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

Okay. Good morning. My name is Nick Heymann, and I'm the research analyst at William Blair who covers Curtiss-Wright Corporation. I'm required to inform you that a complete list of research disclosures or potential conflicts of interest is available on our website at williamblair.com. Here with us this morning from Curtiss-Wright is David Adams, who's Chairman and Chief Executive Officer; Christopher Farkas, who's Vice President and Chief Financial Officer; Jim Ryan, the Senior Director, Investor Relations; Lynn Bamford, who's President of Defense and Power; and Kevin Rayment, who is President of Commercial and Industrial for Curtiss-Wright. So we really appreciate all of you joining this morning. And with any luck, we'll manage to get through without too many glitches.

I guess we've had a lot of discussion this week with various companies that have participated about the overall outlook for the commercial aerospace side. And in particular, we've had some folks, like RBC, who thought that Boeing might end up having to lift production above 31 next year. And we've had others who have been more cautious like, Woodward. I was curious on how you're thinking about the MAX program, in particular, but also the adjustments that have been made by Airbus, which they've now said, they have no more fine-tuning on. Then this morning, I guess, this week Boeing has adjusted a little bit the pace at which it ramps and restores initial production levels for the MAX. So if you can talk a little bit about that. And your run rate for the last couple of years, I think, have been 52 a month. And how that might shake out as you look forward in '21 and '22 and what you might alternatively be able to produce on those lines if you do cut back some of your volume for the MAX?

Yes. Thanks, Nick. We're glad to be here. And thanks, everybody, for tuning in to us. The aerospace of Curtiss-Wright is about 17% of the business. And we follow the run rates just pretty much like everybody else. With the exception of this year, has been somewhat of an anomaly for us as compared to the rest of the market, the folks that service the commercial aerospace side, in particular Boeing. Last year, we worked with Boeing, entered into a contract for 52 a month shipset on the MAX. And we've been producing at that rate, like you said, for the last couple of years. Where it goes, I'm not sure exactly. Just reading this morning, one came out just, I guess, a short time ago, a few minutes, that Boeing is going to be at 31. I don't know what the ramp rate is. But for us, the way we look at it is, we've got this year covered at a higher rate at the 52. It's going to be a fairly decent year for us comparatively from those that are basically shut off for the moment. And that, as I said, will continue through the end of the year. And then what happens in the next year, you could obviously foresee some potential headwinds with regard to inventory buildup and with, in particular, our parts that go on that particular platform. With regard to Airbus and the parts that are on that, we're just following the same track that everybody else is. And with the balance of our business other than the actuators that are run at 52 rate out of our shops, we're on the run rate that everybody else is with that. So I'll just speak to the roughly $100 million worth of business that is in question right now that we're talking about. And it's been great for us. If they do have an inventory buildup, then what we look forward to in the future is either offsetting some of that, let's say, the slowdown for us with other business that we might pull forward from our defense side. We build them in the same factories that we currently build this product in and/or fill it with more than likely backfill that revenue with M&A activity, which we had a fair amount going before we entered into the COVID situation. So that's kind of how we look at it, Nick. And we prepare ourselves this way as we have done with the lumpy defense business that we've had since I've been here, the last 22 years. And it's just the way we run the business. We look at the top line and then we try to backfill with more accretive or better op margin business than we had prior. So it's worked out pretty well for us. I can't hear Nick. Nick, we can't hear you.

Okay. There we go. So you feel you have enough buffer to be able to fill whatever variability there might be in '21, '22 with Boeing?

We think that we have the wherewithal to make it happen from the actuators on the 737 MAX. I don't know if that would pick up in that time frame back from where we will have been at after having supplied them at 52 a month. But other business, there's a very strong likelihood that we would have picked up and hopefully gone beyond that and continued our growth.

Okay. Excellent. Maybe, Lynn, can you talk a little bit about the defense fighter outlook and the budget and the fact that we've spent, I don't know, I hear something like $3.8 billion. And usually, no matter who wins this election this fall, we're likely to see probably some tempering at some point in the future for defense procurement and how that might impact the business?

Okay. If I can step in on that one. Thank you for the question. As you know, I think we've announced that we have $340,000 roughly of content on the F-35 specifically. But I think one of the things that's really important to take note of across our aerospace business is, we do a lot of work that is not associated with new build, that there's continuous tech refreshes and capability enhancements on older planes back to the B-52s. And so it's kind of difficult sometimes to tie our business directly to new build. I think the general consensus is that defense budgets will flatten over the upcoming years. Optimistically maybe, I don't think they will be reduced. I mean, there's a lot of momentum and a lot of money that's sent that we need to turn into production volumes. So I think that's the general consensus, whether we stay with the current administration or do a flip is that the payback on COVID, it probably will tamp growth, but most likely it will flatten.

