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

Okay. Good morning, everyone. Thanks for joining us. My name is Peter Arment. I'm the senior aerospace defense analyst here at Baird. With us this morning, we're very happy to have Curtiss-Wright Corporation. Joining us from Curtiss-Wright, we have Lynn Bamford, who's Chair and Chief Executive Officer; and Chris Farkas, who's Vice President and Chief Financial Officer. Lynn, Chris, thanks for joining us. Really appreciate your support of the conference.

Thank you very much for inviting us. It's been a great conference, and look forward to this discussion.

Great. So one of the areas, I guess, we're going to start with is Defense Electronics. It's been kind of a hot area for supply chain disruptions over the last, really probably 2 years, but particularly within the areas that you've been participating. What are the signs you're seeing, kind of in -- the conditions? Is there any stabilization? And when do you think the industry can kind of get back to pre-pandemic levels? Is that still a possibility when you think about that?

Definitely an area we've talked a lot about between yesterday and this morning. So clearly, it was an area that dominated a lot of what we talked about in 2022 is we were really living the life of some turbulent times in the supply chain. I think even in the beginning of this year, we began talking about seeing some stabilization. And I think that's just incrementally improved as we've gone through the year. I would say we're definitely nowhere near back to the 2019 levels. And to your last question, I don't know if we have line of sight on when we think we will return to those levels. But to be more specific, what we're seeing now is the on-time delivery out of our supply base continues to creep up. We're over 90% on-time delivery for the majority of our components across our various divisions in Defense Electronics. But the lead times definitely are still an issue. The lead times, we bucketize our lead times for just getting statistics on how the supply chain is performing. And we tend to think of long lead items as 40 weeks and over. The parts that are in that category -- the lead times have been pretty stable, let's say, very stable and reasonably good on-time delivery. The components that are more in the 20 and 30 lead times, we still see some turbulence in the lead times, and some lead times actually going up in those areas. And a lot of those tend to be older processors, older memory chips that one of the value proposition Curtiss-Wright brings is when we produce a product, we will revision lock it and supply it to our customers, ideally as long as they want us to. And so we have a lot of products that we build that use older chipsets, and those definitely become more on the back burner from some of the big suppliers, and so we need to be really proactive with that. And we've seen some tumult with the supply chain. But I'd say, obviously, we're really pleased with the performance of the Defense Electronics group. We raised guidance again to 12% to 14% growth year-over-year, so pleased with that, and inched up the margins in that group to 23.5% to 23.7%. So the team is really performing well. And certainly, the supply chain situation externally has helped, but I really do give credit to the team and the people working in that group. They've done a lot of things in 2022 from -- we've implemented major new tools that help us have really analytics and predictability around the supply chain or predictability of -- unpredictability might be a better way of saying it, so that we can really proactively manage the situation. So the team has done a great job. The order book is really strong. Our trailing 12-month order book in that team is $983 million. So just really outstanding. And I think it's reflective of the focus we've had on where we've spent our R&D over the past many years, but specifically since the MOSA mandate was put forward between 2019, 2020. And the success of the product offering we've had. So things are going great, and that team is doing a great job.

Yes, I just want to ask you about that MOSA standing because you were kind of preparing for that for a long time. I think you kind of thought that was going to be an advantage for you guys.

Very much so that -- for those -- again, it's an acronym from the industry. It's really an open standards approach to producing the various parts of a computing solution that go into many different applications, whether it's electronic warfare, a mission computer, a radar system. And the government really -- the government pushed the concept of COTS, and it's really the roots of that team's inception for many years. But they really upped it when they put forward the MOSA standard like 3.5 years ago to saying it was going to be a discriminator in decisions made on awarding various systems -- electronic systems. And we very much -- from the get-go, we participated in making the standards and very much jumped on to having the most robust product offering compliant to that standard in the industry. And it has surely served us well with the business we're winning. And if you look on our website, we have a handful of press releases of systems we've won based on the MOSA standard. That's where we can get our customers' agreement to let us do a press release, which is more rare than the norm, but it does give you a sampling of the various types of systems we're winning based on that MOSA standard. Thank you.

Yes. So you did just recently raised your '23 outlook in defense. You're now projecting that you mentioned double-digit growth. Maybe help us understand where you see some of those opportunities and particularly how it's flowing from the '24 budget.

