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

Okay. Moving right along. Now I'd like to introduce our next company, Curtiss-Wright. Today with us, we have Ms. Lynn Bamford, CEO of Curtiss-Wright and Mr. Chris Farkas, CFO; as well as Jim Ryan, Director of IR. Curtiss-Wright designs, manufactures and overhauls precision components and engineered products and services primarily to the aerospace, defense, general industrial and power generation markets worldwide. Curtiss-Wright has 40 million shares outstanding, trades at about $115 for 50 -- I'm sorry, $4.8 billion market cap and $860 million of net cash for a $5.6 billion market cap -- I'm sorry, net debt for $5.6 billion total enterprise value. We are delighted to have Curtiss-Wright here with us today virtually to discuss its growing role in the aerospace and defense industry. But before I get started, I'm going to turn it over to Jim Ryan, who will go over some comments on safe harbor.

Thanks, Tony. Good afternoon, everyone. I just wanted to provide a brief statement 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. And we detail those risks and 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, Tony.

Great. Well, thank you again for being with us today, Lynn and Chris, and welcome. At your recent Investor Day, you revealed the new pivot to growth strategy. Why is this the right strategy for Curtiss-Wright today?

Well, greetings, and it's a pleasure to be here for starters. I just would start out with really speaking about the new pivot to growth strategy, maybe adding some color around it. We really are focused on maximizing our revenue and our income growth for our shareholders. We believe this is the right time to pivot to growth as we've worked over, as many of you know, over recent years, to really drive a lot of our financials into top quartile performance. And the one that really has not achieved that is growth. And so we're really pivoting to putting management's attention on that top line growth. It's going to come through a combination of organic growth and acquisitions and just to add a little color on both of those. We have over the past couple of years really been increasing our R&D funding. We were very proud that in 2020, in the pandemic, we increased our R&D by $4 million, and we're increasing it again, $17 million -- or $12 million this year on some really targeted areas where we have very good positions in some growing markets, and we really feel like it's the right time to make those investments and capture some of the trends in the markets where we do play. To be able to do this, we need to really maintain our lean operating structure and continue to focus on operational improvements. So we're not taking our eye off of those types of focuses, and that's really what's going to give us these incremental R&D dollars. So we will maintain our top quartile performance while we pivot to growth. This is going to continue to drive double-digit EPS growth and continued strong free cash flow for our shareholders. Some of the areas where we're focusing on is things -- if you've been listening to Curtiss-Wright over the recent past is our defense electronics that we really -- I think we are very well positioned with some of the initiatives that the DoD is focused on that our technology is very much match set. But even outside of our defense industries, which are very strong, as there's emerging technology trends in industrial and nuclear where we have some great technologies to capture things such as digitization, electrification of vehicles and Internet of things that we think of the right time to spend some R&D in those and position ourselves for growth over the long term for Curtiss-Wright and we think this will really benefit our shareholders.

Thank you for that, Lynn. What areas of the business are stronger, better today than they were 6 months ago? And where do you have better or worse visibility?

That's an excellent question. And I guess I'd open by saying when we gave our Q2 results in August, we did raise our guidance for the full year. So we really feel good and optimistic about 2021 and delivering a great year for our shareholders. But to be more specific to your question, the areas that are stronger. Our defense backlog remains strong, particularly in our naval defense. You probably saw the 1 press release recently for some significant orders. We continue to build on our strong position in defense electronics. Our approach has really been platform agnostic has served us well over past years and continued, make sure we're maximizing our market penetration with a lot of great technologies on a variety of platforms and programs. Again, can keep maintaining that broad breadth of program, so we're not as vulnerable to any 1 program. PacStar has had a really strong start to the year and the integration remains on track and is going well. Looking to the commercial side of our business. Commercial orders were 1.1 book-to-bill in the first half of the year. So that was really great to see as this portion of business obviously was the most hit by the pandemic. Sensors and actuation are really -- they're -- we're really looking for them to have a solid second half of the year. And our restructuring savings that you heard us talk about potentially in 2020 or have seen us reference, are delivering the results we had expected and we expect to get $19 million of savings in those in this year. So visibility, we've always had our area of highest visibility has always been our naval defense, and that continues to be true. We had good orders in the first half, and we're expecting strong orders in the second half of this year. I'd say if there's a place that we're keeping our eye on very carefully is around surface technologies that their industrial orders have been good, but the commercial aerospace a little slower on the recovery than we would have anticipated. If I think of risks in the year, COVID is still real, and it's still out there and we're managing it. All our plants are operating. That's good. But we still are having occasional cases within our plants and we really need to keep a keen eye on that. But I'd say more than within our own plants from COVID is the impacts on the supply chain. And there is, I think, the most significant in that area is around electronic components affecting both our A&I segment and our Defense Electronics segment. We're managing it well. We don't think there's anything material to the year. But I would say that's one of the risks I very keenly have my eye on and making sure there's appropriate oversight to ensure we're doing everything we can to manage it.

