Circor International Inc (CIR) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to CIRCOR International's Fourth Quarter Fiscal Year 2017 Financial Results Conference Call. Today's call will be recorded. (Operator Instructions) .

I'll now turn the call over to Mr. David Calusdian from Sharon Merrill for opening remarks and introductions. Please go ahead, sir.

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, 10Qs 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, February 28, 2018. While CIRCOR may choose to update these forward-looking statements at a later date, the company specifically disclaims any duty to do so.

On today's call, management will refer to adjusted operating income, adjusted operating margins, adjusted net income, adjusted EPS and free cash flow. These non-GAAP metrics exclude any special charges and recoveries. The reconciliation of CIRCOR's non-GAAP metrics to the comparable GAAP measures are available in the financial tables of the earnings press release on CIRCOR's website.

I'll now turn the call over to Mr. Buckhout. Please turn to Slide 3.

Thank you, David, and good morning, everyone. We concluded 2017 with a strong fourth quarter, generating adjusted EPS of $0.57 on revenue of $206 million, including the results from our Fluid Handling acquisition, which closed on December 11. Overall, orders grew 32% organically, revenue was up 4% organically, and adjusted EPS was 19% higher than last year.

Let me summarize our orders performance starting with Energy. We saw a significant improvement in order intake for the refinery valves business, especially for DeltaValve capital projects. As many of you know, refineries have been deferring capital projects for the past 18 months. In Q4, we recorded a number of large orders for both capital projects and aftermarket requirements. It's still early to conclude that the market has changed, but we're seeing increased levels of late-stage order activity, and we're optimistic that refineries will start executing on delayed capital projects this year.

Distributed valve bookings were exceptionally strong in the quarter, with stocking orders increasing beyond recent run rates as distributors placed orders in advance of our price increase we took effect at the beginning of this year. Bookings for short-cycle demand were strong and consistent with what we saw in the third quarter.

Instrumentation and sampling bookings increased year-over-year and sequentially, driven by improved downstream refinery activity overall, and several small project wins in the quarter. We rolled out a price increase in October.

In engineered valves, we continued to experience a difficult market environment with orders in line with recent quarters. Pure active projects combined with a competitive pricing resulted in low order intake in the quarter. We continue to aggressively manage the cost business. As we adjust head count to reflect market conditions, we're being careful to maintain the talent required to succeed when markets improve.

Turning to Advanced Flow Solutions. In Aerospace & Defense, we saw another strong quarter for orders with strength across the majority of the business. Commercial aero strength was driven by increasing build rates of Boeing and Airbus, especially single-aisle programs, the A350 platform growth and our commercial MRO business. Defense orders were strong across the board, but most notably in international and domestic submarine programs, both new build and refits, as well as several missile programs.

Aerospace margins improved year-over-year and sequentially as our margin-expansion actions improved the bottom line. Most notably, we continue to rationalize our product portfolio with a focus on improving profitability. As part of that, we renegotiated a low margin contract with a major commercial aerospace customer resulting in a significant price increase. We improved our margins with the consolidation of part of our French design-to-spec business into Morocco, and the sale of our French build-to-print business. This project was completed last summer.

And finally, we raised prices across many of our Aerospace businesses through the year while growing our high-margin MRO business. As expected, demand in power and process was relatively soft in the quarter, while industrial solutions orders were up modestly, both sequentially and year-over-year. In our power and process business, we expect mid-single-digit growth this year, mainly from process applications in emerging markets, higher aftermarket sales in Germany, offset in part by overall softness in the power market. Industrial solutions serves the HVAC in industrial gas markets as well as the U.S. Navy. Overall, we expect these markets to be flat to slightly up this year, with potential upside from the U.S. Navy.

During the quarter, we completed the acquisition of Colfax' Fluid Handling business, significantly enhancing our overall scale and ability to deliver high demand, flow control solutions across a complementary set of attractive end markets.

