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spk00: Greetings, and welcome to the CIRCOR International's fourth quarter and full year 2022 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.
spk02: 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'd like to receive copies of these materials, please email CIR at investorrelations.com and our IR team will provide them for you. Turning to slide two, 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, March 15, 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 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 SERCOR's Form 10-K, 10-Qs, and other SEC 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 financial 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, SERCOR'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 fourth quarter and full year performance. A.J. will review the financials and discuss our guidance for the first 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 five as I hand the call over to Tony.
spk03: Thank you, Scott. Good morning, everyone, and thank you for joining us to discuss our fourth quarter and full year 2022 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 very strong Q4 and full year 2022 results despite an overall challenging macroeconomic environment. Since our Q3 earnings call, I have spent much of my time with our teams and customers, including having the opportunity to meet with our industrial valve sales team and customers at Valve World in Dusseldorf, Germany in late November. More recently, I had the opportunity to engage with some of our key defense customers at the Middle East Defense Expo in Abu Dhabi. I also had the chance to spend more time with our teams at many of our locations in Europe and North America the kickoff 2023, and recently visited our two manufacturing sites and shared services center in India. I continue to be delighted by the level of commitment and focus on execution and customer satisfaction our teams display in every interaction and by the strength of the SOCOR family of brands throughout the industries we serve. After a very strong Q3, our team Again, performed exceptionally well in Q4. We navigated ongoing supply chain disruptions, the inflationary environment, and rising energy costs to deliver 19% organic orders growth and a 550 basis point improvement and adjusted operating margin. Turning to slide six, our results underscore continued success in executing on our strategic priorities which include, first, organic growth through new product development and leverage of our strong aftermarket position. Second, margin expansion, which includes value pricing, simplification, best-cost country sourcing and manufacturing, and factory modernization. And third, reducing our leverage, which we accomplished in Q4 through strong cash generation from operations and adjusted EBITDA growth. We have made solid progress in reducing leverage over the past four quarters and look to continue that progress in 2023. AJ will provide more details on our improved leverage and outlook in his prepared remarks. Turning to our fourth quarter and full year highlights on slide seven, organic orders increased 19% versus prior year driven by growth in our industrial segment. Industrial orders were up 29% organically in the quarter, supported by strength in our aftermarket, pricing, and downstream. For the full year, industrial orders were up 7% organically, driven by pricing, strength in our aftermarket, and downstream, which more than offset the exit of the pipeline engineering business and timing of a large Navy order in the prior year. Orders in A&D were down slightly on an organic basis in the quarter, as strength in commercial aerospace and Navy was offset by timing of a large medical order in the prior year. For the full year, A&D orders were up 24% organically, driven by commercial aerospace recovery, aftermarket, new products for missiles and hydrogen applications, medical, and pricing. Pricing in the year was strong in both segments, which is indicative of the power of our brands and our team's focus on maximizing value from the products and services we provide. Backlog at the end of Q4 was up 22% from the same period last year to $543 million, positioning us well for 2023. On the top line, we reported year-over-year revenue growth of 5%, or 11% on an organic basis in Q4, with AMD up in the high teens and industrial up mid-single digits. We accomplished this despite continued supply chain challenges in some of our businesses. Our 62% increase in AOI in Q4 was supported by both segments, with our industrial segment delivering another step-change performance compared to prior year, supported by our value pricing initiatives and cost controls. AJ will provide additional color on the margin drivers in the quarter during his prepared remarks. The solid demand environment for our products is evidenced by sustained order strength and a healthy backlog. We are positive about our business as we look ahead in 2023. Moving to slide eight, each quarter we like to highlight specific growth areas that our teams are driving. Today, I'll discuss industrial pumps and A&D innovations that showcase our product differentiation for severe service mission critical applications. On the left side of the slide is a new three screw industrial pump capable of handling higher pressures and lower viscosity fluids. This product leverages our industry leading technology for three screw pumps to penetrate applications that are typically handled by different pump technology. In head-to-head testing and severe service applications, SERCOR's new pump has demonstrated performance far exceeding competitive products. The product is in initial launch phase, and we are seeing early success. The pump will primarily serve the energy markets, which continues to show solid growth, as well as selected general industrial applications that require the higher pressures and or low viscosity performance. On the right side of the slide, our A&D team in France was selected to provide mission-critical helium valves for the new airship being developed by French aeronautical company Flying Whales. The airship will be lifted by helium cells and propelled by hybrid electric system powered by sustainable aviation fuel. Capable of transporting up to 60 tons of cargo, the innovative airship is designed to carry items such as blades for wind turbines, logs collected from steep mountain sides, construction materials being delivered to remote isolated location, or food and aid after natural disasters where railways or roads may be inaccessible. Our team worked side by side with Flying Whales for nearly 18 months to develop the requirements for this critical application. We leveraged our core technology and valve design and electromechanical actuation to develop an innovative solution. We are working with Flying Whales on another major package for the airship and are well positioned to capture additional content on this exciting program. Before I turn the call over to AJ, I would like to provide you a quick update on our strategic review process. As we announced in late February 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. Our board, through its external advisors, is in dialogue 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 Ajay to cover the financial results in more detail.