Maybe switching to the defense and defense budget. What are your thoughts on how the latest happenings of the defense budget playing out as far as in Congress? And what areas are you seeing that could benefit Curtiss-Wright or maybe be a risk to it?

Yes. Thanks for that. I guess backing up a second, not knowing how familiar everyone that's listening into this is with Curtiss-Wright. Curtiss-Wright has got a great track record of over the past 20 years, outperforming the base DoD budget in all of those years. And that's through both Democrat and Republican presidencies. And we're on track to do that again this year with our organic growth in our defense businesses being up 2% to 4% and exceeding the DoD budgets. One of the things that is great about the portfolio mix we have in the defense arena is we have very long-term visibility on the shipbuilding platforms and submarine platforms and the F-35, where there's very strong bipartisan support, and we have significant content on those. When I look at the President's budget request, which came in slightly up, flat inflation adjusted. It's been very positive to see it go through the congressional markups. And in both the Senate and House Armed Services committee have increased the budget about 5% or $25 billion. So that's a solid indication that with bipartisan support for some increasing in the defense budget, which is great. We were okay with the 715, even pleased with what we have seen in it, and this just really adds on top of that specifically because some of the areas, we think that $25 billion would be directed to is potentially a third Virginia class sub, a second destroyer and some more funding for Battlefield modernization, which is highly connected to our PacStar acquisition. So those are -- we're optimistic that, that will get signed into lot and those programs will follow through. We haven't seen the 5-year defense program budget yet, but we're expecting that in 2022. But I would say what we're seeing now is good indicators that we will like what we see when that comes out. But we obviously sit there, we know any program could experience some risks or some defunding or slowing of fundings. And so we're always keeping a keen eye to that. And that's why we work so hard to match that we are working on the programs that are the highest priority to the DoD. So we can really minimize this impact. So I'd say, overall, we've been really optimistic about the current and future years for our defense markets.

Yes. It does seem that you could comfortably say that you're pretty well positioned with the future growth of where the money is going in the budget. Maybe to your Defense Electronics business, you've spent a lot of time lately referring to modular open system approach or MOSA. What does this mean to Curtiss-Wright? And how could it drive incremental higher sales over time?

So an area near and dear to me for those of you who maybe don't know me so well, that was how the leadership part I had in my career as it's gone through a Curtiss-Wright. So it's an area of business I'm always very passionate to talk about. I'm proud to say that we really are the leading supplier of embedded computing technology in the open standard arena. We have been building products in this area for over 20 years and really led the creation of an open standards in the industry. We have a very diverse platform content with 4,000 or more programs over 10 years that we've participated in with various defense industries around the globe. And we've developed some capabilities that really allow us both to keep those customers as they continue to do life extensions in those programs, either with insertions of new technology into those or extending building old products for a long period of time. And we've built up a really great expertise in this area. This is an area where we have spent really the highest portion of R&D spend within Curtiss-Wright consistently over the years to assure we have that leading-edge technology portfolio of products. And to most specifically, that we've been part of the industry standard generation since it started several years ago and invested -- committed and invested early in our building out a robust product offering in this area. So it's the very many different applications across all the services are looking to build programs with this. We have the right set of products to do this. For those of you who maybe aren't familiar, this really kicked off in late '19 when there was a tri-services memo signed by the Secretary of the U.S. militaries of Army, Navy and Air Force that directed that most standards be included in all programming developments. And so we felt really good about us being an early mover in this space and really having the broadest most portfolio of products in the industry today. And so we feel that we are well positioned to capitalize on the growth phase in defense electronics.

How would you may be moving to sort of what's going on in the dynamics, COVID right now and supply chain pressures. How is that impacting your business? Are there certain segments that are more impacted? And maybe how would you quantify the impact and maybe what your inventory looks like and how your supply chain and the health of it?

Okay. Yes. The impact to the supply chain are real in the industry, and we are definitely feeling some of those. To some degree, they're impacting the timing of revenues. I think we've talked about that in the past. I'd say most specifically, the impacts are in our defense electronics and our industrial vehicles businesses really with the dynamics that have taken place with the economic recovery, the uptick in commercial electronics when people started staying at home has really put a real demand on the chip supply, which you can't hardly pick up any business news that you don't see about that. And we are working hard to minimize those impacts and the teams are doing a great job to minimize the impacts, but it's real. We don't think there's anything that's material to Curtiss-Wright. But it is putting a lot of stress on the teams. We are seeing some increase in costs for freight that is put a little stress on margins in some portions of our business. But that's why we are continuously looking for operational excellence improvements that we can use to offset some of those increased costs. And just to be specific about a few of the things that we're doing to manage the supply chain challenges, we're continuously looking to build forces as we have, but we've really increased the engineering networks around that. We have really worked to leverage key vendor partnerships and at a much more senior level than normally or we have historically in the past, have built some partnerships at senior executives in those suppliers so they can really understand the importance of where Curtiss-Wright is selling products for our national safety and to ensure that we stay high on their priority list. And we're also looking to use government ratings on any programs where we can get it much more aggressively. So of course is to prioritization of chips to Curtiss-Wright.

