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CIRCOR International (CIR)
Q2 2019 Earnings Call
Aug 01, 2019, 9:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good day, ladies and gentlemen. Welcome to CIRCOR International second-quarter fiscal year 2019 financial results conference call. Today's call will be recorded. [Operator instructions] I'll now turn the call over to David Mullen of CIRCOR for opening remarks and introductions.

Please go ahead.

David Mullen -- Senior Vice President Finance and Corporate Controller

Thank you, and good morning, everyone. On the call today is Scott Buckhout, CIRCOR's president and CEO; and Chadi Chahine, the company's chief financial officer. The slides we'll be referring to today are available on CIRCOR's website at www.circor.com on the webcasts & presentations section of the investors link. Please turn to Slide 2.

Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these factors, the company advises you to review CIRCOR's Form 10-K, 10-Qs and other SEC filings. The company's filings are available on its website at circor.com.

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Actual results could differ materially from those anticipated or implied by today's remarks. Any forward-looking statements only represent the company's view as of today, August 1, 2019. 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, free cash flow and organic measures.

These non-GAAP metrics exclude certain special charges and recoveries. A reconciliation of CIRCOR's non-GAAP measures 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 Scott. Please turn to Slide 3.

Scott Buckhout -- President and Chief Executive Officer

Thank you, Dave, and good morning, everyone. In June, we communicated our detailed 18-month plan for delivering significant shareholder value. I'm pleased to report that our Q2 results and our outlook for Q3 are right in line with that plan. Our initiatives are on track, and markets are in line with our expectations.

We delivered a solid Q2 with $270 million of revenue and $0.45 of adjusted EPS. Excluding the recently divested non-core engineered valves business, EPS was $0.56. We delivered $276 million of orders in the quarter resulting in a book-to-bill ratio over 1. Orders were down about 1% organically after adjusting for divestitures and $7 million of foreign exchange headwind.

Aerospace and defense continues its strong performance with orders up nearly 60% organically. We're entering the back half of the year with a record backlog in that business. Industrial segment orders were in line with prior quarter but down versus a strong Q2 2018. Softness in Europe was partially offset by growth in North America and Asia.

energy orders remained soft in the quarter, largely driven by weakness in upstream oil and gas and the timing of large project orders in downstream oil and gas. Adjusted operating margin in Q2 was 8.7%, up 120 basis points from Q1 and 50 basis points from last year. Excluding our divested engineered valve business, adjusted operating margin was 10% in the quarter. We expect margins to continue to improve for the rest of 2019 due to price increases, ongoing productivity and simplification initiatives, integration synergies and transitions to low-cost manufacturing.

The fluid handling integration remains on track with $7 million of incremental savings expected in 2019 and $23 million of run rate savings expected by the end of 2020. We continued our progress in reshaping the portfolio. In Q1, we completed the sale of reliability services for $85 million in cash, an 11x multiple on 2018 EBITDA. In July, we completed the sale of our non-core upstream oil and gas engineered valve business.

Segment operating losses for that business were about $4 million in the first half of 2019 and $9 million for the full-year 2018. We remain on track to launch 35 new products this year and we reiterate our forecast of $70 million of revenue from new products. We continue to invest in innovation and new products to drive growth. I'd like to highlight two product launches from the second quarter, both of which deliver improved operational efficiency for our customers.

First, our refinery valve team continues to identify and develop new opportunities for their differentiated gauge valve sealing technology. Their new fractionator isolation valve allows refinery operators to avoid the use of physical blinds during routine and emergency maintenance activities. This improved safety and reduces the shutdown-start-up cycle for a fluid catalytic cracking unit by up to two days. The second product I'll highlight is our smart cavitation control package launched by our industrial pumps team.

The smart technology deliveries speed, efficiency and predictability in tank unloading applications at terminals and seaports. Our patented cavitation sensing technology automatically adjust flow in realtime to protect the pump, while maintaining the highest possible throughput. In the first half of 2019, we reduced debt by nearly $60 million. We're evaluating the sale of additional non-core assets to simplify the company, strengthen the portfolio and further delever the balance sheet.

