Q2 2020 CIRCOR International Inc Earnings Call
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And he will should require operator systems. During the conference. Please press star zero on your telephone keypad.
Ill now turn the conference over to David Calusdian from Sharon Merrill Associates. Thank you Sir you may begin.
Hello, and good morning, everyone.
On a call today, it's Scott.
Of course, president and CEO and I'll be kind of all the company's chief financial officer, otherwise, we'll be referring to today are available in sort of course website at www Dot CIRCOR dot com on the Webcasts and presentations section of the investors like 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.
Discussion of these factors the company advises you to review circles form 10-K, 10-Q's, and other FCC filings.
The company's filings are available on its website at CIRCOR dot com actual results could differ materially from those anticipated or implied by today's remarks.
Forward looking statements only represent the company's views as of today August seven 2020.
I'll start I may choose to update these forward looking statements out of later date the company specifically disclaims any duty to do so.
On today's call measurable refer to adjusted operating income adjusted operating margins adjusted net income adjusted EPS free cash flow net debt inorganic measures. These non-GAAP metrics exclude certain special charges and recoveries. The reconciliation of CIRCOR as non-GAAP measures to the compare.
GAAP measures are available in the financial tables or the earnings press release on sort of course website I'll now turn the call over to Scott.
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Thank you David and good morning, everyone.
Before getting into our second quarter highlights I want to acknowledge the CIRCOR teams continuous dedication and productivity during this difficult time.
The support team has gone above and beyond to deliver a central products to our customers well keeping each other safe and maintaining business continuity.
Please turn to slide three.
CIRCOR delivered a strong second quarter, despite unprecedented macro challenges.
I'm proud of the portfolio transformation that we've executed over the last couple of years.
With the recent divestiture of distributed valves, we completed our shift out of upstream oil and gas and other commodity businesses.
As a result of this transformation, we've sharpened our focus on our core mission critical flow control platforms, and we position at CIRCOR for strong future growth.
Our current portfolio of mission critical business. It is more diversified and less cyclical mitigating the impact of the broader economic environment.
In addition, our portfolio of products has differentiated technology and a strong market position that has enabled us to raise prices through the current downturn.
Turning to operations all of our factories are operating in line with customer demand.
As of today, we're absorbing some inefficiencies associated with safety protocols, we put in place to ensure our employee safety.
We continue to manage some cobot 19 related challenges on the supply chain side.
On this we're experiencing limited direct disruption in operations from covert 19.
Despite these challenges the CIRCOR operating system is delivering improved operating performance across most metrics.
And finally, we're positioning CIRCOR to take advantage of a market recovery.
We remain on track to deliver on our commitment of launching 45, new products. This year.
We continue to invest in front end resources and strategic growth initiatives.
We're closely collaborating with suppliers and customers to ensure alignment as markets change.
Lastly, we continue to focus on de leveraging the balance sheet.
Now I'd like to provide some highlights from the second quarter.
Please turn to page four.
We booked orders of $193 million with a book to bill ratio slightly over one and a backlog build up $7 million.
Sales came in at $186 million down, 14% organically largely driven by industrial.
Aerospace and defense is topline remained robust through the quarter.
Adjusted operating margin was 8.5% down 210 basis points for last year.
The margin decline was primarily driven by lower volume in industrial.
Despite lower revenue, we managed company wide decrementals to 22% due to the aggressive cost in price actions, we implemented earlier this year.
Our cost actions remain in line with the targets, we laid out in our first quarter earnings call.
And our price actions across the company are coming in as expected.
Now, let me turn the call over to a b to discuss our second quarter results in more detail before I review the outlook for our end markets.
Thank you Scott and good morning, everyone.
Let's begin by reviewing our segment results.
All figures out from continuing operations and excluding divestitures.
Starting with industrial on slide five.
In Q2.
Industrial segment orders were down 16% organically.
Due to covert ninetys impacted most industrial end markets.
The industrial segment had sales of $124 million down 19% organically.
The majority of our end markets within industrial were challenged due to the covert 19 condemning.
We saw capital project and custom into those delays to the quarter.
It all our margin was 10% representing a decline of 350 basis points worse is brighter.
