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

Good afternoon, everybody. Thanks for coming to Curtiss-Wright's presentation. Very pleased to have CEO, Lynn Bamford, with us; and CFO, Chris Farkas with us. As with all of these presentations, I'm going to present 3 bear cases, Lynn and Chris is going to tell me why I'm stupid. Then I'll present 3 bull cases, and Lynn and Chris will tell me why I'm a genius.

Brilliant.

They are all valuation agnostic as we are with all of these things. So we don't use valuation as a bull or a bear case.

So first bear case. Guidance for operating income to grow faster than revenue doesn't commit to much margin expansion over the next 3 years. Lower operating leverage could call into question a 10% earnings CAGR target.

I'll turn them over to you, Chris.

Okay, sounds good. I guess just for some historical context, if you go back and look at where our company was about a decade ago, our operating margins were in the single digits. And this year, we're guiding to 17.4% to 17.6%. So we've expanded our margins historically through operational excellence and commercial excellence and achieved more than 800 basis points of expansion during that time frame. More recently, I think as you take a look at what we're doing under the Pivot to Growth strategy, the fundamental premise is that we will continue to take operational excellence and commercial excellence and apply that to the core of our business to free up money for either margin expansion or investments that go back into the core of the business. Now we launched our Pivot to Growth strategy back in May of 2021. Our guidance was operating income growth greater than sales growth. And during that time frame, we were able to expand our margins by more than 110 basis points. So very successful. And during that time frame, we actually overcame some pretty significant supply chain challenges. We overcame inflation. And we invested significantly back into talent management within the organization to position ourselves for future capacity to grow. So as we entered into this most recent Investor Day that we just came out of within the past few weeks. We're continuing with that theme of operating margin growth or operating income growth greater than sales growth, which implies operating margin expansion. And it's important to note that this year, we're guiding 10 to 30 basis points of margin expansion, but we're increasing our R&D investments by more than $20 million across the company. We've got so many great things that are going on in the markets that we participate in right now that there's a really exciting time for us to invest for future growth. So if we didn't invest in the future, and we weren't thinking about the long-term profitable growth for our investors, we could provide 50 to 70 basis points of expansion this year alone. So operational excellence and commercial excellence are thriving within the corporation. And we're committed to providing that operating margin expansion going forward while we continue to invest in the future.

Thanks, Chris.

So if I ask -- can I ask a follow-up question to that. If there are a number of good growth investments that you could make, 1 or make more?

So we've -- one of the things I think I'm very proud of that we did as Chris was talking about some of the numbers over the past 3 years is we outpaced our investment in R&D ahead of our sales growth. And so we are showing that we are quite willing to flex and step up when the business case is right for the organization. But we take a very disciplined approach to how we allocate our engineering resources. And when we speak of R&D, I would definitely note that it's both customer-funded R&D and internally funded R&D. And we see that as a combined pool for what we choose to have our engineers work on to do the maximum return. And where we have business cases, we have flexed up. We spent $20 million -- in 2023, we increased our total R&D spend by $20 million, and we've increased it again $20 million this year. So it's very significant amounts of money, but while delivering margin expansion to our shareholders because we do see it as a balance to create value for our shareholders. And so we will look at the total picture, but make those investments where needed.

Is there a bandwidth issue when it comes to R&D investments? I mean a lot of it is engineering right? Is there just only so much you can put through? Is there only so many engineers you can hire? Is that kind of something that naturally throttles the level of investment that you could flex up to?

There's a degree of that, for sure, because engineers -- of our 8,600 employees in the organization, about 20% are engineers. So we're a very engineering-centric company. And do a lot of cool things. So we've got a great track record of attracting talent into the organization. We added over 500 people to the organization over the past 3 years during the last Pivot to Growth strategy, and we have probably 400 open heads in the organization right now for many technical people, whether they're technical machines or technical engineers. So there is absolutely a balancing factor with that, but we have a great -- one of the things I spoke about at Investor Day was our corporate talent management group that helps us attract talent across the entire organization, which is a real strength for Curtiss-Wright because it's a very sizable group that is able to invest and have best-in-class practices and understand the most leading-edge ways to attract talent into the organization. And we can surge that team at places where we have needs where there's great opportunities and we need to build up technical staff, plus we work with a lot of outside groups that maybe have very specialized skills that you don't need all the time that we have good ongoing relationships that we can work with them. So it's a balance. And I would say for probably some of the Curtiss-Wright people that are listening out there because I know they're all always listening, they'll say, for sure, that we need more engineers, more engineers, more engineers. So I definitely have to recognize that. But I think we -- or do a great drop of attracting talent to the organization.

