Circor International Inc (CIR) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to CIRCOR International's third-quarter 2015 financial results conference call. Today's call will be recorded. (Operator Instructions)

I will now turn the call over to David Calusdian in from Sharon Merrill for opening remarks and introductions. Please go ahead.

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 webcast and presentation section of the investors' link. Please turn to slide 2.

Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties, and other factors. For a full discussion of these factors, the Company advises you to review CIRCOR's Form 10-K, 10-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 will now turn the call over to Mr. Buckhout. Please turn to slide 3.

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 (inaudible) 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 the large instrumentation and sampling project in 2014 adversely impacted the comparison to this year.

Aerospace and defense sales were down year over year, primarily due to push outs of large military programs, most notably the F35, 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 operation's 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 and 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 are 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 and 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 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.

Thanks, Scott. Before I get into the segment numbers for the third quarter, let me start by providing you with some additional detail on Brazil-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 salable 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 a 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 are working to remediate this weakness until the facility is closed in the first quarter of next year. We are pleased 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 and 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 valves sales.

For aerospace and defense, please turn to slide 5. Aerospace and 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 F35, and the residual impact of exiting our structural landing gear product lines.

Aerospace and 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 gear 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 US 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 are adapting to this new reality by strategically holding inventory of parts ready for rapid delivery.

And second, due to strong orders for long cycle projects 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 8. 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 it back over to Scott.

Thank you, Rajeev. Let's start with an overview of our current market trends for energy and aerospace and 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 the 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 are 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 are 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 and 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 and defense, as our operations continue to improve, we're focusing more on growth. We are 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 are 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 a 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 environments. During his career at Siemens, he has 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 and defense, adjusted operating margin was up 510 basis points from the 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 will continue to take smaller incremental actions in response to changes in the market as necessary.

Second, we are 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 are 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 are actively working 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 Instructions) Charley Brady, SunTrust.

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 hadn't seen before. Can you give us maybe an order of magnitude on that? And on the large projects side, that pressure that continues -- has that gotten stronger pressure? Or is it kind of level it's been?

Yes, let me take that, Charley. We saw about 90 to 100 basis points of pricing pressure in the third quarter, both from an engineered valves 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 are anticipating 100 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 the fourth quarter here.

Where we are seeing the -- let me just add to that. Where we are 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 through the distributors, we are seeing some pressure that we haven't seen the past.

Okay. That's helpful, thanks. And just switching gears, on the aerospace defense, on the -- can you give us some indication of the specific projects that you guys are bidding on on aerospace and defense?

Sure. 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 recurring business in new lots. The first is the F35 that we mentioned, the joint strike fighter. Getting the additional orders not only through the low rate initial production lot number 9, but also as 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 P8, the multi-maritime aircraft program. And then also on the UAV side with the Predator and a handful of missile programs as well, the SM3 included in that. So those are the key programs.

All right. Thank you.

Nathan Jones, Stifel.

If we could just I guess talk a little bit more about Brazil. 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 are thinking about balancing the short-term softness there versus the long-term nature to serve Brazil? And if this was just a -- you got to the point where you couldn't see a path to profitability for that business?

Right. Yes, 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 in the third is our local business based in Piracicaba, north of Sao Paolo.

The local business is the one that we've been talking about here. That was acquired in 2011. It has been through I would say difficult times from the very beginning. It is a business that sells largely commoditized valves. It is a lower end scope of projects -- so gate, globe, check valve, some butterfly valves.

These are valves where you're basically competing on price. So you are 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 2 1/2 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 has just deteriorated 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.

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 rails?

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 will 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 are 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.

Let me just add one thing as well. 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 will be dealing with for Milan product.

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?

Yes, I think there is -- well, I guess there is couple of things happening. One is we are still in the ramp-up phase. So we are still doing a lot of work on supplier consolidation that of course will 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 would 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 higher to drive that net number.

Okay. Thanks, guys.

Kevin Maczka, BB&T.

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 are 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?

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 engineered valves, the large project side that we expect to deliver in the fourth quarter. So that's a sequential benefit is being driven by our engineered valves.

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 deliveries 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 know that you -- we expect to see a decline, not only sequentially but year over year as well.

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 are pretty confident in going into Q4. So we will see sequential revenue growth in control valves from Q3 to Q4.

I would say there's sequentially -- there is little bit of upside in instrumentation and sampling as well on our large project, the Johan Sverdrup project. We're expecting to start shipping in Q4 as well. So we have some fairly -- I would 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 are being reasonably conservative with what we see there right now.

And let's not forget: we do expect to see much improved margins out of our aerospace and defense business here sequentially as well, Kevin.