This was primarily driven by lower sales volume.
And inefficiencies associated with the meet demand in social distancing on the factory floor.
Among other safety policies due to colder 19.
The cost actions that we initiated at the end of 2019.
Coupled with further action starts dependent Mick.
Resulted in a drop through of 27% richest significantly lower than our contribution margin.
Turning to slide six.
In Q2 in aerospace and defense segment.
We delivered orders a $77 million down 18% organically due to a difficult compare.
Last year, but you seem to large joint strike fighter order for $17 million well. This year, we have the impact of gold at 19 on commercial aerospace, although partially offset by the Virginia class submarine order for $9 million.
Aerospace and defense had sales of $62 million down 3% organically due to covert 19 impact on commercial aerospace and ongoing 77 Max delays.
This was partially offset by strong different shipments, especially for the working their class submarine and the joint strike fighter programs.
The aerospace and defense operating margin was 21.1% up 500 basis points.
But $2 million of lower revenue.
Aerospace and defense team delivered $3 million of incremental operating income driven by pricing productivity and cost actions.
Turning to slide seven.
For Q2, the adjusted tax rate was 14.8%.
Due to foreign tax the differential and heart R&D tax credits.
Looking at special items, and restructure charges recorded total pretax charge of $17 million in the quarter.
The acquisition related amortization and depreciation was a charge of $12 million.
110 professional fees were a charge of $4.6 million.
Attributable to.
Last year's unsolicited tender offer corporate governance actions and other proxy related matters.
Interest expense for the quarter was $8 million down $5 million compared to the prior year.
This was the result of lower debt balances and a favorable interest rate of 25 basis points.
Other income was it to mind, our charting the quarter, primarily due to foreign exchange losses, partially offset by pension income.
Corporate cost in the quarter were $9.7 million higher than normal primarily driven by a write off of $1.8 million against a region asset from a previously divested business.
For Q3 in Q4, we expect the corporate cost run rate to be approximately $7 million per quarter.
Turning to slide eight.
Our free cash flow from operations was negative $28 million into second quarter.
Which is in line with the guidance provided during our first quarter earnings call.
During the quarter, we disposed off our distributed valves business for a negative $8.25 million in cash.
The company also incurred approximately $10 million of cash disbursements associated with last year's unsolicited tender offer to acquire the company support for corporate governance changes restructuring investment banking fees and other professional services.
At the end of second quarter, our net debt was at $467 million, which was $205 million lower than Q2 2019.
As you mentioned in our Q1 quarterly call. We expect our Q3 free cash flow to be approximately breakeven to slightly negative as they complete the final disbursements.
Related to the exit of distributed valves.
And other restructuring expenses.
Q4 is expected to be a strong positive cash flow quarter.
Actually cleanup transition and restructuring expenses.
Now I will hand, it back over to Scott to provide some color on our end markets and outlook.
Thank you a b.
Now I'll provide an overview of what we're seeing in our end markets as well as some of the actions, we're taking to manage through the pandemic.
Please turn to page nine.
Let me start by recapping, our end market exposure.
First we've completely exited upstream oil and gas.
Looking at today's portfolio, approximately 46% of our revenue as general industrial.
27% is aerospace and defense with defense approximately twice the size of commercial.
And 27% is aftermarket sales and support.
I'd like to point out a few aspects of our current portfolio.
Our aftermarket business is largely driven by industrial and defense.
Aftermarket margins are higher than OEM margins.
It is driven by our large global installed base are mitigating the impact of the broader economic decline.
Aftermarket as a strategic growth area for CIRCOR and aftermarket growth investments will continue through 2020 and beyond.
We expect defense to remain robust our defense team is winning new programs and next year's U.S. defense budget appears to be coming in at 2020 levels were slightly better.
In addition, we're seeing strong support from many of our larger defense platforms.
Our commercial business represents 8% of revenue and less than half of it is driven by Boeing and Airbus commercial aircraft platforms.
The majority of the remaining commercial sales come from a long list of OEM platforms across business and regional aviation civil helicopters and space programs.
Our industrial business is very diversified by end market.
