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

Good morning, everyone. I'm Nathan Jones. I'm the covering analyst at Stifel for Curtiss-Wright. And we're very glad to have with us CEO, Lynn Bamford; CFO, Chris Farkas; and Investor Relations, Jim Ryan. Jim is going to make a couple of comments before we get started. Over to you, Jim.

Thanks, Nathan. Good morning, everyone. I just wanted 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 detail those recent uncertainties associated with our forward-looking statements in our public filings with the SEC. So with that, I'll turn it back over to you, Nathan.

Thanks, Jim. Before we get started, a couple of housekeeping items. I'm going back to that bull case, bear case format this year. We did abandon that last year because of the singular focus on COVID. I'll present 3 bear cases and then 3 bull cases. Management will have the opportunity to respond to each one, and then we'll dig into each topic with questions, time permitting. Feel free to ask questions on any of the topics through the chat box on the conference portal. I welcome questions from Investors, which I'm sure will be smarter than any of the questions I'll ask anyway.

With that, I'll get started on the first bear case. U.S. government defense spending isn't likely to grow over the next few years under a Biden administration. Growth in the defense business is likely to be relatively low with limited upside potential.

Well, thanks for that. And that's a bear case. So I think is a reality that is likely. So it's a very, very good opening question. And I guess we are bullish in spite of that bear case scenario. I think everyone, maybe on the phone call, knows that our defense business represents about half of our overall revenues. And we remain very optimistic about our position to grow even in potentially challenged defense budget at times. And I start by looking backwards and say Curtiss-Wright has grown over the past 20 years at a faster rate than the base DoD budget, and that's been through both Democratic and Republican Presidency. So we know this industry and we know how to grow in it. And even just very pragmatically here today in 2021, we will outgrow the base DoD budget. We're positioned to grow our A&D end markets by 7% and 9%. So just demonstrating here now this year what we're anticipating. So -- and how we're able to do this is, we are well positioned on very high priority, high visibility platforms, whether it's the critical aircraft carriers, submarines or fighter jets, we really maintain a very focused position on these platforms that have great bipartisan support. On top of that, we very much have focused our investments and our technologies around areas that are pretty immune from budget trimming. And we have a very broad breadth of product portfolios, strong market penetration, and they really align with the DoD priorities. So the recent budget that came out, the Friday before Memorial Day weekend, was very much in line with what we anticipated, and I think many people anticipated, was about 2% topline growth. So that is very much what we have had, and we were very pleased to see that where money was put in that budget, very much supports where we hope to see it. And so again, strong support for our enable platform, the Columbia class, the Virginia class, and then top strategic priorities around C5ISR, cyber, encryption, hypersonics and especially the NetCentric battlefield. So we were very pleased to see that while the Army who is frequently a bill payer, is a bill payer here. They're not being a bill payer in the areas that's critical to our new PacStar acquisition where the Army modernization program was increased 25% year-over-year. That's $537 million to $2.7 billion. And that's exactly the bucket of money where PacStar receives a lot of their funding. So that just really reinforce that the high single digits growth that we've been talking about for PacStar looks very well supported by that budget. And so again, the overall budget is huge. But when you have pockets of business like we do, within that budget, the overall topline can go up and down, and we can still absolutely go within that. So one of the programs you hear us talk about is the F-35, yes, F-35 was slightly lower year-over-year in the President's budget. I will say that with the international business growing, there is still an overall positive ramp rate. And we think there is a chance that as the budget goes to Congress that there might be some plus ups on the F-35. We've seen that happen in prior years. And so that would be great if it happens. Again, we're not counting on that, but that's just upside in goodness, if we do see some plus ups on the F-35. I think there's no doubt that there's -- the bipartisan support for the ship building business with everything going on in the international front with the U.S. adversaries is just 100% supported across the aisle. And so that's fantastic, and that's the largest portion of our Defense business. So that's super important to us. And there was not a third Virginia class in the budget. And again, things that we think there's a chance that will provide upside on top of what was in the budget, is potentially a third Virginia class being added by the congressional markups and even another DDG destroyer, there's a lot of talk about both of those. So again, I take our technology, where we're positioned with a shift to RDT&E. And really where our Defense Electronics capability there that is just poised to take advantage of new program starts in that area. On top of our positioning with the major platforms that have continued to have production support. I think we have clean line of sight on why we're going to continue to outpace the base DoD budget. And if the base DoD budget does remain flat, we have avenues to grow, regardless.

