CIRCOR International, Inc.
Q3 2015 Earnings Call Transcript

Published: 9 Nov 2015

[Operator:]

Good day, ladies and gentlemen. Welcome to CIRCOR International's Third Quarter 2015 Financial Results Conference Call. Today's call will be recorded. At this time, all participants have been placed in a listen-only mode. There will be an opportunity for questions and comments after the prepared remarks. I'll now turn the call 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 & Presentations section of the Investors link. Please turn to slide two. Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors, the company advises you to review CIRCOR's Form 10-K, Form 10-Q 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, November 9, 2015. 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 non-GAAP metrics exclude any pre-tax 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 three.

[Scott A. Buckhout:]

Thank you, David. And good morning, everyone. During the third quarter, we demonstrated good progress on our margin improvement strategy as we continue to face macroeconomic headwinds. We delivered revenue of $160 million at the midpoint of our guidance range and our adjusted earnings per share came in at $0.64 at the high end of our guidance range. We delivered strong year-over-year sales growth in our large projects business, especially in the Middle East, and higher sales of control valves including sales to the U.S. Navy. But that was more than offset by the continued and significant decline in our North American short-cycle distributed valves business. In addition, the completion of a large instrumentation and sampling project in 2014 adversely impacted the comparison to this year. Aerospace & Defense sales were down year-over-year, primarily due to push-outs of large military programs, most notably the F-35 as well as the residual impact of exiting the structural landing gear product line last year. Today, we announced that we will be closing our manufacturing operation in Brazil. While results have been inconsistent, the Brazilian manufacturing facility has realized significant losses since it was acquired in 2011. The Brazil operations' operating loss was approximately $5 million in 2014. We anticipate a similar loss in 2015. We began curtailing business operations in Brazil in the fourth quarter of last year, and the underlying market conditions that led to that curtailment have continued to deteriorate. This closure permanently removes a high-cost, negative margin business from the CIRCOR footprint and puts us another step closer to achieving our long-term margin targets. We expect to complete the exit before the end of the first quarter next year. As a result of this closure, we recorded $16.9 million of special restructuring charges during the third quarter. Rajeev will provide more color on these charges later in the call. Going forward, we intend to maintain our small sales office in Rio de Janeiro to continue our relationship with Petrobras and other Brazilian customers. Any orders from Brazil would be shipped from our Milan or Oklahoma City facilities, which are both qualified by Petrobras. During the quarter, we made substantial progress in the integration of our Schroedahl acquisition, and we're now beginning to capture new business, especially in the North American power generation market. We continue to expect that in year one, our return on invested capital will exceed our cost of capital, and that Schroedahl will be EPS-accretive. Our simplification and operational excellence priorities remain on track. Last quarter, we announced the closure of one of our two California manufacturing facilities as an important part of our effort to improve Aerospace & Defense margins. The plan is on track and we continue to expect to exit this facility by the third quarter of 2016. The annualized savings from this project are expected to be approximately $3 million, beginning in the second half of 2016. We're still on track to recognize savings of $10 million in 2015 from the restructuring actions we announced earlier this year, with annualized savings of $15 million. On the operational excellence front, we are methodically improving our key operating metrics across CIRCOR. For example, our customer on-time delivery is now at 90%, compared to 86% in the last quarter and 73% last summer. In addition, our Strategic Sourcing team has delivered savings of 2% net of inflation year-to-date. Now, I'll turn the call over to Rajeev.

[Rajeev Bhalla:]

