Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 001-14962
 
CIRCOR INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter) 
 
 
 
 
Delaware
 
04-3477276
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
c/o CIRCOR INTERNATIONAL, Inc.
30 Corporate Drive, Suite 200, Burlington, MA
 
01803-4238
(Address of principal executive offices)
 
(Zip Code)
(781) 270-1200
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer," “smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Emerging growth company
o
Non-accelerated filer
o
 
Smaller reporting company
o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    Yes  o    No  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

As of October 29, 2018, there were 19,843,533 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.



CIRCOR INTERNATIONAL, INC.
TABLE OF CONTENTS

 
Page
 
Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017
 
Condensed Consolidated Statements of (Loss) Income for the Three and Nine Months Ended September 30, 2018 and October 1, 2017
 
Condensed Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2018 and October 1, 2017
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and October 1, 2017
 

2



PART I. FINANCIAL INFORMATION
ITEM 1.
 FINANCIAL STATEMENTS
CIRCOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(UNAUDITED)


 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
71,334

 
$
110,356

Trade accounts receivable, less allowance for doubtful accounts of $6,965 and $4,791 at September 30, 2018 and December 31, 2017, respectively
192,110

 
223,922

Inventories
226,047

 
244,896

Restricted cash
919

 
1,937

Prepaid expenses and other current assets
84,265

 
57,282

Total Current Assets
574,675

 
638,393

PROPERTY, PLANT AND EQUIPMENT, NET
215,206

 
217,539

OTHER ASSETS:
 
 
 
Goodwill
504,638

 
505,762

Intangibles, net
470,722

 
513,364

Deferred income taxes
33,130

 
22,334

Other assets
14,479

 
9,407

TOTAL ASSETS
$
1,812,850

 
$
1,906,799

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
111,400

 
$
117,329

Accrued expenses and other current liabilities
108,031

 
170,454

Accrued compensation and benefits
30,827

 
34,734

Total Current Liabilities
250,258

 
322,517

LONG-TERM DEBT
802,069

 
787,343

DEFERRED INCOME TAXES
25,397

 
26,122

PENSION LIABILITY, NET
142,067

 
150,719

OTHER NON-CURRENT LIABILITIES
18,888

 
18,124

COMMITMENTS AND CONTINGENCIES (NOTE 10)
 
 
 
SHAREHOLDERS’ EQUITY:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.01 par value; 29,000,000 shares authorized; 19,843,533 and 19,785,298 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
212

 
212

Additional paid-in capital
443,984

 
438,721

Retained earnings
253,107

 
274,243

Common treasury stock, at cost (1,372,488 shares at September 30, 2018 and December 31, 2017)
(74,472
)
 
(74,472
)
Accumulated other comprehensive loss, net of tax
(48,660
)
 
(36,730
)
Total Shareholders’ Equity
574,171

 
601,974

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,812,850

 
$
1,906,799

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3



CIRCOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF (LOSS) INCOME
(in thousands, except per share data)
(UNAUDITED)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Net revenues
$
297,514

 
$
159,693

 
$
874,462

 
$
456,131

Cost of revenues
212,436

 
112,390

 
624,829

 
314,527

     GROSS PROFIT
85,078

 
47,303

 
249,633

 
141,604

Selling, general and administrative expenses
74,106

 
38,120

 
229,343

 
116,425

Special and restructuring charges (recoveries), net
2,756

 
2,319

 
17,202

 
(443
)
     OPERATING INCOME
8,216

 
6,864

 
3,088

 
25,622

Other expense (income):
 
 
 
 
 
 
 
Interest expense, net
14,100

 
2,445

 
39,656

 
6,298

Other (income) expense, net
(1,580
)
 
823

 
(7,200
)
 
2,022

     TOTAL OTHER EXPENSE, NET
12,520

 
3,268

 
32,456

 
8,320

(LOSS) INCOME BEFORE INCOME TAXES
(4,304
)
 
3,596

 
(29,368
)
 
17,302

Provision for (benefit from) income taxes
2,537

 
(21
)
 
(10,988
)
 
(57
)
NET (LOSS) INCOME
$
(6,841
)
 
$
3,617

 
$
(18,380
)
 
$
17,359

(Loss) Earnings per common share:
 
 
 
 
 
 
 
Basic
$
(0.34
)
 
$
0.22

 
$
(0.93
)
 
$
1.05

Diluted
$
(0.34
)
 
$
0.22

 
$
(0.93
)
 
$
1.04

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
19,843

 
16,503

 
19,829

 
16,486

Diluted
19,843

 
16,709

 
19,829

 
16,721

Dividends declared per common share
$

 
$
0.0375

 
$

 
$
0.1125

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4



CIRCOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
(UNAUDITED)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Net (loss) income
$
(6,841
)
 
$
3,617

 
$
(18,380
)
 
$
17,359

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 

Foreign currency translation adjustments
3,128

 
9,510

 
(15,380
)
 
28,091

       Interest rate swap adjustments
2,224

 

 
3,449

 

COMPREHENSIVE (LOSS) INCOME
$
(1,489
)
 
$
13,127

 
$
(30,311
)
 
$
45,450


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5



CIRCOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
 
Nine Months Ended
OPERATING ACTIVITIES
September 30, 2018
 
October 1, 2017
Net (loss) income
$
(18,380
)
 
$
17,359

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation
21,556

 
10,889

Amortization
36,845

 
9,491

Bad debt expense
1,078

 
265

Loss on write down of inventory
4,632

 
1,463

Amortization of inventory fair value step-up
6,600

 

Compensation expense for share-based plans
4,303

 
2,696

Change in fair value of contingent consideration

 
(12,200
)
Amortization of debt issuance costs
2,852

 

Loss on sale or write-down of property, plant and equipment
1,305

 
87

Loss on sale of business

 
5,300

Trade accounts receivable
21,510

 
8,782

Inventories
4,463

 
(29,703
)
Prepaid expenses and other assets
(31,034
)
 
(11,424
)
Accounts payable, accrued expenses and other liabilities
(32,267
)
 
(997
)
Net cash provided by operating activities
23,463

 
2,008

INVESTING ACTIVITIES
 
 
 
Additions to property, plant and equipment
(17,030
)
 
(7,773
)
Proceeds from the sale of property, plant and equipment
207

 
269

Business acquisition, working capital consideration adjustment
6,300

 
1,467

Net cash used in investing activities
(10,523
)
 
(6,037
)
FINANCING ACTIVITIES
 
 
 
Proceeds from long-term debt
199,600

 
378,263

Payments of long-term debt
(186,874
)
 
(361,325
)
Debt issuance costs

 
(727
)
Dividends paid

 
(1,879
)
Proceeds from the exercise of stock options
690

 
707

Return of cash to seller
(61,201
)
 

Net cash (used in) provided by financing activities
(47,785
)
 
15,039

Effect of exchange rate changes on cash, cash equivalents and restricted cash
(5,154
)
 
6,338

(DECREASE) INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
(39,999
)
 
17,348

Cash, cash equivalents, and restricted cash at beginning of period
112,293

 
58,279

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT END OF PERIOD
$
72,294

 
$
75,627

Non-cash investing activities:
 
 
 
Purchases of property and equipment included in accounts payable and accrued expenses
$
1,574

 
$
1,400

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6



CIRCOR INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1) Basis of Presentation

The accompanying unaudited, condensed consolidated financial statements have been prepared according to the rules and regulations of the United States (the "U.S.") Securities and Exchange Commission (“SEC”) and, in the opinion of management, reflect all adjustments necessary for a fair statement of the consolidated balance sheets, consolidated statements of (loss) income, consolidated statements of comprehensive (loss) income and consolidated statements of cash flows of CIRCOR International, Inc. (“CIRCOR”, the “Company”, “us”, “we” or “our”) for the periods presented. We prepare our interim financial information using the same accounting principles we use for our annual audited consolidated financial statements. Certain information and note disclosures normally included in the annual audited consolidated financial statements have been condensed or omitted in accordance with SEC rules. We believe that the disclosures made in our condensed consolidated financial statements and the accompanying notes are adequate to make the information presented not misleading.