Our integration is off to a strong start. We have a 12-person full-time global integration team on the ground. We're on track to deliver cost synergies as planned. And as we get into the details of our markets, channels and customers, we're finding more opportunities to drive growth synergies. As a result, we're organizing CIRCOR to optimize our ability to execute on the inherent growth synergy opportunities across the portfolio. One of the guiding principles is to align the businesses that serve common end markets. Beginning in Q1 this year, we're realigning CIRCOR around 3 end-market focus groups: Energy, Aerospace & Defense, and Industrial. I'll give more detail on this later in the call.

Our margin expansion and simplification program continues. We're in the process of executing 3 programs across the company, 2 structural cost reduction programs in Europe, and the third program related to rationalizing our service network for reliability services. These actions will cost approximately $11 million in aggregate, and are expected to generate annual run rate savings of approximately $8 million. With the Fluid Handling acquisition complete, our top near-term capital allocation priority is to reduce our leverage. In that regard, we're suspending the nominal quarterly cash dividend beginning in the first quarter of 2018, in order to redirect those funds towards repayment of debt. We believe taking this step is in the best interests of our shareholders.

Before I review our outlook and talk about our end markets, let me turn it over to Rajeev to discuss the fourth quarter results in more detail.

Thanks, Scott. Let's review the segment results starting with Energy on Slide 4. Fourth quarter revenue of $92 million was up 4% compared to the prior year. Higher revenue from Distributed Valves and Refinery valves over the prior year were offset in part by a 50% decline in the engineered valves business, as well as slightly lower volume in instrumentation and sampling. Energy segment operating margin of 8.3% was down 210 basis points year-over-year, due in large part to the lower volume in engineered valves, and increased cost associated with ramping up Distributed Valves in Oklahoma City and Monterrey, Mexico.

Turning to Slide 5. Advanced Flow Solutions had sales of $77 million, 11% higher than the fourth quarter of 2016, and 7% higher on an organic basis. Sales in our Aerospace businesses increased 22% year-over-year due to strength across the majority of the business, both commercial and defense OEM growth as well as aftermarket volume. Higher volumes in Aerospace & Defense and power and process were partially offset by lower shipments in industrial solutions. Advanced Flow Solutions operating margin of 14.8% increased 190 basis points over the prior year due to price increases, higher volume and the benefit of prior restructuring actions, including the exit of the French build-to-print business last summer.

Moving to Slide 6. On December 11, we completed the acquisition of Colfax' Fluid Handling business. For the stub period of about 3 weeks in December, Fluid Handling reported $36 million of net revenues. The revenues related to strong shipments for screw pumps into the industrial and commercial marine markets, as well as the completion of a number of large projects delivered at the end of the year. Reliability services delivered their largest order for oil mist equipment at the end of December. The high volume of activity in the period favorably impacted the operating results, delivering segment operating income of $5.5 million. Orders during this period were $24 million consisting largely of run rate bookings for OEM and aftermarket business.

In the first quarter this year, we initiated a reduction in force in one of our German manufacturing facilities to reduce overhead costs, and in reliability services to rationalize unprofitable service centers. These actions and Fluid Handling are expected to be completed by the end of the first quarter, and are expected to contribute to our cost synergy targets with an annual run rate savings of $4 million.

Turn to Slide 7 for selected P&L items. In connection with the passage of the Tax Cuts and Jobs Act, there are 3 main areas impacting the company: first, we recorded a minor benefit in the fourth quarter of 2017 related to the revaluation of net U.S. deferred tax assets, given the lower corporate tax rate of 21%. One area that remains open with respect to our deferred taxes is the foreign tax credit carryforward. Limitations on the use of these credit carryforwards may adversely impact our tax rate. We will complete our analysis by mid-year. Second, we do not expect the material impact with respect to the transition tax on unrepatriated foreign earnings. And finally, the global intangible low taxed income provision relates to additional U.S. taxes on foreign earnings in the future. So no impact to 2017. We are analyzing the provisions of this legislation on whether we would be required to pay this incremental U.S. tax, and we'll provide an update on the expected impact later this year.

