Earnings Transcript for CIR - Q4 Fiscal Year 2020

Operator: Greetings. And welcome to CIRCOR International Fourth Quarter 2020 Earnings Conference Call. [Operator instructions] As a reminder, this conference is being recorded. I will now turn the conference over to Alex Maki, Vice President Financial Planning and Analysis and Investor Relations. Thank you, sir. You may begin.

Alex Maki: Good morning. And welcome to CIRCOR's fourth quarter 2020 earnings call. I am joined today by Scott Buckhout, CIRCOR's President and CEO, and Abhishek Khandelwal, the company's Chief Financial Officer. Before we start, I'd like to remind you that today's presentation and press release are available on circulars website at investor.circor.com. Today's discussion contains forward-looking statements and only represent the company's views as of today. These expectations are subject to known and unknown risks, uncertainties and other factors and actual results could differ materially from those anticipated or implied by today's remarks. While CIRCOR may choose to update these forward looking statements at a later date, the company specifically disclaims any duty to do so. You can find a full discussion of these factors in CIRCOR's Form 10-K, 10-Q and other SEC filings also located on our website. On today's call, management will refer to GAAP and non GAAP financial measures. The reconciliation of CIRCOR's non-GAAP measures to the comparable GAAP measures is available in our earnings press release. With that, I'll turn the call over to Scott.

Scott Buckhout: Thank you, Alex, and good morning, everyone. 2020 was another transformational year for CIRCOR. And despite the continued challenges presented by COVID-19 our team made significant progress on executing our strategic plan. I'm proud of the resilience and efforts of the entire CIRCOR team in navigating such a challenging year while continuing to deliver for our customers and shareholders. As we saw throughout the year, our diversified product portfolio across multiple end markets and geographies helped mitigate the impact of a weaker macro environment. Our defense business delivered strong results for the year, which mostly offset lower demand for our commercial products. Our differentiated technology and market positions enabled us to increase prices across the portfolio. We executed well throughout this year's downturn, and exited the year with positive momentum. With the health and safety of our employees as our foundation we focused on the things we control. We achieved decremental margins of 25% for the year through value based pricing and difficult but necessary cost actions of $45 million. Aerospace and Defense improved their margins by 290 basis points despite lower volume, notably aerospace and defense won 20 new programs, including 16 in defense and four commercial. We continue to implement the CIRCOR operating system across the company resulting in improved operational performance. CIRCOR is well positioned to take advantage of an eventual market recovery in 2021 and beyond. With the sale of instrumentation and sampling and distributed valves earlier in the year, our exit from upstream oil and gas is complete. We continue to invest in innovation launching 49 new products in 2020 versus 33 in 2019. We delivered on our free cash flow commitments throughout the year and ended with strong free cash flow of $20 million in the fourth quarter. And finally, reduce our debt by $126 million, or 22%. I want to highlight some new mission critical technology we introduced in 2020. On the defense side, our new missile arming switches are designed to operate more severe environments with respect to temperature, radiation, and G force. We launched self arming switches in support of various missile programs, including hypersonic applications. On the commercial side, we introduced a switch which activates the aircraft's location transmitter in case of an in flight emergency. In Industrial, we launched a series of new gas pressure reduction systems to help our customers and marine, medical and public utility industries. These systems help our customers transport and manage high pressure industrial gas, LNG, CNG, bio methane fuels and medical oxygen. Now I'd like to provide some financial highlights from the fourth quarter. We booked orders of $168 million in the quarter, which was flat sequentially and down 25% organically. Sequentially industrial is up 12% in the quarter. A&D had lower orders sequentially down 21% due to the timing of large naval program orders that pushed into 2021. Revenue in the quarter was $208 million, up 10% sequentially driven by strong defense deliveries, mainly on US Naval programs, and moderate growth across most end markets in Industrial. Adjusted operating income was $23 million, representing a margin of 11.2%, up 200 basis points from the prior quarter. Margin improvement was driven by sequential volume recovery, pricing, cost actions and productivity. As a result of improved operating income, the company delivered $0.66 of adjusted earnings per share. Finally, we generated strong free cash flow of $20 million during the fourth quarter as we exited the year with operational cash flow unencumbered by transformation disbursement. Now let me turn the call over Abhi to discuss our fourth quarter results in more detail.