It's a great answer. Thanks. I'll go on to the next one. Longer term, the nuclear power generation business looks to be challenged. With developed markets unlikely to put in more nuclear capacity. At best, there's significant uncertainty about the medium to long-term outlook in this business, which is going to be a continued overhang on the stock.

So I think we are -- as I've watched our nuclear aftermarket business, our commercial nuclear business, it has been -- there's been challenges over the past years. And we have the greatest optimism we've had in, I would say, the past 5 years right now for growth in this market. That there's a lot of factors going on right now that give us real reason for optimism that we are going to grow in this market. And you start with, I'll say, the Biden administration has taken a very strong stance towards a carbon-free energy generation. I had the luxury of sitting on a roundtable meeting this Monday of this week with very senior members of the Department of Energy, Department of Commerce and Secretary of the State. And they very much see nuclear power as an essential, not a nice, but an essential portion of us being able to reach our carbon-free energy goals. And with that, they are very committed to working to stop the closure of further plants that they want to maintain, the fleet as it exists today. And so there are some plants scheduled to close yet this year, whether those will be able to be impacted. We'll see about that. But I mean, I think long term, they're very much committed to maintaining the nuclear fleet as it exists today. And so that's really where our core business has been doing the aftermarket services in that footprint. And I think that is very stabilized. On top of that, you move to the fact that many of these plants are moving for their 60 to 80-year life extensions. There's already 40 plants have -- are in some part of applying for their life extensions in the current fleet that this is going to happen across the fleet. And that is a great opportunity for Curtiss-Wright to gain additional businesses. We outfit these plants with replacement work to just assure the safety, but also a lot of these plants are going to move forward and do some modernization efforts, moving from a more analog to a more digital capability. And that's an area that, over the past 2, 3, 4 years, Curtiss-Wright has put a lot of investment in being there with products to move the modernization of these plants. So as they go through this 40 and 60 will not just get the traditional kind of outfitting work, but the modernization of them. And we're right there with the right products to do that. And then on top of both those dynamics, and I would also back it up for a second. Comment that, that plant life extension as much as it's happening here in the U.S. That's going on in Canada and South Korea also, where we have very strong footprints in those markets. So we're not just getting the benefits of the U.S. market. We're getting the Canadian market and the South Korean market. So that's all reasons for optimism. And on top of that, what was talked about Monday at this roundtable, quite a bit, was a real desire to get the United States back to being a leader in nuclear energy. And the Department of Energy, and we saw it in the budget that was also released, people -- much more visibility on the DoD budget, but in the Department of Energy budget, there's a significant increase in money that's going to be made available to fund some of the advanced gen 4 nuclear developments, and that's whether they're small modular reactors or the advanced development reactors. And we are very much engaged with industry. And honestly, it was quite an honor to be on this roundtable with the CEOs that are leading these development -- these new developments as being such a critical part of the supply chain that we had a seat at that table. So that was really exciting. And we can see content anywhere from $10 million to $80 million on these new development reactors, and we've talked, publicly, about the new scale reactor, where we have $40 million of content per a 12 reactor plant, which is kind of how they're positioning it for being deployed. And so this is an opportunity. Simply in the developments. But as it looks -- there's growing belief that these are going to be part of a carbon-free world going forward, that our footprint here is something that really gives us a reason for optimism in this market.

I think I know China and the RCP business gets all the press for you guys on the nuclear business. It's important to highlight that this nuclear aftermarket business is much larger than the China RCP business. However, I'm going to have to ask the question about the prospects for you guys participating in the next round of build-outs of Chinese nuclear reactors with your RCPs.

No call would be complete without a good question about orders. So we appreciate that. So I believe by saying our guidance that we put out in our Investor Day, 2 weeks ago, does not include getting a new China order. So we're running this business. We're confident of our growth trajectory, and it does not depend on a China order. China has put out their new 5-year plan for carbon-free energy. It's pretty aggressive. And obviously, Hualong One has come online in China, but for them to meet that build out, will they be able to do it with just indigenous suppliers or go worldwide, we still think they're going to need to reach outside of China and leverage the global supply chain. And for sure, we've -- given the success of the AP1000 in China, it would seem natural that, that would be where they're going to go. But we don't -- we're not speculating on it. It's -- there's a lot of things to go in, geopolitical type of things. But we're there, we're optimistic. We think it will happen. We think it's more a win, not an if, but it's not in our plans. We're going to grow and be successful with or without. And obviously, then if it does come, what a great upside opportunity for us if it were to happen. But it's not -- we're going to hit what we put forward 2.5 weeks ago without getting AP1000 will grow out of China.

