructuring and synergy actions are realized. Turn to slide 6, Energy sales of $100 million, increased 7% on a pro forma organic basis reflecting growth in short cycle distributed valves up 30% as well as in refinery valves up about 15%. Engineered valves as well as instrumentation and sampling were down slightly. With the inclusion of reliability services, sales were up 31% overall. Energy segment operating margin was 5.7%, a decrease of 270 basis points year-over-year. The Reliability Services business was dilutive to the Energy segment results due to its breakeven performance in the quarter. In addition, we experienced a lower drop through on the distributed valve sales as we ramped up production in Oklahoma City and Monterrey. Our Oklahoma City facility struggled with increasing head count and productivity in a difficult labor market. Engineered valves delivered a smaller loss in the quarter sequentially. Refinery valves delivered stronger margins in the quarter. Instrumentation and sampling margins were in line with prior year. For the second quarter, we expect margin expansion sequentially from restructuring savings as well as a benefit of higher volume in our distributed valves and refinery valves product lines. Turning to slide 7. Aerospace & Defense had sales of $59 million, up approximately 8% on a pro forma organic basis. Revenue from our U.S. government defense business increased significantly in the quarter, primarily for Missile and UAV launcher programs. Including the pump defense business, sales were up 41% year-over-year. Aerospace & Defense operating margins of 15.3% were up 620 basis points from prior year. Higher volumes, operational improvement and price increases contributed to the margin expansion. The pump defense business was accretive to the Aerospace & Defense margins. We expect margins to moderate in the second quarter based on the expected sales mix. Turn to slide 8 for selected P&L items. Regarding income taxes, the adjusted rate for the quarter was 18%, lower than our forecast due to a discrete item relating to a resolution in the quarter of a previously uncertain tax position. We continue to expect the full year effective rate to be 23%. Looking at special items and restructuring charges, we recorded a total pre-tax charge of $33 million, or $1.28 per share. The largest component of this charge relates to non-cash acquisition related amortization expense totaling $20 million including inventory step up of $7 million. Going forward, we will not have any further charges of the step up of inventory. For the three restructuring programs, we recorded $9 million of charges primarily for severance. The remainder of the charges relate to separation costs for the Fluid Handling transaction as well as other simplification actions. Interest expense for the quarter was $11.8 million, or $0.48 per share, up over $10 million compared to the prior year due to higher debt balances as a result of the Fluid Handling acquisition. Turn to our debt position on slide 9. During the quarter, we spent approximately $8 million on capital expenditures. This unusually high spend in the quarter was driven by a number of upgrade projects in the Fluid Handling businesses that were in process when we acquired them. It does not reflect the run rate on CapEx for the year. For the full year, we expect CapEx to be approximately $25 million. In addition to the seasonally high level of disbursements in the first quarter, we incurred a number of large disbursements for advisor fees, severance costs and health care funding. We expect to improve cash flow through the remainder of the year including better working capital performance. On our last call, I noted that we were evaluating options to fix the interest rate for a portion of our debt. In April, we completed a four-year interest rate swap agreement that fixes the interest rate of $400 million of our term debt at 6.15%. As a result, we now expect the full year interest expense to be in the range of $51 million to $53 million up about $2 million from our prior guidance. For the second quarter, we expect interest expense in the range of $13 million to $14 million. Moving to guidance on slide 10, overall, we expect second quarter 2018 revenue in the range of $275 million to $285 million and adjusted EPS in the range of $0.44 to $0.54 per share. We continue to expect to see revenue and earnings increase sequentially with integration costs decreasing in the back half of this year. Regarding special and restructuring charges for the second quarter of 2018, we anticipate charges for the following items. Acquisition related amortization expense of $0.51 to $0.53 per share and special and restructuring charges totaling $0.12 to $0.18 per share. Regarding our second quarter tax rate, we expect the adjusted tax rate to be approximately 23%. Now let me turn it back over to Scott.

