CIRCOR International, Inc. (NYSE:CIR) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Greetings, and welcome to the CIRCOR International First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I will now turn the conference over to Mr. Scott Solomon, Senior Vice President of the company’s Investor Relations firm, Sharon Merrill Associates. Thank you, sir. You may begin.

Scott Solomon: Thank you, and good morning, everyone. Before we begin, let me remind you that our earnings release and presentation are available on CIRCOR’s website at investors.circor.com. If you would like to receive copies of these materials, please e-mail cir@investorrelations.com and our IR team will provide them for you. Turning to Slide 2. Today’s discussion will contain forward-looking statements as they are defined under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These statements represent the company’s views only as of today, May 11, 2023. 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 filings also located on our website. As referenced on Slide 3, on today’s call, management will refer to GAAP and non-GAAP financial measures. The reconciliation of the non-GAAP measures to the comparable GAAP measures are available in our earnings press release. Please turn to Slide 4. Joining me on today’s call are Tony Najjar, CIRCOR’s President and Chief Executive Officer; and A.J. Sharma, Chief Financial Officer and Senior Vice President of Business Development. Tony will begin with a strategic overview and the highlights of our first quarter 2023 results.

A.J. will review the financials and discuss our guidance for the second quarter and full year 2023. Tony will provide our market outlook and then management will be happy to take your questions. Now, please turn to Slide 5 as I hand the call over to Tony.

Tony Najjar: Thank you, Scott. Good morning, everyone, and thank you for joining us to discuss our first quarter 2023 financial results. Before we review our results, I want to thank our teams across the globe for their continued focus on execution and for delivering another solid quarter despite the ongoing macroeconomic challenges. Since our year-end earnings call, I have spent most of my time with our teams and customers in Europe and North America, including having the opportunity to participate in the supplier conference with one of our top U.S. defense customers to discuss the expected ramp up of a new key defense program that we are supporting. Recently, I also had the opportunity to visit our manufacturing site and Tangier, Morocco there, our dedicated team of more than 150 members continues to optimize lean manufacturing processes to support the growth and demand for our hydraulic and electromechanical products from our commercial aerospace customers.

Our team in the Morocco supported by our A&D team from Corona, California has also recently established advanced manufacturing capabilities for Brushless DC Motors. This added capability is geared to supporting the expected growth from new programs and applications we recently captured. I continue to be delighted by the level of customer intimacy and innovation that our teams are driving, and by the strength of the CIRCOR family of brands throughout the industries we serve. Our team performed exceptionally well in the first quarter, delivering excellent results supported by both segments. We delivered 13% organic orders growth, 9% revenue growth, or 13% on an organic basis, as well as 840 basis points of margin expansion. The margin expansion was supported by our value pricing initiative with a benefit from pricing more than offsetting the impact of inflation.

Turning to Slide 6. Our Q1 performance underscores our team’s continued focus and success and executing on our strategic priorities. These include first, margin expansion, which includes value pricing, simplification, best cost country sourcing in manufacturing and factory modernization. Second, organic growth, new product development and leverage of our strong aftermarket position. And third, reducing our leverage, which we accomplished in Q1 to a solid adjusted EBITDA growth. A.J. will provide more details on our improved leverage and outlook in his prepared remarks. Turning to our first quarter highlights on Slide 7, organic orders increased 13% versus prior year driven by growth in both segments. Orders in A&D were up 12% organically.

The strength in A&D was driven by the continued recovery of the commercial aerospace market, strength in our Naval Defense programs, and value pricing in both the foremarket and aftermarket. Industrial orders were up 14% organically supported by strength in our aftermarket, pricing, and downstream oil and gas primarily in the aftermarket. Pricing was strong in both segments, which is indicative of the power of our brands and our teams focused on maximizing value from the products and services we provide. Backlog at end of Q1 was up 22% from the same period last year to a record $584 million positioning us well for the remainder of the year. On the top line, revenues increased 9%, the $203 million supported by our strong orders and backlog and easing of supply chain pressures.

Our 173% increase in adjusted operating income was also supported by margin expansion across both segments with industrial delivering another quarter of step change performance compared to prior year. In addition to value pricing, the margin expansion was driven by the cost controls, our teams continue to execute in the businesses and at corporate. A.J. will provide additional color on the margin drivers and the quarter during his prepared remarks. The demand environment for our products continues to be healthy as evidenced by sustained order strength and our growing backlog. We are positive about our business as we move through the second quarter of 2023 and look ahead for the rest of the year. Moving to Slide 8. Each quarter I like to highlight specific growth areas that our teams are driving.

