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

Good morning, everyone. Welcome to the Stifel Cross Sector Insight Conference. With us today, we have Curtiss-Wright. We have Lynn Bamford, Chair and CEO; and Chris Farkas, VP and CFO. So today's format, I'm going to start with 3 bear cases, followed by 3 bull cases to help better understand the story.

So with that, let start with bear case #1. About a year ago, Curtiss-Wright held an Investor Day event and issued top line growth targets of 3% to 5% organic and 5% to 10% total growth. However, over the last 5 years, the portfolio has seen roughly 1% organic growth and roughly 3% total growth, which suggests that those targets may be difficult to achieve.

Thank you, Adam, and welcome, everybody. Thank you for joining us today. It's my pleasure to be here and speak with you. So just the elevator ride introduction, if you're not very familiar with Curtiss-Wright, we're a globally integrated company that focuses on highly engineered products. Our two-thirds, we service the A&D markets, but we also service some very specialized high-demand markets in the commercial power, process and specific industrial types of markets. The question is very reasonable. And depending on your history with Curtiss-Wright, you might know that back and around the 2013 time -- '13 time frame, we really took a pause from acquiring and really focused on driving some financial metrics, put a lot of focus on operating margin, working capital, free cash flow, and we're very successful at driving those improvements across the corporation. We also took quite a few actions to divest some portions of the portfolio that we did not feel fit well or would be part of a long-term strategic fit. Some of those were in oil and gas, some were build-to-print products in the commercial aerospace. So really a time of making ourselves a company that we felt had an integrated portfolio that was ready to be successful as a combined company. So that backdrop really, I feel has set the stage for the pivot to growth. That -- we've accomplished that journey, we've reached our target of 17% operating margin last year, we put forward targets -- financial targets at our Investor Day that show what we continue to intend to drive financial performance, but really add the top line focus to that. And I think that similarly to how we really put some really specific rigor around driving the financial targets back 7, 8 years ago, we've put a similar amount of rigor around driving our pivot to growth over the past 1.5 years. We've introduced growth council, and innovation and operating system, and various things that I think are putting the processes around it, and we've done some modifications to our incentive program to make sure that we're making it clear to the management across the corporation that we are targeting growth. And growth is a corporation, for example, in our long-term incentive program, it's growth of the total corporation, not individual groups to really make sure we're emphasizing the collaboration and to working across the corporation. In addition, there's been some things that since we put forward those targets back in May of '21, that I would say are good market influences for Curtiss-Wright. There was a lot of uncertainty around U.S. defense budgets at that time. I think we have seen that the focus out of the current administration, support for the defense budget share up with what was passed for '22, what's being proposed for '23. So I feel like that's a very good tailwind for us. Clearly, the unfortunate situation in Ukraine has led to renewed focus across NATO countries to shore up their defense spending. We have a very good footprint, both through a lot of the foreign military sales will come through U.S. companies and then directly into Europe to be able to be participate in some of that increased spending. And then the AUKUS proposal out of Australia, surely will provide tailwinds to Curtiss-Wright. So across our defense markets, there's a lot of things that have happened internationally that will support our pivot to growth. And then if you turn to commercial markets, just picking one, for example, across commercial aerospace tends to -- is on path to rebound at a pace faster than we had even anticipated last year. And many good tailwinds around the nuclear industry. And I would remind everyone that our 2023 targets do not include an anticipated AP1000 order. And really since the time of having our Investor Day, again, tied independent of the situation in Ukraine, but then driven by the situation in Ukraine. I think the world recognition that nuclear needs to be part of a carbon-free footprint has only increased. And with that, we feel even more optimistic about our future with Westinghouse to build out AP1000 plants around the globe, along with other commercial nuclear, the Gen IV type of reactors or participation in that, that there's both the nearer-term market trends and then longer-term trends around nuclear energy, other green initiatives and ways that we participate in those industries makes me very confident about our pivot to growth strategy and our ability to achieve the targets we put forth in May of last year, and then build that out in the back half of this decade.

Thanks, Lynn. That's very helpful. We'll move on to bear case #2. It doesn't make sense to have all these different businesses together in one portfolio. There's not a lot of synergy or cross-selling opportunities between the various businesses.