Turning to special and restructuring charges, we recorded a total pretax charge of $23.7 million. This charge consists of acquisition-related cost totaling $11 million, the noncash acquisition-related amortization expense of $9.2 million, a legal settlement and restructuring cost for previously announced actions totaling $3.8 million. With higher debt levels, we incurred $3 million or $0.14 per share of higher interest expense in the fourth quarter compared with the prior period. Our adjusted tax rate for the quarter was 21% compared to 24% in the fourth quarter of 2016. For the full year, the adjusted tax rate was 22% in 2017 compared with 20% in 2016. You may recall that at the end of 2016, we completed the repatriation of $32 million of cash, which resulted in a significant tax benefit in that year.

Turning to our cash flow and debt position on Slide 8. Our quarterly cash flow performance was adversely impacted by over $9 million of payments for M&A-related advisers. Although working capital did not deteriorate sequentially, it remains too high and we are focused on improving it in 2018. On December 31, 2017, our net debt position of $684 million reflects the completion of the Fluid Handling transaction. Our top capital allocation priority in 2018 is improving our leverage position. As Scott mentioned, with the completion of the Fluid Handling acquisition, we are in the process of realigning our businesses into 3 groups focused on end markets: Energy, Aerospace & Defense and Industrial. Prior to reporting the 2018 first quarter results, we will revise and publish our historical results to reflect this new segment structure. This brings us to our guidance for the first quarter. Please turn to Slide 9.

Overall, we expect revenue in the range of $260 million to $275 million, and adjusted EPS in the range of $0.26 to $0.36 per share. The Fluid Handling acquisition is accretive for the full year. However, as you would expect, the impact of the acquisition on the first quarter is dilutive given a seasonally low revenue quarter, incremental integration costs in Q1 and the impact of interest expense. As the year progresses, revenue and earnings are expected to increase sequentially for Fluid Handling and the rest of CIRCOR, while integration costs decrease in the second half. Regarding special and restructuring charges for the first quarter of 2018, we anticipate charges for the following items: noncash intangible amortization of approximately $0.55 to $0.57 per share, which we would expect to record in each quarter this year. In addition, the Q1 charge includes the amortization of the stepped-up inventory acquired in the Fluid Handling transaction amounting to $0.37 per share. We do not expect any further charges after Q1 for this item. And finally, the charge includes restructuring and integration costs of $0.58 to $0.64 per share. In the aggregate, for the restructuring programs, we expect annual run rate savings of $8 million, with $5 million of benefit in 2018. We expect first quarter interest expense in the range of $12 million to $13 million. Interest expense includes principal amortization as well as the amortization of deferred financing fees. These fees were paid at closing. However, the accounting rules require amortization over the term of the debt. On a full year basis, this amortization will be approximately $4 million. In total, we expect our full year interest expense related to our debt balances to be in the range of $49 million to $51 million.

A final point on our debt. Currently, all of our debt has a variable interest rate. We're evaluating our options to fix the interest rate for a portion of our debt and expect to complete our evaluation over the next few months. Regarding our tax rate, we expect our first quarter adjusted tax rate to be approximately 23%. The proportion of U.S. pretax income to foreign pretax income affects the tax rate. Since our interest expense reduces U.S. pretax income, the benefit from the lower tax rate is also reduced. In certain countries where we do business, like Germany and France, the statutory rate is higher than the U.S. rate, which also keeps our overall rate higher.

With that, let me turn it back over to Scott.

Thank you, Rajeev. Before I get into the market outlook and trends, let me discuss the reorganization in more detail.

Turn to Slide 10. We're aligning our businesses with end markets which will simplify the business, clarify customer and channel relationships and help us exploit growth synergy opportunities across the organization. The new groups will be Energy, Aerospace & Defense and Industrial. The Energy group will remain unchanged except for the addition of reliability services, a business from the Fluid Handling acquisition. With annual revenues of approximately $70 million, reliability services sells products and services primarily into the mid- and downstream refinery market, so it fits nicely into Energy. Erik Wiik will continue to run our Energy group, which he took over 3 years ago.