Absolutely. So really, really pleased with what we've been able to see and the order book, as I just mentioned, really demonstrates that we've got a great future before us with this group. But one area I'd point out, we're really seeing pretty strong growth across the various product offerings within that team. But I would say one that stands above the others is really the tactical communications equipment from our PacStar acquisition from a couple of years ago that -- their order book has really been strong, and you can see it in the growth that we're predicting in our Ground Defense business. And I think some of that is -- absolutely, it's the U.S. Army and the U.S. Marines, who are big fans of their equipment. We work very closely with them to continually evolve our product offering to meet whatever the latest needs are from them. But I think we're also seeing the flow, direct and indirect, from increased NATO spending. Their type of equipment is equipment that can really increase the operational readiness of a war fighter in the battlefield. And I think that's also very much supporting their sales. And I think that's going to continue to be a tailwind -- a good tailwind for Curtiss-Wright Defense Electronics going forward. And I think that's just -- that's the type of equipment they can get that they can have it near term and it's impactful to their operational capability immediately. And so I think we're seeing that surge most there. But I think it's just going to continue in whether it's vehicle production or the other areas we've talked about.

It's in all that modernization trend you just kind of see in front of you.

Absolutely. So a lot of retrofits to existing systems, new mission capability. I mean we do a lot of programs that are driving special needs and operational capability on existing platforms. Another area I'd say that's really we're seeing that trend is in our test instrumentation area that there's really a change of mindset, the instrumentation on these very advanced fighter jets isn't do it once and then set it aside and say, the airplane is qualified, that they're continuously changing mission packages and different things that they always need to be reinstrumenting and has almost become a mentality towards a permanent fit on those planes. And so that fits very nicely into our product offering that was from our TTC acquisition back in 2017. So that business has performed outstanding for the corporation and continues just to be a source of growth for us.

And just when we think about Defense Electronics in general, you have exposure in kind of all areas in terms of Army, Navy and kind of airborne and Air Force, right?

Absolutely. It's across the services and globally. So a reasonable portion of that business is sold internationally throughout the NATO countries. And we have good growth factors really across all those. Our 901D acquisition from a couple of years ago really has helped us really start to build out our naval footprint, which was never as dominant of a piece of that business is, the Air Force and the ground. And so we're really just beginning -- early days of being able to see the growth we can drive through that acquisition.

So let's talk about FMS because I think foreign military sales. It seems like it's an opportunity when you think about that, the demand factor there. You just mentioned kind of your global exposure, but also like just what we've seen just since Ukraine happened. Maybe you could talk a little bit about that.

Maybe I'll turn that over to Chris.

Sure. Yes. So when we talk about foreign military sales, we're talking about sales directly to foreign customers. So this doesn't include those sales to U.S. primes that are shipping internationally and the platforms that we support, like the F-35, the F-16, maybe it's a Stryker, maybe it's a Blackhawk. So this is direct foreign military sales. Today, it's about 8% to 9% of our business. And we're starting to see a pickup in order activity this year globally, but also in NATO countries that are committing to increase their spending relative to GDP. And this year-to-date, we're up 15% in that area. So we're seeing it more broadly across our Defense Electronics portfolio. We have a fairly extensive product portfolio serving the aerospace ground and naval markets. So we're seeing it there. We had our Arresting Systems business for fixed-wing aircraft that we bought back in June of 2022. That concentration is 25% domestic, 75% rest of world. But that acquisition this year is growing in the high teens, and so doing another acquisition that's doing very, very well for us. And then we have kind of a legacy rotary wing resting systems business, pulling helicopters onto the backs of frigates and things like that. But that business is doing very well this year and demand as well. So I think as we look out into the future, given the rising threat environment and the alignment of our technologies to both domestic and foreign defense priorities, we see this as a growth area for us in the future.

Yes. So tailwinds in defense for sure?

Yes.

Yes.

All right. Let's switch over to a subject that I'm sure no one wants to hear about is nuclear. There's been a lot of exciting news coming out of kind of Eastern Europe around potential AP1000 reactors. Maybe help us understand how you're sizing the overall demand for Curtiss-Wright in this area.

