CIRCOR International, Inc.
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Good day, ladies and gentlemen and welcome to CIRCOR International's Second 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. [Operator Instructions] I’ll now turn the conference over to Mr. Scott Solomon from Sharon Merrill for opening remarks and introductions. Please go ahead.

[Scott Solomon:]

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 & 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 and 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 27, 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 and 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 Buckhout:]

Thank you, Scott, and good morning, everyone. We had a strong second quarter. On a pro forma organic basis, orders grew to $309 million, up 15%. Revenue grew to $301 million, up 9%. Operating margin improved sequentially by 100 basis points to 8.2%; adjusted EPS came in at $0.57, 46% higher than last year. Before we get into our segment financial performance and market outlook, I'd like to cover some operating and strategic highlights since our last call. In June, Lane Walker joined CIRCOR as President of our Energy Group. Lane brings an excellent track record of global P&L management, growth and operational experience to CIRCOR. At Schlumberger, he ran a series of P&Ls of increasing size and complexity, including their downhole and surface testing business, the OneSubsea production systems division and Cameron’s downstream valve business. He's very familiar with our products, markets, channel partners and end customers. We're excited to have him on board. The Fluid Handling integration remains on track. The teams are adapting well within the CIRCOR environment. Our synergy plan is ahead of schedule. We expect to deliver the $23 million run rate cost synergies by the end of year three, a year earlier than our original timeline. As part of that, the rationalization of the Reliability Services network is complete. We exited the facilities and executed the reduction-in-force. We expect approximately $1 million of savings this year and $1.7 million annualized. The reduction-in-force for our EMEA business is on track. We expect approximately $1.5 million of savings this year, mostly in the back half and $2.5 million annualized. Overall, we expect a synergy action plan to deliver $4 million to $5 million of savings in 2018. In addition, due to additional opportunities, we expect to exceed the synergy commitment by year four. In the second quarter, we shift the first set of DeltaValve gates from our Indian manufacturing facility and now we're ramping up volume and expanding the scope of manufactured product. We expect to start shipping TapcoEnpro product out of India in the second half of this year. Our Indian manufacturing capabilities strengthens our position in the downstream market for our refinery valve product line. This important transition will expand margins due to significant cost savings but also gives us better proximity to important growth markets in Asia. Distributed valve production in our Monterrey, Mexico facility continues to ramp up. We expect to more than double output in Q3 compared to Q2. Our low-cost manufacturing facility in Mexico continue to play an increasing role in better serving our customers and drive improved margins in North America. In June, we completed the market offering for all of the CIRCOR shares that were held by Colfax. As a result, Colfax liquidated 100% of its position, thereby eliminating the overhang that existed since we closed the Fluid Handling transaction in December of last year. Let me turn the call over to Rajeev to discuss the second quarter results in more detail before I review our end market outlook.

[Rajeev Bhalla:]