So I would open by commenting that we hold a very strong leadership position in the vast majority of our end markets. And so that's a great place to start from. And we believe there is a lot of synergies and integration that's possible through by working more as One Curtiss-Wright. We started the journey of One Curtiss-Wright, again, 7, 8 years ago. And that was really with a focus on back office types of activity to take costs out of the organization, and have more integrated G&A types of functions. And over the past 1.5 years, we've put a real emphasis on creating the processes and the systems to be able to make sure we're maximizing our ability to work together as an organization to attack our end markets. And it's been great, we put the systems in place, whether it's the innovation operating system to make sure that people have visibility as to what opportunities people are assuming across the organization and then to participate in supporting that. We found a lot of examples of doing this. And I do want to emphasize -- we're looking for these areas where we work together collaboratively and whether that's leveraging a customer relationship to bring a product in, leveraging engineering capability across the organization where people have expertise that can be -- help solve problems across the organization or really work together on a joint project to bring a better value to our customers by bringing capabilities from multiple divisions together for a better value solution for our customer. And I think we've found examples of all of those. We've built some examples just to put forward our -- we've developed flight data recorders, cockpit recorders for military applications that we've now taken into commercial applications. And our footprint with the commercial aerospace customers and our knowledge of their business practices have allowed us to be successful in bringing that technology across. We've taken our pumping technology from Navy nuclear into the commercial oil and gas market. There's just many, many examples where we're being able to take technology and read it across end markets. Also, the examples where we're working with our high-power electronics as we move to electric actuation, put forth the press release with aviation about working with them for the first demonstrated all electric aircraft, and that was a collaboration across the division. So again, we've opened up the communication and put some structures in place to really encourage the teams to work together to be able to find these things. And for me, as CEO, I would say something that's really exciting is this wasn't something that took a push to get the employees at large to embrace, it's something I think the teams have been hungry for is to really dive into who Curtiss-Wright is as a corporation and take their skills and talents and use them for the best of the total corporation, not just the specific business unit they've sat in. So as we've put the structures in place to encourage this, the employees absolutely have stepped right in and made this reality. And so it's really rewarding to see.

Great. On the bear case #3, all the margin improvement from internal initiatives is in the rear-view mirror with costs taken out and restructuring largely complete. It's going to be more difficult for the company to expand margins going forward.

So, I'll take that one. Lynn had mentioned that we started our operational excellence journey back in 2013. And if you look at Curtiss-Wright and where we were at that point in time, we were a high single-digit operating margin company. And this last year, in 2021, we achieved a record 17% operating margin. We have businesses that are incredibly agile. Just as an example, if you look at what we're able to do in 2020, we entered 2020 with a recession pay book in hand. We had restructuring plans, we encountered the pandemic as everyone did, and we've modified those plans and accelerated them in some ways. But we suffered a drop of $300 million of commercial revenue instantaneously. And within 9 short months, we were able to mitigate that margin decline to only 20 basis points across the entire corporation. We have a lot left in the sales, I think as you look forward and where we're heading. At our May Investor Day this last year, we communicated our new operational growth platform, which builds upon the strong foundation of operational excellence that we have as an organization and focuses management time and attention towards those things that drive profitable growth. So things like accelerating innovation, deploying strategic pricing programs, commercial excellence programs or even trying to enhance collaboration between business development, sales and engineering in the organization. And it's been successful so far. We're really -- the team is excited, and we're seeing a lot of good things come out of that, and that will help our pivot to growth. But beyond that, it will free up monies that we can use to contribute to incremental R&D investments. And we've done that over the past 2 years, we've had fairly substantial increases as we're trying to seize opportunities that exist within the markets. It'll also provide us with an opportunity to find critical IP adjacent technologies that may be -- aren't at the 17% in year one, but we need a little bit of coverage and the initial dilution to get them into our operating systems and up to speed. And if we can't find those opportunities and we don't make those conscious investment decisions, then we'll provide operating margin expansion going forward. Throughout 2022, like most companies, we've been heavily focused on mitigating the effects of inflation, we got a jump start on that. This last year, we engaged the organization, work with people to identify where those early warning indicators were for inflation, and we've adjusted our pricing and operational excellence practices to be able to compensate. This year, we are projecting in our guide to provide additional operating margin expansion and things have been successful, and we're excited about it. Going forward, beyond 2022, what we said in our targets is that, operating income growth will be faster than revenue growth, and that implies continued operating margin expansion. The team is engaged. We're dedicated. We've got a long successful track record of being able to execute to our targets, and feel confident that we're going to be able to deliver profitable growth going forward.

All right. Thanks, Chris. And on to the good ones, we have bull case #1. Increased growth investments offer the opportunity to further differentiate Curtiss-Wright's product offerings, gain share and drive above market growth across a number of businesses and markets.