Well, as an engineer, I'm sure you agree with them.

Yes, of course.

Okay. I'll go to the second back case. Over the last decade, the portfolio has seen an average of 1.3% organic growth and 3.5% total growth. Recent elevated growth has been driven primarily by inflationary price increases, the 5% plus organic growth target that you laid out at Investor Day a couple of weeks ago is incredible.

Well, thank you. So...

This is the part where you tell me, I am stupid.

So I can understand the question and put it in perspective, but let me -- Chris, started by giving just a little bit of history in Curtiss-Wright, and I'm not here to do a history lesson. But up until the Pivot to Growth strategy was launched in 2021. We had really focused on really optimizing the financial performance across the portfolio and made great stride. Chris said 800 basis points over that prior decade. So when we put our minds to something, we get it done. We have now pivoted to growth. And we -- I talked at Investor Day about a lot of the things that we're doing inside the company, and it's -- you have to balance the actual spending of the R&D as to the systems and processes and how you're managing the company. So you're growing and maturing as a company to be able to have the proper oversight and risk management across those activities. So with that, we're building momentum towards where we're going. And we gave our guidance 3 years ago, at the '21 Investor Day of 3% to 5%, we came in at 4.7%. So we really delivered at the very high end of that organic growth range and 7.4% total growth during that time frame. And so we feel that the 5% is achievable and doable, and that's really how we set targets within Curtiss-Wright, is setting targets for the investment community that we feel confident we can achieve. And I would also add comment that we chose not to put in the AP1000 orders, which is a large commercial nuclear program that we participate in as a supplier to Westinghouse. That we do anticipate the flow of orders beginning in the 1 to 3 years that could have dramatically changed that number, but we chose for showing what is credible that we chose to not put it in the number and make it even higher than that and show what the core business outside of that dramatic event when we get that AP1000 order will be. So we feel really pleased about what we did in the last Investor Day and feel good that the 5% is a base case that we will achieve or beat. I don't know, Chris, if you'd like to comment on a few of the drivers in the end markets.

Sure. I think you just step back and you look at Curtiss-Wright and who we are, we are predominantly an A&D company. It's 2/3 of our portfolio today. And as you look across those A&D markets, we have good to great visibility for the long term of that revenue. Just as an example, 30% of our business is to enable defense markets. And that's comprised predominantly of long-term contracts, and we have very secure and stable content across all of the major naval platforms, including the Columbia-class submarine program. We're also starting to win new development work on the next-generation programs. And that's development wins now for production work that will go into play in a decade from now. So we've got a tremendous long-term visibility. I think as you look across the rest of our defense markets, and I'll talk mainly about defense electronics, I think the demand for our advanced technologies, the demand for advanced electronics and tactical communications in the battlefield is tremendous right now and it's only growing given the elevated threat environment. If you look at our company and where we've been over the past few years, we've had record levels of orders, record levels of backlog. So that continues to mount and only become more special for us. I think when you look thematically across our defense markets, we're also experiencing a strong pull from foreign direct military customers right now. As you look broadly across our portfolio, those sales to foreign direct customers grew 20% this last year. And in 2024, we're off to another great start. Now Lynn had mentioned that I think just turning to our commercial markets that as you look at commercial nuclear, we don't have an AP1000 order projected within our guidance for the next 3 years, but we continue to believe that we will receive an order for the next 1 to 3 years. We showed at our Investor Day how this could be very impactful to Curtiss-Wright, and we believe that it will be. It's just that the timing isn't right, and we wanted to show what a great core of businesses that we have absent this, we'll call it, nuclear optionality that is in front of us right now. So -- but that market is projected to grow low double digits, really driven by the strong demand for energy, carbon-free energy and energy independence that exists, changing public sentiment and also showing in a lot of the regulation through strong bipartisan support going forward. So we feel very confident in our guidance and where we're headed going forward. And on top of that, we've got a strong balance sheet, and we generate a lot of free cash flow, and we'll put that to work for our investors as well.

So I know both you guys and investors are very excited about the nuclear opportunity that's ahead of Curtiss-Wright and I'm going to admit to cheating because I knew that we were going to need to talk about nuclear, but I couldn't really come up with a third bear case. So I put nuclear in here as the third bear case.

I'm curious to see how you're going to make our nuclear story a bear case.

I know, right? Just watch me, right here. Nuclear opportunities are significant, but it's going to take a long time for revenue to actually hit the P&L, which increases the risk of that revenue actually materialize.

