CIRCOR International, Inc.
Q3 2013 Earnings Call Transcript

Published: 31 Oct 2013

[Operator:]

Good day, ladies and gentlemen. Welcome to CIRCOR International's Third Quarter 2013 Financial Results Conference Call. Today's call will be recorded. [Operator Instructions] I'll now turn the conference over to Mr. Dennis Walsh from Sharon Merrill for opening remarks and introductions. Please go ahead, sir.

[Dennis J. Walsh:]

Thank you, and good morning, everyone. On the call today is Scott Buckhout, CIRCOR's President and CEO; Wayne Robbins, President of CIRCOR's Energy Group; and Fred Burditt, 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 Webcast and Presentation section of the Investors link. 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 2012 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, October 31, 2013. 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 EPS and free cash flow. These metrics exclude any pretax special charges, restructuring inventory reserves and intangible impairments. The reconciliation of CIRCOR's non-GAAP adjusted operating income, adjusted net income, adjusted EPS and free cash flow to the comparable GAAP measures are available in the financial tables of the earning's press release on CIRCOR's website. I will now turn the call over to Mr. Buckhout.

[Scott A. Buckhout:]

Thank you, Dennis, and good morning, everyone. Overall, I'm pleased with the financial results the CIRCOR team produced in the quarter. As you know, margin expansion is one of our top priorities. In Q3, we delivered our second consecutive double-digit adjusted operating margin. AOI was 11.1%, up 230 basis points from last year, and 110 basis points sequentially. We saw significant improvements in both the Energy and the Aerospace groups. The main factors driving the improved margins were better pricing, mix and productivity, as well as the recently completed restructuring that was announced last year. Another top priority for us is cash flow. Our focus on working capital, along with strong earnings, helped us deliver free cash flow of nearly $30 million in the quarter. This was up over $10 million from the same period in 2012 and puts our year-to-date free cash flow to net income ratio at 105%. This is a ratio we monitor closely. On the top line, revenues grew 2%, with increases at our Flow Technologies and Aerospace businesses, which offset a slight decline in Energy. The main highlight in the quarter, from a commercial perspective, was our order intake in our Flow Technologies business, which was up 22% versus prior year to a record $79 million. I'll discuss orders across all of CIRCOR in more detail later in the call. During the third quarter, we initiated the first major step of our ongoing simplification process at CIRCOR. This included the 3 restructuring actions we announced on our last call. These actions are intended to reduce complexity, expand margins and better align our businesses with common end markets. We're on schedule with this initiative and expect to complete these actions by Q1 of next year, at which time we will begin to realize the previously announced annualized cost savings of about $4 million. Finally, we recently completed an update of our 5-year strategic plan. Based on that work, we're changing our organizational structure to simplify the way we manage CIRCOR and further align our businesses with end markets. As part of the organizational change, we will consolidate our group structure from 3 groups to 2. Initially, these changes are focused on reducing management layers and combining back-office operations. Our commercial organization will remain unchanged. But over time, we will incrementally align our customer-facing organization by end market rather than the existing internally focused business unit alignment we have today. The first new group will be Energy, which will include all of the businesses from the existing Energy group and most of the current Flow Technologies businesses. The primary markets served in the new Energy group are

[Frederic M. Burditt:]

