Curtiss Wright Corp Q3 FY2022 Earnings Call

Welcome to the Curtiss-Wright Third Quarter 2022 Earnings Conference Call. I will now turn the call over to Jim Ryan, Vice President, Investor Relations. Jim, please proceed.

Thank you, Gretchen, and good morning, everyone. Welcome to Curtiss-Wright Third Quarter 2022 Earnings Conference call. Joining me on the call today are Chair and Chief Executive Officer, Lynn Bamford; and Vice President and Chief Financial Officer, Chris Farkas. Our call today is being webcast and the press release as well as a copy of today's earnings release and financial presentation is available for download through the Investor Relations section of our company website at www.curtisswright.com. A replay of this webcast also can be found on the website. Please note, today's discussion will include certain projections and statements that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are not guarantees of future performance. We detail those risks and uncertainties associated with our forward-looking statements in our public filings with the SEC. As a reminder, the company's results include an adjusted non-GAAP view that excludes certain costs in order to provide greater transparency into Curtiss-Wright's ongoing operating and financial performance. Any references to organic growth are on an adjusted basis and exclude foreign currency translation, acquisitions and divestitures unless otherwise noted. GAAP to non-GAAP reconciliations for current and prior year periods are available in the earnings release and on our website. Now I'd like to turn the call over to Lynn to get things started. Lynn?

Thank you, Jim, and good morning, everyone. I'll begin our remarks today by covering the highlights of our third quarter 2022 performance and some recent events that are influencing our business and financial outlook. Then I'll turn the call over to Chris to provide a more detailed review of our quarterly financial results and updates to our 2022 guidance. Finally, I'll wrap up our prepared remarks before we move to Q&A. Starting with our third quarter 2022 results. Sales increased 3% overall, reflecting the strength of Curtiss-Wright's combined portfolio. We delivered strong sales growth across our commercial aerospace, Nuclear Aftermarket, process, and general industrial end markets. This strength was partially offset by the impact of continued supply chain challenges in our defense markets, mainly impacting the timing of revenue in our Defense Electronics segment. Despite this headwind, we delivered 70 basis points in overall operating margin expansion to achieve 18.2% in the third quarter. This reflects a strong performance within our Aerospace & Industrial segment and the benefit of our company-wide operational excellence initiatives, which are helping to combat rising inflationary pressures. Adjusted diluted EPS increased 10% year-over-year to $2.07 and up 13% sequentially, which exceeded our expectations. New orders were strong, up 32% year-over-year to $818 million, reflecting 1.3x book-to-bill overall with orders exceeding 1x sales in each of our 3 segments. Notably, this was the highest level of quarterly orders since the fourth quarter of 2015, which, as a reminder, included the last AP1000 award, which was valued at $450 million. It is also worth noting that our Defense Electronics segment achieved a record bookings quarter. This was driven by strong demand for C5ISR and tactical communications equipment as we benefited from the improved pace of defense outlays during the past few months. Our new engineered arresting systems business, which we acquired on June 30, also recorded a strong bookings quarter, including an award announced yesterday to support the United Emirates Ministry of Defense. In naval defense, we secured several significant orders to support aircraft carrier and submarine platforms, including various contracts announced via press releases during the third quarter. Outside of defense, orders remained strong in commercial aerospace, Nuclear Aftermarket, and process as these markets continue their recovery to 2019 levels. Collectively, our orders, along with our strong backlog, which is now up 19% year-to-date, provides heightened visibility and tremendous confidence to support Curtiss-Wright's long-term growth outlook. Before I review the guidance highlights, I'd like to spend the next few minutes reviewing the macro-level headwinds that influenced our third quarter sales, which came in lighter than our expectations. This was principally driven by 2 factors: supply chain and foreign exchange. First, I'll discuss the global supply chain challenges, which continue to have a considerable impact on the timing of revenues in our Defense Electronics segment. While our year-to-date order activity is really encouraging, the delays in deliveries of semiconductors continue to defer our conversion of bookings to revenue, which has typically been within 6 to 9 months. We had expected this to ease up in the second half of this year and, even more importantly, for supplier decommits on critical components to decline more significantly as we move through the balance of the year. Unfortunately, this was not the case, and we continue to experience greater volatility in these areas. In addition, as we have mentioned over the past year, lead times on more complex devices have extended from a typical 10 to 12 weeks to 52 weeks or even greater in some cases and also remain quite volatile. As a result, we now expect approximately $45 million of Defense Electronics revenue to push out of 2022. We have revised our 2022 guidance to reflect this more derisked scenario for the timing of revenues and the related impact on free cash flow. Despite the delays, our Defense Electronics business remains fundamentally sound. We fully expect to recover these sales and related strong profitability as these conditions subside. This remains a timing issue with a strong but extended tail of revenues and free cash flow. Aside from the supply chain, FX headwinds due to the strength of the U.S. dollar are beginning to have a more pronounced impact on our sales performance for the first time in years. This resulted in a slightly greater than 1% impact on our third quarter sales or nearly $10 million, mainly within our Aerospace & Industrial segment. We expect these FX headwinds to continue into the fourth quarter and likely have a modest impact on our top-line results in 2023. We are closely monitoring this situation and the related impact on our business. Next to our updated full-year 2022 adjusted guidance. Our sales guidance for both our A&I and Naval & Power segments remain unchanged with each reflecting mid- to high single-digit growth. Regarding our Defense Electronics segment, as I shared earlier, we are now expecting $45 million in segment revenues to push out of 2022. As a result, we have reduced our overall Curtiss-Wright sales growth outlook to a range of 2% to 4%. While total Curtiss-Wright operating income guidance has also been reduced, we continue to expect strong year-over-year margin expansion based upon improved profitability within our A&I segment and our overall focus on operational excellence. As a result, we were able to maintain our prior guidance to reflect 10 to 30 basis points in margin expansion this year despite the top-line reset. We also remain on track to achieve double-digit growth in diluted EPS. While Chris will discuss our free cash flow in more detail, we have revised our expectations lower based upon the timing of the defense revenues, as well as the revised timing for receipt of a significant cash payment on the China AP1000 contract, which we now expect to collect in 2023. To summarize our guidance update, we certainly had our challenges during the quarter and a year with the supply chain situation, but business fundamentals and underlying demand across our portfolio remains strong. Next, I'd like to provide a few updates on some recent events. First, we were pleased to announce in September that we signed a preferred strategic supplier agreement with X-energy for the design and deployment of their advanced small modular reactor. We were selected to provide several critical systems for the reactor, which we expect to generate in excess of $100 million in revenue per plant. We'll discuss this agreement in more detail later in our prepared remarks. We are also excited to share the recent news that Westinghouse was selected by Poland to build the country's first nuclear power plant, initially expected to include 3 AP1000 reactors with the potential for 6 total reactors. As the reactor coolant pump or RCP provider for this reactor, this provides us an opportunity for new RCP orders from Westinghouse within the next 3 to 5 years to support these reactors in Poland, which are expected to begin producing electricity in 2033. In summary, we are well positioned to capitalize on the tremendous secular growth trends across our end markets, including emerging technologies and nuclear power and an increasing global focus on defense, which will enable Curtiss-Wright to deliver long-term profitable growth. Now I would like to turn the call over to Chris to provide a more thorough review of our third quarter 2022 performance and our outlook for the remainder of the year. Chris?