Outside of downstream oil and gas, which represents 10% of revenue no end market represents more than 6% of revenue.
This offer significant diversification, reducing cyclicality and our dependence on any one end market.
Please turn to slide 10 to discuss the current market outlook.
Let's start with industrial.
Orders overall in Q2 were down 16% organically.
During the second quarter and the industrial business, we saw the impact of Coven 19 across most major end markets.
For market orders were down 23% impacted by an overall slow down and global manufacturing as well as large project delays linked to the global reduction in Capex.
We saw capital project delays in commercial marine machinery manufacturing chemical processing and building and construction end markets.
The impact on water and wastewater was relatively modest compared to other end markets.
[noise] Alternatively, we saw slight order growth in our U.S. consumer goods manufacturing sector.
The cobot 19 environment, coupled with some customers shifting consumer goods manufacturing from China to the U.S. created a moderate increase in orders in this sector.
Aftermarket orders were down 8% organically in Q2.
Our global installed base combined with our dedicated aftermarket commercial team has mitigating the impact of steeper declines in for market capital projects.
Yeah aftermarket weakness was most significant and commercial marine due to lower utilization of cruise ships and offshore service vessels.
We're seeing pockets of growth in some areas like nuclear power in Asia, and midstream oil and gas in Latin America.
Downstream order intake in the quarter was relatively low due to delayed capital projects and maintenance turnarounds.
Refiners are minimizing short term spending and reducing the scope of activities planned for the fall turnaround season.
Aftermarket backlog is expected to grow as we exit the year in preparation for the delayed maintenance activities from 2020.
And layering on top of the already planned repair and maintenance work slated for 2021.
Coating activity remains strong for long cycle capital projects in growth markets.
For industrial overall in Q3, the end market outlook is similar to market levels in Q2.
We expect the impact of Coben 19 to driving year over year decline in revenue of 18% to 28%.
We expect most OEM end markets in Q3 to remain at Q2 levels due to ongoing capital expenditure reductions and capital project delays.
On the aftermarket side, we're starting to see some improvement sequentially in Europe, and Asia as those markets recover from the covered related downturn.
In North America, we expect Q3 revenue to be in line with Q2.
Regionally the general industrial market is expected to decrease in Q3 versus the prior year in North America, Europe, and India. However, we expect to see growth in China.
Please turn to slides 11 and 12.
Our aerospace and defense segment delivered orders a $77 million in the quarter driven by ongoing strength in defense programs like the joint strike fighter The U.S. Navy, Virginia class submarine the CVN 80 aircraft carrier and various missile programs.
Strengthen defense orders offset weakness in commercial aerospace orders, which were down from the previous quarter due to the impact of covert 19 on production rates at Boeing and Airbus and the ongoing delays at the seven through seven Max.
Overall, we expect Q3 orders to decrease sequentially driven by the timing of defense program orders and covered related headwinds in the commercial business.
For aerospace and defense in aggregate, we expect revenue to be up sequentially in Q3, but down 3% to 5% versus last year.
Commercial revenue is expected to be down approximately 30% to 40% versus last year, while defense should be up 12% to 17%.
It's important to note that we're increasing prices on both sides of the business defense and commercial aerospace.
With carryover pricing from 2019, and new increases this year, we expect to net a 4% price increase in Q3.
The price increases are heavily weighted in the aftermarket.
Before I wrap up I want to reiterate that despite covered 19, we're still driving the transformation. We laid out last summer and have continued to make strong progress while the pandemic has had a significant impact on our end markets. We've responded accordingly by accelerating and expanding many aspects of the plan, particularly with respect.
Back to reducing structural costs and leaning out the company.
It's also important to know that we're preserving the growth capacity of the company. Despite the expanded reduction of structural cost.
Notably we've increased our commitment of new products launched in 2020 to 45 up from 40 in the original plan.
And finally price remains an important part of our playbook due to the mission critical nature of our products, we've been able to raise prices. This year in line with your original plan, we committed to last year. Despite the recent market disruption.
To summarize we're taking the appropriate steps to navigate the current environment, while continuing to execute on our strategic plan.
As the market continues to change we will continue to adapt to ensure we are positioned to succeed.