The Aerospace & Defense group will include the Aerospace business out of our AFS segment, as well as the Defense business and Fluid Handling. The Defense business provides pumps and valves primarily for the U.S. Navy, and generates approximately $50 million of annual revenue. Aerospace & Defense will be run by Tony Najjar, who joined CIRCOR in 2015. Tony was most recently the Vice President and General Manager of CIRCOR Aerospace inside of AFS. Tony has a wealth of experience in the Aerospace & Defense market, including a number of leadership roles at Rockwell Collins and Kaiser Aerospace prior to joining CIRCOR. The industrial group will include the remaining portion of Fluid Handling as well as the industrial solutions and power and process businesses that were part of AFS. These businesses serve a number of common Industrial end markets, channels and customers. The Industrial group will be run by Sumit Mehrotra, who's been with CIRCOR since 2013, and has served as President of Advanced Flow Solutions for the past 1.5 years. Prior to that, he was responsible for developing and executing our global sourcing strategy, as well as running the product management function for the company.

With that background, let me give you our outlook and trends for the markets we serve, starting with Energy. Energy segment orders increased 37% organically in the fourth quarter. We saw significantly improved orders in refinery vales, and we continued to see solid demand for Distributed Valves. Orders in instrumentation and sampling posted modest increases, while orders in engineered valves were down in line with recent run rates. The near-term outlook for the Energy segment overall is improving despite ongoing weakness in our engineered valves business.

In refinery valves, we saw a significant increase in orders in Q4, driven by an increase in capital project orders and ongoing strength in the aftermarket. Although it's too early to confirm a trend, there's a number of factors contributing to an improved outlook. Higher oil prices and overall global economic growth are building confidence among our customer base. As you would expect, there's pent-up demand for maintenance that has been deferred over the past 18 months. The process licensers are now busy with preengineering, and as a result, we expect to see more projects move forward this year. We expect to maintain a high win rate as projects move forward due to the technological differentiation of our products, especially with the DeltaValve Center Feed device, which provides a significant competitive advantage. We expect ongoing aftermarket strength for both the TapcoEnpro and DeltaValve products, driven by the install base and refinery utilization. Aftermarket represents about half the business.

And finally, certain regulatory changes such as the MARPOL requirement to reduce sulfur emissions from ships by 2020 could spur orders to upgrade coke-drums and increased capacity. Overall, we expect substantially higher orders leading to double-digit revenue growth in 2018. In distributed valves, demand continues to be strong, especially in the Permian Basin. In addition, we're seeing increasing demand for midstream valves into the Marcellus and Eagle Ford basins. We expect this trend to continue. North American production is strong. Rig counts, as well as drilled, but uncompleted valves remain high. Sequentially, orders are expected to remain strong, but lower than Q4 due to the extraordinary level of stocking orders that we do not expect to repeat in Q1.

Operationally, in Q4, we experienced higher costs as we ramped up production and reduced our past 2 backlog. Supply chain delivery performance has significantly improved as we've qualified new suppliers for critical components. In addition, Oklahoma City and Mexico improved output and efficiency in the quarter, but continued to operate with higher-than-normal costs. We expect operational performance will further improve in Q1.

In instrumentation and sampling, fourth quarter orders were higher sequentially and versus prior year. Quoting activity remains high. However, we're seeing lower value project opportunities in the pipeline. Short-cycle demand remains consistent with prior quarters. As the year progresses, we expect to see modest growth in this segment driven largely by increases in the downstream refining market, especially for our sampling products. We raised prices through 2017 with the most recent price increase effective in October last year. Overall, we expect the market for our instrumentation and sampling business to be up low single digits for 2018 compared to prior year. The market for engineered valves remains challenging and pricing pressures intense. Activity is largely driven by projects in the Middle East and the North Sea. Middle East projects are relatively small and continuous, driven mostly by upstream oil with midstream gas projects playing an increasing role. We recently signed a frame agreement with Statoil. As a result, we're well positioned to receive orders this quarter and next on a number of projects, including the Johan Castberg FPSO project. Overall, we expect orders in the first half of this year to be modestly better than last year. In the meantime, we continue to manage the cost structure of this business as we rightsize our Milan facility and further expand our low-cost supply base.