Abhishek Khandelwal: Thank you, Scott, and good morning, everyone. As we talk through our segment results this morning, we will discuss both sequential and year-over-year changes to results. We are providing both comparisons, use a significant impact of COVID-19 in our end markets and year-over-year comparison. Starting with Industrial on slide 4, in Q4, Industrial segment orders were up 12% sequentially and down 22% organically. Industrial segment saw sequential recovery in all major end market driven by opening economies. Revenue in the quarter was $131 million, up 4% from prior quarter and down 13% organically. Sequential improvement was primarily driven by strengthened aftermarket sales across the portfolio. We exited the year with an operating margin of 9%, a sequential improvement of 160 basis points, driven by price increases and cost actions taken throughout the year. Lower sales volume continues to drive lower operating margin versus prior year. Turning to slide 5, our Aerospace and Defense segment book orders of $47 million in the quarter, down 21% sequentially and down 33% versus prior year. Both declines are primarily driven by timing of large defense program orders and the ongoing impact of COVID-19 on our commercial business. We remain confident in the segment's growth outlook in 2021. Revenue in the quarter was $78 million, up 25% from prior quarter. Strong defense deliveries mostly offset the COVID-19 impact on commercial aerospace, resulting in only 3% lower revenues versus prior year. Finally, operating margin was 24% in the quarter, roughly flat sequentially and year-over-year. Pricing up 3% combined with productivity and cost actions drove strong margins in line with prior year despite lower revenue. Moving to slide 6; for Q4, the effective tax rate was approximately 14%. The company took a non cash charge of approximately $15 million to record a valuation allowance against this remaining deferred tax asset in Germany. This non cash charges are required under GAAP accounting rules. This charge does not impact our non-GAAP after tax results for the quarter, and is not expected to have an impact on our future non-GAAP after tax results. Looking at special items and restructuring charges, we record a total pretax charge of $13.4 million in the quarter. The acquisition related amortization and depreciation was a charge of $12 million, with the remaining charges associated with restructuring activities in the quarter. Interest expense of the quarter was $8.5 million, down $2.3 million compared to last year as a result of lower debt balances. Other income was approximately $1 million primarily driven by pension income. Finally, corporate costs were $7.8 million in the quarter. Turning to slide 7. As Scott mentioned previously, our free cash flow was $20 million in the fourth quarter, up 11% compared to 2019. Free cash flow was positively impacted by improved operating income and lower working capital, particularly inventory. Reducing working capital remains one of our top priorities and we expect further improvement in 2021. We use the proceeds from the sale of our instrumentation and sampling business to reduce our net debt to $443 million, a reduction of $126 million or 22% year-over-year. Free cash flow generated in 2021 will be used to further pay down debt and the continued target leverage ratio of 2x to 2.5x net debt to adjusted EBITDA. Now I will hand it back over to Scott to provide some color on our end markets.

Scott Buckhout: Thanks, Abhi. Let's start with our industrial outlook on slide 8. As Abhi mentioned signs of auto recovery were evident in the fourth quarter across most major industrial end market after hitting the bottom in Q3. Geographically, we continue to see growth in China and India. And we started to see signs of recovery in Europe and North America in the quarter. Downstream orders were up sequentially driven by an increase in aftermarket orders, but down significantly versus last year due to a difficult compare. We're expecting Q1 Industrial revenue to come in between down 1% and up 4% year-over-year. We expect to see a normal seasonal dip in revenue sequentially in Q1 versus Q4. We're starting to see improvement in our short cycle end markets, including machinery manufacturing, chemical processing and waste water as consumer demand starts to improve. We're also expecting a mid single digit increase in aftermarket as global economies open up and consumption increases. Downstream oil and gas revenues expected to be down as refiners continue to manage CapEx. We're seeing a similar customer CapEx dynamic across midstream oil and gas, power generation and building construction, but to a lesser degree. We expect these end markets to improve further as the year unfolds. Pricing is expected to be a benefit of roughly 1% consistent with prior quarters. Moving to Aerospace and Defense, Aerospace and Defense orders in Q4 were down sequentially and versus prior year. Both declines were primarily driven by the timing of large defense program orders and the ongoing impact of COVID-19 on our commercial businesses. We expect order strength across our defense programs to continue through 2021 driven largely by the Joint Strike Fighter and multiple missile and drone programs. We expect a modest improvement commercial order as aircraft utilization improves, and OEM production rates increase through the year. We remain confident in the segment's growth outlook in 2021. Revenue in the first quarter is expected to be down 7% to 12% versus prior year. Defense revenues expected to be down 1% to 5% due to the timing of large defense shipments, and lower US Defense spares orders leading into the quarter. We anticipate growth of 5% to 10% from our other OEM group, which includes products for drones, missiles and helicopters. In addition, we're planning for increased build rates for the predator drone in the US and the Rafale fighter jet in Europe. Commercial revenue is expected to be down between 35% and 40% in line with the broader commercial aerospace market. Our market position on both Boeing and Airbus aircraft is strong, and we expect revenue to improve throughout the year in line with aircraft utilization and production rates. Pricing is expected to be at benefit of 1% in the quarter, but in line with 2020 for the full year. Now I'll hand it over to Abhi to discuss our guidance.