Okay. So you don't see sequestration out there anywhere on the horizon right now?

So we won't have it in 2021. And I think people understand that was a really foolish way to trap us into how we spent our defense budget and maybe optimistically, again, but I would think that we would not go back there.

Okay. And fighter production around the world is near 25-year highs. Do you have participation in programs outside the F-35, not so much on retrofit, but on new build or that you're participating in, in NATO or other areas of the world?

We definitely have about 25% of our electronics business is outside of the U.S. and a large portion of that is in aircraft production.

Okay. And does the trend there look encouraging or is it really, if things get tight, they just go back to refurbishment and upgrade as opposed to new build? How should we think about that?

So the place, I think, already, we have seen, in general, our defense business has survived this COVID condition very well. And we've not seen much impact. The minimal amount of impact we have seen is really tied to foreign military sales, whether it's directly to a foreign military or through a U.S. banking on getting the contract from some foreign military. So I do think as the COVID bill is paid, it will hit the sales outside the U.S. more than the sales within the U.S. And honestly, whether they choose to fall back to refurbishments over tamping down new production, I don't really have much insight as to which way they would look to cut the money.

Okay. Okay. Shifting gears a little bit. China Direct, your 2015 contract is winding down. And the current year, I think sales are something in the $100 million range, and then there's about $50 million yet to record in '21 and '22. And I was curious if we could talk a little bit about, one, the 50 megahertz RCP that you're working on and what the status of that is and how related that might be to your next China order? And then, two, I think, if I'm not mistaken, you have about 42 reactor coolant pump capacity at your facility that was recently increased over the last couple of years. And if you have a gap between your next order from China, would that be likely filled from business from Turkey or India on the commercial side or would that actually be able to be fully utilized for all the work you're doing for the U.S. Navy?

Yes. Our business from China has been that original $448 million contract we got in 2015. You're accurate with the statement that we will have shipped roughly $100 million this year and $50 million trailing off from next year and then a little bit of it into the following year. The question of when we're going to get another order has been the preeminent one for a long time. We took it out of our forecast. Back in 2018, we provided a 3-year outlook of what our top line and bottom line would be with other metrics that we're achieving or striving to get to. And we took that contract, the new contract completely out of the forecast for the very reason, we just don't know when it will come. We believe that it will. It's just a matter of when, not if. And so far, the program has run exceptionally well with the exception of a onetime road bump last year, and then we got that behind us, but we're on the order of 250,000 hours cumulatively on all pumps that are in process right now that are working and providing electricity on those nuclear reactors. So the program is going great. The demand out there is very strong. It continues to be over the next 8 to 10 years would be on the order of 72-plus pumps for China alone. And then beyond that, a considerable number of them. So we still chase on the order of $2 billion worth of visible business. It's just a matter of when China starts to dig dirt and apply what they need to, to start building those reactors. Again, I think what has slowed down a little bit was the GDP had slowed somewhat, then COVID put a little wrinkle into it. And so I think as they emerge from that, it starts to pick up once again. When you talk about capacity at our plants, internally, all these pumps are built in Pennsylvania. And we have a capacity of 24 a year in the current situation. So given the current workforce that we have and the current shift, work that we do is 24. We could expand upon that pretty readily. The only thing that we would run into and it might be a slight hiccup, but wouldn't be perceived as one too much really, would be the test loop. And that can handle, that was what I talked about with the 24, and that runs on a continuous basis. So maybe a minor upgrading to that and/or replacement if we had to or in addition. And that's not a very costly endeavor. So if, for example, we were to receive a rather large order that required more than 24 in a year, we could probably fairly easily adapt to that, certainly easy from a manpower standpoint. But when we do, speaking of manpower, is because it's built in Pennsylvania, in the same factory where our Navy nuclear, the ship RCPs are built, then we are able to have the agility needed to migrate that manpower over from commercial nuclear to Navy nuclear and back and forth. So that's how we manage that side of the business. And it's been so long ago that you asked your second question. I forgot what it was.

No. It was just about this idea of dovetailing. So if, for whatever reason, the Chinese were to delay this. I guess the other question I was asking was, the 50 megahertz, which I think you provide today a 60 megahertz RCP. They then convert it to a 50. And you've been working on trying to be able to produce the 50 yourselves so that might make the Chinese more excited to get another order in.

