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

Okay. Thanks, everyone, for joining. This is Peter Arment. I'm the senior aerospace and defense analyst here at Baird, and we're delighted to be hosting Curtiss-Wright here with us today. With us from Curtiss-Wright, we have Dave Adams, who's Chairman and Chief Executive Officer; with Chris Farkas, who's the Vice President of Finance and Chief Financial Officer; also joining is Lynn Bamford, who's President of Defense and Power segments; Kevin Rayment, who's President and Commercial and Industrial segment; and Jim Ryan, who's Senior Director of Investor Relations. And before we get started, we are going to have a quick forward-looking statement and before we get into Q&A. So with that, we'll kick it over to you.

Good morning. I just want to provide a quick note on our safe harbor, which is available in the latest investor slide deck on our website. Please note today's discussion may include certain projections and statements that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are not guarantees of future performance. We detailed those risks and uncertainties associated with our forward-looking statements in our public filings with the SEC. And with that, I'll turn it over to Peter.

Okay. Terrific. Thanks very much, Jim. Welcome, everyone. Thank you again for supporting the Baird Industrial Conference. I always look forward to hosting you guys. It's -- you've got a lot of different areas that you have insight into in different end markets. But I wanted Dave to start with you just because you just did close on one of the largest deals for the company's recent history with PacStar. So it feels important to kind of touch upon that. Why you kind of went after and sought the business? And what kind of growth and synergies you expect under kind of a Curtiss-Wright leadership?

Yes. Thanks, Peter. Great to be here, and we appreciate the opportunity. On PacStar, it was a company that we worked with for, I can say, a good number of years was not an auction, and it was an area that we were very interested in from a modernization standpoint. And it utilizes some of the same techniques and elements of our strategies that we've deployed in our other businesses within the Defense group. This one has hardware and software related to it. And as you know, we dipped our toe in the software side a couple of acquisitions ago, we're doing very well in that area. And this just fit right in the same sweet spot as that and then the other ones -- other acquisitions that we made more recently. The -- and we were excited about it because it's got a positioning in the high-priority areas of the Army's procurement standpoint. We look at it from each of them. The Navy, you know, run big ships. But in this perspective, the Army has 6 high-level technologies that they focused on and the battlefield modernization and integrated tactical network is one of them. That's actually probably upwards to the upper top and middle of the pack in terms of the importance that it carries. So we looked at that long and hard before we acquired the company, just to make sure that it would stand the test of time through various administrations. And this one looks very solid. It's got great contracts with the Army and Marine Corps. We look outward maybe good 10 years of its capability to grow with us. And we kind of position that internally when we pitched it to the Board and amongst ourselves with all the due diligence, we did. And we look at it to grow in the mid- to high single-digit level over -- each year, over the next couple of years. And so it's got a multiyear capability that is very impressive for us. And some of the areas of synergy that we're looking for is a platform network integration that really utilizes what we currently have, and that's what we call an intra platform, that's what we offer today, and PacStar offers an inter-platform hardware. So it really fits well. Capabilities are perfect, like I said, with our software company that we acquired. And then the tactical data link opportunities in the comms side of the battlefield areas are very appealing to us. So we're real happy with it.

Yes. So I mean, following up on the PacStar acquisition, you continue to have a lot of solid cash on the balance sheet. And you continue to generate a lot of excess free cash flow. You've recently announced a $200 million share repurchase authorization. Maybe you could talk to us a little bit about that. Are you still actively considering acquisitions? And how would you characterize the pipeline when you balance it against other [indiscernible]?