And then you have a pretty diverse set of businesses. Is there one area that is getting impacted more than the other? Or is it just -- But just you say generally, you're just having -- you're seeing it in all of your businesses?

No. I mean, some of the businesses are very likely impacted. I don't think anybody -- I think every portion of the business, there's some strain, whether it's manpower, people or whatever some strain. But if I was to pick out one, probably the business that has the most stress on it is the Defense Electronics segment.

Chris, maybe switching to some color on the commercial aerospace market. We've heard a lot about that today. Are you expecting a second half ramp? And how is 2022 shaping up for Curtiss-Wright?

Yes. Thanks. So just to start off with a little bit of color and background. Our commercial aerospace markets represent approximately 10% of our business. Our largest customers are buying an Airbus. And I think as you dive deeper into our product and where we align ourselves within the market, we're roughly 50-50 between wide body and narrow body, which we expect to have different recovery rates here coming out of the pandemic. We're also more heavily focused on OEM than we are in aftermarket. I'd say about 85% OEM and about 15% on aftermarket. But last year was a real tough year for a lot of companies in commercial aerospace. But we're happy to say that we've experienced slow and steady sequential improvements in orders since the Q2 lows of last year. We were really pleased with the orders and what we saw in Q2. They continue to improve sequentially overall and actually year-over-year. So in our long order cycle businesses, which are actuation and sensors, we're really starting to build up some backlog, and we expect that -- those businesses really to ramp in the second half. As Lynn said a little bit earlier, we are being a little bit cautious with the way that we're handling the commercial aerospace recovery within our surface treatment business, given that it's primarily a shorter order cycle business and more heavily focused on wide-bodies. But even where we don't have the orders coming in, in advance and it is a short cycle, we are continuously talking to our customers, and we do feel like the ramp is coming. They're coming to us and asking questions about our readiness. We are ready for that ramp and we think it's going to help to improve the second half of the year. So we started '21 a little bit down mainly based upon some of the pressures in what we've seen in wide-body. Certainly, the Boeing 787 announcement didn't help, although that is a very immaterial part of our overall commercial aerospace portfolio. But we expect narrow-body to ramp as the year progresses heading into 2022. And it's probably too early to comment on 2022 at this point in time, but we're expecting a steady ramp. We just had our Investor Day back in May. I think as we look at the cycle a little bit longer term, we expect narrowbody to recover by '23 and widebodies going to come in a little bit slower, maybe '24, '25. But overall for our entire commercial aerospace market, and probably about an average at '24, we'll see that recovery to those 2019 levels. I don't know if you want to add anything on...

Yes, I would just add just a couple of comments that, as Chris opened, we are very -- right now, a lot of our commercial aerospace business is with the OEMs, Boeing and Airbus. And right now, we're focusing a lot of our business development efforts on some emerging opportunities and emerging platforms in the business jets and the all-electric aircraft. And this is an area where, again, we've got some technologies that fit very nicely into the needs of the various people building out these new capabilities and driving from more green initiatives. You might have seen our press release with Eviation and applying hardware for their flight tests program. And we're pursuing quite a few more things like that, but I think down the road as electric aircraft or more green and energy-efficient aircraft are really the focus that we're really working hard to make sure we're well positioned on those types of platforms.

That's very interesting. A previous presenter sort of alluded to the fact that higher in the electric -- with electric aircraft, you're probably going to have incrementally higher content with electronics and systems like that. Is that a fair statement would you say from a Curtiss-Wright point of view?

We're working hard to make that the case, yes. So, yes, we do see, I mean, not joking. We do see that the shifts and the types of needs definitely go with where we have made investments that started with really ground electrification and more efficient engines and that types of stuff that are definitely moving to the air. So we do think we're well positioned in that space.

I would also just add really briefly that some of the work that we do today in electrification electronification supporting the vehicle markets is technology that can be transferable over to the defense markets, whether that's air, land or sea and we're really excited about those opportunities. So I think there's some good synergies here between segments as we look at the future of the battlefield.

Yes. Very interesting. Maybe switching over to nuclear power, Chris, that market. How would you describe the short- and long-term outlook and what's going on there now?