Thank you, Scott, and good morning, everyone. I will begin with Slide 3, which is a summary of our consolidated results. Scott already provided the high-level overview of our third quarter results, the 230 basis-point improvement and adjusted operating margin to 11.1%. In addition, adjusted operating income was up 28% year-over-year to $23.7 million. Adjusted earnings per diluted share, excluding the impact of special charges, was $0.93, a 22% increase compared with $0.76 last year. And backlog of $446.9 million was up 1%. Now please turn to Slide 4, which provides an update of the restructuring-related charges associated with our 2012 programs that we are now -- that are now complete. The charges in Q3, which wrapped up this program, were $1 million. We expect this program to generate $7 million of annual savings, with approximately $1.6 million benefiting our Q3. Slide 5 outlines the impact of the program's launch last quarter. We expect that the total charges relating to this restructuring will be in the range of $8.3 million to $9.1 million, with 20% being noncash and 80% being cash. About $1.4 million was recorded in Q3, and about $2.7 million to $3 million is expected to be recorded in the current fourth quarter. The anticipated annualized savings will be in the range of $4 million, beginning in the first quarter of 2014 with a full run rate beginning in the second half. As Scott reviewed, we are now seeing new organizational changes that will benefit CIRCOR annually by approximately $5 million. The cost to achieve this will be approximately $2.6 million to $3 million, which will be recorded as special charges in the fourth quarter. Related to this, we will also be moving to 2 reporting segments in the fourth quarter, aligned with this new group structure. We will report our fourth quarter earnings and our 2013 10-K in this new format early next year. With that, let's move to the segments, with Energy on Slide 6. Energy revenues of $108.4 million for Q3 decreased 1% year-over-year. This was driven by reductions in the North American distributed valves market, as rig counts are down year-over-year, partially offset by growth in large international projects. The segment's adjusted operating margin was a very strong 17.1%, up from 14% in the third quarter of 2012, primarily driven by improved pricing and favorable order mix within our large international projects business, Brazil restructuring benefits and reduced operating expenses, partially offset by lower shipment volume and the associated leverage. For Flow Technologies, turn to Slide 7. Revenue was $69.8 million, up 3% year-over-year, due to contributions from power and instrumentation, as well as favorable foreign currency fluctuations. Flows' third quarter adjusted operating margin was 13.6%, up from 13.1% last year, primarily due to improved volume, associated margins and favorable pricing, partially offset by sales and marketing growth investments. Now Aerospace on Slide 8. Revenues of $36.4 million were up 15% from prior year, with strength in most of our markets, as well as favorable foreign currency fluctuations of 2%. Aerospace margins in Q3 were 11.3% compared with 4.2% in Q3 of 2012, due primarily to increased volume and savings associated with the California restructuring. Slide 9 shows our consolidated P&L. I'll comment on special charges and the tax rate. In Q3 of this year, we recorded net special recoveries of $200,000. This is composed of special charges of $2.9 million, primarily associated with our restructuring discussed earlier, offset by a gain of $3.1 million from the settlement of a prior acquisition purchase price dispute. The tax rate for Q3 was 21.7% compared with our tax rate of negative 92.8% from the same period of 2012. Excluding the impact of restructuring charges, the comparable tax rate for last year would've been 20.9%. We anticipate our fourth quarter tax rate to be approximately 29%. Now turning to Slide 10. During the third quarter, we generated a positive $29.6 million in free cash flow, which put us at $40.2 million year-to-date. With that, I'll turn the call back to Scott who will give us an update on orders and our guidance for the fourth quarter.

[Scott A. Buckhout:]

Thank you, Fred. Before I get into our guidance, let me start by giving you a quick overview of our third quarter order intake, as well as current market trends. Let's start with Energy. Incoming orders were $101 million in the quarter, down 14% year-over-year, primarily due to lower orders in our large international projects business. The trends we discussed last quarter in this business continued through the third quarter, including delayed decisions on large projects despite strong quoting activity. Overall, our win rate remains unchanged, and we did not lose any major project proposals. As we enter Q4, we're not seeing a meaningful change to this trend, which is increasing price pressure on some of the larger project proposals. However, despite a somewhat stagnant environment today, we remain optimistic about an increase in activity in 2014. In our short-cycle business, the market demand has played out as expected. Orders were slightly down versus prior year, driven largely by rig counts. As with our large project business, we did not anticipate a meaningful change in our order run rate before the end of the year. We expect modest growth to resume in 2014. In Flow Technologies, orders were up 22% to a record high of over $79 million in the segment, with strong contributions from most end markets. Strength in Flow Technologies orders included a large project order for the Australian Ichthys LNG project. Products include valves and instrumentation along with our proprietary gyro lock fittings. In the offshore Oil and Gas segment served by our Flow Technologies businesses, we are seeing an ongoing shift to higher strength alloys to improve service life. We expect this trend to support solid demand levels into 2014. In Aerospace, orders were up 2% year-over-year to $44 million. This was due to modest growth in most end markets that we serve. That brings us to our guidance for the fourth quarter. Based on our end market assumptions, we expect the fourth quarter revenue will be in the range of $222 million to $228 million, which represents organic growth between 10% and 13%. We expect to report adjusted EPS in the range of $0.88 to $0.95, which represents year-over-year growth of 29% to 40%. Overall, we feel good about the quarter we just delivered, as well as our outlook for the remainder of the year. We have a solid foundation in place at CIRCOR, with exposure to good end markets and significant opportunity to improve our performance on our top 3 priorities

[Operator:]

[Operator Instructions] Our first question comes from Nathan Jones with Stifel, Nicolaus.

[Nathan Jones:]

I guess I'll start with probably the one weak area that's obviously out of your control, which is the long cycle Energy business. Continued to see orders decline throughout the year there. Can you give us any more color on your expectations, particularly on the long cycle Energy business for when we might see some movement on release of these projects?