spk04: Thank you, Tony, and good morning, everyone. Let's turn to fourth quarter financial highlights on slide nine. Excluding previously divested businesses, we posted the highest backlog and the strongest industrial AOI margin, A&D AOI margin, and consolidated AOI margin in at least the past four years. With the strong fourth quarter results, we built upon the step change performance delivered in the prior quarter. We continue to see the financial benefits of the transformation we launched in early 2022. We believe we have a long runway for growth and margin expansion. Organic orders were up 19%. primarily driven by Navy, pumps aftermarket, and downstream. We saw orders growth across our platforms in most of the regions and end markets. The orders trend remains robust, but speaks to the power of our brands and the strength of our technologies. On the top line, our teams delivered double-digit organic revenue growth, with most of our businesses posting organic sales growth in the quarter. We continued to execute value pricing, maintain cost controls, and drive growth. These efforts helped generate 62% increase in adjusted operating income and 550 basis points of adjusted operating margin expansion. We delivered 77 cents of adjusted EPS, up 67%, and grew adjusted EBITDA 50% to 37 million. we posted strong improvement in adjusted free cash flow for the quarter, both sequentially and over prior year. Strong cash flow from operations more than offset special expenses and continued investments in capex. Turning to slide 10 and our aerospace and defense segment results, we saw 11.6% orders growth in defense, led by very strong growth in U.S. Navy, partly offset by timing of JSF order in prior period. Overall, aerospace and defense organic orders declined by 1% due to timing of a large medical order of approximately 16 million in prior period. Organic revenue grew 18%, with all of the aerospace and defense businesses posting revenue growth in the quarter. Aerospace and defense delivered highest ever adjusted operating margin of 27.3%, fueled by pricing, volume, and mix. Moving to our industrial segment results on slide 11. Organic orders were up 29%, driven by both core industrial and downstream. We were especially pleased to see continued momentum in our core industrial aftermarket, which posted organic orders growth of 23%. We remain laser focused on growing this high margin part of our business and see tremendous opportunity to leverage value pricing and take share. Organic revenue grew 7%, with broad-based trends across the platform that more than offset the exit of pipeline engineering. The exit of pipeline engineering impacted growth by two points. Industrial posted exceptional AOI growth of 109% and AOI margin expansion of 710 basis points. The margin expansion was largely a result of value pricing, cost optimization, and exit of pipeline engineering. At 13.5% AOI margin, fourth quarter performance further validates the business differentiation and margin expansion potential implicit in our industrial platform. As we continue to find success with value pricing, OpEx optimization, and aftermarket growth, and further supported by improvements in factory performance, we expect to deliver industrial AOI margins of 18% to 20% within the next three to five years. Turning to slide 12, net leverage and compliance leverage have continued to improve throughout the year. We ended 4Q at net leverage of 4.2%, which was 0.8 tons lower than 3Q and 2.1 tons lower than 1Q 2022. We remain focused on de-levering and it remains our top priority. With our expectation of continued expansion of EBITDA, we anticipate exiting 2023 with net leverage in the mid to high threes, exclusive of any divestitures. Turning to slide 13 and our expectations for first quarter and full year 2023. With record backlog of $543 million exiting the fourth quarter, we expect full year organic revenue growth of 3% at the midpoint of our range. Our strong backlog and current order trend helps de-risk a demand slowdown scenario. We expect pricing to remain a strong driver of AOI growth and margin expansion, particularly in our industrial segment. we continue to see signs of easing of supply chain constraints and moderating inflationary pressures. As in 2022, this year, we expect to make investments to enable growth in attractive segments. These investments include engineering resources to help develop new products, channel expansion and product localization to help grow in newer regions, and factory modernizations to lower operating costs and enhance customer experience. Supported by pricing, cost optimization, and growth initiatives, we expect Q1 2023 adjusted operating income of 17.5 million to 19 million, an increase of 75% at the midpoint. For the full year, we expect AOI of 90 million to 105 million, up 11% at the midpoint. Interest expense is expected to be approximately 60 million for the full year, up approximately $16 million compared to prior year. The increase in interest costs is a result of higher rates. We have assumed additional 50 basis points Fed-wed increase in March, followed with 25 basis points in May and another 25 basis points in June. As a result of higher interest costs, we expect full-year adjusted EPS to be in the range of $1.19 to $1.74. Overall, we are bullish about 2023 and continue to build a strong foundation for delivering and improving performance. I'll hand the call back to Tony to discuss our market outlook for orders on slide 14.