The consolidated balance sheet as of December 31, 2017 is as reported in our audited consolidated financial statements as of that date but does not contain all of the footnote disclosures from the annual financial statements. Our accounting policies are described in the notes to our December 31, 2017 consolidated financial statements, which were included in our Annual Report on Form 10-K for the year ended December 31, 2017, as updated by Note 2 with respect to newly adopted accounting standards. We recommend that the financial statements included in our Quarterly Report on Form 10-Q be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2017.

We operate and report financial information using a fiscal year ending December 31. The data periods contained within our Quarterly Reports on Form 10-Q reflect the results of operations for the 13-week, 26-week and 39-week periods which generally end on the Sunday nearest the calendar quarter-end date. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 or any future quarter.

Unless otherwise indicated, all financial information and statistical data included in these notes to our condensed consolidated financial statements relate to our continuing operations, with dollar amounts expressed in thousands (except per-share data).

(2) Summary of Significant Accounting Policies

The significant accounting policies used in preparation of these condensed consolidated financial statements for the three and nine months ended September 30, 2018 are consistent with those discussed in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2017, except as updated below with respect to newly adopted accounting standards.

New Accounting Standards - Adopted

On January 1, 2018, we adopted the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. ASU 2017-01 provides further clarification of the definition of a business with the objective to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets versus businesses. The amendments in ASU 2017-01 provide criteria to determine when a set of assets and activities is not a business. ASU 2017-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The adoption of ASU 2017-01 has not had a material impact on our condensed consolidated financial statements.

On January 1, 2018, we adopted the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under this guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award changes as a result of the change in terms or conditions. The amendments in this ASU also clarify that no new measurement date will be required if an award is not probable of vesting at the time a change is made and there is no change to the fair value, vesting conditions, and classification. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of ASU 2017-09 has not had a material impact on our condensed consolidated financial statements.


7



On January 1, 2018, we adopted the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this update do not provide a definition of restricted cash or restricted cash equivalents. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of ASU 2016-18 has not had a material impact on our condensed consolidated financial statements.

On January 1, 2018, we adopted the FASB issued ASU 2017-07, Compensation—Retirement Benefits (Topic 715), which improves the consistency, transparency, and usefulness of the service cost and net benefit cost financial information components. This ASU amends presentation requirements of service cost and other components of net retirement benefit costs in the income statement. In addition, the ASU allows only the service cost component of net benefit cost to be eligible for capitalization. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The amendments in this ASU are applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic post-retirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic post-retirement benefit in assets. We have elected to use the practical expedient that permits us to use the amounts disclosed in our pension and other post-retirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. For prospective and retroactive reclassification, service costs are recorded within the selling, general, and administrative caption of our consolidated income statement, while the other components of net benefit cost are recorded in the other expense (income), net caption of our consolidated income statement. The adoption of ASU 2017-17 did not have a material impact on our prior period condensed consolidated financial statements.

On January 1, 2018, we adopted the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which reduces the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This ASU addresses eight specific cash flow issues with the objective of enhancing consistency in presentation and classification. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of ASU 2016-15 has not had a material impact on our condensed consolidated financial statements.
On January 1, 2018, we adopted the requirements of ASU 2014-09, Revenue from Contracts with Customers and all the related amendments (“ASC 606” or the “new revenue standard”) using the modified retrospective transition approach. The new revenue standard provides for a single comprehensive model to use in accounting for revenue arising from contracts with customers and replaces most existing revenue recognition guidance in U.S. Generally Accepted Accounting Principles ("GAAP"). We recognized the cumulative effect of adopting the new revenue standard as an adjustment to the opening balance of retained earnings as of January 1, 2018. The comparative periods presented have not been restated and continue to be reported under the accounting standards in effect for those periods.

The Company recognizes revenue to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled to in exchange for performance obligations. In order to apply this revenue recognition principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when, or as, a performance obligation is satisfied. See Note 3, Revenue Recognition for further information.

8




The cumulative effect of the changes made to our consolidated January 1, 2018 balance sheet for the adoption of the new revenue standard were as follows (in thousands):
 
As of
December 31, 2017
 
ASC 606 Adjustments
 
As of
January 1, 2018
Assets
 
 
 
 
 
Contract assets (1)
15,019

 
(2,995
)
 
12,024

Inventories
244,896

 
540

 
245,436

Deferred income taxes
22,333

 
1,123

 
23,456

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Contract liabilities (2)
(33,718
)
 
(1,517
)
 
(35,235
)
Deferred income taxes
(26,122
)
 
92

 
(26,030
)
 
 
 
 
 
 
Equity
 
 
 
 
 
Retained earnings
(274,243
)
 
2,757

 
(271,486
)
 
 
 
 
 
 
(1) Recorded within prepaid expenses and other current assets. Debit balances are presented as a positive and credit balances are presented as a negative herein.
(2) Recorded within accrued expenses and other current liabilities. Debit balances are presented as a positive and credit balances are presented as a negative herein.

The net impact on retained earnings under the new revenue standard is the result of offsetting amounts attributed to contracts that converted from point in time to over time recognition of $2.5 million and contracts that converted from over time to point in time recognition of $5.3 million.

For contracts that were modified before the effective date, we reflected the aggregate effect of all modifications when identifying performance obligations and allocating transaction price in accordance with the practical expedient method under the new revenue standard, which did not have a material effect on the adjustment to retained earnings.



























9



The tables below illustrate the differences in our condensed consolidated statement of (loss) income and balance sheet due to the change in revenue recognition standard (in thousands):
 
For the three months ended September 30, 2018
 
As Reported
 
Balances Without Adoption of ASC 606
 
Effective Change
 
 
 
 
 
 
Net revenues
297,514

 
291,564

 
5,950

Cost of revenues
212,436

 
209,123

 
3,313

Provision for income taxes
2,537

 
1,944

 
593

Net (Loss) Income
(6,841
)
 
(8,885
)
 
2,044

 
 
 
 
 
 
 
For the nine months ended September 30, 2018
 
As Reported
 
Balances Without Adoption of ASC 606
 
Effective Change
 
 
 
 
 
 
Net revenues
874,462

 
831,479

 
42,983

Cost of revenues
624,829

 
597,903

 
26,926

Benefit from income taxes
(10,988
)
 
(14,587
)
 
3,599

Net (Loss) Income
(18,380
)
 
(30,838
)
 
12,458

 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2018
 
As
Reported
 
Balances Without Adoption of ASC 606
 
Effective Change
Assets
 
 
 
 
 
Contract assets (1)
43,791

 
7,702

 
36,089

Inventories
226,047

 
254,246

 
(28,199
)
Deferred income taxes
33,130

 
35,623

 
(2,493
)
 
 
 
 
 

Liabilities
 
 
 
 
 
Contract liabilities (2)
33,416

 
41,583

 
(8,167
)
Deferred income taxes
25,397

 
24,291

 
1,106

Retained earnings
253,107

 
239,249

 
13,858

 
 
 
 
 

(1) Recorded within prepaid expenses and other current assets.
(2) Recorded within accrued expenses and other current liabilities.

For the three and nine months ended September 30, 2018, we realized changes to our net (loss) income and in the working capital accounts as described above, with no impact on our net cash flows from operating activities.

For the three and nine months ended September 30, 2018, the only impact to comprehensive income as a result of the changes between the balances with ASC 606 and without ASC 606 related to the adjustments to net (loss) income shown in the table above.

New Accounting Standards - Not Yet Adopted

In March 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 outlines a model for lessees by recognizing all lease-related assets and liabilities on the balance sheet. The amendments in this ASU are effective for fiscal years beginning after

10



December 15, 2018 and interim periods within those fiscal years. Early application is permitted. ASU 2016-02 requires a modified retrospective approach for all leases existing at, or entered into after, the date of initial application, with an option to elect to use certain transition relief. In July 2018, the FASB issued ASU 2018-11, Leases: Targeted Improvements. The amendment provides transition relief, as entities may elect not to recast the comparable periods and rather change the date of initial application to the beginning of the period of adoption.

