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spk01: Greetings and welcome to CIRCOR International's second quarter 2021 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I will now turn the conference over to Alex Mackey, Vice President, Financial Planning and Analysis and Investor Relations. Thank you, sir. You may begin.
spk00: Good morning, and welcome to SIRCOR's second quarter 2021 earnings call. I'm joined today by Scott Buckout, SIRCOR's President and CEO, and Abhi Kondiwal, 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 SIRCOR 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 SIRCOR'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 SIRCOR's non-GAAP measures to the comparable GAAP measures are available in our earnings press release and slides. With that, I'll turn the call over to Scott.
spk04: Thanks, Alex, and good morning, everyone. SERCOR delivered another solid quarter, and we're entering the back half of the year with high confidence that we'll achieve our 2021 guidance. Our Q2 performance was highlighted by 27% organic orders growth in our industrial business, as both short and long cycle demand remains strong. We saw continued recovery across virtually all industrial regions and end markets with orders exceeding pre-COVID levels. Book-to-bill in industrial was 1.2, consistent with the first quarter. Despite some headwinds from inflation and COVID-related supplier issues, we delivered revenue and earnings in line with guidance. Our free cash flow conversion was 115%, a sign that our efforts to improve working capital are taking hold. Based on our strong orders performance in the first half, our $436 million backlog, and all the work we've done to streamline our operations, we're well positioned for a very strong second half. And finally, we made significant progress on our strategic priorities. I'll talk more about this later, but I'm excited about the momentum the team is building, especially around growth and margin expansion. Now, let me turn the call over to Abhi.
spk05: Thank you, Scott, and good morning, everyone. Let's start with the financial highlights on slide two. Organic orders of $210 million in the quarter were up 4% versus prior year. We saw a strong year-over-year increase of 27% in industrial, driven by improvements in virtually all of our end markets. As expected, orders were down 31% in aerospace and defense due to the timing of large defense orders. Our backlog remains strong at $436 million, up 4% sequentially, Our backlog in industrial is $248 million, up 26% since the end of last year. Organic revenue was $190 million, down 2% versus prior year, and up 5% sequentially. Revenue came in as expected, given the timing of orders and lead times across our portfolio. Sequentially, industrial was up 7% as revenue starts to ramp from strong orders in Q1 and Q2. A&D was in line with prior quarter, driven by timing of defense deliveries and a slowly improving commercial market. Adjusted operating income was $14.6 million, representing a margin of 7.7%, up 80 basis points from previous quarter and down 80 basis points from prior year. Finally, we delivered $0.35 of adjusted earnings per share and generated free cash flow of $8 million as the team continues to drive working capital improvements across the company. Moving to slide three. Industrial organic orders were up 27% versus last year and 1% sequentially. Regionally, order growth was led by North America and Asia, and we saw improved project orders as customers start to increase capex spending. Our book-to-bill ratio for the quarter and for the first half was 1.2, which will support double-digit second-half revenue growth and represents a revenue inflection point post-COVID. As expected, Industrial organic revenue was down 1% versus last year and up 7% sequentially. By region, we saw year-over-year strength in both EMEA and China, partially offset by lower revenue in North America. By end markets, our downstream business was negatively impacted by COVID-related supply chain issues in India and customer-driven aftermarket project delays in the U.S., Outside of these isolated issues, revenue was in line or better than expectations across our end markets. Adjusted operating margin was 8%, down 200 basis points versus last year, which reflects the downstream volume and aftermarket mix challenges in the quarter. Operating leverage, simplification, and continued strategic pricing will drive strong second half margin expansion. Turning to slide four. Aerospace and defense orders of $54 million were down 31% versus last year and 26% sequentially. Orders were lower versus prior year due to a large multi-year defense order for the Virginia-class submarine. Versus prior quarter, the lower orders were driven by the timing of large orders for the Joint Strike Fighter and CVN-80 and 81 aircraft carriers. Lumpy defense orders were partially offset by a modest sequential and year-over-year improvement in commercial airspace. As expected, revenue in the quarter was $61 million, down 5% year-over-year, and up 1% from prior quarter. Looking to the back half, we're expecting double-digit organic revenue growth as we ramp deliveries on key defense programs. Finally, operating margin was 19.9% of the quarter, down 120 basis points year over year. The margin decline was driven by lower aftermarket revenue. Sequentially, margins expanded 210 basis points due to pricing actions and material productivity. We remain confident in our ability to expand margins through the remainder of the year with higher defense and aftermarket volume. Turning to slide five. Free cash flow in the quarter was $8 million, a significant improvement versus prior year. Working capital was a source of cash. primarily driven by improved AR collections through the quarter and the timing of customer down payments. We paid down $40 million of debt in Q2 with free cashflow and the proceeds from the sale of a non-core industrial product line. We ended the quarter with $451 million of net debt, and we are on track to improve our leverage by greater than one turn this year. Please turn to slide six, where we will discuss our 3Q and full year outlook. In the third quarter, we expect revenue to be up 8% to 10% organically. For industrial, deliveries will be heavily weighted to Q3 