Thank you, Lynn, and good morning, everyone. I'll begin with the key drivers of our third quarter 2022 results by segment. In Aerospace & Industrial, we delivered another strong performance, generating 9% sales growth in the quarter were up 12% when excluding the impact of FX. Within the segment's commercial aerospace market, our results reflected strong demand on both narrow-body and wide-body platforms. In the general industrial market, our results reflected double-digit sales growth in both industrial vehicle products and surface treatment services where we continue to experience strong demand. In this segment's Ground Defense market, we benefited from a development contract for ground missile launcher EM actuation technology. And regarding the segment's profitability, we delivered 260 basis points in year-over-year margin expansion, which reflected favorable absorption on strong sales and the benefits of our operational excellence and pricing initiatives as we continue to outpace any supply chain or inflationary pressures on margin. Next in Defense Electronics, our performance again reflected the timing of defense revenues. Overall, we would have expected approximately $20 million in higher revenues in the quarter as changes in supplier schedules resulted in lower embedded computing revenues in aerospace and defense, as well as reduced sales of tactical communications equipment and Ground Defense. Turning to the segment's operating performance, our third quarter results principally reflected under absorption on lower A&D revenues. Next, in the Naval & Power segment, sales growth of 9% principally reflected the contribution from our new arresting systems business and its sales to the aerospace defense market. Naval defense revenues were essentially flat in the quarter, reflecting the timing of production on both the major aircraft carrier and submarine programs. In the power & process market, our results reflected solid demand in the Nuclear Aftermarket supporting existing reactors along with double-digit sales growth in process where we continue to experience very strong demand. These increases more than offset the wind down of production on the CAP1000 program. And regarding the segment's profitability, our results reflect favorable absorption on higher organic sales as well as the benefits of our operational excellence initiatives. To sum up the third quarter results overall, Curtiss-Wright's operating margin of 18.2% was slightly above expectations, up 70 basis points year-over-year and up more than 200 basis points sequentially. Next, turning to our full-year 2022 guidance. I'll begin on Slide 5 with our end market sales outlook. Based upon the macro impacts that Lynn mentioned earlier, we now expect total Curtiss-Wright sales growth of 2% to 4%, which includes the contribution from the arresting systems acquisition, offset by a 1% headwind from FX. As a result, we now expect organic sales to grow 2% to 4%. I'll begin in our A&D markets where we reduced our growth outlook to a new range of 1% to 3%. This primarily reflects the timing of revenues within our aerospace and Ground Defense markets due to supply chain delays, which we expect to slowly recover in 2023. We also reduced our naval defense outlook slightly based on the timing of program revenues. Wrapping up our A&D sales, our guidance remains unchanged in commercial aerospace, where we continue to experience very strong order activity in support of our current and long-term outlook. And turning now to our commercial markets, where we have raised our overall sales growth guidance to a new range of 6% to 8%. This reflects a more favorable outlook for the power & process market, which we raised to a new range of 5% to 7%. This increase is based on the strong year-to-date performance and increased sales within our nuclear business supporting Gen 4 advanced small modular reactors, most notably tied to our recent agreement with X-energy. In addition, we continue to expect strong general industrial market sales growth of 6% to 8%. As we've experienced historically, we expect the fourth quarter to be our strongest in 2022 and will reflect year-over-year sales increases across all of our A&D and commercial markets. Continuing with our outlook by segment, I'll begin in Aerospace & Industrial, where we continue to project strong growth in both commercial aerospace and general industrial market sales. Our top line guidance remains unchanged, reflecting growth of 6% to 8%, though we now expect more favorable operating income growth of 12% to 16% and operating margin to increase 90 to 110 basis points based upon the continued benefits of our operational excellence and pricing initiatives. Next, in Defense Electronics, we have revised our current year sales and operating income growth expectations, which we believe fully derisks our full-year outlook. Again, this