Curtiss-Wright Corporation

Welcome to the Curtis Wright Third Quarter 2023 Earnings Conference Call. At this time, all participants have been placed on the listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star 2. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Jim Ryan, Vice President of Investor Relations.

Thank you, Raisa, and good morning, everyone. Welcome to Curtis Wright's third quarter 2023 earnings conference call. Joining me on the call today are Chair and Chief Executive Officer Lynn Bamford and Vice President and Chief Financial Officer Chris Farkas. Our call today is being webcast and the press release as well as a copy of today's financial presentation 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 the 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 and occurs for its ongoing operating and financial performance. Any references to organic growth are on an adjusted basis and exclude foreign currency translation, acquisitions, and divestitures unless otherwise noted. GAAP to non-GAAP reconciliations for current and prior year periods are available in the earnings release and on our website. And I'd like to turn the call over to Lynn to get things started.

Thank you, Jim, and good morning, everyone. I will begin by covering the highlights of our third quarter 2023 performance and a brief update on our full year financial outlook, which we are updating to reflect stronger expectations for revenue, earnings, and free cash flow generation. Then I'll turn the call over to Chris to provide a more in-depth review of our financial results and updates to our 2023 guidance. Finally, I'll wrap up our prepared remarks before we move to Q&A. Starting with our third quarter 2023 highlights, sales increased 15% overall to $724 million and improved 14% organically as we demonstrated higher year-over-year sales growth in all our end markets. Our A&D markets grew 18% year-over-year as we benefited from the continued easing of the supply chain in defense electronics. which drove strong increases in both aerospace and ground defense, as well as mid-teens growth in commercial aerospace. We also experienced widespread growth in our commercial nuclear, process, and industrial markets, which Chris will cover in more detail shortly. Operating income grew 17% year over year and exceeded our strong sales growth, while operating margin expanded 30 basis points, Underscored within this performance was strong profitability in defense electronics segment. As we continue to overcome the dramatic impact of last year's supply chain challenges, we continue to benefit from steady improvements in lead times and component availability within defense electronics, providing further confidence in achieving our full-year outlook. Diluted earnings per share of $2.54 increased 23% year-over-year, while adjusted free cash flow was up 59%, resulting in 140% in free cash flow conversion. We were also pleased with the continued growth in our order book, up 3% in the quarter and now up 8% year-to-date. Leading the way was our defense electronic segment, which achieved a record bookings quarter exceeding the previous record set in the last year's third quarter. This activity was driven by continued strong demand for embedded computing and tactical communications equipment. In addition, in our naval and power segment, we continue to experience strong demand for commercial nuclear products to support maintenance, modernization, and plant life extensions, as well as advanced small modular reactor designs. Overall, book to bill was 1.2 times in the third quarter, building upon our already strong backlog, which is now up 12% year to date, and in excess of $2.9 billion. Next is some highlights of our full-year 2023 guidance. Our growing backlog and strong performance to date, along with favorable trends across all our end markets, provides us with confidence to raise our sales outlook again. This positions us to deliver 8% to 10% top-line growth with increased sales projected in all three segments. Overall, strong profitability remains unchanged, with expectations for 10 to 30 basis points in year-over-year margin improvement, reflecting the balance of the combined portfolio, whereby a reduction in the naval and power segments profitability was offset by a stronger outlook in defense electronics. As a result, diluted EPS is now expected to grow 11% to 13%, which, as a reminder, keeps us on track to exceed our long-term targets. In addition, for the second consecutive quarter, we increased the bottom end of our already strong free cash flow guide to reflect the year-to-date performance and higher confidence in the full year outlook. In summary, Curtis Wright remains well-positioned to deliver another strong performance in 2023. Now, I would like to turn the call over to Chris to continue with our prepared remarks.