I'd like to close by once again thinking the entire CIRCOR team for their service and unwavering dedication to our customers. They have been doing a remarkable job.
We remain committed to positioning CIRCOR for long term growth expanding margins generating strong free cash flow and deleveraging the company.
Now being I will be happy to take your questions.
Thank you we will now be conducting a question and answer session.
That's a question. Please press star one on your telephone keypad a confirmation total indicate your line is in the question Q you may Prestart Sue if you'd like you have your question from the Q repurchases using speaker equipment, maybe necessary to pick up your handset more pressing mr. Keith one moment, please pull for your questions.
Our first question comes from the line as Andy Kaplowitz with Citigroup. Please proceed with your question.
Hey, good morning, guys.
Morning, any are you doing good are you Scott. So obviously strong performance on the margin can you talk about whether the transition to the lot. Morocco said is complete you mentioned pricing quite a bit in your prepared remarks, how much is that contributing as mix, helping I think it is and then the sustainability of this type of margin.
And even one commercial aerospace continues to be so weak.
Sure. Okay. So a lot a lot in that question. So let me start with your Morocco question. So some Morocco is not done we we expect we have a five year plan for Morocco. Some Morocco will continue to grow every year as we as we leverage that as our local.
Yes platform for aerospace and defense so.
Has contributed this year to the margin expansion and we'll continue to contribute to ongoing and we're finding in Morocco by the way is that our customers are actually very interested in Morocco. In many cases, there they are asking us to move programs to Morocco and of course, we share the savings with them. So you should expect the Morocco story to continue.
For for years to come here with respect to the margin expansion. There were lots of contributors here pricing. You mentioned is is a big one and probably the biggest factor in the quarter would be pricing mix is helping.
If you if you step back and look at aerospace and defense.
The margins are better in aftermarket you can see from the the.
The growth in aftermarket in defense is much higher than than what we're seeing elsewhere and more than offsetting the decline in on the commercial side. So we're seeing a mixed benefit by having more aftermarket.
And and less OEM few will so that's certainly is certainly helping as far as the sustainability of the margins in aerospace and defense, we're very comfortable with where we are.
We believe longer term this is a mid twenties operating margin.
Business.
And the levels that were at right now are certainly sustainable through through the remainder of the year based on what were based on what we're seeing now.
Thanks for that Scott and then if we step back and think about the momentum of the overall business right industrial revenue guidance for Q3 as you said the declines are relatively similar to Q2.
You could argue maybe slightly worse, maybe just being conservative there and indeed guidance is only slightly better. If you include led the weaker commercial and stronger defense. So maybe you could talk about the shape of the recovery you're seeing how concerned are you the shape of their coverage has more at whole shaped versus you or the shape.
So.
You're right. The way you just recap how we're seeing Q3. So I would say we are seeing a similar types of revenue in Q3 versus Q2, two and industrial.
We will see moderate growth sequentially on the aerospace and defense side as we go from Q2 to Q3.
If you drill down into that to see some of the dynamics in industrial let's start with that after market. We are starting to see an improvement in aftermarket orders in Asia and Europe.
The U.S., we're not we're seeing flat, maybe slightly down a little bit in aftermarket in the U.S.
On the OEM side, we're not seeing much change at all.
The order rate that we saw in Q2 has continued through July.
And we're not expecting to see much change through the remainder of the quarter, we think thats going to recover slower. So I think the way we've guided Q3 with revenue more or less in line with Q2 is what we're seeing in July and probably what will happen.
Barring some kind of.
Change with infection rates around the world or some some change in one of our factory something like that based on what we're seeing today it looks to be more or less in line with Q2.
On the aerospace and defense side, we have good solid growth in the aftermarket on defense. This is largely driven by orders in the first half of the year. So we've got a backlog coming into the back half on the aftermarket side longer term you won't see this level of growth in aftermarket. This is probably a high so.
Total digital growth component of our business, but for the remainder of the remainder of the year, you'll see very good growth in aftermarket on the defense side and then on the on the commercial side is it really just driven by the platforms. We've got a number of new programs in defense that are that are launching this year for aerospace and defense overall, we're launching 20.