Absolutely. Thanks. All the margin improvement from internal initiatives is in the rearview mirror with costs taken out and restructuring largely complete. It's going to be more difficult for the company to expand margins going forward.

I think that sounds like a great question for Chris to answer.

Well, fair question. We are, again, bullish on this bare case. Just a little context, a little history. As you look at what we've done, we've had great success in improving our operating margins. And over the past 5 years, we've expanded our operating margins by 220 basis points. And we've drove operating income growth at a faster rate than revenue growth. Last year, with our recession playbook in hand entering into 2020. And then additional actions that we took in response to the pandemic, we were able to mitigate the loss of $300 million in commercial market revenues. So only a 20 basis point decline in margin, and that was in 9 months. So our businesses have exceptional agility. And those actions that we took last year generated annualized savings in excess of $40 million and $19 million of that's going to be recognized this year. So while we've certainly addressed the low-hanging fruit, our efforts are ongoing, and the journey is certainly not complete. And we talked a little bit at our Investor Day about our new operational growth platform, which builds upon that strong foundation and operational excellence that we have and things like lean and organizational optimization or critical components of what we do and we'll continue to do. And in addition, this platform will provide new opportunities for margin expansion, through things like the selective application of R&D investments, commercial excellence, which we talked a little bit about, strategic pricing opportunities to expand margins. But right now, we are extremely focused on achieving that 17% operating margin target in 2022. And while we're not ready to talk about 2023 at this time. Under the new strategy that we've announced, our focus is really on maximizing revenue and operating income growth for our shareholders, and we feel confident in our ability to do that.

That's a good segue from the bear cases into the bull cases, talking about growth, increased growth investments, offer the opportunity to further differentiate Curtiss-Wright's offerings, gain market share and drive above-market growth across a number of businesses and end markets.

I like your bear cases more than the bull cases. So -- like honestly, that bear case is very much what we believe is the case for Curtiss-Wright. And I'd say we've talked a couple of times about we've increased R&D this year, $10 million over last year. And I think something we're also exceptionally proud of. We increased R&D spending in 2020 during the pandemic $4 million over 2019. And I think that shows the commitment of the company to invest in growth opportunities for the long-term and not go for the short term. I mean, we would be at 17% this year if we hadn't chose to make that $10 million of additional investments this year. And we're choosing to make them because we really can see a clear line of sight that we have things to invest in, that are absolutely aligned with growth vectors in markets that we are well positioned in. And that's a lot of what we tried to communicate in the Investor Day. I hope that came through. But to just touch on a couple that, we talked about this at extent, in the Investor Day is, if I pick one out of the defense area is the MOSA or -- and you would put a couple of press releases out about really major wins that we've had in this space. We started investing in our portfolio of products in this MOSA area, back in 2019, as it was taking form. And we participated in the creation of the standards and I believe that this is going to be the direction the DoD is going. There's been a Tri-Service Memo put out that is really encouraging all branches of the defense department to really move towards outsourcing in this area. And the investments we made starting 2 years ago to have a product portfolio to capture this and put this in a position to win some of the major wins that you've seen press releases on come out. And so that's just -- just one example. It's an area that is probably one of our larger focuses of our R&D dollars right now. But it's just one of many where we have great things that are aligned with where the defense budget is going. And we saw that with what came out 2.5 weeks ago. And if I shift to commercial because we absolutely -- that $10 million, I'd just like to comment, is an increased R&D budget across all 3 of our segments. So it's not as just as -- we're only funding our Defense Electronics segment, there's great things where we can invest R&D dollars and build up our growth strategies for the future across all 3 segments. And another thing that got a lot of talk during the Investor Day is the position where we are building for ourselves around the electrification. And the electronification in the vehicle market, both on-highway and off-highway. And we are very excited about -- this market is young yet. And we already are seeing such a great position, establishing ourselves with all the major players across this industry that is going to provide great growth for Curtiss-Wright in decade to decades to come. And on top of this on off-highway commercial market, there's already early signs that this technology is going to be pulled into the defense industry. And the technology that we're building and being able to produce positive growth for Curtiss-Wright in this commercial industry and being funded through that then we will be there and ready as the defense industry moves to this to read that technology across, which is one of the things we really talked a lot about during the Investor Day is clearly looking to build technology in an initial market that has the growth vectors to justify the investment. And then taking that technology to adjacent markets as those adjacent markets adopt that technology. And so that's something we're -- with our growth platform that we really are raising the visibility up to make sure we find those connections and are committed to doing that. And something we've been asked about a handful of times is whether -- we speak very openly about our R&D investments growing this year. We're not committing to a specific R&D growth investment year-over-year, but we'll look at that really and make strategic decisions based on the opportunities that are before us. And something else that we talked a lot about with our innovation operating system. We're really raising up the ability to understand what those investment opportunities are in the company and make sure we're picking the best priorities for Curtiss-Wright in funding those growth priorities. So we're really enthused about this. And for those -- I'm an engineer by training. So was my undergraduate, my graduate degrees are intellectual engineering. So R&D and building technology is something that's very near and dear to my heart, that I really view as one of the greatest levers we have, as a company, to grow is to really spend those R&D dollars wisely. So something I'm very passionate about.