Yes. You're right on top of that, Nick, and that is, on the 50 hertz, they do have to provide electronics systems for converting their 50 power over to the 60 for our reactor coolant pumps. We do have a 50 hertz version that has been on the design books for a while now and what would be necessary for them to convert all the way over. That would eliminate a huge expense and a reliability issue on their part with regard to the electronics that are required to make that RCP work in China. So that would be a boon for them. They're very interested in it. And we're interested in furthering that technology. So we have continued our efforts and what it would require at this point would be some, let's say, commitment and potential funding from our customers to migrate into that. It not only helps China, but it helps Europe as well because they're on the same system. So I think from an electrical grid perspective, it would be a definite reliability enhancement and an improvement. I can't talk to the cost of it in terms of a recurring cost. But assuming that it's pretty much the same kind of unit, maybe slightly smaller, takes up a little bit less of a footprint, but certainly would be a benefit to the longevity of a reactor coolant pump and a reactor itself. So we've got the wherewithal to do it. And like I said, we continue. And then we also have a lot of dialogue with them and other customers with regard to that. And then just to mention other customers, I think you mentioned India as well. India is behind China in terms of their need. And I believe they would be the second in line after we would see another order from China. And the Indians, in that country, we have heard that they would need approximately 24 reactor coolant pumps. So once again, big market, and I didn't even talk about the Turkeys, the Czechoslovakias and Saudi Arabias and the others who continue to express interest.

Okay. Okay. Maybe shifting over to Kevin. I wonder if you could talk a little more about the economically sensitive portions of the company's business in the commercial and industrial sector. If I recall correctly, I think it was down 11%, the sales for commercial in the first quarter. This is the trough quarter. And maybe kind of review how you're seeing things in Class 8 heavy-duty trucks in surface treatment, at off-highway and mining. Are these factors that are going to bottom in V or bottom in U or how do things look for you as you work through the recovery from COVID-19?

Sure, Nick. Well, I think you probably would expect a number of our businesses across Curtiss-Wright are affected by COVID-19. Some are more affected by sort of, if you like, the sort of economic trends, like our surface technology businesses and industrial controls, where others, which are more akin to the Class 8, for example, follow certain cycles. And as you'd expect, those change over the sort of the period and obviously have been impacted by COVID. I think also you probably realize that Curtiss-Wright is a component supplier and a subsystem supplier to a number of the primes. And I think over the last sort of few months, we've seen some delays in order visibility coming through, in addition to the fact that our facilities have been shut down due to the plan. And that's why we found it quite difficult in the last earnings call to give sort of guidance in relation to our orders because, as you'd expect, it took a while for those to flow through. In April, what we saw was probably the lowest point for some time associated with our valve businesses and surface technologies. They, in particular, really did sort of get, sort of suffer in that sort of dip in terms of the quarter. But what was quite encouraging is we started to see the other parts of our businesses coming back in May with an increase in activity. So that we really started to see some pickup in their activity levels across all of our businesses at that time. What you'd expect, though, we've been monitoring the performance across all of our different businesses very, very closely. And in particular, as we mentioned, from a Class 8 perspective, as we went into this year, what we'd actually done is we'd already taken into account the 30% drop that we saw from last year into this year. So we already sort of accommodated that into our forecast. And with the sort of changes that we saw more recently with COVID obviously impacting the business, we were easily able to sort of deal with that sort of drop in production that we've seen in the recent time. And we do that across each of our different businesses. We work on looking at the trends, looking at the forecast that we've seen over this period and then act accordingly. We've got some good experience in this space, as you know, from previous recessions for our industrial businesses. And we utilize a lot of playbooks. In fact, I think someone actually mentioned it earlier that we brought in our playbooks at the back end of last year with sort of some signs of softening in the economy. So we were able to utilize those playbook actions and get ahead of the situation to obviously help maintain our performance.

Just, Nick, I wanted to add one thing that, just add to what Kevin said. And he mentioned it in passing. And that is, the order book and what we're looking at now with COVID and so forth, we believe that the second quarter will be the lowest of the year and will be sequentially lower than prior. And so we're hoping to see ourselves emerging from this debacle over the last several months. But like I said, it looks like this quarter will be the lowest as we emerge back from going into the third and fourth quarter.

Just to clarify, is that for your commercial/industrial or is that for the entire company?

Entire company.

Okay. Okay.

Yes.

The next question, I guess, leads kind of into this, is your decremental margin. And without having done anything, maybe this is something, Chris, you can speak to. I think you had prospects for 40% but then you put in place, I think, $28 million worth of restructuring with the savings of $20 million that was largely expected in '21, but now you're working overtime to kind of pull that forward a bit. And so therefore, kind of walk us through how that's coming together. And in turn, how your decrementals might feather out as you go through the second half of the year?