Abhishek Khandelwal: Before jumping into full year guidance, I'd like to share a few more expectations for the first quarter. In addition to the revenue guidance that Scott provided, we're expecting incremental margins of 30% to 35% in Industrial and detrimental margins of 30% to 35% in Aerospace and Defense. Decremental margins in aerospace and defense are slightly higher than our full year 2020 detrimental due to the expected mix of OEM and aftermarket revenue. We're also planning for corporate costs of $8.5 million higher than expected full year run rate due to the timing of certain expenses such as RFPs. Interest expense is expected to be roughly $8.5 million in Q1. Finally, free cash flow for Q1 will be negative due to seasonality of annual disbursement. Now moving to full year 2021 guidance; we are expecting organic revenue growth of 0% to 4% with aerospace and defense expected to grow at low to mid single digits and industrial at low single digits. We are planning for continued slow recovery in commercial aerospace, where we expect to be better than 2020 but remains significantly lower than pre pandemic levels. Our defense business remains healthy as we continue to win new business and deliver on growing US Defense programs. In our industrial end market, we expect to see modest recovery with downstream activity improving in the back half of 2021. We're expecting adjusted earnings per share of $2 to $2.20 up 40% to 54% increase versus 2020. This improvement is driven by top line growth and improved margins from price increases, structural costs out in 2020 and ongoing productivity. Finally, we're planning to deliver free cash flow as a percent of adjusted net income of 85% to 95%. We feel that this guidance reflects what we are seeing in our end market and the operational improvements that we can control within the four walls of CIRCOR. We're confident in our ability to deliver these results not only for our shareholders but for our customers, suppliers and employees. Now I hand back to Scott to wrap up.

Scott Buckhout: To summarize, we remained focused on delivering our strategic priorities. In 2021, we're taking actions to further improve our customers experience and our operational financial performance. We remained focused on attracting, developing and retaining the best talent while fostering a diverse and inclusive culture. We continue to invest in growth through innovative new products, aftermarket support technology to enhance our customers experience and regional expansion. Value based pricing continues to be a top priority, leveraging our differentiated technology and our strong market position in the niches where we compete. The CIRCOR operating system will continue to drive operational improvement and margin expense. And by enhancing free cash flow through efficient working capital management we will continue to delever the balance sheet. In closing, I'd like to thank the entire CIRCOR team for their ongoing commitment to safety and delivering mission critical products to our customers. With that Abhi and I'll be happy to take your questions.

Operator: [Operator Instructions] Our first question comes from line of Andy Kaplowitz with Citi.

AndyKaplowitz: Hey, good morning, guys. Maybe talking about industrial first, in terms of your revenue guide for Q4 it came in at the lower end, and last quarter you said you expected to pick up in sequential orders, which you did see, just focusing on downstream for a second. Obviously, your Q1 assumptions for downstream are still quite muted. So can you give us more color on what's going on specifically in downstream related businesses and your assumptions for 2021?

ScottBuckhout: Sure, so in downstream -- so for let's start with Q4 what happened in downstream. So we had a difficult compare year-over-year. Last year in Q4 downstream business was up about 50%. So this year, you see a fairly significant drop in orders as a result of the difficult compare. If you look at industrial overall, all ex downstream it was roughly flat without downstream. So that was the big variance in the quarter for Q4. As we look at downstream going forward, we're taking a somewhat cautious view, through the first half, we have a lot of activity actually, as we did in Q4, and we continue to see a lot of activity. On the aftermarket side in downstream it's global, we are managing and quoting and in process on a lot of different aftermarket projects. On the CapEx side on the capital project side, it's more international, it's outside of North America. So we're seeing a decent amount of activity in India, in Russia, and to some degree in Europe. And so but in North America, capital projects are a lot less activity. So when we look forward in downstream, we're expecting an improvement sequentially in orders as we go into Q1. And I'd say we're being cautious for the first half. But we're pretty excited about the back half. We think a lot of these projects that we're managing right now particularly aftermarket, they have to drop. The refiners can only delay aftermarket projects for so long, and then they have to eventually convert and start doing the work. So we think we'll see improvement through the first half. But we're optimistic that the back half will be significantly better than the first half.