Look, as an analyst, I'm always supportive of increased growth investments to drive growth. I think that's one of the biggest areas of value creation for shareholders. What we typically get from shareholders are questions about what the level of investment is likely to be, what the impact is likely to be on margins there? Investors generally don't like to see the investments going into a level that you start actually compressing margins. So maybe you could talk about how you're thinking about balancing those desires to invest more in growth in the portfolio versus at least maintaining or continuing to expand margins, while you're continuing to invest in growth.

I think one of the things you saw in our financial projections that we put out at the Investor Day was we are committed to growing our op income at a faster rate than growing our topline. And that fundamentally says we're going to build, we're going to maintain or incrementally build our op margins. And so we wanted to put that out very publicly. It was one of our 5 financial commitments that we made during the Investor Day. So -- and that level of growing op margins over -- or our op income over sales. Might be slightly higher or might be slightly lower. And we're giving ourselves the freedom to pick whether as we see the portfolio of investments that are before us, that will provide a great future for this company to be able to select those more or less, but we are committed to maintaining op income growth faster than our sales growth.

Thanks for that clarification. I'll move on to the next one. The portfolio presents unappreciated technology synergies with crossover applications across the portfolio, a renewed focus on 1 Curtiss-Wright should allow the company to better leverage technology to drive growth across the portfolio.

Thanks for that. And that was -- I really appreciate that question because it aligns with a lot of what we spend our time talking about at Investor Day. So if I harken before Investor Day and I go back to our earnings call at the beginning of this year in Q1, where we shared our full year 2020 results, we took this opportunity to realign the segments of the company. So when we talk about unrecognized value, we do believe Curtiss-Wright has unrecognized value. And so much of the realignment of the segments was to give much better transparency into our core portfolio and what our end markets are. So we realigned both the segments and our end markets. So people would really -- investors can really understand where we do business, what our technologies are and where end markets are. And then a lot of the Investor Day was spent around talking about what are the growth vectors in those end markets? And why our core technologies are really aligned to capture those growth vectors, and we are very passionate about it. We believe we are very well positioned in our markets and in our business. And think we've done the right thing, not just starting this year, but building up to this year to really have the technologies to capture those growth vectors. And then I lay on top of that, our operational growth platform that we rolled out that really is bringing forward the ideas of innovation and end market strategies which, again, the company has a history of innovation. Innovation isn't like a new thing that we're doing. But what we are is we're bringing it up in the visibility and the focus. And something else we talked about was, we've realigned some of our in year compensation programs to really, like, make this a priority for the senior leadership across the company is to prioritize being innovative, collaborating across the company, looking for new design wins, building up the long-term value of the businesses we're capturing across the organization and compensating people on it. I mean, compensation is a big lever you have as a company, and we're making it clear, that's the direction we're going. So we -- as we put forward this pivot to growth, it's -- we're disseminating that message throughout the organization. And paying people for it. And so that's part of why we feel so optimistic, we're going to be able to achieve that. I look at the made-up of Curtiss-Wright, and we have 1,800 engineers in our company. That is a powerful resource and creating some of these tools for those 1,800 engineers that are spread across a lot of businesses. We have a very diverse business to be able to really have a tool to collaborate and share the best ideas, provide comment on the best ideas out of other companies. These are all things that are really reasons for optimism for us as a company.