Thanks, Scott. Before I get into the segment numbers for the third quarter, let me start by providing you with some additional detail on Brazilian-related special and restructuring charges. In total, we recorded $16.9 million in charges, of which approximately $11 million are non-cash. These charges included the write-down of fixed and intangible assets, an estimate for potential claims, and the revaluation of inventory to its saleable value. We expect to record an additional $2 million of closure-related expenses, primarily severance and shutdown costs, between now and the end of the first quarter 2016 when we expect to have exited the facility. In addressing the deteriorating economic environment in Brazil, we performed additional audit procedures in the third quarter and concluded that the previously reported operating income for the second quarter this year was overstated by $2.5 million. This was primarily due to an overstatement of certain Brazilian taxes, such as the value-added tax, that we assumed would be recovered upon sale of our product. Accordingly, this morning, we filed an amended Form 10-Q for the second quarter of 2015. In performing our audit procedures, we also reevaluated our internal controls for the Brazil business to better understand the root cause of the misstatement. We found that the local management team was not adhering to our established control policies and procedures and as a result, determined that we have a material weakness with respect to the Brazil control environment. We're working to remediate this weakness until the facility is closed in the first quarter of next year. We are pleased to put this behind us and to move forward without the negative effect on earnings from this business. Now, as a reminder, we have excluded last year's divestitures in our year-over-year comparisons for both segments. Let's start with Energy on slide 4. Energy sales of $123 million decreased 16% over the prior year. We delivered strong year-over-year sales growth in our large projects in control valve businesses, especially into the power generation market. But that was more than offset by the continued and significant decline in our North American short-cycle distributed valves business. We saw a 54% decline in short cycle sales compared to the prior year, as bookings were lower by over 60%. Energy's adjusted operating margin decreased 210 basis points year-over-year to 15.4%, but was up sequentially as our restructuring and cost-cutting initiatives helped to minimize the impact on margins from lower volumes. We continue to take strong actions to mitigate the margin erosion from lower distributed valve sales. For Aerospace & Defense, please turn to slide 5. Aerospace & Defense sales of $36 million decreased by 10% organically, in part due to a difficult comparison to 2014 when we completed certain UK Navy deliveries. As Scott mentioned, the decline was also due to push outs of certain large military programs, most notably the F-35, and the residual impact of exiting our structural landing gear product lines. Aerospace & Defense adjusted operating margin of 9.1% increased 510 basis points year-over-year and 30 basis points sequentially, driven by ongoing operational improvements and the benefit of exiting the structural landing and product lines. We remain on track to exit the year with double-digit margins. Turn to slide 6 for selected P&L items. In the quarter, we recorded special and restructuring charges totaling $19.7 million. Excluding Brazil, special and restructuring charges relate to continued reductions in workforce and acquisition-related amortization expense. Our tax rate for the third quarter was significantly higher due to the charges taken for the closure of a manufacturing facility in Brazil. As you may know, we do not get a U.S. deduction for the losses from our Brazil business. Excluding all of the results from the Brazil business, the adjusted tax rate for the quarter was 28%. We expect our fourth quarter tax rate to be in the range of 28% to 29%. Turning to our cash flow and debt position on slide 7. During the quarter, we generated $2.2 million in free cash flow, below our expectations as a result of increase in working capital, especially inventory. Two important factors impacted inventory. First, availability of product for smaller book-and-ship demand has become the most important factor in taking share in our North American short-cycle business. We're adapting to this new reality by strategically holding inventory apart ready for rapid delivery. And second, due to strong orders for long-cycle project in the first half, we increased work-in-process inventory for projects that will ship in the fourth quarter and next year. Therefore, the combination of the current short-cycle market dynamic, focus on availability and the ramp-up of engineered products led to lower cash flow in the quarter. With that said, we remain focused on improving our working capital position and driving better free cash flow going forward. That brings us to our fourth quarter guidance. Please turn to slide eight. Given our backlog in the large project and control valve businesses and considering the market dynamics in our short-cycle book-and-ship businesses, we expect revenue to be in the range of $155 million to $170 million. We expect adjusted EPS in the range of $0.58 to $0.68 per share, reflecting the benefit from cost reductions, restructuring actions and productivity. For Q4, we anticipate special charges to be in the range of $3.5 million to $4 million or $0.18 to $0.20 per share. In addition, our guidance reflects currency headwind of $9 million on revenue and $0.06 per share on adjusted EPS. With that, let me turn back over to Scott.

[Scott A. Buckhout:]