[Scott A. Buckhout:]

Thank you, Rajeev. Let me give you an overview of our end markets and the drivers that we believe will give us momentum as we move through Q2 and the balance of 2018. Please turn to slide 11. In the Industrial segment order momentum is healthy across most regions and lines of business. Book-to-bill in the quarter was almost 1.2 and pro forma organic orders grew 19%. In the first quarter, we saw a significant increase in orders for pumps in the general industrial and commercial marine sectors. The increase in orders from the general industrial sector in Europe and North America was largely driven by heavy machinery OEMs selling into the construction, oil & gas and mining industries. As a result of higher new ship building activity in the back half of last year, we saw an increase in orders for the commercial marine market as well. For the second quarter, we expect orders overall to be in line with the first quarter driven by continued order growth for the general industrial market. Durable goods orders in the PMI indices remain positive. Pumps going into the oil & gas sector are expected to be up sequentially as well. However, we expect orders from the commercial marine sector to moderate sequentially. In addition, we raised prices in our pump businesses globally affecting about one half of the revenue. The effective date was May 1st. I'm also excited to announce that we recently launched two new all-weather products in our Industrial group. The OptiFix progressing cavity pump is designed for faster and easier maintenance that enables customers to avoid costly downtime, reducing maintenance times by up to 85%. Our biggest market for the OptiFix is in wastewater pumping applications. Our all-marine specialty centrifugal pumps are used in marine applications from water cooling to firefighting. In the first quarter, we introduced two new all marine products that have a 23% smaller footprint than comparable pumps. The compact size is ideal for offshore vessels where space is critical. Our product is also 40% lighter which is significant in terms of fuel savings and ease of installation. Now let me shift to our Energy segment. The refinery valves product line consisting of DeltaValve and TapcoEnpro brands provides both capital projects and aftermarket parts and services. In the first quarter, we more than doubled our orders over the prior year. This follows a strong Q4 as well. Capital projects and MRO orders were up significantly both year-over-year and sequentially. After a sustained period of maintenance deferrals by the refineries, we're now seeing an increase in capital spending and MRO investment. Refineries are placing orders and firming up quotes we've have previously provided. Over the last two quarters, we've maintained our historically strong win rate. As you know this business can be lumpy and project timing can be difficult to predict. Having said that, crack spreads are favorable for refiners, and the level of activity in the market is high, process licensors and EPCs are busy with pre-engineering work as well as project management. We expect solid order intake as the remainder of the year unfolds. Looking at distributed valves, the North American market continues to be strong. Rig count, well completions and production remain high. As expected, orders in Q1 were lower than Q4 in large part due to the pull-in effect of our January 1st price increase. We expect Q2 bookings to be in line with the past couple of quarters after adjusting for the Q4 pull-in. From an operational standpoint, we're increasing the output and efficiency of our distributed valves facilities in Oklahoma City and Monterey. In addition with the API certification in place, we expect to double production in Monterey in Q2 versus Q1. In instrumentation and sampling, orders in the first quarter were in line with Q4 sequentially, but lower than prior year due to a difficult comparison. We booked a number of larger projects in Q1 last year. As we look forward to Q2, we're seeing moderate improvements in quoting activities for smaller projects especially in MRO. Most of the upstream activities fittings and valves concentrated in Europe and North America, while the downstream market for our sampling products has strengthened globally. Overall we expect slow, but steady orders improvement as we move through Q2 and the rest of the year. As mentioned on the last call, we successfully launched the GYROLOK XP product line effectively increasing the pressure capability of our severe service fittings. On the heels of that launch, we recently introduced the HOKE close coupled monoflange valve. This product offers enhanced valve technology that significantly improves the long-term reliability of high pressure measuring instruments. In addition, it provides for a simpler and safer installation that meets our customers' most demanding specifications. Turning to engineered valves, orders were up sequentially and year-over-year largely due to bookings related to the Johan Castberg FPSO project in the North Sea. Overall, the market remains challenging and pricing pressure is intense but we continue to see a gradual increase in the number of quote requests. These requests follow the increase in project commitments we saw in 2017, especially for offshore FPSOs and Middle East projects. For the second quarter, we expect order levels to be generally consistent sequentially and we expect our order intake to further improve in the second half of the year. Our Aerospace & Defense segment executed well in the first quarter and we expect order strength to continue as we move into Q2. Given the lumpy nature of orders in this segment we saw an 11% decrease in orders on a pro forma combined basis, driven in large part by the Q1 2017 order for the Joint Strike Fighter program. That order for 2018 is now expected in Q4. In our defense business, increased production on international and domestic fighter jet and submarine programs along with a number of missile programs continue to drive higher bookings. On the commercial front, order growth is being driven by increasing build rates for single-aisle aircraft, the growth of the A350 platform and an active MRO pipeline. In addition, we're raising prices across the business as appropriate. To summarize, we continue to see solid order momentum across most of our businesses and we're optimistic as we look ahead to Q2 and the second half of the year. Overall, we remain committed to driving long-term growth, generating strong free cash flow and de-levering the company by reducing debt and expanding margins. Now Rajeev and I will be happy to take your questions.