Great. Thanks. In the interest of time, I'll just jump on to the last one here. Our capital allocation has been a source of significant upside with the company buying good to great properties at very reasonable prices and in outperforming targets on synergies and accretion. Going forward, management is leaning in more aggressively on the acquisition front and with a good record for smart buying, this should lead to more inorganic value creation. Portfolio diversity means that there are likely to be numerous potential targets for management to deploy capital and create shareholder value.

Yes. I'll start off with that one, Nathan, and then maybe just turn it back over to Lynn just to talk a little bit more about that. I'd certainly agree. I mean, you look back over the past 5 years, and we've deployed $2.4 billion towards our capital allocation plan and that included acquisitions, returns to shareholders, other operational investments. We spent $1.1 billion on 6 deals, which were 5 A&D, 1 commercial and acquired nearly $400 million of revenues and we substantially improved the product portfolio at the same time. At our recent Investor Day presentation, we highlighted the strategic benefits of each of these acquisitions and what they brought to Curtiss-Wright. And I think that reflects our strong due diligence and integration processes because we've been very successful. And as a reminder, we paid less than 12x EBITDA for these acquisitions. So not only did we enhance the portfolio or grow the portfolio, but we did it at a very effective price. Moving forward, our preference in capital allocation leans heavily towards M&A. We have an active pipeline, and we certainly have capabilities to handle small or larger acquisitions and any property that we take on has to be the right strategic and financial fit to help our top and bottom line grow faster. I don't know if you want to.

Yes. No. I mean, that's well said. And I would start off by reiterating what Chris said about. We are looking to prioritize the use of our capital for acquisitions, but that does not, in any way, shape or form, mean that we are going to lower the bar for what qualifies as an acquisition to be brought into Curtiss-Wright. We're simply going to bring more companies into the pipeline. So as we parse through them, we hopefully find more that we will be able to have become part of Curtiss-Wright. And so that's something we just -- I know we've said it, we repeat it, but it's really important that people understand this isn't going to become anything reckless or frivolous in what we look. We know how to do this. And we wanted to put up that track record of the last 6 deals we did because we're really proud, and I appreciate the way you asked the question with that we bought great companies, and we're really proud of that, and we believe we know how to do that. And we think that muscle that we have created in doing that really has put us in a position that we know how to go in, assess companies, understand their financials, understand their unique value proposition with their technology and determine whether there's something there that fits our criteria to join the company. We did talk a little bit in Investor Day about priorities. Our embedded computing capability, our Defense Electronics segment is definitely a priority where we're looking to acquire. There's still -- that is a big, big market we put out during Investor Day that we see that as a $15 billion market cap. And so we are -- still get a small piece of that. So there's many types of capabilities we can bring in that will allow us to continue to grow within that market space and bring better value to our customers by having a more integrated capabilities that we bring to them. The naval is a very stable, strong portion of our business. We talked about that just a bit today. So additional safety, power and propulsion systems is an area that is very much of interest. And then on the commercial side, it's not only on the defense side, but also on the commercial side, we have specialty sensors and technologies that will support the electronification and electrification, both on and off-highway vehicles. Specialty sensors, those are all things that are of interest to us. And again, we will add on small specialty technologies, smaller companies, but we're willing to like look at bigger capabilities. And we have a lot of dry powder. We have a capacity up to about $1.6 billion. And we're not taking anything off the table at this point.

Yes. I think what gives people confidence and comfort is that with those 6 deals over the last few years, they've all been middle of the fairway deals. They've all been in markets that you guys already play in technologies or adjacent technologies that you guys always play in. And it sounds to me from those comments there that, that's what you're looking at. There's not the thought of adding another leg or going outside of core competencies or something like that anytime in the short term?

I would say that's generally true. We're not looking to build up a 4 segment in the company or something. But we're willing to push the bounds as I look at what we bought in our defense space, buying a TCG, which is a tactical data link company. That isn't -- that's adjacent technology, but in our core space. So we're willing to push the technology spaces, but where we know and understand the end market or places where we can take our capability and maybe apply it to a new market, but it's going to be something that's in our wheelhouse that we know either from a customer or a technology space, not something which is out of left field. That is true.

Great. Thanks very much. We're up on time. So I will say, Lynn, Chris, Jim, thanks very much for your time today, and thanks for everybody who's joined us on the line. Have a great day.

Thank you.

Thank you.