So it is definitely something we're really looking to -- forward to landing some of those really big orders here. And a lot of people have asked this, probably many of you in this room have heard it, that we think we will have orders within the next 2 to 4 years. And the background giving us confidence in that time frame is really a lot of activity, as Peter just mentioned around -- throughout Eastern Europe of various countries, consistently making progress on their commitments to build out a nuclear capability to give them energy independence. So really, there was the push from green, but surely the war with Russia galvanized the need to have energy independence across many of those countries. And so a couple of examples for those maybe are not as close to it as Poland has declared that they're going to build 6 large nuclear reactors and declared the first 3 will be AP1000. The following 3 quite likely could be, but they have not made that selection yet. Just last week -- or 2 weeks ago, I guess, now, Bulgaria declared that they're going to build 2 AP1000 reactors. So that's great. Again, kind of a similar time frame, early 2030s for being on board, which -- it's a very kind of well-established time line for pouring concrete, ordering materials and stuff, which is what drives those orders to us in the next 2 to 4 years. But broadly, when we look across Eastern Europe, across Sweden, Finland, Slovakia, Slovenia, all the countries that have said they're going to build large reactors, that there's roughly 25 plants have been declared throughout Eastern Europe. And not that those have all been selected Westinghouse as the technology. But even if you say they win half of those, that's $1.5 billion of business for Curtiss-Wright that will materialize over the next decade. And again, so we think we'll start recognizing those orders and then have a steady drumbeat of those following. So a real great trend for Curtiss-Wright.

Let's maybe just remind everyone like so if Poland wants to have an operational plant in 2033, they have to have what the industry calls the concrete date 5 years before, I think if I remember correctly, so '28. But then the orders have long lead materials, that's even before that, correct?

Yes. And if you dig back through scripts, you'll find that we've in the past indicated that those orders could come to us up to 4 years beforehand. That would put an order next year. We're not saying that because we're not hearing that from Westinghouse, but that has been the traditional cadence that has been laid out in the industry for how this would play out. But Westinghouse is definitely indicating to us. They think it will be 2 to 4 years. And so that's what we're sharing with our investor base is that that's when we anticipate we'll start seeing orders.

And Chris, just to talk about the financial aspect of -- in terms of this is a very high-priced product for you, high-margin product. Maybe give everyone just a little flavor because of the past when you had the China direct order.

Yes. Sure. So the last order that we had directly with China was for 16 RCPs. It's $450 million. So that puts the price of the RCP at roughly $28 million. That was back in 2015. Things have changed. Very profitable business for us. We don't like to talk about that, especially as we go to head into commercial negotiations in the future, but I think 23% plus-plus is certainly accretive to Curtiss-Wright. And I like to do simple math. So I think, as I look at it, you go, well, 4 reactors 4 plants. So every time you hear somebody talk about a plant being added, 3 in Poland, 2 -- 1 in Bulgaria and 9 in the Ukraine, whatever it is, just take that number and multiply it by $100 million, and that will give you a rough idea of the revenue that's associated with it. And those are typically recognized over like a 5-year bell curve. So...

So it just feels like this is going to just layer in -- throughout the second half of this decade when you're thinking about the AP1000?

Yes.

Yes.

And how do you think about competition for your reacting cooling pumps?

So again, those of you who have maybe followed us for a bit longer that we signed an agreement with Westinghouse in the beginning of 2022. We talked about it on our earnings call at the beginning of that year that we had just some contractual debates we had been having with them, put those all to bed. And they signed an agreement that we would be their RCP supplier going forward. So we feel very positive. We have a great working relationship with Westinghouse even when we were bumping elbows over some contractual issues that really never changed the working relationship. And so we're a great supplier to them. We work well with them. And so we feel very positive about those plants driving orders to Curtiss-Wright.

Yes. Great. Let's stay with the nuclear new build. Small module reactors, a hot topic in advanced reactors, I guess, also included in there. Possible time lines on announcements? And maybe talk about how you think about potential content and just the timing in general.

