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

Hi, good afternoon, everyone. I'm Kristine Liwag, Morgan Stanley's aerospace and defense analyst. Very excited to have Curtiss-Wright with us for their presentation. We have Lynn Bamford, who's Chairwoman and CEO; and Chris Farkas, who's VP and CFO. Before we begin, the standard disclosures I have to read. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. So Lynn, Chris, thank you for making it to Laguna.

Our pleasure.

Yes. Thank you.

So maybe kicking off, let's get a time machine and rewind back to 2021. You laid out at that time a new Pivot to Growth strategy. And at that time, it was a rather set -- a rather ambitious set of numbers, right? You had 3-year financial targets. And despite all the supply chain issues that we've seen and despite the inflationary pressures in that time frame, you managed to hit all your targets. Maybe the free cash flow was a little bit light, like 3 percentage points, Chris.

That hurts. That hurts. 108%.

108% versus your target of 110%.

Versus 110%.

So 2 percentage points. Yes. So I guess -- but everything else you hit despite all these operating challenges. So I guess, in hindsight, what allowed you to overcome those headwinds and achieve the targets that you did achieve?

Well, thank you for that question because there's a lot that I'm really proud of in that time frame, but I wanted to first say thank you for inviting us again. It's our pleasure to be here. And today's discussions will include some forward-looking statements that include risks and they are outlined on our public filings on the website. I'd have to do that for him or I get...

Jim makes this stuff.

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So there are so much to be proud of in Curtiss-Wright. And again, different people have different knowledge of where we are as a company. We had an Investor Day in May of this year and presented our Q2 results a handful of weeks ago. And if you're less familiar with Curtiss-Wright, I definitely encourage you to go to our website and check out those presentations. It's a pretty solid overview of our end markets and our strategies to grow within those markets going forward. But turning more to your question. Curtiss-Wright is a highly engineered -- produces products and services that are highly engineered that are in critical, must-not-fail applications. And with that, we really have a deep relationship with our customers and deep knowledge of our customers' applications. So that's really kind of a fundamental principle as to who we are that always gives us strength in our end markets. Specifically to how we were able to achieve those targets, and I can run through this real quickly but without belaboring them, there's really a lot. And I think the first thing I have to say is a real shout-out to the employee base at Curtiss-Wright. People really -- we manufacture things. We have design capability and we manufacture the majority of what we make. So we needed people to come to work and be on the floor and work together, and that obviously took many different forms during COVID. But people really flexed how they went about it, worked crazy shifts and did things to allow us to go through that period and continue satisfying our customers and strengthening those relationships during that time as being a reliable supplier. So I'd say that the work ethic of the employees and their commitment to us as a company and meeting our commitments to our customers really was foundational to everything. But we also changed as a company. The area that was kind of the most visible and we had the biggest business impact was across defense electronics, where the semiconductor shortage was in the news every day and we absolutely felt those shortages and just ever-increasing lead times and unstable supply. And we definitely implemented some new processes, implemented new tools across the business to be able to better manage that, really deepened our relationships with our customers, just trying to be a good supplier to them to make sure we understood those needs. And so that was part of it. We had in 2020 when the -- earlier things we had done was really decide that we needed to increase our training across the employee base on pricing and how we take contracts and put provisions in for inflation and different things and have trained in the entire employee base in better practices for contracting, and that turned out to be very fortuitous as the inflation came with a roar as we entered into COVID. And so I think those strategies really -- and that really more fine-tuned thinking around contracting really helped us make sure we were driving pricing strategies out to our customers that allowed us to still continue to expand margins in that very inflationary environment. Those are a handful of the things. And the culture of operational excellence and driving cost savings continued through that whole period. And so I think it's a lot -- we're very proud to get to ending last year and being able to put up. We had driven total growth at 7.4% and 4.7% organic growth, which was at the very top end of the range; growing operating income at 9.6%, definitely beating our double-digit EPS growth at 12.5%; expanding operating margins 110% and coming very close on free cash flow at 108%. And really, that's probably the one metric because our inventory levels were impacted a bit as we absorbed the supply chain issues. And so we did the right things to make sure we were a great supplier to our customer. And if that was the impact of that, we accepted that in the crazy environment. So...

Great. That's really helpful context. And the reason for the time machine is because you now have a new set of 3-year targets.

Yes, we do.