Thanks, Scott. Let's review the segment results, starting with Industrial on Slide 6. The Industrial segment had sales of $131 million, up 12% organically compared to pro forma Q2 2017. The European pump business saw a significant increase in deliveries, including a number of large projects. We experienced sequential and year-over-year growth in the North American pump market. The valves business was up slightly in the quarter with growth in Europe, partially offset by declines in North America. Industrial segment operating margin of 11.5% is up 40 basis points from Q1 and 30 basis points from prior year. While strong revenue and productivity from restructuring actions provided a lift, it was somewhat muted by lower margins on a few large projects. For the third quarter, we expect moderate margin expansion sequentially from the continuing benefit of our restructuring and synergy actions. Over the longer term, this business should operate with margins in the mid-teens. Turn to Slide 7. Energy sales of $113 million increased 16% on a pro forma organic basis, reflecting growth in short cycle distributed valves and refinery valves, both up about 40%. Instrumentation and sampling and reliability services sales were flat year-over-year and engineered valves were down slightly. Energy segment operating margin of 8.2%, an increase of 250 basis points from Q1 while still down year-over-year; losses in engineered valves continued to be a drag on margins. However, increased profitability in refinery valves and an improvement in distributed valves and reliability services contributed to the overall sequential margin expansion in the quarter. As Scott mentioned, production for distributed valves product has ramped up in Monterey. As we gain additional traction in Mexico, and deliver on higher volumes in the other product lines, we expect to expand margins in the third quarter and beyond. We expect this business to operate with mid-teen margins over the longer term, assuming a cyclical rebound for the engineered valves business. Turning to Slide 8. Aerospace & Defense have sales of $58 million, down compared to Q2 2017 on a pro forma organic basis. You may recall that we divested a French business last year with approximately $4 million of annual sales. Aerospace & Defense operating margins were a strong 12.2%, moderating from Q1 levels, based on the mix of sales and in inventory-related charge in the quarter. We expect margins to continue to improve in the third quarter based on the sales mix, recent price increases and operating efficiencies. Over the longer term, Aerospace & Defense margins should reach high teens. Turn to Slide 8 for selected P&L items. Our adjusted tax rate for the quarter was 23%, in line with our quarter and full-year expectations. Looking at special items and restructuring charges, we recorded a total pretax charge of $17 million. The largest component of this chart relates to noncash acquisition-related amortization expense, totaling $13.5 million. The remainder relates primarily to cost for our restructuring programs. Interest expense for the quarter was $13.8 million or $0.53 per share, up more than $11 million compared with the prior year due to higher debt balances as a result of the Fluid Handling acquisition. We had about $0.05 per share lift from FX gains associated with the revaluation of certain balance sheet accounts, based on the appropriate currency rates in the quarter. Turn to our debt position on Slide 10. During the quarter, we spent approximately $4 million on capital expenditures. For the full year, we continued to expect CapEx to be approximately $25 million. Consistent with the first quarter, we incurred a number of large disbursements for advisor fees and severance costs, totaling approximately $8 million. This reduced our operating cash flow. We expect operating cash flow to improve significantly in the second half, based on reduced level of extraordinary disbursements and improved working capital. Leverage continues to be above 5x. Clearly, cash flow generation, debt paydown and margin expansion remains top priorities as we target our leverage ratio to approximately 3x by the end of 2019. Overall, we expect to generate free cash flow in the range of $30 million to $50 million in the second half of this year. Moving to guidance on Slide 11. Overall, we expect third quarter 2018 revenue in the range of $290 million to $300 million, an adjusted EPS in the range of $0.45 to $0.55 per share. From a top line perspective, we expect growth in our Energy and Aerospace businesses, moderated by seasonally lower sales for part of our European businesses. We expect pro forma year-over-year margin expansion across all groups in Q3, due to the benefits of price, volume and realized synergies. Regarding special and restructuring charges for the third quarter of 2018, we anticipate charges for the following items. Acquisition-related amortization expense of $0.52 to $0.54 per share; and special and restructuring charges totaling $0.09 to $0.14 per share. We expect the third quarter adjusted tax rate to be approximately 23%. Before I wrap up, I want to give you a quick update on commodity inflation and the potential impact of tariffs. To date, we've been able to generate net material productivity by offsetting commodity inflation with sourcing savings. We expect that to continue through the remainder of the year. The main impact of commodity inflation is on our distributed valve products. Regarding the Trump administration's proposed tariffs, the initial round of tariffs is expected to have a minimal financial impact on our imports from China. However, the additional round of proposed tariffs if enacted in August, would have an approximately $2 million impact this year on the cost of importing material for the distributed valve product line. As production and import location transition to Mexico, we expect this impact to be mitigated. In addition, we are exploring pricing as another path to offset the impact on profitability. Now let me turn it back over to Scott.

[Scott Buckhout:]

