CIRCOR International, Inc.
Q3 2014 Earnings Call Transcript

Published: 31 Oct 2014

[Operator:]

Good day. Welcome to CIRCOR's International Third Quarter 2014 Financial Results Conference Call. Today's call will be recorded. [Operator Instructions] I will now turn the call over to Mr. David Calusdian from Sharon Merrill for opening remarks and introductions. Please go ahead, sir.

[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 & Presentations section of the Investors link. Please turn to Slide 2. Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors, the company advises you to review CIRCOR's Form 10-K for 2013 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 view as of today, October 31, 2014. 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 often refer to adjusted operating income, adjusted operating margins, adjusted net income, adjusted EPS and free cash flow. These metrics exclude any pretax special charges and recoveries, restructuring inventory reserves and intangible impairments. 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 will now turn the call over to Mr. Buckhout.

[Scott A. Buckhout:]

Thank you, David, and good morning, everyone. Our adjusted EPS for the quarter came in strong at $0.95 versus $0.93 last year. We expanded our adjusted operating margin by 30 basis points over a strong quarter in 2013. We continue to simplify CIRCOR and reduce the costs built into our current operating structure. Our simplification actions, combined with our operational excellence program, are expanding margins and simultaneously improving customer service. Our revenue for the third quarter was $204 million, with orders of $242 million, including record bookings out of our Energy segment. We continue to focus on revenue growth through new products and expansion into new markets. During last quarter's call, I told you about our new zero-leak turbine bypass valve for the power market. I'm pleased to announce that our new valves were selected for a large coal liquefaction plant in Ningbo, China. Our new offices in Malaysia and Brazil are fully functioning now, staffed with salespeople and application engineers to work with the EPCs and distributors in the region. Our team in Malaysia was instrumental in winning a Canadian oil sands project that's being managed by an EPC based in Southeast Asia. Overall, we're pleased with the progress we're making on our growth initiatives. The restructuring we announced in April is progressing as planned. The third facility closure and G&A headcount reductions will be completed by the end of this year. As we continue to drive operational excellence at CIRCOR, I've prioritized improving on-time delivery for our customers. One of our root-cause issues is supplier performance. We've made significant progress here with better supplier management and supply base rationalization. As a result of these actions and others, we're starting to see a favorable impact on our customer delivery as well as an improvement in net material cost. Finally, I'm pleased to report that we've realized a 50% reduction in workforce injuries year-to-date as we increased our focus on health and safety of our employees. With that, I'll turn the call over to Rajeev and come back later to provide more detail on recent order trends and our guidance for the fourth quarter.

[Rajeev Bhalla:]

Thanks, Scott, and good morning, everyone. Let's move right to the segment results, starting with Energy on Slide 4. Energy sales of $158 million decreased 6% over the prior year. This was primarily driven by lower sales at our large international projects business due to order intake in the first 3 quarters of last year. In addition, we continued to experience an increased level of finished product not yet required by our customers due to project delays and deferred product inspections as well as customer change orders. This decrease was partially offset by higher volumes in our upstream North American short-cycle business as well as our downstream instrumentation businesses. Energy's adjusted operating margin was up a strong 170 basis points to 16.9%, primarily due to higher productivity, savings from our previously announced restructuring activities and growth in our North American short-cycle business. For the Aerospace & Defense segment, please turn to Slide 5. Aerospace & Defense revenues decreased by $1 million from the prior year to $46 million, primarily due to lower sales of landing gear structures, partially offset by higher actuation shipments. Aerospace & Defense adjusted operating margin decreased to 5% compared with 12% in the third quarter of last year, primarily due to operational inefficiencies in exiting certain landing gear structures and the incremental cost associated with eliminating critical customer past due shipments in California. Turn to Slide 6 for selected P&L items. Our all-in tax rate for Q3 was 22.8%. Excluding the impact of special and restructuring charges, the comparable tax rate was 24.7%. We expect our fourth quarter adjusted rate to be between 26% and 27%. Adjusted earnings per diluted share were $0.95 compared with $0.93 in the prior year. Restructuring savings, productivity and lower interest and tax expense more than offset the impact from lower volumes. Slide 7 shows the special adjustments that we recorded during the third quarter. These include special charges of $0.5 million, primarily related to restructuring actions announced earlier in 2014. We benefited from the fact that we were able to sell one of the European facilities in lieu of shutting it down. In addition, we recorded a $2.9 million restructuring charge related to the exit of certain structural landing gear product lines. So overall, for Q4, we anticipate special charges related to restructuring actions to be in the range of $3 million to $3.3 million or $0.11 to $0.12 per share. Turning to our cash flow and debt position on Slide 8. We continue to generate solid cash flow and ended the first 9 months of the year with $36 million of free cash flow. With that, I'll turn it back over to Scott to provide an update on our orders and guidance for the fourth quarter of 2014.