So you unveiled that in your May Investor Day earlier this year. So you've talked about a greater than 5% organic growth CAGR, operating income growth to outpace the top line and greater than 10% EPS growth CAGR and greater than 100% -- 105% free cash flow conversion. I guess like building on the pieces that you accomplished before, what are the building blocks of accomplishing your new 3-year targets? And how do we think about the foundation of the company getting you there and the confidence and visibility that you have?

Sure. Maybe I'll ask Chris to speak to some of the end market growth drivers that are behind those targets.

Sure. Yes. So we are very proud of the performance over the past 4 years. But as you mentioned, I mean it's still very early phases for our execution in the Pivot to Growth strategy. There's a lot that lies ahead of us, and it's really exciting times for us right now. So if I take a look at the 3-year organic growth CAGR that we set at 5%, that shows acceleration. We set the last target at 3% to 5%. We set our operating income growth to be greater than our revenue growth, which implies continued operating margin expansion. As you know, we have a tremendous history of continuing to grow operating margin, 800 basis points over the past 10 years; just the last 3 years alone, 110 basis points. And we did that while we were increasing our research and development back into the organization significantly. We increased R&D $20 million back in 2023. And we're doing that again this year, another $20 million of incremental R&D, that's IR&D and CR&D, while providing operating margin expansion. So part of the Pivot to Growth strategy is using that operational excellence to free up that funding for investments back into the business. Now as we look at the growth, the markets and the growth beneath that, we're 2/3 aerospace and defense and we're 1/3 commercial. Our commercial exposure is resting commercial nuclear process and general industrial. And as you look across the A&D markets, whether it's ground, aero or naval defense, we've committed to grow those markets at mid- to high single digits over the next 3 years. There's a lot of great things happening in commercial aerospace right now. The backlogs are very strong. In that market, we've committed to grow high single digits. And then as you look at general industrial, we have some great initiatives that are in place in the power electronics management space that are helping us to kind of navigate more turbulent times within that market, but we're still committed to low single-digit growth in that market over the next 3 years. And then certainly, there's a lot of excitement that has been focused on the power and process markets. We're doing some really big, significant development efforts not only in commercial nuclear but also in subsea pumping to support the process markets. And commercial nuclear is going to grow at low double digits while the process markets will grow mid-single digits. So there's a lot of work that goes into that. These investments that we're making are capturing these strong secular growth trends that we're facing right now, whether it's an increase in NATO spending that's affecting foreign military sales, whether it's energy independence and decarbonization affecting commercial nuclear or electrification just broadly across many, many platforms. And beyond investing in R&D, we're also investing back into the people and the systems and the talent across the organization to be able to execute on that going forward. So a lot of this is just making sure that we're putting money to the highest and best use in trying to provide the longest and most durable returns to our investors. And then I think as you step back, lastly, just regarding our cash flow targets. We are continuously focused on working capital management, and we've committed to generate $1.3 billion of free cash flow over the next 3 years. And that's capital that we will put towards our capital allocation strategy, whether that's inorganic growth or returning capital to shareholders. So a lot of exciting things happening right now and we're really just starting to build momentum in our strategy.

And I'd love to touch base on the nuclear commercial and subsea pumps later. So we'll touch more on that. But pivoting to defense, the fiscal year '25 budget request, 1%. It seems like there's going to be another continuing resolution this year. There seems to be pressure in DC to increase this budget, but we don't know, it's an election year. How do you think about that playing out? And what gives you the confidence that regardless of where that final top line is that your business will outgrow the overall DoD top line?