and Q4 as we shift the backlog that we built in the first half. In A&D, the growth in the back half is driven by the ramp in defense program deliveries and a modest recovery in commercial airspace. Scott will cover this in more detail in the upcoming slides. We're expecting adjusted earnings per share of 55 to 60 cents in the third quarter, a 53% to 67% increase versus prior year. 3Q free cash flow conversion is expected to be between 120% and 140%. Inflation will be a headwind in the third quarter and second half, but we expect material productivity to offset any cost increases. For the year, we are reaffirming the guidance that we provided during the first quarter earnings call. Organic revenue growth is expected to be in the range of 2 to 4%, with adjusted earnings per share of $2.10 to $2.30. Free cash flow conversion remains at 85 to 95%. We have high confidence in our second half margin outlook, and we expect to exit the year with 4Q operating margin of 13 to 15% for the company. As we head into the back half of the year, we are closely monitoring the impact of COVID-19 variants on our global end markets and operations. Now, I'll hand it back to Scott to discuss our market outlook.
spk04: Thanks, Abhi. Let's start with our industrial outlook on slide seven. As Abhi mentioned, in the second quarter, we saw continued recovery across virtually all industrial and markets with orders exceeding pre-COVID levels. In Q3, we expect double-digit order growth versus prior year with a seasonal sequential decline. For Q3 industrial revenue, we expect solid improvement year-over-year with growth between 7% and 11%. Improvement across our short cycle end markets is expected to lead revenue growth as shorter lead time products in our backlog ship in Q3. Aftermarket remains strong with a double-digit increase expected in the third quarter. Our longer cycle end markets are expected to be up 5% to 9%. In downstream, we're expecting revenue more or less in line with last year. We're encouraged by the orders and quoting activity we saw through July, and we've addressed the supplier issues that impacted us in Q2. In commercial marine, orders and revenue are increasing as shipbuilding activity picks up from historically low levels. Finally, pricing is expected to net roughly 1%, consistent with prior quarters. Moving to aerospace and defense, Orders in the second quarter were down sequentially and versus prior year, driven by the timing of large defense program orders. Q3 orders are expected to be in line with prior year, and we're expecting a significant increase in Q4. Revenue in the third quarter is expected to be up 12 to 15% versus prior year. Growth in defense revenue is primarily driven by strong volume on smaller OEM programs, such as the Boeing P-8 Poseidon and various missile switch programs. Revenue from our top OEM programs is expected to be up low to mid-single digits, with growth across nearly all of our major platforms. Year-to-date, aftermarket revenue has been trending below our expectations, driven by delayed government spending. Looking forward, we expect sequential growth in spares and MRO activity in both Q3 and Q4. Commercial aerospace is expected to be up between 15% and 20% in the third quarter. Revenue from commercial air framers will be up roughly 50%, mostly driven by increased A320 volume and favorable comparisons to last year. Aftermarket is expected to be up roughly 30%, in line with increased aircraft utilization. In both cases, narrow body volume continues to lead the recovery. Finally, pricing is expected to be a net benefit of 3% for defense and 5% for commercial due to price increases secured earlier in the year, a higher level of spot orders, and an increase in commercial aftermarket volume. Our full year pricing outlook remains in line with last year. As we did last quarter, I'd like to provide an update on our previously shared strategic priorities. These priorities continue to guide what our team works on every day. We're investing in growth. We launched 21 new products through the first half of the year and remain on track to deliver 45 new products in 2021. On the aerospace and defense side, we launched a new brushless DC motor and brake assembly, which actuates the vertical stabilizers and aileron flight control surfaces on a high-altitude, long-endurance surveillance drone operated by the U.S. Air Force. On the industrial side, we introduced a new control valve that was entirely designed, sourced, and manufactured in India, the first of its kind for SERCOR. This flue gas desulphurization valve is not only compliant with the new clean air regulations for Indian power plants, but also positions SERCOR as the sole local partner providing a total solution. Next, our regional expansion strategy is gaining traction. Our industrial team recently won a large multi-product pump order with Daewoo Shipbuilding in Korea. By providing a complete solution, we were able to secure a position on a long-term submarine program and strengthen our relationship with the Korean Navy. On margin expansion, we're building on our Circor operating system and simplification program by kicking off 80-20 at three of our largest industrial businesses. We're still early in the process, but we're excited about the structured approach to accelerate margin expansion at SERCOR. Finally, as Abhi covered earlier, we made progress in reducing our total debt. We'll continue to use free cash flow to pay down debt for the remainder of 2021. Before we move to Q&A, I want to highlight a recent customer perception study for our industrial business. It was an independent global survey with participation from roughly 70 of our largest customers. the results confirm that our strategic priorities are aligned with our customers. Our net promoter score of 67 is exceptional and is a testament to our product quality and technical customer support. Given the mission-critical nature of our products and the high cost of failure, our customers have a strong preference to buy OEM spare parts, and price is one of the least important buying criteria. This study illustrates the power of our differentiated product portfolio and confirms that our strengths are aligned with our customers' top priorities. With that, Abby and I will be happy to take your questions.