[Scott A. Buckhout:]

Thank you, Rajeev. Let me start by providing an overview of our third quarter order intake as well as current market trends. Let's start with Energy. As a reminder, approximately half of our Energy revenue is project related, which can lead to significant variations in order intake and revenue from one quarter to the next. For Q3, Energy bookings were $198 million, up a strong 18% versus last year and a record high for our Energy business. Bookings at our large international Project business more than doubled versus last year with strong quoting activity and a higher win rate in the quarter. Our upstream North American short-cycle business reported double-digit order growth year-over-year, driven largely by an increase in rig counts. Our Project quoting activity in emerging markets, especially Asia, remained strong. Our win rate has been gradually improving through the course of this year. On the other hand, demand in the North American and European power segments has been weak. In Aerospace & Defense, third quarter orders were down 21% year-over-year to $45 million, driven by the exit of certain landing gear product lines and a tough compare with large platform orders received last year. Looking ahead to Q4. At our large international Project business, we expect the recent strength in orders to moderate due to the lumpy nature of our business, but we do not currently expect any major shift in global CapEx spend in the near term. While quoting activity overall is still good, we expect a moderate decline from recent quarters. Pricing remains positive. In our upstream short-cycle business, we expect the order run rate to be up high single digits due to higher rig counts. Downstream short cycle is expected to remain positive globally, driving solid growth in our instrumentation and sampling businesses. We expect power orders to grow moderately, with strength in Asia projects partially offset by a flat market in North America and Europe. As a final note on Q4, we are closely monitoring our customers' reactions to the recent oil price volatility as well as the timing of large-project delivery dates, which has proven difficult to predict. At this stage, we're not expecting a meaningful change in the trends we're currently seeing in our customer base, but we are prepared to react if it becomes necessary. We expect the revenue from our Energy business will be up nicely in Q4 as we deliver on our backlog. In addition, we expect Energy margins will improve sequentially as a result of increased volume as well as continued savings from restructuring and higher productivity. In Aerospace & Defense, revenue should be in line with last year, with lower sales of landing gear offset by growth in our Defense businesses. We expect margins to be in the mid-single-digit range. Restructuring actions and the exit of landing gear structures are expected to improve margins next year. That brings us to our guidance. We expect fourth quarter revenue to be in the range of $210 million to $225 million, with adjusted EPS in the range of $1.02 to $1.12. I'd like to close by thanking all of you who attended our Investor Day in New York, where we discussed our overall strategy and financial goals. The slides and audio webcast from the day are up on our Investor Relations website. As we discussed, CIRCOR is at an inflection point in its evolution from a holding company to a world-class operating company. We're in good end markets with good products, good brands and a global footprint. We have a strong and experienced team that's committed to delivering on our objectives. We remain focused on growth, margin expansion, cash flow and disciplined capital deployment. With that, Rajeev and I are available to take your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Kevin Maczka with BB&T.

[Kevin R. Maczka:]

Scott, I guess, first question on Energy. Very strong orders in the quarter. It doesn't sound like you're seeing any change in the tone of business or customer behavior as oils come down and now below $80. You just made the comment about you're not expecting trends to change much, but you're prepared to react if necessary. Can you just kind of describe a little bit more about what that means? What kind of reaction could you take if, in fact, things did materially slow?

[Scott A. Buckhout:]

Okay. Yes. I -- yes, there's a number of things that we can do. We have, like any business, we have fixed and variable costs associated with running our businesses, where, if you look at what could happen to us, let's say, oil prices continue to -- or, I'd say, start to come down from where they've been floating here for a little bit, you won't see much change in our large Project business. That -- those -- that spend is committed well in advance, and we wouldn't -- a drop in oil prices today wouldn't lead to a change in demand in large projects for probably 1 year to 1.5 years. That's very different, obviously, on the short-cycle business. If the prices start to come down significantly, you can see rigs start to shut down. As a result, we have the option of reducing headcount. The factories that we have serving this business are really in North America and in China. We can react pretty quickly with headcount changes in both of those parts of the world. We also outsource quite a bit of the machining for that product, which makes it very easy to turn off. When you're -- if we were machining internally, it takes a little bit longer. But when you're doing it outsourced, obviously, you can turn that off pretty quickly as well. So it would really be just flexing the costs down pretty quickly, in line with demand. Having said that, we are -- the prices of oil would have to come down pretty significantly from where they are now before we would expect a real material change in rig counts in North America. So we can get into more of that later if there are more questions on that. But we feel pretty comfortable right now at $85 for Brent, slightly over $80 for WTI. We're not expecting a big change in rig counts in the short term at this price.

[Kevin R. Maczka:]

Okay. And on the projects side, you mentioned some delays there, customer-driven delays, deferred inspections, things like that. We've heard that from some others as well. I assume that has nothing to do with the commodity prices. But can you just talk about what's driving that? Do you expect that to -- is that just product pushing from Q3 into Q4? Our do you expect lengthy delays or perhaps even cancellations there?