very much remains a timing issue as the ongoing challenges in the supply chain are delaying the recognition of our strong order book. Despite those impacts, we maintained our operating margin guidance range of 22.2% to 22.4% for this segment. And lastly, in the Naval & Power segment, our top line guidance remains unchanged, reflecting overall growth of 7% to 8%, of which, 3% to 4% is organic driven mainly by an increase in the power & process market. Our outlook also includes the contribution from the arresting systems business, which delivered solid third quarter results and remains on track to contribute $40 million in revenue this year. For this segment, we continue to expect operating income to grow 6% to 8%, while operating margin remains strong, ranging from 18% to 18.2%. Next, I wanted to share a few comments about our research and development activities. Though we are experiencing some moderate delays from a staffing and engineering resource perspective, particularly in Defense Electronics, total Curtiss-Wright's combined spending on internal and customer-funded R&D is still expected to increase year-over-year by approximately $12 million. It's important to note that we're constantly seeking customer funding for our growth investments and that we are directing our resources to the highest and best use. If you recall, this activity began in the second quarter with a modest change to our guidance and shifted to development contracts as we were able to secure an increase in customer-funded programs. This shift is now taking place more broadly across the portfolio to support numerous projects, including electromechanical actuation technologies to support aerospace and Ground Defense and in the A&I segment, avionics and instrumentation as well as advanced naval cost technologies within our Defense Electronics segment and support for the new X-energy small modular reactor as well as subsea pumping initiatives in Naval & Power. Collectively, we expect these investments in total engineering spending, which are increasing year-over-year, to enable future organic growth and also support our pivot to growth strategy. So to summarize our outlook, we now expect total Curtiss-Wright operating income to grow 3% to 6% overall, still in excess of sales growth, and continue to expect operating margin to improve 10 to 30 basis points, ranging from 17.1% to 17.3%, including the headwind of the CAP1000 wind-down and first-year margin dilution on the new arresting systems acquisition. Continuing with our financial outlook, I'll begin with an update of our recent financing actions. If you recall in July, we took the opportunity to further strengthen our balance sheet. And last week, we closed on $300 million in new senior notes, which, as a reminder, at a blended rate of 4.54% on 10- and 12-year notes. We intend to utilize these proceeds to pay down our revolver, which was used to fund our recent acquisition. Of note, the continued increase in yields on 10-year treasuries and the timing of cash flows due to the supply chain is driving higher interest expense. And as a result, we increased our interest expense guidance by $2 million. Based on this increase and the impact from lower defense revenues, our updated full-year 2022 adjusted diluted EPS guidance reflects a new range of $8.05 to $8.20, which continues to represent double-digit growth this year. Turning to our full-year free cash flow outlook, our revised guidance reflects a new range of $275 million to $315 million, and I wanted to provide some color on the 2 main drivers. First, the timing of defense revenues due to supply chain challenges and our related ability to collect on those revenues as well as higher inventory levels have resulted in a lower-than-expected year-to-date free cash flow performance. Given the expectations for timing of fourth-quarter revenues, we see a related impact with collections pushing into 2023. Second, if you recall from our August update, we noted that we were expecting a significant cash payment upon final delivery of our CAP1000 reactor coolant pumps to China. And at this time, in alignment with the customers' project schedule, they're not ready to take delivery of these pumps, which would have substantially marked the completion of our contract. We are working with the customer and are confident in a successful resolution that this payment will not likely occur until 2023. As a result, we now expect to recognize approximately $40 million for the final cash receipt next year. The management team remains very focused on free cash flow generation and working capital, especially as we conclude this year and plan for 2023. It's important to note that excluding the delayed receipt of the CAP1000 payment, our adjusted free cash flow conversion would have exceeded 100%, a target that we've consistently achieved for the past decade.

