CIRCOR International (CIR) Q4 2020 Earnings Call Transcript

CIRCOR International (CIR)
Q4 2020 Earnings Call
Mar 04, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to CIRCOR International's fourth-quarter 2020 earnings conference call. [Operator instructions] 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 -- Investor Relations and Vice President of Financial Planning and Analysis

Good morning. And welcome to CIRCOR's fourth-quarter 2020 earnings call. I'm joined today by Scott Buckhout, CIRCOR's president and CEO; and Abhi 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 CIRCOR's website at investors.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-Qs 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 are available in our earnings press release. With that, I'll turn the call over to Scott.

Scott Buckhout -- President and Chief Executive Officer

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.

s 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 focus 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 60 defense and four in 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, we reduced 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 in 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 in Marine, Medical and public utility industries. These systems help our customers transport and manage high-pressure industrial gas, LNG and CNG, biomethane 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 was up 12% in the quarter. A&D had lower orders sequentially, down 21% and 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 U.S. 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 disbursements. Now, let me turn the call over to Abhi to discuss our fourth-quarter results in more detail.

Abhi Khandelwal -- Chief Financial Officer

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 due to the significant impact of COVID-19 on our end markets and year-over-year comparison. Starting with industrial on Slide 4.

In Q4, industrial segment orders were up 12% sequentially, down 22% organically. The industrial segment saw a sequential recovery in all major end markets, 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 strength in 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 continued to drive a lower operating margin versus prior year. Turning to Slide 5. Our aerospace and defense segment booked 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 by year.

Finally, operating margin was 24% in the quarter, roughly flat sequentially and year over year. Pricing, up 3%, combined with factory 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 its remaining deferred tax assets in Germany. This non-cash charge is acquired 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 recorded a total pre-tax 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 for 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 used 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 we continue to target leverage ratio of two to two and a half tiems net debt to adjusted EBITDA. Now, I will hand it back over to Scott to provide some color on our end markets.

Scott Buckhout -- President and Chief Executive Officer

Thanks, Abhi. Let's start with our industrial outlook on Slide 8. As Abhi mentioned, signs of order recovery were evident in the fourth quarter across most major industrial end markets 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 wastewater 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 revenue is 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 in commercial orders as aircraft utilization improves and OEM production rates increased through the year. We remain confident in this segment's growth outlook in 2021. Revenue in the first quarter is expected to be down 7% to 12% versus prior year.

defense revenue is expected to be down 1% to 5% due to the timing of large defense shipments and lower U.S. 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 U.S.

in the Rafal fighter and 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 a 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.

Abhi Khandelwal -- Chief Financial Officer

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 decremental margins of 30% to 35% in aerospace and defense. Decremental margins in aerospace and defense are slightly higher than our full-year 2020 decrementals due to the expected mix of OEM and aftermarket revenue. We're also planning for corporate cost of $8.5 million, higher than our 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 disbursements. Now, moving to full-year 2021 guidance. We are expecting organic revenue growth of 0% to 4%, and with aerospace and defense expected to grow at low to mid-single digits and industrial at low single digits.

We are planning for a continued slow recovery in commercial Aerospace, where we expect to be better than 2020, but remain significantly lower than pre pandemic levels. Our defense business remains healthy as we continue to win new business and deliver on growing U.S. defense programs. In our industrial end markets, 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, a 40% to 54% increase versus 2020. This improvement is driven by top-line growth and improved margins from price increases, structural cost 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 markets 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'll hand back to Scott to wrap up.

Scott Buckhout -- President and Chief Executive Officer

To summarize, we remain focused on delivering our strategic priorities. In 2021, we're taking actions to further improve our customers' experience and our operational and financial performance. We remain 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 positions in the niches where we compete. The CIRCOR operating system will continue to drive operational improvement and margin expansion. And by enhancing free cash flow through efficient working capital management, we'll 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 will be happy to take your questions.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from the line of Andy Kaplowitz with Citi.

Andy Kaplowitz -- Citi -- Analyst

Hey. Good morning, guys.

Scott Buckhout -- President and Chief Executive Officer

Good morning, Andy.

Abhi Khandelwal -- Chief Financial Officer

Good morning, Andy.

Andy Kaplowitz -- Citi -- Analyst

Scott, 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 a pickup in sequential orders. What 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 '21?

Scott Buckhout -- President and Chief Executive Officer

Sure. So in down. So for -- let's start with Q4, what happened in downstream. So we had a difficult compare year over year.

Last year in Q4, our downstream business was up about 50%. So this year, you see a in a fairly significant drop in orders as a result of the difficult compare. If you look at industrial overall ex downstream, it was roughly flat without downstream. So that was the big variance in the Q4.

As we look at downstream going forward, we are taking a somewhat cautious view through the first half. We have a lot of activity, actually, as we did in Q4. We continue to see a lot of activity. On the aftermarket side in downstream, it's global.

We have -- we're managing and quoting and in process on a lot of different aftermarket projects. On the capex side, on the capital projects side, it's more international. It's outside of North America. So we see 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 though the first half, but we're optimistic that the back half will be significantly better than the first half.

