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

Okay. Thanks. Good morning, everyone. My name is Peter Arment. I'm a senior aerospace defense analyst here at Baird. We are delighted to have Curtiss-Wright Corporation with us this morning to kick things off day 3 of the conference. And with us from Curtiss-Wright, we have Lynn Bamford, who's Chair and Chief Executive Officer; and we have Chris Farkas, who's Vice President and Chief Financial Officer. So Lynn and Chris, welcome. Thank you very much for coming. Appreciate it.

So I guess let's just start with the most popular topic that seems to be emerging in the last -- well, over the last year regarding nuclear. So you've received some strong public and government support for your nuclear exposure. You recently signed a deal with X Energy to support their reactor development. Where are some of your largest opportunities when you think about small molecule reactors, advanced reactors? And maybe just help everyone understand what you're thinking about on time lines.

Okay. Thank you for that, and it's a real pleasure to be here today, and thank you for everybody who's here in attendance or possibly on the phone. Just to open today's conversation may include some forward-looking statements. Those are not guarantee of future results. Just do my [indiscernible] duties. So with that, it's -- even before I touch -- we've spent a lot of time talking to a lot of people. The nuclear content has been a big focus of discussion, and I always don't want it to overshadow the strength of the breadth of the portfolio and what's going on across the business, both in defense and ordering to come to some of these topics in our industrial businesses. And it is the thing that's kind of the hot topic for a really good reason because there is a lot of really exciting things going. But for us, as leaders of the company, we're managing the total business and driving success across all of those end markets. And so I think that's important, if you're less familiar with Curtiss-Wright, different people, different exposure, to understand that we are a multi-industry business, and we got great things going on in all of our end markets. But moving from that, I think one of the things that's really exciting is there's very strong bipartisan support for returning the U.S. to being the nuclear powerhouse in the world, and that obviously commercial, but then that feeds into the military, where we have a very strong presence also. But this started back in 2020 under the prior administration with the funding of the ARDP program for developing future advanced reactors. So sort of the Gen 4, you'll hear it as different things, small modular reactors, advanced reactors, Gen 4 reactors, kind of all is geared at this kind of next generation of reactors that have an entirely different safety footprint, cost footprint that makes them very viable for, really, providing clean energy, carbon-free energy for the globe. And we've been very active for quite a few years working with the companies that were starting this. We've talked about our content with NuScale for several years that the team is very passionate about this and very aggressive in understanding who's developing these reactors and making sure we're securing meaningful content on all of the major players. And very, very pleased with our partnership with X Energy and to announce our strategic alignment with them to provide 3 of the major safety systems on the reactor and then a variety of other content also. And that will be announced in our press release, equal $100 million plus of content per 320-megawatt reactor. So significant business. If you think of replacing an average coal plant, it would probably be 2 of those 320-megawatt reactors, so $200 million of content for Curtiss-Wright. And there's a lot of funding that's going on to support, a, first, the existing nuclear fleet, which is an important part of our business and doing the aftermarket work and the existing fleet to help stop the slowdown of reactors, which is a really great thing to see. And we're seeing great strength in our order book on the work that goes to the existing nuclear fleet. Here in the U.S., up in Canada, in South Korea is our main markets today. And as that base of reactor stabilizes and there's no more shutting down of reactors, really gives us an opportunity to grow. And then as they continue operation, they need to apply for additional license renewals to operate from the 60- to the 80-year time frame, and that drives even an increased amount of ACRA market work. So funding for that in -- across the infrastructure bill, the Inflation Reduction Act. And even in the CHIPS Act, there is funding that's really driving the build-out of nuclear across the U.S. And so it's great to see all that stuff. We're pleased with our partnership with X Energy, but it's also important to note that there's a handful of major players that are going after the larger small modular reactors, and we are very much pursuing content with TerraPower, GE Hitachi, Rolls Royce to just name a couple of the more prominent names. But the team is very systematic about knowing who always developing these reactors in countries we want to do work with, obviously, and making sure that we're sharing what we can do to support them in the building out of their reactors, make sure we're maximizing our content. So it's just -- it's a great time for a portion of our portfolio that has been just fighting the headwinds of reactor shutting down over the past decade and not much new going on or not much support for the new going on to a complete sentiment change from that here in the U.S. And then you move overseas. And obviously, the unbelievable changes in Europe driving the absolute essential need for energy independence is really driving interest in a lot -- building out a lot of these reactors. So it's a pretty dynamic time, and it's a great position for us.