Thank you, Chris. Before we move to Q&A, I'd like to take a few minutes to share some more exciting news in our commercial nuclear power business, which represents a significant long-term opportunity for Curtiss-Wright and our shareholders. In September, we signed an agreement with X-energy to advance the design and deployment of their Xe-100 advanced small modular reactor, the first of which is expected to begin commercial operation in 2028. Under the contract, we will be providing 3 of the most critical systems for this reactor. We would not have been in this position without the tremendous collaboration of our various nuclear businesses, leveraging their long-standing industry expertise to secure this important agreement for Curtiss-Wright. We estimate that our content will be in excess of $100 million in revenue per 4 unit X-energy plant. As a frame of reference, a typical build-out to replace an expiring coal plant would likely include a pair of X-energy plants and provide Curtiss-Wright in excess of $200 million in revenue. We are also working closely with other major reactor designers to develop similar partnerships including, but not limited to, expanding our existing relationship with NuScale and developing new content with TerraPower, GE Hitachi, and Rolls-Royce. We are recognizing initial design and development revenue in 2022 related to Generation 4 technology, which we expect to continue for the next several years as the demonstration projects are completed and anticipate that we would recognize production revenue in the middle to later part of this decade. We're also excited to see the continued drumbeat of U.S. government support for this technology and a steadily rising pro-nuclear sentiment, which should provide long-term benefits to Curtiss-Wright. We've seen several pieces of important legislation released in the past few quarters, including the Infrastructure Bill, the Inflation Reduction Act, and even the CHIPS Act all of which support the exciting existing nuclear infrastructure and the deployment of advanced reactors. This legislation will provide billions of dollars of investment and production tax credits dedicated to preserve the operation of the existing nuclear fleet and also helps fund the build-out of next-generation reactors. To help frame the potential of the advanced reactor market, we point you to a recent NEI survey of its membership, which includes utilities generating approximately half of the total electricity production in the U.S. today. They identified the need for more than 90 gigawatts of new nuclear power generation equating to more than 300 SMR plants being required over the next 25 years, many of which will be targeted to replace retiring coal plants. This represents a significant opportunity for Curtiss-Wright. Beyond the U.S., there is rapidly growing interest in advanced reactor technology in Canada, the U.K., and Eastern Europe. In addition to power generation, substantial opportunities exist for industrial and high-temperature process heat applications that greatly broaden the use of the potential end-user base. For example, Dow Incorporated recently announced their intent to deploy an X-energy plant at their Gulf Coast operations to provide carbon-free process heat and power that is expected to be operational in 2030. The global drive for climate change, clean energy, and carbon-free emission goals and the strategic importance of energy independence are all generating strong support for this industry. Overall, we see a tremendous global market opportunity for Curtiss-Wright to be part of every leading SMR and advanced reactor with the potential to drive above-average long-term growth in this market. As I wrap up our prepared remarks today, I want to emphasize that although we expect the challenging near-term market conditions to continue into 2023, I remain ever confident in our strong business fundamentals and the exciting opportunities that lie ahead for Curtiss-Wright. As evidenced by our growing order book, Curtiss-Wright remains extremely well positioned for long-term profitable growth, and we expect to enter into this next year with a very strong backlog across the portfolio. This, in turn, will provide a significant opportunity to deliver value to our shareholders. With the increasing U.S. defense budget environment and the emerging growth trends driving global defense spending as clear tailwinds to Curtiss-Wright, we are confident in our ability to demonstrate strong long-term growth across our defense businesses. Across our commercial markets, we remain well aligned with the leading long-term secular growth trends such as electrification and commercial aerospace, general industrial, and perhaps even in military, and in nuclear to help sustain the 20-plus operating reactors in the U.S. and hundreds more worldwide, as well as the opportunities at our doorstep to participate in the development and eventual production of advanced reactors. We remain focused on executing our pivot to growth strategy to maximize revenue and operating income growth. Despite fairly significant top-line headwinds this year, we remain well positioned to deliver solid operational performance in 2022 and beyond. Curtiss-Wright also maintains a healthy and balanced capital allocation strategy, and we are focused on investing our capital for the best possible returns. In closing, the prospects for Curtiss-Wright in the markets we serve remain very healthy, and we remain committed to driving solid execution and delivering long-term value for our shareholders. At this time, I would like to open up today's conference call for questions.

