Curtiss-Wright Corporation (CW) Earnings Call Transcript & Summary

Good morning, everybody. I'm Nathan Jones with Stifel. We have Curtiss-Wright here for a fireside chat this morning. We've got pretty much the entire leadership team here, which is fantastic. So we have Dave Adams, CEO; Chris Farkas, CFO; Lynn Bamford, who's President of Defense and Power; Kevin Rayment, who's President of Commercial and Industrial; and Jim Ryan from Investor Relations. Chris has got a few opening comments, and then we'll get into questions. Chris?

Great. Thanks. Thank you, Nathan. Just a bit of housekeeping before we begin today. I want to note that today's discussion will include certain projections and statements that are forward-looking in nature. These statements are based upon management's current expectations and are not guarantees of future performance. We detail those risks and uncertainties associated with our forward-looking statements in our public filings with the SEC. Nathan, I'll turn it back to you.

Thanks, Chris. For those on the line, there is a text box on webcast for you to ask questions. If you submit those, we'll get to them as we go along. So I'm going to get started with some questions here. On the first quarter earnings call, you guys didn't give a huge amount of color on April sales levels or really framing expectations for the year. So I'd like to give you the opportunity to update investors on trends you've seen in the second quarter and how those trends have progressed through the quarter. So starting off here prior to withdrawing guidance for the year, you had expected that the Defense business organic revenue growth of 4% to 6%, with acquisitions adding another 4 points. And the key driver -- or, excuse me, key growth drivers were all coming from the U.S. Military. Is there anything you've seen in those markets in April and May that changes that outlook for the defense markets specifically?

Yes. Thanks, Nathan. We feel really good and very optimistic about the defense side of the business. And we're very fortunate to have almost half our business in that market space. So far, it looks to be relatively insulated from COVID-19 and the recession in general, and we do expect to have continued solid organic growth this year. And as we find normally, we get -- we have multiyear orders, the large multiyear orders, and they're sometimes lumpy, but when they come in, they are 3 -- 2, 3, 5 years. So it's been very good so far. For those of you who're less familiar, based on our February 2020 guidance, about 20% -- 45% of our sales are from Defense in markets and the naval is about 25%, then 16% aerospace and 4% ground. But the navy has been fantastic for us. And Nathan, you've seen the story for a long time that we will get these large orders. Usually, the first half of the year, this year doesn't appear to be any different than other prior years, our solid revenue from the aircraft carriers, of which our content is about $380 million, The Columbia class sub, which is $105 million. And then the Virginia-class sub, of which they're 2 per year is $65 million each. And then lastly, on the F-35 on the aerospace side, we've secured orders for covering the next 3 years, and that's LRIP 12 through 14 so it's doing great. Like I said, this quarter, this half should be no different than what we've seen in other years. I know in prior years, we've had orders of -- in excess of $150 million in the first half on defense-related large programs. So like I said, the status quo for us, and we're extremely elated to in this time frame to have that kind of position.

It's -- it appears to be 1 of the best markets to have been in so far this year. So we've got 45% of the business here that's still expected to have some organic growth. So let's move on to some other parts of the business. So maybe we'll go to commercial aerospace which might be the business that's performing the weakest at the moment. I wanted to ask a question that was only partially addressed on the call as it relates to the actuated contract with Boeing. You guys have stated that, that actuated contract has you shipping to the equivalent of 52 a month production on the 737 MAX. Clearly, Boeing is not producing at 52 per month. So investors are rightly wondering what impact that has on commercial aerospace revenue in 2021? Given Boeing probably ends this contract with quite a lot of inventory of your products, what color can you give us on the size of this contract and your current thoughts on how much lower Boeing's order rates are likely to be in 2021? And then would you expect 2022 shipments to be back in line with whatever Boeing's MAX production ends up being at that time?