Thank you, Rajeev. Let's start with an overview of our current market trends for Energy and Aerospace & Defense. First, Energy. As a reminder, about a third of our consolidated revenue last year was in the upstream oil and gas segment. This includes most of our distributed valve and international project businesses, as well as part of our instrumentation and sampling business. Energy segment orders were lower in the quarter primarily due to the continuing decline in our upstream North American short-cycle business, as well as lower large project bookings. In our short-cycle distributed valve business, distributors continue to carry a significant amount of product on their shelves with a goal of substantially reducing that inventory. We expect that destocking will continue to have a negative effect on our fourth quarter bookings and that our order run rate will not improve over the third quarter. As a result, we anticipate North American short-cycle orders in Q4 will be down about 60% from a year ago. This market continues to value inventory and availability and rapid delivery, so we are responding accordingly. In addition, we're starting to see pricing pressure in this market that we were not seeing in prior quarters. We anticipate this will increase over time with ongoing market weakness. Within our long-cycle project and instrumentation and sampling businesses, we're seeing delays to major projects as the oil majors continue to reduce capital expenditures. As you know, large project orders are lumpy and a number of orders that we had expected to book in the third quarter shifted out of the quarter. Despite this overarching trend, quoting activity for projects in the Middle East continues to be strong. The North American large gas pipeline projects are still progressing as companies execute their firm backlogs. In addition, the approved LNG projects are proceeding. However, in the downstream oil and gas sector, we're seeing lower CapEx spend with the oil majors. We continue to see pricing pressure in our large project business, as discussed in previous quarters. In power, we're seeing good quoting activity in both North America and the emerging markets of Southeast Asia and China. Control valve orders in power were a bright spot in the quarter. We expect continued demand in Q4 in the power and process markets, with some moderation in industrial markets. Aerospace & Defense orders were lower year-over-year as a result of a number of defense-related programs being pushed out. However, we did see higher orders for our fluid control products sold into the commercial sector. In Aerospace & Defense, as our operations continue to improve, we're focusing more on growth. We're bidding on a number of large military and helicopter programs. We're seeing improved growth in our MRO business, resulting from dramatically improved turnaround times. In addition, we're developing a number of exciting new products for both the commercial and defense markets. Before concluding our prepared remarks, I want to take a moment to thank Jerry Brady for his more than 12 years of service on our Board of Directors. As you may have seen in the press release we issued this morning, Jerry will be retiring from the Board of Directors at the end of this year. While we will miss Jerry and wish him well in his retirement, we're excited to welcome Helmuth Ludwig to the board at the beginning of next year. Helmuth brings a wealth of global experience and a keen understanding of IT and manufacturing environment. During his career as Siemens, he's also had significant success in integrating and simplifying complex global organizations. We look forward to having him on our board. Let me sum up by leaving you with three important points. First, we continue to make excellent progress on our margin expansion initiatives across CIRCOR. In Aerospace & Defense, adjusted operating margin was up 510 basis points from prior year and 30 basis points from the prior quarter to 9.1%. This solid ongoing expansion reflects the success of our operational improvements and restructuring efforts. We remain on target to achieve our goal of double-digit adjusted operating margins by the end of the year. In addition, our Corona, California restructuring project is on track and we expect to reap the benefits of that effort in the second half of 2016. Our margin improvement initiatives in Energy are yielding positive results, offsetting much of the margin erosion from the decline in our short-cycle distributed valve business. Our adjusted operating margins in the Energy segment are up sequentially to 15.4% on lower revenue. We continue to align the size of our operations with market demand. We've reduced the workforce in Energy by approximately 25% from the beginning of this year. We'll continue to take smaller, incremental actions in response to changes in the market as necessary. Second, we're increasing our focus on cash flow as we implement a more robust sales, inventory and operations planning process to improve the flow of product through our factories. And third, despite the downturn in the energy markets, we continue to invest in long-term growth across CIRCOR. We're investing in new products, improving customer service, realigning our global sales team and selectively increasing our engineering capacity and capability. On the M&A side, we're actively working on a strong pipeline of opportunities. Going forward, we continue to focus on creating long-term shareholder value by investing in growth, expanding margins, generating strong free cash flow and being disciplined with capital deployment. With that, Rajeev and I are available to take your questions.

[Operator:]

Thank you. We will now be conducting the question-and-answer session. Thank you. Our first question comes from the line of Charley Brady with SunTrust. Please go ahead with your questions.

[Charles D. Brady:]

Hi. Good morning, guys.

[Scott A. Buckhout:]

Hey. Good morning, Charley.

[Rajeev Bhalla:]

Morning, Charles.

[Scott A. Buckhout:]

Hey. Welcome back.

[Charles D. Brady:]

Thanks. Thanks. Good to be back. Hey, just on the pricing pressure, can you elaborate a little bit more about that? You said you're starting to see pressure, I guess it was in short-cycle, you haven't seen before. Can you give us maybe an order of magnitude on that? And on the large project side, that pressure that continues, has that gotten stronger pressure or is it kind of level it's been?