Andy Kaplowitz -- Citi -- Analyst

Thanks. Got it. And then you were maybe a similar question for Defense. You're pretty confident coming into '21, 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, has 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?

Scott Buckhout -- President and Chief Executive Officer

So the -- in our defense business, as you know, we can get very lumpy orders. We can get orders $10 million, $15 million, $20 million in defense that fundamentally will 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 '21 and '22. 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.

Andy Kaplowitz -- Citi -- Analyst

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 further improvement expected in '21. So maybe give us a little bit more color on that, sort of what's the potential on the working capital side to hit that 85% to 95% guide that you have?

Abhi Khandelwal -- Chief Financial Officer

Yeah, absolutely. So look, as you think about 2020, and we've been talking about throughout 2020 is that we have opportunity on the working capital side, specifically in inventory. So if you look at 2020 on a year-over-year basis, we drove 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 haul, 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.

Andy Kaplowitz -- Citi -- Analyst

Abhi, thanks.

Operator

[Operator instructions] Our next question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your question.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey. Good morning, guys.

Scott Buckhout -- President and Chief Executive Officer

Good morning, Jeff.

Abhi Khandelwal -- Chief Financial Officer

Jeff, Good morning.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

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.

Scott Buckhout -- President and Chief Executive Officer

Yeah. I think -- so let me start. For industrial specifically, we're seeing some pieces of that business lead in terms of recovery. We saw it 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 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 the 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 to geographic. We have been seeing growth in Asia, in China and India, and we're continuing to see that. Europe and -- or I should say, EMEA and North America are both starting to come back as well. So we're seeing improvement in Europe and 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 of CIRCOR. But we're certainly seeing an improvement in chemical processing, machinery manufacturing, wastewater. 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.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

OK. 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?

Scott Buckhout -- President and Chief Executive Officer

Sure. Yeah, 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 '19. We still expect that commercial doesn't go 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.

And we expect in line with guidance. We expect roughly mid single-digit growth as we go into 2020 into 2021.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

So they're both kind of in that low to mid-single band?

Scott Buckhout -- President and Chief Executive Officer

That's exactly -- yeah, that's right.

Abhi Khandelwal -- Chief Financial Officer

Correct. Keep in mind, as we progress through the year, the comps in commercial Aerospace get pretty easy too. So you may start to see that growth come through, which kind of ties back to the guidance we laid out.

Scott Buckhout -- President and Chief Executive Officer

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.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

OK. 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?

Abhi Khandelwal -- Chief Financial Officer

Yeah. 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, right, we talked about the $45 million of cost out.

There are three pieces to it. There's a $20 million piece to it, which is structural. Now keep in mind, that structural costs start coming out even before the pandemic. So as we went through the pandemic, a lot of that 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 part of the run rate. The balance $20 million was tied to temporary costs. And when you think about that, really the benefit portion of that temporary cost avoidance is already back in the business, but there's about half of that, that is still out there. That hasn't come back, which is tied to furloughs or travel expenses still being at a lower level because the world is still pretty short.

And that's still out 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.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

So roughly about half of it's back and the other half is weighting on volume.

Abhi Khandelwal -- Chief Financial Officer

Correct.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

OK, perfect. Thanks guys.

Operator

[Operator instructions] Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Nathan Jones -- Stifel Financial Corp. -- Analyst

Good morning everyone.

Scott Buckhout -- President and Chief Executive Officer

Good morning, Nathan.

Abhi Khandelwal -- Chief Financial Officer

Good morning, Nathan.

Nathan Jones -- Stifel Financial Corp. -- Analyst

I think quite a bit of the inflation in the system here recently. Can you guys talk about price cost? Are you able to pass this through? Are you able to pass it through quickly? And what's the assumed contribution from pricing in the revenue guidance this year?

Scott Buckhout -- President and Chief Executive Officer

OK. Would I start, Abhi?

Abhi Khandelwal -- Chief Financial Officer

OK.

Scott Buckhout -- President and Chief Executive Officer

So on -- we'll start with the -- your inflation question. So we are -- 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. We're almost always buying components and 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 inflation that the suppliers will absorb. Anything outside of that band then 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 we'll 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 '20 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.

Abhi Khandelwal -- Chief Financial Officer

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.

Nathan Jones -- Stifel Financial Corp. -- Analyst

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 -- President and Chief Executive Officer

So at this point in time, we're -- all of our factories are up and running at the levels of demand. 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.

Nathan Jones -- Stifel Financial Corp. -- Analyst

All right. Thanks for taking my questions.

Abhi Khandelwal -- Chief Financial Officer

Thank you, Nathan.

Operator

[Operator signoff]

Duration: 36 minutes

Call participants:

Alex Maki -- Investor Relations and Vice President of Financial Planning and Analysis

Scott Buckhout -- President and Chief Executive Officer

Abhi Khandelwal -- Chief Financial Officer

Andy Kaplowitz -- Citi -- Analyst

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Nathan Jones -- Stifel Financial Corp. -- Analyst

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