AndyKaplowitz: Thanks, Scott. And then you were maybe a similar question for defense, you're pretty confident coming into 2021, at least when you're talking last quarter, it seems like some of these projects and programs are pretty lumpy. So you're talking about Q1 being down here. So I guess my question is anything changed? Is it really just timing? You mentioned the spares, obviously, the administration has changed. So has the outlook changed? Or is this really just timing?

ScottBuckhout: So in our defense business, as we get, we can get very lumpy orders, we can get orders $10 million, $15 million, $20 million orders in defense that fundamentally change the nature of a quarter. We did see some big orders push from Q4 on the Navy side, into the first half of 2021. What you see on the Navy spares piece is largely timing. And so I think in aggregate, when you look at our aerospace and defense business, the defense piece, what you're seeing is largely timing. So we're still very bullish about defense. We're bullish about the programs that we're on. We won a lot of new platforms in 2020 that are going to start ramping up in 2021 and 2022. So we still feel good about defense going forward. And we -- what you're seeing in terms of variances year-over-year is largely timing of large orders with specifically with respect to the Navy.

AndyKaplowitz: Thanks, Scott. And then last question for Abhi obviously good cash flow in Q4, maybe just talk about the working capital situation. You mentioned improvement in inventory in Q4 further improvement expects in 2021. So maybe give us a little bit more color on that sort of what's the potential in the working capital side. You need to hit that 85% to 95% guide that you have.

AbhishekKhandelwal: Yes, absolutely. So look as you think about 2020, and we've been talking about throughout 2020 is that we've opportunity in the working capital side, specifically in inventory. So if you look at 2020, on a year-over-year basis, we do about $6 million of inventory out. That said we have further work to go do so as you think about 2021 and going into 2021. And as our net income starts to improve on a year-over-year basis, you're going to see that coupled with working capital improvement. Over the long, we expect the company to be in the 20% range. That's what industrial companies typically are. We have some work to go do. And that's what we're focused on.

Operator: Our next question comes from line of Jeff Hammond with KeyBanc.

JeffHammond: Hey, good morning, guys. Hey, so I think the biggest variance in the framework versus my model is industrial. And I just thought given kind of how easy the comps are we'd see more growth. And I understand some markets are maybe turning faster, but just want to get a better sense of beyond the downstream discussion, what you're seeing in some of these lagging markets in terms of quoting activity and bidding activity that would suggest kind of further acceleration, because we're seeing -- it seems very broad industrial recovery here.

ScottBuckhout: Yes, I think. So, let me start for industrial specifically, we're seeing some pieces of that business lead in terms of recovery, we saw in Q4 and we're expecting that to continue in Q1. So the industrial orders were up about 12%, sequentially in Q4, and we're expecting they're going to be up again. Now rough order of magnitude high single digits again sequentially as we go into Q1. The specific pieces, we are seeing a difference geographically, but also by end market. But let me start with aftermarket versus OEM. So aftermarket, we're seeing an improvement before we're seeing the OEM part of industrial improve. And we have been seeing, let me shift the geographic, we haven't seen growth in Asia, in China and India. And we were continuing to see that. Europe and Russia or I should say EMEA and North America are both starting to come back as well. So we're seeing improvement in Europe, in North America. When we look at the end market specifically, the shorter cycle businesses are recovering first. And so this is where we're being a little bit cautious about what's going to happen with the longer cycle pieces of CIRCOR. But we're certainly seeing an improvement in chemical processing, machinery manufacturing, waste water; these are areas that tend to be short cycle for us. And that's where it seems to be starting. The longer cycle is slower; we're not sure what the pace will be here. And so we're trying to be balanced here as we look at the future. And there's still a lot of uncertainty with the way these economies are going to open up. And the way these markets are going to turn. So we're being a little bit cautious here with how we look at this with specifically with respect to the longer cycle pieces of the business.

JeffHammond: Okay, great. And then on Aerospace, defense, your guide for the full year is low to mid single digits, is there a way to break out? How you think about commercial growth versus how you think about defense growth?