[Scott A. Buckhout:]

Yes, Nathan, I think the way to think about it -- this is a very lumpy business for us. We can have quite large orders that can fundamentally change that year-over-year percentage. So I want to be careful with how I answer your question. We -- up to this point in the quarter, we're seeing, I'd say, slightly better traction than we saw last quarter. But I'm reluctant to tell you that the -- we're going to see a meaningful inflection point this quarter versus last quarter based on our 1-month track record here. So we are more confident about next year. We aren't seeing the orders that we've quoted dropping out of our pipeline. We just continue to see them get delayed. So I'm more optimistic about Q1 and Q2 in this business than I am about this current quarter. But we are seeing a little bit better traction so far here in October.

[Nathan Jones:]

Okay, but -- and I mean, I think with that business, I mean quarter-to-quarter, is not really that relevant. But you do feel like these orders are likely to be released maybe in the first half of next year?

[Scott A. Buckhout:]

That's the right -- yes, I think that's the right way to say it, Nathan.

[Nathan Jones:]

And -- on the Flow Technologies orders, I think you said that was a record quarter for that. Is -- were there some large, discrete orders in there that you wouldn't expect to repeat? Is this kind of an order level that we shouldn't be expecting to continue? Or is this kind of an order level that we should be expecting to continue?

[Scott A. Buckhout:]

I think that -- okay, so I'll answer both -- 2 questions there. The first is, yes, we did have a large order in the $5 million range. This was the Australian LNG project that we received our first initial order for in the quarter. But you can see from the improvement year-over-year, it wasn't all that project. We also anticipate that, that project is going to continue to drive strong orders. So we're in now, we received, I'd say, our first initial order, and that will continue over the next 12 months. So I think the rate you're seeing might come down a little bit. But we expect ongoing strength in this business. So from a sequential basis, I would expect maybe slight moderation as we close the year and go into early next year, but ongoing strength.

[Nathan Jones:]

Fair enough. And if I could just get one more in on the restructuring benefits, incremental restructuring benefits we should be looking at next year. I wonder if you could break out, maybe between the 3 different programs, what the incremental benefit in '14 will be versus '13?

[Frederic M. Burditt:]

Yes, this is Fred. Yes, the -- the one we -- the organizational change we just announced, that's approximately $5 million. We'll get the full benefit of that next year because we're taking those actions in Q4. As it relates to what we announced last quarter, which is around $4 million annually, we will get close to half of that next year. Again, the biggest savings is in -- is the downsizing of our Newark facility, and that should be completed the end of the first quarter going into the second quarter. So we'll get probably a little more than half of the $4 million next year. And we certainly have carryover -- the $7 million, we'll probably have at least close to -- I would say $3 million of that will be a carryover next year. So those are the 3 big chunks.

[Operator:]

Our next question comes from Matt Summerville with KeyBank.

[Matt J. Summerville:]

A couple of questions. First, just on your Aerospace segment, can you guys bridge both year-over-year and sequentially kind of the buckets that are driving the margin improvement there? And then Scott, do you feel like a double-digit margin rate from here looking forward is sustainable in Aerospace? Or was there something timing-related that maybe helped out a bit?

[Frederic M. Burditt:]

Yes, I'll start with the first part for you, Matt. On a year-over-year basis, it is primarily volume that is the first issue. We had increased volume year-over-year in that business. And it's got a pretty good improvement. We have had -- we had very good mix as it relates to programs. And thirdly, we had about $800,000 on the restructuring, which is on a year-over-year basis, was -- benefited us. And I would say most of that is also true if you look sequentially. Again, the mix was very positive, volume and we had more savings from the restructuring project.

[Scott A. Buckhout:]

I think to answer the second part of your question on whether double-digit is sustainable, you go through the 3 things that Fred just mentioned. Certainly, 2 of the 3 are not going to change as we go forward. So the restructuring savings will still be there. We don't expect volume to drop off in any meaningful way. I think the unknown on the margin would be the mix, the mix between the Flow control, actuation and landing gear, which could have an impact on margin. But we're not anticipating that the margin is going to somehow go down to single digits.

[Matt J. Summerville:]

And then, Scott, you mentioned, you've sort of recast CIRCOR's longer-term business plan. You mentioned one of the cost levers with this upcoming reorg from 3 to 2 businesses or 2 segments. I guess, what are you looking at from -- if you kind of bucket things from a cost perspective beyond this latest $5 million, how much more is there to come in your mind over the next 24 months?

