Earnings Call Transcript - CW Q1 2021

Operator, Operator

Good day, and thank you for being here. Welcome to the Curtiss-Wright First Quarter 2021 Financial Results Conference Call. I would now like to turn it over to your speaker today, Jim Ryan, Senior Director of Investor Relations. Please proceed.

Jim Ryan, Senior Director of Investor Relations

Thank you, Dana, and good morning, everyone. Welcome to Curtiss-Wright's First Quarter 2021 Earnings Conference Call. Joining me on the call today are President 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 financial presentation is available for download through the Investor Relations section of our company website at www.curtisswright.com. A replay of this webcast can also 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. Also note that both our adjusted results and full year guidance exclude our build-to-print actuation product line that supported the 737 MAX program, as well as our German valves business, which was classified as held for sale in the fourth quarter. In addition, discussions about our first quarter results and full year guidance reflect our new segment structure, which we announced earlier this year to provide greater clarity and transparency to our portfolio. Reconciliations for current and prior year periods are available in the earnings release, at the end of this presentation and on our website. Any references to organic growth exclude the effects of restructuring, foreign currency translation, acquisitions and divestitures, unless otherwise noted. Now I'd like to turn the call over to Lynn to get things started. Lynn?

Lynn Bamford, President and CEO

Thank you, Jim, and good morning, everyone. I'll begin with the key highlights of the first quarter performance and an overview of our full year 2021 outlook. Then I'll turn the call over to Chris to provide a more detailed review of our financial results and an update to our full year guidance. Finally, I'll wrap up our prepared remarks before we move to Q&A. Starting with the first quarter highlights. We're off to a great start with higher sales and improved profitability, driven by strong operational performance that exceeded our expectations. The net sales increase of 2% was led by solid growth in our aerospace and defense markets, which improved 8%. The adjusted operating income improved 15%, while adjusted operating margin increased 160 basis points, reflecting strong margin improvement in the Defense Electronics and Naval and Power segments. Our results also reflected our swift actions taken last year in response to the pandemic, where we committed to controlling our costs to preserve profitability and free cash flow. Restructuring savings resulting from those efforts are reflected in our first quarter results and provide a strong base for our margin expansion over the course of the year. We also continue to fuel our innovation pipeline with a $4 million year-over-year increase in research and development investment to support our strategic growth initiatives. Adjusted diluted EPS was $1.51 in the first quarter, which increased 18% year-over-year. As a reminder, our prior year first quarter results were largely unaffected by the pandemic. Looking at our first quarter orders, overall book-to-bill was solid at approximately one times sales in the first quarter with 1.2 times in our commercial markets. This performance was led by a surge in demand for industrial vehicle products in both on- and off-highway markets. Looking across the rest of our commercial markets, we have been encouraged by steady improvement since the third quarter of last year and remain optimistic for a continued solid rebound in the back half of this year. We also experienced solid new order growth in our A&D markets, principally led by higher demand for defense electronics and our recent acquisition of PacStar. Speaking of PacStar, the integration is on track, and I am encouraged by their strong performance to begin the year. As a reminder, PacStar is projected to deliver high single-digit revenue growth and is aligned to one of the Department of Defense's top priorities in upgrading and modernizing the NetCentric connected battlefield. Next, to our full year '21 guidance highlights, where we raised our adjusted guidance for sales, operating income, margin and diluted earnings per share. These increases are based upon higher demand in defense electronics and improved profitability in the Naval and Power segment. We now expect adjusted operating margin to range from 16.6% to 16.7%. We also increased diluted EPS by $0.10 to a new range of $7.10 to $7.30, with the top end of our range reflecting double-digit growth compared to 2020. Overall, we are encouraged by a solid start to the year, which supports our continued confidence to deliver strong results in 2021. Now I would like to turn the call over to Chris to provide a more thorough review of our first quarter performance and our improved outlook for 2021. Chris?