ScottBuckhout: Sure, yes, we can do that. So we -- when you look at commercial, we're expecting a modest recovery as build rates start to improve and have been announced to improve. And as aircraft utilization starts to improve, so we -- when we look at our commercial business, it was down along with the whole market significantly in 2020. We expect 2021 to be modestly better, and but obviously far away from where we were in 2019. We still expect that commercial doesn't get back to 2019 levels until around 2024. So we think it's a long slow recovery. But having said that, 2021 is better than 2020. And we expect orders to improve as aftermarket and OE starts to recover. On the defense side; we are still bullish about defense. We expect organic growth from 2020 to 2021. We expect in line with guidance. We expect roughly mid single digit growth as we go into 2020 into 2021.

JeffHammond: Both kind of in that low to mid single band.

AbhishekKhandelwal: That's exactly, yes, that's right. Correct. Just keep in mind as we progress through the year that the comps in commercial aerospace get pretty easy too. So you might start to see that growth come through, which kind of ties back to the guide we laid out.

ScottBuckhout: And a lot of this is linked to specific platforms, we're seeing good growth in our Navy platforms, the submarines, missiles, those are two big pieces that are driving the growth.

JeffHammond: Okay and then just on the cost side, how do we think about, I don't know, if I missed this in the prepared remarks? But how do we think about temp costs coming back?

AbhishekKhandelwal: Yes, I can answer that question. So before I answer that question, let me set the stage a little bit just so that we can all be on the same page here. But if I think about 2020, that we talked about the $45 million of cost, there are three pieces to it, there's a $20 million piece to it, which is structural. Now keep in mind that structural cost start coming out even before the pandemic. So as we went through the pandemic, a lot of that was already -- it was already part of the run rate. So if you just think about structural for a second, we have about $2.5 million of carryover that's going to come in 2021. But majority of that is already a part of the run rate. The balance $20 million was tied to a temporary cost. And when you think about that, really the benefit portion of that temporary cost avoidance is already back into business. But there's about half of that that is still out there, that hasn't come back, which is tied to furloughs or travels expenses still being at a lower level, because the world is still pretty shot. And that's a lot of the business. And that only comes back as the volume starts to come back. So that's how we think about the temporary cost piece. So roughly about half of it's back and the other half is waiting on volume.

Operator: Our next question comes from a line of Nathan Jones with Stifel.

NathanJones: Good morning, everyone. I think quite a bit of inflation in the system here recently. Can you guys talk about price costs? Are you able to pass these through? Are you able to pass it through quickly? And what's the assumed contribution from crossing the revenue guidance this year?

ScottBuckhout: Okay, part one I start, okay, so on -- we'll start with your inflation question. So we're -- I think the way to think about inflation for CIRCOR, let me start by what we buy, it's rare that we're buying raw commodity. It -- we're almost always buying components and in parts that we're assembling. And so when you think about our businesses in general, our supply chain team has done a nice job of signing our suppliers up with long-term contracts. Those long-term contracts usually have some kind of band of absorbable and inflation that the suppliers will absorb. Anything outside of that band and we get into a negotiation. At this point, we don't expect a significant variance associated with inflation. In fact, we're still expecting that our net productivity from our supply chain team will be positive, meaning we'll get more cost reductions than the inflation that will absorb. So we're not expecting inflation to be a major issue for CIRCOR at this point. Based on the nature of our supply base, and the contracts we have in place with our suppliers. On the pricing side, for the full year, I think you should expect pricing more or less in line with 2020 is what you should expect from us in 2021. That's the way we're expecting it to play out. There's some seasonality in pricing, you'll see relatively low percentages in Q1, that's linked to the relative volume of aftermarket and the kinds of the nature of the mix of the business, if you will. But we're expecting pricing more or less in line with 2020.

AbhishekKhandelwal: So, Nathan, this is Abhi. So if you really think about the company in total what you saw in 2020 was about a 2% price in 2020. And you should expect similar levels in 2021.

NathanJones: Helpful, thanks. Hearing about some supply chain shortages, some supply chain disruptions. Can you guys talk about anything that you're seeing out there and any mitigating factors that you're undertaking?

Scott Buckhout: So at this point in time we're -- all of our factories are up and running at the level of demand. And so we're not experiencing any meaningful disruption. Of course, we have some shortages here and there that we manage day-to-day, but there's nothing meaningful like we saw a few times last year. So the world seems to have adapted for the most part, at least our supply chain has as well as us and we're not -- we don't have any meaningful supply chain issues at the moment.

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