[Operator:]

Thank you. We'll now be conducting a question-and-answer session. Our first question today is coming from Jeff Hammond from KeyBanc. Your line is now live.

[Patricia Gorman:]

Hey. This is Trish Gorman on for Jeff Hammond. Can you guys talk a little bit more about the key issues impacting Energy margins and help us understand the gating factors for improvement as well as timing around when we can expect to see that come through in the results?

[Scott A. Buckhout:]

Sure. This is Scott. Good morning, Trish. How are you? Let's start – we'll start with the Energy margins in Q1, and then I'll talk a little bit about the outlook and how we see this playing out in Q2. There were really three primary situations that pushed Energy margins down in the quarter. The first was in our distributed valve's business, as we've been ramping up that business to meet higher and higher levels of demand. We've run into some situations that have cost us on the margin side. The first in Q1 is we had three days of shutdown where we had no production in Oklahoma due to weather in the first quarter which of course affects our volume and margins. We also have been struggling with ramping up labor, bringing in labor and efficiently ramping up in a productive way in this business. It's a tight labor market in Oklahoma City as you can imagine with the whole industry booming right now, we've been having trouble getting qualified labor and getting them trained and getting them up and running. We've – the second, I guess looking forward in this business, we've changed the shift structure, we've changed the way we hire and the type of people we're bringing into the business in Oklahoma City and we're seeing a lot more stability in April versus what we saw in Q1. The second part of this is Mexico. We are ramping up Mexico and that's working very well. You should expect to see Mexico's output double between Q1 and Q2. So, we expect that the margin hit that we took in distributed valves and Energy in the first quarter will largely – well the majority of that will be resolved as we go into the second quarter. To quantify it, we took about a 200 basis point hit at the Energy level for the inefficiencies I just talked about in distributed valves. The second issue we had in Energy was in engineered valves. We had a loss in the engineered valve business in the quarter. As you might know from previous calls, we restructured that business in the first quarter. We completed the restructuring in the first quarter. That hit us for about 100 basis points in Q1. We expect that to – we expect that to improve going into Q2. We still anticipate a much smaller loss, but – we still anticipate a loss, but a much smaller loss in Q2. And then the third piece would be Reliability Services, the new business that we acquired as part of the Fluid Handling acquisition. This business is a service business. It tends to be lumpy in the first quarter it was breakeven. We're forecasting a profitable second quarter on higher revenue. So the total hit for these three issues was about 400 basis points in Q1. We think the majority of that goes away in Q2, but not necessarily all of it.

[Patricia Gorman:]

Just a follow-up there...

[Scott A. Buckhout:]

Anything to add, Rajeev?

[Patricia Gorman:]

Sorry. What's a reasonable margin run rate that we should be thinking about going into second half in 2019?

[Rajeev Bhalla:]

Yeah, we should be getting into the high-single digits, Trish, this is Rajeev. As we look into the back of this year and then well above double digits as we look beyond that.

[Patricia Gorman:]

Okay, great. And then just one final question, any early thoughts on Fluid Handling and how that integration is going? Any upside or downsides surprises?

[Scott A. Buckhout:]

Sure, I'll take that, and then, Rajeev, you can jump in. The – so, yeah, I'll start with the upside or the positives. We're delighted with a number of things that we've found. I'd say the first is we are seeing more cost opportunities than we expected. I would not necessarily categorize them as synergies in that they're there because of CIRCOR, but cost opportunities that we see that was unnecessary costs that we think we can get at over the coming months here. The second opportunity that we're finding is pricing. We are – we just raised prices in this business globally. We've learned that really not much – almost nothing has been done with price since 2014 across this business. Effective May 1st, we've raised prices globally. And so we're looking forward to seeing how that plays out. And then the third is orders are coming out a bit stronger than we expected, when we closed the deal particularly in the commercial marine side. We did not expect to see some of the strength that we saw in Q1. On the opposite end of the spectrum, we did inherit some operational issues that we're working on. We have a higher than expected past-due backlog in a number of the facilities in Fluid Handling that we're in the process of working on and burning down. And then I guess last I'd say we've probably forced more turnover than we initially expected faster in the integration, then I would have said we would expect it. So we've got some open positions that are, some critical open positions that we're in the process of working through. We've filled a lot of the critical roles working with CIRCOR employees, but we still have some open positions that we're working on.