Chris Farkas, CFO

Thank you, Lynn, and good morning, everyone. I'll begin today with a review of our first quarter sales and profitability where we again delivered another strong operational performance. Starting in the Aerospace and Industrial segment, sales were lower year-over-year, as anticipated, based upon reduced demand on wide-body jets within the commercial aerospace market. However, on a positive note, we experienced an uplift in industrial vehicle product sales to both on- and off-highway markets driven by solid order growth, as Lynn mentioned earlier. This segment's operating performance, while bolstered by year-over-year restructuring savings, primarily reflects unfavorable absorption on lower sales and an immaterial impact due to supply chain constraints in both container shipments and electronic components. In the Defense Electronics segment, the strong 31% growth in revenues reflects the contribution from our PacStar acquisition and a 4% increase in organic growth principally in aerospace defense for our commercial off-the-shelf or COTS products. Segment operating performance was very strong as adjusted operating income increased 42%, while adjusted operating margin increased 170 basis points to 20.9%. Key drivers of this performance included higher organic sales volumes, favorable mix toward our COTS products and the benefit of our cost containment efforts, which more than offset higher investments in research and development. Of note, this performance did include the acceleration of some revenues from the second quarter as several customers took action to stabilize their supply chains due to global concerns for potential shortage in electronic components. In the Naval and Power segment, we experienced solid revenue growth for our naval nuclear propulsion equipment and higher fleet services, which was mainly offset by lower aftermarket revenues to our commercial power and process markets. Adjusted operating income increased 21%, while adjusted operating margin increased 300 basis points to 17.7% due to favorable sales mix within our naval defense markets and an increased benefit from our 2020 restructuring actions. To sum up the first quarter results, overall, adjusted operating income increased 15%, which drove margin expansion of 160 basis points year-over-year. Turning to our full year 2021 guidance, I'll begin with our end market sales outlook, where we've made a few changes highlighted in blue on the slide, reflecting a modest increase in total Curtiss-Wright sales. Our outlook for overall aerospace and defense market sales growth is now 7% to 9% based upon strong first quarter demand and higher orders for our defense electronics equipment. This positions Curtiss-Wright to once again grow our defense revenues faster than the base DoD budget. In our commercial markets, our overall sales growth is unchanged at 6% to 8%, and we are encouraged by the strong 1.2 times book-to-bill recorded in the first quarter. We now expect total Curtiss-Wright sales growth of 7% to 9%, of which 2% to 4% is organic. Continuing with our outlook by segment, I'll begin in Aerospace and Industrial, where our top line guidance of 1% to 3% sales growth remains unchanged. And we continue to project solid growth in operating income and margin, mainly reflecting the benefits of our prior restructuring initiatives. As we look across the remainder of the year, we continue to monitor the impact on our industrial supply chain very closely. We believe that we can fully mitigate any such impact through various initiatives and expect it to be immaterial to our full year performance. Next, in the Defense Electronics segment, based on the solid first quarter orders within our defense markets, we now expect the segment sales to grow 22% to 24%, driven by a combination of 4% to 6% organic growth and a strong contribution from PacStar. Segment operating income guidance increased $2 million on a $5 million increase in sales. And as a result, we're now projecting segment operating income to grow 10% to 13% while operating margin is projected to range from 21.3% to 21.5%. Of note, segment profitability reflects a $6 million year-over-year increase in research and development, unfavorable mix due to a ramp-up in lower-margin system sales and inorganic sales from PacStar, which will be dilutive to overall Curtiss-Wright margins in year one. In the Naval and Power segment, our top line guidance of 1% to 3% sales growth remains unchanged. However, we increased adjusted operating income guidance to reflect an additional $2 million benefit from our prior year restructuring actions. Segment adjusted operating income is now projected to grow 2% to 5%, while adjusted operating margin is expected to increase 20 to 30 basis points to a range of 18.2% to 18.3%. So, to summarize our outlook, we expect full year 2021 adjusted operating income to grow 9% to 11% overall on a 7% to 9% increase in sales. Operating margin is expected to improve 30 to 40 basis points to 16.6% to 16.7%, reflecting the strong profitability and savings generated by our restructuring initiatives. Continuing with our 2021 financial outlook, where we've increased our full year adjusted diluted EPS guidance by $0.10 to a new range of $7.10 to $7.30, reflecting growth of 8% to 11%. Following our strong first quarter performance, we now expect second quarter diluted EPS to be similar to the first, followed by sequential quarterly improvement during the second half of 2021 with the fourth quarter being our strongest. Turning to our full year free cash flow outlook, our guidance remains unchanged with a range of $330 million to $360 million. During the first quarter, which reflected our typical outflow of cash, we experienced a solid 34% year-over-year improvement in adjusted free cash flow due to higher cash earnings and lower capital expenditures. Our solid first quarter performance provides us with confidence, and we remain on track to achieve our full year free cash flow guidance and exceed our long-term conversion target of 110% again in 2021. Now I'd like to turn the call back over to Lynn for some closing remarks. Lynn?