Overall, we feel good about the remainder of the year. New product launches are gaining traction. Our 2019 price increases are in place. Simplification initiatives are in process.

And our low-cost manufacturing facilities continue to ramp up. Now let me turn the call over to Chadi to discuss the second-quarter results in more detail before I review the outlook for our end markets.

Chadi Chahine -- Chief Financial Officer

Thank you, Scott, and good morning, everyone. Let's begin by reviewing our segment results, starting with industrial on Slide 6. The industrial segment reported sales of $119 million, down 4% organically compared with Q2 2018 largely as a result of timing of large projects. It's worth noting that foreign currency headwinds reduced industrial revenue by 4% in the quarter as well.

The industrial segment delivered very strong margin of 13.5%, up 200 basis points from Q2 2018 and 380 basis points sequentially from Q1 2019. The margin improvement was driven by integration synergies, sourcing savings, simplification initiatives and price increases as well as the absence of the onetime expenses we highlighted in Q1. For the third quarter, we expect revenue in line with second quarter and margin expansion year over year for the remainder of 2019. Turning to Slide 7.

We continue to execute on our plan to reposition the energy segment. energy sales of $86 million decreased 9% organically. Weakness in upstream North American land was partially offset by growth in downstream refinery valves revenue. Revenue excluding engineered valves was $77 million.

Adjusted operating margin in the quarter was 4.1%, driven primarily by the impact of upstream North America market softness and the resulting weaker revenue. Excluding engineered valves, adjusted operating margin was 7.7%. In Q3, we expect margin in the mid-single digits largely driven by ongoing weakness in upstream markets, particularly, in North America. Turning to Slide 8.

Aerospace and defense had sales of $65 million, up 14% organically on strength across both our Defense and Commercial business sectors. Aerospace and defense operating margin of 16.1% was up 390 basis points versus second quarter of 2018, reflecting the benefit of higher revenue, price increases and our ongoing productivity initiatives, including low-cost manufacturing. We expect to deliver double-digit revenue growth for the remainder of the year as we execute on our strong backlog. In addition, we expect to deliver ongoing margin expansion for the rest of 2019.

Turning to Slide 9 for Q2 selected P&L items. Our adjusted tax rate for the quarter was 15% driven by foreign tax rate differential and higher R&D tax credits. We now expect the full-year adjusted tax rate of 16%, down from our previous expectation of 18%. Looking at special items and restructuring charges, we recorded a total pre-tax charge of $19 million.

The largest component of this charge continued to be the noncash acquisition-related amortization expense, totaling $12 million. The remainder was made up of a $4 million charge related to other restructuring activities primarily the closure of our OKC manufacturing facility, $2 million of professional fees related to the unsolicited offer to acquire the company. Net interest expense for the quarter was $13 million, down nearly $1 million compared with prior year as the impact of lower debt balances are partially offset by higher interest rates. Other income, which was negligible in the quarter primarily reflect pension income and both realized and unrealized FX gains.

In Q2, 2018, other income was about $4 million. The change in other income is a $0.16 adjusted EPS headwind year on year. Turning to our debt position on Slide 10. Our operating cash flow was $12 million in Q2, up from slightly negative in Q2 2018.

We spent $3 million on capital expenditures resulting in a $9 million of free cash flow. We expect to invest approximately $20 million in capex for the year. We've reduced net debt by $66 million since year-end, including nearly $60 million of debt paydown. We continue to expect to reduce our leverage by one turn by the end of 2019 excluding the divestiture of non-core assets.

I will now hand the call to Scott to discuss our market outlook.

Scott Buckhout -- President and Chief Executive Officer

Thank you, Chadi. Now I'll provide an overview of our end markets and the drivers that we believe will give us momentum as we move through the second half of 2019. Please turn to Slide 11. Let's start with industrial.