We established a cross-functional implementation team including representatives from operations, legal, and finance. We identified potential changes to our business processes and controls to support recognition and disclosure under the new standard. We made progress toward completing our evaluation of the potential changes from adopting the new standard on our financial reporting and disclosures. Activities performed during the third quarter included collecting and reviewing our lease agreements and training our finance professionals on the new standard. We continue to gather and analyze our lease agreements to determine proper classification and accounting treatment, as well as working with finance and legal advisors on specific interpretative issues. We intend to adopt this new standard on January 1, 2019, and we are still evaluating the impact it will have on our consolidated financial statements.

(3) Revenue Recognition

Our revenue is derived from a variety of contracts. A significant portion of our revenues are from contracts associated with the design, development, manufacture or modification of highly engineered, complex and severe environment products with customers who are either in or service the energy, aerospace, defense and industrial markets. Our contracts within the defense markets are primarily with U.S. military customers. Our contracts with the U.S. military customers typically are subject to the Federal Acquisition Regulations (FAR). We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. Contracts may be modified to account for changes in contract specifications and requirements. Contract modifications exist when the modification either creates new, or changes the existing, enforceable rights and obligations. Contract modifications for goods or services that are not distinct from the existing contract are accounted for as if they were part of that existing contract. In these cases, the effect of the contract modification on the transaction price and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis, except when such modifications relate to a performance obligation which is a series of substantially the same distinct goods or services.  If the modification relates to a performance obligation for a series of substantially the same distinct goods or services, the modifications are treated prospectively. Contract modifications for goods or services that are considered distinct from the existing contract are accounted for as separate contracts.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, control is transferred to the customer. Consistent with historical practice, we exclude from the transaction price amounts collected on behalf of third parties (e.g. taxes). Our performance obligations are typically satisfied at a point in time upon delivery and shipping and handling costs are treated as fulfillment costs. To determine the proper revenue recognition method for contracts for highly engineered, complex and severe environment products with right of payment, which meet over-time revenue recognition criteria, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. In certain instances, we accounted for contracts using the portfolio approach when the effect of accounting for a group of contracts or group of performance obligations would not differ materially from considering each contract or performance obligation separately. This determination requires the use of estimates and assumptions that reflect the size and composition of the portfolio. For most of our over-time revenue recognition contracts, the customer contracts with us to provide custom products which serve a single project or capability (even if that single project results in the delivery of multiple products) with right of payment. In circumstances where each distinct product in the contract transfers to the customer over time and the same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each unit to the customer, we would then apply the series guidance to account for the multiple products as a single performance obligation. Hence, the entire contract is accounted for as one performance obligation. An example of these performance obligations include refinery valves or actuation components and sub-systems. Less commonly, however, we may promise to provide distinct goods or services within the over-time revenue recognition contract, in which case we separate the contract into more than one performance obligation. For all contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. Generally, the contractually stated price is the primary method used to estimate standalone selling price as the good or service

11



is sold separately in similar circumstances and to similar customers for a similar price and discounts are allocated proportionally to each performance obligation. The Company will not adjust the promised amount of consideration for the effects of a significant financing component as we expect, at contract inception, that the period between when the transfer of control to our customers and when the customer fully pays for the related performance obligations will be less than a year.

Revenue from products and services transferred to customers over-time accounted for 1 percent and 5 percent of our revenue for the three and nine months ended September 30, 2018, respectively. The majority of our revenue recognized over-time is related to our Refinery Valves business within our Energy segment and certain other businesses that sell customized products to customers that serve the U.S. Department of Defense within our Aerospace and Defense segment and have contract provisions guaranteeing us costs and profit upon customer cancellation. Revenue is recognized over-time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion, known as the “cost-to-cost” method) to measure progress. We generally use the cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, revenues are recorded proportionally as costs are incurred. Contract costs include labor, materials and subcontractors’ costs, other direct costs and an allocation of overhead, as appropriate.

On September 30, 2018, we had $557.0 million of revenue related to remaining performance obligations. We expect to recognize approximately 42 percent of our remaining performance obligations as revenue during the remainder of 2018, 48 percent in 2019, and the remaining 10 percent in 2020 and thereafter.

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the consolidated balance sheet. Contract assets include unbilled amounts typically resulting from over-time contracts when the cost-to-cost method of revenue recognition is utilized and revenue recognized exceeds the amount billed to the customer, and right to payment is not just subject to the passage of time. Amounts may not exceed their net realizable value. Contract assets are generally classified as current. Generally, payment terms are based on shipment and billing occurs subsequent to revenue recognition, resulting in contract assets for over-time revenue recognition products. However, we sometimes receive advances or deposits from our customers, before revenue is recognized, resulting in contract liabilities. Contract liabilities are generally classified as current. These assets and liabilities are reported net on the consolidated balance sheet on a contract-by-contract basis at the end of each reporting period. Consistent with historical practice, we elected to expense the incremental costs of obtaining a contract when the amortization period for such contracts would have been one year or less.

In order to determine revenue recognized in the period from contract liabilities, we first allocate revenue to the individual contract liabilities balances outstanding at the beginning of the period until the revenue exceeds that balance. If additional advances are received on those contracts in subsequent periods, we assume all revenue recognized in the reporting period first applies to the beginning contract liabilities as opposed to a portion applying to the new advances for the period.

The opening and closing balances of the Company’s contract assets and contract liabilities balances as of September 30, 2018 are as follows (in thousands):
 
 
With ASC 606
 
 
September 30, 2018
 
January 1, 2018
Increase/(Decrease)
Trade accounts receivables, net
 
192,110

 
223,922

(31,812
)
Contract assets (1)

43,791

 
12,024

31,767

Contract liabilities (2)
 
33,416

 
35,235

(1,819
)
 
 
 
 
 
 
(1) Recorded within prepaid expenses and other current assets.
(2) Recorded within accrued expenses and other current liabilities

The difference in the opening and closing balances of the contract assets and contract liabilities primarily result from the timing difference between the Company’s performance and the customer’s payment.

Trade account receivables, net decreased $31.8 million, or 14%, to $192.1 million as of September 30, 2018, primarily driven by cash collections during the nine months ended September 30, 2018.


12



Contract assets increased $31.8 million, or 264%, to $43.8 million, as of September 30, 2018, primarily related to unbilled revenue recognized during the nine months ended September 30, 2018 within our Refinery Valves business (+106%), U.S. Defense business (+57%), and North American Valves business (+45%).

Contract liabilities decreased $1.8 million, or 5%, to $33.4 million as of September 30, 2018, primarily driven by revenue recognized over time during the nine months ended September 30, 2018 within our Refinery Valves business (-11%), partially offset by customer advance payments within our U.S. Defense Business (+4%).

Contract Estimates. Accounting for over-time contracts requires reliable estimates in order to estimate total contract revenue and costs. For these contracts, we have a Company-wide standard and disciplined quarterly Estimate at Completion ("EAC") process in which management reviews the progress and execution of our performance obligations. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities include management's judgment about the ability and cost to achieve the delivery schedule (e.g., the timing of shipments), technical requirements (e.g., a highly engineered product requiring sub-contractors) and other contract requirements. Management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the performance obligation (e.g. to estimate increases in wages and prices for materials and related support cost allocations), execution by our subcontractors, the availability and timing of funding from our customer and overhead cost rates, among other variables. Based on all of these factors, we estimate the profit on a contract as the difference between the total estimated revenue and EAC costs and recognize the resultant profit over the life of the contract, using the cost-to-cost EAC input method to measure progress.

The nature of our contracts gives rise to several types of variable consideration, including penalties. We include in our contract estimates a reduction to revenue for customer agreements, primarily in our large projects business, which contain late shipment penalty clauses whereby we are contractually obligated to pay consideration to our customers if we do not meet specified shipment dates. We generally estimate the variable consideration at the most likely amount to which the customer expects to be entitled. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The variable consideration for estimated penalties is based on several factors including historical customer settlement experience, contractual penalty percentages, and facts surrounding the late shipment.