Yes. And as Chris just stated, across all 3 services were mid- to high single-digit growth during the 3-year time, and we had visibility into the FYDP and what was being put forward in '25 when we set those targets. So there are definitely things that make us have confidence in the targets we put forward. And one is a track record over the past 20 years of being able to grow faster than the base DoD budget. But there's -- when you're a company our size, it's a big budget and you really got to look under the hood to see how it impacts you. And the areas where we do business, shipbuilding broadly; the Columbia submarine remains the #1 priority; the commitment even in the Army to the modernization of the battlefield and broadly advancing all of our defenses with more high-tech capabilities, which is a very important spot for us, are all places where we're aligned. So our product offering very much aligns with where the DoD wants to spend money. And so that's really an important kind of underpinning. We have a fleet services. We have 3 service centers that are very much working at -- hand-in-hand with the Navy to return as many ships to an operational capability as possible. So that's not the business in the defense space that always gets talked about as much. But there's great needs in that area, and we have some great capabilities. So that's another area where we're very much able to grow. And then broadly, if I turn to our Defense Electronics group. Outside of some of the trends I just mentioned, we have a very balanced strategy that gives us growth opportunities both in flat defense markets and in growing defense spending markets. And we have honed over the years and being in this market since its inception back in the mid-90s, the ability to extend the life of our products beyond what our customers expect. And what that allows them -- affords them the opportunity to do when budgets are tight and they can't afford to do tech refreshes and certain things. We'll work hand-in-hand with them and extend the life of the existing systems to be able to continue shipping them those systems. And so we're a really good partner in that. And also the mandates towards MOSA and SOSA, which are just 2 acronyms that refer to the current best-in-class open standard architectures within the industry, we've really got the best product offering in that space to be able to win content with that. And so that is investing that Chris mentioned, the increase in R&D, an area where we've spent a lot of that R&D over the past 5, 6, 7 years, and that's really affording us an opportunity when there are new program starts. The customers, the primes that are on maybe tighter budgets are really driven to outsourcing because they're trying to do things on a cheaper and faster and quicker budget, and that is good for us. So there's just a lot of dynamics that we set the stage for ourselves to be able to grow in large markets. And just to quickly mention 2 others. The NATO spending increases were very well aligned to capture the increased spending across NATO countries, and that comes from everything from our aircraft arresting systems to our arresting systems and chip-building that have seen some early nice growth trends, to the build-out of our tactical communications equipment across the NATO countries as it's a NATO standardized capability. So you put all these things together and that gives us the confidence that we've got a great ability to grow over the next 3 years across our end markets.

Thank you for the color. Shifting gears to restructuring efforts. Last quarter, you've announced a restructuring centered in your Aerospace & Industrial businesses. Can you unpack for us exactly what you're doing in those efforts and why now?

Yes. So we've talked a lot about the operational and commercial excellence that we have in Curtiss-Wright and how that's contributed to margin in the past. And it's something that we are consistently doing. Lynn and I, and the rest of the management team, take a lot of time to think about how do we position ourselves for growth going forward. Our backlog is at record levels. And there's always a business that can be optimized in some way, right? I mean you're going to contribute to Curtiss-Wright's overall growth and profitability objectives at the end of the day. So right now, we're planning on spending $15 million this year, and that will result in $10 million in annualized savings going forward. The bulk of that, to your point, will be within the Aerospace & Industrial segment, and we'll recognize $2.5 million of that savings this year. We actually increased our guidance in the Aerospace & Industrial segment margin in the second quarter in response to that restructuring. But this is just something that's ingrained within our culture, responding to the strong order book within defense electronics. We're doing some things to kind of rationalize our footprint and prepare for that going forward. But there's also some staffing and efficiency moves that are taking place here. But we will consistently do this going forward. We're always looking to find opportunities to fund all these great investments that we have.

Great. Now let's talk about one of the things most defense investors maybe ignore: commercial nuclear power.

Absolutely.

But it is piquing interest for other types of investors. So on commercial nuclear power, I mean, there seems to be excitement about nuclear renaissance, right? And I don't know, I've been around that longer, too. And I remember the nuclear renaissance and it didn't pan out in the 2010s.

Yes.

So you're now projecting this end market to grow low double digits through 2026 and leading the growth across really all your other end markets. So at this time, like what's so different about nuclear power? How are you positioned for the aftermarket? Because I don't think people really understand what you do in the commercial nuclear aftermarket for life extension, and the opportunity for AP1000? And let's save small modular reactor for the next question. So let's focus on the existing build and the AP1000 for now.