[Rajeev Bhalla:]

Yes. Let me take that, Charley. We saw about 90 basis points to 100 basis points of pricing pressure in the third quarter, both kind of from an engineered valve and a distributed valves perspective. A little bit more on the distributed valves than what we've seen in the past. And as we look ahead, we're anticipating 100 basis points to 150 basis points again on both the engineered valves and the distributed valves, probably a little more biased towards the engineered valves as we go into fourth quarter here.

[Scott A. Buckhout:]

Where we're seeing the – let me just add to that, where we're seeing the pressure in distributed valves is really where we are quoting projects through the distributors. So, the normal book-and-bill fast-turn, we're not seeing it as much there, but when we do have projects that we quote to the distributors, we're seeing some pressure there that we haven't seen in the past.

[Charles D. Brady:]

Okay. That's helpful. Thanks. And just switching gears on the Aerospace & Defense, can you give us some indication of the specific projects that you guys are bidding on, on Aerospace & Defense?

[Rajeev Bhalla:]

Sure. Yeah. Let me take a crack at that. The three big ones that we're going after, these are both a combination of some new business as well as kind of recurring business and new lots. The first is the F-35 that we mentioned, the Joint Strike Fighter, getting the additional orders not only through the low-rate initial production lot number nine, but also if we get into lot 10, which that is going to be clearly next year. The other two programs that we're looking at relate to the P-8, the multi-maritime aircraft program. And then also on the UAVs side with the Predator and a handful of missile programs as well, the SM-3 including in that. So those are the key programs.

[Charles D. Brady:]

All right. Thank you.

[Operator:]

Our next question comes from the line of Nathan Jones of Stifel. Please go ahead with your question.

[Nathan Jones:]

Good morning, guys.

[Scott A. Buckhout:]

Good morning, Nathan.

[Rajeev Bhalla:]

Good morning, Nathan.

[Nathan Jones:]

If we could just, I guess, talk a little bit more about Brazil. I mean, I know, Scott, pretty much since you got there, you'd been talking or you have been talking about the fact that you thought that was a strategic mistake to buy that business in the first place. Can you talk about how you're thinking about balancing the short-term softness there versus the long-term need to serve Brazil? And this was just a – you've got to the point where you couldn't see a path to profitability for that business?

[Scott A. Buckhout:]

Right. Yeah. So, I think the way this – maybe the best way to describe it is, we have really three channels into Brazil that we – how we get into Brazil. One is with our engineered valve business through Milan. The second would be the distributed valve business from North America. Both of those export into Brazil. And then, the third is our local business based in Piracicaba, north of São Paulo. The local business is the one that we've been talking about here. That was acquired in 2011. It has been through, I'd say, difficult times from the very beginning. It is a business that sells largely commoditized valves. It is a lower end, we'll say, scope of products, Gate, Globe, Check Valves and Butterfly Valves. These are valves where you're basically competing on price, so you're competing with local players as well as low-cost imports in Brazil. So, we were at a structural disadvantage really from the very beginning with this business. If you go back a couple of years to two-and-a-half years ago, we had some inconsistent results. We did a lot of work on – we closed down a foundry. We re-laid out the factory, and we got the business to where it was slightly above breakeven at the end of 2013 and early 2014. But as everybody knows, with the market turmoil there starting really at the end of last year, the outlook is just deteriorating pretty significantly here. So, we had a problem from the beginning really with the types of product that we were selling in that business and then with the changes with our largest customer, Petrobras, and the change in the market there, we just don't see a long-term viable, growing, profitable business there. So, we made the decision that now is the time to get out.

[Nathan Jones:]

So, you'd still stand to supply the distributed valves and the engineered valves, just not from within Brazil. Is there any issue there on the local content rules?

[Scott A. Buckhout:]

We've actually done quite a bit of work on that. What we've learned is that where you run into issues with local content is when you have competitors locally. And what we find is that our business in Milan generally does not compete with local players in Brazil. We compete with the other large, highly engineered companies that you all know. So, we haven't had trouble selling those products into Brazil just for that reason. With the Oklahoma City business, probably we'll have – could run into some issues there with local content, but it's really all upside for us. We have distributor partners down there who represent us that we will seek to improve our relationships with now that we're getting out locally. So, we could have some issues there, but at the end of the day, it's really just going to be upside to this business in Brazil. It's incremental for us.