Thank you for that. And on to the more upbeat question. Thing goes. So we absolutely believe that to be true and really believe that we really are at a great position with where we sit with our technologies and the dynamics going on in our end markets. So we're really passionate about taking those R&D dollars and really making sure we're doing the best things with them as a company. And I guess, as I speak to that, I'd step back for a second. When I think about Curtiss-Wright and our engineering spend. We spend almost equal amount, it varies year-to-year, but on customer-funded engineering work versus internally funded engineering work. And I think about that pot as a total and really making sure we're using that engineering spend for the best purpose for growing the corporation over time. And just because a customer is willing to pay you to do something and your engineering costs we cover doesn't mean it's the best use of that very precious engineering talent to grow the organization. And so we're very judicial about where engineering spends in. It's a journey, that something I'm very passionate about that we started 1.5 years ago, it's still a work in process, but really assuring we have greater leadership oversight of how that engineering gets spend, and that ties into our innovation efforts. But setting that aside for a second, I'll come back to that, is really the better -- greater oversight and use of that engineering spend to grow the organization. And as Chris just mentioned, we have increased our R&D spending, and we were very proud in 2020, we actually increased our internal IRAD funding by $2 million, increased at $14 million last year and intending to increase at $8 million more this year. So that's pretty steady ramps of spending. And we believe it's the right thing to do for the corporation, given our end markets and where we are at inflection points of bringing those technologies to the market that are going to allow us to grow. And just a couple of examples of those. From the defense side, one I would highlight is, across our defense electronics group. There's a -- started a couple of years ago, the move towards the MOSA standards across all services of the U.S. defense budget. And we very quickly jumped on that and started building out our portfolio of products to have a world's best leading set of products in that space and have spent a lot of that incremental R&D I just referenced in that area and continue to work on that as we feel that, that is going to provide growth for many years to come and very profitable growth. If you look at our margins in that segment, it's almost profitable portion of the business. So it's a great place to be investing. But if I flip to the commercial half of the business, we've established a very nice position around the electric drive chain for a lot of the electric and hybrid vehicles that have some great technologies we're bringing to the market there and making sure that we take those core technologies and very frequently you have to tailor them for each application to fit a specific vehicle and making sure that we have the engineering resources to be driving those types of innovations and making sure we can maximize our footprint and coverage across electric vehicles, that's 2 examples of where we've really made sure that we're targeting our R&D investments. But the other side to R&D is to making sure, as a corporation, we are bringing forth the innovative ideas that come out of our employee base and making sure that there is an opportunity for them to surface, Curtiss-Wright has about just under 8,000 employees and about one-fourth of them are engineers. And I would say I don't think only innovative ideas don't only come from engineers, but a lot of them do come from engineers. But our innovation platform is open to every employee across the company to bring forward ideas to help us improve our technologies, take our technologies to new markets, improve our processes to make things more efficient. And that -- those ideas are visible to all the employees across the corporation, and people are encouraged to make comment and provide input on those ideas to help improve them and vet them out from a business case type of scenario to bring them forward. And so that's something that's really an exciting and new with Curtiss-Wright within the past couple of years. And is continuing to gain traction with the employees. And we review it monthly as a management team to see how many ideas are being put forward, how they're moving through the system, what the participation rate is. And so, it's something that's very much been ingrained into our culture. So both the innovation ideas to just bring forth those ideas and then the assurance that we're allocating R&D dollars to the best ideas that are going to create the best value in the marketplace is very much a focus for me and the leadership team across Curtiss-Wright.

Great. On to bull case #2. Capital allocation has been a source of significant upside with the company buying good product -- properties at very reasonable prices and then 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.

Thank you for that. I think maybe I'll make some more broad comments and then turn it over to Chris to maybe talk a little bit more deeply to the financial way we think through the use of our capital. So for a long history, Curtiss-Wright has prided themselves in a very disciplined approach to our capital allocation. And that continues on -- with myself as CEO and into the future, and I think we've really demonstrated a great track record of the use of our capital and a balanced approach with both returning capital to shareholders and using capital to grow the company. We've been very purposeful to say our #1 target for use of capital is acquisitions, but that does not mean that we've lowered our filter or our criteria for using the capital to buy a company that, that remains very high. And that includes both a strategic fit from a company that we really can see comes into Curtiss-Wright. And we, as a corporation are better, that company is better as part of it, that it has unique IP, it brings value to the overall portfolio of products that we take into the marketplaces. And then it has a financial fit that it can be accretive to the financial metrics that we've achieved as a corporation and where we're driving this company. And I would say, in 2021, we've entered into the process with, I would say, double-digit numbers of companies that we looked at in the diligence process and chose to step away from, because they did not meet either of the strategic fit or we did not see the path to the financial fit. And as evidence that we've continued that rigor in how we evaluate companies. We're very excited about the Safran acquisition that we should close at the end of this month as being a great both strategic and financial fit for the corporation and a great example of the rigor that we put to this process.

