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Thank you for your support, and welcome to the Curtiss-Wright Second Quarter 2021 Financial Results Conference Call. [Instructions for Operators] After the speaker’s introduction, there will be a question and answer session. 【Instructions】
Thank you, Andrew, and good morning everyone. Welcome to the Curtiss-Wright earnings conference call for the second quarter of 2021. Joining me on the conference call today are Lynn Bamford, President and CEO; and Chris Farkas, Vice President and CFO. Our today’s conference call is being webcast live, and the press release and a copy of today’s financial report can be downloaded from the investor relations section of our company’s website www.curtisswright.com. A replay of the webcast can also be found on the website. Please note that today’s discussion will include certain forward-looking forecasts and statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations and are not a guarantee of future performance. We have detailed the risks and uncertainties associated with our forward-looking statements in our public documents filed with the SEC.
As a reminder, the company’s performance includes an adjusted non-GAAP view that excludes certain costs in order to provide greater transparency to Curtiss-Wright’s continued operations and financial performance. Please also note that our adjusted results and full-year guidance do not include our print-manufactured drive product line that supports the 737 MAX program, and the German valve business that we were classified as holding for sale in the fourth quarter. GAAP and non-GAAP reconciliations for the current and previous year periods can be found in the earnings announcement, at the end of this presentation, and on our website. Unless otherwise stated, any reference to organic growth does not include the effects of restructuring, foreign currency translation, acquisitions and divestitures.
Thank you, Jim, and good morning everyone. I will start with an overview of the main highlights of our second quarter results and our full-year outlook for 2021. I will then forward the call to Chris to provide a more detailed review of our financial performance and guidance updates throughout the year. Finally, before we enter the question and answer session, I will end our prepared comments.
Start with the highlights of the second quarter. Overall, our sales increased by 14%. Our aerospace and defense markets grew by 11%, while sales in our commercial markets increased by 21% year-on-year. Going deep into our market, our commercial aerospace, power and process, and general industrial market sales have achieved double-digit continuous growth. These markets were among the most severely affected by the pandemic last year, and we are encouraged by their improvement.
Look at our profitability. Adjusted operating income increased by 24%, while adjusted operating profit margin increased by 120 basis points to 15.6%. This performance reflects the substantial increase in profit margins in the aerospace and industrial and naval and power sectors based on higher sales and the benefits of our operational excellence program. It is worth noting that this strong performance is due to an increase of US$5 million in R&D compared with the previous year while we continue to make strategic investments.
Based on our solid operating results, the adjusted diluted earnings per share for the second quarter was US$1.56, slightly higher than our expectations. This reflects a strong year-on-year growth rate of 22%. Although interest expenses and tax rates are slightly higher, they are usually offset by the benefits of our continued share repurchase activities.
Turn to our second quarter orders. We achieved an 11% growth, and our overall order-to-shipment ratio increased by 1.1 times, because orders in each of our three market segments exceeded one-time sales. It is worth noting that our performance reflects strong orders in the commercial market, with a year-on-year increase of 50%, including a record quarter of order activity for our industrial vehicle products covering the on- and off-highway markets. In our aerospace and defense markets, the order-to-bill ratio is 1.15. This includes the US$130 million Navy Award for Aircraft Carriers and Submarine Platforms, which we announced in an earlier press release, and we also look forward to strong orders in the second half of the year.
Next is our adjusted guidance for the full year of 2021. We have improved sales, operating income, profit margins and diluted earnings per share. Our updated guidance reflects the improvement of our industrial market prospects, some additional planned R&D investments to support our revenue growth and the increase in tax rates throughout the year. Chris will introduce it in detail in the next slide. But all in all, we are capable of achieving strong results in 2021.
Now, I want to forward the call to Chris for a more thorough review of our second quarter performance and the prospects for improvement in 2021. Chris?
Thank you, Lynn, and good morning everyone. I will start with the key drivers of our second quarter performance, and we have once again achieved strong financial results.