A change in one or more of these estimates could affect the profitability of our contracts. We review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter it is identified.

The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating expenses or revenue. There have been no significant changes in estimates in the three months ended September 30, 2018.


13



Disaggregation of Revenue. The following table presents our revenue disaggregated by major product line (in thousands):
 
 
September 30, 2018
 
Three Months Ended
 
Nine Months Ended
Energy Segment
 
 
 
 
Oil & Gas - Upstream, Midstream & Other
$
63,810

 
$
166,688

 
Oil & Gas - Downstream
57,213

 
167,110

 
Total
121,023

 
333,798

Aerospace & Defense Segment
 
 
 
 
Commercial Aerospace & Other
28,571

 
81,420

 
Defense
29,186

 
92,314

 
Total
57,757

 
173,734

Industrial Segment
 
 
 
 
Pumps & Valves EMEA
74,193

 
240,415

 
Pumps & Valves North America
44,541

 
126,515

 
Total
118,734

 
366,930

Net Revenue
$
297,514

 
$
874,462


(4) Inventories

Inventories consisted of the following (in thousands):
 
September 30, 2018
 
December 31, 2017
Raw materials
$
79,321

 
$
82,372

Work in process
109,591

 
121,709

Finished goods
37,135

 
40,815

Total inventories
$
226,047

 
$
244,896


(5) Business Acquisition

Fluid Handling

On September 24, 2017, CIRCOR entered into a Purchase Agreement (the “Purchase Agreement”) with Colfax Corporation (“Colfax”). Pursuant to the Purchase Agreement, on December 11, 2017, the Company acquired the fluid handling business of Colfax ("FH") for consideration consisting of $542.0 million in cash, 3,283,424 unregistered shares of the Company's common stock, with a fair value of approximately $143.8 million at closing, and the assumption of net pension and post-retirement liabilities of FH. The cash consideration is subject to customary working capital adjustments. The Company financed the cash consideration through a combination of committed debt financing and cash on hand. During the second quarter of 2018, the shares were registered and sold with all proceeds going to Colfax.

FH is a leader in the engineering, development‚ manufacturing‚ distribution‚ service and support of fluid handling systems. With a history dating back to 1860‚ FH is a leading supplier of screw pumps for high demand, severe service applications across a range of markets including general industry, commercial marine, defense, and oil & gas. FH leverages differentiated technology, and provides critical aftermarket customer support, to maintain leading positions in high demand niche markets.

Effective January 1, 2018, the operating results of FH have been split between each of our operating segments, Energy, Aerospace & Defense, and Industrial based upon the end markets of the sub-businesses within FH.

The purchase price allocation is based upon a preliminary valuation of assets and liabilities that was prepared with assistance from a third party valuation specialist. The estimates and assumptions are subject to change as we obtain additional information during the measurement period (up to one year from the acquisition date). The purchase accounting is expected to be finalized in the fourth quarter of 2018. The assets and liabilities pending finalization include the valuation of acquired

14



tangible and intangible assets, certain operating liabilities, and the evaluation of income taxes. Differences between the preliminary and final valuation could have a material impact on our future results of operations and financial position.

The following table summarizes the preliminary fair value of the assets acquired and the liabilities assumed, at the date of acquisition:
(in thousands)
 
Cash and cash equivalents (a)
$
63,403

Restricted cash (a)
1,911

Accounts receivable
76,111

Inventory
78,240

Prepaid expenses and other current assets
17,044

Deferred income taxes
41,454

Property, plant and equipment
122,128

Identifiable intangible assets
383,178

Other assets
338

Accounts payable
(46,011
)
Cash payable to seller (a)
(65,314
)
Accrued and other expenses
(69,969
)
Long-term post-retirement liabilities
(143,067
)
Other long-term liabilities
(11,215
)
Deferred tax liabilities
(48,776
)
Total identifiable net assets
$
399,455

Goodwill
298,132

Total purchase price
$
697,587

 
 
Consideration
 
Base purchase price
$
542,000

Net working capital and other purchase accounting adjustments
11,821

Common Stock
143,766

Total
$
697,587

 
 
(a) Cash acquired and returned to seller by the second quarter of 2018.
 

During the first nine months of 2018, we identified certain uncollectible accounts receivables ($1.4 million), obsolete inventories ($0.4 million), and obligations ($0.7 million). Additionally, we received cash from Colfax to settle customary working capital adjustments ($6.3 million) and recorded a liability for a loss customer contract ("Loss Contract") of $9.6 million, including $1.7 million for liquidated damages. We also identified certain working capital adjustments ($0.2 million). These all required further adjustment to our December 11, 2017 opening balance sheet, and have been recorded during the nine months ended September 30, 2018.

The excess of purchase price paid over the fair value of FH's net assets was recorded to goodwill, which is primarily attributable to projected future profitable growth, market penetration, as well as an expanded customer base for the acquired businesses. As of September 30, 2018, approximately 63% of goodwill is projected to be deductible for income tax purposes.


15



The FH acquisition resulted in the preliminary identification of the following identifiable intangible assets (in thousands):


Original Estimate
Measurement Period Adjustment
Fair Value
 
Weighted average amortization period (in years)
Customer relationships
$
215,000

$
(7,000
)
$
208,000

 
19
Acquired technologies
107,000

6,000

113,000

 
20
Trade names
44,000

2,000

46,000

 
Indefinite-life
Backlog
22,000

(6,000
)
16,000

 
4
Total intangible assets
$
388,000

$
(5,000
)
$
383,000

 
 

During the measurement period, with the help of third party specialists, we adjusted the fair value of the acquired FH intangibles based upon better information regarding discount rates, royalty rates, and more detailed business unit forecasts that was determinable at the time of acquisition. The revised fair value of acquired FH intangibles have been recorded against our FH opening balance sheet during the first quarter of 2018.

The fair value of the intangible assets was based on variations of the income approach, which estimates fair value based on the present value of cash flows that the assets are expected to generate. These approaches included the relief-from-royalty method and multi-period excess earnings method, depending on the intangible asset being valued. Customer relationships, backlog, and existing technology are amortized on a cash flow basis which reflects the economic benefit consumed. The trade name was assigned an indefinite life based on the Company’s intention to keep the trade names for an indefinite period of time. Refer to Note 6, Goodwill and Intangibles, net for future expected amortization to be recorded.

(6) Goodwill and Intangibles, net

The following table shows goodwill by segment as of December 31, 2017 and September 30, 2018 (in thousands): 
 
Energy
 
Aerospace & Defense
 
Industrial
 

Total
Goodwill as of December 31, 2017
$
154,058

 
$
62,548

 
$
289,156

 
$
505,762

Adjustments to preliminary purchase price allocation
(5,479
)
 
(6,050
)
 
16,317

 
4,788

Currency translation adjustments
(1,440
)
 
(33
)
 
(4,439
)
 
(5,912
)
Goodwill as of September 30, 2018
$
147,139

 
$
56,465

 
$
301,034

 
$
504,638


During the first nine months of 2018, we identified certain uncollectible accounts receivables, obsolete inventories, a liability for a loss contract, and other obligations which required further adjustment to our December 11, 2017 opening balance sheet. The identified adjustments have been recorded against our FH opening balance sheet during the first, second, and third quarters of 2018 and are reflected in the line "adjustments to preliminary purchase price allocation" listed in the table above.

During the first quarter ended April 1, 2018, we realigned our organizational structure under three reportable business segments: Energy, Aerospace & Defense and Industrial. Our realignment was a triggering event for goodwill impairment testing. During the first quarter of 2018, we evaluated our reporting units for goodwill impairment and determined no impairments existed.