[Patricia Gorman:]

Thanks, guys.

[Scott A. Buckhout:]

Thank you.

[Rajeev Bhalla:]

Thanks, Trish.

[Operator:]

Thank you. Our next question today is coming from Charlie Brady from SunTrust Robinson Humphrey. Please proceed with your question.

[Patrick Wu:]

Good morning, guys. This is actually Patrick Wu standing in for Charlie. Thanks for taking my question.

[Rajeev Bhalla:]

Hey good morning Patrick.

[Scott A. Buckhout:]

Hi, Patrick.

[Patrick Wu:]

Scott, pushing on the break down in the earlier question about energy inefficiencies in the quarter, it sounds like came in about 400 bps from all those inefficiencies, and then when you look – when you pair that with energy margins being down 270 bps for the quarter, and as I recall, there were some pricing that was put into place I think particularly in engineered valves at the end of last year. Can you talk a little bit about the pricing for the quarter in Energy and are you guys seeing good traction there?

[Scott A. Buckhout:]

Yes. I can talk about pricing. So let me talk about pricing, and Rajeev, if you want to add something jump in. So within Energy, if you think about the five product lines including Reliability Services, we've recently raised prices in two of them. So in engineered valves, we haven't raised prices as you know that's still a struggling market and we're competing for every project we can get. In distributed valves, we raised prices 5% effective January 1. We expect that that is going to stick. Now you're not seeing the impact of that yet because we're still shipping through Q1, we're shipping backlog. So we had an acceleration of orders in Q4 that you might remember all of that's at the old pricing and we're shipping that backlog. So you don't see the impact of that 5% yet, but that 5% was across the board in distributed valves. The other product line where we've been raising prices is instrumentation and sampling. We had a price increase that went into effect in October of last year. We're getting good traction on that increase, that's an annual increase that we do every year. And then we do more targeted surgical increases through the year in instrumentation and sampling as well. In refinery valves and Reliability Services, we haven't raised prices in the last 12 months.

[Rajeev Bhalla:]

A lot of those are project based jobs and like engineered valves, Patrick, so it's a little difficult to just do a blanket price increase.

[Patrick Wu:]

Okay, that's helpful. And just want to switch gears to A&D. I understand the orders were you know facing a pretty tough comp from the defense side. I want to give you guys a chance it sounds like the commercial side is pretty strong. I wanted to give you guys a chance to talk a little more about sort of order growth and the order intake on the commercial side specifically you know maybe any additional color there would be helpful?

[Rajeev Bhalla:]

Yes, Patrick. Let me give you some color there. So, on the defense side as you mentioned it's a tough compare. If you recall last year, we got the Joint Strike Fighter and two lots of the Multi-Mission Maritime Aircraft in the first quarter of 2017. So this year we don't get any MMA orders and the Joint Strike Fighter order has been pushed out of Q4. Those are two large orders that are creating a bit of a difficult compare, but with that said, good order intake for a lot of the missile programs, a lot of the UAV launches side as well. On the Commercial side, the build rates are up from the single-aisle where there's the A320 program, with the Boeing 737, the build rates are going up as you recall A320s were up to about 56 aircraft a month by Airbus. The Boeing 737's a little over 52 aircraft a month. So we're seeing good growth there. And the other piece to keep in mind is that with respect to the defense just to mention, one of the programs that we don't generally talk a lot about is the tanker program the 767, where we have good content on that, and you've got about 25 aircraft a year that are coming out of that program as well.

[Scott A. Buckhout:]

And then last I would just add that we have a good sized Navy business now particularly with the addition of the Fluid Handling defense business and increased budgets have been approved, increased build rates on carriers and submarines are leading to expected growth here in 2018 and 2019 on order intake. So we feel pretty good about that piece of the business as well.

[Rajeev Bhalla:]

And let me just add one last thing that just came to mind here with respect to the commercial business, a lot of that fluid controls and actuation that we ship out of our Corona business in California those orders were actually up close to 20% in the quarter. So, it's being overwhelmed a little bit by the tough compare, but the commercial piece is up nicely.

