CIR (2019 - Q4)

Good day, ladies and gentlemen. Welcome to CIRCOR International's Fourth Quarter Fiscal Year 2019 Financial Results Conference Call. Today's call will be recorded. At this time, all participants have been placed in a listen-only mode. There will be an opportunity for questions and comments after the prepared remarks. [Operator instructions] I'll now turn the call over to Scott Solomon from Sharon Merrill Associates for opening remarks and introductions. Please go ahead. Scott So

Thank you, and good morning, everyone. On the call today is Scott Buckhout, CIRCOR's President and CEO; and Chadi Chahine, the company's Chief Financial Officer. The slides we'll be referring to today are available on CIRCOR's Web site at www.circor.com on the Webcast & Presentation Section of the Investors link. Please turn to slide two. Today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties, and other factors. For a full discussion of these factors, the company advises you to review CIRCOR's Form 10-K, 10-Qs, and other SEC filings. The company's filings are available on its Web site at circor.com. Actual results could differ materially from those anticipated or implied by today's remarks. Any forward-looking statements only represent the company's view as of today, March 2, 2020. While CIRCOR may choose to update these forward-looking statements at a later date, the company specifically disclaims any duty to do so. On today's call, management will refer to adjusted operating income, adjusted operating margins, adjusted net income, adjusted EPS, free cash flow, and organic measures. These non-GAAP metrics exclude certain special charges and recoveries. A reconciliation of CIRCOR's non-GAAP measures to the comparable GAAP measures are available in the financial tables of the earnings press release on CIRCOR's Web site. I'll now turn the call over to Scott. Please turn to slide three.

Thank you, Scott, and good morning, everyone. Before I get into the financials, I'd like to comment on our 12b-25 filing this morning explaining the delay to our 10-K filing. We've identified material weaknesses in our internal control over financial reporting, primarily associated with our finance team's ability to manage the large number of unique and transformative transactions in the second-half of 2019 in a timely manner. Within our discontinued operations, we're conducting an independent review of certain accounting and financial reporting matters in order to determine if there are any matters that could have a material impact on our financial results with discontinued operations. We're evaluating the impact of a recent cyber incident that affected three of our 25 manufacturing facilities. We're working with experts and the authorities, and believe the matter is under control. Until these reviews are complete, our audit firm cannot complete its audit of our financial statements and internal controls for 2019. Based on the reviews and analyses to-date, we do not expect adjustments to the preliminary financial results we're discussing today. As I hope, you can appreciate, we cannot discuss this further, but rest assured, this is our top priority. We're working diligently to finalize our financial reporting process, and will file our form 10-K as soon as possible. Now, let's get into our results and outlook for 2020. Last June, we communicated our detailed 18-month plan for delivering significant shareholder value. I'm pleased to report that we delivered on our 2019 commitments, and we're on track to deliver our goals for 2020. We'll talk more about the progress we've made delivering on our strategic plan, but first, let me recap our Q4 results at a high level. We delivered another solid quarter with $243 million of revenue, and $0.82 of adjusted EPS. Adjusted operating margin in Q4 was 13.3%, up 170 basis points from last year, and 250 basis points from last quarter. We received $237 million of orders in the quarter. Orders were down about 2% organically after adjusting for divestitures, and $3 million of foreign exchange headwinds. In our Aerospace and Defense segment, we had a solid quarter of orders of $68 million, up from the previous quarter, driven by defense spares and new program wins. In 2019, total orders for A&D were $314 million, up $37 million, or about 15% versus prior year. The book-to-bill ratio was 115%. Industrial segment orders were down about 8% from prior quarter, mainly due to push-outs of large capital projects globally, partially offset by strong aftermarket orders. Please turn to slide four. Revenue in the quarter was up 2% organically with A&D delivering 26% organic growth, offset by lower revenue in instrumentation and sampling, and refinery valves. Industrial revenue was down 1% organically. The 200 basis points of margin expansion from continuing operations was driven by the transformation actions communicated in the 18-month plan, strong growth in A&D, price increases, ongoing productivity and simplification initiatives, and transitions to low cost manufacturing. When we look at 2019, I'm proud of the progress we've made in our business transformation. We've largely completed our shift away from upstream oil and gas, divested other commodity businesses, and sharpened our focus on our core mission-critical flow control platforms. Since January 2019, we generated over $340 million of proceeds from non-core asset sales, and used the net proceeds to reduce debt. The actions taken include sold reliability services business for approximately $85 million in cash, completed the disposition of our loss-making engineered valve business, sold our Spence and Nicholson product lines for approximately $85 million in cash, announced our intent to sell the loss-making distributed valves business, and completed the sale of our instrumentation and sampling business for approximately $172 million in cash. In addition, we delivered on our strategic priorities communicated in our 18-month plan. Please turn to slide five, so I can highlight a few of the notable achievements since we published our plan in June last year. A&D delivered an exceptional second-half as noted on the slide, organic growth of 21%, AOI up 57%, representing 500 basis points of margin expansion. We exited the majority of our commoditized upstream oil and gas businesses, and eliminated the Energy Group. We executed four divestitures in 2019, and reduced our net leverage by approximately two turns. We launched 35 new products last year, and generated $73 million of revenue from new products. We continue to invest in innovation and new products to drive growth. And finally, we reduced corporate and group costs in line with the 18-month plan. Please turn to slide six. As noted on the slide, we delivered our 2019 commitments, and we're on track to deliver 2020. It's important to note that our leverage is a full-term below our commitment as a result of our non-core divestitures. Overall, we feel good about how we ended 2019 and our momentum as we enter 2020. Finally, as you know, this is Chadi's last earnings call as he plans to step down effective after the filing of the 10-K. Chadi has been a valued member of our management team, and on behalf of everyone at CIRCOR, I want to thank Chadi for his leadership and his willingness to continue to the 2019 year-end close to help ensure a seamless transition. With that, I'll turn the call over to Chadi to discuss the fourth quarter results in more detail before I review the outlook for our end markets.