Yes. So just to back up on -- when we think of the X Energy agreement or just small measures, help us understand kind of that time line that you think about where it would start to impact Curtiss-Wright?

It's a great question. Thank you, Peter. I didn't touch on that. So we're recognizing revenue in 2022 with our work on X Energy as we do really the design phase. And we're publicly talking about our relationship with X Energy, so I can speak to that. We are working with the other players, but nothing that we really want to put forward in the public forum yet at this point. But recognizing revenue with X Energy. And if you think that $100 million plus of content to build out 1 of their 4 packs, which they are committed through their funding through the ARDP program to have online in 2028, and you back that up, that means we need to be building those prototype systems for them in the 2024-'25 type time frame to get to them so they can build out the reactor and prove out their reactors. So that's just the one advanced reactor that they're building for the government from receiving that funding. And I think the much larger question is as people are seeing interest, they've already signed like a memorandum of understanding was Dow Incorporated. The Dow was one of these reactors. And so I think -- and interest elsewhere that's not been announced yet. But as these companies want these, they're not going to wait to try. I don't believe -- and I don't think even believe that they're going to wait to 2028 and then say, "Okay. Now you've proven it, I will place my orders." They need to get in line to be doing things. And I mean this is a very known technology. And as the design is stabilized, I think we can start working with them to help building parts that will be -- help them be ready to provide more reactors. And so the middle of this decade is going to be a really great time for Curtis-Wright as that business ramps up in a very exciting way.

Yes. Terrific. We look forward to seeing more announcements there. One of the areas that you've also received attention is just regarding with your relationship with Westinghouse in sort of the larger the AP1000 design. You've been selected -- Poland has been selected Westinghouse to move forward as their first nuclear power plant and which is pretty exciting. Maybe just share some details on how we should think about Curtiss-Wright involved in that order, maybe revenue? And Chris, if you want to touch upon profitability because those of us who have followed Curtiss-Wright for a long time understand it's a pretty profitable business, and so it's nice to see it returning back.

Yes, yes. It's really exciting, and we've been delivering the tail end of our -- prior China direct order is winding down, and so it's great to see this new development. And for those of you who listened to our calls, we have had some contractual disputes with Westinghouse that we put to bed at the end of last year. And in February of this year, announced that we had settled all of our issues with Westinghouse, just for those of you who would be aware of it. And we've always had a great relationship with Westinghouse. That just put it to bed and back locked arm and arm of helping them pursue these opportunities, which have just accelerated from what we thought would be a great set of opportunities, but the acceleration with the war in Ukraine and just the increased sense of urgency out of these countries to have energy independence is just amazing to see. And they -- just last 2 weeks ago, it was announced that Poland has selected Westinghouse to build out 6 plants for energy production. It looks like they're going to contract 3 first. The time line that was presented by Poland prior to the Ukrainian invasion was they wanted the first plant to be online in 2033, which meant hard concrete in 2028, which meant long lead orders in 2024. We stated in February of this year, we thought we'd get an order in 3 to 5 years, saying those things take longer than anticipated, not less. So -- but if you say, surely, the situation and the desire for energy independence, whatever it was in January of this year, it's radically different today. And so we've definitely seen the pace of activity around in Poland, specifically, but elsewhere, too, but of them signing up their partners, doing their FEED studies, getting EPCs in place. It's just been wildly different than what we would have expected. So we feel very optimistic. We'll be on the short end of that time frame, and there's a chance it would even be earlier, but it's too early to predict anything specific. But it's not just about Poland. Ukraine has already done things to apply for their licenses to build out as their energy infrastructure has been clearly destroyed in that country. Then Bulgaria, Romania, Czechoslovakia, Slovakia, just across the region, people are looking for a way to have energy independence. And nuclear is clearly the go-to, and the AP1000 is today the world's safest nuclear power plant and performing in China very reliably. So it's a great solution that exists today, and we're definitely seeing the uptick of that in kind of similar time frames, and we will see when the order comes from Poland or whoever is first. It could be Ukraine for that matter. They've already done a lot of their work, too, and there's a lot of IMF funding to support them to help rebuild that country. So a great future there also. .