Lynn Bamford, President and CEO

Thank you, Chris. In summary, we expect to deliver strong results in 2021. We are well positioned to deliver a high single-digit growth rate in sales and double-digit growth in operating income and diluted EPS in 2021, while continuing to expand our margins to reach 17% in 2022. We expect to accomplish these results while making an additional $10 million of strategic investment in R&D to fuel future organic growth. Our adjusted free cash flow remains strong as we expect to generate north of 110% free cash flow conversion. We also continue to maintain a healthy and balanced capital allocation strategy to support our top and bottom line growth. Our balance sheet remains very strong, and we have sufficient capacity to spend up to $1.6 billion in strategic acquisitions. Of course, should acquisitions not transpire as expected, then we will consider additional share repurchase activity as we have done historically to ensure maximum return to our shareholders. Later this month, on the morning of May 26, we will be conducting our virtual Investor Day event. During the event, we will share Curtiss-Wright's new vision and pivot to growth strategy driven by a renewed focus on top line acceleration. We will provide an overview of our new operating growth plan, led by our continued focus on operational excellence, as well as a deeper dive into the segments where we have tremendous potential to leverage technological leadership across the corporation. As we will demonstrate, we continue to build upon the company's strong foundation and decades of engineering expertise through ongoing innovation and collaboration. This, in turn, drives our continued strategic investments. We will conclude the day by delivering our new three-year targets building upon our top quartile performance while driving solid growth in operating income, EPS, and free cash flow. We hope that you will join us in a few weeks as we reinforce Curtiss-Wright's strong culture of innovation, proven operational excellence, and dedication to delivering long-term value for our stakeholders. At this time, I would like to open up today's call for questions.

Operator, Operator

And our first question comes from Mike Ciarmoli with Truist.

Mike Ciarmoli, Analyst

Hey, good morning, guys, and thanks for taking my question. Nice results. Lynn or Chris, I mean, you mentioned supply chain various times throughout the prepared remarks. Can you just maybe give a little bit more color on where specifically you're seeing the tightness? Is it at the printed circuit board, semiconductor level? And you mentioned some good pickup in on-road, off-road vehicles. Is there any concern on that side of the market regarding supply chain constraints? And then even dovetailing in there, maybe just what you're seeing on raw material and input prices as well as it relates to the whole supply chain?

Lynn Bamford, President and CEO

I'll begin, and then Chris can provide additional details. We are experiencing some impacts from the supply chain, but nothing that will significantly affect us. We are closely monitoring the situation. There is a slight margin impact due to increased freight costs, as well as delays from container shipments, particularly around the Los Angeles port. We are actively managing these issues and working closely with our customers to inform them of the delays and explore solutions. The most critical area for us is electronic components, which affect both our A&I segment, particularly with vehicle programs, and Defense Electronics. We are taking several steps to mitigate risks in this area. We leverage our established relationships with suppliers, dual source whenever possible, and utilize government priorities to expedite our electronics. Currently, we believe we have the situation under control, although things can change. These are the primary areas where we are experiencing delays, and we are confident in our management of them.

Chris Farkas, CFO

Yes. And I would only add that a little bit of cost erosion in the Aerospace and Industrial group, but that's a pretty flexible and agile group and reacting to shifts in material cost and whether it's passing it on to the customer or tightening the belt to offset that. I think we've got that under control and in our guidance for the year. And on the defense side, it's really more about customers reacting, trying to pull in a little bit out of Q2 into Q1 to get ahead on this. But I think there it's more timing than anything, but Lynn said it well.

