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spk03: Good day and thank you for standing by. Welcome to the Curtis Wright First Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. Please be advised that today's conference may be recorded. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your host today, Jim Ryan, Vice President, Investor Relations. Please go ahead.
spk00: Thank you, Michelle, and good morning, everyone. Welcome to Curtis Wright's first quarter 2022 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 Barkus. Our call today is being webcast, and the press release is all the copy of today's financial presentation, It's available for download through the investor relations section of our company website at www.curtiswright.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 and 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 Curtis-Rite's ongoing operating and financial performance. Any references to organic growth are on an adjusted basis and exclude foreign currency translation, acquisitions, and divestitures in what's otherwise noted. GAP to non-GAAP reconciliation current and prior year period are available in the earnings release and on our website. Now I would like to turn the call over to Lynn to get things started. Lynn?
spk01: Thank you, Jim, and good morning, everyone. I'll begin our remarks by covering the key highlights of our first quarter 2022 performance and some notable events that are influencing our business. Then I'll turn the call over to Chris to provide a more detailed review of our financial results and our 2022 guidance. Finally, I'll wrap up our prepared remarks before we move to Q&A. Starting with our first quarter 2022 performance, our results were principally driven by the timing of revenues in our defense markets, with overall sales below the prior year but in line with our expectations. This timing was influenced by the continued global supply chain disruption due to the extended lead time and delays in the receipt of electronic components. Our first quarter defense sales also reflected the impact of the continuing resolution and the delayed signing of the DOD budget. Outside of defense, we delivered a very strong performance, generating double-digit sales growth in our commercial aerospace, nuclear aftermarket, and process end markets, which truly reflects the merits and strengths of our combined portfolio. Regarding our operational performance, the team has done a commendable job of managing through the supply chain challenges along with the impacts of rising inflation and other global events. First quarter operating margin exceeded our expectations, mainly driven by better than anticipated mix in defense electronics as lower margin revenues pushed out of the first quarter. Diluted earnings per share of $1.31 also exceeded our expectations due to the better than expected profitability. New orders were strong in the first quarter, up 12% year over year, reflecting increases in naval defense and commercial aerospace within our A&D markets and strong demand across all our commercial markets. As a result, we achieved a book-to-bill of more than 1.1 times in the first quarter, which builds on our already strong backlog. While we remain cautious due to the ongoing supply chain constraints, this strong demand provides confidence in our sales outlook for the remainder of the year. Next, I would like to briefly touch upon the full year 2022 guidance. Although the year is off to a slow start, again, mainly due to timing, our full year guidance remains intact. and we continue to expect a strong performance across the board. Chris will review in detail in a few minutes, but in terms of key highlights, we are maintaining our outlook for organic sales growth of 3% to 5% driven by increases in all of our major end markets. Due to the ongoing supply chain challenges and delayed signing of the DoD budget, we continue to expect a greater than normal percentage of our total sales will be weighted to the back half of the year. While we are approaching the situation with tempered optimism, our ongoing discussions with critical suppliers indicate that delays in acquiring electronic components will begin easing in the third quarter, particularly as it relates to semiconductors. While this is encouraging, we are currently anticipating this disruption will continue throughout the remainder of 2022 and likely into 2023. Turning to our operational performance, We expect continued operating margin expansion in 2022, aided by the benefits of our ongoing operational excellence initiatives and our efforts to mitigate challenges in the supply chain. We also remain on track to achieve double-digit growth in diluted EPS and generate strong free cash flow. Next, I wanted to provide a brief overview of some recent industry events influencing our defense markets. First, we were pleased to see Congress pass the FY22 Defense Appropriations Bill in March following a prolonged continuing resolution that delayed funding on critical New START programs. The bill includes a strong 5.5% increase over the FY21 enacted budget, which Curtis Wright is well positioned to benefit from. In addition, the Biden administration released the initial FY23 budget on March 28th requesting $773 billion for the Defense Department, or 4% growth over FY22 enacted. This proposed budget includes increases across all services, with naval shipbuilding receiving the highest increase over 2022, aligned with the administration's focus on the Indo-Pacific region. Notably, this includes strong funding for two critical growth drivers for Curtis Wright, the Columbia-class submarine and Ford-class aircraft carrier programs. Both programs continue to drive strong demand for our nuclear propulsion equipment. The recently released 30-year shipbuilding plan provides further confidence in the Defense Department's commitment to build out the naval fleet and align our forces to be prepared to face the biggest global threats. In the ground defense market, the budget targeted the continued funding for the Army's top modernization priorities, while in the aerospace defense, there was support for various helicopter and unmanned platforms. I'll also remind you that Curtis Wright has one of the broadest portfolios of defense electronics products. Our alignment to and technical leadership in the open standard aspects of MOSA enables us to help modernize military platforms rapidly and cost-effectively. Turning to the international front, The war in Ukraine has further increased the focus on defense spending around the world, as well as energy independence for Ukraine and many neighboring countries in Europe. Since the conflict began, we have witnessed many NATO countries proposing or ramping up defense spending to 2% or greater of GDP. An overall increase in global defense spending provides Kurdish rights with improved visibility and support for our long-term growth outlook across our defense and markets. Now, I would like to turn the call over to Chris to provide a more thorough review of our first quarter 22 performance and our outlook for the remainder of the year.