Today, I’ll discuss one growth area from each of our segments that showcase the focus on growth that our teams are driving across the company. The first growth area we are highlighting is from our industrial control valve business in Germany. Our team was able to capture control valve applications with two different OEMs for the lithium ion battery manufacturing process. Lithium ion battery production requires precise temperature and humidity control to avoid moisture contamination. Our control valves are used in the battery electrode manufacturing equipment to support overall process efficiency. Lithium ion battery market is expected to grow at a CAGR of over 18% between 2023 and 2032. This growth is mainly driven by renewable energy storage infrastructure and eMobility.

We expect to continue to leverage our control valve and pump technology to support our industrial growth strategy from this fast growing market. The second growth area we’re highlighting is a recent product launch, our A&D team and Corona, California completed for the new Airbus A321XLR. The A321XLR is a single aisle aircraft with a range of 4,700 nautical miles and 30% lower fuel burn per seat than previous generation aircraft. CIRCOR’s Hydraulic Rate Fuse is part of the aircraft breaking system and is intended to protect the Hydraulic Circuit in the event of tire failure. We leveraged our core technology and hydraulic valve design and high pressure controlling ceiling to capture this critical application with Airbus. This new product supports our A&D growth strategy with this important family of aircraft.

Before I turn the call over to A.J., I would like to provide you with a quick update on our strategic review process. As we mentioned in mid-March and reiterated in this morning’s earnings release, our Board supported by our external advisors and the management team continues to progress with the review. Dialogue is underway with a number of parties that have expressed interest in acquiring all or parts of the company. Now, let me turn the call over to A.J. to cover the financial results in more detail.

A.J. Sharma: Thank you, Tony, and good morning, everyone. Let’s turn to first quarter financial highlights on Slide 9. We posted another strong quarter of orders growth and margin expansion, further validating the margin expansion and value creation potential inherent in our portfolio. With three consecutive quarters of solid performance, we currently to see the financial benefits of the ongoing transformation we launched in early 2022 and believe we have a long runway for growth and margin expansion. Organic orders were up 13%, primarily driven by pricing, aftermarket, downstream, and continued commercial aerospace recovery. We saw orders growth across our platforms and end markets. On the top line, our teams delivered double-digit organic revenue growth in both Industrial and Aerospace & Defense, most of our businesses posted organic sales growth in the quarter.

We continue to execute value pricing, maintain cost controls and drive growth. These efforts helped generate 173% increase in adjusted operating income and 840 basis points of adjusted operating margin expansion. We delivered $0.53 of adjusted EPS up 960% and grew adjusted EBITDA 103% to $31.8 million. Adjusted free cash flow was negative $16.6 million for the quarter, an improvement of $2.9 million or 15% over the prior period. Higher AOI was offset by interest cost, special expenses, and seasonality of working capital. As a reminder, the first quarter is a seasonally negative free cash flow quarter for us. We expect free cash flow to be positive for the full year. Turning to Slide 10 on our Aerospace & Defense segment results. We saw 12% organic orders growth led by pricing, commercial aerospace, medical and UK Navy, partly offset by timing of Joint Strike Fighter order in prior year.

Organic revenue grew 10% with continued commercial recovery and medical growth. Aerospace and defense delivered solid adjusted operating margin of 21.5%, expanding AOI margins by 360 basis points over prior year. AOI margin expansion was driven by pricing and broad-based volume growth. Moving to our Industrial segment results on Slide 11. Organic orders were up 14% driven by pricing, aftermarket and downstream, partly offset by exit from Pipeline Engineering. We were especially pleased to see continued momentum in our core industrial aftermarket, which posted organic orders growth of 12% year-over-year. We continue to remain laser focused on growing this high margin part of our business as we leverage value pricing and take share. Organic revenue grew 15% with broad-based trend across the platform that more than offset decline Navy and the exit of Pipeline Engineering.

Industrial posted exceptional AOI growth of 196% and AOI margin expansion of 960 basis points. The margin expansion was largely result of the ongoing transformation of our Pumps businesses fueled by value pricing, factory modernization and improving execution. We exit from Pipeline Engineering contributed 190 basis points of margin expansion. At 15.2%, our first quarter Industrial AOI margin continues to validate our business differentiation and margin expansion potential. With continued success of value pricing, aftermarket growth, and improving execution, we are increasingly confident of delivering AOI margins between 18% to 20% in the next three to four years. Turning to the Slide 12, net leverage and compliance leverage have continued to improve.