Yes. Good question. We're not sure of the answer completely, but I'll give you a rough feeling for how we're looking at it. This is not too different than some other programs that we've dealt with. For example, on a completely different story. But on AP1000 where we had big contract and we saw declining over a period of time because that was a 5-year program. And we're on the down slope of that now, I know we'll get into that later. But with Boeing, this one, we are correct, 52 a month is what we're shipping, and we're fortunate enough to have entered that contract last year. And we felt that it was from a most efficient standpoint for us to build at that rate and so we -- like I said, we're happy to have had that. I would agree that it looks as though unless they start building more aircraft at a rate of 52 pretty quick, then they will have likely some inventory and it could be a headwind. But the way we look at it is predominantly how do we fill our factories. And that's why I use the AP1000 as an example, we build different parts in the same facility where we build these actuator parts. And just like we do on the AP1000 in Pennsylvania, we build commercial and defense-related reactor coolant pumps in the same place as the same here, we build the defense products in the same factory that we build these commercial transactor products for the Boeing 737 MAX -- excuse me, their actuators. And what we will do is we'll look at that as the time goes on. If we have a headwind there, if it's going to be a, let's say, a gap, a little bit of a bath tub, we try to fill it with other government programs and/or other programs that product lines that we might acquire. So it's really dependent upon that, how it looks. We don't know yet, and that's not the only business that we have related to aerospace. We do have sensors and surface technologies business which is the service side that will track to the Boeing production rates. But for the most part, if we -- and when we get back into the discussions on that program, we always look every negotiating period if it meets our expectations from -- the expectations from a financial side, then it will proceed and/or if it does not, then we'll reevaluate our interest in that. So it's kind of the way we look at those things, Nathan, it's sort of a high-level view of it, but it's something that we do go through, I'd say, on every couple of year basis, and so this isn't new to us.

Okay. So I mean, I think the point there is, I mean, investors kind of think about this as a 1 or a 0, right? Either you're shipping 52 a month to Boeing or you're not. What you're saying is the Boeing contract might not come through at 52 a month. But you'll then have capacity that you can direct other programs. And you could look to win business on other things to fill that capacity. So it's not necessarily just a straight 1 or a 0 going to Boeing?

That's exactly how we look at it. And it may not be Boeing, it may not be a commercial aerospace. It may be on, like I said, the government side or somewhere else. And just in general, if you take -- back up for a second, take a higher look at it, like I said, the key operative words there were what we do in terms of the financial impact of it. And we look for margin accretive, and that is to the enterprise sort of business. And if -- and so that means if I would replace that business with something else, let's say, '21 or '22 I would certainly look for something that is better than that. And that product is getting fairly long in the tooth. So from that perspective, that's sort of the way we approach this. And for our listeners, just to know that we look at it from a holistic perspective, we do on an accretive platform to build upon, especially when we bill Boeing.

Okay, I think that helps a lot. So overall, we're seeing commercial OEM businesses that are seeing declines in the 40%-plus kind of range at the moment. It would be my assumption that you know at least partially because of that actuated contract that your commercial aerospace business would be doing better than that in 2020. But if there's any color you'd like to provide on what you've seen out there in the market on commercial aerospace overall?

Yes. I think your assumption is pretty right on there. We have certainly seen a decrease in order rates for our services side and our sensors. Because as we've said in the past, we're basically on every platform, in one way, shape or form that Boeing and/or Airbus put out there. And so those have gone down, they're maybe not as heavy as a specific 1 product line, for example, on the 737 MAX. But yes, I don't believe that we can't -- we don't have specifics right now but I would definitely feel that we're not going to be in the same book that everybody else is on 2020 end market sales with regard to that kind of a decline this year.

Okay on general industrial markets [Audio Gap] tech services [Audio Gap] you talked about the big inputs to growth or decline in that [Audio Gap]

Nathan [Audio Gap] you can answer.

Nathan. I think as you'd expect, all of our various industrial markets have been impacted by COVID in one form, shape or another as many industries have. But I think some are more tied to economic activities, such as things like our surface tech businesses and some of our industrial controls, where others are more, I would say, likely to follow sort of industry cycles. And a good example of that would be our businesses and products that we supply into the Class 8 heavy-duty truck arena, for example. As I believe -- I think you know, Curtiss-Wright is a component supplier to many sort of primes and OEMs. And we tended to see sort of delays from the visibility of orders coming through in sort of April and May due to shutdown with our customers as you sort of expect and that sort of delay. It made us it a bit difficult for us to sort of share order details prior to our earnings call. But I think what I could say is that in April, we did actually see probably 1 of the lower months for many years actually within our valves and surface treatment businesses. But what was quite encouraging is that we saw in May, pretty much a pickup in sort of quoting activity, which I think is a positive sign. As most of the world is effectively sort of returning to work. What I would say though is Q2 is definitely, I would see as sort of seen as our weakest quarter from an orders perspective within sort of 2020. And I think looking ahead, what we would expect to see is sort of a phased return of our order intake and performance. And I think each of the different businesses will return at various different stages at different rates as the economy starts to recover. I think we actually sort of spend a lot of time working, analyzing and keeping a very close eye on those trends and obviously act accordingly. And I think probably just because we mentioned it earlier on, from a Class 8 perspective, we already factored in coming into 2020, a 30% drop in that specific market. And when it ended up being sort of 50% drop, we were able to look at that trend, analyze it and adjust our sort of production rates accordingly. And that's something which we've got a good track record of within the industrial businesses of monitoring and managing our businesses to take effect of those sort of ebbs and flows within the business.