Thank you, Scott, and good morning everyone. As my last earnings call, this is certainly a bittersweet moment for me, but I have great confidence in CIRCOR path forward. Let's begin by reviewing our segment results, starting with industrial on slide seven. The Industrial segment reported sales of $107 million, organically 1% down compared with Q4 2018. It's worth noting that foreign currency headwinds reduced industrial revenue by over 2% in the quarter as well. The Industrial segment delivered margin of 11%, down 50 basis points from Q4 2018, and 160 basis points sequentially from Q3 2019, excluding divestitures. The margin decline was driven by volume and mix partially offset by price increases, simplification initiatives, and productivity. For Q1 2020, we expect a seasonal dip in revenue in line with previous years, and a slight margin expansion. Turning to slide eight, Aerospace and Defense had sales of $79 million, up 26% organically on strength across both our Defense and Commercial business segments. Aerospace and Defense operating margin was 22.9%, up 280 basis points sequentially, and 490 basis points versus prior year, driven by volume, price, favorable mix, and manufacturing productivity. In Q1, we expect a seasonal dip of revenue from Q4 2019, but moderate organic growth for the quarter. We expect strong margin expansion year-over-year. Turning to slide nine, energy sales from continued cooperation were $57 million, flat versus prior quarter, and down 14% versus prior year, driven by project timing and refinery valves. Adjusted operating margin in the quarter was 12.9%, up 340 basis points from prior quarter, largely driven by improved project mix and refinery valves. Going forward, we have eliminated our energy segment, and the refinery valve business will be reported as part of the Industrial segment. Turning to slide 10, for Q4 selected P&L items. Our adjusted tax rate for the quarter and full-year was 15%, driven by foreign tax differential and higher R&D tax credits. Looking at special items and restructuring charges, we recorded a total pre-tax charge of $15 million. The largest component of this charge continued to be the non-cash acquisition related amortization expense totaling $12 million. The remainder was made up of approximately $4 million related to restructuring and fees associated with businesses position and takeover defense. Approximately $2 million gain on the sale of a facility. Net interest expense for the quarter was $11 million, down nearly $2.5 million compared with prior years, driven by lower debt balance. Other expense of $2 million is primarily realized and unrealized FX loss partially offset by venture related income. The change in other income is $0.09 adjusted EPS headwinds year-on-year. Turning to our debt position on slide 11, our operating cash flow was $17 million in Q4, up from $9 million in Q3. Free cash flow was $18 million as we had net proceeds from the sale of PP&E. We've reduced net debt by $170 million since year-end, including over $150 million of debt pay-down. Also, during 2019, we reduced our leverage by approximately two times on pro forma basis to 3.6 times. I will now hand the call to Scott to discuss our market outlook.