We ended first quarter at net leverage of 3.8, which was 0.4 turns lower than fourth quarter 2022 and 2.5 turns lower than first quarter 2022. We remain focused on delivering and it remains our top priority. With our expectation of continued expansion of EBITDA, we now expect to exit 2023 with net leverage in the low to mid-3s exclusive of any divestitures. Turning to Slide 13 and our expectations for second quarter and full year 2023. Reported by strong first quarter performance, continued orders growth, improving execution and increasing backlog, we expect Q2 2023 adjusted operating income of $22.6 million to $24.6 million, and an increase of 42% at the midpoint from the second quarter of last year. For full year 2023, we now expect AOI of $105 million to $118 million, an increase of 27% at the midpoint.

This is an increase from our prior full year guidance of $90 million to $105 million. We expect pricing, cost optimization and growth initiatives to remain strong drivers of AOI growth and margin expansion. We continue to see signs of easing of supply chain constraints and improving execution, particularly in our Pumps businesses. Interest expense is expected to be approximately $58 million for the full year, up approximately $16 million compared to prior year. The increase in interest cost is a result of higher rates. As a result of stronger adjusted operating income, partly offset by higher interest cost. We are increasing our full year adjusted EPS to be in the range of $1.74 to $2.23. Overall, we are very encouraged by the momentum of the ongoing transformation and are very bullish about 2023 and beyond.

I’ll hand the call back to Tony to discuss our market outlook for orders on Slide 14.

Tony Najjar: Thank you, AJ. Based on our Q1 results and current market conditions, we now expect full year 2023 orders to be up low single digits. We also expect a book-to-bill ratio over 1, supporting continued future growth. In our General Industrial business, we expect orders to be up low single digits. Strength in the aftermarket and pricing will be somewhat offset by lower core market activities. In Commercial Marine, we also expect low single digit organic growth driven mostly by the aftermarket supported by increased utilization and pricing. In Downstream Oil and Gas, we expect orders to be down high double digits, following a very strong 2022. This is primarily driven by timing of large capital projects booked in Q4 of last year.

Our team is actively pursuing several major opportunities in North America, Latin America and India, which could significantly improve the outlook. Elsewhere in the segment, we expect orders to be up high double digits, primarily driven by naval programs in the U.S. and Europe. Turning to Aerospace & Defense, we expect high single digit orders growth with solid contributions from the defense and commercial end markets. In our Defense business, we expect low double digit orders growth. This growth is driven by increased activities in naval programs, new products for missile fusing devices and space applications and pricing. In Commercial Aerospace, we expect mid-double-digit orders growth, primarily driven by the continued market recovery for the single-aisle platforms at Airbus and Boeing.

Initial recovery of the Airbus twin aisle platforms, as well as the increased activity in the aftermarket supported by pricing and the rebound and air travel. Elsewhere in the segment, we expect orders to be down high single digits due to timing of a large medical order. Turning to Slide 15. In summary, we are extremely pleased with our strong start in Q1 and we are well positioned as we move into Q2 and look ahead for the balance of the year. We expect to continue to leverage our strong aftermarket position in our Industrial segment and deploy our value-based pricing and 80-20 principles across the organization, generating margin expansion and staying ahead of inflation. We continue to benefit from the rebound of the commercial aerospace market and look for further momentum in our defense business, driven by our positions on key platforms, new product development and strength in the aftermarket.

We strive to maximize value creation for our shareholders, pursuing organic revenue and margin growth through new product development, value-based pricing, simplification and cost-out actions, while at the same time, pursuing the parallel path of a potential strategic transaction. We expect our value pricing strategy to continue to drive growth and margin expansion in 2023 and beyond. We’re also continuing to evaluate further simplification opportunities in the businesses and at corporate. While our industry continues to be affected by various macroeconomic factors, we remain fully focused on the areas within our control to minimize the impact from these headwinds and deliver growth and margin expansion. Now, AJ and I would be happy to take your questions.

Operator, please open the line for Q&A.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from line of Nathan Jones with Stifel. Please proceed with your question.

Adam Farley: Good morning. This is Adam Farley on for Nathan Jones. I wanted to start on your value-based pricing initiatives. Could you maybe just go into a little more detail on the various value-based pricing initiatives you have in place across the businesses and then how that should layer into operating margins through the year?