Mike Ciarmoli, Analyst

Understood. Now, looking at the broader perspective of the defense budget, we currently have only been presented with a preliminary outline. As you assess the portfolio, do any specific risks stand out, particularly concerning the Joint Strike Fighter or other platforms? Additionally, we are hearing about infrastructure investments, particularly in shipyards, which seems to be a major focus for the Navy and could potentially benefit Dresser-Rand. Can you share any insights on the overall direction of defense spending or programs?

Lynn Bamford, President and CEO

We feel confident and remain optimistic about our outlook, especially with the anticipated details from the President's budget, which should support our business. It's widely acknowledged that China poses a significant challenge, particularly in shipbuilding, the largest segment of our defense operations. We're seeing strong bipartisan support for the shipbuilding industry, and we don't anticipate any disruptions there. I’ve previously highlighted that feedback from our customers indicates a continuous challenge that we can address, which bodes well for potential capital investments as we prepare for increased demand. While there is always a risk with budget adjustments affecting all programs, we are aware that areas of significant revenue have high priority. With PacStar being our largest acquisition, it is crucial for its performance to meet expectations. It has had a strong start this year, and we remain optimistic as it holds a high priority within the Department of Defense. I want to acknowledge that risks do exist, and we are vigilant about them, but we feel confident in our programs. Lastly, we've adopted a strategy in defense electronics focused on state-of-the-art, program-agnostic products. The progression of the MOSA standard is ongoing, and we recently shared news about F-22 adoption to provide insight into our business successes and the reasons for our optimism.

Mike Ciarmoli, Analyst

Got it, very helpful. Thanks guys.

Lynn Bamford, President and CEO

Thanks, Mike.

Operator, Operator

Your next question comes from the line of Peter Arment with Baird.

Peter Arment, Analyst

Hey good morning, and Lynn, Chris, Jim, nice quarter.

Chris Farkas, CFO

Thank you.

Peter Arment, Analyst

So, the book-to-bill ratio for commercial markets is 1.2. Could you provide more insight into what you're observing there and whether you believe this trend is sustainable or if it's just a temporary rebound in order activity?

Lynn Bamford, President and CEO

I would say our most notable point of optimism is related to the orders we've seen increase in the strong first quarter. The question is whether this is just advance buying or the start of a continuing trend. We genuinely believe it's the beginning of a trend. The growth in both industrial on- and off-highway vehicles is very encouraging. The orders placed and conversations with our customers lead us to believe that this momentum will continue. In the commercial aerospace sector, our actuation and sensor products are indicating a solid rebound in the second half of the year. One area where we are still waiting for clarity is in our surface tech business, as it does not show a significant uptick in advance. We are hopeful to see some improvement in the second half. There has been some increase, but it is not as strong as what we’re experiencing elsewhere. Chris, do you want to add anything to that?

Chris Farkas, CFO

I think you said it well. I'd only go on to say, when you step, when you're looking at the commercial book-to-bill of 1.2 times, so it's not only the vehicle orders, but we have seen a steady sequential ramp in the process markets. Now they're not back to where they were in the prior year, but things are looking good from that perspective. And then as you look at nuclear within power and process and the nuclear aftermarket, they had a very good quarter here in the first quarter of '21 as well, not quite as great as where they were in Q1 of '20, but just continued sequential improvement, and they're on a strong ramp. And then when you do shift over to A&D and you look at commercial aerospace, just to reinforce what Lynn was saying about our long order cycle and short order cycle businesses, I mean we have been getting a lot of feedback from customers asking about rate readiness and expecting volumes to ramp in the second half. So, while we're looking at surface tech with some caution, given its short order cycle nature, I think it speaks favorably to support our full year guide and beyond.

Peter Arment, Analyst

Yes. Chris, also, you mentioned in the power, like there were some reduced valves to the energy market kind of a little bit of a headwind. Do you just need CapEx spending to pick up there in order to see that recover as well?