[Patrick Wu:]

Okay. That's helpful. And I guess I just want to be clear then, it looks like the projects that sort of – that you guys are not seeing, come through in the first quarter are being pushed to the fourth. But netting those out for the entire year, defense orders should be fairly positive year-over-year then?

[Rajeev Bhalla:]

Agreed.

[Scott A. Buckhout:]

Correct.

[Patrick Wu:]

Okay. That's all I have. Thank you.

[Rajeev Bhalla:]

Great. Thanks.

[Operator:]

Thank you .Our next question is coming from John Franzreb from Sidoti & Company. Your line is now live.

[John E. Franzreb:]

Good morning, guys.

[Rajeev Bhalla:]

Good morning, John.

[Scott A. Buckhout:]

Good morning, John.

[John E. Franzreb:]

On the Industrial side of the business, can you just talk a little bit about the disconnect in pump sales in North America versus Europe? You mentioned something about the marine market, is that the case, can you just provide a little bit more color that would be helpful?

[Rajeev Bhalla:]

John, are you asking on orders or sales?

[John E. Franzreb:]

On shipments.

[Rajeev Bhalla:]

Shipments. Yeah, so we did see some good growth in pumps in Europe and Asia as well. Some of that related to the commercial marine market that we talked about in our prepared remarks with respect to the shipbuilding activity that took place in the back half of 2017 that's helping us here. With respect to the North America, part of that is just some of the shipments getting out the door, our past-due backlog is actually up a notch, with respect to some of the North American pumps and that's what's driving a little bit of the delta there as well. But from market standpoint it's still a good healthy market.

[John E. Franzreb:]

Okay. Is there any particular market that you – that the shipments aren't going out the door in North America Rajeev?

[Rajeev Bhalla:]

The power market is a little softer.

[John E. Franzreb:]

Okay. And you're going to get that back in the second quarter?

[Scott A. Buckhout:]

You'll see sequentially, you'll see the shipments in the Americas for pumps will grow meaningfully.

[Rajeev Bhalla:]

Correct.

[John E. Franzreb:]

Perfect. Okay. And I just want to get your sense on the Energy side of the business, I guess two things. Scott, it sounds like you're more positive on the engineered valve side, even though you've taken about a slight loss in the quarter. Are you willing to say we've reached the bottom here given some of the audit trends that you're seeing and the quotation activity? And secondly on the distributed valve side, you said that you're ramping up production what are your thoughts about your customers' inventory levels, how close you think you are to equilibrium or you think the audit trends are going to be pretty strong for the balance of the year?

[Scott A. Buckhout:]

So, okay. I'll start with EV. So I was actually in the Middle East a few weeks ago meeting with a lot of our customers. And so I got a decent amount of color from them on how they're feeling as well. I think when you say we reached the bottom, I put it in my personal opinion is that we have. We are seeing more activity now than we were seeing a quarter ago or even the quarter before that. Our customers are telling us that they intend to – they're finalizing projects, they're sending us RFQ's, things are – the wheels are starting to turn again in the Middle East in a more meaningful way than what we've seen in the past. So the orders that we saw in Q1 are off of a very low base but we're a lot better than what we saw in Q4 and Q3 of last year. We're expecting similar order intake here in Q2 and then we expect it to get meaningfully better in the back half. Now what does that mean for revenue? We're probably not going to see significant revenue in this business until late in the year and in 2019. I think 2019 is a much better year in engineered valves than 2018 will be. But to directly answer your question I do think we're bottom tier. We bottomed in Q4 last year, Q1 this year and I think it starts getting better from here. The – with respect to distributed valves, we believe that we're at a point where the customers are not – are no longer building up inventory in a meaningful way. So, we believe that the order intake that we saw in Q4 and Q1 if you kind of correct for the price increase in the Poland, that's about the run rate that we expect in Q2 and with maybe some modest growth in the back half. But we don't see any inflection point up or down in this market. Our customers are telling us that they are focused on disciplined profitable cash flow positive growth and managing that. So as you know there's some bottlenecks in the industry in North America that are being managed that are going to probably keep somewhat of a lid on it, so we won't see a big inflection. But the order run rate that we're seeing today we expect it to grow modestly through the year.