I may want to add, Nathan. I just want to add 1 point there that you covered it very well, Kevin. I just wanted to reiterate the point that Kevin made, and that is what we said also in our earnings call -- the conference call a few months ago, we do expect the second quarter EPS to be the lowest this year, sequentially lower than first quarter prior to recovering in the second half. But it's still -- we look further out and we look 2 to 3 years out, certainly, this year is challenging, but we don't expect to see any change from that that we've already stated. So just kind of pointing out the obvious that I think most everybody will have experienced.

Okay. Thanks. I think it's -- it might be time to get Lynn to pay for our lunch now. So on power, I know the China AP1000 business gets a lot of attention, even though it's down to only about 4% of revenue now. Can you talk about any impact to the RCP business that COVID-19 has had? Does the current rhetoric between the U.S. administration and China, produce any risks to that business in your opinion? Does it impact the potential for another big AP order, AP1000 order over the next few years?

So thank you for giving me a chance to have lunch, too. So I appreciate that. I think it's always important just to start off with the baseline of where we are with China in case there are some people that don't remember kind of the buildup of where we are. The original order back in 2007, all those pumps are up and working in China. They have about 250,000 cumulative hours. And so we feel good that those first wave pumps are performing as we had hoped. Regarding the second 2015 China direct order, production continues. Coming into 2020, there was about $150 million of revenue left on that contract, that was $448 million. We are expecting about $100 million of revenue this year on that contract and the remaining $50 million will ramp down over the next 2 years. We are seeing some impact of COVID-19 on the execution of -- on the China direct order this year, just really nothing dramatic, just the COVID, interactions, our ability to have meetings is slowing some of the approvals from China. So we are monitoring this closely and working well with trying to move through these things as smoothly as we can. And it's a very cooperative relationship. I think, Dave, over the past few years has really been hesitant about speculating on when next order would come and I would be remiss to break from that tradition. And so really, at this point, it's a good relationship with China. They need power, but the timing is still up in the air. The other half of the nuclear business really tied to the aftermarket business. You well know the part of the Power segment and a significant chunk of it is, with there, I would say we are more seeing the COVID impact. Just as a baseline fact, remember that this year, in 2020, they're 67 outages compared to 51 in 2019. So that's a good thing. There's a few more plants to work with, but we are seeing the plants trim works where they can out of what work they're doing during the current outage season. And that's really simply a little bit of caution on capital spending where there's projects they wanted to do. And then on the maintenance side things, you just limit the human-to-human interaction as people are doing all over the world. I think kind of during the spring outage season, we definitely felt some of that, and it will be reflected in our Q2 also. I think we can see people as we are in our day-to-day lives, everyone is figuring out how to do this. So as we enter the fall outage season in a couple of months, hopefully, I think we'll be back to more the normal level of work. And just to comment the work that did get pushed out of the spring outage season, that work is definitely not gone or it just pushed out. And so that's still revenue that's going to come to Curtiss-Wright in a future outage season or an interim outage season. So it's not lost revenue. It's just delayed revenue.

Okay. That's helpful. So you guys did give some guidance on decremental margins to come into at about 25% to 30%. My calculations would indicate that without the cost reduction initiatives that you implemented in 1Q '20 prior to COVID-19, those decrementals would have been closer to 40%, which kind of surprise me that there hasn't been a lot of additional cost reduction activities implemented just in response to COVID, outside of things like lower travel and entertainment, just COGS reductions with lower sales that naturally comes out of business. So I guess the first question is, do you agree with that assessment? And then does that indicate confidence in the outlook that is there's no real need for headcount reductions and things like that? Or could there be upside to the cost reductions and hence, the decremental margins in the back half of the year?

Okay. This is Chris, Nathan. Yes, our 2020 restructuring projects, which began earlier this year remain on track. I mean, if you recall, those projects were part of our recession playbook, which we initiated before the outbreak and a continuation of actions that we've taken historically to help maintain a solid upward trajectory in our operating margins. In February, we gave guidance that we'd spend about $28 million in 2020 to achieve $20 million in annualized savings, and the bulk of that would be recognized in 2021. So in the first quarter, we spent roughly $2 million, and we expect that to ramp up quickly for the remainder of the year. We've accelerated some of those plans in response to COVID-19. But given the additional cost containment measures that we've implemented, we believe there may be some upside to the annualized savings from these initiatives, and that some of those savings will be accelerated into 2020 to help with mitigate any topline headwinds. As it relates to COVID-19 and our decremental margin guidance of 25% to 30%, on our last call, we discussed that we were taking several mitigation actions to preserve profitability based upon expectations for reduced sales. And that includes things like reductions in force, furloughs, and reduced discretionary spending. Those initiatives are underway, and it's fair to say that these initiatives could also provide some upside to our decremental margin estimates. However, given the sensitive nature, impacting our operations and our employee base, we aren't going to provide more specifics at this time, but we will provide updates later in the year.