Thank you, Rajeev. Let me give you an overview of the end markets and the drivers that we believe give us momentum as we move through Q3 and the balance of 2018. Please turn to Slide 12. In the industrial segment, order momentum is healthy across most regions and lines of business, with particular strength in our European pump business. Both the aftermarket and new equipment markets are healthy. Book-to-bill was above one for the second consecutive quarter, and pro forma organic orders grew 8%. General industrial end markets remained robust with an increase in PMI, strong durable goods orders and higher German manufacturing output. In the second quarter, we saw a significant increase in orders for pumps in the general industrial and marine sectors in Europe. Higher demand in North America was largely driven by broad-based industrial strength, the timing of certain navy orders and bookings in oil and gas end markets. For the third quarter, we expect low double-digit pro forma order growth year-over-year, driven by a solid order intake across most end markets and regions. Sequentially, we expect orders to moderate due to seasonal effects and lower commercial marine activity. Pricing remains a focus for the business. Our Q2 price increase, which impacted about 50% of our industrial revenue, will help lift second half margins. On the rest of the business, we continue to evaluate opportunities as long-term contracts and frame agreements come up for renewal. Finally, I'm excited to announce that we recently launched a new version of our three-screw pump to service machine tool coolant applications. The MTEC C is designed to handle abrasive fluids in the application of coolant lubricants. Our new patented technology improves reliability and significantly increases the service life. It's easy to maintain in this 37% lighter than prior versions. The Industrial group engineering team continues to focus on improving our products, while reducing costs in order to grow the top line and expand margins. Now let me shift to our Energy segment. In Energy, the North American up and midstream markets continue to be robust. International upstream markets are still slow, but improving. Global downstream markets remain strong in our segments. Overall, Energy orders were up 24% on a pro forma organic basis. Our refinery valves business saw orders growth of nearly 60% in the quarter. With stable oil prices, refiners are focused on the impact of the IMO 2020 regulatory change for sulfur content and bunker fuel. We expect continued order growth from this regulatory action for our DeltaValve product line. In the past 12 months, we've booked $120 million of orders in our refinery valve business. Our win rate continues to be strong and while this business can be lumpy and the timing of project awards can be difficult to predict, the environment is positive and we remain bullish on this market. Distributed valves orders remain stable and in line with previous quarters. Distributed valves, the North American market continues to be strong, rig count, well completions and production remain high. Orders in Q2 were up slightly from Q1 and we expect them to continue at this rate for the remainder of the year. In engineered valves, orders were up significantly from Q2 of 2017, which was an especially soft quarter for this business. The Middle East remains the most active market, but we've seen improvement in other areas as well, such as Europe, Nigeria and North American LNG. The market is gradually improving outside of North America with higher quoting activity, but still weak overall with excess capacity and the resulting pricing pressure. Based on current and expected quoting activity, we expect Q3 orders roughly in line with first half run rate orders. Reliability Services saw double-digit pro forma organic order growth in Q2. We expect a seasonal increase in orders sequentially as we approach the fall turnaround season. For Energy overall, we expect Q3 orders more or less in line sequentially and up slightly versus pro forma prior year. Turning to Aerospace & Defense. Our Aerospace & Defense segment had another solid quarter of orders at around $60 million with broad-based strength across OEM and aftermarket products. Pro forma organic order growth was 17% in the quarter, driven by commercial aircraft and defense programs, especially submarines. We recently announced our selection by Rolls-Royce to supply a new vent ejector valve for the TP400 power plant. This is an excellent program for us and demonstrates our ability to leverage of our core fluid control technology into mission-critical aircraft engine applications. We are seeing increasing opportunities to quote existing programs as the second source or to replace competitors with newer technology on both the commercial and defense sides of our business. With our MRO initiatives gaining traction, the higher build rates and the ramp up with newer programs, our market outlook remains robust. Orders for Q3 are expected to be in line sequentially with the bookings of the first half of the year. To summarize, our end markets remains strong and the momentum across most of our businesses continues. In the second half, we expect to start seeing the bottom line benefits from actions that started in the first half of the year. Restructuring programs, integration synergies, manufacturing transitions to low-cost facilities and pricing actions. We are optimistic as we look ahead to Q3 and the second half of the year. Overall, we remain committed to driving long-term growth, generating strong free cash flow and delevering the company by reducing debt and expanding margins. Now, Rajeev and I will be happy to take your questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.

[Jeff Hammond:]

Hey, good morning, guys.

[Scott Buckhout:]

Good morning, Jeff.

[Rajeev Bhalla:]

Good morning, Jeff.

[Jeff Hammond:]

Just a couple of things on kind of balance sheet, free cash flow, just talk about the – I think you said working capital is going to be better. But what you think is the ultimate working capital opportunity for the business? And then, it looks like you had a small divestiture that hit the cash flow statement. Can you just talk about the portfolio what you see in terms of non-core businesses opportunities accelerate debt reduction in a timeframe around that? Thanks.