Our first question is coming from Michael Ciarmoli from Truist.

Lynn, you mentioned the opportunity with X-energy. I understand you took an equity stake and discussed potential similar relationships. Can you provide more details about the equity stake? Will we see additional investments in other companies?

Yes. Curtiss-Wright sees this as a significant opportunity. We believe X-energy is well positioned to introduce unique and safe technology into a rapidly expanding market. That’s why we decided to invest in this technology, which we have confidence in. We recognize the important role that advanced reactors will have in a safe and thriving energy market in the U.S. and beyond. This partnership is quite distinctive; while we are not necessarily projecting investments in other providers, we are proud to invest with X-energy. Our collaboration with them is strong. Importantly, they were eager to establish a relationship with Curtiss-Wright because of our reputation as a top supplier of equipment for nuclear power plants, which adds credibility to their efforts. Our partnership has been exceptional. We are actively engaging throughout the industry to ensure we are involved in every advanced reactor project being developed. I am very satisfied with the collaboration within Curtiss-Wright. For the past year and a half, we have discussed our goal of becoming a more integrated company in our business and market strategies. This is a prime example of how our teams are achieving that, and it has truly energized them with the opportunities that lie ahead.

Understood. That's helpful. I want to shift to the nuclear opportunity in Poland. Can you provide more details? You mentioned three reactors; is that three reactors or three plants? Are we looking at twelve pumps or twenty-four? Also, I know you've discussed the timing, but are you preparing from a resources standpoint? Do you have all the necessary staffing ready, depending on when that order is finalized?

Yes. We received exciting news late last week, and we are in the early stages of working with Westinghouse to determine the exact timing. We have been estimating a timeframe of 3 to 5 years, and this development reinforces that timeline, potentially allowing it to happen sooner, although we don’t have a clear view on that yet. There are 3 plants involved in the agreement with Poland, and their intent is to construct 6 plants. The initial contracting has been announced, though I don’t believe it is finalized yet, and it will pertain to the 3 plants. As Westinghouse strengthens that partnership, we are closely collaborating to ensure their success in launching the first 3 plants and securing the next 3 in Poland. Furthermore, they are actively exploring various opportunities across Eastern Europe, and we are committed to supporting them as their partner. Exciting updates are likely in the coming months as they finalize their contract and we see how that impacts us.

Got it. For my last question regarding the defense supply chain, it seems like the situation hasn't worsened significantly. I assume you were just expecting some improvements. You mentioned a recovery in 2023. Should we see this as a recovery mainly in the second half of 2023? How are you approaching the issue of accessing chips and other necessary products? A bit more detail on this would be helpful.

Sure. Before I comment further, I want to acknowledge that providing guidance for Defense Electronics has been particularly challenging for myself and the team. We believe this decision is the most sensible course of action. As a company, we prioritize transparency, and we feel that this perspective represents a lower-risk outlook for our business. We're making significant efforts to navigate these challenges and move forward. To provide some context regarding your question about the team, we expect to source approximately 30 million electrical components within this segment throughout the year. For instance, we discussed last year in Q3 how we started placing component orders early, anticipating lead times exceeding 52 weeks. One specific order involved 6,000 components expected to generate $45 million in revenue for this calendar year. These components were planned for delivery starting at the end of Q4 and continuing into the first half of this year and into Q3. However, we have seen very few of these components delivered so far this year. This delay significantly contributed to our Q2 revenue reduction for Defense Electronics, amounting to $28 million, largely due to this one component. Initially, we were informed that shipments would increase significantly in Q3 and Q4, and early in Q3, we did start to see a better pace of deliveries, instilling confidence that we would meet our guidance. Unfortunately, later in Q3, we received the disappointing news that no additional components would arrive this year. This one delay accounted for about one-third of the $45 million decrease in expected revenue. The situation remains highly volatile, and while we've made considerable efforts to improve our procurement practices, managing these delays is difficult. Moreover, our team has been proactive in building strong relationships with suppliers. One of our suppliers, who I won't name, has a solid history but was impacted by issues within their own supply chain, resulting in unexpected delays. Their commitment to delivering the parts was there, but unforeseen circumstances arose. In spite of these challenges, we recognize the broader industry trends indicating a decrease in demand. Supply is starting to improve, and forecasts suggest that demand may continue to decline into next year. We anticipate stabilization in the latter half of 2023. We believe that the steps we've taken throughout this year, along with our ongoing improvements, will position us more favorably in 2023 compared to our current situation. We are closely monitoring these developments and maintaining strong collaboration with our suppliers.