Thank you, Lynn. On slide four, we have the key drivers of our third quarter 2023 performance by segment. I'll begin in aerospace and industrial, where overall sales growth of 3% was in line with our expectations. Within the segment's commercial aerospace market, we experienced double-digit growth in OEM sales supporting the ramp-up in production on Boeing and Airbus platforms, most notably on the Airbus A320 and A350 programs. We also experienced higher sales in the general industrial market driven by solid growth in EM actuation products and surface treatment services. Partially offsetting those increases was a decline in actuation sales within the segment's aerospace and ground defense markets due to the timing of production on various programs. Turning to the segment's profitability, favorable absorption on higher sales was offset by unfavorable mix in the timing of development contracts, principally for actuation products. Next, in the defense electronics segment, sales increased $55 million, or 34%, reflecting continued supply chain recovery in the conversion of our strong order book, which showed increases in our aerospace and ground defense markets. Of note, and included within that strong performance, approximately $10 million in tactical communications equipment sales were accelerated into the third quarter from the fourth quarter as we burned down some of our backlog at a faster pace. Elsewhere in ground defense, we experienced increased sales of embedded computing equipment, most notably on the Striker platform, which is another example of the strong demand from our customers for our MOSA-compliant solutions. Within aerospace defense, we experienced strong sales growth for embedded computing equipment on various domestic and foreign military programs, as well as flight test instrumentation on the F-35 program. Regarding the segment's operating performance, operating income increased 54% while operating margin improved 330 basis points, principally due to favorable absorption on the strong sales growth. Also included within those results was a year-over-year increase of $4 million in strategic IR&D investments to enable our future organic growth. Turning to the enable and empower segment, overall sales growth of 12% was essentially in line with our expectations and reflected growth in both our A&D and commercial end markets. Within the segment's aerospace defense market, our arresting systems business continues to perform extremely well based upon the strong global demand for our products. In the naval defense market, our results reflected higher revenues supporting the ramp-up on the Columbia-class submarine and solid growth on the Virginia-class subs, partially offset by the timing of production on the CVN-81 aircraft carrier program. In the power and process market, sales increased approximately 10% overall and reflected mid-teen sales growth when excluding the revenue headwind from the wind down of Cap 1000 production. These results reflected continued strong demand in our commercial nuclear market, supporting the operation and maintenance of existing reactors, as well as higher development revenues, mainly supporting the X-Energy advanced reactor design. We also experienced strong sales growth in the process market, driven by increased refinery maintenance and turnaround activity, as well as higher subsequent development revenues. Turning to the segment's operating performance, favorable absorption on solid sales growth was partially offset by unfavorable mix from the Cap 1000 program. In addition, as you look at the segment's profitability, our results reflect a small number of Mable contract adjustments reflecting the continued training and development of new hires to support our rampant growth. To sum up the third quarter results, overall, strong growth in operating income once again exceeded growth in sales and resulted in 30 basis points in year-over-year operating margin expansion. Next, turning to our full year 2023 guidance on slide five. I'll begin with our in-market sales outlook, where we now expect organic sales to grow 7% to 9%, with total sales growth of 8% to 10% of $30 million, or 1% compared with our prior guidance. Across the entirety of our aerospace and defense markets, we now expect total sales to increase 10% to 12%. Taking a closer look at the aerospace defense market, we've increased our expectations for full-year sales growth to a range of 11% to 13% based on strong demand for arresting systems equipment and higher embedded computing revenues in defense electronics. Next, in ground defense, we now expect an even more favorable full-year sales growth of 23% to 25% driven by the continued strong demand for our tactical communications equipment and easing in the supply chain. Of note, based on the accelerated receipt of materials and timing of revenue that shifted into Q3, we expect sales in the ground defense market to decline sequentially in the fourth quarter. Next, in naval defense, while we expect a solid 5% to 7% outlook for year-over-year growth, we reduced our outlook slightly, mainly due to the timing of production on the CVN-81 aircraft carrier program, as we now expect some revenues to shift out of 2023. Before we wrap up our defense markets, I wanted to highlight an area where we've received a number of questions over the past year since the start of the Ukrainian conflict and commitment by NATO countries to increase defense spending as a percentage of GDP. As anticipated, we've steadily seen an increase in strong contribution in direct foreign military sales as