Yes. So it's something that we've talked a lot about our recent conferences, but even here today that the benefit -- the revenue benefit to Curtiss-Wright from the small modular reactor programs is happening here in 2023 for us that is -- we very publicly announced our work with X-energy that we were pleased they wanted to announce our content in a plant, as they would define it. There's over $100 million of content for each plant being built from X-energy. And they saw as important as having us press release our content with them for their credibility given our reputation as a supplier to this industry. So we are really proud of that. That's been our most visible announcement for revenue content on the SMRs. We said our goal is to have anywhere from $10 million to that $100 million of content per SMR. No dollar figures out of TerraPower. And for those maybe who don't follow it quite as close, TerraPower and X-energy were the 2 recipients or winners of the ARDP funding out of the government back in 2020. So really, they've got good solid backing from that. And TerraPower announced a couple of months ago that we've been selected to build the reactor protection system, which is really the -- a large control system that basically runs the Power land. So obviously, a significant win for us and an endorsement for a different technology than we are providing for X-energy. So just really showing those really meaningful systems that we -- and capabilities we have are being selected across those programs. And then going down the line to the others, we're working very much with Rolls-Royce to secure our content with them. And Rolls-Royce is really gaining far across a lot of the Eastern or Western European countries. They seem to be gaining momentum there, and we feel good about the content we'll have with them. The other SMR that was announced here a few months ago was Westinghouse jumped into the SMR game with kind of a skinny-down version of the AP1000. They call it AP300, and it's essentially 1/4 of an AP1000. And their very publicly stated goal is to reuse as much equipment as they possibly can that's proven in the AP1000. And if you can see a picture of it, that includes one of our reactor coolant pumps. So as Chris just talked about the value of those reactor coolant pumps, that's the starting point for our content in that AP300. And we're working with them to see other products Curtiss-Wright can bring to bear that will support them. So this is the kind of mode -- the way the industry works is they tend to pay for a lot of the development work. And so that's giving us revenue growth this year as we're working across several of those companies to be doing the design work. And specifically, when you think of the 2 ARDP plants and receiving their funding, they had to commit that they would have a -- work to have a reactor online by 2028 in that time frame. And so if you really think what that means for us, we're designing the equipment now. We will need to begin building the prototypes of that equipment so we can get stuff to them that they can build the reactor test it and get online. So that's -- so that content is -- and equipment that needs to go into test facilities, which is on top of that, that is really going to drive revenue through the middle of this decade to support them getting online. And we're super pleased that -- with our most visible and impactful partnership today being with X-energy that they not only have Dow Chemical as their lead ARDP customer. Energy Northwest has indicated they intend to build 3 of the plants. And so it's just great to see them lining up that customer support for their future builds. And again, just as meaningful as the AP1000 orders will be, as Chris talked about, this is an equal kind of impact to Curtiss-Wright. And I think it's interesting to know, like throughout the Eastern European area, where there's a lot of momentum towards the large plants, they're also talking how they'll supplement those large plants with SMRs. And we are pleased to see -- just this summer, Duke Energy actually announced that they intend to tear down 2 coal plants in North Carolina and replace those with SMRs, undeclared which plants they're going to choose yet, but I think it just shows the momentum just continues across the trend that nuclear energy is being embraced as part of the journey to get...

That seems like a no-brainer, yes.

Yes. I mean you look at Duke, I mean, all these energy companies they've committed to trying to be carbon-free by 2050. And I get 2050 is a ways away. But if you talk about today, nuclear in the U.S. only produces about 20% of all energy. That's a lot of other energy that needs to be converted over to carbon-free.

I think the statistics I've seen is 30% the greatest powered by coal. And so if you think about just tearing down a coal plant and swapping it out for an SMR, which will give you the same output, you go from carbon-producing to carbon-neutral right tied into the grid. So it seems like the momentum from SMRs just continue to grow.

Yes. And just sort of for thinking about what -- how impactful this can be to Curtiss-Wright is the average coal plant, and there's no exact figure, is 700 to 800 megawatts. The 4 pack from X-energy is 320 megawatts. So the general assumption is if you're replacing a coal plant with an SMR, it will probably be 2 SMRs. And so each one of those is $200-plus million of business for Curtiss-Wright as they turn those over. So it's just a phenomenal amount of business that we need to be prepared and are doing the work and thinking long-term capacity planning. It's exciting. So...

That's great. You also have exposure to Nuclear Aftermarket. So mid-single digit growth rate. Does that seem sustainable? It seems like maybe that, that could even have some upward lift when we think about that. Maybe describe some of the key drivers in what you're seeing from plant life extensions that are driving this.

Sure. Can you take that one?