The reliability services business serves 2 primary end users: refineries and the U.S. Navy. With 2 main products, oil mist equipment and lubrication services. Orders for equipment are often for projects and can be lumpy. In addition, the service business is seasonal, based on the timing of refinery turnarounds. In both of these markets, we expect low single-digit growth this year.

Turning to Aerospace & Defense. Orders increased organically over 25% in the quarter with growth in all of our product lines. We booked stronger orders for the commercial single-aisle programs due to increased OEM build rates. On the defense side, we received strong orders in the U.S. for missile programs, and in the U.K., for international submarine programs. Pump and valve orders for the U.S. Navy submarines are expected to grow this year as well. In addition, aftermarket sales were up on both commercial and military programs. Although the market is strong and we expect higher orders this year, the year-over-year impact will be partially offset by the exit of our French build-to-print business, which we exited in Q3 last year.

Overall, the record increase in passenger traffic last year, the airframer backlogs and higher defense spending provides for a strong and sustainable long-term market outlook. For the industrials group, we provide both valves and pumps into 2 primary end markets: general industry and commercial marine. For the industrial markets in Europe, Middle East and Asia, including India, we expect the growth rates tied to industrial activity to be in the mid-single-digit range, driven in large part by strength in Germany. International PMIs remain strong and industrial production internationally is showing good growth. For the industrial markets in North America, we expect low to mid-single-digit growth for both pumps and valves. U.S. industrial production continues to grow. In addition, improving durable goods orders for machinery is a positive indicator for our products. The commercial marine market continues to be soft given the oversupply of capacity and few new-ship contracts. We expect improving aftermarket orders as the global shipping fleet ages. However, the ongoing downturn in new-ship builds remains a headwind. Although we're seeing initial signs of improving outlook, we do not expect a significant improvement this year. And finally, we're raising prices globally across industrial pumps with a primary focus on the pump aftermarket. So overall, the industrials group should see solid order growth this year, coming in slightly better than GDP growth.

In summary, we began 2018 well positioned to capitalize on the growth opportunities in a diversified range of end markets while delivering our financial commitments. Our top priorities for delivering long-term value for shareholders include continuing to build a world-class team, investing in long-term growth, delivering a well-executed integration and reducing our leverage.

And now, Rajeev and I would be happy to take your questions.

(Operator Instructions) Our first question today is coming from Charley Brady from SunTrust Robinson Humphrey.

So I guess first, I think you mentioned maybe a pre-buy in front of raising some prices. I think that was in Energy, if I recall. Can you just speak to that as to what kind of pull-forward you might have seen in -- specifically, what area that was in again?

Sure, I'll talk to that. We -- That was in our Distributed Valves business here in North America. So we raised prices across the board on our KF brand that was effective on January 1. So we did see a surge in stocking orders. I think it's worth noting that it was strong before that. But there was a surge in stocking orders that we saw in December ahead of the price increase. So sequentially, we saw orders increasing roughly 50% in that business. Not all of that was the surge in stocking orders, but some of it was.

But that's a business you're still expecting into Q1 for that strength to continue, just not at the same pace because of the outcome of the surge obviously, right?

Exactly right. So we're expecting that and a lot of those stocking orders that we got were pull-ins. And so we won't see nearly as many stocking orders in Q1. But we still expect strong orders in -- that's what we're seeing so far in the quarter.

And the price increases you've put across in other areas of the businesses subsequent to January 1, so we didn't get a pre-buy on that?