we've progressed through the year. Collectively across Curtiss-Wright, we now expect these sales to grow approximately 15% year over year. And the notable drivers of this spending include higher sales of avionics, flight test equipment, and arresting systems in aerospace defense, turret drive stabilization systems on ground defense platforms, and aircraft handling systems on naval vessels. Given the rising threat environment and alignment of our technologies to domestic and foreign defense priorities, we continue to see this as an opportunity to drive solid long-term revenue growth in this area. Turning to commercial aerospace, Based upon the year-to-date performance, we are now increasing our expectations of sales to grow 14% to 16% driven by strong OEM sales growth on both narrow-body and wide-body platforms. Outside of our A&D markets, we raised our growth outlook slightly for the power and process market based on the continued strong demand for both our commercial nuclear and industrial valve products. And as a reminder, the outlook in this market includes a $20 million year-over-year revenue headwind from the wind down on the CAP 1000 program as we substantially completed this contract in the first quarter. Excluding that impact, we expect a high single-digit full-year growth rate in our commercial nuclear market, as well as a low double-digit growth rate in the process market, reflecting higher nuclear outages and process turnarounds, as well as a ramp in development of advanced SMRs. Overall, across our total commercial markets, we continue to expect full-year sales growth of 3% to 5%. Continuing with our full-year outlook by segment on slide 6, I'll begin in aerospace and industrial, where we increased our range of sales slightly to reflect the strong demand in commercial aerospace and continue to expect solid sales growth of 4% to 6%. Regarding the segment's profitability, we maintained our full-year outlook, reflecting strong growth in operating income and 20 to 40 basis points in operating margin expansion. We continue to expect the segment to deliver a strong fourth quarter and finish to 2023. Next, in defense electronics, we raised our revenue forecast again and now expect sales to grow 12% to 14% based upon the strong year-to-date performance, continued improvement in the supply chain, and record-level order activity. Regarding the segment's profitability, we now expect operating income to grow 18% to 21% and full-year operating margin to range from 23.5% to 23.7%, reflecting 110 to 130 basis points in year-over-year expansion, which is 50 basis points above our prior expectations. As noted earlier, based on the segment's stronger-than-expected third quarter results, we expect sales to decrease sequentially in Q4, but still demonstrate strong profitability with an operating margin of approximately 30%. And lastly, Mabel and Power, we increased our range of sales slightly to reflect the aforementioned changes in end markets and continue to expect strong sales growth of 8% to 10%. Regarding the segment's profitability, while we anticipate favorable absorption on the overall increase in sales, we reduced our operating income guidance to now reflect flat to 3% growth and trimmed our prior margin outlook by 40 basis points, primarily due to the timing and efficiency on a small number of naval contracts. While the impact of the contract's adjustment is immaterial to overall Curtis Wright guidance, we see this as an opportunity going forward, which Lynn will address further in our closing remarks. And lastly, in regard to the segment's margins, our outlook continues to reflect margin pressures associated with the timing of development contracts in the power and process market and unfavorable next on lower cap 1,000 revenues. Regarding the increase in non-segment or corporate expenses, our updated guidance reflects an increase in assumptions related to higher than anticipated foreign exchange transactional losses in 2023, which we now expect to fully offset lower year-over-year pension costs. So to summarize our outlook, we continue to expect total Curtis Wright operating income to grow 8% to 11% overall in 2023 in excess of sales growth. And as a reminder, this outlook includes a year-over-year increase of more than $20 million in our total engineering spend on both internal and customer-funded programs and remains in line with our initial guidance provided earlier this year. Despite that offset, we expect to drive 10 to 30 basis points in full-year operating margin expansion as we continue to deliver on our 2021 investor day commitments. Continuing with our financial outlook on slide 7, and building upon our solid year-to-date performance and expectations for a strong finish to the year, we have increased our full-year adjusted diluted EPS guidance to a new range of $9 to $9.20 for up 11% to 13%. And lastly, turning to free cash flow, we delivered a strong performance through the first nine months of 2023 that puts us back in line with our more historical cadence. As a result, we raised the bottom end of our range by $10 million to reflect improved confidence following increases to our full-year financial outlook and our intense focus on working capital management. Our adjusted free cash flow outlook now ranges from $380 to $400 million, reflecting strong growth of 29% to 36%, and is also within striking distance of our record of nearly $400 million achieved in 2020. Our updated guidance continues to imply a free cash flow conversion rate in excess of 110%. Now I'd like to turn the call back over to Lynn.