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?

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

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 are no longer going to have these Brazil losses. Can you just sort of summarize 2015 and 2016 from that standpoint?

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 come back.

Then if you -- you can add Brazil on to that. And of course, that's structural; that's a savings or we will say earnings improvement that is independent of volume. And then you can add the full amount of the Corona restructuring as well as structural to the number.

So if you look at for 2015, clearly the Corona -- the Brazil operating loss is not a net 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 closer to $13 million.

So you have 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 incremental $13 million there.

So incremental in 2016 is about $13 million.

Correct.

Okay. Got it. Thank you.

Joe Radigan, KeyBanc Capital Markets.

As you look into next year based on what you are hearing in the marketplace and some of the 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%. Are you anticipating a similar decline or have things started to stabilize, do you think?

So I think that -- yes, we came into this year thinking global CapEx spend would be down around $20 million. I think we are optimistic that it would be $15 million earlier in the year and I think we've kind of concluded it's around $20 million this year.

We are 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 are thinking about our budgeting process for next year.

If you think about the short cycle business specifically going into next year, we're assuming -- 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.

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

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 was more broad than that, but can you comment on what you're seeing there? Are there any concerns that you're going to see some cancellations or is this just kind of ongoing temple of things that we've been seeing over the last couple quarters of just shifting right a little bit?

So we actually have -- we actually track this pretty closely. And if you look at the average time it takes from when we quote a project and when a PO is issued, we've seen that creeping up. I would say moving up pretty deliberately over the last two quarters.

Our win rate has not changed. We are more -- when you look at projects that are decided and projects that we win, it is 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 will 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. Of course, we're not alone in that.

Right. And then on the aerospace side, it sounds like you are 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?

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 normal production -- 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 -- actually 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 -- we are seeing very significant growth off a small base. We've also added a dedicated salesperson 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.

Let me just add to that, Joe. A couple other areas that we're looking at from a growth perspective. Obviously, if the Boeing and Airbus production rates pickup, that's helpful to us.

And then the new product development, we are 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.

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 the low double-digit exit rate you are targeting for this year?

Yes. So right now, we are 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 are selling as it relates to the total system is a small piece of the puzzle. So we are 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 run into the innate margin pressure of dealing with the Pentagon. But right now, we make some good margins on some of the products that we sell into that space.

Great. Thanks, guys. Appreciate it.

Ryan Cassil, Seaport Global.

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

Sure. I'd be happy to talk about that. I am spending, I would 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, it's -- let's talk about energy. We have a -- I would say a well-developed pipeline of opportunities on the energy side. It's very difficult to say if or when something is going to happen, as you know, but we're having active discussions with a number of targets right now.

The targets span across the segments that we are 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 multiple standpoint that we are seeing outside of upstream. But inside of upstream, the discussions are a little bit different. I would say that if you are -- if it's a company in upstream, the starting point is still earnings in 2014. But I would say that the discussion pretty quickly goes into the downturn and the outlook and being realistic. So I think the upstream, we are starting to see changes in expectations on valuations.

The last piece that I would mention is that we are looking pretty broad across our product line as well. We are 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 and defense, we're still, I would say, early in building up a pipeline of opportunities, but we are active. And we are out talking to companies and building relationships. But I would say it's still early days there. As you know, we've been more focused on execution in that segment over the last couple years and we are just now turning our attention to potential M&A there.

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

Jim Foung, Gabelli.

I just wonder: you kind of seem pretty optimistic about the Schroedahl business. 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?

Sure. We -- I will talk and then you can jump in, Rajeev. I think we are -- 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 are 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 are having some success is well and 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 are 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.

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 -- or return on invested capital -- standpoint are very strong and the cash EPS is also accretive. So -- 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.

That's great. And then just shifting a little bit on the aerospace and defense. I guess you talked a little bit about the F35 and the P8 programs that you are participating. Could you just talk about the ramp-up there? And then what do you see -- I guess the beginning revenues for you -- when you look out in next couple years?

We have been delivering product on the F35. It's just a question of going out of low rate initial production into the full rate production. So same thing with the MM8 -- the P8. It's really just a question of ramping that up a notch. And more importantly, getting the orders in to 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 supposed to new incremental business.

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

We have 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 potentially even into 2017. And the P8s will be next year.

Next year, okay. Great. Thanks so much.

Charley Brady, SunTrust.

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?

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

Thanks. Appreciate the clarification.

The commitment we made was the going in rate, but we're going to try and do better.

Got you.

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.

Okay. I would just like to thank everyone for joining us this morning. Have a good day; thank you.

Thank you.

That concludes our conference call. Thank you for joining us today.