The industrial group backlog continues to be strong. Orders in Q2 were in line with Q1 and 5% lower organically versus last year. It's worth mentioning that Q2 2018 was an especially strong quarter making for a difficult compare. In Q2, we had a better mix of revenue in the quarter versus last year as a result of proactively shifting the sales mix toward more profitable customers, regions and end markets.

Since Q3 2018, we've shifted away from higher-risk, lower-margin projects in oil and gas end markets while increasing our focus on more profitable industrial markets and applications. We're seeing weakness in our foremarket businesses in Europe, which was partially offset by growth in the Americas, commercial marine and aftermarket businesses globally. While European end markets are softening, we're taking advantage of growth in other areas. In commercial marine, with IMO 2020 on the horizon, we're seeing strong demand for our scrubber pumps.

This positive momentum is offsetting the ongoing weakness in new vessel orders. We're expanding our manufacturing and sales capacity in China and Asia-Pacific to better serve our commercial marine customers in the region. For our aftermarket business, we have an extensive installed base that continues to fuel our short-cycle orders. Global aftermarket grew 3% in the second quarter versus prior year.

We've increased our dedicated aftermarket sales capacity to improve the capture rate in our aftermarket installed base. We expect moderate aftermarket growth in the second half. Pricing actions remain a focus for the business. At midyear 2018, we raised prices 4% to 5% on approximately half the revenue.

By the end of the second quarter this year, we increased prices by an additional 2% to 4% on roughly half of the industrial revenue. For industrial overall, we're entering Q3 with the strongest backlog since establishing the industrial group in Q1 2018. This backlog positions us for strong second half revenue. For Q3, we expect orders in line with Q2 sequentially and up moderately versus prior year.

Now let's shift to our energy segment. The results we're seeing in energy are in line with our 18-month plan. As many of you know, we significantly lowered market expectations for energy overall and in our upstream oil and gas businesses in particular. Overall, we had order intake across energy in line with Q1 and lower than prior year.

Organic orders in Q2 were down about 30% versus prior year, primarily due to the timing of project orders in refinery valves and a slow market environment in the upstream North American land market. Refinery valves orders were up sequentially but down year over year in Q2, driven by timing of large project orders. As we've mentioned in the past, project orders in this business can be lumpy with order timing difficult to predict. The pipeline of project activity remains healthy and the outlook for this business remains strong.

In distributed valves, we saw softness in the U.S. upstream market as rig counts declined and well completions grew slower than anticipated. We were expecting a stronger back half on orders driven by higher operator spending levels as takeaway capacity was brought online in the Permian. This isn't happening to the degree expected.

Operators are being more disciplined about capex spending cash flow. That combined with improvements in operator efficiency has resulted in declining rig counts and wells completed significantly below prior industry forecasts. With these market fundamentals unfolding, we're seeing distributors destocking. Looking to Q3 for energy overall, we expect softness in orders and revenue, largely driven by ongoing weakness in upstream markets.

While there is a potential upside driven by the timing of project orders in our refinery valves business, we're expecting orders in line with Q2. This outlook in energy is accounted for in our 18-month plan. Our aerospace and defense segment generated another strong quarter of orders, which increased nearly 60% organically to $93 million. The growth was driven by large Defense orders related to the Joint Strike Fighter, U.S.

Navy Virginia Class Sub, DDG 51 class destroyer and the CVN-80 aircraft carrier. Commercial aerospace orders continued their upward trend in the quarter driven by continued strength in the Airbus A320 and A350 build rates and the strength in aftermarket spares activity. Boeing's recent decision to reduce 737 production amid the ongoing 737 MAX review will not have a material impact on aerospace and defense. We continue to raise prices in aerospace and defense, primarily focusing on OEM spot orders and aftermarket demand.