And just to put the financials into context. The last time that we got into a contract with the AP1000s was China. In 2015, the RCPs was a $450 million contract for '16, so $28 million a piece. -- this is a big -- this is a lot of sales and were $2.5 billion organization. So contracts of the size can be meaningful. The profitability on that contract, while we haven't gone into specifics, we've said 23% plus, plus is what we recognized. And Curtiss-Wright's margins are very strong at 17% today, 17.1%, 17.2%. This is accretive to Curtiss-Wright's margin. So if you start to think about the first 3 plants being 12 months and the next 3 plants being another 12 months, we're talking in the range of $650 million of revenue.

Just to any CapEx that you think that you'd have to go through a CapEx cycle to maybe support all of this kind of effort, whether it's small modular reactors or just supporting the AP1000.

So it's something we're definitely having some very, very exciting discussions about.

Good question.

Good question. A lot of the teams that do this were -- at some point, there will be capital expansion. We have a room to address Poland without any capital expansion. But if you start thinking of Poland and some of these other countries and small modular reactors coming, there will be some capital investment. It's not of any like earthshaking number, and I think we'll probably handle it within our normal 2% that we invest in the company from what we're seeing to date. I mean there are scenarios that, that could be pressed, but these are great scenarios for Curtiss-Wright. So nothing to maybe capital we'd be happy to be spending. It would be fantastic. So...

And just to put a finer point on this, you are the only one in North America, right, that has a -- that makes producers reacting colon pumps?

Absolutely.

Right. So the competitive landscape is pretty attractive okay. Well, let's move over to defense electronics. You faced some several challenges in your supply chain throughout the past 12 months. Maybe what are you doing differently going forward? And what lessons learned? And how do you expect to see kind of the supply chain headwinds going forward?

Yes. So for those of you who listen to our Q3 earnings call, we fell a bit short of where we expected to be in our Q3 revenue and called down our full year by $45 million, and that was specifically in our Defense Electronics segment. So disappointing and a hard reality for myself and the team to accept was the reality, but it was a reality. And for transparency's sake, we wanted to go ahead and forecast where we really believe we are confident we could land at the end of the year. And it's just -- it's been a very dynamic environment. If you've listened to our calls, you've heard us talk about decommits. And as much as we planned for a ramp in the back half of the year from the beginning of the year, we've been talking about that and have done things with staffing, test equipment, different things to prepare for that. As Q3 progressed, we continued to get decommits from our suppliers. And by that case, that doesn't mean something to you. Or expecting to get chips from company X, and we're expecting 5,000 of the chips. And we get 3,000 instead of the 5,000, and they just say sorry. And we walk through one example in our earnings call from one supplier that just had thought they would get us a whole bunch of chips in Q3, and they have a supply chain issue. And so one of the things we've talked about doing, and I think that's important to note because one of the things we've talked about is we've really increased our connection with our supply base at an executive level to really make sure they understand the importance of us receiving these chips. And we have done that, and it's been effective in many cases. But in this -- the case we walked through in the earnings call, they had a supply chain weakness. And so wasn't a lack of commitment to Curtis, right? It was a breakdown in their supply chain. But it's something we've talked about with a few people yesterday is the implementation of the DPAS ratings, which is a government requirement that gives military applications, priority for electronics over commercial applications. The industry is not really set to implement that in a systematic way. And so as much as we've been doing it and sharing it, they don't have the systems all the time to set it up, and then they don't flow it down to their suppliers. So it's really been a learning process across the industry to implement that. But what we do with the supply chain. But in addition, we very much work with our customer base to help them and encourage them, and they've been very open to this, to really give us a much broader forecast of what demand they have. So we can pipeline material and do things, advance our life cycle management programs to work with them for cautionary of the inventory we're pipelining. And we've implemented some new tools that will have only come online in the back part of this year to get better efficiency in our supply chain management better scenario planning for the ever-changing dynamic with inventory to maximize the revenue profile. So I think those tools are going to help us in '23. And there is a belief that through the middle of this year -- middle of next year that we will see stability return in the supply chain.