So I would put it rather differently as to how I see what's going on in the nuclear industry that there has been a really broad shift in opinion across the United States and across the globe as to how people see the role of nuclear energy in the push towards carbon-free and energy independence, which [indiscernible] both the criticality of just continues to rise. And with that, there has been a lot of support here in the U.S. through some of the action the past to Congress, kind of most notably the Inflation Reduction Act and the infrastructure bill, but even in some of the other bills, even in the Chips Act to support all things nuclear. And I look at Curtiss-Wright and from Fukushima up until a handful of years ago, we struggled to have low single-digit growth in this market -- in our commercial nuclear business, and that was with the continuation of the shutdowns of plants here in the U.S. and really globally. Over the past 3 years, from our prior Investor Day, we managed to grow that business in the high single digits. And now we're projecting that we're going to grow going forward, as Chris just mentioned, in the low double digits. So we're seeing those dollars really come to fruition. And to frame our footprint in commercial nuclear for maybe those -- you don't know -- know Curtiss-Wright quite as well. It's about 10% of our portfolio today, and about 90% of that 10% is in the aftermarket and 10% is in new build. And that 90% in the aftermarket is what we're saying is where we see growing at low double digits. And that's really great growth for Curtiss-Wright, great value creation for our shareholders and really pretty tightly coupled to what's going on in the funding of commercial nuclear here in the U.S. and globally. It's not just the U.S. government that's doing that. And then beyond that, we just mentioned briefly the AP1000 opportunity that, again, we see coming in the over-the-horizon, that will be more dramatic to Curtiss-Wright when it does come. And we've framed in our Investor Day recently that over the next decade, we see $1.5 billion of business for Curtiss-Wright as partnering with Westinghouse to provide major equipment into the plants that they are targeting winning. And that's really assuming a fairly moderate 50% win rate for Westinghouse across Eastern Europe in countries where they've already declared and are on the journey of building these plants. And this isn't for the timing of the revenue to the P&L as your bear case is, these countries, Poland put their hand to start the process probably 4 years ago. They have made -- we put in our Investor Day, if you want to reference a time line of kind of what it takes until you're really pouring concrete and building the plant and how our orders flow and time line to that. And so without taking the time to go through that here today, you can see that Poland has just marched through those milestones and are getting close. Bulgaria is marching through those milestones and getting close. Ukraine interestingly is progressing on a desperate need for power in that country, quite sadly of taking the steps and securing global funding. And so those -- there's real evidence, and if you want to have a fun read, pull up world nuclear news and search AP1000 or search things. And you will see just a steady stream. Almost every month, there are some announcements of localization partners being signed site agreements being signed. It was just about 2 weeks ago, Bulgaria signed Hitachi to help them do some major procurements. And so these are all things that lead towards that becoming rail and into revenue. And the last area is the build-out of the next-generation small modular reactors and advanced reactors that are not all technically advanced, but across that portfolio of opportunities, we talked at Investor Day that we feel we will have anywhere from $20 million to $120 million plus of content across each of those reactors, and we're working very hard to make ourselves a player across all the major providers, whether they're U.S.-based or across the pond in -- with Rolls-Royce. And so that's something we feel there is, again, very steady ongoing traction for the things happening ex energy, who we have the most significant content with that we've talked about. The CEO of Dow Chemical, who's their lead customer was on CNBC, gave an interview and was really promoting their commitment to making this happen and getting nuclear to help them drive their carbon-free footprint. And there's a lot more talk here in North America, maybe that even large reactors will be built, but definite plans for hundreds and hundreds of small modular reactors to be built by 2050. And one of the parts if you didn't attend our Investor Day and want to listen in or read the transcript on the part. We have a commercial nuclear panel with experts from the industry, really talking about their perspectives on how much energy is going to be needed over the next 25 years and just the absolute need that nuclear needs to be part of it. And the perception around small modular reactors really breaks that not-in-my-backyard model because it's got such a different safety footprint. And you can read across the various utility companies, them making statements about their intent to replace coal plants with a new small modular reactor. And that's, again, in the Chips Act and some of the other acts, there's a lot of funding made available to support this kind of turnover in the community. So I think there's just so much evidence that I think we're feeling it today, putting up low double-digit growth is no small thing. And then having our -- the nuclear optionality, as Chris just said, layering on top of that, it's real and it's coming for Curtiss-Wright.

And just for clarification for people out there. Your market share of AP1000 is...

100%.