[John E. Franzreb:]

Perfect.

[Rajeev Bhalla:]

And John let me just add a little bit of color to Scott's comments. With respect to engineered valves, one of the key metrics that we look at in the business tracks are those projects that complete the final investment decision, the FID milestone that then are really in shape to kind of go forward. In 2017, there was a significant number of projects that completed that milestone including for some offshore FPSO type of project, so that's positive.

[Scott A. Buckhout:]

And I think 2017 was double of 2016 actually.

[Rajeev Bhalla:]

Right. And then the second piece on distributed valves with respect to the customer inventory, we are – it's a good balance. And so as the stocking orders get filled and sold, we are seeing that kind of that cycle continue as well.

[John E. Franzreb:]

Excellent color both of you. Two other quick questions. In regards to the P&L, I was just wondering if there are any absorbed integration cost that you didn't call out in the quarter, anything related to consulting costs anything that might have impact the margins. And also, could you elaborate more on the other income item, what's FX, what's the pension part, can you break that out a little bit for us? Thank you.

[Rajeev Bhalla:]

Sure. Sure absolutely, John. With respect to integration costs, just to clarify, we look at the costs associated with the Fluid Handling acquisition in two categories. Those costs that are separation related, where I'm paying for example the transition services agreement to Colfax. And those are segregated and adjusted out of operating income. The other bucket of costs, are integration related that as you suggest, we might hire a consultant to help us with a particular project. And those remain as an operating expense in our numbers here. That was to the tune of close to $1 million in Q1. We would expect a similar run rate in Q2 and then it will diminish in Q3 and Q4.

[John E. Franzreb:]

Great.

[Rajeev Bhalla:]

With respect to the other income, the question you had, the bulk of what you see on our base of our income statement is pension related. As we mentioned in the prepared remarks, we move a chunk of the pension components, other than service costs down below the line, so that is all pension income. And the reason it is income this year versus what you might have seen in the prior years is twofold. One is most of the pension numbers now relate to the Fluid Handling businesses we acquired. And when you do the acquisition you do kind of a clean sheet fresh accounting start. So all of the old actuarial losses get wiped out and the return on planned assets ends up being income for us, as we look ahead.

[John E. Franzreb:]

Perfect. Thank you very much, Rajeev.

[Rajeev Bhalla:]

You're welcome, John.

[Operator:]

Thank you. Our next question today is coming from Nathan Jones from Stifel. Your line is now live.

[Nathan Hardie Jones:]

Good morning, everyone.

[Rajeev Bhalla:]

Good morning, Nathan.

[Scott A. Buckhout:]

Good morning, Nathan.

[Nathan Hardie Jones:]

Not much to talk about today. There's not very much going on.

[Rajeev Bhalla:]

A lot of moving pieces.

[Nathan Hardie Jones:]

I would like to talk a little bit about the Critical Flow business here to start with. It under performed by quite a wide margin in 2017 your expectations. When you purchased that business you talked about doubling orders in the first quarter. Refineries placing orders. Certainly the demand picture looks a bit better here. Does this bounce back in at the start of 2018 start to get this business towards where you expected it to be in the first place, are we still operating below that level, or just any thoughts you have around that business?

[Scott A. Buckhout:]

So – yeah. I'll take that, and you can jump in, Rajeev. So you're right underperformed in 2017 in the sense that the order intake is something that wasn't there last year. The orders that we're seeing now are in Q1 are slightly better than where we expected it to be when we put together the investment thesis, if you will. The – so is it going to hold? We hope it holds where it is. We know it's going to be strong through the remainder of the year. But if I look at what's happening right now, I'd say we're seeing order intake that's better than what we originally expected when we bought the company.

[Rajeev Bhalla:]

So...

[Nathan Hardie Jones:]

Okay.

[Rajeev Bhalla:]

And just to add a little bit color to that, Nathan, we're seeing good bookings on the DeltaValve capital fees, which is I think if you recall the place where we had the largest amount of kind of stress with respect to orders being pushed out and these orders are in the U.S. as well. Marathon, the Garyville refinery we have a big project out of Turkey in Tüpraş. So there are some good projects there as well as the aftermarket on the TapcoEnpro. Our estimate today with respect to 2017 versus 2018 will be much stronger, high double-digit digits maybe even mid-teens. But do we get back to 2014 top levels? We don't think so at this point, but we could be surprised on the upside.