Our next question comes from Nathan Jones from Stifel.

Just one follow-up on the SMR opportunity. Just figuring out these numbers here, 300 SMRs in the U.S. by 2050 and that's from half the utilities in the U.S. So if we double that and say it's 600 and the revenue opportunity for you is $100 million per 4 of those. Is it reasonable to size that market opportunity, not necessarily the amount that you're going to get, but that market opportunity would then work out to something like $15 billion through 2050, is that the kind of number that you're thinking about as the opportunity just in the U.S. from these SMRs?

Let me clarify. You are correct that the 300 figure comes from half of the utilities. It would be reasonable to assume the other half would be interested in a similar amount. There’s nothing special about the half that are members of NEI. This is a reasonable assumption, but it doesn't mean that all of them will be X-energy plants. It's reasonable to expect a variety of companies, which we've mentioned, that we are actively working with to secure portions of the SMR build-out. We anticipate significant engagement, potentially in the tens of millions of dollars, though perhaps not reaching $100 million for every contract. It's too early to provide exact figures. Some partnerships are more advanced with X-energy than others, but we do expect meaningful content. You can do the math, and indeed, the numbers are impressive. We're focused on supporting our partners in successfully designing their reactors in a cost-effective way to bring them online. The potential is considerable, especially when you consider the U.S., Eastern Europe, the U.K., and Canada, along with the evolving process market, which is prompting us to think about how to prepare for these opportunities.

Yes, and I would just add on to this, not that we need icing on the cake, I think, at this point. But I would say that that's just electricity generation that we're really talking about. I mean there's applications, particularly for the X-energy reactor, due to its high temperatures and process heat and other industrial applications, hydrogen production, etc. So there's more beyond that market.

Sure, you provided some funding spreadsheets for planning. Lynn, you mentioned that the strong dollar is affecting some of the international businesses. Was your comment only about the translation effect? Typically, a very strong dollar negatively impacts activities, especially in emerging markets. Are you beginning to notice that affecting demand, or were you just referring to the translation?

I'll let Chris take that.

Yes. No, we're not seeing an impact on demand. I think it's natural to assume that some of the order book is being influenced by that because certainly that's what translates into sales, but it's a headwind for us. In the third quarter alone, it was nearly $9 million in sales. I mean, year-over-year, we've seen the U.S. dollar move fairly dramatically against the Euro, GBP, and CAD, which are really the top 3 foreign currencies that we work within. And Q2 was pretty strong as well. I would say roughly half, if not more, in some cases, of that change occurred during the most recent quarter since Q2. So it's something that we're monitoring, and we expect at this point, it's going to be about a 1% headwind to revenues this year, fairly immaterial to operating income, and we expect that to continue into this next year. I would say that the group that's probably most affected by this, as you look across the 3 segments, is really the A&I group based upon what they're doing in the general industrial space and the location of some of their facilities, but it's also affecting the Defense Electronics team as well.

There was some discussion about the end market trends and order trends. I wouldn't classify it as anything significant regarding general industrial order trends. Could you share some insights on the order trends in general industrial markets?

The business continues to perform well, with Q3 revenue increasing by $13 million or 14% compared to the previous year. We experienced 17% growth in vehicles, primarily in on-highway Class 8 and specialty vehicles. Additionally, industrial automation and services rose by 6%. We expect that market to grow by 6% to 8% for the full year. In Q2 and Q3, industrial vehicle product orders returned to what I would describe as strong 2019 levels. Although they were down from last year, which saw historic highs, backlog nearly doubled. Year-to-date, order activity is still up 10% compared to fiscal year 2019, indicating a robust backlog. Managing the supply chain is crucial for this business. While they face challenges, particularly in transportation rather than the semiconductor issue in Defense Electronics, they are doing an excellent job monitoring the order book and appear to be well positioned for 2023.

Our next question comes from Myles Walton from Wolfe Research.

I was hoping to get more details on the Defense Electronics segment, specifically regarding the recovery plan when facing a significant demand signal but limited supply. Managing this situation can vary in duration depending on the business. One of your focus areas is thermal cycling, and you have a seasonal business. Does this give you an opportunity to balance the year more effectively by potentially increasing production in the early part of '23 instead of following the usual seasonal ramp-up in Q4?