spk10: Chris? Yeah, thank you, Lynn, and good morning, everyone. I'll begin with the key drivers of our first quarter 2022 adjusted results by segments. Starting in aerospace and industrial, where we delivered another strong performance, as sales and operating income increased 8% and 34% respectively, while operating margin increased 260 basis points. Looking deeper into the segment sales growth, within its commercial aerospace market, we experienced double-digit growth in sales, primarily on narrow-body platforms, including the 737 and A320. Within the industrial markets, our results principally reflected increased sales of industrial vehicle products, most notably serving off-highway platforms. I also wanted to highlight this segment's aerospace defense market sales, which, while flat overall, included increased sales of our surface treatment services to help extend the life expectancy of the F-35 fighter jet platform. This aligns with our recent press release, which highlights the use of our technology to support the military's premier fighter jet program and represents one of the many unique commercial to defense crossover technologies within Curtis Wright's portfolio. Turning to the segment's operating performance, our results reflected favorable absorption on strong sales and the benefits of our operational excellence initiatives. Next, in defense electronics, our performance principally reflected the timing of defense revenues due to the continued challenges within the global supply chain, as well as the delayed signing of the FY22 defense budget. As a result, we experienced reduced sales of our embedded computing and tactical communications equipment as certain revenues shifted out of the first quarter. Turning to the segment's operating performance, while we experienced underabsorption on lower sales and negative product mix, operating margin of 16.3% was actually better than anticipated as a portion of lower margin system sales shifted out of the first quarter. This in turn allowed us to exceed the first quarter operating margin target of 14% that we provided in February. Next, in the naval and power segment, our results reflected lower naval defense revenues, mainly due to the timing of production on the fourth class aircraft carrier and the wind down of production on the Cap 1000 program. However, those impacts were nearly offset by double digit sales growth in both nuclear aftermarket and process, as these markets continue to strengthen with a tailwind from the economic recovery. It's particularly encouraging to see the uplift within the nuclear aftermarket growth rates, which are also being helped by the U.S. government's renewed support to maintain the existing fleet of operating reactors. Turning to the segment's profitability, our results reflected underabsorption on lower sales, as well as a shift in MEGS on the lower Cap 1000 program revenues. To sum up the first quarter results, overall operating margin was 12.7%, which was slightly above expectations and mainly due to the timing of revenues. We expect the first quarter to be the low point in the year, followed by solid sequential improvement in profitability throughout the remainder of 2022. Turning to our full year 2022 guidance, I'll begin on slide five with our end market sales outlook. We continue to expect total Curtiss-Wright organic sales growth of 3% to 5% unchanged from our initial guide provided in February with contributions from all of our end markets. Within this guide, we expect our A&D markets will grow 2% to 4% and represent two-thirds of our full-year 2022 company sales. In addition, due to the timing and availability of electronic components, we expect a greater than normal percentage of our defense end market sales to be weighted to the second half of the year, with the most pronounced shifts to take place within aerospace and ground defense. Elsewhere, we continue to expect that commercial aerospace will be our fastest growing end market in 2022, with 9% to 11% sales growth driven by strong growth in OEM sales as this market continues its recovery to prior peak levels. We remain encouraged by the continued recovery in passenger traffic activity, along with the expectations for steady increases in narrow body production rates, both in 2022 and over the next few years. Outside of our A&D markets, our commercial market sales growth remains unchanged at 4% to 6%. These markets continue to benefit from a healthy and growing order book, most recently illustrated by the strong 1.2 times book-to-bill recorded in the first quarter. Continuing with our outlook by segment on slide six, I'll begin in aerospace and industrial, where our top line guidance of 4% to 6% sales growth remains unchanged. We continue to project solid growth in operating income and margin, driven by strong growth in both commercial aerospace and general industrial market sales, while also reflecting the benefits of our operational excellence initiatives. Next, in the defense electronics segment, we continue to expect sales to grow 2% to 4% led by modest growth in aerospace and ground defense. And as stated in our prior earnings call, while sales and profitability for our defense electronics businesses are typically weighted to the second half, we do expect a more pronounced shift in sales to the back half of 2022. And lastly, in the naval and power segment, we expect sales to grow 2% to 3%, driven by solid growth in naval defense, most notably on the CVN-81 aircraft carrier and Columbia-class submarine programs. We also anticipate mid-single-digit growth in both the nuclear aftermarket and process market. We continue to expect that operating margin will be essentially flat but strong, ranging from 18.1% to 18.3%, as we overcome the significant headwind associated with the wind-down of the Kaplan-1000 program. So to summarize our outlook, we expect total Curtis Wright operating income to grow 3% to 6% overall on a 3% to 5% increase in sales. Operating margin is expected to improve 10 to 30 basis points ranging from 17.1% to 17.3%, including an $8 million increase in R&D investments and the aforementioned Kaplan 1000 headwinds. To aid in your quarterly modeling, based on the shift in sales to the back half of the year, we now expect second quarter 2022 sales and operating margin to be in line with our second quarter 2021 adjusted results, followed by a strong second half performance. Continuing with our financial outlook on slide seven, while we're maintaining our full year 2022 diluted EPS guidance, we did make a couple of minor offsetting changes in the components below operating income. First, we increased interest expense by $1 million. We also updated our share count, making a slight reduction to reflect the latest estimates on the full year. And as a result, we continue to expect double-digit growth in our full year 2022 adjusted diluted EPS, ranging from $8.05 to $8.25, reflecting both the contributions from our growth in operating income and our ongoing share repurchase activity. Again, to aid in your quarterly modeling, we expect the first quarter EPS to be our lightest, followed by sequential quarterly improvement and the fourth quarter being our strongest, with a higher than normal weighting to the second half. Turning to our full-year free cash flow outlook, our guidance remains unchanged with a range of $345 to $365 million. During the first quarter, while we typically experience an outflow of cash, these levels were slightly elevated due to lower net earnings driven by the timing of defense revenues and higher inventory levels in response to the supply chain. Our reported results also reflect the Westinghouse legal settlement payment of $15 million, which we have excluded from our adjusted results. Looking out to the remainder of 2022, we expect to ramp up as the year progresses in line with our historically strong second half performance. And finally, we expect to deliver on our long-term adjusted free cash flow conversion target of 110% again in 2022. Now I'd like to turn the call back over to Lynn to continue with our prepared remarks. Lynn?