Okay. Thank you for that. It is an area we're very excited about and I think has a lot of growth opportunities for the organization. And the 2 areas you asked about, the aftermarket and the AP1000, are 2 of the main areas that will grow. And we'll save that third one for maybe a question with a different angle to it. But the aftermarket business is really the heritage of the business Curtiss-Wright has been in, and we've been a part of the commercial nuclear industry since its inception. It's another one of those industries we're not a newcomer to. And with this, we have deep, deep partnerships across the entire operating fleet in the United States. There's currently 94 operating reactors. And we do a whole host of different types of work, both products and service works into these operating reactors to be able to keep them in safe operations. But as you mentioned, as I think there's been various bills passed through Congress to provide funding to support the commercial nuclear industry and a ground flow of interest from citizens at large to have carbon-free energy, the realization that what we have been doing in letting a commercial nuclear reactor shutdown every 12 to 18 months was eroding our carbon-free energy while we're working so hard to build it. And with that really came a resolution to not let any more reactors shutdown in the U.S. 2023 was the first year that a reactor had not shut down in quite some time. So -- and I think there's a real commitment to that. They're even talking about bringing Palisades in Michigan back online. And I mean there won't be many of those, but maybe a couple of examples of that. But we're in there with deep relationships in these plants, which is 90% of our roughly $300 million of commercial nuclear work today. So it's the foundation of that business. Working with them to consider how we can make the plants safer and help them be able to apply for their license to go from the 60 to 80 years. And that's significant because they got to do their normal maintenance work. But as they look to extend that license, it opens their minds to maybe some more dramatic changes in the plants, some modernization, moving from analog to digital, things like that, so they can more efficiently run the plants going forward. And so that's the areas where we have a great product offering and are really able to support those operating reactors. This is going to happen in Canada and South Korea also. It's a little early days for those. But this work is going to go on for decades. I mean we're really at the beginning of a 20-, 30-year cycle of supporting these plants as they go through their life extensions. And an area I know you know well from your history with Curtiss-Wright is our work in support of Westinghouse in building out AP1000 plants. And it hasn't been a very good, very profitable work for Curtiss-Wright. That tailed off a couple of years ago and really just -- there was not much discussion around the globe of building more large light water reactors. And that was beginning to change as countries began to figure out they need a -- their need for nuclear energy to meet their carbon-free goals. But really, the invasion of Ukraine just accelerated that intent. And even just in that Eastern European area, there's 20 to 25 plants that are slated to be built. We're not assuming Westinghouse will be chosen as the provider for all of them. But if they even win just say half of them, which I think is pretty conservative, that's $1.5 billion of business for Curtiss-Wright over the next decade. So we've got a great partnership with Westinghouse. We work very closely with them, and we're committed to doing our part to help them be successful in winning those new builds.

So when should we expect the Poland contract announcement?

Yes, that's a -- so one second.

Good thing it's not in your financial guidance.

Yes, I was going to say a very good point as Chris talked about our guide. We chose to leave it out of those 3-year targets just because it can have a pretty dramatic effect on our finances and could skew what we put forward, based on the timing really shift in and out. But I'm really proud to say that back in '22, quite ironically, we had our earnings call the day of the invasion of Russia into Ukraine, which was kind of a strange thing to wake up to in the morning, but announced that we had put all our contractual debates we were having with Westinghouse behind us and we're moving out to really work as a partner with them to help them when this opportunity set that was developing around the globe. And we said then, 3 to 5 years. Last year, we said 2 to 4 years. And this year, we're saying 1 to 3 years. So it's really been the countries where they're going to be built. We think Poland will probably lead the way, with Bulgaria close behind, and then others to follow suit. They're doing the work they need to do to hold to those time lines. So we think it's coming in the near future, and it will be a pretty exciting time for Curtiss-Wright when it does.

Great. So let's now shift to small modular reactors. I think AI data centers, there's a lot of fervor around SMRs and the opportunities that they could provide. Can you talk about the nascency of this technology? How much of your AP1000 work is applicable to the SMR? What's your approach to the market? And how do you view your partnerships and your competitive strengths?

Yes. It's another area, kind of the third bucket of growth in all things commercial nuclear that's here and now but will carry on for decades. And there's kind of 2 groups of the SMRs. There's the ones that are a different approach in deploying a light water reactor that's similar technology to the current generation of nuclear reactors. And then there's the Gen IVs that really are taking a new approach with new approaches to fuel and have even much greater safety approaches. But what's fundamental to all of them is it's a shift of -- from building a reactor like the Vogtle was built, on site to building the majority of the reactor in a plant, in a controlled environment and then basically assembling it on site. So it's really geared to taking the risk out of the huge cost overruns and time delays that the industry has seen. And our approach is really we're not as much focused on the micro reactors and some of the small ones but the ones that are geared at the 300-plus megawatts of power production. Our goal is to capture content across all of those. We think they're all going to be needed and all be built out to meet the carbon goals that our country has and other country has. And so we're not really trying to exactly pick winners and losers among those, that we're trying to maximize our content across those and feel like we have the capability to do that. We've been pretty public about X-energy and having up to over $120 million of content on one of their reactors that would be built out. So that's the most we have. But we laid out at Investor Day, we have a goal for ourselves to have a minimum of $20 million of content across all those SMRs. So as they're build-out, the 2 ARDP reactors, TerraPower and X-energy are committed to having their first reactors on the grid by the end of the decade. We're in design phase now. It's revenue for Curtiss-Wright now as we work with these guys, transitioning to prototype over the next couple of years because we've got to deliver on all that content so they can build their first reactor and have it on the grid. And the data center point is really great that you bring up. And that's really just come to life over the past recent months, is some of these owners of the data centers realizing they need to get ahead of the utilities and the build-out of these SMRs and really can't wait for the electricity to be brought on the grid by the utility providers, and are very integrated into conversations to see how they can make their much deeper capital deployment pockets really move in with these guys, and be able to jump start the build-out of these SMRs. So no announcements yet, but something we're -- we stay in touch with our customers on how that's going to assure we understand the timings and we're ready to be a supplier to them to make them successful.