Chris Farkas, CFO

I think it's a little bit of CapEx spending, but I also think it's really just timing and climbing back to pre-pandemic levels. If things are starting to open up here, we're starting to see improvements. And we're headed in a good direction here. I think it's really timing. We are expecting to see improvements here in the back half of the year. The order signals that we're getting in power and process support that.

Peter Arment, Analyst

And then, just the last question on mergers and acquisitions. Lynn, you mentioned the significant capacity you have for M&A, but it seems like you have been very focused on adding niche companies and technologies, and it sounds like that's still the focus. However, how comfortable are you with taking on additional leverage if the right opportunity arises?

Lynn Bamford, President and CEO

So, I highlight that we have $1.6 billion of capacity because for a very specific strategic company that really added to our capabilities and build out on what we have to offer, I think we would go there and potentially beyond would be possible. So, you are right that we have historically added sub-$100 million companies. I think we showed our willingness to go beyond that with PacStar. And I would feel comfortable continuing on in that direction. And with that, I'll turn it over to Chris to talk a little bit more about the leverage.

Chris Farkas, CFO

Yes. I think from where we are from a debt-to-EBITDA standpoint at about 2.5 times, I mean we are within investment grade. We view investment grade to be in that three times or below level. And something transformational came along, and we felt it would be a good opportunity for us and our stakeholders and shareholders to get up to a 3.5 to 4 times. For the right property, we would do that. And I think we quickly used the cash to delever back down to investment grade. But we found our sweet spot right now, and I think we have great capacity.

Peter Arment, Analyst

Nice results, thanks.

Chris Farkas, CFO

Thank you.

Operator, Operator

Your next question comes from the line of Myles Walton with UBS.

Myles Walton, Analyst

Hey, good morning. I was hoping that maybe you can touch on the performance in the quarter, obviously better than you all had expected and by maybe $0.20 on the EPS, and you raised the full year by $0.10. Am I right to think that the comments about some of the prebuy, I guess, from 2Q into 1Q explains why the full beat versus the expectation maybe doesn't drop to the full year?

Chris Farkas, CFO

Yes, that is it, Myles. I think as you look at what we did here on the full year guidance and increasing the sales by $5 million in the Defense Electronics segment and $2 million of operating income, we really had a much stronger pull from Q2 into Q1. So, that's really half of what I would say you're seeing above consensus. But the rest is just strength in orders and what we're seeing for that business for the remainder of the year. We're also we had some better restructuring savings in the Naval and Power segment, and that will translate to the full year. I think that was roughly $2 million as well. So, you're right on.

Lynn Bamford, President and CEO

Yes.

Myles Walton, Analyst

Okay. It seems like PacStar is doing well. Was it expected to negatively impact the segment margins initially? If so, to what extent, and could you provide more details on how the underlying business performed better in terms of margins?

Lynn Bamford, President and CEO

So, thanks for that. We are very encouraged at how things have performed with PacStar in Q1, the integration into the company, them leveraging. We definitely did talk about them being dilutive in year one, and I'll let Chris add some color to that, but we're well on the path toward leveraging our supply chain and channels to really help them drive their operating margins. And really, the pull for their products is quite outstanding, and we're very encouraged by what we see as an outlook for them.

Chris Farkas, CFO

I'm not going to elaborate much on the impact of PacStar's margins, but I want to emphasize that they are off to a strong start, and we are very pleased with the progress of their integration into our Defense Electronics segment. They will have a negative effect on our overall margins for the year, but we aim to improve them to 17% in the long run. Overall, we see them as a positive contributor, and we are satisfied with the way things are shaping up so far.

Myles Walton, Analyst

Okay. Thanks, so much.

Chris Farkas, CFO

Thanks, Myles.

Lynn Bamford, President and CEO

Yes, thanks, Myles.

Operator, Operator

Thank you and there are no further questions at this time. I will now turn the call back over to the President and Chief Executive Officer, Lynn Bamford.

Lynn Bamford, President and CEO

So everyone, thank you for joining us today. We look forward to speaking with you again at our upcoming Investor Day event. Have a great day.

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.