spk03: Thank you, Ajay. Looking ahead, we expect full year 2023 orders to be up low single digits following the very strong Q4 and full year 2022. We also expect a book-to-book ratio over one, supporting continued future growth. In our general industrial business, we expect orders to be up low single digits following a strong 2022. Strength in the aftermarket and pricing will be somewhat offset by lower for-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 in high double digits following a very strong 2022. This is primarily driven by timing of large capital projects booked in Q4. 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 US and Europe. Turning to aerospace and defense, we expect high single digits orders growth in the segment. In our defense business, we expect low double digits 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 IO platforms at Airbus and Boeing, as well as the increased activity in the aftermarket, supported by pricing and the rebound in air travel. Elsewhere in the segment, we expect orders to be down high single digits due to timing of large medical orders. Turning to slide 15, In summary, we are extremely pleased with our strong finish in 2022, and we are well positioned as we move into 2023 with strong momentum. 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 despite the current macroeconomic climate. We continue to benefit from the ongoing 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 the 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 as we look ahead to 2023 and beyond. We are also continuing to evaluate further simplification opportunities in the businesses and at corporate. While our industry continues to be affected by various macroeconomic factors and disruptions, We remain 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.
spk00: 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 two 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 Andy Kaplowitz with Citi. Please proceed with your question.
spk05: Hey, guys. This is Tish on behalf of Andy. Good morning, and congrats on a good quarter. Good morning. Good morning, Tish. So obviously a strong quarter here, and you touched on simplification and value pricing helping you, but help us understand a little more. Are the benefits from these initiatives coming faster than your expectation? Like 15.5% off margin is new for Sercor. So how much of this do you think is sustainable going forward?
spk03: Yeah, most of the benefit is coming from pricing, about 10 million net in Q4. And obviously there were simplification actions in total for the year. We have taken out about $14 million on a run rate basis, with some of it carrying over into 2023. We took actions very early in the year to drive the pricing. And you can say in some cases it did come faster than we expected, but we did take very specific actions that have driven these price increases in both segments, with industrial driving a significant portion of the pricing. in the year and then obviously it showed it showed up in q3 and more in q4 got it helpful yeah sorry as we look ahead to 2023 we expect similar pricing to what we achieved in 2022 we also expect more of it to drop to the bottom line because of some of the easing and energy costs and other things that were headwinds in 2022. got it i'm just calling up on that like on
spk05: For your 2023 guidance, you have obviously given a little bit of wide range here. So can maybe elaborate on what's based into the lower end of your guidance range and what needs to go right to get you to that higher end of that range?
spk04: Yeah, Piyush, I can take that. So if you look at our internal plans, our bottoms-up plan, we are targeting the high end of the range. The low end of the range takes into account for unforeseen external shocks that may impact our businesses in 2023. So if you ask us, we feel, based on what we know today, fairly comfortable hitting the high end of the range. The low end is a risk assessment on external factors unknown to us that may impact us in the remainder of the year.
spk03: And I'll add to that. Based on what we know today, we haven't seen any significant slowdown. So at least the way Q1 has started, we haven't seen any slowdown yet in the markets. But as AJ mentioned, we did factor some slowdown in our guidance, which is very conservative based on what we see today.
spk05: Got it. Very helpful. And AJ, on free cash flow, it's kind of recovered in 4Q. Maybe elaborate a little bit here. Is it the operating environment easing or are there any actions that you have been taking that kind of helps you get to a positive conversion in 2023 and eventually to that 90 to 95% long-term target that the company has?
spk04: Yeah, so I would say 2023 would still be a transitional year for us when it comes to free cash flow. We would have certain special payments tied to the review that's undergoing. The capex will be in excess of depreciation like it was in 2022. But beyond 2023, I think things will normalize for Serco from a free cash flow standpoint. So as we look into 2023 compared to 2022, the other big element impacting free cash flow in 2022 was consumption of cash and working capital. And if you remember, working capital was built in two places, supporting our U.S. Navy programs and building up inventory, particularly in our pumps businesses to safeguard customers against supply disruptions. So we don't expect working capital to build up in 2023 in any meaningful way. The unlocking of working capital from our U.S. Navy programs, which is probably close to $20 million of cash opportunity for us, that comes in between the second half of 2023 and into 2024. In the way we have forecasted leverage, you've taken a more conservative view on free cash flow, and we're saying that unlocking of working capital from U.S. Navy happens in 2024. Got it.
spk05: I appreciate all the support. Thank you, Max.
spk00: Our next question comes from the line of Nathan Jones with Stiefel. Please proceed with your question.
spk06: Good morning, everyone.
spk03: Good morning, Nathan. Good morning, Nathan.