Thank you, Chris. And turning to slide eight. As we have discussed today, we achieved strong third quarter results and remain on track to deliver another outstanding year for our shareholders. It's worth reiterating that we expect to deliver these strong results while maintaining our commitment to incremental investments in R&D, which further strengthens our ability to sustain organic growth well into the future. As I reflect upon the challenges that we and many defense companies are facing today, ranging from supply chain to staffing, I'm incredibly proud of the accomplishments of the team, our ability to pivot, to deliver strong growth, and the effort we put forth to accomplish our 2021 Investor Day commitments. When leading in a growth environment amidst a dynamic global market, there are always challenges to be faced. For example, The events of the pandemic led to the unfortunate turnover of nearly 15% of our workforce. Within these types of challenges, we have consistently found opportunity to advance both financial and operational excellence with the goal of improving Curtis Wright's overall efficiency and resilience. We've continued to focus on enhancing our processes, programs, and systems to ensure that the team is fully engaged and supported As we've reshaped the workforce, we have done so with increased efficiency while driving record high sales. As we prepare to meet the strong demand ahead of us, we've added back about half of those jobs lost during the pandemic, many of which are engineers. We continue to see encouraging trends in employee hiring, retention, and turnover, and this remains critical as we continue to ramp up our focus on new projects and opportunities which will drive our growth well into the end of this decade. Further, we are committed to continuing to refine our processes as we onboard employees and implement new training programs to assure we develop the future generation of Curtis Wright's workforce. As I near the end of my third year as CEO of Curtis Wright and look out across the portfolio to our future, it is clear that we are well positioned to continue to capitalize on the tremendous secular growth trends driving our A&D and commercial end markets. Before we wrap up, I'll highlight a few of those avenues for growth. In defense, an increasing global focus on security and our position as a trusted, proven supplier provides confidence in our ability to deliver strong, long-term growth across our defense businesses. As you can see by our performance this year, we're certainly benefiting from the strength and alignment of our portfolio to the FY23 spending bill, which appropriated $817 billion, or 10% year-over-year growth for the DOT budget. Although we're faced with the current continuing resolution and delayed signing of the FY24 spending bill, we remain in an elevated U.S. defense budget environment, with the proposed legislation calling for at least 3% top-line growth in FY24. We see continued opportunities to support our efforts in naval shipbuilding, the expansion of our MOSA product offering in defense electronics, as well as ground modernization, to name just a few. The trends driving global defense spending, most notably by the U.S. and its NATO allies, are expected to remain a strong tailwind for Curtiss-Wright and the industry. In commercial aerospace, growth in global passenger travel, the need to replace the aging commercial fleet, and our drive to expand our capabilities on existing and new platforms is expected to provide continued growth for years to come. Further, the emergence of electrification in aerospace and defense provides yet another opportunity to expand Curtis Wright's technological reach, building upon our relationships and new product introductions addressing the electrification of vehicles in the general industrial market. As I look to commercial nuclear, emerging technologies and nuclear power and the tremendous efforts that exist worldwide to truly impact global decarbonization and energy security provide a long runway of opportunities for Curtis Wright. This includes opportunities to support large-scale AP1000 reactors in Europe, as well as the large volume of advanced small modular reactors expected to be built to supplement the existing nuclear reactors or replace existing coal plants, all of which will be needed to meet the tremendous global demand for energy. Level of activity for commercial nuclear continues to advance at a relatively rapid pace and we remained aligned as a strategic supplier to support our customers' needs. Finally, I'm pleased to share that just this week, Bulgaria's government announced that they have approved the construction of their first AP1000 reactor, which is anticipated to be operational by 2033, followed by a potential second reactor expected to go online two or three years after the first one. This exciting news follows Poland's earlier selection of the AP1000 reactor and their recent signing of an engineering service contract with Westinghouse for the construction of the first three of potentially six AP1000 reactors. Those initial reactors are expected to be operational in the early 2030s. Bulgaria's news provides yet another positive endorsement for the AP1000 technology, while also reaffirming Curtis Wright's opportunity to secure multiple contracts for our reactor coolant pumps within the next two to four years. In closing, I'm pleased with our continued momentum and the healthy outlook for the near and long-term prospects for Curtis Wright and the markets we serve. Across every avenue, we are diligently investing in our employees and in critical technologies today to support our future, which will enable Curtis Wright to deliver long-term profitable growth and tremendous value for our shareholders, our employees, and our customers. Braced on our strong outlook in 2023, we continue to maintain line of sight to the three-year Investor Day commitments established in 2021 and providing confidence that our pivot to growth strategy is working. We look forward to providing a recap of our results and performance against our three-year targets in February, followed by our May 2024 Investor Day in New York. Thank you, and at this time, I would like to open up today's conference call for questions.