For aerospace and defense overall, we entered the second quarter with a record backlog. In Q3, we expect timing of large Defense orders to result in a year-on-year organic decline in orders. The remainder of the year looks strong on both the top and bottom line with double-digit revenue growth and continued margin expansion. The growth is driven by continued strength in our current Defense programs, like the Joint Strike Fighter, Virginia Class submarine and Hellfire missile, and the start of new programs like the Dreadnought-class submarine in the U.K.

and the Columbia-class submarine in the U.S., commercial aerospace programs like the Airbus A320 and A350 and Defense and Commercial aftermarket activities. Now, I'll turn the call back over to Chadi to discuss guidance.

Chadi Chahine -- Chief Financial Officer

Thank you, Scott. Turn to Slide 12. Overall, we expect third-quarter 2019 revenue in the range of $250 million to $260 million. And adjusted EPS in the range of $0.52 to $0.60.

The guidance exclude result of the engineered valve business, which we divested in July. We expect an unfavorable FX impact of $2 million to $4 million on revenue as compared to Q3 '18. In the quarter, we expect sequential margin expansion driven by pricing, productivity initiatives, restructuring actions and the sale of the loss-making engineered valve business. We expect positive free cash flow to continue to improve in the second half and for full-year 2019, we anticipate free cash flow of at least $30 million.

Regarding special and restructuring charges for the third quarter of 2019, we anticipate charges for the following items, acquisition-related amortization expense of $0.49 per share and restructuring and special charges totaling $1.96 to $2.18 per share. Included in special charges is an expected loss on the sale of engineered valves of $1.65 to $1.85, which is largely noncash in nature. We expect the third quarter and full-year adjusted tax rate to be approximately 16%. With that, let me turn it back over to Scott.

Scott Buckhout -- President and Chief Executive Officer

Thank you, Chadi. To summarize, we're building positive momentum. As we look to the remainder of the year, we expect to realize continued benefits from our business simplification initiatives, new product launches, pricing actions, manufacturing in low-cost facilities and integration synergies. As you likely saw, we issued an Investor update presentation in June that outlines our detailed plan to deliver substantial earnings growth while deleveraging over the next 18 months.

In addition to executing this plan, we're exploring the divestitures of certain non-core businesses that would accelerate the deleveraging process. Our second-quarter performance and the outlook for the remainder of the year are right in line with the targets we laid out in the plan. We continue to take deliberate actions consistent with our plan, such as the engineered valves divestiture completed in July. And we remain committed to driving long-term growth, expanding margins, generating strong free cash flow and deleveraging the company.

As we continue to build on our transformation and execute on our strategic plan, the company will evaluate a broad range of operational, financial and strategic options that could potentially deliver value in excess of the strategic plan. These options include further portfolio simplification, capital allocation opportunities and the sale of a part or all of CIRCOR among others. There can be no assurance that we will pursue any particular action or transaction. However, we will assess all viable paths to enhancing shareholder value, including continuing to execute on our strategic plan.

We intend to be thorough and diligent in evaluating the relative benefits of various opportunities. We will not be commenting further on this matter today and ask that you please keep your questions focused on our second-quarter results. Now Chadi and I will be happy to take your questions.

Questions & Answers:


[Operator instructions] Our first question today is coming from Andy Kaplowitz of Citi. Please go ahead.

Unknown speaker

This is Piyush on behalf of Andy. Thank you for taking my question.

David Mullen -- Senior Vice President Finance and Corporate Controller

Good morning.

Unknown speaker

Good morning. You recently sold the engineering valves and you talk about divesting other non-core assets, which is, I guess, close to $25 million of EBITDA. Can you provide some more details on these actions? Any time frame? Is this a 2019 story, a 2020 story? And how much proceeds can we expect from these businesses?

Scott Buckhout -- President and Chief Executive Officer

Sure. OK. So yes, so we've estimated that non-core EBITDA that we're evaluating for divestitures is around $25 million. It's very difficult to predict if and when this will happen.

Obviously, the price matters as to whether or not we're going to -- we would move forward or not. We have some of this revenue, some of this non-core businesses are -- we are in process of evaluating and searching to see if we can find an appropriate buyer at an appropriate price. So some of this could happen here in 2019, and some of it could happen in 2020 or it might not happen at all. So it does depend on price.