Tony Najjar: Yes. Good morning, Adam. This is Tony. So it’s really coming from two places. In – on new foremarket, when long-term agreements come up for renewal, we start with a cycle that takes usually six months to a year. And we conclude negotiations, and that’s one part of the pricing that we have been able to drive with some very specific actions that concluded last year and are supporting the pricing this year. The other piece of it is the aftermarket and spot orders. So as we said in past calls, that activities continue. Our leadership teams in the businesses, AJ and myself are fully focused on that. We do establish targets that the team track on a regular basis, and that’s been a significant factor of the results that you saw in Q1 as well as what we delivered in Q3 and Q4 of last year.

So the value pricing initiatives that we have, the 80-20 simplification, understanding our position in the market is really the same strategy that we deployed strongly last year in the industrial business and have been deploying in A&D for quite a few years is continuing, and that’s where the value pricing is coming from. We expect full year to be similar to what we did last year. Q1 started stronger than what we expected, stronger than last year, and that’s been a significant factor in the margin expansion in Q1, in addition to the cost controls that we’ve been implementing.

Adam Farley: Okay, that’s helpful. And then just shifting over the orders growth, really strong organic orders. Maybe specifically for Industrial, how did industrial orders trend through the quarter? Are orders continuing at a similar pace through April and the early part of May? And maybe some color on long versus short cycle markets and some of the trends you’re seeing there?

Tony Najjar: So the aftermarket in industrial as we said in the prepared remarks continues to be strong. It’s both market recapturing some of our share from the installed base as well as the pricing impact. So that’s a significant portion in North America. The foremarket continues to be quite strong and power generation midstream type activities with our three screw pumps as well as chemical processing. So in general, industrial markets to be – continues to be quite strong in North America. We’re seeing good activities with the battery manufacturing processes. We mentioned one example with the control valves. So overall, foremarket in North America is solid, foremarket in Europe is a little bit slower, but the aftermarket continues to be solid across the board.

Adam Farley: Okay. I think you mentioned, you were pursuing some large opportunities within downstream oil and gas that could potentially improve the outlook. Is there any additional color you could provide there?

Tony Najjar: Yes. There’s activities in the U.S. markets with the large refiners. There’s activities in Mexico. There is a lot of quoting activities in Brazil and then even in the Middle East, some activities in Abu Dhabi in that region as well with refiners. So there’s significant what activities across the Board, the Q1 was quite strong for downstream stronger than what we had expected. But for the full year, we are still expecting to be down compared to prior year simply because of the very large orders that we booked in Q4, that will not quite repeat. But we are seeing improvements at least based on Q1. And then Q2 is started relatively well both in downstream and I guess I didn’t answer that part of your question as well as in the rest of the industrial businesses.

Adam Farley: Okay. Thank you for taking my questions.

Tony Najjar: Thank you.

Operator: Our next question comes from a line of Andy Kaplowitz with Citi. Please proceed with your question.

Andy Kaplowitz: Hey, good morning, everyone.

Tony Najjar: Good morning, Andy.

A.J. Sharma: Good morning, Andy.

Andy Kaplowitz: Tony, maybe you could give us some more color regarding your industrial margin progression. Obviously, strong progress into mid-teens you talked about it, you talked about sort of the value-based pricing model, I assume that’s a lot of this. But how much more runway do you have there on value-based pricing and how much is this sort of cost really starting to come down you mentioned easing of supply chain. And I know you’re saying 18% to 20% over the next three or four years, what still needs to be done to get there and how do you think about normalized incremental margin for that business?

Tony Najjar: Yes. So Andy pricing, certainly, in last half of last year, Q1 this year has been a critical factor, in addition to pricing, inflation is starting to ease. So inflation was pretty muted in Q1. Energy cost, which was a significant headwind last year is starting to ease especially in our factory in Germany. The other factor is, we’ve spoken about factory modernization, some of that equipment is in place and starting to support productivity. The improvement in supply chain is also supporting productivity. So there’s various pieces, but looking at the Q1 results, pricing continues to be the largest piece. The other side of it is cost control with OpEx. So we are significant focus by our leadership team and controlling costs as we grow.

So we’ll get the leverage from the growth as well. So there’s various factors, but pricing at this point is the largest element as we look ahead, and that’s why we reiterated our confidence in achieving that 18% to 20% in next three to four years, because of all the other factors that will come into play, plus the continued focus on the pricing, which again, in Q1 started significantly stronger than what we had expected.

Andy Kaplowitz: Tony, maybe I could follow-up there and just ask, like, you mentioned you’re evaluating sort of new simplification and cost out projects, I think, and again, you delivered the margin growth in Q1. We know you’ve been working on this stuff for a while. So maybe to use an American term, what inning are you in of your transformation?