100%. Okay. So if it's Westinghouse, it's Curtiss-Wright.

For the content we provide. So we provide a couple of major components. Most notable is the reactor coolant pump, and we have been Westinghouse's partner in doing that and we'll act like a partner with them to help them succeed. And one of the guests on our panel was the person responsible for the AP300, which is the small modular reactor version of the AP1000 and it's essentially half of an AP1000. And Westinghouse has very publicly stated that their goal for that AP300 is to change as little content as possible to accelerate NRC approval. And so we fully expect to be supporting Westinghouse on the AP300s also.

Huge opportunity over the next 10 20 plus years.

So that pull you from a bear to a bull?

Well, I only put it in bear so we can talk about it.

That's now. 5 years from now. 10 years from now as well so it's brilliant.

Okay. So we'll go into the bull cases. Now we used 2/3 of the time on the bear cases anyway. Increased growth investments offer the opportunity to further differentiate Curtiss-Wright's product offerings, gain share and drive above market growth across the number of business and end markets. I know, Chris, you talked about some of this as in part of one of the bear cases. I know a lot of the R&D dollars go into defense electronics. So maybe you could just talk about areas of focus for growth investments and potential for market outgrowth and potential just for market growth in that business as well.

Why don't you take that?

Okay, sure. I think as you step back and you look at our R&D in total, first, as I think, as Lynn had mentioned, we're talking about R&D, internal research and development. And then we also have CR&D, which is product and things that we're working on mainly as it relates to the U.S. government, where our development activities are actually funded. Now we take a lot of care whether we are designing and developing products with our own money or whether we're using the customers' money to ensure that we have protective IP rights and security and the products that we're designing for our customers. We're really proud of what we've developed, and we want to hold that. We feel like there's a lot of control that exists through pricing by owning the IP in that regard. As you step back and you look at our total IR&D, roughly 50% of our total IR&D is dedicated to defense electronics. I'd mentioned briefly advanced electronics and how important that is in ensuring our defense and the future -- protecting our people in the future battlefields that along with tactical communications. It takes a lot of money to stay advanced and at the state of the art where you can meet the customers' needs now and future needs for generations. So we're putting a lot of money there. I think as you take a step back and you look across our defense electronics business, it is our most profitable business. People have said to us that those are industry-leading margins. We're guiding up into 24% for operating margin this year. So these are investments that we're making to continue to grow this business. And it's growing tremendously this year. I had mentioned the record-breaking order book that we have and where we're headed going forward, and we're really proud of what's -- what we've achieved in that regard. But we're also investing in a number of other areas across the business. We're investing in EM actuation technology that can transition between commercial aerospace to industrial applications to ground defense applications. We're investing in taking our technologies and our rich history in producing reactor coolant pumps for the U.S. Nuclear Navy into products like the AP1000 that are paying off for us now. But then as we also mentioned with Investor Day, we're investing in things like subsea pumps for process markets where our technology, given how ruggedized and durable it is, can be used by oil companies to save them massive amounts of money at a fraction of the cost, and we're actively working on the development of those pumps with 3 different customers right now. And we see that by the end of the decade here that, that market will be substantial. And then I think as you look out the next 10 years, some pretty big opportunities. So we're investing in a number of different places in the business. It's very important to us. This is why not to get repetitive, but to come back to the margin discussion, and we could be that 18% business. We could be that 18% business today, but we're investing for the future, and that's what's most important going forward. I don't know, Lynn, if you have anything else that you'd like to add on that?

The only supplement that was 1 point and something that got mentioned at our Investor Day that was new news and pretty exciting for Curtiss-Wright as we've entered the NVIDIA partnering program to codevelop products with them to take to the military market. And -- all things -- NVIDIA are pretty exciting in this day and age and...

[indiscernible] just went up.

So I'll just put that out there. So it's a big development for us, and I think it's a real testament to who Curtiss-Wright is because they're very selective in who they work with that -- because it's a complicated product and they don't want to support a ton of people, and I think it really shows where Curtiss-Wright fits into the strategic defense of our nation.

Okay. Next one. Capital allocation has been a source of significant upside with the company buying good to great properties at very reasonable prices and in outperforming targets on synergies and accretion. Going forward, management is leaning in more aggressively on the acquisition front and with a good record for smart buying, this should lead to more inorganic value creation pretty timely seeing, as I think you announced something very simply.