Now these are non-core assets. They tend to be more on the commoditized side of the spectrum. And the multiples typically would reflect that.

Unknown speaker

All right. That's helpful color. And can you elaborate on the market conditions in Europe? You mentioned that orders were weak. So wanted to check how much of that is just the function of market being soft? Or is there anything else that you want to highlight? How our customers should -- are generally responding to your pricing policies? Any visibility into that market would be helpful.

Scott Buckhout -- President and Chief Executive Officer

Sure. Yeah. So we're seeing weakness in Europe -- is largely our industrial business. And it's -- I'd say the weakest market inside of Europe is Germany.

But we're also seeing weakness in France and Italy as well. So Europe as a whole for general industrial is weaker for us, and I would say slowing. Having said that, when you look at industrial globally, the aftermarket business actually is growing globally including in Europe. And so we haven't been able to take advantage of that.

I mentioned some things in my prepared remarks on how we're doing that. So global aftermarket seems to be doing reasonably well, but the foremarket in Europe is down. Outside of Europe, things seem to be pretty still moderately healthy. So the U.S.

and North America in general continues to grow. Asia continues to grow. Commercial marine is doing reasonably well, largely because of the scrubber pumps. New vessel orders are down, but scrubber pumps is more than offsetting that.

So commercial marine is growing as well. So it's really -- it really is Europe as the weakest point for us in industrial. With respect to price, we have not had a meaningful pushback on the prices that we've put in place earlier this year. We're confident of realizing the price increases that we put in place.

So we haven't had issues with customers canceling orders or even pushing back excessively. So we're in a reasonably pretty good position with the prices increases in industrial.

Unknown speaker

Gotcha. And just to follow up on this. How much of this weakness in Europe is baked into your 18-month plan?

Scott Buckhout -- President and Chief Executive Officer

All of it. So the markets are performing right now really right in line with what we built into our 18-month plan, which is what you would expect. I mean we just rolled it out a couple of months ago. So everything is behaving exactly as we expected.

And so we're not seeing any red flags that would suggest that we've got a problem with our market assumptions right now.

Unknown speaker

All right. Thank you so much. I'll pass it on.

Scott Buckhout -- President and Chief Executive Officer

Thank you.


Thank you. Our next question is coming from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

Unkown speaker

Hey, good morning. This is Brad on for Jeff.

Scott Buckhout -- President and Chief Executive Officer

Hey, Brad.

Unkown speaker

Hey, good morning. Just on the adjusted EBITDA bridge, I think $120 million for 2018. It looks like that implies a nice acceleration in the second half. It sounds like the underlying market assumptions are about as expected.

But can you talk about maybe some of the moving pieces that justify the ramp in the second half especially given maybe continued pressure in energy?

Chadi Chahine -- Chief Financial Officer

Yes. This is Chadi, Brad. So a couple of things here. As you appropriately mentioned, we've reflected this in our 18-month plan.

Really the expectation is in line with prior years. A seasonal increase in our revenue specially in Q4 as well as our pricing actions that have been completed as of Q2, will have full effect for the rest of the year in addition to the synergies that have been ongoing as a result of the fluid handling integration. In addition, we've mentioned in our plan that we are simplifying the company through the divestiture, and that's generating G&A savings that will materialize primarily in Q3 and Q4. So all these drivers are the key drivers we feel confident that we are -- we will see an acceleration of EBITDA in Q3 and Q4.

Unkown speaker

OK. That's helpful. And then just on the timing of some of these large projects, both in industrial and energy, can you talk about maybe your visibility around when they might begin to come through? Sounds like maybe there's higher conviction on the industrial side than in downstream energy, but any kind of color there would be helpful.

Scott Buckhout -- President and Chief Executive Officer

So I would say that you're right. I'd say what we probably have more but smaller projects in industrial that tend to just be a little bit more predictable just because the law of the large numbers, I guess. We just got more of them and they are smaller, so they don't necessarily move the needle as much. So we're reasonably confident in the project side of our industrial group.