16



The table below presents gross intangible assets and the related accumulated amortization as of September 30, 2018 (in thousands):
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Patents
$
5,399

 
$
(5,399
)
Customer relationships
311,846

 
(54,971
)
Backlog
23,494

 
(15,457
)
Acquired technology
141,305

 
(21,401
)
Other
5,258

 
(4,882
)
Total Amortized Assets
$
487,302

 
$
(102,110
)
 
 
 
 
Non-amortized intangibles (primarily trademarks and trade names)
$
85,530

 
$

Total Non-Amortized Intangibles
$
85,530

 
$

 
 
 
 
Net carrying value of intangible assets
$
470,722

 
 

The table below presents estimated remaining amortization expense for intangible assets recorded as of September 30, 2018 (in thousands):
 
Remainder of 2018
 
2019
 
2020
 
2021
 
2022
 
After 2022
Estimated amortization expense
$
12,248

 
$
49,851

 
$
45,742

 
$
43,574

 
$
38,161

 
$
195,616


(7) Segment Information

Our Chief Operating Decision Maker evaluates segment operating performance using segment operating income. Segment operating income is defined as GAAP operating income excluding intangible amortization and amortization of fair value step-ups of inventory and fixed assets from acquisitions completed subsequent to December 31, 2011, the impact of restructuring related inventory write-offs, impairment charges and special charges or gains. The Company also refers to this measure as adjusted operating income. The Company uses this measure because it helps management understand and evaluate the segments’ core operating results and facilitate comparison of performance for determining incentive compensation achievement.

As of December 31, 2017 we had organized our reporting structure into three segments: CIRCOR Energy ("Energy segment" or "Energy"), CIRCOR Advanced Flow Solutions ("Advanced Flow Solutions segment" or "AFS"), and CIRCOR Fluid Handling ("Fluid Handling"). 
 
Effective January 1, 2018, we realigned our businesses with end markets to simplify the business, clarify customer and channel relationships and help us exploit growth synergy opportunities across the organization. The new reporting segments are Energy, Aerospace & Defense and Industrial. The Energy segment remains unchanged except for the addition of Reliability Services, a business from the FH acquisition. The Aerospace & Defense segment includes the Aerospace business out of our AFS segment, as well as the Pumps Defense business of Fluid Handling. The Industrial segment includes the remaining portion of Fluid Handling as well as the industrial solutions and power and process businesses (mainly control valves) that were part of AFS. In addition, a number of smaller product lines were realigned as part of this change to better manage and serve our customers. The current and prior periods are reported under the new segment structure.

The following table presents certain reportable segment information (in thousands):

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018

 
October 1, 2017

Net revenues
 
 
 
 
 
 
 
Energy
$
121,023

 
$
88,569

 
$
333,799

 
$
243,055


17



Aerospace & Defense
57,757

 
41,117

 
173,734

 
126,022

Industrial
118,734

 
30,007

 
366,929

 
87,054

Consolidated net revenues
$
297,514

 
$
159,693

 
$
874,462

 
$
456,131

 
 
 
 
 
 
 
 
(Loss) Income from operations before income taxes
 
 
 
 
 
 
 
Energy - Segment Operating Income
$
9,163

 
$
6,936

 
$
24,101

 
$
21,512

Aerospace & Defense - Segment Operating Income
8,709

 
4,333

 
24,631

 
12,492

Industrial - Segment Operating Income
14,609

 
5,675

 
42,592

 
14,960

Corporate expenses
(8,034
)
 
(5,067
)
 
(22,284
)
 
(15,942
)
Subtotal
24,447

 
11,877

 
69,040

 
33,022

Restructuring charges, net
1,348

 
341

 
11,807

 
5,366

Special charges (recoveries), net
1,408

 
1,978

 
5,395

 
(5,809
)
Special and restructuring charges (recoveries), net
2,756

 
2,319

 
17,202

 
(443
)
Restructuring related inventory charges

 

 
1,538

 

Amortization of inventory step-up

 

 
6,600

 

Acquisition amortization
11,734

 
2,694

 
35,299

 
7,843

Acquisition depreciation of fixed assets step-up
1,742

 

 
5,314

 

Acquisition amortization and other costs, net
13,476

 
2,694

 
48,751

 
7,843

Consolidated Operating Income
8,216

 
6,864

 
3,088

 
25,622

Interest expense, net
14,100

 
2,445

 
39,656

 
6,298

Other (income) expense, net
(1,580
)
 
823

 
(7,200
)
 
2,022

(Loss) Income from operations before income taxes
$
(4,304
)
 
$
3,596

 
$
(29,368
)
 
$
17,302

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018

 
October 1, 2017

 
September 30, 2018

 
October 1, 2017

Capital expenditures
 
 
 
 
 
 
 
Energy
$
2,572

 
$
1,202

 
$
6,852

 
$
2,699

Aerospace & Defense
1,320

 
909

 
3,161

 
2,379

Industrial
910

 
901

 
6,760

 
2,035

Corporate
187

 
39

 
574

 
782

Consolidated capital expenditures
$
4,989

 
$
3,051

 
$
17,347

 
$
7,895

 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
 
 
 
 
 
Energy
$
4,061

 
$
3,147

 
$
12,408

 
$
9,342

Aerospace & Defense
2,716

 
1,073

 
8,244

 
3,253

Industrial
12,337

 
2,266

 
37,158

 
6,765

Corporate
171

 
328

 
592

 
1,022

Consolidated depreciation and amortization
$
19,285

 
$
6,814

 
$
58,402

 
$
20,382

 
 
 
 
 
 
 
 
Identifiable assets
September 30, 2018
 
December 31, 2017
 
 
 
 
Energy
$
905,708

 
$
837,492

 
 
 
 
Aerospace & Defense
642,431

 
375,094

 
 
 
 
Industrial
1,020,849

 
1,408,217

 
 
 
 
Corporate
(756,138
)
 
(714,004
)
 
 
 
 
Consolidated identifiable assets
$
1,812,850

 
$
1,906,799

 
 
 
 


18



The total assets for each reportable segment have been reported as the Identifiable Assets for that segment, including inter-segment intercompany receivables, payables and investments in other CIRCOR companies. Identifiable assets reported in Corporate include both corporate assets, such as cash, deferred taxes, prepaid and other assets, fixed assets, as well as the elimination of all inter-segment intercompany assets. The elimination of intercompany assets results in negative amounts reported in Corporate for Identifiable Assets. Corporate Identifiable Assets excluding intercompany assets were $28.2 million and $51.5 million as of September 30, 2018 and October 1, 2017, respectively.

(8) Financial Instruments

Fair Value

The company utilizes fair value measurement guidance prescribed by accounting standards to value its financial instruments. The guidance establishes a fair value hierarchy based on the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:

Level One: Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets.

Level Two: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level Three: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

The fair value measurements of the Company's financial instruments as of September 30, 2018 are summarized in the table below:


Significant Other Observable Inputs

Level 2


Current Liabilities
$
(102
)
Derivative Assets
3,449

Total Financial Instruments
$
3,347


 The carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments. Cash equivalents are carried at cost which approximates fair value at the balance sheet date and is a Level 1 financial instrument. As of September 30, 2018 and December 31, 2017, the outstanding balance of the Company’s debt approximated fair value based on current rates available to the Company for debt of the same maturity and is a Level 2 financial instrument.

Effective April 12, 2018, the Company entered into an interest rate swap pursuant to an International Swaps and Derivatives Association ("ISDA") Master Agreement with Citizens Bank, National Association ("interest rate swap").  The four-year interest rate swap has a fixed notional value of $400.0 million with a 1% LIBOR floor and a maturity date of April 12, 2022. The fixed rate of interest paid by the Company is comprised of our current credit spread of 350 basis points plus 2.6475% for a total interest rate of 6.1475%. The ISDA Master Agreement, together with its related schedules, contain customary representations, warranties and covenants. This hedging agreement was entered into to mitigate the interest rate risk inherent in the Company’s variable rate debt and is not for speculative trading purposes.