Great. Yes. So just in summary, we have a very strong balance sheet and healthy free cash flow generation each year. If you step back to the 2016 time frame, we've spent $3.3 billion towards our capital allocation strategy and $1.4 billion of that has gone to high-quality acquisitions. We bought 7 companies over that time frame, acquired $450 million of revenue, 6 were in the A&D space, one was in the commercial space. I think it's more about the technologies, making sure the IP is critical and adjacent to what we are offering today as we look at what we're targeting. But as you think about where we're headed going forward and what we have at our -- are ready. We have a very large capacity and the ability to go on out and leverage ourselves to another $1.4 billion. Now we're a conservative company. We like to maintain our leverage in that 3x or below debt to EBITDA type of rating. That's where our bankers like us to be, and that's what allows us to get very attractive rates in financing. We recently went out understanding what's happening in the interest rate environment and upsized our revolver from $500 million to $750 million and also increased our accordion feature from $200 million to $250 million, just to provide us some additional flexibility as we move forward to support that capital allocation strategy. But Curtiss-Wright is very focused and conscious in continuing to improve our cash flow for the use of our shareholders.

Thanks. And lastly, bull case #3. The current geopolitical environment with the war in Ukraine creates long-term business opportunities for Curtiss-Wright. European defense spending is likely to increase significantly and the desire to eliminate reliance on Russian oil and gas will likely involve nuclear as part of the solution.

So I would open by saying the situation in Ukraine is very sad and our sympathies go to the people of Ukraine and hope for a swift and successful resolution of the situation, just to set the table before we speak to the business impacts of that situation. But it clearly has impacted defense spends here in the U.S. and specifically across NATO. And those are good business opportunities for Curtiss-Wright, that the increased spending in NATO comes maybe partially through FMS types of buyings where they're coming into U.S. companies and buying different products, whether it's F-35s or some announcements over the weekend, first Chinooks being bought, just various different F-15s, F-16s you can really go down the line of things that are being planned to be bought. But equally, that increased NATO spending is going to go towards ground vehicles. So I think clearly, the terrible situation has been proof positive of the importance of having the ground vehicle fleet in Europe. And I think it has brought forward to NATO countries that we were under-prepared in that situation for that. And hence, a very urgent need to fix that situation that -- and that is an area where we have European businesses that have been very active over the years with the ground vehicle manufacturers across Europe, NATO Europe to be able to be a partner for the building out of those ground vehicles. And something that's been a relatively flat portion of our business over the past couple of years as funding was kind of routinely taken away from those programs. But nonetheless, we've persisted and worked with those companies to build out prototypes and be prepared. So we feel like we're very well positioned that as, there is a desire to spend money and have product as a result of that in the near future. The work we've done has positioned us with those companies. One example that we can talk about publicly is, we press released our partnership with RBSL, which is a joint venture between Rheinmetall and BAE U.K. To build out the Challenger 3 tank. Now that didn't happen because of Ukraine, but it was surely maybe accelerated because of the situation in Ukraine and our partnership with Rheinmetall is much broader than that, and our belief that we will win ground-based vehicles across the European build-out is very good. So that's one aspect of the situation in Ukraine that is driving their very obvious need for better defenses. But equally, it is having an impact on the energy industry. And clearly, you can't turn the news on, and you don't hear the desire to have European NATO countries cut their dependence on Russian energy. And I think even before the invasion, there was a realization that this was going to have to include nuclear energy as part of that solution. Westinghouse had made -- who was a great partner of ours, had made some very significant advances before even February 24, was signing some memorandums of understanding in Poland, Czechoslovakia, Romania, just to name a few, to build out a nuclear fleet. And I think that, galvanization that, was needed before February 24 has only gotten greatly enhanced since then in the sense of urgency to really make that a reality even more firm. And we've seen some steady movement of the activity that's going to be necessary to make that happen, at a pace that's not typical in that industry since the February 24. So we're very optimistic about our nuclear build. And that's -- AP1000, first and foremost is there's a lot of known decorations of Poland wanting to build 6 plants, Ukraine going from building 5 to now 9 plants and other countries. But also blended with some of the Gen IV SMR types of technologies that a lot of those countries are realizing that they need a blend of the AP1000 larger plants and some of the smaller Gen IV type plants to meet their energy needs. And that's an area we've been very active in over the last 3, 4, 5 years of making sure we've positioned ourselves with the Gen IV power plant producers and have significant content with them to participate in that market expansion. So as unfortunate it is the situation, it does show the criticality of the products we make for a safe and secure world, and we're proud of what we provide to participate in that security.

All right. That concludes today's presentation. Lynn, Chris, thank you.

Thank you, Adam.

Thanks, Adam.