Thank you, Chadi. Now, I'll provide an overview of our end markets and the drivers that we believe will give us momentum as we move through 2020. As discussed, before we've exited our energy segment. So going forward, we'll report our results in two segments, Industrial and A&D. Please turn to slide 12. Let's start with Industrial. Orders in Q4 were down about 8% sequentially from Q3, mainly due to the push-out of some large project orders in commercial marine and power generation. The four-market order intake was weaker than anticipated in the Americas in China, while we saw a modest increase in Europe and rest of the world. The weakness in project orders was partially offset by strength in our aftermarket business globally. We're seeing an acceleration in aftermarket growth in Q4 as a result of the dedicated aftermarket commercial team that we created in the middle of last year. As a reminder, beginning in Q1 2020 we consolidated our refinery valves business into industrial. Refinery valve orders were up 49% year-over-year in Q4. The pipeline of project activity remains healthy, and the outlook for this business remains strong. We expect ongoing strengthen orders in the first-half of 2020. As we've mentioned in the past, project orders in this business can be lumpy with specific order timing difficult to predict. For Industrial, overall in Q1, we expect global and markets to remain sluggish with four-market activity levels in line with Q4. Capital project ownership improved as we finalize projects pushed out of last year. We expect the strong momentum in our aftermarket business to continue. Orders in Q1 are expected to be in line with Q4 last year. Our Aerospace and Defense Group generated another strong quarter of orders at $68 million driven by both our defense and commercial businesses. The strength and defense was primarily driven by U.S. Defense spares, and new products from missile and engine applications. Commercial aerospace orders continued their upward trend in the quarter, driven by the increase and build rates for major platforms like the Airbus A320, and new program wins. The backlog for the aerospace and defense segment continues to be strong, driven by ongoing strength in commercial aerospace, and large defense orders in prior quarters related to multiple programs including the Joint Strike Fighter, the U.S. Navy Virginia Class submarine, the DDG 51 class destroyer and the CVN-80 aircraft carrier. Overall, we expect Q1 orders to increase sequentially driven by defense programs like the Joint Strike Fighter and the Virginia Class submarine, as well as defense spares. Commercial wars are expected to remain strong in line with Q4. With respect to the possible impact of the coronavirus, we're closely monitoring the situation to assess implications for our colleagues, sales, and supply chain. The impact on our overall business in China has been limited. That said in our industrial segment, the coronavirus is proving to be a factor in the market's weakness and a headwind for growth initiatives in China and Asia Pacific. Looking ahead, we anticipate that there could be an impact on our supply chain in 2020, based on complications with logistics, and border control measures. If the situation worsens, particularly in Europe or other large end markets, we may start to see a more meaningful impact. At this stage, it's too early to predict the size of the impact. Going forward, we'll keep you informed any changes that can materially influence our business. At this time, we factored only a modest potential impact into our 2020 guidance. Now, I'll turn the call back over to Chadi to discuss guidance.