The Company has designated the interest rate swap as a qualifying hedging instrument and is treating it as a cash flow hedge for accounting purposes pursuant to ASC 815, Derivatives and Hedging. The net fair value of the interest rate swap was $3.3 million and is recorded in Other assets of $3.7 million and Accrued expenses and other current liabilities of $0.4 million on our condensed consolidated balance sheet as of September 30, 2018. The unrealized gains recognized in other comprehensive

19



income (loss) were $1.6 million and $2.2 million for the three and nine months ended September 30, 2018, respectively. The realized loss of $0.6 million and $1.2 million were reclassified from other comprehensive income (loss) to interest expense as interest expense was accrued on the swap during the three and nine months ended September 30, 2018, respectively. Amounts expected to be reclassified from other comprehensive income into interest expense in the coming 12 months is a loss of $0.2 million. Interest expense (including the effects of the cash flow hedges) related to the portion of the Company's term loan subject to the aforementioned interest-rate swap agreement was $6.2 million and $17.5 million for the three and nine months ended September 30, 2018, respectively.

(9) Guarantees and Indemnification Obligations

As permitted under Delaware law, we have agreements whereby we indemnify certain of our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, we have directors’ and officers’ liability insurance policies that insure us with respect to certain events covered under the policies and should enable us to recover a portion of any future amounts paid under the indemnification agreements. We have no liabilities recorded from those agreements as of September 30, 2018.

We record provisions for the estimated cost of product warranties, primarily from historical information, at the time product revenue is recognized. We also record provisions with respect to any significant individual warranty issues as they arise. While we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to us. Should actual product failure rates, utilization levels, material usage, service delivery costs or supplier warranties on parts differ from our estimates, revisions to the estimated warranty liability would be required.

The following table sets forth information related to our product warranty reserves for the nine months ended September 30, 2018 (in thousands):
 
Balance beginning December 31, 2017
$
4,623

Provisions
1,488

Claims settled
(1,570
)
Currency translation adjustment
(57
)
Balance ending September 30, 2018
$
4,484


Warranty obligations decreased $0.1 million from $4.6 million as of December 31, 2017 to $4.5 million as of September 30, 2018, primarily driven by net claims settled and quarterly provisions within each of our operating segments.

(10) Commitments and Contingencies

We are subject to various legal proceedings and claims pertaining to matters such as product liability or contract disputes, including issues arising under certain customer contracts with aerospace and defense customers. We are also subject to other proceedings and governmental inquiries, inspections, audits or investigations pertaining to issues such as tax matters, patents and trademarks, pricing, business practices, governmental regulations, employment and other matters. Although the results of litigation and claims cannot be predicted with certainty, we expect that the ultimate disposition of these matters, to the extent not previously provided for, will not have a material adverse effect, individually or in the aggregate, on our business, financial condition, results of operations or liquidity.

On February 21, 2018, the Company entered into a mediated settlement regarding a wage and hour action in California by a former employee. In October 2016, the plaintiff alleged non-compliance with California State labor law, including missed or late meal breaks, for hourly employees of CIRCOR Aerospace, Inc. in Corona, California. The total settlement amount of $2.4 million has been recorded as a liability as of September 30, 2018 and December 31, 2017.  This settlement resolves all wage/hour claims by all potentially affected employees through the settlement date and was approved by the California Superior Court during 2018. The Company has yet to fund the settlement as of September 30, 2018.

Asbestos-related product liability claims continue to be filed against two of our subsidiaries: Spence Engineering Company, Inc. (“Spence”), the stock of which we acquired in 1984; and CIRCOR Instrumentation Technologies, Inc. (f/k/a Hoke, Inc.) (“Hoke”), the stock of which we acquired in 1998. Due to the nature of the products supplied by these entities, the markets they

20



serve and our historical experience in resolving these claims, we do not expect that these asbestos-related claims will have a material adverse effect on the financial condition, results of operations or liquidity of the Company.

Standby Letters of Credit

We execute standby letters of credit, which include bid bonds and performance bonds, in the normal course of business to ensure our performance or payments to third parties. The aggregate notional value of these instruments was $70.0 million at September 30, 2018. We believe that the likelihood of demand for a significant payment relating to the outstanding instruments is remote. These instruments generally have expiration dates ranging from less than 1 month to 5 years from September 30, 2018.

The following table contains information related to standby letters of credit instruments outstanding as of September 30, 2018 (in thousands):
Term Remaining
Maximum Potential
Future Payments
0–12 months
$
38,741

Greater than 12 months
31,245

Total
$
69,986



21



(11) Retirement Plans

The following table sets forth the components of total net periodic benefit cost (income) of the Company’s defined benefit pension plans and other post-retirement employee benefit plans (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
September 30, 2018
 
October 1, 2017
Pension Benefits - U.S. Plans
 
 
 
 
 
 
 
Service cost
$

 
$

 
$

 
$

Interest cost
1,762

 
426

 
5,285

 
1,278

Expected return on plan assets
(3,771
)
 
(576
)
 
(11,313
)
 
(1,726
)
Amortization
146

 
184

 
439

 
551

Net periodic benefit (income) cost
$
(1,863
)
 
$
34

 
$
(5,589
)
 
$
103

 
 
 
 
 
 
 
 
Pension Benefits - Non-U.S. Plans
 
 
 
 
 
 
 
Service cost
$
736

 
$

 
$
2,271

 
$

Interest cost
523

 

 
1,617

 

Expected return on plan assets
(243
)
 

 
(755
)
 

Amortization

 

 

 

Net periodic benefit cost
$
1,016

 
$

 
$
3,133

 
$

 
 
 
 
 
 
 
 
Other Post-Retirement Benefits
 
 
 
 
 
 
 
Service cost
$

 
$

 
$
1

 
$

Interest cost
86

 

 
259

 

Amortization

 

 

 

Net periodic benefit cost
$
86

 
$

 
$
260

 
$

 
 
 
 
 
 
 
 
There were no international pension plans or other post-retirement benefits for the period ended October 1, 2017.

The periodic benefit service costs are included in the selling, general, and administrative costs, while the remaining net periodic benefit costs are included in other (income) expense, net in our condensed consolidated statements of (loss) income for the three and nine months ended September 30, 2018 and October 1, 2017, respectively.

Employer contributions to the Company's U.S. and non- U.S. based pension plans during the three and nine months ended September 30, 2018 were $0.0 million and $0.6 million, respectively.

(12) Income Taxes

As of September 30, 2018 and December 31, 2017, we had $1.1 million and $3.0 million of unrecognized tax benefits, respectively, of which $1.0 million and $2.6 million, respectively, would affect our effective tax rate if recognized in any future period.

The Company files income tax returns in U.S. federal, state and local jurisdictions and in foreign jurisdictions. The Company is no longer subject to examination by the Internal Revenue Service (the "IRS") for years prior to 2015 and is no longer subject to examination by the tax authorities in foreign and state jurisdictions prior to 2006. The Company is currently under examination for income tax filings in various foreign jurisdictions.

The Company has a net U.S. deferred tax asset and a net foreign deferred tax liability. Due to uncertainties related to our ability to utilize certain foreign deferred income tax assets, we maintained a total valuation allowance of $23.6 million at September 30, 2018 and $22.1 million at December 31, 2017. The valuation allowance is based on estimates of income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. If future results of operations exceed our current expectations, our existing tax valuation allowances may be adjusted, resulting in future tax

22



benefits. Alternatively, if future results of operations are less than expected, future assessments may result in a determination that some or all of the deferred tax assets are not realizable. Consequently, we may need to establish additional tax valuation allowances for all or a portion of the deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition.

In connection with the enactment of the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017, we recorded provisional estimates for certain provisions of the Tax Act as of December 31, 2017. We have not made any changes to these provisional estimates as of September 30, 2018.

In addition, the Tax Act created a new requirement that certain income, the Global Intangible Low-Taxed Income (“GILTI”), earned by a controlled foreign corporation must be included in the gross income of its U.S. shareholder, effective January 1, 2018. The Tax Act also created the base erosion anti-abuse tax (“BEAT”), a new minimum tax, effective January 1, 2018. We have included the impact of the GILTI provision in the calculation of our 2018 effective tax rate. We do not believe that BEAT will have a material impact on our financial position or results of operations.