spk01: Thank you, Chris. In summary, we remain confident in our outlook to generate 3% to 5% sales growth this year, driven by increases in all A&D and commercial markets, and to deliver strong operational excellence. The Curtis Wright team continues to do a great job managing through the ongoing supply chain disruption. We expect continued operating margin expansion, including our investments in R&D and the CAP 1000 headwinds, and remain firmly on track with our expectation for double-digit EPS growth, which, as a reminder, is in line with our long-term guidance. We expect our free cash flow to remain strong and we are on track to achieve our 10th consecutive year of greater than 100% free cash flow conversion. We remain committed to a disciplined capital allocation strategy, prioritizing acquisitions as a strategic accelerator under our pivot to growth strategy, supplemented by continued share repurchase and operational investments. Earlier this year, we announced the acquisition of Safran's arresting systems business, which positions Curtis Wright to become a leading global supplier in aircraft recovery systems. As previously stated, the business generated about $70 million in revenue in 2021 and has demonstrated a solid pace of revenue growth over the past few years. We expect this business to align with our long-term organic sales growth rate of 3% to 5%. This transaction is presently on track to close by the end of the second quarter, And as a reminder, we are not including its financials within our guidance at this time. In closing, I remain confident that we are well positioned to deliver strong, profitable growth in 2022, advance the One Curtis Wright vision, and deliver it on our pivot to growth strategy to drive long-term value for our shareholders. Before we turn to Q&A, I want to take a moment and express our heartfelt concern and sympathy for the Ukrainian people. We hope for a swift and peaceful resolution to this tragic conflict with Russia. As you would expect, we have ceased all business activities in Russia and are in full support of all the global sanctions. We will continue to focus our efforts on supporting Ukraine's defense and energy independence through our domestic partners and NATO allies. We and our employees across Curtis Wright understand the critical importance of our products. At this time, I would like to open up today's conference call for questions.
spk03: Thank you. If you have a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. And our first question comes from the line of Peter Armit with Baird. Your line is open. Please go ahead.
spk09: Yeah, good morning, Lynn and Chris, and thanks for your time. Lynn, maybe could you talk about just the chip shortages and overall supply chain? We've heard from other companies that it's resulting in carrying more working capital, higher inventories, obviously reflected a little bit of that in the first quarter, but just your thoughts on that going forward.
spk01: Yes, it's definitely something that's top of mind and we anticipate talking about this morning, so thank you for the question and joining us. Yeah, I mean, as you heard us say, it definitely impacted our Q1, pushing some revenues out. I think one of the things that we've really come to dial in with our supply chain over the past couple quarters, we've been talking about this for three, four quarters at this point about really needing to get ahead of our purchasing and such and placing much longer lead time on orders. than we would have traditionally done starting even in Q2 of last year, that we saw at first a lot of lead times push out to 26-plus weeks. And over the past handful of months, we've seen some of those lead times extend to almost a year and even greater in some cases. So with that and all the orders we've placed, we're anticipating a real increase in deliveries. you know, beginning in the back half of Q2 and early Q3 to really support that ramp up of revenues in the back half of the year that Chris talked about. We're sitting on a lot of pent up demand and we're making sure we're doing what's necessary that as those supplies begin coming in more rapidly, that we're really poised to, you know, ramp up our production and turn those into products and get them out the door. And I think the team has done a good job of that. You know, we've been talking about this, and one thing I would say that we've come to understand is, you know, as this was new to us, it was also new to our suppliers. And as they've worked to make commitments to us, their ability to be more clear and firm in those commitments has increased over the past several months. And so we do feel an increased level of confidence in the commitments we have and that, you you know, again, later this quarter in the beginning of Q3 and feel good about that and believe we've staged the table for that. You know, Chris mentioned briefly on, you know, the impact on our working capital in Q1, and maybe I'll turn it over to Chris to maybe make any other comments he would have on working capital.