Starting from the aerospace and industrial fields. Sales increased significantly year-on-year, which was due to a strong increase in the demand for industrial vehicle products for the on-road and off-highway markets by approximately 40%. The sales growth of this sector is also due to the strong demand for surface treatment services in our industrial market, which is driven by the steady improvement in global economic activity.
In the commercial aerospace market segment, we have increased demand for our sensor products on narrow-body platforms. However, as we expected, these gains were mainly offset by the continued slowdown of several wide-body platforms.
Looking ahead to the second half of 2021, driven by the increase in the production of narrow-body aircraft (including the 737 and A320), we expect the performance of the market to improve. In the long run, we expect narrow-body aircraft to return to their previous production levels by 2023, while wide-body aircraft may not fully recover until 2024 or even 2025.
Turn to the profitability of the sector. Adjusted operating income increased by 138%, while adjusted operating profit margin increased by 800 basis points to 15.7%, reflecting the favorable absorption of increased sales and a significant recovery in the second quarter of last year. In addition, our results reflect the benefits of our ongoing operational excellence program in saving restructuring year by year. Although we continue to be slightly affected by container shipping and electronic component supply chain constraints, this impact is not important to our overall results.
In the defense electronics sector, overall revenue in the second quarter increased by 17%. This is due to another strong performance of our acquisition of PacStar. The company has performed very well, and its integration is still proceeding normally. In addition to PacStar, due to the timing of various C5 ISR programs in aerospace defense, sales in the second quarter declined on an organic basis. If you remember, the organic sales of our higher-margin commercial off-the-shelf products accelerated in the first quarter because some customers took action to stabilize their supply chains due to concerns about possible shortages of electronic components. The department’s operating results include incremental R&D investments of 4 million U.S. dollars, unfavorable portfolios, and approximately 2 million U.S. dollars in unfavorable foreign exchange. Without these effects, the operating margin in the second quarter was almost the same as the strong performance of the previous year.
In the navy and power sector, our naval nuclear propulsion equipment continues to achieve solid revenue growth, mainly supporting the CVN-80 and 81 aircraft carrier programs. Elsewhere, in the commercial power and process markets, our nuclear aftermarket revenue in the United States and Canada has increased, and valve sales to the process market have increased. The adjusted operating income of the division increased by 13%, while the adjusted operating profit margin increased by 30 basis points to 17.2%, due to the favorable absorption of increased sales and the savings from our previous restructuring actions.
Summarizing the results of the second quarter, overall, adjusted operating income increased by 24%, driving a profit margin increase of 120 basis points year-on-year.
Turn to our full-year 2021 guidance. I will start with our end-market sales prospects, and we continue to expect Curtiss-Wright’s total sales to grow by 7% to 9%, of which 2% to 4% will be organic growth. As you can see, we have highlighted some changes in blue on the slide.
Starting with naval defense, our updated guidance range has increased from flat to 2%. This is due to the expectation of slightly higher revenue for the CVN-81 aircraft carrier and the less offsetting of the revenue time of Virginia-class submarines. Our outlook for the overall aerospace and defense market sales growth is still 7% to 9%. As a reminder, this makes Curtiss-Wright’s defense revenue growth rate once again exceeding the basic budget of the Department of Defense.
In our commercial market, our overall sales growth rate remains between 6% and 8%, but we have updated the growth rate of each end market. First, in terms of power and process, we continue to see a strong rebound in MRO activity in our industrial valve business. However, due to the postponement of large-scale international oil and gas projects until 2022, we lowered our end market guidance for 2021. Therefore, we now expect the market to grow by 1% to 3%. Secondly, in the general industrial market, based on year-to-date performance and strong growth in orders for industrial vehicle products, we have revised up our growth outlook to a new range of 15% to 17%. What I want to point out is that on our recent investor day, we stated that we expect our industrial vehicle market to return to 2019 levels in 2022, and we have strong orders to support this road.