[Rajeev Bhalla:]

Let me just add one thing as well, Nathan. On the engineered valves, recognize that our goal here is to sell to those EPCs that are viable and that I can collect my receivables from. So, whether it's a South Korean or French EPC, that's who we'll be dealing with for Milan product.

[Nathan Jones:]

Got you. And just on the sourcing, Scott, you noted that you've been 2% net of inflation this year. I think when we've talked about this in the past, you set that as more of a long-term goal, but thought given the immaturity of that organization at CIRCOR that you would be able to drive above that for a while. Are we still on the ramp-up phase here and perhaps you would expect a higher number to come out of 2016?

[Scott A. Buckhout:]

Yeah. I think – well, I guess there's a couple of things happening. One is, we are – it's still in the ramp-up phase. So, we are still doing a lot of work on supplier consolidation that of course will help drive that number. But also, remember, volumes are down year-over-year fairly substantially right now. So, it's a little bit easier for us to drive higher numbers when volumes are growing and increasing as opposed to going down. So, it's a little bit of both. I'd say it's a little bit of – we're still ramping up the organization here. But also in the face of a downturn, it's a little bit harder to drive that net number.

[Nathan Jones:]

Okay. Thanks, guys.

[Scott A. Buckhout:]

Thanks, Nathan.

[Operator:]

Our next question comes from the line of Kevin Maczka with BB&T. Please go ahead with your questions.

[Kevin Richard Maczka:]

Thanks. Good morning.

[Scott A. Buckhout:]

Hey. Good morning, Kevin.

[Kevin Richard Maczka:]

Can I first touch on the Q4 guidance? So, at the high end, it looks like sales and earnings, you think, could actually be a bit better than we saw in Q3. And from your commentary and what we're seeing in Energy, of course, some of the pressures there related to price and CapEx budgets are getting more difficult. And your orders declined sequentially. I'm just – I'm wondering what gets better in Q4? Is it a matter of timing and maybe there's some projects that are expected to ship here and then maybe it softens in the first half? Can you just give a little more color around that issue?

[Rajeev Bhalla:]

Sure, Kevin. Let me start, and I'm sure Scott will chime in as well. If you look at the high end of our guidance range, it does include a number of orders especially in the engineered valves, the large project side that we expect to deliver in the fourth quarter. So, that's a sequential benefit that's being driven by our engineered valve. So, this is firm backlog that we need to execute on and we put a range in because there's always timing issues here with respect to customer acceptance and delivery there. But that is a key driver. And with that obviously comes better margins. So, those are key drivers there. Going the other way is obviously the distributed valve short cycle side of the house where, as we noted, we expect to see a decline, not only sequentially, but year-over-year as well.

[Scott A. Buckhout:]

So, I would add just a little bit to that. In control valves that we have, particularly into power, is one of the bright spots that we have. So, we have some momentum going into Q4 and we have a backlog that we're pretty confident in going into Q4. So, we'll see sequential revenue growth in control valves from Q3 to Q4. I'd say there's sequentially – there's a little bit of upside in instrumentation and sampling as well on a large project, the Johan Sverdrup project, we're expecting to start shipping in Q4 as well. So, we have some fairly, I'd say – we're fairly confident in the backlog going into Q4 such that we feel pretty good about the revenue number right now. The real unknown, of course, is distributed valves and I think we're being reasonably conservative with what we see there right now.

[Rajeev Bhalla:]

And let's not forget, we do expect to see much improved markets out of our Aerospace & Defense business here sequentially as well, Kevin.

[Kevin Richard Maczka:]

So, the Aero margins sequentially get much better, embedded in your guidance, can you hold the 15.4% or something close to that in Energy sequentially? Because I think, Rajeev, did you say there's about 150 bps of new pricing pressure coming in Q4?

[Rajeev Bhalla:]

That's right. So, that's what we'd expect to do as the restructuring, productivity and cost reduction actions continue to kick in. So, that's what we're driving for, Kevin.

[Kevin Richard Maczka:]

Okay. Got it. And separately, can you just maybe summarize all of the structural cost actions that you've been taking and expect to continue taking? What is the total net structural savings, if you will, that you expect to realize this year? And what all is incremental that we should be expecting next year? I know you mentioned some of the California restructuring that benefits the second half. And of course, you're no longer going to have these Brazil losses. Can you just sort of summarize 2015 and 2016 from that standpoint?