Great. That's helpful. Maybe you could talk about how you thought about and decided between reducing costs more aggressively in the short term to protect margins versus maybe maintaining some of that employee base in the short term to make sure that you have the capabilities to support customers as demand improves?

Yes. We spend a lot of time on this. I mean, it's a day-to-day discussion. We, as a management team, recognize the need to take swift or more significant actions, like reductions in force in response to prolonged market drops, and to balance that of short-term actions like furloughs and discretionary spending cuts in response to temporary changes. It's difficult for us really to predict exactly how quickly some of the markets will rebound, but we're actively working to balance those needs.

So does this downturn provide you with the opportunity to take some more structural actions to improve the cost base, productivity, supply chain efficiency or other areas to drive better margins over the next couple of years, that will never waste a good crisis kind of outlook?

Yes, sure. It does. As Chris mentioned, we're looking at many different scenarios, which -- that impact us now and well into the future. And like I said earlier in one of my answers, we look out 2 or 5, 10 years. We've got some activities that we look out 15, 20 years. But part of our DNA is and always has been, always will be, as far as I'm concerned, continuous improvement in margin expansion and other areas. You saw what we put out in 2018 for the next 3 years, those were highlights of margin expansion, sales growth, those kind of things or highlights is part of that. And with part of focusing on improving the lower margin, let's call them the bottom 10% performers, we try to help them get to 17%. If we can't get them there, then we find other methods, I mean, we sell a product line or we just don't accept the contract, as I mentioned before. We can see additional restructuring actions that go beyond '21. Including '21 and beyond, just for the same reason, the similar operating margin improvement initiatives that we've conducted over the past 7 years that I've been a CEO here in facility consolidations, sale product lines. And then like I said, some of the stuff that we look at with regard to fixing up some of the bottom performers. We are compensated. We have -- on margin improvement as one of the areas, but we focus on that, and we have found that once you address the pocketbook of our key leadership teams. They all get behind it and with very, very positive results, among other metrics that we have but efficiency throughout the global supply chain is another area. And we've been talking about that for a number of years. We spent a lot of money on parts, and we want to buy those parts cheaper. And we continue to get pressure from our customers, and we continue to live by the saying that I've always held near and dear to my heart, that is under promise and over deliver. And the only way we're going to do that is to continue to work on our improvement across the board. So it's part of the DNA.

Great. I would like to get your thoughts on the medium to longer term outlook, in particular, for the commercial OEM piece of the business. We've talked to a lot of folks over the last few days. And I think that the consensus is that the commercial OEM business doesn't get back to 2019 revenue levels until about 2023, 2024 kind of time frame. So I'd be interested in your thoughts on that. And Curtiss-Wright has a diverse set of businesses. Commercial aerospace is about 17% of revenue in 2019. Clearly, it's going to be less than that this year. With the good growth expected in defense, do you still consider commercial aerospace a core part of the portfolio? Are there any synergies with the defense aerospace part of the business? And I know you talked earlier about being able to fill that kind of capacity potentially with other business? And is that something that you would look at doing?

Yes. We do still consider it core, Nathan. It's -- like I said, we have content on every Airbus and Boeing jet and then content on some of the smaller ones as well. So we're more focused on the wide body, it's more weighted to the narrow body, sorry, not the wide body, but most -- 98% of which are OEMs, so we do very little aftermarket. And it has been a purposeful drive of ours to head in that direction. We've been living with this market upturn. The market itself, commercial aerospace has been great over the last -- this cycle. Nobody ever saw an end into it. And this unfortunately came to an abrupt let's say, slowdown because of the disease, but we do look to see something that's going to be, let's say, fairly different than it was before. I think we -- you're correct, we're moving more towards a half and half at this point, defense and commercial, industrial. But it's all good stuff. We're making great products with super margins. And we will continue to participate in commercial aero, but I would agree with you. Unfortunately, that I think it's out there 2023, '24 before it really gets back up there. But like I said, we do build same products in those -- we build other products in the same factories. So we are able to flex substantially and acquisition of other product lines as one potential to help that out.