Five new products. This year, which are all went to to new program wins. So we're seeing pretty good momentum here on defense commercial.
I mean, it we're seeing what everybody else is seeing pretty significant dropped in in revenue.
But as you can see we're offsetting that with the defense side of the business.
Just one more quick one for me can you sustain the kind of detrimental that you had in Q2 going forward given you laid out pretty explicitly sort of temporary versus structural cost out last quarter.
You know how does that balance out as you go for the balance of the year.
Yes, Andy this is a b. If you if you think about company Decrementals moving forward I'd say, it's fair to assume that overall for CIRCOR, you'll see decrementals in the 20% to 25% range.
So very similar to what you saw in Q2.
Thanks, guys appreciate it.
Okay. Thanks, Andy.
Thank you once again you'd like to ask a question. Please press star one on your telephone keypad. Our next question comes from the line of Jeff Hammond with Keybanc capital markets. Please proceed with your question.
Hey, Good morning, guys wondering Jeff how are you.
Good doing real well.
Lot of good color on industrial, but I guess, what I'm hearing from a lot of other industrial companies is kind of bottoming April may and then starting to get less bad I guess in June July and you guys seem to be a little more stable I'm just wondering.
What markets are getting definitively less bad and how much is like it seems like downstreams might be gone the other way and so how much of a drag is that kind of in yes. As you kind of assess the whole you know the whole group of businesses within industrial.
Sure.
I think it's easier for us.
End markets the end markets aren't moving around that much I mentioned water wastewater is doing a little better than some of the other end markets, but I think where we're seeing the most differences by region and then aftermarket versus OEM. So if you if you step back and look at our order intake and whats happened to last.
Couple of months versus earlier in Q2.
You will see aftermarket improving regionally in Asia, and aftermarket improving in Europe, but we don't see that yet in the us.
If you if you look at.
At the region's I'm sorry, if you look at the the the OEM side of the business, we're just not seen.
An inflection point really in any any part of the business, we're seeing things move around here and there and some pockets of growth I mentioned nuclear power in Asia. We saw strong orders in the second quarter for nuclear power I mentioned midstream in Latin America I mean these are relatively.
Small pieces of our business, but we saw strong orders in the quarter. So there's pockets of of activity, but broadly speaking, it's really only aftermarket that we're seeing things improve in a material way and it's only in Asia and in and in Europe at this point.
Okay, and then last quarter, you gave kind of a to Q3 Q view and clearly have a little more visibility in the Andy said, So maybe you can speak.
Is this trend of kind of defense being better and.
In commercial being worse does that carry into into Fourq, you as well.
Yes, we have you're right, we do have more visibility in aerospace and defense I think what your should expect to see into Q4 is going to be very similar to what you're seeing in Q3 in aerospace and defense. So from a sequential standpoint, you should expect to see similar kinds of of revenue.
Margin expansion will continue year over year, as well and aerospace and defense. So we've got a decent decent visibility through the remainder of the year that you're not going to see a huge change to what you're seeing in Q3.
Okay, and then free cash flow B. I think you may you made some comments but.
It looks like you're paying everybody on time, and you know maybe or your.
Receivables aren't coming in as fast so just talk about like working capital for the year.
Given the revenue decline and you know.
How much free cash flow you know how much of this negative free cash flow, we can offset you know into the second half.
So.
We are so just Andy let me just start with what we're expecting to happen and cash flow. So for cash flow in Q3, we're expecting to be about breakeven, we're still absorbing disbursements associated with the exit of distributed valves. We've still got some risk restructuring expenses that were going to absorb here in the in the third quarter. So roughly.
Breakeven, maybe little bit negative in Q3 going into few Q4 should be largely clean you should see good solid operating cash flow.
Relatively clean cash flow in Q4.
Sores working capital we.
That was a headwind for us in Q.
The first half of the year Q2, you see we increased working capital you're going to see that reverse here in Q3 in Q4, So working capital will be a tailwind and will help us generate cash through the remainder of the year as far as how we're thinking about.
Capital allocation, it's all about debt repayment and debt reduction for US right. Now. So we are we have cut capital expenditures. This year, so you'll see a significant cut year over year.