spk10: Yeah, I mean, we typically start off the year a little bit higher than where we end up the full year from a working capital perspective. I mean, there's a lot of payment holds and things that happen at year end, and we typically flood that cash back into our supply base and into inventory in Q1 as we look to ramp up deeper into the year. So We're used to a normal Q1 outflow. We did dip down in free cash flow year over year, approximately $77 million. I'll say $20 million in last year's Q1 was probably a little bit abnormally high due to the timing of advances and things that came in. But we are carrying a little extra inventory right now, and we're really positioning ourselves for these semiconductors and other critical components to come in here at the end of Q2 and Q3 so that we can deliver. Yeah, we're heavily focused on working capital. We're heavily focused on free cash flow. A little bit slow to start the year, but that will improve as product starts to move out the door.
spk09: Appreciate that. And just as a follow-up, Lynn, you mentioned in your overview about the recent DOD budgets that were enacted, and obviously we've seen what the fiscal 23 and the fit-up looks like. How do you view that when you compare to your long-term targets that you established today? You know, thinking about how Curtis Wright's position, it seems like there would be potentially an upward bias to your long-term growth targets.
spk01: I would think, well, to start out, we were really pleased with what we saw come out to be appropriated in the 22 budget and what the initial 23 budget is. It really aligns to, you know, where we have very strong positions across various platforms. Obviously, the Navy, you know, has, you know, very solid funding, had the biggest increase in the 23 proposed budgets. I think there's belief there'll be top-ups to it yet to come. And then the focus on the high-tech aspects of warfare with enhanced C5ISR and electronic warfare types of products is very much a good spot for us. Again, we were relieved to see that the Army is usually the go-to group for paying for things. And there was some trimming on some vehicle programs where we do have content. But more importantly, where PACSTAR receives their funding with the network modernization and soldier lethality, those continue to be top priorities in the Army with very strong commitment to maintain the ramp rates and the execution on those programs. So overall, good. Could there be some upside? I think there's a chance to that. I mean... For now, we're sticking by our 2023 guidance, but there's a lot of reasons to be very optimistic about the growth that we are going to be able to achieve through 2023, but definitely beyond that as you look at where things are going in the commercial nuclear market as AUKUS takes form and where those subs are going to be built. That's a great place for us. Obviously, none of that is no AP1000 orders, you know, some of the ongoing small modular reactor work. None of that is, you know, dramatic in the timeframes as we see it, but great tailwinds that are coming behind us. And, you know, I just, you know, mentioned one data point that we actually just recently had a visit from the Royal Australian Navy and one of our significant plants to, you know, consider, you know, what it takes to produce the products that we've produced for, you the nuclear submarines, and it was a very positive visit. And so I just feel ever more optimistic that, you know, all these, you know, trends in the industry are going to lead to really good growth for Curtis Wright.
spk09: Thanks for all the call, Lynn. Thanks so much.
spk01: Yeah, thank you, Peter.
spk03: Thank you. And our next question comes from the line of Nathan Jones with Stiefel. Your line is open. Please go ahead.
spk06: Good morning, everyone. Good morning. Good morning. Well, it might be a bit distasteful to talk about given it's capitalizing on the misery of others. We are here to talk about the impact on the business and there are clearly likely to be several positive outcomes from the Russia-Ukraine for Curtis Wright's business. So I'm hoping we could talk about your thoughts on that. So the three I think of short term, there's increased weaponry being shipped to Ukraine that I'm sure Curtis Wright has content on some of that. In the medium term, you probably see significant increases, as you mentioned, in European defense spending, if not global defense spending on the back of this. And then the third one being weaning off Russian oil and gas and the potential for that to add nuclear capacity to the global grid. You've already started to hear about some of the Western European countries reconsidering their anti-nuclear positions. So maybe you can talk about how those could impact the business in the short, medium, long term. Thanks.
spk01: Thank you for that. And you're right not to talk about it only from a business viewpoint because it is a very sad situation. But I tend to like to make it focus on the importance of what we do as a business in the safety of our world. And that comes both from defense products and energy independence products. So You're right on, you know, touching on both sides of that. Also, you are correct from a weaponry being rapidly shipped over there. There really is no, you know, that is not business for Curtis, right? It's not an area where we have any products. So that is, you know, in that immediate short term, you know, we're not seeing that. However... As you mentioned, the buildup and increase in spending in Europe is very much something that will drive business to Curtis Wright, and that will come both directly from sales in Europe to the major vehicle manufacturers as well as other systems directly into those businesses, and then foreign military sales through U.S. suppliers who are supplying products over there. And kind of the one that's been the biggest in the headline is the F-35s. with how many countries have said that they're going to buy F-35s. But there's been a lot more than that. There's Seahawk helicopters are being talked about, F-15s and F-16s, some UAVs, C-130Js. I mean, a whole variety of products coming through the U.S. that we have content on. I think we've talked a couple times about one of our most significant areas of business directly in Europe is on-ground defense vehicles. around high-power stabilization equipment, and then, you know, various electronic subsystems and displays that, you know, are embedded into the vehicles, either wheeled or tracked. And, you know, those are areas that, truthfully, over the past couple years have been pretty lackluster in our business that, you know, we can clearly see a change in. And we put out a press release yesterday or the day before, yesterday, I think, about a partnership with a Ryan