[Nathan Hardie Jones:]

And you guys also noted that that was one of the business where you've yet to raise prices. Those are some pretty large pieces of steel that you're putting in there. So, I'm sure you're dealing with some steel and raw material cost inflation here? Are there plans to raise businesses to raise prices here? Have you reduced the cost of these products? How are you protecting margins in that business?

[Scott A. Buckhout:]

Okay. So there's a couple of ways – a couple components to the answer here. So the – this is – there's a project and an aftermarket piece of this business, and in the project business we price every project, we have to get the maximum price that we can get. And if you break the business into a couple of pieces, the DeltaValve project piece we don't have a lot of competition. It's not fiercely competitive, is what I should say, some of our products are unique, very unique in some cases. So we have a decent amount of pricing power, and we're very happy with the margins that we get in that piece of the business. When you look at the aftermarket, we feel similarly. We are uniquely qualified to do the aftermarket work and we're able to get very good pricing on aftermarket, and that's for both the DeltaValve and the TapcoEnpro piece of the business. For TapcoEnpro capital projects, there's more competition. It's more – there's more pricing pressure in that market, and that's the spirit if you will of the business that's being moved to India right now. So we are focused very much on addressing the cost piece of that business in responding to the competition in the market overall. So yeah, we push price when we can, but that's a more competitive piece of the business.

[Nathan Hardie Jones:]

So, is it fair to say on that capital project side there in the TapcoEnpro business that your – despite having increased raw material costs and not raising prices overall that you've been – that you're able to take costs out of that business to protect margins?

[Scott A. Buckhout:]

Correct. That's exactly right.

[Nathan Hardie Jones:]

Okay. So in the Fluid Handling business, you talked about seeing more cost opportunities than you thought unnecessary cost that you can get out. Can you give us a little more color on that, maybe the scale of that and the timing?

[Rajeev Bhalla:]

Sure. Sure, Nathan. We've looked at really the G&A piece quite hard. Think of it as kind of the divisional group structure and the set up around that. And we think there's some good opportunities there. We're obviously being very careful with respect to the other parts of SG&A specific with selling and engineering, that's – we think that that's – it's important to keep the new product development and the growth part of it invested in. But it's really kind of the G&A structure that we're looking at hard. And some of it is synergy related in the sense that we can combine IT functions is a good example where we can get some incremental synergies than what we anticipated walking into the deal and then there are some areas where we're actually adding a little bit of cost to kind of beef up the team.

[Scott A. Buckhout:]

So let me add to that a little bit. So there's the piece that Rajeev referred too, it's maybe you can call the group headquarters cost that we're trying to understand that, that seem quite large. And then there's other pieces of the SG&A, OpEx in Europe specifically in our European piece of the business as a percentage of sales is significantly higher than what you see in the America or what you see in other parts of CIRCOR. So we're digging into that to try to understand what's driving that in Europe, is there a good reason for and are there opportunities to reduce that.

[Nathan Hardie Jones:]

Okay. Then I'm going to sneak one more in on the higher than expected past-due backlog in the Fluid Handling business there. Seeing a lot of Fluid Handling business over the years and seeing past-due backlog a fair bit over the years, it tends to take a lot longer than people think to clear that out of the system. Can you talk about what you guys and how much it is, how big of a problem it is and what actions you guys are taking to ensure getting that out as quickly as possible?

[Rajeev Bhalla:]

Yeah. In terms of sizing, Nathan, its – I think it was probably – it's not – there's two pieces to this. There's a piece of it that's part of what stays in the Industrial and there is a piece of it that's part of the Aerospace & Defense business now. And I would say that let's put it this way. Revenues in the quarter should have been up probably 10-ish percent more if we were being able to execute on that backlog. With respect to clearing it we absolutely understand and – what's involved and what it takes and that's why we have J. Lapointe and Mike Archer specifically involved from an operational standpoint to do that. And Mike Archer is actually the Head of Operations that's in charge of the integration and dealing with items like past-due backlog.