Yes. So similarly to most commercial markets or businesses that we're facing the pandemic last year. I mean this business took a little bit of a step backwards and it was mostly based upon social distancing and our inability to kind of get into the nuclear power plants to do the aftermarket and service work that we do. But we have, again, seen a very steady -- slow but steady recovery in these markets. We were a little bit down in Q1 of this year, but we did have a fairly strong Q2. We were up 10% year-over-year, mainly based upon U.S. [ MRO ] and plant life extension work. As we approach the second half of the year, we were expecting a fairly strong ramp in H2 that will be the outage season for us this year. And we are also starting to see some increased development work coming out of the DoD based upon their 10-year strategic plan. So overall, for '21, I think we're going to see low single-digit growth in our domestic aftermarket in [ DOE ] which will mainly be offset by some headwinds that we're facing on the CAP1000 program as that program winds down. But things are good on the domestic front. We're getting good funding coming out of the DOE international aftermarket is more flat to stabilizing. I'm saying we're not really seeing a lot of recovery or exciting things coming out of the international space at this point in time, but we expect to see more of that this next year. And as we look even further out at our recent Investor Day, we said that we expected the nuclear aftermarket to grow at a low single-digit growth rate for the next few years excluding our AP1000 headwinds that we're facing. But there is a lot to be excited about in nuclear. I think everything that's going on right now with the Biden administration and with the strong bipartisan support that we're seeing is exciting. And I don't know if you want to talk a little more on that?

Yes. I think you touched on a lot of really important points, Chris. So thank you for that. And I guess something else that's been very encouraging as there's a lot of spending bills being proposed in Congress. It's really great to see there has been very much an increase in bipartisan support for updating the power infrastructure and very specifically, including nuclear in that. So we feel good about that. we've been talking a bit about recently on our participation in many of the small modular reactors and the advanced reactor programs and are trying to get some insights to those on what we're winning on those. We've been very public about our position on new scale to date. I would say that where we have $40 million potential per site. We recently announced our win that we secured with X-energy on the High-Temperature Gas-Cooled reactor. And so we're trying to -- as we can with our customers, demonstrate the traction we're making in this area as we -- some of our technologies are finding homes in these new reactors that we really see being part of the energy solutions in the U.S. and around the globe going forward.

It's very interesting. At your Investor Day, you talked about your willingness to lever up for the right deal. Where do you stand today? And what is the limit on that on your comfort zone for leverage?

Okay. Yes, we're really excited about the position of our balance sheet. We've worked very, very hard to bring our working capital percentage of sales down since we started the journey towards -- that we did back in 2014, and we started off, I think we were somewhere in the range of about 32% working capital sales. And today, we're down at 23%. We have more opportunity to go. But that strong cash flow generation is going to fuel our capital allocation strategy and not only do we feel like we have strong free cash flow. But based upon the position of our balance sheet, we feel that we have an opportunity to lever up really to support that capital allocation strategy. At the end of June, we had a net debt of about -- net debt to capital of about 31% and a debt-to-EBITDA of about 2.2x and we view anything under 3x to be within investment grade, which really allows us to retain that attractive pricing when it comes to the financing markets. And we have an active acquisition pipeline. If the right opportunity becomes available and supports our pivot to growth strategy, and we're going to go on out there, and we're going to seize it. In May, we talked a little bit about our balance sheet and how we could use that to support our capital allocation strategy, and we demonstrated or showed that we can comfortably execute a $400 million acquisition every year, similar to what we recently did with our successful acquisition of PacStar and remain below that 3x debt-to-EBITDA level. So we have a real opportunity in front of us here, and we're excited to be able to use our balance sheet with a little bit more emphasis here to support that strategy. Now I would say that transformational deals don't come around all that often. If we did run into a transformational deal maybe we might let our debt-to-EBITDA get up somewhere in the 3.5 to 4x range. But our intent will be to quickly delever back down below that 3x level with free cash flow from the acquisition. So I think we're well positioned.

And maybe as we're running out of time, I'll ask sort of a summation question to you, Lynn. In 5 years, where do you see Curtiss-Wright going? What's your vision of a 5-year outlook?

That's more than a wrap-up question -- to give a meaningful answer. So I believe that we put out near-term targets for 2023 at the Investor Day with a range of top line growth from 5% to 10%. I believe we can drive the market capitalization of our stock up to be double what it is today and really deliver on creating strong shareholder value and continue to shape the portfolio of the company to really be in highly engineered products and severe applications. I don't see us deviating far from what is that core type of direction that is a great fit. And I think there's a lot that we can do within that space that would allow us to really build out in the key markets that we're in.

Well, thank you so much for being with us today. Lynn. It's really great to meet you and Chris, and hopefully, we can get you back in person next year. Great job. Thank you.

Thank you.

Okay. Thank you.