We do actively consider acquisitions. We've got people out on the street that are looking for different opportunities from each business element, be it on the power side or the industrial side or in the defense areas. And then they -- those bubble up to my desk eventually. And if it passes a lot of gates, that is. And then we review it as a whole to see how it fits in the enterprise. Nothing really far afield, no fourth leg kinds of activities. But we do have an active M&A strategy that is a -- really positioning ourselves for further growth. And we talked about the growth back in 2018 that we gave a 3-year outlook for our growth expectations, a little bit slowing down because of COVID. We've lost some of the business due to that temporarily. We believe it comes back after the next couple of years, certainly from a commercial aerospace side, but we think that it will pick back up again, but we're going to replenish a lot of that with further acquisitions. So again, very deliberate and disciplined approach. So no change in strategy there related to the acquisition targets. And then from a capital allocation standpoint, we still aim for a balanced scorecard. We like share repo. You mentioned the $200 million authorization. And we talked about what we'll began in the fourth quarter this year with $50 million that we're going through. And timing is right. We still believe in the value of this company. And I believe in the future, we'll continue to look at a balanced approach to this with growth -- strategic growth where important for us. It's got to be filled with intellectual property capability and strong applicability within our marketplaces that we can help, let's say, drive the architecture of our pricing strategies rather than be driven. And you've seen some of that at play more recently. And so I think we have a great future in this regard.

Yes. You've talked about that balanced approach, and it seems like it's worked really well for you on the M&A front and with share repurchase. Just wanted to circle back on the PacStar. When you think about just multiples, I know that you're a stickler with not wanting to overpay, and you talk about that quite a bit. I'm just curious when you think about -- when you look at the acquisition pipeline, the ability to kind of see multiples where they are at low-double digits, but your ability to kind of, obviously, extract some synergies out of -- how do you think about that when you think about the overall balanced allocation approach?

Yes. It's been a little bit difficult over the last 8 months as M&A is ground down to not a halt, but it slowed down considerably. And as M&A multiples are finding their footing, but one premise still remains preeminent, and that is for high-value properties, you're going to pay more, and we know that. And we like to find high-value properties that we've stayed away from the classic true fixer uppers, but those that we believe can attain a level that is accretive to our financial story, then those are the ones that we pursue. And we're not shy about paying a little bit more for them. You're right, we've been very fortunate to have been in the 10 to 12 range over the last couple of years, and we've done quite well with those acquisitions. We still look for not deals on the cheap, but reasonably priced deals and they can be found out there. As I said, this one -- I don't know if I just mentioned it, but I have -- earlier this morning, this was not an auction with PacStar, and we did quote them for a considerable amount of time as we do most of our acquisitions. So these are strategic versus opportunistic for the most part. In other words, they don't just come over the transom. We ferret them out, and we spend a lot of time to make sure both sides are comfortable and that we can get what we pay for. So we aren't willing -- I mean, we are not unwilling to pay a little bit more for the right companies. And so that has not held us back. We certainly like to pay less when we can, but you usually get what you pay for.

Right. No, that's helpful. So regarding your commercial aerospace business, you recently, on the earning -- the most recent earnings call, you gave us an update on where you were on exiting the 737 MAX actuation business at year-end, which you've been providing kind of a steady stream of revenues in 2020. Maybe you could just talk a little bit about what drove that decision. Why now? And maybe just start there.

Well, I can go back as far as March of 2000 when I joined the company, and I looked at the portfolio back then because I was hired as a business development guy and was hired to come in and help augment and supplant the business that we currently had at that time, which we were fairly small corporation back then. And we had mostly commercial aerospace in the division that I was with, if not all, commercial aero, maybe a little bit of defense aero. But the issue at that time that I had recognized and the leadership of the company then recognized also was that build a print business was just not going to bode well for the longest-term future that we could envision from a business interruption perspective and then from the commoditization, as I call it, of certain product lines. And it's sure enough, this lasted 20 years for us, actually more than that because it was here well before I was here. But this business that we've had with Boeing was a business that was built to print. We did not own the intellectual property rights to it. And that has always been a concern of mine that we've built our future based upon intellectual property that we can drive the architecture, the pricing strategies and so forth and have a product that's of higher-level value than just a simple build for the print. So it was something that we had considered that it might come to a point at some time. And as we went through our pricing strategies, over the last several years, you've watched and over the last 7 years, this was part of our pricing strategy that we were increasing prices here and there, where we could. And this one fell into the category of not being accretive to our story, except for this last contract that we received. And not being accretive to the story of the enterprise is really -- has really placed it in a position for us to look to go beyond that and find other properties that are accretive, like PacStar will be. And so it was inevitable that at some point, it would be coming to a point like this. But not a negative point whatsoever. It's been great. We continue to do a lot of business with Boeing, we will always do business with them. And this is just a product line that has got a maturity cycle on it that got a little bit beyond, and it lasts us a long time. We were very happy with it. So we did decide to exit that by virtue of a pricing strategy that we needed for our enterprise, and it just didn't work out overall, and that's fine. It's worked out fine for all parties.