Thank you, Scott. Turn to Slide 13. Overall, we expect first quarter 2020 revenue in the range of $190 million to $205 million and adjusted EPS in the range of $0.50 cents to $0.60. The guidance excludes the result of instrumentation and sampling, which was divested in January 2020. In the quarter, we expect strong year-on-year expansion. We expect free cash flow to be negative in Q1 due to seasonal disbursements in the quarter and increase throughout 2020 similar to prior years. Regarding special restructuring charges for the first quarter of 2020, we anticipate charges for the following items, acquisition related amortization expense of $0.48 per share, and restructuring and special charges totaling $0.17 to $0.27 per share. We expect the 2020 adjusted tax rate to be approximately 18% to 20%. With that, let me turn it back over to Scott.

Thank you, Chadi. To summarize, we're right on track to deliver the 18-month plan published in June of last year, we've largely completed our shift away from upstream oil and gas, divested other commodity businesses, sharpened our focus on our core, mission critical flow control platforms, and significantly de-leverage the company. As we enter 2020, we expect to realize continued benefits from our improved business portfolio, our business simplification initiatives, new product launches, pricing actions manufacturing and low-cost facilities. We remain committed to driving long-term growth, expanding margins, generating strong free cash flow, and further de-leveraging the company. Now, Chadi and I'll be happy to take your questions.

Thank you. [Operator Instructions] Our first question comes from line of Andrew Kaplowitz with Citi. Please proceed with your question.

Good morning. This is Piyush on behalf of Andy. Thanks for taking my question.

Sure, good morning.

On Industrials, you mentioned little bit growth in large projects and weakness in OEM. Maybe elaborate more on the geographic dynamics that you're seeing today. You have mentioned the weakness in Europe in the past, and Asia is now expected to be soft, is that only a function of coronavirus, or is there any other drivers that we should be aware of?

So, yes, I'll take that. So, the weakness that we're seeing in capital projects, we saw in capital projects in Q4 was global. So, it was North America, across Europe, as well as Asia-Pacific. The difference between what we expected was we did expect more strength in four markets in the Americas, so it came in weaker than expected. On the positive, the aftermarket also globally grew significantly better than we thought it would in Q4. So, we're seeing our customers basically extending the life of existing installations, and spending more on aftermarket. The impact with the coronavirus so far is really hard to see. We're definitely seeing weakness in Asia and in China, but we're not sure how much of it is attributable to the coronavirus. So, if I step back to talk about the coronavirus in general for CIRCOR, it's largely an industrial impact issue as opposed to Aerospace & Defense, where we don't expect an impact. We don't do a lot of sales in China, roughly $30 million of sales in aggregate, that's inside of China, including what we export into China. So the impact inside of China would be relatively modest for us from a revenue standpoint. On the supply chain side, we do have suppliers in China for both our industrial business and our energy business, largely in disc ops, and so far, we haven't seen any kind of disruption from that, and I will say that it's a relatively small percentage of our total supply base. So, as of now, we've factored into our guidance and expectations for 2020, a relatively modest impact from the coronavirus, and you know, things change of course, and we start seeing an impact in Europe or in North America, then obviously that could have a bigger impact on CIRCOR, but at this stage, we're not seeing a huge impact.

Got it, and continuing on Industrial, your initial guide for the organic growth rate was around low single-digit, then you lowered it to flattish, given the current environment you are seeing, any color you want to provide there?

So, you're right, we expected roughly flat sales for industrial business in 2020 versus 2019. We're planning around a scenario, where they're actually down year-over-year, and we would -- we expect to continue to deliver our 2020 commitments even if they are down year-over-year. Now obviously the magnitude matters a lot, but we built contingency plans around industrials markets getting more difficult, but as of now, we're still expecting them to be down very little or flat versus prior-year.

All right, and lastly, free cash flow continues to remain weak, any color on how we should think about free cash flow for 2020? Any particular drivers that you want to highlight that you think that can support cash going forward?