spk01: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Nathan Jones with Stiefel. Please proceed with your question.
spk06: Good morning, everyone. Good morning, Nathan. Good morning, Nathan. How are you? Good, thanks. I wanted to start off on with critical flow solutions. You guys mentioned some supply chain challenges out of India and I guess demand challenges in the US, which I assume is related to site access on COVID. Could you just explain a little bit more what the supply chain challenges were? I think you said you've addressed those, how you've got around them and if you're seeing that site access improve for installations to pick up in the back half of the year?
spk04: Yeah, thanks for your question, Nathan. So yeah, the one place where we did experience disruption in the quarter related to COVID was in our downstream business. And we have a pretty significant portion of our supply chain for this business is in India. And as you may know, we have one of our factories for this business in India as well. So what ended up happening in the quarter was we had a number of our critical suppliers essentially shut down in the quarter and stopped shipping product in the last month of the quarter. So that prevented us from in turn taking their product, turning it into the end product for our customers and shipping and recognizing revenue. That was the first challenge in the business. The second was in North America related to aftermarket projects that we're doing at refineries in North America. We had several of our customers in this part of the business who delayed the projects that were expected to be executed in the quarter. Those are probably going to happen as late as Q4. One of them will happen in Q3, and the rest are scheduled to happen again in Q4. So we haven't lost any revenue as part of this, but we experienced delays in both cases. If you want to know the impact of the issues, it's roughly $3 million of income and about $5 million of revenue in the quarter.
spk06: And it was just side access issues with the issues in North America? It was all COVID-related, not something else?
spk04: Yes, they were COVID-related.
spk06: Great. I wanted to then maybe ask a little bit about the 80-20 deployment that you're doing at Circle. Maybe you could talk about what 80-20 means to Circle. What are the primary initial focus areas that you're looking at with an 80-20 lens? um just any more detail on what you're doing there yeah thanks thanks nathan um so
spk04: We're really excited about this. We view it as an extension of the simplification mission that we've been on at CIRCOR for some time. We've kicked it off at three of our largest businesses in industrial. We brought in a consulting firm to help us guide the process, train the team, build the core competence internally. And we're in the diagnostic phase, and the results are very interesting. We are able to segment our customers, segment our products, segment our channels, and really understand where we make money and where we don't make money, and where we have complexity that we really shouldn't have. We're viewing 80-20 as a way of accelerating simplification, prioritizing resources, prioritizing customers, who we serve, how we serve them, which channels, which product lines are most profitable, and ultimately will guide new products, will guide our pricing initiatives. So it's a fairly holistic process that we're ultimately going to integrate into the SIRCWR operating system. So we're excited about it. It's still early days, but the initial data that we're seeing is very promising.
spk05: No, Nathan, this is Abhi. The only thing I'd add is, look, I've gone through it in a prior life and I've seen the benefit of it. As Scott mentioned, we are in the early phases. We're still doing our cords and quartile analysis. We are, like Scott mentioned, we're looking at who the profitable customers are, where the profitable product lines are, and how do we take our best people and deploy them on those so that, A, we can grow faster and over-serve our profitable customers. Still early, but I think by the end of the year, early Q1, we should have a good understanding of, you know, what the impact is. And then as we start to make progress in the three sites that Scott mentioned, we're going to start to deploy it across the company.
spk06: Okay, so pretty early in the process here, but with the potential to really drive some upside through the business over, you know, the next few years, I would think.
spk04: Yeah, I think we'll start talking about results next year, Nathan. I think this year we won't be talking about it at this point.