Mattel BAE joint venture, and some business going forward that I think I've mentioned a couple times that our relationship and business partnering with Ryan Mattel has continued to grow over recent years, and we wanted to put that out as one indication of that. Now, that program was intended before the Ukrainian war to be built out, but Europe's had a long history of starts and stops on intending to build out ground vehicles, and I think we're not going to see so many stops anymore. I think we'll see the starts and the commitment, and they're moving rapidly on that. And we have quite a few other programs with Ryan Mattel that we'll hopefully be able to make press releases on over the next six to 12 months on other big programs that we'll be doing with them. So again, I do think we're well positioned with the business that's going to be driven through what's going on in Europe. And then lastly, we talked when we did our Q1 earnings result, it was quite sadly ironic on the day of the Russian invasion into Ukraine on February 24th, and talked about the build-out in our presentation then of what was already being pretty committed to across Eastern Europe for build-out of nuclear power, and had Ukraine listed on that, and I still think you know, we've downweighted it in our one and a half billion potential. But from what we're hearing is, I think, you know, what we're seeing in Ukraine, I think it will be part of that and, you know, maybe even, you know, provide some upside to that. But, you know, again, all of these things are slow. They're not going to drive revenues I don't anticipate in 2022. But I think we'll see movement in these areas in 2023, both in defense and in in energy, you know, to build out some of the nuclear power plants. And again, that's, you know, I think first and foremost, that's going to be the AP1000s. And there's lots of public, you know, statements and partnerings, which Westinghouse has done a great job of getting over there and, you know, building up the relationships, building out the local networks of, you know, in-country workers and companies that need to be part of the building of these plants and getting that started. So, All good things, and I would say just the intensity of our engagements and the sense of urgency. We've felt it over the past couple months. It doesn't mean something happens in a week or a month, but you can feel the galvanization that this is going to happen. And you're right, it's been encouraging to see, hear some of the talk, the UK, a couple months ago about reconsidering its position towards nuclear energy, a few other companies. And, you know, the other aspect of our nuclear business is having the U.S. reactor fleet continue to have shutdowns. And, you know, we've mentioned in the past a couple plants that have said they're not going to, you know, shut down anymore. And I think I read just earlier this week that even in California that said they're reconsidering shutting down their last nuclear power plant, which is, you know, We all know the position of California, so I think that's a pretty strong indicator of the world is seeing that nuclear power has to be part of a carbon-free footprint, and then energy independence. Both of those are pretty driving forces in the world right now.
spk06: One follow-up on the nuclear side of it, and specifically thinking about Western Europe and maybe them reconsidering their position on nuclear power. And I know these are very, very long duration things. If you're starting somewhere in the UK from zero, from a standstill, what's the kind of planning time, construction time? And if you started today from zero, how long would it be until Curtis Wright was realizing revenue from something like that?
spk01: So we've given the example of you know, what Poland has stated, because they've been, I think, been more specific in what they expect timeline. And again, this was a timeline put forth before February 24th. So you have to imagine they're doing everything they can think of to shorten that timeframe. But, you know, they stated that of the plants they intend to build, they would like the first one to be online in 2023, which the, you know, 33, sorry, yes, important correction, 2033. which really backs them into having the concrete ready for that plant in 2028, which backs them into needing to have orders placed on the key component suppliers of which Curtis Wright would be one in 2024. Now, when we gave our guidance, we said, you know, in February of this year, three to five years, saying frequently things, don't happen exactly to schedule. I would think if there's any time in the world things are going to happen to schedule, you know, if not better, it would be now. And so it's kind of that, you know, if you want to plant in 10 years, you need to be, you know, moving on with getting products on order and starting to do things. So I'm sure that's painful to people looking to, you know, break their dependence on Russia, talking about a 10-year cycle is long. But that's where I also think you know, as the SMRs, you know, go into production, that it's going to be a combination of both. And, you know, necessity is the mother of invention, and there's a big necessity right now. So we'll see if people can't find ways to do things a lot quicker because, I mean, everybody thinks 10 years seems like a pretty long time. So for something that's been built, we know how to do it. We have successful plants working in the world. And we'll absolutely lean forward and be part of the solution to, you know, help the world, you know, break itself in dependence on Russia. I mean, that's just so important.
spk06: Thanks very much for the call, Lynn. I'll pass it along.
spk01: Okay. Thank you, Nathan.
spk03: Thank you. And our next question comes from the line of Michael Ciamoli with Truist Securities. Your line is open. Please go ahead.
spk05: Hey, good morning, guys. Thanks for taking the questions here. Chris, how are you guys? You know, I think you called out that the margins were in line with your expectations. And I'm just looking at it. I mean, I don't think you've had a defense margin this low for several years. I mean, you know, and even the defense organic declines, you know, pretty low, you know, as far as I can go back. So You know, and you even talked about the margins benefiting from some low mix slip out. I mean, is there anything else you're kind of seeing there or you can kind of give us, you know, more color? I mean, we've obviously got some substantial cost headwinds, you know, as you guys are going to try and ramp these margins. But any more color you can kind of shed, you know, was it really just volume on those margins? And I know you usually have a low margin. start to the year anyway, but these seem to be, you know, abnormally low.