Continue our full year outlook. I will start with the aerospace and industrial sectors. The increase in sales and profitability reflects the continued strong recovery of our general industrial market. We now expect sales in this division to increase by 3% to 5%, and we have increased the revenue guidance for this division by $3 million to reflect higher sales. With these changes, we now expect segment operating revenue to grow by 17% to 21%, while operating profit margins are expected to be between 15.1% and 15.3% of 180 to 200 basis points, which enables us to surpass our 2019 profitability. year.
Next, in the field of defense electronics. Although we are still implementing the previous guidance as planned, I want to highlight some of the moving aspects since the last update. First of all, based on our pursuit of technology, we now expect to make an additional strategic investment of US$2 million in R&D, with a total of US$8 million year-on-year to promote future organic growth.
Secondly, in terms of foreign exchange, we have seen a weakening of the U.S. dollar in the second quarter, which will cause slight headwinds to the annual operating profit margins of companies operating in Canada and the United Kingdom. In addition, in the past few months, our supply chain has received some mild impacts, mainly related to the supply of small electronic products, and we expect this impact to continue at least into the third quarter. Although this is still an observation item, especially the impact on revenue timing, we still hold the full-year segment guidance.
Next, in the navy and power sectors, our guidance remains unchanged, and we continue to expect profit margins for solid sales growth to increase by 20 to 30 basis points.
Therefore, summarizing our full-year outlook, we expect adjusted operating income to grow by 9% to 12% in 2021 and total sales to grow by 7% to 9%. The operating profit margin is now expected to increase by 40 to 50 basis points to 16.7% to 16.8%, reflecting the strong profitability and the benefits of our restructuring and continuous company-wide operational excellence plan last year. Continuing our financial outlook for 2021, we once again increased our full-year adjusted diluted earnings per share guidance to a new range of US$7.15 to US$7.35, which reflects 9% to 12% growth and is consistent with our operating revenue growth. Please note that our guidance also includes the impact of higher R&D investment and higher tax rates. According to the recent changes in the UK tax law and the reduction in the number of our shares driven by continued share repurchase activities, the estimated tax rate is now 24% . In the last six months of 2021, we expect the diluted earnings per share in the third quarter to be the same as the third quarter of last year, and the fourth quarter will be our strongest quarter this year.
Speaking of our full-year free cash flow outlook, we have generated $31 million so far this year. As we have seen from history, we usually generate about 90% or more of free cash flow in the second half of the year, and we are still expected to achieve the full-year guidance of US$330 million to US$360 million.
Thank you, Chris. I want to discuss some of the thoughts and observations since our recent May Investor Day in the next few minutes. I will start with the President’s FY22 defense budget application, which was issued shortly after our Investor Day event. This version reflects an increase of approximately 2% over the budget issued in fiscal year 21, and is reasonably consistent with our expectations and plans. The budget shows that the United States’ most critical naval platforms continue to receive strong support, including the CVN-80 and 81 aircraft carriers and Columbia-class and Virginia-class submarines. We believe that the support of the two parties for the future of the Navy provides us with a strong foundation from which we can increase our revenue from nuclear and surface ships. If they add a third Virginia submarine or another DDG destroyer, we still have potential upside potential.
We also look forward to continued support for funding for the Department of Defense’s highest strategic priorities, including networking, encryption, driverless and self-driving cars, all of which were highlighted in the budget release. This bodes well for our support for defense electronics in all these areas.
Another bright spot is the modernization of the military. Despite the reduction in the Army’s overall budget, in the service budget request for FY22, funds used to upgrade the battlefield network increased by 25% to $2.7 billion, which is the largest increase in the Army’s modernization priorities. In addition, it provides great confidence in our decision to acquire PacStar, as they are in a prime position to take advantage of the ongoing modernization of ground forces.
Since then, we have seen more and more signs of optimism as the budget passed Congress to increase prices. The Senate Armed Services Committee recently voted to approve an additional $25 billion to the Pentagon’s fiscal year 22 budget, which is an increase of 3% over the president’s initial request and an overall increase of 5% over the current fiscal year. Although it is not the final result, it once again gives us confidence in the long-term organic growth assumption of our entire defense market.