[Scott A. Buckhout:]

Sure. Let me jump in and, Rajeev, you can help if you want. You can jump in as well. If you look at the $15 million of run rate restructuring savings that we've executed on this year, so $10 million in the year, about half of that would be structural savings and about half of that would be volume-related that you would expect the cost to come back when volume comes back. Then if you – you can add Brazil on to that, and, of course, that's structural, that's savings or we'll say earnings improvement that is independent of volume. And then I think you can add the full amount of the Corona restructuring as well as structural to the number.

[Rajeev Bhalla:]

So, if you look at, for 2015, clearly, the Corona – the Brazil offering loss is not in that number, so there's about $12 million and as Scott said, half structural, half volume. As I look at 2016, all else being equal, the total there, including the Brazil loss of $5 million, is close to $13 million. So, you have the incremental $5 million out of the 2015 actions. You'll have $2 million to $3 million out of the closure of the California manufacturing, plus the Brazil loss. So, there's an increment of $13 million there.

[Kevin Richard Maczka:]

So, incremental in 2016 is about $13 million?

[Rajeev Bhalla:]

Correct.

[Kevin Richard Maczka:]

Okay, got it. Thank you.

[Rajeev Bhalla:]

No problem.

[Operator:]

The next question comes from the line of Joe Radigan of KeyBanc Capital Markets. Please go ahead with your question.

[Joe K. Radigan:]

Thank you. Good morning, guys.

[Rajeev Bhalla:]

Good morning, Joe.

[Joe K. Radigan:]

As you look into next year, sort of based on what you're hearing in the marketplace and some of that quoting activity that you're seeing, what are you assuming for global CapEx spending year-over-year? I think you came into this year thinking it was going to be down 20%. I mean, are you anticipating a similar decline or have things started to stabilize, do you think?

[Scott A. Buckhout:]

So, I think that, yeah, we came into this year thinking global CapEx spend would be down around 20%. I think we were optimistic that it would be 15% earlier in the year and I think we've kind of concluded it's around 20% this year. We're in the middle of budgeting for next year right now. We're expecting it gets worse next year, probably an incremental 10% of CapEx down again next year. At least that's how we're thinking about our budgeting process for next year. If you think about the short-cycle business, specifically going into next year, right now, we're assuming at least early in the year that the market is – we're not going to see a recovery here in the short term.

[Joe K. Radigan:]

Okay.

[Rajeev Bhalla:]

We'd expect to see the run rates – the run rates that we see out of our distributed valves that we're seeing now, we do expect to continue at least into the first half of next year.

[Joe K. Radigan:]

Okay. And then, Scott, I think you mentioned that you're seeing some delays in projects. I think it was the sampling business or maybe it was more broad than that. But can you comment on what you're seeing there? I mean, are there any concerns that you're going to see some cancelations, or is this just kind of the ongoing tempo of things that we've been seeing over the last couple of quarters of just shifting right a little bit?

[Scott A. Buckhout:]

So, we actually track this pretty closely. And if you look at the average time it takes from when we quote a project to when a PO is issued we've seen that creeping up, I'd say moving up pretty deliberately over the last two quarters. Our win rate has not changed. When you look at projects that are decided and projects that we win, it's more or less the same as it has been all year. So, we haven't seen a change there. We are quoting smaller projects than we have in the past. So, more projects, but smaller. And so, I think from an individual project standpoint, we have not seen anything canceled out of our backlog. So, orders that were won, we haven't seen anything canceled yet, that could happen. I would say that it certainly could. But, right now, we haven't seen a single order canceled. And we're still generating pretty good quoting activity, it seems to be just – everything just seems to be moving out to the right. And, of course, we're not alone in that.

[Joe K. Radigan:]

Right. And then on the Aerospace side, I mean, it sounds like you're making some progress in growing the MRO business, which has been an initiative there. Can you just maybe give a little more color there? What are you doing to grow that business? Are you investing in sales resources, or is it just improving execution?