[Scott A. Buckhout:]

I think a couple of extra comments here is we – we've dealt with these kinds of issues at CIRCOR in the past and the specific team has. So this is something that we do know how to do. The majority, more than half of the past-due backlog is in the defense piece of the business that moved to Aerospace & Defense. This is something that we're managing closely with the Navy. There's not a customer risk here with this past-due backlog that you might be concerned about. We're managing it well with the Navy. They understand what we're doing. They understand the plan to burn it down. The remainder of the backlog is spread between the Americas and Europe on the Industrial side and it's smaller and the age of the past-due is lower than what we're dealing with on the defense side. So we feel better about that too. So yes it is going to take time particularly the Navy backlogs, but we're working with the Navy and they're working with us, so I think it's going to be okay.

[Nathan Hardie Jones:]

Okay, thanks very much. I'll pass it on.

[Rajeev Bhalla:]

Thanks, Nathan.

[Operator:]

Thank you. Our next question is coming from Brett Carney from Gabelli & Company. Your line is now live.

[Brett Kearney:]

Hey guys, good morning.

[Rajeev Bhalla:]

Good morning, Brett.

[Scott A. Buckhout:]

Good morning, Brett.

[Brett Kearney:]

I just want to ask on the pickup a bit in commercial marine activity that you're seeing whether that's primarily related to the aftermarket or whether the OE piece of that and I know you guys said you expect the activity to moderate a bit going to Q2, maybe your outlook for the back half of this year and heading into 2019 for that piece of the business?

[Scott A. Buckhout:]

So the majority of the increased – improved activity we're seeing is actually not aftermarket, it's more on the OEM side and it's based on increasing ship building activity in the back half of last year, it's on the Merchant Marine side of our commercial marine business as opposed to the offshore vessel, the OSV. So the Merchant Marine side we're seeing good growth OEM not aftermarket and we're not seeing that on the OSV side yet.

[Rajeev Bhalla:]

Brett, one of the metrics you can take a look at is the freight rates that's up nicely, there is some indices on that front as well and that's helping do some of that shipbuilding activity that allows us to sell our pumps. So there is probably about a three- to four-month lag between when the shipbuilding is occurring versus when we get an order. So that's another key metric to look at.

[Brett Kearney:]

Great. Thank you guys.

[Scott A. Buckhout:]

You're welcome.

[Operator:]

Thank you. Our next question is a follow-up from John Franzreb from Sidoti & Company. Your line is now live.

[John E. Franzreb:]

Yeah, just quickly on the Joint Strike Fighter orders that you referenced earlier, that you expected in the fourth quarter, will that ship in 2018, or will that ship in 2019?

[Rajeev Bhalla:]

That would ship in 2019, John. So we get the orders every year so the pipeline fills up, so the 2018 shipment pipeline is full and but there is long lead time, there is material deliveries et cetera but that would ship primarily in 2019.

[John E. Franzreb:]

Okay. And none of that would fall into 2018, got it.

[Rajeev Bhalla:]

Only on the occasion that for some reason it came in earlier than what we're thinking today that could happen. But I don't think that's likely at this point.

[John E. Franzreb:]

Great. Thank you, Rajeev.

[Rajeev Bhalla:]

You're welcome.

[Operator:]

Thank you. Your next question is a follow-up from Charlie Brady from SunTrust Robinson Humphrey. Please proceed with your question.

[Patrick Wu:]

Hi, guys. This is actually Patrick Wu again, thanks for taking the follow-up. Just on the Industrial side, I just want to make sure I heard correctly you guys raised prices for pumps across the board and the effect of a half of the segment. And I think that was implemented in May 1st. So I just wanted to understand the cadence of margins sort of in the second quarter and also for the second half of the year. Can you talk a little bit more about that?

[Scott A. Buckhout:]

So, let me clarify the pricing and then I'll let Rajeev talk about the cadence of margins. So the pricing is it is across the board, but as we have in many of our other businesses, we have long-term agreements with some customers. So, we're raising prices in the 4% to 5% range that's going to be applicable to roughly half of the business, so I think that's the way to think about kind of the net effect. And there's usually a little breakage as well that you would have on that, so you take half of the business getting 4% to 5% with some breakage. I'll let Rajeev comment on.

[Rajeev Bhalla:]

Yeah, from a margin standpoint Patrick we will start to see an improved cadence here a little bit in Q3, but a lot more in Q4. So just based on shipping the backlog, getting new orders, have those new orders priced and shipped, we would expect to see some really nice margins as we close out the year in Q4.

[Patrick Wu:]

Okay. Thanks for all the color.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We do thank you for your participation today.