Yes. Thanks, Nick. Yes. Our decremental margin guidance, what we gave here in Q1, is 25% to 30%. As you had mentioned, we did start prior to the outbreak of COVID with our recession playbook, where we were already taking on $28 million of restructuring for $20 million in annualized savings. We're on track with that. And in fact, we've actually accelerated some of those initiatives where most of that $20 million savings was going to be recognized in 2021, but we're pulling ahead on that. Additionally, on the first quarter call, we talked about actions that were taken specifically in relation to COVID-19, and that includes furloughs, RIFs, discretionary spending cuts. And those actions are ongoing. We are actively managing our long-term perspective for these markets that are being affected with short-term needs. Where we have to balance for the long term, we're taking more aggressive actions. And we believe some of these market did surge, more short term in nature. We're balancing that with furloughs and discretionary spending cuts. But we believe that there will be some additional savings that comes out of our restructuring initiatives. And then we also believe that there will be some upside to our decremental margins this year as a result of those additional actions we're taking.

Okay. And are you seeing any reduction in your input cost as a result of COVID-19 or is it all really incremental cost?

Well, there's certainly a reduction in our input cost. I mean, we have seen our sales forecast erode in response to some of the order patterns that Kevin was talking about, we've taken a lot of actions within our supply chain to ensure that only necessary costs are coming into the organization. And then beyond that, all these other actions that we're taking, restructuring and then also the COVID-related is affecting the input cost as well.

Okay. Okay. What is right now the whole scenario look like, David, as far as M&A? We've had issues with regards to doing due diligence. We've had issues with regards to actually doing the on-site integration. And then we've also had the issue of valuations. And as you look at things, I think this morning, HEICO announced some small acquisition that was related to nuclear Navy service -- not nuclear, but Navy service business for pumps, industrial pumps and hydraulics. How are you seeing things fit together? Because you have a tremendous amount of capacity for being able to afford to make additional acquisitions. And I know that's an important component if you're certainly in a long term value creation proposition since you've improved so much the operating performance of the company.

It is, Nick, and well put. I think that the benefit that we have and one advantage that we've gone into this year with was that we had activity ongoing prior to COVID. And we're pretty far along actually in some deals. And what had happened was, I mean, very far along in the due diligence and the vetting process. So where those stand are, were just put on hold. I think the biggest question amongst those that you had listed out there is valuation. What valuations apply today? And how do we manage that side of it? So we're in the process of establishing that. I think when you look at from, let's say, a defense perspective, the valuations on a defense company still are pretty strong. And we happen to like defense. We happen to like to buy into defense. That's what we've been doing over the last several acquisitions that we've done. And it's been great for us. They've been margin accretive and will continue to be successful within Curtiss-Wright ranks. And so if that is where we were working before and they've been put on pause, then we have a pretty decent outlook to do what I said earlier, and that is to grow via M&A. Back in '18, we said we're going to grow 5% to 7% overall. And the thing was, that was dependent upon overall, Nick, acquisitions and organic. Now certainly, organic dropped but the acquisition side, we're going to continue that, but very diligently and very prescriptively so that we never return back to what we were doing back in our heyday of serial acquirers. So we've got a pretty good playbook in terms of what to do when we acquire. I think you said valuations. That was one thing. Another is, it is an issue now getting on an airplane and going and visiting someone. So good news, again, we did visit people before. So we know what we've got that we were looking at. Now it's establishing contacts and let's say, reinvigorating some of those older contacts without seeing them or doing virtual tours. That's another issue. And we'll learn to get through that. But I think we have a pipeline now that's pretty well charged. I mean, good enough for us and to keep us busy. And we certainly have the wherewithal and the pedigree and the heritage of recent to do what we've done in the past to grow this company.

Okay. And I think, if I recall correctly, you kind of had a set of priorities with regards to where your focus was and where M&A would not be undertaken. And I think defense electronics was at the top of the list. And then...

You're right.

What's that?

You're right, absolutely.

And then industrial specialty valves which were not related to oil and gas and then perhaps nuclear aftermarket or maybe even industrial sensors. Are there anything that I'm missing or that you've added to that list and things that you're looking at?

No. You hit the nail on the head, Nick. I'm going to take you on one of my roadshows. You've got it. And you dialed us in really well. That's exactly what our interest is. And we'll continue to pursue areas that are of interest in those particular ones. Commercial aerospace is not really of interest to us. It hasn't been for many years because it's been pretty pricey. And given the current situation anyway now, that just reduces that further. So I think it's further expansion of the strengths that we have and to take advantage of what we do. And that is, we do defense electronics and some electromechanical and pure mechanical defense, we do it very well. So we'll continue to do that. I like valves. I like very niche-oriented valves. It's great. And we bought that company a few months ago. It is going to serve us well. It's Dyna-Flo that is in that market as well. And so we are staying away from oil and gas.