Tony Najjar: So last year, we spoke about taken out about $14 million of cost on a run rate basis, about $6 million to $7 million basically what will happen this year, portion happened last year, portion will happen this year. We still have higher OpEx and businesses than we believe we need. So two things that we’re doing as attrition happens in the businesses, we’re replacing some of those roles where it makes sense and our shared service center in India. And then as we grow – the plan and what we have been doing is to do more with the same resources that we have. And that’s the leverage that we expect to get. If we look at our OpEx in total for 2023, we expect it to be about a 100 basis points lower for the whole company as a percentage of sales compared to last year. So these are the various elements that we continue to drive, again, a lot of actions have been implemented and more is ahead.

Andy Kaplowitz: And then I’m not sure if you can answer this, but I’ll ask it anyway, like, the strategic review has obviously been going on for a while now, any additional thoughts on timeline? What’s a realistic timeline for all of us to think about for you to – the board to make the decision that it needs to make?

Tony Najjar: Andy, it’s very difficult for us to comment on timing, obviously, as we said and reiterated the process is underway. If you recall, we spoke initially about strategic review back in March of last year, but all of last year was focused on catching up with our filing, the restatement process that we had to go through early this year, we said the process has been formally launched and it is – and not cycle now going through it. It’s really difficult to provide timing, even if we were to guess at timing, we will likely be wrong. So we’re not getting into timing discussions, but the process is underway and the board is committed to completing that review.

Andy Kaplowitz: Totally fine. One more question from me, like, A.J., on cash generation, you mentioned it’ll be positive for 2023, you start out seasonally weak. Maybe commentary on sort of improvement in sort of working capital, like how do you feel about this year versus where you entered sort of last year at this time?

A.J. Sharma: Yes. So I would say, Andy, we are growing the top line this year, so there still would be in dollar terms growth in working capital through the year. Consistent with what we said in the last earnings call, we expect to have mid single digit sort of in dollar terms, mid single digit free cash flow performance for the full year. The first half would be negative, the second half turns positive, and this is while maintaining the elevated levels of CapEx as we continue to modernize our large and critical factories.

Andy Kaplowitz: Thank you guys.

Tony Najjar: Thank you, Andy.

Operator: Our next question comes from line of Brett Kearney with Gabelli. Please proceed with your question.

Brett Kearney: Hi guys. Thanks for taking my question and congrats on the continued momentum.

Tony Najjar: Good morning.

Brett Kearney: You guys touched on this a bit already, but Tony, as you get out more you visit, the factories, meet with teams, it feels like coming doing the results, there’s re-energization process that’s taking place. You’ve spoken about a number of the performance drivers. I was wondering if you can expand a bit on the factory modernization initiative, what opportunities you’ve seen there and whether those investments have been made or continuing to be made at some of your core sites today.

Tony Najjar: Yes. So we have several in our new machining centers, including robotic type machining centers for – with the key focus being on our screw pump type product line. So there are already significant investments that have been put in use, starting late last year, continuing this year. And there’s more that’s on order that we expect to receive into this year as well, can continue to put into production. We – it’s still in the early stages of the benefits from that, but we are starting to see signs and we’ve been able to leverage its equipment and our solid backlog to drive this revenue growth, and we expect that to continue in the year as well. So we’re probably 30%, 40% down that modernization path and expect to maybe get about 60% of it by the end of this year. And most of the equipment that we are planning to invest and will be on order throughout this year, and we’ll continue to come into next year as well.

Brett Kearney: Excellent. And then just lastly on new product development, great, you highlight another key win with the control valve product line. I guess, more broadly, can you talk about what you touched on in terms of the deeper market mapping and segmentation work that the teams are doing to really identify some of these growth verticals and go after them in a more impactful way?

Tony Najjar: Yes. So that’s going on in both segments, but specifically, in the Industrial segment. So we spoke about the control valves, I think I touched a little bit on the pumps. The control valves is just one element of growth that we see in this area. There’s opportunities in carbon capture and various other renewable type markets or clean energy, but specifically with the batteries, that’s obviously high growth area, high growth market beyond the control valves, we have metering pumps that have applications and we’re already applying those and various applications. And we also have our progressive cavity pumps with applications and moving lithium slurry in addition to the pumps – some of our pumps that are used on the mining side, some of our large propeller pumps.

So we have various elements in our portfolio, and we’re looking at the whole supply chain for that side of the market to continue to drive growth. It’s still in early stages. It’s hard to put in number on it, but we see significant potential from that market as we look ahead.

Brett Kearney: Excellent. Very helpful. Thanks so much.

Tony Najjar: Thank you, Brett.

Operator: Thank you. We have no more questions at this time. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.