spk10: Yeah, I mean, yeah, these are really unusual times, Mike. I mean, I feel, you know, like we were talking about this the other day, you know, back in 2020 when the pandemic hit, I mean, people stopped providing guidance, and we tried to reinitiate as soon as we can to try to help guide people through the circumstance. And this supply chain issue that everyone's facing right now, and we're particularly facing within defense electronics, extremely dynamic. So what we've been trying to do, which we haven't normally done in the past, is provide you and the rest of our investors with additional information to help you understand what we're seeing on a quarterly basis. So you saw it last time on the call. We tried to provide the guides from a few different angles here to let you know what we're seeing. And when we were in February, we did expect that sales would be down. And, you know, overall, as we look at the reported revenues for, you know, A&I and Defense Electronics, I mean, they were fairly in line with what we had expected at, you know, I'd say plus or minus $2 million. At that time in February, we also said that we expected those segments to be down around 14%. And, yes, we realized that those are, you know, lower margins than those businesses have seen in quite some time. But at that point, we explained it as really two things. One, the volumes were going to be down in Q1, mainly in defense electronics, mainly because of what was happening in the supply chain. But then also the continued push of lower margin system sales out from Q4 into Q1. We did expect that we were going to have a little bit of a different mix here in Q1 with those lower margin system sales, but they continued to push out. So Was it better than expected? Yes, it was. We came in above 16% in the defense electronics segment, but it's not something that we would characterize as anything else than just timing and moving out into a future quarter. Now, as we look at what happened within naval and power, last year in the first quarter, there was a small favorable naval contract adjustment, nothing very big, but we also knew you know, with the timing of the cap 1,000 program and production here in the first quarter on that very profitable program that we would be down. And those margins came in fairly, you know, fairly well in alignment with what we're expecting. So we are sharpening the pencil. We're trying to give you the best look that we can, you know, considering what's happening in volume and absorption, considering what's happening here within Mix and a few of our businesses. And we hope that that helps you guys as you approach Q2 and the rest of the year.
spk05: Got it. What about just can you give us a little bit more color on kind of the cost equation and inflation and maybe You know, take us through some of your contracts. I know it seemingly varies by contractor and contract type, and you certainly have some commercial off-the-shelf products, which I'm assuming you can get the price increases there right away. But are you, you know, seeing some pricing pressure on some of your longer-duration firm fix that you're having to absorb right now? Are you having discussions with customers? I guess just broadly, how much risk is in your contracting portfolio in terms of being able to pass through these price increases?
spk01: As you stated, it is all of the above. Being a diverse business, we have contracts that we take revenue over time. We have units of delivery. We have LTAs that go out years and some of our more commercial businesses. So it is a variety. We absolutely have made this a focus over the past nine months for sure of really putting some new measurement tools to understand our cost structure. So we're anticipating cost increases and getting ahead on the pricing. I think the area we've seen the most success in this is across the A&I segment. The team has done a really nice job being agile and passing that on. I'd say in general, our customers have been pretty cooperative in understanding. I mean, they're not liking it, but they understand it. And working with us, we've even had some customers where we've had LTAs in place that went out a few more years that didn't have flexible enough indices in them to work with us to change those indices to allow us to flex more So, but, you know, I mean, it's true, you can't, this isn't a say you're going to do it and all of a sudden in three months you're realizing all this new pricing. It is, it takes, you know, it's realized incrementally over time as you, you know, burn through your backlog where you've already, you know, taken contracts and we're not trying to do anything like go out and change, you know, pricing on products that we have, you know, under contract currently, maybe shipments under LTAs, but it's a big focus and I, I think the price increases have started to settle down a little bit. I think we know where we are, and so, you know, we're doing the work, the planning around that. I mean, the other aspect of the cost structure really is the labor costs, and, you know, that continues to be a dynamic situation as, you know, we have, you know, quite a few open heads and go to hire across our organization. I mean, the teams are managing it. Again, I give, you know, credit throughout our business units for handling this situation. But, you know, I'd say the supply chain and the materials is more impactful, but we're also watching the labor pretty closely.
spk05: Got it. And on those, just on firm fixed prices, you know, even something like the Columbia or Virginia class, I mean, do you have to wait to your next kind of opening of that contract or next task order and you've got to absorb the costs on those or is there any flexibility in the short term?
spk10: Yeah, you know, I think it's, again, it's important to note that, you know, all of our businesses are going down the path of improving pricing. I mean, everybody's really giving that a hard look. So it certainly is going to be more difficult, and it's going to take longer time to make changes on those longer-term naval contracts than it is in, you know, maybe some of the shorter cycle stuff that you see on the commercial side. But the conversations are happening, you know, and the negotiations continue. and the communication with the customers is frequent and ongoing. And where opportunity presents itself, Mike, whether it's through an escalation provision that might be contained within the contract, given the unique situation that we're all facing right now with the inflationary environment, where we can find flexibility, we will find flexibility. And I agree with Len. I think the team's done a good job so far. Perfect. Thanks a lot, guys.
spk05: I'll jump back in the queue. Thanks, Blake.
spk03: Thank you. And our next question comes from the line of Miles Walton with UBS. Your line is open. Please go ahead.
spk08: Thanks. Good morning. I was wondering if I could just touch on the sales cadence here for the rest of the year. I think, Chris, you talked about similar sales in 2Q to last year's, and that would imply a 9% sequential move. If you do that, and obviously it would have to be in large part driven by Defense Electronics, It would seem like the backdrop would be getting a lot better from a supply chain perspective. Is that sort of the way it all folds together that you're seeing that kind of sequential improvement in terms of supply and deliveries and getting back to normality?