[Rajeev Bhalla:]

Thanks Jeff. Let me take the divestiture question first, and then we'll chime in on the working capital and where that’s headed. We did not have a divestiture in the quarter. I think what you may be referring to on the cash flow statement in the investing section is about a $6 million amount that was actually the adjustment to working capital. So what we did the deal with Colfax. We paid an estimated amount of consideration associated with working capital. In December, that amount was adjusted down such that we got $6 million back from Colfax and that's what you're seeing in the statements. So it's just really part of the purchase consideration, not a divestiture. On the working capital, we do continue to have a significant opportunity. As you know, if you heard from us before, we've targeted to get down to close to 20% – between 20% and 25% of sales of working capital and we're well above that today. But let me turn it over to Scott to give you a sense of what it is we're doing specifically to drive a better outcome of working capital.

[Scott Buckhout:]

So as Rajeev said, we have opportunity. I think the majority of the working capital opportunity that we have is in Legacy CIRCOR. We have quite a bit of inventory as you probably know and if we continue to drive to the lower percentage of sales, we have several parallel initiatives going. Shortly after we closed the transaction with Colfax earlier this year, we kicked off a cash management office at CIRCOR. We got five people on the team. That are basically a corporate team, and then we've got teams in every business unit that are accountable for each component of working capital. So we’ve got someone on inventory receivables and payables. This team is driving daily cash management, so its ins and outs. In parallel, we've got experts driving initiatives on each component of working capital as well. So we've got someone responsible for inventory and taking inventory down and driving more effective sci-op process in all the areas we have the most opportunity. I think it's important to say that we also have an incentive program really through the organization around cash flow and working capital. So everyone on the cash management, office team as well as the teams in each business unit are all financially incentivized to deliver cash flow in – cash flow at or above their budget targets. It's also probably not known is that we changed our short-term incentive program, which is everyone's annual bonus at CIRCOR such that 35% of everybody's bonuses is now directly related to free cash flow. So we've got the whole organization very focused on this. We're driving very hard on the working capital opportunity, particularly on the Legacy CIRCOR side of the business. And you'll see improving working capital and cash flow in the back half of this year as we get some of these extraordinary disbursements out of the way and we get better traction on these initiatives that we've got on working capital.

[Jeff Hammond:]

Okay, good color there. And then just on the distributed valves in Oklahoma and Mexico ramp, just maybe talk about – you gave some good color there, but talk about where that’s ramping versus your expectations? And then, how should we just generally think about the margin trajectory in the Energy segment into 3Q and kind of run rate in – as we exit 2019? Thanks.

[Scott Buckhout:]

So Monterey is ramping up as expected that's probably the right way to say it. We had some hiccups here and there, but it's ramping up as expected. As we continue to increase volume in Monterey, of course, the margins improved over time here. Right now, the margins are lower than historic margins in DV for a number of reasons. I'd say there’s three primary reasons

[Rajeev Bhalla:]

Just to add a little color to that. Recall in the first quarter call, Jeff, we talked about the fact that we received the API certification in April. So that was obviously a gaining factor prior to the ramp up here. Now that we have that, it's full speed ahead. And so that ramp is going to accelerate as we close out the year. And as we look at margins for the full year, our expectation is to end at high-single digits.

[Scott Buckhout:]

So I think with respect to Energy margins, we expect them to continue to improve through the back half of the year, we expect our engineered valves balance margins will improve through the back half of the year. And I think it's worth noting with respect to engineered valves, that we feel pretty good about the margin that we have in backlog. Right now, we're expecting materially better Q4 than what we've been seeing out of this business year-to-date. And as orders start to come in here in the second half of the year, we'll have a better read on the first of 2019. But certainly, you'll see a better Q4 based on what we have in backlog today, Q3 better than Q2, but Q4 will even be better than Q3.

[Jeff Hammond:]

Okay, great color guys. Thanks.

[Scott Buckhout:]

Thanks Jeff.

[Operator:]

Our next question is from Nathan Jones with Stifel. Please proceed.

[Nathan Jones:]

Good morning everyone.

[Scott Buckhout:]

Good morning, Nathan.

[Rajeev Bhalla:]

Good morning, Nathan.