(13) Share-Based Compensation

As of September 30, 2018, there were 882,164 stock options and 330,428 Restricted Stock Unit Awards ("RSU Awards") and Restricted Stock Unit Management Stock Plans Awards ("RSU MSPs") outstanding. In addition, there were 397,381 shares available for grant under the 2014 Stock Option and Incentive Plan (the "2014 Plan") as of September 30, 2018.

During the nine months ended September 30, 2018, we granted 127,704 stock options compared with 142,428 stock options granted during the nine months ended October 1, 2017.

The average fair value of stock options granted during the first nine months of 2018 and 2017 was $14.68 and $19.36 per share, respectively, and was estimated using the following weighted-average assumptions:

 
September 30, 2018
 
October 1, 2017
Risk-free interest rate
2.5
%
 
1.7
%
Expected life (years)
4.4

 
4.5

Expected stock volatility
37.2
%
 
35.1
%
Expected dividend yield
%
 
0.3
%

For additional information regarding the historical issuance of stock options, refer to our Annual Report on Form 10-K for the year ended December 31, 2017.

During the nine months ended September 30, 2018 and October 1, 2017, we granted 160,604 and 56,948 RSU Awards with approximate fair values of $43.11 and $60.76 per RSU Award, respectively. During the first nine months of 2018 and 2017, we granted performance-based RSU Awards as part of the overall mix of RSU Awards. These performance-based RSU Awards include metrics for achieving Return on Invested Capital and Adjusted Operating Margin with target payouts ranging from 0% to 200%. Of the 160,604 RSU Awards granted during the nine months ended September 30, 2018, 48,080 are performance-based RSU Awards. This compares to 31,369 performance-based RSU Awards granted during the nine months ended October 1, 2017.

RSU MSPs totaling 34,937 and 26,726 with per unit discount amounts representing fair values of $14.06 and $20.13 per share were granted during the nine months ended September 30, 2018 and October 1, 2017, respectively.

Compensation expense related to our share-based plans for the nine months ended September 30, 2018 and October 1, 2017 was $4.3 million and $2.7 million, respectively. The primary reason for lower expense during 2017 relates to a change in estimate of $1.1 million for anticipated below-threshold achievement of performance-based RSU Awards granted in both February 2015 and February 2016. In addition, 2018 compensation expense includes amounts related to employees from the FH acquisition completed on December 11, 2017. Compensation expense for both periods was recorded as selling, general and administrative expenses. As of September 30, 2018, there was $10.4 million of total unrecognized compensation costs related to our outstanding share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.1 years.


23



The weighted average contractual term for stock options outstanding and options exercisable as of September 30, 2018 was 4.9 years and 4.2 years, respectively. The aggregate intrinsic value of stock options exercised during the nine months ended September 30, 2018 was $0.2 million and the aggregate intrinsic value of stock options outstanding and options exercisable as of September 30, 2018 was $3.1 million and $2.0 million, respectively.

The aggregate intrinsic value of RSU Awards settled during the nine months ended September 30, 2018 was $1.2 million and the aggregate intrinsic value of RSU Awards outstanding and RSU Awards vested and deferred as of September 30, 2018 was $12.1 million and $0.1 million, respectively.

The aggregate intrinsic value of RSU MSPs settled during the nine months ended September 30, 2018 was $0.4 million and the aggregate intrinsic value of RSU MSPs outstanding and RSU MSPs vested and deferred as of September 30, 2018 was $1.1 million and less than $0.1 million, respectively.

International participants are issued Cash Settled Stock Unit Awards. As of September 30, 2018, there were 51,476 Cash Settled Stock Unit Awards outstanding compared to 40,469 as of December 31, 2017. During the nine months ended September 30, 2018, the aggregate cash used to settle Cash Settled Stock Unit Awards was $0.3 million. As of September 30, 2018, we had $1.2 million of accrued expenses in current liabilities associated with these Cash Settled Stock Unit Awards compared with $0.9 million as of December 31, 2017. Cash Settled Stock Unit Award related compensation costs for the nine months ended September 30, 2018 and October 1, 2017 was $0.6 million and $0.2 million, respectively, and was recorded as selling, general, and administrative expenses.

(14) Accumulated Other Comprehensive Loss
The following table summarizes the changes in accumulated other comprehensive loss, net of tax, which is reported as a component of shareholders' equity, for the nine months ended September 30, 2018 (in thousands):
 
Foreign Currency Translation Adjustments
 
Pension, net
 
Derivative
 
Total
Balance as of December 31, 2017
$
(28,584
)
 
$
(8,146
)
 
$

 
$
(36,730
)
Other comprehensive income
(15,380
)
 

 
3,449

 
(11,930
)
Balance as of September 30, 2018
$
(43,964
)
 
$
(8,146
)
 
$
3,449

 
$
(48,660
)

(15) Earnings (Loss) Per Common Share ("EPS")
 
(in thousands, except per share amounts)
Three Months Ended
 
September 30, 2018
 
October 1, 2017
 
Net
Income
 
Shares
 
Per Share
Amount
 
Net
Income
 
Shares
 
Per Share
Amount
Basic EPS
$
(6,841
)
 
19,843

 
$
(0.34
)
 
$
3,617

 
16,503

 
$
0.22

Dilutive securities, common stock options

 

 

 

 
206

 

Diluted EPS
$
(6,841
)
 
19,843


$
(0.34
)

$
3,617


16,709


$
0.22

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
Net
Loss
 
Shares
 
Per Share
Amount
 
Net
Income
 
Shares
 
Per Share
Amount
Basic EPS
$
(18,380
)
 
19,829

 
$
(0.93
)
 
$
17,359

 
16,486

 
$
1.05

Dilutive securities, common stock options

 

 

 

 
235

 
(0.01
)
Diluted EPS
$
(18,380
)
 
19,829

 
$
(0.93
)
 
$
17,359

 
16,721

 
$
1.04


Stock options, RSU Awards, and RSU MSPs covering 371,017 and 253,664 shares of common stock, for the nine months ended September 30, 2018 and October 1, 2017, respectively, were not included in the computation of diluted EPS because their effect would be anti-dilutive.

24



(16) Special & Restructuring Charges (Recoveries), net

Special and Restructuring Charges (Recoveries), net

Special and restructuring charges, net consist of restructuring costs (including costs to exit a product line or program) as well as certain special charges such as significant litigation settlements and other transactions (charges or recoveries) that are described below. All items described below are recorded in Special and restructuring charges, net on our consolidated statements of (loss) income. Certain other special and restructuring charges such as inventory related items may be recorded in cost of revenues given the nature of the item.

The table below (in thousands) summarizes the amounts recorded within the special and restructuring charges (recoveries), net line item on the condensed consolidated statements of (loss) income for the three and nine months ended September 30, 2018 and October 1, 2017:
 
Special & Restructuring Charges (Recoveries), net
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018

 
October 1, 2017
 
September 30, 2018

 
October 1, 2017

Special charges (recoveries), net
$
1,408

 
$
1,978

 
$
5,395

 
$
(5,809
)
Restructuring charges, net
1,348

 
341

 
11,807

 
5,366

Total special and restructuring charges (recoveries), net
$
2,756

 
$
2,319

 
$
17,202

 
$
(443
)

Special Charges (Recoveries), net

The table below (in thousands) outlines the special charges, net recorded for the three and nine months ended September 30, 2018:
 
Special Charges, net
 
For the three months ended September 30, 2018
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Brazil closure
$
198

 
$

 
$

 
$

 
$
198

Acquisition related charges

 

 

 
1,210

 
1,210

Total special charges, net
$
198

 
$

 
$

 
$
1,210

 
$
1,408

 
 
 
 
 
 
 
 
 
 
 
Special Charges, net
 
For the nine months ended September 30, 2018
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Brazil closure
$
730

 
$

 
$

 
$

 
$
730

Acquisition related charges

 

 

 
4,665

 
4,665

Total special charges, net
$
730

 
$

 
$

 
$
4,665

 
$
5,395


Acquisition related charges: On December 11, 2017, we acquired FH. In connection with our acquisition, we recorded $1.2 million and $4.7 million during the three and nine months ended September 30, 2018, respectively, related to internal costs and external professional fees to separate the FH business from Colfax and integrate the FH business into our legacy structure.