One of the things we're starting to look at is a big shift that has started in the last few years and would like to accelerate, which is in precision health care products. So today, most of the products for that market are vertically integrated and now designed, developed, marketed and produced by companies like Medtronic and Johnson & Johnson. But there's a big sense that they may look to exit the actual manufacturing. This is all regulated markets, not only the product, but also the process of producing them. And you get long-term contracts. They're extremely profitable and ironically draw on a lot of the skill sets for engineering and manufacturing that are the same as a lot of our aerospace suppliers. Have you ever thought about looking at maybe diversifying over time some of your exposure. Now this would presumably be in the industrial markets that Kevin is kind of overseeing. But is that something that you've ever looked at or thought about?

We do participate in medical mobility, which is probably the mainstay of our medical side, which isn't a huge number within the business. We do like the regulatory side of it and the stringent requirements. It meets up with the kinds of products and technologies that we deploy, meaning that if this thing fails, there's going to be a serious problem. So I think from that aspect, it could be enticing to us. I have to honestly say, we have not pursued that. In light of what's going on in the world, I can only imagine that, that is becoming, let's say, a higher profile opportunity that companies like ourselves could look into. I'm not looking from an M&A perspective to get into that marketplace, nor am I looking for a fourth leg, in addition to the fourth leg of the stool. But from an opportunistic standpoint, we look for areas that we could collaborate with those who might have the need for something that fit all the little niche orientations, as you just described, especially the highly profitable one. We like that.

Okay. But as you see things right now, going forward, you don't see a dramatic change then where defense instead of being 45% in the first quarter, was almost 50% of your sales. It's not likely to be 60% or 65% of your sales in 2 or 3 years?

I don't see that.

Okay.

I don't see it. I think you'll see probably a little bit of shifting because of what's happened in the world, with industrial dropping and commercial aerospace dropping. I think that you'll see that natural shift, and then we acquire something. So then that's kind of a double shift, but then you'll see industrial come back. And then that will sort of manage its way back into, let's say, a more even split or slightly tilted. So I think it's just going to ebb and flow somewhat.

Okay. And if you look externally in terms of factors that might be legislated to help Curtiss-Wright or trends that might benefit the company, does reshoring have a positive impact on the company or an infrastructure program that might be part of the next round of fiscal stimulus? Are there anything out there that could really become a tailwind that you hadn't really been counting on or expecting?

There are possibilities. I mean, anything with a tax implication from a positive perspective, we'd jump on. And when you get other stimulus to help you out from manufacturing or anything along those lines, we tend to pretty much keep a keen eye on those, and we will take advantage of them. I don't know of any offhand. Chris, are you aware of any?

No. I wouldn't. I do know that there has been some discussion lately about revitalization programs related to nuclear and putting the U.S. on a more competitive basis internationally versus China and Russia. But outside of that, I think -- and that is a positive indication. Outside of that, nothing that I think we could comment on at this point.

Okay. And there's nothing that you do overseas that you'd think about bringing back to the U.S.?

Occasionally, we do. When the plants were closed in Mexico for 2 months because of COVID, certainly brought up the question. Is it something feasible? Is it worthwhile? Well, the answer to that was, look, it's so close and it's probably not going to stay closed for very long, which it didn't. It was 2 months. And we actually got it back opened via the essential businesses clause that they had. So we were able to go through that. But we do look regularly at the opportunistic side that says, it weighs the cost, the cost in China versus cost here. And as long as it pays off, which it continues to do. And I have to say, our facilities in China are phenomenal. They do a great job. We have opportunities to grow further over there from an indigenous perspective. And then our low-cost economy, for example, activities that we have in Costa Rica, that's sort of back-office, white-collar work, and they do a phenomenal job for us as well. So we augment what we do domestically with the activity we have overseas. I wouldn't say it's a dependency as much as it's an augmentation.

Okay. Okay. Well, we're, I think, pushing our time slot here by a few minutes. I'm sorry for my glitch, getting up and running out of the blocks here with the power flickering here in Vermont. But I appreciate all of you joining and sharing the insights this morning. And I hope that the path ahead, as you get through the second quarter, the second half is a little easier for you and things start to come back together and your M&A activities begin to also get some tone block on them so that you can square up on a few additional opportunities to supplement your business in the years ahead.

Well, that was a great fortune cookie read. Appreciate it. Thank you very much to everybody listening and stay well. Thank you very much.

Okay. Thank you all. Have a good one.

Thank you. Bye.

Bye.