[Nathan Jones:]

Just I’d like to get a little bit color on the 3Q guide. Relative to your 2Q results, the revenue for 3Q is fairly close to what it was in 2Q. But the midpoint of earnings is about $0.07 lower. Can you talk about what the differences are there in Q2 in terms of mix? It sounds like you had an FX gain in 2Q that was included in reported results. And then could you quantify the inventory charging in euro as well please?

[Rajeev Bhalla:]

Sure. So if you're looking at year-over-year EPS bridge here, Nathan, we had about $0.05 of FX left to inside of our $0.57. And this is really FX is associated with – as I mentioned on the call, when you have for example a payable that's euro denominated and an European supply from a U.S. business and you end up settling that at an amount lower because as a euro as you know has gone from $24 so to down to $16, we end up recording that gain. That's what that reflects. So you do see some of that. So as I look at relatively constant revenues sequentially, you need to adjust for this $0.05 in Q2 versus the Q3. And then with respect to margins on Aerospace & Defense that segment in particular we have this inventory charge, a couple of other nonrecurring charges that are embedded in there as well. It damps down margins, it drag margin down by about 100 basis points.

[Nathan Jones:]

Okay. And then it sounds like engineered valves is finally starting to show some signs of life in the markets out there. You talked fairly constructively about the orders in the quarter, profitability in 4Q. I assume the wrapping profitability gets back to actual profitability instead of loss there. Can you give us any more details about what you're seeing out there in the market? What your expected trajectory of profitability for that business today through the end of the year? And anything you can give us on the outlook for next year?

[Scott Buckhout:]

So I'll start with - I'll start on that one. So we are – for the remainder of the year, we have a pretty good read on what's that's going to look like because it's mostly in backlog. So as we look into Q3, we're expecting a loss in Q3. But it should be significantly lower loss than what we incurred in Q2. As we look at Q4, unless there are changes to the schedule of projects, we expect to swing to a profit in Q4 in engineered valves from losses that we've had year-to-date. As we look into 2019, Nathan, it's really hard to know at this stage. We are quoting a lot of projects right now. We're being disciplined about the margins that we put in our backlog. But we really don't have a firm read on the first of all 2019. What I’ll say, it's still very competitive there is still excess capacity in the market. The pricing is still difficult. So we have a good read on Q3 and Q4 as I just laid out but its really hard to say right now what's going to happen in the first half of 2019 right now.

[Nathan Jones:]

Okay. On distributed valves, investors out there being concerned about take-away capacity out of the Permian and how that might influence well completions there. And so to keep your distributed valve business, have you seen any slowdown in demand out of that basin or any destocking from distributors in anticipation of a slowdown in that basin or any change from that kind of concern?

[Scott Buckhout:]

Nathan, we're reading about that as well. And so we've been asking some point of questions of our sales team in distributed valves in the Permian. And we're not hearing this in the field and on the ground. There doesn’t appear to be any slowdown from what we can see activity levels are still high. We’ve not been reading the same thing as you, we wouldn’t realize that there could be a take-away capacity issue. It could be that they haven’t hit the capacity issue yet, I guess that's supposed to happen around now. But certainly, our customers are not giving us an indication of a slowdown.

[Rajeev Bhalla:]

I think in fact, Nathan, we're looking at this closely to see if there are actually opportunities here. As you get into the midstream field to build that infrastructure, can we sell more valves? And so we are looking at that piece of it as well as an opportunity. But we've had a lot of good dialogue with our distributors and we do not see a destocking going on.

[Nathan Jones:]

And then just last one on the 2Q price increases that you talked about. Can you – was that broadly across the entire portfolio? Was it targeted more in areas like distributed valves where you're seeing more material and tariff impacts there? Just any kind of additional color you can give us on where the price increases occurred?

[Rajeev Bhalla:]

Sure, absolutely, Nathan. So if you think about the product line specifically, we would react according to that. Distributed valves is pretty broad-based, relative to the catalog there.

[Scott Buckhout:]

Pretty much across the whole business.

[Rajeev Bhalla:]

That's right. And obviously, I'm putting aside project businesses because that's a unique animal. But if you look at some of the other parts of – other product lines in our industrial segment, about half of the business, we took up close to 5% on a price increase. The other half, as you heard Scott talk about, we're working with customers that may have frame agreements, long-term agreements and managing through that negotiation. And then with Aerospace & Defense, as you know, historically, and as we continue to do, we get a good 100 to 150 basis points of net price increase a year out of those businesses. So a little more targeted, excluding the project businesses, pretty broad-based.