Yes, that's a good observation. You've clearly been monitoring us for some time. It's true that historically our revenue is stronger in the second half of the year compared to the first half. We entered this year expecting that trend to be even more pronounced than usual. The team has prepared extensively for this. Despite the call down, we still anticipate significant growth in the fourth quarter. I believe the team is well-equipped for this challenge. This has been a tough period, but our team is dedicated to meeting customer needs and is ready for the ramp-up required in Q4. While the exact timing of the revenues we aim to push to next year is not fully determined yet, it seems reasonable to expect a smoother flow of revenues throughout 2023, potentially resulting in less of a spike than in previous years. So yes, it's a valid point to raise.

Okay. All right. And then the other question I had was on Nuclear Aftermarket in particular. So obviously, there's a lot of positive things going on and the potential for new builds in the future and SMRs. But on the aftermarket side, there was pretty positive legislation that was, as you mentioned, signaling to the current reactors, extended lives for many years to come. I'm just curious if the order activity for life extensions has now blossomed considerably and what your outlook is for the growth rate there. I think you had a low single-digit CAGR previously at the Investor Day for Nuclear Aftermarket. And I'm just curious if there's an update to that?

I'll start with a broad overview and then let Chris address the specifics of the orders. It's noteworthy that orders are performing well within the group. We discussed our capability to distinguish between normal aftermarket work and orders related to plant life extensions. This distinction can be somewhat ambiguous since both involve maintenance activities at the plant. Our team believes it's still early in this process, but we are noticing an uptick in orders attributed to plant life extensions, and we are just in the initial stages of that trend. I expect this will create a favorable environment for our team over the coming years as various plants reach their life extension phases at different intervals. We're definitely seeing some of the activity in 2022 linked to plant life extensions. Chris, would you like to provide some figures?

Sure. I can do that. As you've seen over time, the aftermarket business can have seasonal variations, sometimes favoring the first half of the year over the second half. This year follows a similar pattern. In the third quarter, orders for this business increased by 4%, and year-to-date, they are up 13% compared to last year. We need to exclude the AP1000 from the power and process markets to fully understand what’s happening in nuclear and the processes involved. This year, we anticipate the aftermarket will grow at a high single-digit rate, with a solid increase in revenue. In Q3, we experienced an 8% growth in that market. The primary challenge we face is the wind down of the CAP1000. We expect to see higher maintenance and license renewals in both the U.S. and Canada. Regarding SMR development, we are noticing some of that activity reflected in our sales as we engage with development contracts alongside X-energy and NuScale. Looking ahead to the fourth quarter, we project revenues to increase by 7% year-over-year, and we expect to finish the year strongly. We are well-positioned for next year due to the strength of our order book and are optimistic about 2023.

Our next question comes from Peter Arment from Baird.

Lynn, regarding the supply chain discussions, how are you considering the strategy of possibly increasing inventory levels, given your strong focus on free cash flow? And Chris, could you share your thoughts on working capital and our strategic approach moving forward?

Sure.

That's a great question. One of our competitive advantages is our ability to manage lead times better than our competitors. We need to align these lead times with our customers' schedules, which requires us to think differently than in the past. Previously, even the most complex components had lead times of 10 to 12 weeks, but now we are exploring a just-in-time inventory management system. This year, we’ve been focusing on a long-term solution rather than just a quick fix to the problem by ordering advanced materials. It seems unlikely that lead times will decrease to previous levels in 2023, and possibly not even in 2024, though that is speculative. We are definitely considering how to manage our long lead items more proactively, which signifies a shift in our business strategy. Chris can provide additional insights, but regarding the 30 million components I mentioned earlier, many have seen lead times decrease. The remaining issues are mainly with complex components like processors, advanced memory chips, GPGPUs, and FPGAs, which still face long lead times. The financial impact of managing these components is not dramatically high, and we have found ways to collaborate with our supply chain to pipeline inventory at their cost. While the overall impact isn't straightforward, we are adopting new strategies this year that we believe will enhance our stability in 2023.

I believe you articulated that well, and from a financial perspective, I don’t have much more to add. However, when it comes to managing working capital, particularly inventory, we currently have excess inventory. Typically, we build up our inventory as the fourth quarter is historically our strongest output period, and we expect the same for Curtiss-Wright this year. We anticipate reducing a significant portion of that inventory in the fourth quarter, although we will still be slightly above last year’s levels. As we refine our focus and adapt to lead times, which are stabilizing for these parts, we should be better positioned to manage our inventory balance. This will require ongoing effort, especially as the supply chain situation improves in the first half of the year and hopefully into the second half of next year. We are actively managing our working capital with all available resources. This quarter, we have redirected efforts towards cash collection, placing greater emphasis on receivables that are close to or overdue. We aim to proactively engage with customers to ensure timely cash inflow, utilizing customer financing options where feasible and ensuring borrowing costs are comparable or better than what we have on our revolving credit. We are applying more scrutiny to risk orders and buffer stock, and our teams are collaborating creatively with industry partners to explore trade-offs. We're all navigating similar challenges, and there could be opportunities where we can support each other. We are also approaching accounts payable with caution, having started this earlier in the year to ensure we proceed carefully and preserve cash flow. Furthermore, we are evaluating our tax positions and payment options to enhance our situation. There are many changes occurring, and we’re working diligently to meet our commitments.