Hello, Piyush. This is Chadi. So, the primary driver of our weak cash flow in 2019 is the contribution of our discontinued operation. One of it was sold in July, the engineered valves, and the other one DV continue to be a slight drag on our cash. In totality for 2019, these two businesses had a negative cash flow of $30 million. We expect in 2020, for this $30 million to mostly go away. We've reduced our activity in our discontinued operation that's still with us DV. Therefore, as I look at -- while, we've exited nicely the cash flow for Q4 at $18 million, as I look at 2020, we expect, as we said in my prepared remarks a dip in Q1, but then, a growth over the rest of the year. When I look in totality, I would say when we look that we've achieved $9 million total free cash flow on a total year for 2019, I would look at around $30 million in 2020.

All right, thank you, guys. I will get back in queue.

Thank you. Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Good morning, everyone.

Good morning, Nathan.

Hello, Nathan.

Hi, Chadi. Hi, Scott. Maybe we could start with some of the puts and takes in getting to the $139 million, it looks to me like a little bit worse in the industrial businesses, maybe a little bit worse in the energy businesses, and then that's being offset by better activity and better margins, quite frankly than I think we were expecting in the Aerospace & Defense business. Is that the way you see 2020 playing out relative to kind of the plan you put out in July last year?

So, let me comment on that. I think the industrial being worse than expected is, yes, we agree. Industrial will be weaker on the top line than what we thought. Aerospace & Defense will be significantly stronger than we thought on the top line and the bottom line. So, I agree with that as well. Energy is playing out about as expected. Nathan, we're not looking -- there's what's left of energy is playing out with what we thought in the middle of last year, and then the last piece is the cost actions that we committed to are on track as well. Maybe we're being a little bit more aggressive actually on the cost side. So, if you net it all out, we're still feeling good about our 2020 commitment.

Okay, then maybe we could talk a little bit more about the margins here in Aerospace & Defense. You've been at or above 20% here in the last couple of quarters. You clearly had some strong shipments here in the fourth quarter. Are margins at kind of that 20% level, something that can be maintained in 2020, and is that -- are we kind of setting a new baseline here? I think we're looking at mid-teens as your target in Aerospace & Defense, not all that long ago. So, it's pretty impressive to see those at and above 20% in the back-half, have we set kind of a new target here?

So, I believe we've been saying that our medium to long-term target is high-teens, low 20s, and so, we're there obviously. You should expect that you'll continue to see growth through 2020, and you'll continue to see margin expansion year-over-year, each quarter in 2020. So, what you're seeing is sustainable, as you know, there's seasonality in both revenue and margins. So you'll see, you won't see the same exact margin in Q1 that you saw in Q4, but year-over-year, you'll continue to see solid margin expansion through 2020.

Nathan…

Go ahead, Chadi.

Just to add to what Scott said, I think we have a great momentum in A&D. When we look at what we've done in 2019, we focused our efforts on pricing, and aftermarket, and spot orders, and that is gaining a lot of fruit and good carryover into 2020. So, when we look at the bridge that we put in front of you in the 18 months plan, a lot of this pricing that we put there, $10 million, we're seeing a lot of it coming from A&D. So that's why when we look at our margin and the sustainability of our margin, we feel very, very comfortable with that.

Okay, I just want to slip one more in here on the leverage level and plans for that. Three, six pro forma at the end of the year, I think your slide say 3.0 by the end of 2020. What kind of number does that need to get down to before you would start looking at capital deployment other than just paying down debt?

So, our long-term comfort level is between the 2 and 2.5 range. So, we're still very focused through 2020 on the de-leveraging process.

Okay, that helps. Thanks very much, I'll pass it on.

Thank you, Nathan.

Thank you.

Thank you. Thank you, ladies and gentlemen. We have reached the end of our question-and-answer session, and with that the conclusion of today's call. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.