Next, I want to highlight some of the key points of our recent investor day and thank everyone who participated. Our shift to growth strategy is dominated by a renewed focus on revenue acceleration. We expect this to be achieved through organic and inorganic sales growth and our expectation of operating revenue to grow faster than sales, which means continued expansion of operating profit margins. In addition, our goal is to achieve at least double-digit earnings per share growth over the three-year period ending 2023 and continue to generate strong free cash flow. Based on our new long-term guidance assumptions, we at a minimum expect our organic sales in each of our end markets to achieve low-single-digit growth. We are very optimistic to achieve a 5% compound annual growth rate of basic sales by the end of 2023, including PacStar.
In addition to these expected organic growth, we are also focused on maximizing our growth potential in key end markets based on our contribution to continuous incremental investment in research and development and the benefits of our new operational growth platform. We are reinvesting in our business at the highest level in Curtiss-Wright’s recent history. As you know, this is an area that I am very passionate about. As you can see in our updated guide, we have increased our R&D investment in 2021 by another US$2 million, and total expenditures have increased by US$12 million year-on-year. These investments are aimed at key technologies and fastest-growing carriers in our end markets, such as MOSA in our defense electronics business.
In addition, the launch of the new operational growth platform provides greater management focus, attention and energy to drive all things critical to growth, from reinvigorating innovation and collaboration to providing new opportunities for business excellence and strategic pricing. Therefore, we will have the opportunity to continuously reduce costs, which can free up funds to make up for short-term acquisition dilution, allocation to R&D investment or lead to profit margin expansion. These will be targeted and conscious investment decisions.
In addition, I think it’s important to point out that we will continue to drive our strong processes and dedication to operational excellence at the same level of commitment and greater commitment that the team has shown since 2013. Finally, I want to reiterate our goal of a minimum EPS compound annual growth rate of 10% over a three-year period, which may include annual stock repurchase activities that are higher than our current basic level of $50 million per year. We remain committed to the effective allocation of capital to bring maximum long-term returns to shareholders. Therefore, the annual distribution of stock repurchases will be different, depending on the size and timing of future acquisitions that we introduce Curtiss-Wright.
Finally, as management pays more attention to mergers and acquisitions and a very complete opportunity pipeline, I feel very optimistic that we will have the opportunity to exceed 5% and approach the 10% sales target because we have found key strategic acquisitions to introduce Curtiss-Wright.
All in all, we are capable of achieving strong performance this year. We expect sales to achieve a high single-digit growth rate this year, and operating income and diluted earnings per share will increase by 9% to 12%. Our 2021 operating margin guidance is now 16.7% to 16.8%, including our incremental investment in research and development. We are still expected to continue to expand the profit margin to 17% in 2022. Our adjusted free cash flow remains strong, and we continue to maintain a healthy and balanced capital allocation strategy to support our revenue and profit growth, while ensuring that we are investing our capital for the best return to drive long-term shareholder value.
Thank you. [Operator Instructions] Our first question comes from the product line of Nathan Jones and Stifel.
I want to first talk about your comment on the cost of customers who may inventory in the first quarter, which may lead to a decline in the second quarter. You will usually see a seasonal increase in the second half of the year. Still looking forward to seeing seasonal growth? How do you view customer inventory and channel inventory? Do you think they are still ahead of where they usually are, lined up, and behind? Can you give us any color?
Okay, of course. I’ll get that one. I mean, in the first quarter, we must have seen some defense customers speed up their orders, trying to get ahead of the shortage of electronic components. So when you see this organic headwind that we grew by approximately $8 million year-on-year in the second quarter, this is actually just work that accelerated in the first quarter. I mean, we continue to experience some small delays in electronic components. Therefore, considering the situation that most companies experienced last year and the sharp growth that most companies are fortunate enough to face this year, the market is quite active. But it does mainly affect the revenue time of our defense electronics department, aviation defense revenue, and C5 ISR products with higher profit margins.