[Scott A. Buckhout:]

So, it's both. And keep in mind, I don't want to overplay this, it's still a small base for us. But it's a very profitable base. And we've done a couple of things. One is we've invested in production capacity. So, we were running our MRO business through our normal production lines and the turnaround time was around 80 days. We've driven that down to 28 days now which is about the market expectation and we expect to cut that in half before the end of the first quarter. So, we've dedicated capacity to MRO and this is focused largely on the commercial sector of the Aerospace business. So, the dramatic reduction in turnaround time where we're seeing very significant growth off of small base, we've also added a dedicated sales person to that business who is out working with airlines and the Tier 1s to grow the business. So, we're pretty excited about it, but I don't want to overplay it yet. It's still relatively small in the big picture for CIRCOR.

[Rajeev Bhalla:]

Let me just add to that, Joe. The couple other areas that we're looking at from a growth perspective, obviously, if the Boeing and Airbus production rates pick up that's helpful to us. And then the new product development we're continuing to focus on that, whether it's looking at new motor-operated valves or attitude control systems, high-flow regulators, those kind of products that we can drive into the marketplace. So, MRO production rates and then the new product development, those are the three key ones.

[Joe K. Radigan:]

Got you. And if I could just get one more on Aerospace, it sounds like some of the new product development opportunities are on the Defense side, how much of the Aerospace business today is Defense related, and from a margin perspective, is the margin profile of that business in line or better than kind of the low double-digit exit rate you're targeting for this year?

[Rajeev Bhalla:]

Yeah. So, right now we're running a little bit about half of the business in Defense-related sales and that will turn as we start to ramp up on some of the commercial programs, in particular the A350. But with that said, the key point to remember here is that as we sell our components that are vital to the particular system, we own the intellectual property, and that allows us to drive the better pricing. And what we're selling, as it relates to the total system, is a small piece of the puzzle. So, we're able to get very good margins off of that. Now, as we continue to drive for incremental military type of sales, you're right, you start to kind of run into the innate margin pressure of dealing with the Pentagon. But, right now, we made some good margins on some of the products that we sell into that space.

[Joe K. Radigan:]

Great. Thanks, guys. Appreciate it.

[Rajeev Bhalla:]

No problem.

[Operator:]

Our next question is from the line of Ryan Cassil with Seaport Global. Please go ahead with your questions.

[Ryan Curtis Cassil:]

Hi, guys.

[Rajeev Bhalla:]

Hey. Good morning, Ryan.

[Scott A. Buckhout:]

Hi, Ryan.

[Ryan Curtis Cassil:]

Good morning. So, I guess, just looking at the M&A front, you guys have been focused on looking at deals on the Energy side. Could you tell us how things are developing there, if multiples are starting to reflect some of the challenges in the space and whether you're just keeping it to Energy at this point or whether you're starting to look elsewhere?

[Scott A. Buckhout:]

Sure. I'd be happy to talk about that. I'm spending, I'd say, a significant amount of my time on this now. So, as we've started to get the business on track operationally, I've been spending more of my time on M&A and more of my time on the organic growth side. With respect to M&A, let's talk about Energy. We have, I'd say, a well-developed pipeline of opportunities on the Energy side. It's very difficult to say if or when something's going to happen as you know. But we're having active discussions with a number of targets right now. The targets span kind of across the segments that we're in. So, we have companies that we're talking to in upstream, we have a couple in power that could be interesting for us. With respect to multiples, there's really no changes from a multiples standpoint that we're seeing outside of upstream. But inside of upstream, the discussions are a little bit different. I'd say that if it's a company in upstream, the starting point is still earnings in 2014, but I'd say that the discussion pretty quickly goes into the downturn and the outlook and being realistic. So, I think, the upstream, we're starting to see changes in expectations on valuations. The last piece that I would mention is that we're looking pretty broad across our product line as well. We're seeing potential opportunities for our instrumentation and sampling business, control valves and engineered valves. All three of those, there's quite a bit of fragmentation in these markets and some interesting opportunities. With respect to Aerospace & Defense, we're still, I'd say, early in building up a pipeline of opportunities, but we're active and we are out talking to companies and building relationships. But I'd say, it's still early days there. As you know, we've been more focused on execution in that segment over the last couple of years and we're just now turning our attention to potential M&A there.

[Ryan Curtis Cassil:]

Okay. All right. That's all I got. Thanks, guys.

[Scott A. Buckhout:]

Thanks.