spk06: Yeah, and I know it needs a lot of planning to do this kind of stuff, having followed Abby's former life. Thanks very much for taking my question. I'll pass it on.
spk01: Our next question comes from the line of Jeff Hammond with KeyBank. Please proceed with your question.
spk03: Hey, good morning, guys. Morning, Jeff. Just back on the – you know, some of the delays. Is this Indian supplier one back up? And then just as you think about, you know, being able to kind of get back on track and ship, you know, this order growth and backlog in the second half, what are some of the risks and upsides?
spk04: So it was actually three suppliers in India that gave us issues in the second quarter. They're all back up and running, including our own factory is back up and running in India. So we've rescheduled the aftermarket projects that we were expecting to do in Q2 for later this year, as I mentioned earlier. So we're being very proactive right now with the supply base in India related to this business. If there is a risk, it is going to be COVID-related, but we're minimizing that to the degree that we can. We have a significant ramp in the back half, as you know, in Q3, and then again in Q4. We've instituted a process, if you will, production readiness reviews, where we're going through all the critical sites that are ramping up for us in the back half of the year, and we're evaluating risk and addressing it. We're looking at supply chain, we're looking at manpower, we're looking at critical machines and shifts. So we're taking a pretty holistic view of this to mitigate risk as we go into the back half of the year. To directly answer your question on downstream, we are expecting a revenue increase sequentially from Q3 to Q4, and then we're expecting another sequential increase into – I'm sorry, from Q2 to Q3, and then another sequential increase in Q3 to Q4. And that's in the current outlook, and we're being pretty proactive here about managing supply chain on this.
spk03: Can you just talk about margins in your industrial order book or what's in your backlog? I know there's been a lot of inflation. I think you're only calling out one point of price, and it just seems like a lot of companies are going for a second and third bite of the apple.
spk04: Sure. So the margin and backlog is – well, let me answer it a little differently, and I'll come back to that. The expectation of margins as we go into the back half is a fairly substantial increase in Q3 and Q4, and it's driven by the things that we've been talking about. There's, of course, price, but as you said, that's not the biggest part. Operating leverage is fairly a big component of this. We've took out a lot of costs last year and we've continued to do that into this year. So we should see good drop through in the 30 to 35% range as we enter Q3 and then go again into Q4. Those are two big ones. We're seeing some favorable mix as well in the backlog. Aftermarket and short cycle, some of our more profitable end markets are leading the recovery. So we should have some favorable mix as we go into the back half. So there's nothing special about the margin in backlog. I think it's mostly around the things that we've done from an execution standpoint as we go into Q3 and Q4 that are going to drive the bottom line. Hey, Jeff, this is Avi.
spk05: The only thing I'd add to that, and I think Scott touched about, like, to spend a couple seconds on it is, as you look at the back half, right, and look at the revenue expectations that we have laid out, you're starting to see an inflection point on the top line, whereas we start to deliver that top line, the operating leverage, the volume leverage on our P&L start to really, you know, flush through. So as you think about the back half of the year and the margin expectations that we have, volume plays a big role in it, in addition to what Scott just mentioned.
spk03: Okay, and then just last one. I think you gave some color on aerospace and defense order trends. And just, you know, I'm just wondering with kind of the moving pieces of, you know, defense programs and commercial coming back, you know, and kind of looking at the orders and backlog, how that kind of frames what you think like a 2022 trajectory would look like for air on defense.
spk04: So, so 2022, so we have a, We've said in the past, and it hasn't really changed around the growth. I'll talk about the pieces separately, Jeff. It's easier for us to explain it that way. On the defense side, we've been saying mid to high single revenue growth over the next several years. Mid to high single digit top line revenue growth. We still expect those numbers. So you should see over the next several years, top line growth in the mid to high single digit range. Our orders in the business and our order expectation for the rest of the year supports that. A lot of the new products that you hear me talking about are on the defense side of the business as well, so we're layering new products on top of growing platforms. So we feel pretty good about that. So you'll see some noise quarter to quarter, but as you look over an annual timeline, you should see mid to high single digit growth. On the commercial side, we were expecting commercial to recover to 2019 levels in 2024. We most recently have changed that to believing that commercial will recover by 2023. We're seeing strong recovery on narrow body much faster than wide body. I think that the whole industry is seeing that as well. And so we're seeing moderate growth off of a relatively low base here in the back half of the year, so Q3 and Q4, and it's accelerating. And then we expect to see similar moderate levels of growth in 2022. So we're tightly linked to aircraft production rates, and so you can kind of back into our business by looking at production rates, and that's largely what you should expect from us.
spk03: Okay, thanks so much.