[Scott A. Buckhout:]

Okay. So I think the right way to answer the question is to maybe talk about how we compare to our peers. If you look at CIRCOR's OpEx as a percentage of sales, we're somewhere between 21% and 22%. If you were to aggregate up all our peers and look at their average, they're probably running somewhere around 16%. I haven't seen anything specific about CIRCOR that would suggest that we need to be 5 or 6 points higher than our peers in OpEx. So I wouldn't say that, that's a 24-month outlook, Matt, but I would say that our goal is to get our OpEx directionally in the same range as our peers. But I wouldn't say that's going to happen in 24 months.

[Operator:]

[Operator Instructions] Our next question comes from Kevin Maczka with BB&T Capital.

[Kevin R. Maczka:]

Similar question in terms of margin sustainability, but on the Energy side. We haven't seen 17% margins there in a long time. That's up 310 basis points year-over-year, but really even more than that if we back out a favorable adjustment from last year. So I'm just wondering can you say a little bit more there? I think you mentioned price, you mentioned mix. I know price, you've been talking about that getting a little bit better, but not dramatically so. And I'm just wondering if you can dig a little bit deeper there and, again, with a focus on sustainability and what we should expect?

[Frederic M. Burditt:]

Sure, Kevin, this is Fred. The 3 big drivers were, as you -- as I said and as you heard, is definitely price in the backlog and project mix in the backlog for the project business, plus about $800 million -- actually, about $1 million of savings from the Brazil project. And I want to clear up some -- maybe some confusion on pricing. Our price as it relates to shipments has been down. I mean, it came back obviously last quarter, but the pricing in our backlog recovered really at the beginning of this year and the end of last year. So the backlog pricing is good in the project business. And obviously, you're seeing that as we're now shipping that backlog. And we would -- we anticipate that Q3 will be another strong -- excuse me, Q4 will be another strong quarter. So I think that maybe there's been some confusion on the price piece.

[Kevin R. Maczka:]

Okay. But I mean, it sounds like your message, as it relates to price and mix, is obviously very favorable this quarter, but that mix is something that we always have a hard time really knowing and you have a hard time guiding. But how should we be thinking about that? Because it seems like with the huge gains we saw in both Aero and Energy, that was a real -- one of the primary contributors?

[Frederic M. Burditt:]

Yes. And it is -- as you say, it is -- it moves quarter-to-quarter. So in the Energy project business, for example, spares is a big part of the mix, so we had good spares shipments in the quarter. And we had some good -- yes, we had some good projects that shipped.

[Wayne Foster Robbins:]

Kevin, this is Wayne Robbins. The other thing, of course, is late last year, when all these orders were coming in and the activity was very strong, and we did -- were able to get some additional price. As Scott alluded to, projects are being delayed, that's adding some price pressure. So it may not be quite as favorable from a price standpoint, but we've also taken and done a lot of cost out in the Energy side of the business, and we'll continue to do that. So the margins will go up and down, as you suggest. It's a much better business this year than it has been historically.

[Kevin R. Maczka:]

And can you comment, Wayne, on the short-cycle side as well? I know you've made operational improvements there. Have you been able to take share? Is it -- are you seeing the same favorable price trend on that side as well?

[Wayne Foster Robbins:]

There's some -- I would say, that's flat. And I think that is also impacting our price a little bit, I wouldn't say, significantly. We are -- I don't know that we have taken share. I think that's an opportunity for us going into the future. So I think we've been riding basically the way that the rig counts has been going up and down for the moment.

[Kevin R. Maczka:]

Okay. And then on Flow Tech, as I look at your comments here on Page 12, a lot of commentary here about delays and uncertainty and limited recoveries. But yet, your commentary on the orders being a record and being fairly broad-based, excluding the one big order, sounds better than that. I'm just wondering if you can sort of square that for me?

[Wayne Foster Robbins:]

Yes. I think there's 2 elements there. We've been talking about the investment in the Power side. And from a sales standpoint, we're seeing some of that result in some additional volume on Power. But also, this cycle where that group comes in the project business is later than, say, our Ball Valve business. They're both on platforms, but the HOKE product tends to come a little bit later in that cycle. So they're seeing that uptick in volume that we saw in the project business late last year from an order entry standpoint. So it's a slightly different cycle time for that business.

[Operator:]

[Operator Instructions] It seems there are no further questions at this time. I will now turn the conference back over to Mr. Buckhout for closing remarks. Thank you.

[Scott A. Buckhout:]

Okay. Thanks, everyone, for joining the call. I hope we'll have good participation in May at our Investor Day. Please hold the day and more details to come on the day. Thank you for your time.

[Operator:]

Thank you. This concludes today's conference. All parties may disconnect. Have a great day.