Brazil Closure: On November 3, 2015, our Board of Directors approved the closure and exit of our Brazil manufacturing operations due to the economic realities in Brazil and the ongoing challenges with our only significant end customer, Petrobras.
CIRCOR Brazil reported substantial operating losses every year since it was acquired in 2011 while the underlying market
conditions and outlook deteriorated. In connection with the closure, we recorded $0.2 million and $0.7 million of charges within the Energy segment during the three and nine months ended September 30, 2018, respectively, which relates to losses incurred subsequent to our closure of manufacturing operations during the first quarter of 2016.


25



The table below (in thousands) outlines the special charges (recoveries), net recorded for the three and nine months ended October 1, 2017:
 
Special Charges (Recoveries), net
 
For the three months ended October 1, 2017
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Acquisition related charges

$

 
$

 
$

 
$
1,786

 
$
1,786

Brazil closure

192

 

 

 


 
192

Total special charges, net
$
192

 
$

 
$

 
$
1,786

 
$
1,978

 
 
 
 
 
 
 
 
 
 
 
Special (Recoveries) Charges, net
 
For the nine months ended October 1, 2017
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Acquisition related charges

$

 


 
$

 
$
1,923

 
$
1,923

Brazil closure

619

 

 

 

 
619

Divestiture


 
3,748

 

 
101

 
3,849

Contingent consideration revaluation

(12,200
)
 

 

 

 
(12,200
)
Total special (recoveries) charges, net
$
(11,581
)
 
$
3,748

 
$

 
$
2,024

 
$
(5,809
)

Acquisition related charges:
On October 12, 2016, we acquired Critical Flow Solutions ("CFS"). In connection with our acquisition, we recorded $0.1 million of acquisition related professional fees during the nine months ended October 1, 2017. No CFS professional fees were recorded during the three months ended October 1, 2017.
On September 24, 2017, we entered into the Purchase Agreement to purchase FH. In connection with the Purchase Agreement, we recorded $1.8 million of acquisition related professional fees, primarily for legal services, during the three and nine months ended October 1, 2017.

Brazil Closure: In connection with the closure, we recorded $0.2 million and $0.6 million of charges within the Energy segment during the three and nine months ended October 1, 2017, respectively.

Divestiture: On July 7, 2017, we divested our French non-core aerospace build-to-print business within our Aerospace & Defense segment as part of our simplification strategy. We considered this business as non-core because the products or services did not fit our strategy and the long-term profitable growth prospects were below our expectations. Divestiture of this non-core business enables us to focus resources on businesses where there is greater opportunity to achieve sales growth, higher margins, and market leadership. We measured the disposal group at its fair value less cost to sell, which was lower than its carrying value, and recorded a $3.8 million charge during the second quarter of 2017. Also, in connection with this disposition we recorded $1.5 million of severance included as a restructuring charge.

Contingent Consideration Revaluation: The fair value of the earn-out in connection with our October 2016 acquisition of CFS decreased $12.2 million during the nine months ended October 1, 2017. The change in fair value was recorded as a special gain during the nine months ended October 1, 2017. Accordingly, the revised fair value assessment indicated an earn-out of zero as of October 1, 2017.

Restructuring Charges (Recoveries), net

The tables below (in thousands) outline the charges (or any recoveries) associated with restructuring actions recorded for the three and nine months ended September 30, 2018 and October 1, 2017. A description of the restructuring actions is provided in the section titled "Restructuring Programs Summary" below.

26



 
Restructuring Charges
 
As of and for the three months ended September 30, 2018
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Facility related expenses
$
708

 
$
60

 
$

 
$

 
$
768

  Employee related expenses, net
300

 

 
280

 

 
580

Total restructuring charges, net
$
1,008

 
$
60

 
$
280

 
$

 
$
1,348

 
 
 
 
 
 
 
 
 
 
Accrued restructuring charges as of July 1, 2018
 
 
 
 
 
 
 
 
$
1,547

Total quarter to date charges, net (shown above)
 
 
 
 
 
 
 
 
1,348

Charges paid / settled, net
 
 
 
 
 
 
 
 
(342
)
Accrued restructuring charges as of September 30, 2018
 
 
 
 
 
 
 
 
$
1,006

 
 
 
 
 
 
 
 
 
 
 
Restructuring Charges
 
As of and for the nine months ended September 30, 2018
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Facility related expenses
$
2,380

 
$
190

 
$

 
$

 
$
2,570

  Employee related expenses, net
7,748

 

 
1,489

 

 
9,237

Total restructuring charges, net
$
10,128

 
$
190

 
$
1,489

 
$

 
$
11,807

 
 
 
 
 
 
 
 
 
 
Accrued restructuring charges as of December 31, 2017
 
 
 
 
 
 
 
 
$
1,586

Total year to date charges, net (shown above)
 
 
 
 
 
 
 
 
11,807

Charges paid / settled, net
 
 
 
 
 
 
 
 
(12,387
)
Accrued restructuring charges as of September 30, 2018
 
 
 
 
 
 
 
 
$
1,006


We expect to make payment or settle the majority of the restructuring charges accrued as of September 30, 2018 during the fourth quarter of 2018.


27



 
Restructuring Charges, net
 
As of and for the three months ended October 1, 2017
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Facility related expenses
$
227

 
$
165

 
$

 
$

 
$
392

  Employee related (recoveries) expenses
(89
)
 
38

 

 

 
(51
)
Total restructuring charges, net
$
138

 
$
203

 
$

 
$

 
$
341

 
 
 
 
 
 
 
 
 
 
Accrued restructuring charges as of July 2, 2017
 
 
 
 
 
 
 
 
$
2,118

Total quarter to date charges, net (shown above)
 
 
 
 
 
 
 
 
341

Charges paid / settled, net
 
 
 
 
 
 
 
 
(592
)
Accrued restructuring charges as of October 1, 2017
 
 
 
 
 
 
 
 
$
1,867

 
 
 
 
 
 
 
 
 
 
 
Restructuring Charges, net
 
As of and for the nine months ended October 1, 2017
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 

Total
Facility related expenses
$
2,221

 
$
497

 
$

 
$

 
$
2,718

  Employee related expenses
886

 
1,762

 

 

 
2,648

Total restructuring charges, net
$
3,107

 
$
2,259

 
$

 
$

 
$
5,366

 
 
 
 
 
 
 
 
 
 
Accrued restructuring charges as of December 31, 2016
 
 
 
 
 
 
 
 
$
1,618

Total year to date charges, net (shown above)
 
 
 
 
 
 
 
 
5,366

Charges paid / settled, net
 
 
 
 
 
 
 
 
(5,117
)
Accrued restructuring charges as of October 1, 2017
 
 
 
 
 
 
 
 
$
1,867


Restructuring Programs Summary

As specific restructuring programs are announced, the amounts associated with that particular action may be recorded in periods other than when announced to comply with the applicable accounting rules. For example, total cost associated with 2017 Actions (as discussed below) will be recorded in 2017 and 2018. The amounts shown below reflect the total cost for that restructuring program.

During 2018 and 2017, we initiated certain restructuring activities, under which we continued to simplify our business ("2018 Actions" and "2017 Actions", respectively). Under these restructurings, we reduced expenses, primarily through reductions in force and closing a number of smaller facilities.

Charges associated with the 2018 Actions were recorded during 2018. Charges associated with the 2017 Actions were finalized in 2017.
 
2018 Actions Restructuring Charges, net as of September 30, 2018
 
Energy
 
Aerospace & Defense
 
Industrial
 
Corporate
 
Total