[Nathan Jones:]

Great, thanks very much.

[Rajeev Bhalla:]

Thanks, Nathan.

[Operator:]

Our next question is from Charley Brady with SunTrust Robinson Humphrey. Please proceed.

[Charley Brady:]

Hey, thanks. Good morning, guys.

[Scott Buckhout:]

Good morning, Charley.

[Charley Brady:]

Just back on the, I guess, on the distributed valve inventory, or field inventory. You're not saying a destocking, but I'm just wondering do you have a sense of – I don't think I'm seeing a slowdown but kind of where the channel inventory levels are right now? I mean, is there a concern that what goes on their kind of comes through a quick halt and there's a – you're stuck with a surplus of channel inventory? Or is it being managed pretty tightly given the pain these guys felt during the last down tick?

[Scott Buckhout:]

So our view on channel inventory is that, it's been stable for a couple of quarters now. So we're not seeing our distributors increasing or destocking, it's run at a pretty stable level, stocking orders have been relatively stable over the last couple of quarters. So we're not anticipating a slowdown. We – as we guided, we're expecting orders to be more or less in line with what we've been seeing. And when we talk to our customers, virtually none of them have said that they're anticipating a – looking at destocking or slowing down. We're actually getting quite the opposite.

[Charley Brady:]

Thanks. And then on the engineered valves, as you talked about how it's still pretty price competitive. But I'm wondering has the spread on what you consider a normal or optimized margin, and I realize that varies project by project. But just in broad terms, is that spread shrinking at all? Or is it still kind of 400 to 600 basis point spread in kind of what will be an optimal, normal margin in a normalized market? I'm just gauging – trying to – how much better, if at all, is the margin getting on the EV side of the business in large projects?

[Scott Buckhout:]

I would say it hasn't changed, it hasn't gotten worse than what we've been seeing in the last six months but it hasn't necessarily gotten better. So what really happens is that, the competitive dynamic on a given project will change how we can price. And so in general, most projects we're competing on are very competitive, not necessarily all of them. And so we try to put ourselves into situations where we're quoting projects that are less competitive and we can get a bit of a better price or where we have a better relationship with the customer. But broadly speaking, I would not tell you that the pricing has improved over the last six months.

[Rajeev Bhalla:]

Just to add to that, Charley, the capacity, right – during this downturn, surprisingly, not much of the capacity came out. And so my sense is that I think once you start to see a significant uptick in the offshore projects, where you really start to see the spread shrink, as you're suggesting, because the capacity is still pretty high right now.

[Charley Brady:]

Yes, that’s helpful. Thanks. And just one more for me, I Just want to make sure I heard you correctly. On the Aerospace & Defense, is that 12.2% EBIT margin in Q2, that includes the inventory charge of 100 basis points?

[Rajeev Bhalla:]

Correct.

[Charley Brady:]

Okay. And are there – back half of the year – I mean, is that a one offer or we don't see that again in the back half of the year?

[Rajeev Bhalla:]

That's right. That is a one offer. So the expectation here is to close out kind of high double-digit low teens type of a range.

[Charley Brady:]

Okay. And then I guess I'll stick one more. On Energy, just to clarify, you want to exit the year at a high single-digit rate?

[Rajeev Bhalla:]

The full year should be at a high single-digit rate, Charley.

[Charley Brady:]

Okay, fantastic. Thanks.

[Rajeev Bhalla:]

You’re welcome.

[Operator:]

Our next question is from John Franzreb with Sidoti & Company. Please proceed.

[John Franzreb:]

Good morning, guys.

[Rajeev Bhalla:]

Good morning, John.

[John Franzreb:]

I guess a little more color on the acquired business and the order bookings there. Can you talk about them relative to your expectations, are some doing better than expected versus a year ago, and some worse?

[Scott Buckhout:]

So orders on the acquired business overall are, I'd say, significantly better than what we expected when we made the acquisition. And it's fairly broad-based, I mean, we're seeing stronger orders in North America, we're seeing stronger orders particularly in EMEA. So we're pleased with the order intake that we're seeing, it's significantly better than what we built into our acquisition model.