We did just yesterday. So with that, so we really are -- I want to start by saying we take our use of our capital as a very large responsibility as the leadership of the company and are very purposeful and disciplined in how we evaluate the use of that capital. And of course, we're going to make the investments we need to be operationally ready for the growth that we've talked about that's coming in the commercial nuclear. So that really sometimes almost gets set aside, but it is priority #1. We don't see anything dramatic over the immediate horizon, maybe at the end of this decade, there might be a greenfield project if things go the way we anticipate, but it will be a great day and a great ribbon cutting for Curtiss-Wright, if we get to that point by the end of the decade. But we really do very much say our top priority outside of that is M&A for our use of capital. And that doesn't mean that we will change the discipline with which we evaluate targets. And during the first 3 years, really the only major acquisition we did was ESCO, which is doing fantastic and really outperforming what we had anticipated. We've announced 2 acquisitions here recently over the past couple of months, both in the commercial nuclear space, really reflecting our firm belief that the commercial nuclear business is here. It's real. It's building. 2 very different companies, the one about a month ago does simulations for nuclear plants. And so they have access to practically every nuclear plant around the globe and helps the plant operators figure out what maintenance they want to do and plan for new builds. And so they are the first partner almost as these utility operators and others are planning plants. So what a great position and part of your go-to-market strategy to have as an organization. So very, very strategic, smaller in nature, they are about $15 million in revenue last year. We announced an acquisition, again, as you said, at good prices, $200 million for Ultra Energy. It hasn't closed yet. It'll probably take about a month to close, but we think we'll close in Q3. We don't see any obstacles to that. And again, paid just under 12x earnings for that. So we feel, again, paying the right price that we can really create value for Curtiss-Wright shareholders. And so we continue to look. We had said over the last year that we had held on to some cash because we knew we had a good pipeline. And so pleased to say that we put some of that cash to use here in the past couple of days and brought in a great company into our portfolio that was about $65 million in revenue next year. We've got a great pipeline. That Ultra Energy not only gives us new technology that we can take into the power plants and the nuclear defense industry also, it's not a big portion, but an area where we have a lot of content and they're a critical supplier in there. But they also have a plant over in the U.K., the primary plant, which gives us a footprint over in that -- in Europe to build out from as these -- when they're building nuclear power plants, people are always looking for localization partners. It's part of the financial equation that justifies the spend. And so this really opens up a pathway for us to be able to expand and offer that localization partner for a wide variety of our products. And so it's both geography reach and technical reach with the product offering they add to our portfolio.

All right. You've got 90 seconds for the last one. The current geopolitical environment with the war in Ukraine, rising tensions in the Middle East and geopolitical issues with China creates long-term business opportunities for Curtiss-Wright's defense businesses, which are more than half of the portfolio.

I'll turn that one over to Chris. I did a lot of talking.

Sure. So I think as you look at the rising threat environment, whether it's the situation that we have in the Indo-Pacific and the strategy that the U.S. government has to kind of shore up our naval industrial base, it's of critical importance. I mean, you've heard a lot about the submarine industrial base in particular and being behind in rates of production. We have very, very strong content on not only the Virginia-class submarine and about $75 million per ship set but then also on the Columbia-class submarine program, which is in excess, I think, of $140 million of content. And that's the U.S. Navy's #1 priority. I think as you step back about 10 years from this date, you would also say that 10% of the fleet that's out there is more active and you've got more ships in a maintenance status than you have 10 years ago. And that represents an opportunity for us because we have 3 fleet service centers, 2 on the East Coast and one in the West Coast, where we're going to be able to leverage those fleet service centers to see the types of products that are getting repaired to get in there and provide additional aftermarket services going forward. And then also see where our competitors are stubbing their toes, right? And that provides opportunities not only to take product maybe through a tech refresh or some other milestone within the program, but then to also be an alternative source, given the restraints on capacity going forward. So there's a lot of opportunity there. I talk briefly about what's happening in the defense electronics area, the critical importance of advanced electronics and tactical communications in the battlefield. We're seeing a lot of that through what's happening in the Ukraine right now. These are all very unfortunate situations, but a strong defense is your best defense, right, to making sure that you have yourself in your country protected going forward. So there's a lot that's going on domestically and internationally. We've got a proven ability to grow regardless of local budgetary pressures based upon our approach to total life cycle management and tech refreshes and defense electronics. So a lot of -- a lot going on out there right now, but our portfolio is really well positioned to the top priorities of our defense, our DoD and international defenses agencies.

Okay. Cool. Well, we're out of time. So thanks, everyone, for joining us. Lynn, Chris, thanks for joining us.

Thank you, Nathan.

Okay. Thank you.