Thank you for that information. I have a quick follow-up regarding the discussion about Poland. It seems there has always been mention of 2033, and you've indicated that we need to have that industry standard in place five years in advance. How do your orders relate to that timeframe? You mentioned a window of three to five years, but it feels like we might need to act sooner. Could you provide some background on that?

Yes, we previously discussed a timeline that, unfortunately, aligns with the day of the invasion on February 24. This is the timeline Poland has been referencing. As for the 3 to 5 year outlook, we lack evidence to suggest that this will change. Typically, it suggests an order in 2024, but we've extended that to 3 to 5 years since projects usually take longer. However, the urgency of the situation could potentially alter that expectation. We don't yet have evidence that it will speed things up. Nevertheless, the fact that Westinghouse is establishing EPCs and localization partnerships, along with the announcement from Poland moving towards a contractual commitment, is promising. This progress allows for some optimism that timelines may shorten, but we'll need to wait for more evidence before getting ahead of ourselves.

Our next question comes from Kristine Liwag from Morgan Stanley. We don't have any evidence of that yet, but there is no doubt that the various deals and the situation that Westinghouse has established with EPCs and localization partners, along with the recent announcement from Poland and the movement towards a contractual commitment, is impressive. This is a fantastic pace, and it definitely gives us optimism that things will progress positively. However, we are waiting to see evidence of that before we get ahead of ourselves.

For your full-year guidance, you are still projecting a significant increase for Defense Electronics. The fourth quarter suggests a growth of about 40% compared to the previous quarter. Can you discuss your approach to reducing risk in your outlook for the full year? Have you secured the necessary components to meet this guidance, or are you still waiting for some of them? Is there a risk associated with that outlook?

Thank you for the question, Kristine. It's challenging for me, the leadership team, and the Defense Electronics team to present this call down. We analyzed our approach from various perspectives and considered multiple scenarios. We are still depending on some component deliveries in the fourth quarter, and we do not have all components available. However, we understand our diverse supply chain and have identified which suppliers are reliable and fulfilling their commitments consistently, as well as those with more volatility. We have adjusted our forecasts based on materials we expect to receive reliably as we progress through Q4. While there are still components required, we believe we have evaluated this from several angles and set a forecast level we can meet. As mentioned earlier, we anticipated significant growth in the second half of the year, especially in Q4, and have been preparing for it. We have increased our staff and testing equipment and arranged for multiple shifts. We have actually started working in Q3 to get ahead of some card and system builds. Therefore, not all the work is confined to Q4. The team is confident we have chosen this forecast level carefully and expect to deliver on it.

And maybe taking a step back on supply chain. I mean, part shortages are an issue for you to deliver on products. And this is in context of still a relatively stable geopolitical environment. So if you look at the lessons learned about the difficulty with managing a supply chain and if geopolitical risks get worse, are there changes in how you look at your supply chain strategy so that you could be prepared in a, let's say, a worsening geopolitical environment scenario, so you could still fulfill national security needs in that event?

Yes, that's an important question. We have significantly changed our practices and approaches this year to continually seek dual sourcing. We have implemented this across the A&I segment, though it is not directly associated with national security. We are actively pursuing dual sourcing within the Defense Electronics segment where possible. However, some specialized high-performance chips do not have dual sourcing options as they are unique to the industry. In those instances, the suppliers of those chips are diligently working to mitigate geopolitical risks that could affect their ability to supply. We are also enhancing our tools for inventory visibility and management, and have introduced new resources in the latter half of this year to support scenario planning and improve prioritization of inventory risks. We continue to evolve our collaboration with customers and suppliers, maintaining a proactive approach to long lead materials, and striving to navigate this environment as effectively as possible. However, it's important to note that this challenge is not fully resolved.

And it appears we have no further questions. I will now turn the floor over to Lynn Bamford, Chair and Chief Executive Officer for additional or closing remarks.

So thank you, everybody, for joining us today, and we look forward to speaking with you again during our fourth quarter 2022 earnings call. Have a good day.

Thank you. This concludes today's Curtiss-Wright Third Quarter 2022 Earnings Conference Call. Please disconnect your line at this time, and have a wonderful day.