spk06: I'm going to start with a couple of questions on the strategic review. I think it was a year and a day ago that it was announced. Can you just give us a few comments on why this is taking so long? I mean, it wouldn't typically take this long. I mean, I imagine that You know, it probably causes some internal disruptions with talent retention and acquisition, given the uncertainty, and any comments you can make on whether or not you think it's impacting your ability to win business with this uncertainty around the company.
spk03: So, Andy, the last tier... Nathan, last year was basically spent focusing on completing the restatement, as you know, which we finished in September. And then after that, you know, we started to more actively work the process. The process is underway, as we have communicated a couple times now recently. So that's really what we can say about that at this point. But again, last year was a big focus here to complete the restatement, which came up early in the year. From a talent perspective, we have basically maintained our key talent in the businesses. The businesses are focused on execution, as shows up in our results. So we haven't had any issues attracting talent. From a customer's perspective, You know, the question doesn't really come up very much, and when it does, we explain where we are, but it really hasn't had any impact from the customer's and order perspective. And again, the results, I think, speak to that. So that's where we are. We'll continue to communicate as we make progress with the review, but at this point, all we can say is the process is underway. Okay.
spk06: Okay, I'll go on to aerospace and defense with very high margins in the quarter and I think all-time record for the company. Can you talk about the drivers of that margin performance in the fourth quarter and whether there was anything more discreet that might have driven it up or it's more of a sustainable level you think you can hold?
spk03: In Q4, typically, we do see higher margins in A&D, and it's basically a lot of the spot orders that we receive during the year, which kind of start to shift in Q3 and Q4, and that's where most of our pricing is coming in. So it's pricing, and then it's volume. It's usually our highest volume quarter in the year as well. So these are the two key elements, basically.
spk06: So this is not really a new kind of baseline level for A&D margins. It's more typical seasonality and a good performance during the quarter.
spk04: Yeah, I think that's the appropriate way of characterizing it, Nathan. And as we look into 2023, we do expect on a full year basis A&D margins to expand slightly. But we're not, at least at this time, we're not baking in an equally strong margin quarter for aerospace and defense in 2023.
spk06: Okay, a couple on cash and investments. You guys have talked about growth investments, CapEx, for various reasons. Can you provide a little more color on kind of the magnitude of the incremental investments that you're making in 2023 both that run through the P&L and that are going to run through CapEx?
spk04: Yeah, you know, I'll have Tony give you some color on the types of investments you're making and why you're making these investments. But quantifying it for you, I would say the amount of CapEx that's exceeding depreciation, that's the amount of CapEx that's truly tied to the factory modernization that is well underway in our two largest factories in Port Austin and Monroe. So as we're looking at 2023, we expect to spend about 10 million of CapEx in excess of depreciation. We have the option to throttle it down if you feel that that would be appropriate. But that's to give you a sense of the magnitude. And once we get past 2023, the pace of CapEx investments will moderate in a very meaningful way. So I expect 2024 onwards, CapEx equating depreciation again for the company.
spk03: Yeah, the additional investments, Nathan, beyond CapEx is really a new product development. We see opportunities in very specific areas and industrial and A&D, and then we are making investments. Some of it is customer funded, but not all of it. So there's investments that we are continuing to make where we see good business cases for new product.
spk06: Is there a number you can give us on what that investment is incremental that's being paid for by Circle?
spk03: It's about $4 million or so.
spk06: Great. Thank you very much for that, and I'll pass it on. Thanks, Nathan.
spk00: As a reminder, if you would like to ask a question, press star 1 on your telephone keypad. Our next question comes from the line of Brett Keeney with Gabelli. Please proceed with your question.
spk01: Hi, guys. Good morning. Thanks for taking my question.
spk00: Good morning, Brett.
spk01: Had the nice order from the downstream valves business in the quarter, and it sounds like although you're not baking much into the expectation this year, there is a number of opportunities out there across a few different geographic regions. I guess on the downstream balance portion of the industrial business, can you just talk about overall kind of the project funnel, the tone of activity you're hearing from customers? And then what, obviously we've seen the very strong margin performance at industrial as a whole. What margin expectations you have both on the order you booked in the quarter and kind of maybe on what some of those projects out on the horizon are shaping up as?
spk03: So in downstream, in total we're tracking about $100 million of various opportunities, both capital and then turnarounds, which is basically refits, that we could book in the next 12 months or so. So we haven't factored all of that into our forecast, obviously, because there's always timing risks that we could see. But that's kind of the funnel. It's heavy North America. And then there's good activities in Latin America and India where we have seen some good recent successes. As far as the margin, industrial margins, the big lift, as we mentioned, came from pricing, you know, being a significant factor. There was also some leverage of the volume and then overall cost simplifications or cost outactions.
spk01: Okay. Thanks so much, Troy. Thank you.
spk00: Thank you. There are no further questions at this time. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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