On the energy side, the only project business that -- the only meaningful projects that we have is in our refinery valve business. And as you probably know already, those tend to be quite large projects. We have -- it's very difficult for us to predict within three months or even six months when some of these projects are going to turn into orders. But we do have a very good read on the level of activity and the pipeline of projects.

So we can confidently say that the level of activity in the market is still very good and very high. And so we feel good about where we are in terms of the project pipeline. And what we think is going to be converting here in the next six months into orders. So it's hard for us, but we feel good knowing that the process licensers are very busy.

The customers are not canceling projects, they're actually moving forward and very active with the projects. It's just when do we actually get the purchase orders is very hard for us to predict.

Unkown speaker

And if some of those do pull forward into 2019, that would just be upside versus kind of conservative expectations you have in the guidance for this year?

Scott Buckhout -- President and Chief Executive Officer

That's largely correct. I would agree with that. And typically, when these big projects come in, we are able to recognize revenue relatively quickly. So I think what you said is correct.

Unkown speaker

OK. And then just last one on energy margins. I think you said 7.7% in the second quarter, maybe mid-single digits in the third quarter. Is that mid-single digit with the engineered valves business? And if without, then on forward run-rate basis, how should we be thinking about the margins in that business once engineered valves is completely out of it?

Scott Buckhout -- President and Chief Executive Officer

Right. So we do have engineered valves out of in our guidance and the -- so we are saying about mid-single digits for Q3. I will -- We'll hold off guiding Q4 at this minute, but largely the concern here is volume in North American land. And so we -- in our 18-month plan, we pushed that way down.

We really lowered the expectations on that. And that's playing out largely as expected. And so that's really the impact that you see the margin going into Q3.

Unkown speaker

All right. Thank you very much. I'll pass it on.

Scott Buckhout -- President and Chief Executive Officer

OK. Thank you.


Thank you. Our next question is coming from Brett Kearney of Gabelli & Company. Please go ahead.

Brett Kearney -- Gabelli and Company -- Analyst

Hi, guys. Good morning. Thank you for taking my question.

Scott Buckhout -- President and Chief Executive Officer

Hi, Brett. Good morning. How are you?

Brett Kearney -- Gabelli and Company -- Analyst

Doing well. Just wanted to ask one piece of clarification. You provided a lot of helpful commentary in the release and on the call thus far this morning, how you're thinking about strategic path or paths, value realization? Just want to ask, at this point now, would you all initiate outreach to interested or potential interested parties as part of your exploration and evaluation of options that you indicated in the release and in the comments this morning.

Scott Buckhout -- President and Chief Executive Officer

Sure. So let me take that, Brett. So we'll -- I'll give you a little bit broader answer. So we've clearly articulated our plan and the benefits of the plan to our shareholders.

We believe in the plan, we're confident in the plan. And we're executing against that plan. That being said, we think it's prudent to evaluate a broad range of options, strategic, financial and operational options that include the items that you see in our press release. And we will be evaluating that to see if there is value in excess of the plan that we're already executing on.

As part of that, if and when we choose a path that may include selling some or all of CIRCOR, of course, there would be a reach-out at that point. Having said that, we haven't reached that point yet. We're still in the evaluation mode, but we thought it was appropriate to let everybody understand in a very transparent way the exercise that the board is going through right now.

Brett Kearney -- Gabelli and Company -- Analyst

Sure. That's helpful. Thank you, Scott.

Scott Buckhout -- President and Chief Executive Officer

Thank you, Brett.


We have reached the end of the question-and-answer session and with that, the conclusion of today's call. [Operator signoff]

Duration: 38 minutes

Call participants:

David Mullen -- Senior Vice President Finance and Corporate Controller

Scott Buckhout -- President and Chief Executive Officer

Chadi Chahine -- Chief Financial Officer

Unknown speaker

Unkown speaker

Brett Kearney -- Gabelli and Company -- Analyst

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