Now, when you look at the second half of the year, we expect some pressure based on when these components are received, and most of the pressure will be applied in the third quarter. But as you have seen in history, coming out of the defense electronics business, we usually have a very large fourth quarter slope, and we expect this to happen again this year. Therefore, we are currently working hard to solve these problems and feel that we are doing a good job in overcoming these pressures.
Then, I want to go back to Lynn’s favorite field, research and development. You increased your research and development expenses in the second quarter and raised your full-year target. Can you talk about your opportunities there? Do you think that as we move forward, where is there an opportunity to continue to increase R&D investment, should we consider stabilizing at this level more? Can you give us any guidance?
Thank you very much for your help. As you said, this is an area I like to talk about. So, therefore, we have done some additional R&D in our defense electronics group, because we just continue to see very good opportunities to expand our product line, whether it’s around the MOSA plan to expand our product line because it Just continue to gain traction for a wide range of customers in the defense industry, and some specific technologies around encryption and denied GPS, networks, and really some additional investment-our PacStar team modernizes around the battlefield.
Therefore, opportunities will only continue to grow. We are really at a good time now, and really feel that now is a good time to invest. Another area where we are also increasing investment is A&I, which is actually around electrification and electronics, Internet of Things, electric vehicles, hybrid vehicles and our promotion in this field. We truly position ourselves as a leader-this field The technology leader is the first choice of many major automakers. We really make sure that we have a very systematic understanding of who makes vehicles in this field, and work with them, often customizing variants of specific products to specifically fit their vehicles. This requires us to make some investments, and we think this is the right approach.
Again, I-we are often asked whether we think R&D will increase again in 22 years. You did not give specific guidance. And I do think it is important to let people understand that we are indeed studying how we allocate capital and whether R&D is the best investment, other investments or when it is time to return to profit. We will make balanced decisions in this area based on the opportunities before us. But we are not afraid to spend some R&D to ensure long-term growth, and we see opportunities that we can see will pay dividends in the next few years. To be honest, the R&D investment we make will only generate returns in the same calendar year, the next calendar year, and sometimes even three to four years later. So, again, you must not only balance returns, but also make sure that you are driving [technical issues] near-term, near-term, and long-term growth. Therefore, these are the trade-offs around how we broadly view these investments across the organization and make the best strategic investments to improve our processes.
Maybe, Lynn, you talked about the current acquisition channels are very full, maybe you are optimistic about reaching the upper limit of your sales target. Can you re-discuss and talk about what attributes, size, scale, pricing, and any other characteristics you want to enrich, and do you think you will close one before it ends? The material of that year?
certainly. Therefore, I think that, to be honest, the expectation of changes to the tax law in 22 years has increased people’s motivation that we are considering telling PE and private companies to try to complete the transaction this year. Therefore, for many active properties under construction, the driving force this year is to reach a deal. Now, whether we actually make a deal will depend on the properties that are currently active when we conduct our due diligence. And-but again, we will not reach an agreement as we always say. If I do not reiterate, you will be disappointed, we will not exchange transactions for transactions. It must be the right strategy and financial match. But there are goals within that range. I want to say that the most asset we see now is our defense market. This is the bulk of the pipeline. Not only that, but it also seems to be the most active area at the moment, which is a high priority area for us. So, this works well. I mean, we are not saying that we will only buy real estate in the defense industry. But this is an area, especially as we see them complementary to our current product supply, and we can bring something extra to our current customer base, whether it’s one of the people who enable platforms or build electronic subsystems. So, this is very much.
What I want to say is that the price is consistent with what we have seen in history. It doesn’t-I mean, I know there is some discussion, and there are some more expensive examples-the multiple is more extreme. I think we are looking for quality products that have reasonable multiples and that make them a good strategic fit for Curtiss-Wright. Therefore, this is something that our management is very concerned about, many processes. We now have a lot of active assets, and we are studying which strategies we think are most suitable for Curtiss-Wright.
Therefore, I think we have a reasonable opportunity to add something to our portfolio in the calendar year. We see that properties within the income range of the PacStar type will be listed soon. Therefore, it is really a very healthy channel now.
Post time: Nov-05-2021