That's correct, yes. So we've had -- if you're referring to Energy, we raised prices in October in instrumentation and sampling. So there might have been a little bit of pre-buy on that, but it wasn't -- there was nothing dramatic there. That was one of several price increases through the year and wasn't as high as what we did in Distributed Valves.

So on the AFS business. The margins there, sound like they've really hit a pretty good stride. That was pretty good margin from year-on-year. Stronger than what we thought it was going to be. Can you speak to anything in particular that just drove that? Or is it -- it's a combination of better pricing, better execution? Where do you see that margin for that business, that segment going? I think now it's going to be, obviously, it's mixed in a couple of businesses, but I'm just trying to get at least the entity we know today, where that could go.

Sure, Charley. This is Rajeev. I'll take that. You're right, they were a combination of factors that drove good, good margins there, pricing was one of them. If you recall, we've done some restructuring in the past, we got out of the French build-to-print business. That obviously helped margins there as well. The usual actions that we take around productivity, sourcing contribute to that as well. Going the other way, we did have some mix and concerns there with respect to the power business that went the other way here. But if you think about it in the aggregate, there's probably about 150 basis points or so. If I look at just the AFS segment that was a price benefit and some favorability that we took in the fourth quarter here. So as you look ahead, that probably will not repeat, but overall, we do expect strong margins in AFS going forward.

Okay. Just one from me. Then you talked about tax rate for Q1. And I know you're still examining everything else, but any idea what the tax rate for the full year might come out to be?

Yes, you're right. We're examining a couple of other items here. It should be around the Q1 number. I don't expect it to be materially different, but there are 2 open items that we talked about in the prepared remarks. Absent any change with respect to those 2 items, we should be -- we should hover around what you're seeing in the first quarter.

(Operator Instructions) Our next question is coming from Jeff Hammond from KeyBanc Capital markets.

Just with the Fluid Handling business coming in first full quarter, just -- I think you said seasonal weakness and some integration. Can you just frame how you're thinking about that business from a revenue contribution in 1Q, and maybe margin contribution just so we can frame up early expectations not having seen the business before?

Yes. I will help you there, Jeff. The -- clearly, the stub period was a very nice revenue and profitability period, and you're smart enough not extrapolate that over the full year. But as I looked at the pro forma for 2017 and the first quarter for the Fluid Handling business standalone, it's going to be about the same in Q1 of 2018. The sequence and the profile is, it kind of ticks up in the second quarter. There are some services businesses that tick up in the second quarter based on refinery turnaround as well as some of the deliveries. And then it kind of ticks down a notch in the third quarter and is level into the fourth quarter. That's the kind of a profile for that. From a margin standpoint, we would continue to expect double-digit margins for this business. So the 15.5%, you saw on the stub period was really just helped a lot by the fact that there were costs that were incurred prior to the acquisition date that really helped grab the margins in the stub period.

Jeff, as you know, Q1 is normally our lowest quarter on legacy CIRCOR as well and we see increasing revenue and earnings through the year as part of that business too.

Okay, perfect. Can you just speak to the -- as you look at the markets and fixing some of the debt, do you see a material change to your interest cost run rate that you laid out for the year?

Jeff, we would expect it to tick up if we do fix the interest rate that -- it's tough to quantify because it depends on how much of the debt you fix it. But as you would expect, when you do fix at that rate, it's initially higher. And then as interest rates go up, you go from being underwater to in the money. So we don't have a specific number around that at this point, but suffice to say that we would expect it to be up.

And what's the reasonable amount of debt paydown in year 1 given the focus on that?

That's a hard question. We obviously have our expectations internally. We haven't really committed externally to a specific number here. But we do expect the leverage to come down by one turn. So that's going to be a combination of debt paydown and earnings growth.

So directionally, one turn of reduction. And if -- the way we're expecting that to play out is roughly half reduction in debt and half increase in EBITDA.

Ladies and gentlemen, there are no further questions at this time. Thank you for joining us today. This does conclude our conference call. You may now disconnect your lines and have a wonderful day. We thank you for your participation today.