Excellent, excellent. So maybe just staying within defense, when you think about the '23 budget, which was plused up. And now we're just in an environment where we're going to have probably a multiyear elevated spending globally on national security. But when you just look at the budget, the domestic budget fiscal '23, certain areas when that budget that you think are favorable for Curtiss-Wright. And then when you think of what are there opportunities outside of internationally when [indiscernible] increasing their spending? Are there opportunities there?

It's what we've seen of the FY '23 budget. I mean the President's budget was put forward was very positive. The House markups pushed that up to either just over or just under $800 billion. And for us, the important thing is there's very strong increases in the RDT&E and the procurement portion of the budget, which is where we receive most of our revenue from those portions of the budget very consistent, strong support for naval ship building. I mean that is just a rock within support across all portions of the government and parties. And then continued support for modernization, tech refreshes, and those are all the things that feed business into our defense electronic. So we're really -- it's a really good environment, and maybe I'll turn it to Chris to talk a little bit about the international impact to the company and what we see there.

Yes, sure. So as you look at Curtiss-Wright's defense footprint, approximately 12% of our sales in defense are to direct foreign military customers. So that doesn't even include our 35 or anything that we're selling directly to domestic primes that's going internationally. So we call it 7% across total Curtiss-Wright. And that area is actually growing for us this year. We're seeing a good mid-single-digit growth rate in both aero defense and then also ground defense. You may have seen we issued a press release earlier this year for a partnership with Rheinmetall on the British 3 Challenger tank. We've been working to strengthen our relationship with Rheinmetall, and that's kind of a proof point that we wanted to share with you guys because we feel it's very, very important with what's happening with the conflict in the Ukraine, especially within ground defense and need -- in recognition for improved ground defense that there's going to be some additional spending there. So we see that. We're working the relationship. And then as you look across these NATO countries and their commitment to increase spending to 2% of GBP, that could represent $80 billion to $100 billion of spending. Now we're not seeing that -- obviously, that flush of funding coming out right away. But we do think that it's -- we will start to see more meaningful increases affect Curtiss-Wright towards the tail end of this next year. And then when you step outside of the direct foreign military sales that we currently have, it's important to note that we have a very strong content across the key major naval platforms for the U.S. military. So the CVN-80, the Virginia-class submarine, the Columbia class submarine. And on the Virginia cost submarine, we have $75 million of shipset content. And the AUKUS program, which is a strategic partnership between Australia, the U.K. and the U.S., to support the development of a naval nuclear submarine to support the Indo Pacific strategy, where they believe that they're ultimately going to build 8 to 10 of these submarines, they're making technology decisions as to will that be more like an astute class, which is a U.K. sub or will it be more like a Virginia-class submarine. And we believe that Virginia-class submarine is state-of-the-art technology and that, that has -- that we view ourselves as a strong frontrunner in that. And we did have the Royal Australian Navy in one of our shops earlier this year in March, and they were very pleased with the technology, very impressed with what we're doing, found it very hard to replicate. So I think ultimately, what that means is we're anxious for this decision this next year and the direction that they're going to go in. But $75 million of shipset content per se if they go in our direction. So...

Yes. And then just on the -- just sticking on the defense electronics, you had -- I think it was really -- or record orders really in Q3. So just -- so it's -- the demand is there. So just your confidence level kind of seeing that abate as we -- the supply chain as we get into '23.

Yes, thank you for that because it is as much as it's been tough times for that team in managing through the situation, we're very confident that the fundamentals of the business are very sound. And the order book is kind of the most demonstrable evidence of that, that record Q3, record year-to-date through Q3. And I really give kudos to the teams as much as like it's been this very dynamic, difficult situation. They've worked very hard to stay very close with our customers and maintain support for their critical needs to make sure we're prioritizing those, and so really maintain really goodwill with our customers through some difficult delivery times. We pride ourselves on our execution and having very high on-time, on-quality deliveries. And so clearly, those numbers have suffered during this time frame, but we've maintained great connections with our customers and even enhanced them to some degree.

And also maintains your strong margins.