Okay. I'll jump over to the balance sheet now in the time we've got left. You guys ended the downturn with a very strong balance sheet. Ended the first quarter with net debt at about 1.4x. Despite the decision to jump in, in March and repurchased $112 million of stock, still only 1.4x net debt at the end of the quarter. And also about $150 million of pension contribution that you made in the first quarter. Your stock hasn't seen the bounce off the bottom that a lot of peers and other industrial companies have seen, which I actually find surprising given the lower risk in the portfolio, with nearly half of the business being defense that we're going to see growing. And the multiple is still at quite a discount. If the stock was attractive to you in the first quarter, the balance sheet is very strong. And in my view, the business continues to produce strong free cash flow, why not be more aggressive on deploying capital into buybacks in this environment?

Well, the share repurchases we may speak to the strength of our balance sheet, and more a function of buying back the corporation's most expensive form of capital. We executed $100 million in opportunistic share repurchases in March solely to take advantage of the lower stock price, and we expect a $0.15 EPS cushion on the year as an added benefit. And additionally, we continue to work through the initial $50 million 10b5-1 program that we began in January to cover share dilution. I'll turn it over to Dave to talk a little bit about our focus on capital deployment.

Yes. Nathan, as you said, I mean, I'm in your camp, but I think this is a phenomenal buy. We thought it was so phenomenal, and we bought $100 million worth in March. And I'm thinking that we are very much underappreciated for -- I don't know what reason, particularly because very strong, I said half and half with the defense and then commercial, industrial. So we've got some very recession-resistant businesses that we look to continue to perform. But share repo certainly has its place. I've been always of the mindset that I would rather buy a company as strategic in value that would go 5, 10, 20-plus years, and that helps us out from a growth perspective. And if we can find the right M&A activity, we can allocate that capital there for the right deal. So a lot of dips but you've seen over the last 5 years, 3, let's say, 3 or 4 that we have been acquiring companies that we have found the right strategic and financial fit with some of these companies, and they're doing phenomenally well, better than accretive to the enterprise. So that's exactly what we want to do is enhance the focus on the company for the long term. So I guess, as a backdrop, if acquisitions don't materialize, then we look at other capital allocation options such as share repo, as we've done in the past. So it's a timing kind of thing.

Okay. So on that front, I think over the last few years, you guys have started to establish a consistent record of finding good businesses to buy at good prices. Can you talk about how the current environment disrupts the progress of deals? Does it only disrupt things on the commercial side? Or have you seen it impact things on the defense side as well?

That's impacted both. The -- it's hard to find a good benchmark for a multiple in this kind of an environment, the pace of M&A has slowed down everywhere. It doesn't mean that we've stopped, we're out, we're still out beating the doors as possible on the phone and talking to the people that we have had in process before this activity hit or before this disease hit us, we did have several board in terms of opportunities. So the targets that we're watching, we have not seen a lot of disruption in those. And the reason is because we usually pick targets that we think will live through issues like what we're seeing now. I mean, not COVID specifically, but some market impediments that may come up. So we do look for opportunities that are -- that have some more attractive multiples, and we -- that we have experienced in the past, but a little bit early to tell. We're still waiting for some of these things to just open up and some other people to stick their toe on the water before we do.

Okay. Just 1 last question. You recently took advantage of the low interest rate environment to place $300 million of 10- and 12-year debt in the market that a tick over 3%. Was that just opportunistic to take advantage of the low interest rate environment? The 8-K you guys stated general corporate purposes, which may include reducing other indebtedness. Is this just a plan here to swap higher cost debt for lower cost debt? Or are there opportunities to deploy that capital that you're looking at?

Yes, this is a great opportunity for us to strengthen our already solid balance sheet and rebalance our debt structure. We took advantage of some excellent pricing in the private placement markets. The rates that we got were better than many of the recent deals that have been announced, and we've got 10- to 12-year maturities, as you pointed out, that provide us with a lot of financial flexibility. In terms of timing, our circle date was May 15, and we opted for a delayed drawdown feature of up to 3 months. So we got some additional short-term flexibility with that, but we did not enter into this deal to pay off our revolver. We feel confident about our full year cash position and ability to pay down the current revolver. It really had more to do with executing our balanced capital allocation strategy, which is reinvesting in our business, supplementing our organic growth with strategic acquisitions and then returning capital to shareholders. So we've got a lot of confidence in our balance sheet and our ability to deploy capital for the benefit of the corporation and our shareholders.

Excellent. Well, I say we've come up on time here. So I'd like to thank you all again for being here and the high degree of transparency you've provided everybody today. So thanks very much for that.

Thanks, Nathan. Thanks for hosting.

Thank you.

All right guys. I look forward to catching up with you during the day. All right. Bye.

Bye.