spk04: Okay.
spk01: Our next question comes from the line of Andy Kaplowitz with Citigroup. Please proceed with your question.
spk02: Hey, good morning, guys.
spk03: Hey, Andy. Good morning, Andy.
spk02: I wanted to follow up on Jeff's question in the sense that, you know, just to talk about pricing, you know, you mentioned the good drop through that you expect in industrial 30 to 35%, but it's hard for us to understand sort of the 1%. In Q3, when that's what we saw in Q2, I mean, is inflation similar? Because it doesn't seem like it would be similar for you guys. So any help you can give us on sort of the pieces around that would be helpful.
spk04: So, sure. So on the... On the inflation side, we are seeing increased inflation through the year. So if you look at what happened to us in the first half and you compare it to our forecast in the back half, we're expecting the inflation impact in industrial to double. So it's not insignificant. Having said that, our material productivity, we're expecting to fully offset inflation in the back half of the year. We were still generating material productivity in the first half. In the back half, it's a lot less, but we're still not going backwards from inflation. I think it's maybe important to understand a few things about this. We have a decent amount of our spend is on long-term contract. It's rare that we're buying raw material. We're usually buying components or parts from suppliers. And the lead times are pretty long. As you know, we don't make standard product. Everything we make is either engineered or designed to a customer specification. And so what we have in our backlog that we're shipping in the remainder of the year, a lot of it is already in our backlog, and the supply base is already committed. So we're feeling pretty good about inflation and where we are from a productivity standpoint for the rest of the year. You know, next year it could get worse. We're kind of anticipating that it will, but we feel like we've got it in hand for this year.
spk02: So, Scott, what you're trying to do then is you're trying to offset inflation with productivity, right, just to be clear versus, you know, yes, you're pricing strategically, but it's more productivity that offsets. And to your point, long-term contracts and then sort of next year is the goal to either raise prices or offset productivity or use productivity to offset. If you do have higher inflation, is that the goal?
spk04: Well, the goal was always to generate as much productivity as we can. And then independently, we're trying to maximize price based on the value that we're delivering to customers. So I think I can extrapolate from your question a little bit here is can we and are we using inflation as a reason for raising prices, because regardless of productivity, we're still incurring more inflation. And yes, that's the case. We are doing that, and we're doing that right now in the back half, and we'll continue to do that next year. But so what we're absorbing, we're offsetting with productivity, but that's not stopping us from raising prices and the rationale being inflation, because it certainly is still affecting us.
spk02: That's helpful. And then I wanted to follow up also on the comments that you made about the defense side. You know, you still expect mid to high single-digit growth in defense. You also mentioned these aftermarket delays we were seeing. Do you need to see those resolved to sort of hit that sort of mid to high single-digit sort of medium-term growth? I'll just stop there.
spk04: Yeah, so... Aftermarket revenue is surprisingly lumpy. You know, if you look last year in Q2, I think it was up 30% or 35% for aftermarket defense revenue. This year we're showing it's off. I'm sorry for Q3. This year we're showing it's off 5% to 10%. So it tends to be a little bit lumpy. We have seen delays this year versus what we expected coming into the year. And so we'll be at the lower end of the range this year when we say mid to high single-digit growth as a result of the delayed spend in aftermarket. So for defense overall, this year we'll be at the low end of the range, and it's aftermarket-driven.
spk02: Scott, that's helpful. And one for Abhi, you had a nice uptick in free cash flow. We know you're still guiding to that 85% to 90%, but maybe you can talk – about where you're seeing the most improvement in working capital and sort of what to expect moving forward.
spk05: Yeah, absolutely. Thanks for the question. So as you mentioned, if you look at second quarter free cash flow, as part of the first quarter earnings call, we got it flat to slightly better or flat to slightly negative, and we ended up at a positive $8 million. So if you take a step back, really two things in Q2, and I'll talk about What is the expectation? Where do we see this continue to improve? First of all, we had great performance on the receivable side. We've kind of bolstered our receivable collection process, if you will, and we saw a big pickup in the quarter, better than what we had expected. And secondly, we had timing of some down payments from our customers that we saw in Q2 that we were expecting in Q3. That said, if you think about it, go back to what we said is our goal long-term is is to get to the low 20% working capital improvement, and we continue to work towards it around our size of process and making sure we're thinking through the inventory buys intelligently, making sure we continuously build on our receivable process and do the best we can to collect on time so that we can improve our working capital performance, if you will.
spk02: Appreciate it, guys. Thanks, Andy.
spk01: Thank you. Thank you. We have reached the end of the 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.
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