Sure. I mean, broadly speaking, and things are good in commercial nuclear, we've seen a number of forces across the globe that are influencing the trajectory of whether it's SMRs or Gen 3+ technologies or just maintaining the existing infrastructure and operating fleets that we have today. I think is -- if you look back to where we were as a business maybe 10 years ago and you asked us that same question, we'd be talking about this as a low single digit growth rate business. Kind of shrugging a little bit going, boy, we wish we could do a little bit better. But we've been fighting since post-Fukushima, the consistent shutdown of plants year after year after year. And that's presented opportunity for some consolidation within the industry for us to take on some additional technologies and supplement our portfolio during that time frame. But more recently, as you look across the U.S., the U.S. government said they want to reassert themselves as a commercial -- global commercial nuclear leader across the globe. And I think that that's -- there's some geopolitical implications to that, but it's also just a recognition that nuclear has to be a critical component to meet our future rising energy demand. And then beyond that, we have to meet our carbon-free goals. So we've seen strong bipartisan support coming through the government through the infrastructure bill. There was the civil nuclear credits program, which provided $6 billion of funding to operating fleets to protect them and prevent them from shutting down. We've actually seen some plants in California and Illinois stopped their plans to shut down, which has been nice. And then I think as you look at the Inflation Reduction Act, there was $30 billion of production tax credits that were offered to the fleet operators and owners, which basically cuts the cost of producing nuclear energy in half of them. So there's a lot of incentives for them to continue to now upgrade and maintain those facilities and preserve the life of those going forward. So in the U.S., we've seen some good signs in that regard. There's also a movement to take these plants that have been operating for close to 60 years and extending their licenses so that they can operate another 20 years, so a movement from 60- to 80-year life. And that provides an opportunity for us not to just go into our kind of typical 18- to 24-month maintenance. It has to happen in the turnarounds, but now you're doing work inside the plants that's going to preserve those plants to be able to operate for another 20 years. So that kind of layers in on top of that work. And 2/3 of the plant operators have declared that they have -- they intend to go from 60 to 80 years life, and we feel it will certainly be more than that. I think as you look outside the U.S. and you look more globally, we're seeing some good things. We have a footprint in Canada. We have a footprint in South Korea. We're seeing things grow in that regard. And then beyond that, I think there's a lot of countries like the U.K. or you step into Japan, or you look at France, where they've kind of done a turnaround in the past few years and said, "We need to preserve these fleets and get them back up and running." So we've been working hard as an organization to try to drive into those markets and gain some share and show our capabilities, and that represents an opportunity for us. So year-to-date, the order book is up in the mid-teens. We've seen commercial nuclear grow high single digits year-to-date. And as we look out into the future, we see mid-single digit growth is very achievable.

Sure. We are now remaining just a few minutes. So with the strong growth you're kind of talking about for 2023, what are your thoughts relative to kind of your Investor Day targets? And also just when we think about your working capital kind of profile and also opportunities for improvement?

So first, speaking about the Investor Day, we're looking forward to it. And a shameless plug, it will be next May in New York City. And I hope everyone here could attend or possibly listen in, if you can't attend, but we'd invite you in person. We're going to have some show and tell and really try and make it a great event.

Everyone gets an SMR?

Absolutely. Everybody gets their own SMR. So -- but we're really working through the process about how to best present the company to our investor base to understand what the future is, and it's -- the timing is really great because there is so much taking form around all these topics -- all these nuclear topics that we've been talking about that we're thinking a lot of things will -- more things will have shaken out by then. And we're really hoping to paint a really great picture for the investment community to understand where we're going in the future. For where we're going as a company, we said for a long time, we're committed to being a top financial performer as a company. And how we take that commitment and turn that into goals, we'll make you wait for May to hear. But maybe, Chris, you can talk a little bit about capital allocation.

Yes. Sure. And just really quickly on the Investor Day targets, so we are hitting and expect to fully achieve all of the targets that we laid out in 2021 as it relates to sales growth, operating margin expansion, top-quartile margin performances -- performance. And the one target where we're struggling ever so slightly is we said that we would do a 110% conversion over the 3-year period. 9 out of the last 10 years, we've been greater than 100% conversion. It's how we like to run our business. This year, we're having a great year with free cash flow. We're guiding to $380 million to $400 million, a 29% to 36% improvement year-over-year, conversion of 110% to 113%. But we think we're going to fall just 2% short of that 110% after the 3 years. So we'll probably come in around 107%, 108% on the conversion over the 3-year period. But we still have a few days left. We're working real hard. It's kind of hard, though, when your earnings keep going up and you've got a lot of sales in the fourth quarter to kind of bring that.

But on the working capital front, that was a big focus on for several years. And I still think -- do you still view that as an opportunity to kind of continue to kind of work on that?

Absolutely, yes. So I think with -- especially with what's happened in the supply chain and then talked about that extensively already. I mean it's been difficult for many companies to control their inventory and make sure that they're able to meet their customers' needs. So we did see a spike this last year. I think this year, through some of those practices that Lynn had talked about to kind of get a better flow of product through the shop and continued focus, we're hoping to bring those inventory levels back down as a percentage of sales down to where we were in like '20 and '21, so kind of prior to this whole issue breaking out. And then we have a tremendous collection opportunity in front of us. I mean our sales were up mid-teens year-to-date, and that provides opportunity to take money out of the hands of our customers, and we're only so happy to do that. So I think there's an opportunity in DSO and inventory turns going forward.

Terrific. Well, we're exactly out of time. So thank you, Lynn. Thank you, Chris, for joining us. Thank you, everyone, for joining us. Appreciate it.

Yes. Thank you, everybody.