Was this -- was it part of your 2020 restructuring plans that you kind of announced in February? And then are you looking to kind of replace that business with other kind of commercial aerospace revenue?

Well, we really -- the discussion I've had over the last several months has been that if -- when and if we were to replace a business like this, as we've talked about this specifically, then we would do so with an acquisition and PacStar would be that one that's most recent that would apply to that. And it comes with about $120 million in revenue. And so that one will certainly replace the revenue side with this -- the Boeing work being about $70 million on that particular product line. So this one does and then goes beyond, which is great. And that was the plan as we came along toward the middle of this year. But our restructuring plans last year, as we put together a recession playbook, included the general outlook that we are continuously improving our factories and our product, margins and so forth. And so from a perspective, we -- all along, we've been attempting, as I said, the increased pricing and move forward with various products. And then restructure where necessary. And every year, we do look at products to see where they are in their own life cycle. And we will moderate those with possibilities of licensing or selling off the product lines or just basically exiting. And so this one just fell into that camp. But I don't see a replacement of the $70 million that we're talking about with other commercial aerospace work that we would go out and acquire. The commercial aerospace, it's going to be down for a little bit of time. I write stuff all the way out to 2026, not sure the vaccine comes in, it certainly helps things quite a bit. So I'm optimistic, and I'm very hopeful because we do still have a decent amount of business in that space, and we're very comfortable with it, and we like it very much. So this was sort of a one-off thing that just occurred.

Right. Okay. Well, and obviously, it's expected to generate some positive free cash flow, too, which is very favorable. So Chris, I wanted to ask you on the free cash flow component. So Q3 was a bit lighter than expectations, which implies obviously a pretty strong Q4, just based on your outlook. Any concerns about as the sequential improvement as you wrap up 2020?

At the onset of the pandemic, we took pretty aggressive actions to preserve liquidity and improve working capital. Q3 was down. It was down about $52 million from the prior year. But this is largely due to the collections impact from our Q2 revenue trough, which we expected. It's important to note that while we did have this downturn in Q3, our adjusted year-to-date free cash flow year-over-year is up $15 million. And we do expect a strong Q4, which is typical for our business. Our defense markets, which are about 50% of the portfolio, offer really great stability in free cash flow. And while we are anticipating some collection headwinds in the fourth quarter, we have a strong head start as we go to close out the year.

So -- that's great. And how should we think about -- when you think about 2021, are you expecting any adjustments similar to kind of the 2020 for pension or restructuring or any of the large capital investments?

Yes. Based on current projections, we expect a more normalized free cash flow without adjustments for pension, restructuring, other major capital investments. The only other thing I'll say about cash flow, Peter, is it's important to note that we do still remain on track to achieve our 2021 target of $1 billion in cumulative free cash flow, which we said in early 2019. So I think the team has done a great job in focusing on cash.

And also maybe just update us on your views on the pension plan as we head into 2021.

Yes. The pension plan is well funded. No concerns from that standpoint. We are watching discount rates carefully. I think it's too early to tell if we have a headwind, but it is likely if current rates hold. 2021's rate, as you know, will be determined in December 31 of this year, and we're currently seeing anywhere in the range of 50 to 75 basis point drop in discount rates. Our sensitivity is roughly $2.5 million of expense or income for every 25 basis points change in the discount rate. So this implies at least a noncash headwind of somewhere in the range of $5 million. Most of that impact will be to other income. Some of that comes through corp and other. But we also believe that the actions that we have taken this year with our 2020 share repurchases, at least the ones we've announced to date, will help to offset this impact in 2021.