spk10: Yeah, at the risk of even going deeper into these soft guides that we've been providing here, I mean, defense electronics is truly heavier-weighted to the back half of the year. I mean, we said it on February that we could see $40 million to $50 million of sales move from the first half to the second half, and the majority of that was going to be within our defense markets and defense electronics. So as you look at what we've given for a soft guide in our prepared remarks from Q1 to Q2, if you look at defense electronics, we would expect the sequential growth between Q1 and Q2 of this year to be at a high single-digit growth rate, as well as a modest improvement in operating income. But when those deliveries start coming in for those critical components and defense electronics, I think that's when you're really going to start to see some things take off. But we are, you know, as you look across the full year and the full portfolio, you know, we will see steady sequential improvement in both sales and operating income for the remainder of the year.
spk08: Okay, because it would seem like you, that $40 to $50 million that you just referred to, that happened in the first quarter effectively. I mean, $40 million was what happened in the first quarter.
spk10: Well, yeah, I would say I think as you look at the first quarter year over year, you did. You had about a $40 million drop in Q1 defense electronics year over year. You did see a drop within Naval Empower, and that was primarily we had the AP1000 program and a little bit of Naval defense timing, but we were offset by about a $13 million improvement on the commercial side. We will see sales improve in the second quarter. It's going to be at a high single-digit rate, but the rest of that recovery for Defense Electronics is going to be Q3, Q4.
spk01: I would just supplement what Chris has said. I think this is where it's important for Chris and I that we look at the company as a corporation as a whole, and as we look to deliver the financial results that are expected from You know, we have a very diversified portfolio that has different stresses on it in different areas. And, you know, we'll deliver, you know, the results that we're predicting by managing the portfolio as a total.
spk08: Okay. And maybe on that question, Lynn, portfolio and M&A backdrop, obviously the Saffron deal here closing in the near term, but just curious what the pipeline is looking like over the medium term. Thanks.
spk01: Thanks. So, I mean, there are definitely interesting properties in the pipeline. I think we've remained true to what we've said a couple times. I think last year we made mention that, you know, we looked at double-digit numbers of properties that we chose not to act on and were maintaining that tempo, I would say, in the beginning of this year. But there are still, you know, absolutely properties in the pipe of various sizes and, you know, across various segments of the business. And so, I remain optimistic that, you know, we will continue our cadence of being able to bring, you know, to deploy, you know, the majority of our capital towards acquisitions. But, again, when we find those strategic and financial fits, not forcing it. Thanks. Thank you. All right. Thanks, Bob.
spk03: Thank you. And, again, if you have a question at this time, please press star then 1. And our next question comes from the line of Christina Liwag with Morgan Stanley. Your line is open. Please go ahead. Hey, good morning, everyone. Hey, good morning.
spk04: Good morning, Christine. Lynn, you know, following up on Peter's earlier question, we've seen meaningful step-ups in defense spending levels, both in the 22 spending bill and the 23 request. When you first established your 5% growth target last year through 2023, the outlook for defense was much dimmer and a lot less clear. With the opportunity for the programs you've highlighted, could this growth look more like high single digit? And what has to firm up for you to feel confident to change your outlook?
spk01: So, you know, we love seeing what we're seeing in the spending, and it is absolutely good for our business. I think, you know, what we've seen is, you know, if you take half of our defense business is naval, what we've seen is a shirring and a you know, affirming up of the business that we anticipated would be in the naval budget, so it's still great to have it be, see it committed to in a bipartisan manner, but it doesn't, you know, there isn't necessarily anything in that spending that's a radical step up in that area. You know, across some of our groups, you know, the confidence in, you know, what we're seeing for the PACSAR spending, you know, could that go higher? I think there's a chance. I think we have pockets of our business that, you know, could go higher, and I think, you know, there's some reason For optimism, you'll see our orders were a bit tamped down across some of our defense markets in Q1. We've seen a nice shift even early in Q2, I think, with the CR being put behind us. And I guess it's a little hard to anticipate how the pace of order flows through those increased budgets. And so I think we want to see a little more evidence of that before we begin discussing to speaking to any optimism.
spk10: Yeah, and of course we're optimistic and hopeful that the 23 budget actually gets passed on time this year. So if that happens in September, that'll provide greater clarity.
spk01: Yeah, and we don't just go back to another long CR. But as answered, we have a lot of reasons to make ourselves optimistic about where we're taking Curtis Wright over the next handful of years.
spk04: Great. That's really helpful. And maybe following up on nuclear power plants, right? I'm thinking about Eastern Europe. You've highlighted the opportunity for the $1.5 billion in MOUs. I mean, there's clear focus on energy independence, and there's finally recognition that nuclear power has a role to play in clean energy, right? But at the same time, if you look at Russia and what they were doing in Ukraine... it seems like there's a slight increase in operating risk of nuclear power plants as we saw them fire upon some of these facilities in Ukraine. How does this balance in your view? How much would you weigh the positives of the opportunity from clean energy and energy independence versus the potential headwind from this increased operating activity in the region? And how does this change your view on that $1.5 billion opportunity?