Absolutely. That's -- thank you. You're my best questioner. So really hats off to the team also for -- we dropped $45 million of revenue out of that segment and are maintaining the margins to the prior guidance that are very strong margins, obviously. So the team has done a great job of doing the work to anticipate potential disruptions and be able to adjust and maintain the profitability. So a lot of good things, the hard thing with the revenues, but the team has done a lot of other really good things during the time and driving their cash flow.

Sure. Well, that's good segue because that's -- we're getting to my favorite part of the question is about free cash flow, and I know it's something you guys focus on. Maybe with some of the large items that kind of shifted out of '22 into next year. When we think about free cash flow, including the payment from China for the AP1000, maybe just help us understand some of the moving pieces, how you think about kind of the rationale..

Yes, sure. I'll take that one. So just as a baseline, Curtiss-Wright did $347 million in free cash flow. In '21, we had 116% free cash flow conversion. We entered into this year targeting $345 million to $365 million in free cash flow. Again, we're targeting in excess of 110% free cash flow conversion. This would have marked our 10th consecutive year above 100% free cash flow conversion. So we certainly like to have money in advance of performing the work and have done that well. But we are facing some timing challenges. You first heard Lynn talk about some of the supply chain challenges in defense electronics, $45 million worth of revenue. There's obviously billing and inventory implications there. The team is working very, very hard to offset that. We've got about $25 million of identified opportunities that we're actively pursuing to mitigate the impact of what's happening there. But then in addition, the CAP1000 and the China AP1000 program is a very large and profitable program, as we talked about, and we're in the process of shipping our final pumps under that 2015 contract to $28 million a piece. Now we're owed $40 million of cash upon the final shipment of those pumps. We thought that was going to happen here in the fourth quarter. The customer schedule and production is delayed. So they're delaying us in shipping the pumps, and we're confident that's going to happen this next year. But when that does that $40 million is just shifting to next year. So these things that we're facing are purely timing, and it's cash that's coming in here in 2023. Now I'll just talk a little bit more about what we're actually doing to try to mitigate some of the impacts here. I mean we've been focused on this for 3 quarters. The supply chain problems are no stranger to most defense electronics businesses. And we've been reallocating resources to collections efforts. We've been strengthening our relationships with operations and accounting to be able to pull in money. We are using customer financing portals, where it's a cost effective from a cost of debt perspective. We're going out and looking at our risk and buffer stock and seeing where we have opportunities there, stretching suppliers cautiously given the situation that we're working. And then I mean no stone left unturned. We're looking at taxes and tax elections and things that we can do to defer payments where it makes sense to do so without penalty. But the team is working very, very hard to reach that 100% conversion level again. It's obviously a record we're very proud of, and we want to continue to sustain. But the important thing, again, to remember is it's all about timing. The order book is incredibly strong. Backlog is up 19% year-to-date. The profitability, you had both mentioned, we are improving profitability year-over-year, and it's really all about delivery. So when we deliver we will get that cash, and it's really a timing issue.

So let's end the last like remaining minute here, just capital allocation, just remind us just kind of how any kind of impacts on timing of defense electronics or anything like that. Just your view on M&A and just thoughts in general on capital allocation.

We've been very forthright in saying that M&A is our top priority for capital allocation and broad in -- finally closed on the Safran acquisition here just a few months ago. Fantastic. We put out a press release on a huge order they received from the UAE, and the company is going to just thrive as part of the Curtis-Wright, and exciting to see that. So that's a great example of the type of business we like to bring into the fold. But we've done a significant amount of share buyback over the past 2 years, and that continues to be part of our thinking as we drive our EPS and we put our 3-year targets out back last year. I said double-digit EPS, share buyback will be part of that, and so we continue to always evaluate those opportunities. But we are proud of the way we've been able to acquire companies over the past 5-ish years. Acquired 6 out of the 7 acquisitions have been in the A&D space. So I think that's indicative of our priorities, and we continue to see defense electronics is a great area where we're we still see target properties that we are working with to bring into it like that is a great market. We drive great profitability, great cash flows and the current situation with the timing is just a situation we have to deal with. It doesn't change our strategic focus.

Terrific. Well, we are up against our break. So thank you, everyone, for joining us. Thank you. Lynn. Thank you, Chris. And the breakout room is in Salon A. So please join us there. Thanks so much.

Thank you, Peter.

Thanks.