[Operator:]

Our next question is from the line of Jim Foung with Gabelli. Please go ahead with your questions.

[James V. Foung:]

Hi. Good morning.

[Scott A. Buckhout:]

Good morning, Jim. How are you?

[James V. Foung:]

Good. I was just wondering, you kind of seem pretty optimistic about the Schroedahl business. It seems to be doing better than you expected. Could you talk a little bit about that and what you expect in 2016 from that acquisition?

[Scott A. Buckhout:]

Sure. I'll talk and then you can jump in, Rajeev.

[Rajeev Bhalla:]

Sure.

[Scott A. Buckhout:]

I think the more we learn about Schroedahl and their customer base and the more we integrate with our existing control valve business, the more excited we get about the growth opportunities that we have. And you may remember, Jim, when we put our financials together for this deal, we did not consider growth synergies as part of the valuation. But we're finding, as we dig into this, that that looks like that's going to be the biggest part of the value creation over the next few years here is being able to drive the growth. So, in addition to the auto recirculation valves that we acquired with Schroedahl, they have an interesting and complementary product line on the steam conditioning valves and other control valves as well that work with our Leslie brand of products out of Tampa. So, we've trained up the sales forces on both sides of the business to sell each other's products. We've had some pretty good success in North America so far in selling the automatic recirculation valve from Schroedahl into North America, which was a market they had no presence in before. And we're having some success as well in selling our Tampa product through the Schroedahl channels into Asia. So, overall, we're pretty excited about the top line. As far as the cost side, we're seeing some synergies on the sourcing with Schroedahl. So, we've integrated the spend, the purchasing from Schroedahl with our Global Sourcing Group, and we're getting some savings there as well. So, all in all, we're feeling pretty good about the business. And as you know, it's pretty high margin, so for us – it's very high margin, so for us the biggest lever here is to drive the top line.

[Rajeev Bhalla:]

And along those lines, Jim, just to add a little color, as we mentioned in our prepared remarks, the results from this business from an ROIC, a return on invested capital standpoint, are very strong and the cash EPS is also accretive in year one, so we like that. And from a top line, we would drive a target of getting at least 5% to 10% growth in this business.

[James V. Foung:]

That's great. And then, just shifting a little bit on the Aerospace & Defense, I guess you talked a little bit about the F-35 and the P-8 programs that you're participating. Could you just talk about the ramp up there and where do you see, I guess, the beginning revenues for you when you look out in the next couple of years?

[Rajeev Bhalla:]

Well, I mean, we have been delivering product on the F-35s. It's just a question of going out of low rate initial production into the full rate production. So, same thing with the MMA, the P-8, it's really just a question of ramping that up a notch; and more importantly, getting the orders into the right period that we would expect. So, there's always movement. More often than not, the movement is to the right versus to the left here. But it's really more along those lines as opposed to new incremental business.

[James V. Foung:]

So, I guess, in what quarter do you start seeing the ramp up to higher production from low rate on these programs?

[Rajeev Bhalla:]

We had expected it to have started towards the end of this year, early next year. But it feels like the F-35 is probably going to move a little bit into the later next year or actually even into 2017.

[James V. Foung:]

Okay.

[Rajeev Bhalla:]

And the P-8 will be next year.

[James V. Foung:]

Next year. Okay. Great. Thanks so much.

[Operator:]

Our next question is a follow-up from the line of Charley Brady with SunTrust. Please proceed with your questions.

[Charles D. Brady:]

Thanks. Just real quick. Just a clarification on the Aerospace & Defense margin expectation in Q4. You commented you expect to exit at a double-digit rate. Are you expecting Q4 to be at a double-digit rate or should we assume that's kind of the go-into-2016 rate?

[Scott A. Buckhout:]

We've been talking about go-into-2016 rate, but we're pushing to make that for the full quarter, Charley.

[Charles D. Brady:]

Thanks. I appreciate the clarity.

[Scott A. Buckhout:]

Yeah. The comment that we made was the going in rate but we're going to try and do better.

[Charles D. Brady:]

Got you.

[Operator:]

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Scott Buckhout for closing comments.

[Scott A. Buckhout:]

Okay. I'd just like to thank everyone for joining us this morning. Have a good day.

[Rajeev Bhalla:]

Thank you.

[Scott A. Buckhout:]

Thank you.

[Operator:]

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