spk01: So I don't think it impacts the one and a half billion dollar opportunity, but you are absolutely right to point out, you know, when some of the initial events were happening and, you know, it definitely makes you take a breath and hold your breath for a second. But I think that is where I mean, there must be energy independence or cannot be dependence on Russia. And, you know, so if you start with that as a starting point, you know, nuclear is going to be a part of that. And what do you need to do? You need to have the defenses across Europe. be ever stronger, that, you know, these types of activities are thwarted going forward, and so that that threat is taken away. So, I mean, I don't think it's going to take away the move towards nuclear. I think it's going to, you know, I think we'll see more countries join NATO over the next short period. I don't think it's going to take years. And then the ramp to that committed spending that, you know, gives us a much stronger Europe, I think, is the way that that you know, potential risk is balanced.
spk10: Yeah, and I would only add that, you know, the AP1000, you know, we've said it in the past, it has entirely passive safety systems. So, you know, not saying that anything in this world is really war-proof, but if you're certainly going to go in that direction, you want entirely passive safety systems for the protection of that reactor. Good point.
spk04: Great. That's really helpful. And if I could add one more, you know, pivoting back to the U.S. on this nuclear theme, it seems like the U S nuclear Renaissance that didn't play out a few years ago is finally starting to get some traction. And Lynn, you highlighted that life extension of the nuclear power plant in, uh, in California. Can you quantify the opportunity for this domestic aftermarket? Um, and what's embedded in your outlook and, uh, how much could we see, uh, as these, you know, I mean, a lot of these plants are what, 50, 60 years old. If they're extending them, um, how large of an opportunity and how quickly could you see some of these play out?
spk01: So it is going to be an important growth driver for Curtis, right? You know, I've tried to get my hands and quantify, you know, what's the revenue per reactor that would do these plant life extensions. And it really is varied from single to double digits of millions based on what kind of maintenance schedules they've made, what type of equipment they have inside it. So it really is varied across the reactors. And then also there's a lot of choices that the reactors will make from do they do the minimum to get the plant life extension or do they take the opportunity to modernize it, move to more digital systems that needs less manpower as everybody's trying to figure out how to do things more efficiently and less dependent on labor. that can really make them even richer opportunities for us as they go through that. But that's something that's being figured out right now, and I don't really think we could put a number on it. But, yeah, I mean, it's definitely an important trend, and maybe you've heard us mention about a third of the U.S. nuclear power plants have made either through their paperwork or filing paperwork or have indicated they're starting the process. And I think there's a really strong belief that that's going to sweep across the majority of the rest of them. I think there's still maybe one or two, maybe a small handful of reactors that were too far down the path towards closing. I'm not saying there will never be another reactor closed. In the U.S., but, you know, we saw those four in Illinois probably six months ago say that they weren't going to, you know, close. Having Governor Newsom make this statement publicly, you know, he's not going to say something like that if it's not, you know, it's not going to be popular in California necessarily. So, yeah, it is. we feel good about what it's going to drive.
spk10: Yeah, and I would just offer, because many of you have been following us for a very long time, and as we've looked at the nuclear aftermarket with all those plant shutdowns that have been taking place, the business has been low single-digit growth. We're really encouraged by what we're currently seeing within the nuclear aftermarket, and Last year was a good increase in orders, up 10% year-over-year. Q1, we were up 7%, continuing to support those stronger mid-single-digit aftermarket growth rates that we have here for 2022. And it's not just the nuclear aftermarket. It's that increase in funding from the DOE to support a strategic plan and the investment in Gen 4 technology. So there's some good things that are happening here, and I think, you know, While it may be difficult to put our finger precisely on what that means for Curtis Wright, it certainly means opportunity above where we were.
spk03: Great. Thank you very much.
spk01: Thanks, Christine.
spk03: Thank you. And our next question comes from the line of Christopher Rieger with Berenberg. Your line is open. Please go ahead.
spk07: Hi. Good morning, Lynn, Chris, and Jim. Thanks for taking the question. Just real quickly, getting back. Hey, how are you doing? Just getting back to the topic of M&A really quickly, has the recent increase in interest rates had any impact on the amount of leverage that you might be willing to take on to finance potential acquisition or series of acquisitions?
spk10: No, I think we like where we are and where we're positioned within our balance sheet. I think the balance sheet continues to be strong. We continue to be focused on finding the right properties to invest in. And as Lynn said a little bit earlier, that is our number one priority. But as we move forward, we will also think about returning capital to shareholders and making sure that we put our best foot forward to maintain an appropriate balance. I will maybe go off topic a little bit here. It is really an interesting time here with what's happening with rising interest rates and how that's impacting many businesses, not just from an inflation perspective. You know, it is really a good time to kind of take a look at, you know, your financing vehicles within the corporation. And, you know, we're certainly doing that. So, with what's happening in the environment right now, you know, we're looking at, you know, our current revolver, which expires at the end of 2023. And is this the right time to kind of maybe seize an opportunity to add a little bit more capacity? Think about maybe going out into the bonds market. It's a good time to be proactive in thinking about how you're financing your business and keeping your eye on the future.
spk07: Great. Helpful. That's it for me. Thanks. Thank you.
spk03: Thank you. And I'm showing no further questions at this time, and I would like to hand the conference back over to Lynn Bamford for any further remarks. Thanks.
spk01: Thank you for all the thoughtful questions and joining us today, and we look forward to speaking to you in another three months.
spk03: This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.
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