[Rajeev Bhalla:]

The other piece to it that has provided some fluctuation here relative to expectations, John, is on the commercial marine side. You recall, we saw a nice uptick in Q1, it's kind of moderated, it maybe a little lower now but it'll tick back up again. So there's some fluctuation on that. But as Scott mentioned, once you look at the industrial side of it, it's actually doing better.

[John Franzreb:]

Okay. Well, then I guess I'm wondering it seems to me that you're saying that the sequential margins will be improved in all three business segments. But referencing the earlier question, seems like the guide should be better. I'm wondering what else could there be other than FX, because unless the magnitude of the improvement we're talking about isn't that great, I was thinking the guide would be a little bit stronger. What am I missing here?

[Rajeev Bhalla:]

I think there's always an important part of any guide is ensuring that we balance out the risk and opportunities, John, and I think that's what we're looking at here. Operationally, sequentially, it is better, recognizing you have to adjust for the FX piece in Q2. And we do see margin improvement there. Could we do better? Obviously, we're going to try to, but one always takes the risks and opps into account.

[John Franzreb:]

I understand the measure conservatism. And Scott, just want – just to make sure I got this right, you said the Monterrey facility was going to double the output in Q3. From what I recall, last quarter, Q2 was supposed to be 2x of Q1. Are you talking about Q3 being 2x of Q2? Or is it 2x year-over-year?

[Scott Buckhout:]

It'll be double what we did in Q2. So in Q2 versus Q1, we were slightly less than 2x. But in Q3, we're expecting to be a little more actually than 2x of Q2. So now that we've got the API certification, it will really open the floodgates here and ramp up the volume in Monterrey.

[Rajeev Bhalla:]

Recognize, we started with the low base, right?

[John Franzreb:]

That’s true.

[Scott Buckhout:]

Yes, John. So it's good that we're accelerating this but we need to do it faster.

[John Franzreb:]

And when would Monterrey be fully ramped up?

[Scott Buckhout:]

Well, we're expecting early next year, we'll be fully ramped up.

[John Franzreb:]

Okay. And Rajeev, you've had what you used to call one-time short-term integration-related cost embedded in the EPS in the first quarter. Was any of that occurring here in the second quarter? And if so, when does that kind of go away?

[Rajeev Bhalla:]

Yes. We did have some in the second quarter. It will moderate, probably come down by about 40% or so here in the third quarter and dissipate in the fourth quarter here. It was about the same level as Q1, John, in Q2.

[John Franzreb:]

Got it. And I guess one last question. In the cash flow statement there is a $60 million outflow returned to the seller. Just – can you tell me what that was?

[Rajeev Bhalla:]

Yes, so if you recall, when we closed the deal, the deal was a cash-free, debt-free deal. And when we closed, there was about close to $65 million of cash, there was an excluded asset that was left behind in the businesses that we acquired, that we returned back to Colfax over these last two quarters here. So that amount reflects the return of that excluded asset to Colfax. And we're done. So at the end of Q2, that matter has been resolved.

[John Franzreb:]

Okay, all right. Thanks guys. Thanks for taking my questions.

[Rajeev Bhalla:]

Thanks John.

[Operator:]

[Operator Instructions] Our next question is from Brett Kearney with Gabelli & Co. Please proceed.

[Brett Kearney:]

Hi, guys. Good morning.

[Scott Buckhout:]

Good morning, Brett.

[Brett Kearney:]

Just wanted to ask. I know you finished Q1 with a little bit of past due backlog, mostly on the business that you guys acquired. Just want to ask any update on progress, working that down in this quarter and expectations for the rest of this year there.

[Scott Buckhout:]

Yes. So we have actually made very good progress. We've cut it in aggregate for the acquired entities. We've cut it about 50% from where we started the year. And so, we feel very good about this. We'll be – it'll be largely gone by the end of the year. And we expect to probably cut it in half again here in the third quarter.

[Brett Kearney:]

Okay, that’s great. Thanks so much guys.

[Scott Buckhout:]

Thanks Brett.

[Rajeev Bhalla:]

Thank you.

[Operator:]

Ladies and gentlemen, that concludes our conference call. Thank you for joining us today.