On Capex and then the cash that we generate the remainder this year will go towards paying down the debt.
Okay, and then what's the other expense item there is like 2 million headwind I think.
Oh, yeah. The other income so it really what it is the FX impact that we saw in the quarter.
For the for the intercompany loans that we have so that was a bad for us in the quarter.
We have taken some actions in place for Q3, so moving forward will not be as big an impact for us we're hedging we're hedging that away going forward.
Okay. Thanks, guys, yes.
Thank you. Our next question comes from the line Nathan Jones with Stifel. Please proceed with your question.
Good morning, everyone. Good morning Nathan.
He is going to go after a little more detail on the industrial audit trend.
If you're willing to could you talk about how they progressed through the quarter did did they did the comparison don't know what is at least improve as you went through the quarter in any comments you make on July.
Sure. So so we when we had the earnings call. The Q1 earnings call we were.
We were seeing order rates and expecting revenue at the better end of the range that we that we had guided we came in a little better than that so I'd say very modest improvement through the quarter last year or I'm, sorry last quarter in terms of orders and revenue as we look at Q3.
We are.
We are coming in is July would indicate that were at the better end of the range. The revenue range that were indicating here in the in the presentation. So we're at the.
We're right at the better end so.
It could get worse, we'll see what happens with infections here in the U.S.. That's our biggest concern is what's going on in North America.
But right now were coming in at the better into the range.
And just a follow up on the comment that you're cutting capital expenditures pretty significantly. This year can you talk about wed where the capex is getting caught and where you're you're maintaining that capex to invest in growth and those kinds of things.
Just every night, what's getting caught and what's still getting funded.
Right, so you'll you'll see roughly 20% to 25% reduction in capex for the full year.
We have preserved all the growth capital expenditures that we were expecting to spend coming in coming into the year. So the so so and that's that's opex as well so the the resources that we were expecting to invest in coming into the year largely in emerging markets were still investing in that.
We're still investing in engineering and product management, so those things are still happening.
On the capital side.
It's hard to there is not broad categories that were cutting Nathan its basically.
Parade going out the the projects and cutting off the tail. The things that are that at least important to driving results at CIRCOR. So of course, we're preserving all of the safety capital, we're maintaining our equipment that we need to maintain we're doing all the things that we need to do that to ensure business continuity, but the things that.
We're on the margin.
We're close to the line, we would push them below the line for this year and we'll pick that back up next year.
What I really wanted the there was that you are cutting the birth investments that's good.
Our pricing, obviously, a lot of pricing going through this year.
It's a usually a pretty difficult environment. When revenues are down this much to be able to proscribed can you talk about a little bit more about the areas that you're pushing price through what gives you the ability to get that pricing for any normal circumstances for three ballpoints across would be a lot and the customary accepted.
To date based pricing increases.
So we're we've got a pretty detailed playbook for how to raise prices.
We raised prices, where we know we have the the value that we're delivering to the customer to justify it and in many cases. We are we are in situations where were sole sourced though to talk about aerospace and defense for a first were sole sourced and on the vast majority of this business.
The aftermarket part of the business is.
We're not on long term contracts and so we're able to raise prices more freely in that part as part of the business. If if something is urgent and the customer need something very quickly, we typically charge for that as well and so it's a there's a pretty detailed decision tree on how we work our way.
Through what the price increase should be in is typically based on the value, we're providing to the customer so on the aerospace and defense side, obviously, we're getting a lot more price than we are on industrial we're getting about 4% on on a indeed.
On the on the industrial side, we're getting about 1%.
Thats largely happening in the aftermarket piece of the business, so selling and the majority of our aftermarket is selling.
Replacement parts, you know screws for screw pumps et cetera, but also replacement product and it's the same kind of of logic, we have an installed base.
Many of our some our customers will will will order parts and were able to get a premium to despite those parts, especially if they need to merge only will typically charge for that so that's that's essentially how we're doing.
Great. Thanks for taking my question.
Thank you. Thank you we reached the end of our question and answer session and the conclusion of todays call. You may now disconnect. Your lines. Thank you all for your participation and had a wonderful down.
Thank you.
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