[Scott A. Buckhout:]

Yes, so, so far, we haven't had any cancellations that I have, at least, been made aware of. Perhaps something small that I'm not aware of. But we're not seeing any cancellations and really haven't seen any cancellations all year. The delays tend to fall into 2 buckets. One is the project itself is -- has run into difficulty and is delayed. So these are complicated projects, as you know, and these -- the EPCs, there's a sequence of events that has to happen, and they run into problems. The other delay that happens for us is actually good, and that's a redesign or a change in specification that causes the delay but also allows us to charge for change orders and redesigning the product. We tend to have the ability to expand our margins when that happens. But of course, it leads to revenue being delayed out, out farther into the year. So in short, we're not seeing cancellations, and we don't really expect to see cancellations. But we do see delays in both of the other categories that affect the revenue in a current quarter.

[Rajeev Bhalla:]

And Kevin, this is Rajeev. Let me just add to that as well. As you would expect, we do look at this. We do try and anticipate that and put our best judgment in when we give you a guidance range for the quarter from revenues. It's always difficult to nail it down exactly. But that's why there are puts and takes, as you would expect with any forecast. And we apply our best judgment in anticipation of that.

[Operator:]

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

[Nathan Jones:]

I'm sorry if I missed anything. I jumped on a little late. Did the Petrobras project that was delayed in the second quarter ship in the third quarter?

[Rajeev Bhalla:]

Yes, it did.

[Nathan Jones:]

And you're still anticipating the Statoil project shipping in the fourth quarter?

[Rajeev Bhalla:]

We are. Yes, that's still on track, Nathan.

[Nathan Jones:]

And what do you see as -- I know those are pretty large. What's the risk that those could possibly be pushed out into 2015?

[Rajeev Bhalla:]

The -- there's always some level of risk. But we feel pretty comfortable at this stage with respect to those projects we talked about at the end of last quarter's call. You will have some puts and takes at some of the other projects here. But those 3 that we talked about the last quarter are on track. We haven't seen that move at this point.

[Nathan Jones:]

Is that kind of you'll come in at the bottom end of the revenue range if they don't ship and the top end if they do ship kind of thing?

[Rajeev Bhalla:]

That's one way to look at it. Yes, I mean, assuming all else is equal.

[Scott A. Buckhout:]

I think that's -- we put together a fairly detailed list of risks and opportunities when we think about putting the range out there, and those are obviously some of the bigger pieces of that. But there are other components to it, Nathan, as you can imagine.

[Nathan Jones:]

Yes. And you said Project bookings doubled in the quarter. Can you talk about how they're due to sequence shipping?

[Rajeev Bhalla:]

Yes, the usual lead time here, anywhere from 20, 25 to 55 weeks. These have kind of fallen in that -- towards the middle end of that range there. So we'll expect to start seeing that shift towards the back half of next year.

[Scott A. Buckhout:]

So in -- and in addition, so we had good orders on large projects that Rajeev just talked about. We had good orders in short cycle as well, which obviously ships in, say, 1 to 3 or 4 months. So both were up in the quarter.

[Nathan Jones:]

Okay. And Energy margins, obviously, very good. It sounds like you've generally righted the ship there. Things are executing pretty well. Does the focus now turn to M&A, certainly, at least, in that part of the business where -- it certainly would appear that those businesses are ready now to accept acquisitions.

[Scott A. Buckhout:]

I -- here's how I would answer that. We have shifted our attention here at CIRCOR from being, I'd say, passively interested in watching what's happening on in our markets to being more proactive and reaching out and building relationships. So it's a good question. The answer is that, yes, we're spending more time on it. We do have companies out there that look interesting to us that are in pieces of Energy that we'd be very comfortable acquiring and integrating into. Obviously, we don't know if these things will play out in our favor or not. But yes, that is something we're spending more time on now.

[Nathan Jones:]

Okay. And just one on Aerospace. I understand there's some long-cycle business in there. Can you talk about how quickly you can go about rehabilitating the margins in there and whether or not there's legacy stuff that you need to work through before you can really aggressively get after the margin structure there?

[Rajeev Bhalla:]

Yes, the -- you're tipping it on the head with respect to some of the legacy issues here. We've talked about, in the last call and here, you've heard here that we are dealing with some of the operational issues as we go through this. Our expectation is there's a lot that can get done this quarter, which we will work on and move into a much better margin position next year. But it's going to be towards the back end of next year where, we would argue, it's a little more the ship is righted to the point we like. So it's going to take a little longer, but margins will improve next year, as we expect and as we talked about in the last call.

[Operator:]

[Operator Instructions] There are no further questions at this time. I would now like to turn the floor back over to Mr. Scott Buckhout for closing comments.

[Scott A. Buckhout:]

Thank you. I guess, first, I'd like to mention before I close out that we will be presenting at the Baird Conference in a couple weeks. So we'll hope to see you there, and thank you for joining us this morning.

[Rajeev Bhalla:]

Thank you.

[Operator:]

And that concludes our conference call. Thank you for joining us today.