Great. And historically, Curtiss-Wright is an acquisitive company. And more recently, a lot of your acquisitions have been focused on nuclear. We saw a few nuclear space -- nuclear -- sorry, M&A in the nuclear space.

Yes.

They're not space and nuclear.

Yes.

That would be pretty cool, though, like thermonuclear stuff.

Yes.

But are you pulling together a string of pearls approach in commercial nuclear? And when you look at the pipeline of deals, is that where we should expect you to deploy capital? Or how do you see your priorities for incremental deals?

So we definitely -- the last 2 acquisitions were in the commercial nuclear space. So one was a simulation technology, which is very strategic to us as it gives us the ability to work with either the new SMR providers or existing plants as they plan their outage or design their plants to fit our equipment into it; and Ultra Energy, which we're hoping to close in the near future to bring new capabilities to Curtiss-Wright and give us the European footprint, which is really going to be support of our partnership with Rolls-Royce. But maybe I'll ask Chris to talk a bit more on our capital deployment strategy.

Sure. Yes. Just at a very high level, and I'll be brief. I love the metaphor, by the way. That's great, a string of pearls. Our capital allocation strategy is balanced. I mean we have a very strong balance sheet. We are known for our strong free cash flow generation. We're going to close on these deals this year. We're not going to have to go on a revolver to do that. M&A is clearly our top priority. We've made that clear. We want to use that as an accelerator to growth on top of what we're doing organically. But we're not going to compromise and grow just for the sake of growth. It's got to be the right strategic and financial fit. We're looking for critical adjacent technologies that are going to help to supplement our portfolio. So beyond that, we are focused on returning capital to shareholders, and we believe this share buyback is the most effective way to do that. And I'm pleased to announce that just yesterday, we released a press release that increased the share repurchase program that we have this year by $100 million. So in addition to the $50 million 10b5-1 that we had in place, now we're going to buy another $100 million. So that will put to $150 million in share buybacks this year. Just as a reminder, in the last 3 years' journey, we bought back $450 million of stock. So this puts us in a really good position. Given the longevity and the growth that we have in front of us and the Pivot to Growth strategy, we feel like it's still a really excellent time to buy Curtiss-Wright stock, and we're pleased that we can do this and still have cash in hand at the year-end should another opportunity materialize that we can seize on the M&A front.

Great. And maybe going back, seeing your success in commercial nuclear power because it's clearly a significant driver of growth in the medium term and long term for the company, you leveraged navy technology to be able to build the AP1000. And now it seems like the subsea pumps business is another example of the company leveraging existing technology and adapting to new markets. So how should we think about the TAM in subsea pumps? And at the Investor Day, you said this could be a $500 million-plus market of production by 2035. Can you give us a little bit more understanding of what this is and what kind of revenue stream does it really open for you?

Yes. Thanks for that. It is -- and I mean it's something Curtiss-Wright does very well is develop technology for one end market and then apply it to other end markets with very modest investments. And I think it's been part of the thesis that has allowed us to drive the financial performance we have. And I know we're running short on time. We have partnerships with 3 major customers, Petrobras, Shell and Saipem. They're at different levels of their maturity, and we're getting ready to ship our first production unit to Shell for deployment by the end of this year. And we just announced that we passed qualification with Saipem. So really moving forward. And the market, as we see it today, is $250 million by the end of the year, $500 million by the end of the decade but -- or the middle of next decade. But it's interesting, the dynamics within that industry that there's leaders and followers. And a lot of the people that would buy the technology want to see it deployed and want to be successful and then they say they will come forward. And so I think it's exciting that we're getting the first pump out there this year. And I think as it demonstrates its reliability, I only think those opportunity sets are going to grow.

Well, great. Lynn, Chris, thank you very much for your time this afternoon. Everyone, this concludes our presentation on Curtiss-Wright.

Yes. Thank you, everyone.

Thank you.