The floor is now open for questions. At this time, if you have a question or comment, please press star 1 on your telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing star 2. Again, we ask that you pick up your handset when posing your questions to provide optimal sound quality. Thank you. Our first question comes from Peter Armand with Baird. Your line is open.

Yeah, thanks. Good morning, everyone. And congrats on the nice results. Lynn, when you think about the nuclear business, just thinking back to the days when we had the big China direct order and you look at the kind of outlook over the next several years, how do you think about in terms of sizing the opportunity? It certainly seems like there's just a lot more going on, a lot more opportunities, whether you look at the AP-1000 or you look at SMRs. How are you framing it?

So the potential is actually very significant, and, you know, we're very encouraged to see the steady drumbeat of, you know, this, you know, wide group of opportunities for RCP pumps to keep, you know, across all the fronts. You know, there's multiple countries, and we talked about Bulgaria and Poland on the call here, but Ukraine, Romania, the Czech Republic. even in the U.K., Slovenia, Slovakia, Finland, and Sweden are all, you know, you can find press on all of them that they are taking steps to move forward with building significant new nuclear power. Some of those are still in a competitive position, but, you know, Lessinghouse clearly continues to begin, you know, continue to win, you know, across that market, you know, given the track record and the great safety profile of the AP1000 nuclear power plants. Today, we think there's potentially room for 50 to 100 RCPs, and this is well into over a billion dollars and potentially north of $2 billion of business for Curtis Wright. And it's a pretty consistent timeline. The countries seem to be targeting on getting these plants online in the very early 2030s. So the the significance of bringing some meaningful orders to Curtis Wright, you know, similar to what we saw with the China direct order or even more, you know, is coming in the next two to four years. And we're making sure we're prepared to be a great partner to Westinghouse and ready to ramp up and to do that. So it's fairly dramatic when it comes. It's going to be, you know, an amazing flashpoint for Curtis Wright. And, you know, the timeline, you know, we said three to five years, you know, at the beginning of 22, we're now saying two to four years, and, you know, things consistently are just moving forward, then, you know, it's not, you know, as if a year passes and the timeline still remains three to five, you know, we feel good that this is, you know, moving in a very meaningful direction.

Appreciate that. And just on your overall defense business, are you seeing any kind of replenishment activity. I know there's, you know, a lot of activity that we're sending over to Ukraine and giving everyone's kind of interest in what's going on in the Middle East. Are you guys seeing any impact in your order environment?

Yeah, we're not... Not heavily, to be transparent. We're not in munitions and the type of stuff that is being very much replenished. However, we are in a lot of the equipment that is very much needed, and whether that's from tactical communications types of equipment, definitely seeing some order trends there. to many of the missile defense systems where we have significant content. So it's a little, it's not the quick reaction stuff that is being asked for, but definitely Chris spoke to the increase trends. And one of the other areas outside of defense electronics we tend to think about, but clearly our new ESCO acquisition is 75% of their business is outside of the U.S. They're having an absolutely knock-the-doors-off kind of year, and a lot of that is countries throughout Europe trying to assure their position for readiness, and their equipment is essential for that. So clearly that is You know, the position there has, you know, been driving orders into our ESCO business.

Thanks. And just one quick last one, Chris. You guys continue to generate, obviously, very strong free cash flow. Are you still seeing opportunities kind of whether it's working capital days or how should we think about just working capital profiles going forward?

Yeah, I'm pretty pleased with the performance and what we've been able to accomplish here to date. I mean, just even looking at Q3 and that high free cash flow that we generated, which I think if you look back over the past five years is stronger than most. But year over year, you know, we were able to reduce our working capital as a percentage of sales in the third quarter by approximately 300 basis points. And, you know, with the increase in sales and what's happening across the organization to support the rampant growth, it really didn't come through collections, right? Collections is certainly an opportunity for us on a throughput basis, but we've got a lot to close out here at year-end. It really came through lower inventory. So I think we're starting to make some progress. You're going to see that in the throughput of the product. And as we get to year-end here, we're expecting to finish in that 24% range, showing 200 basis points of year-over-year improvement. A lot of that will be burning off this great collections opportunity that we have in front of us now, an inventory burndown. I don't know that we'll be quite as aggressive as we have been in the past with payable stretching. We were pretty tough with our suppliers this last year, and I think given our situation here, it's good to maybe not be quite so aggressive. Yeah, there is opportunity ahead of us. I mean, I think we still have more opportunities. We head into 24 to burn down inventory and to get this working capital as a percentage of sales back in line with some of those historical bests that we were hitting back in that 2019 timeframe. So more to come. Appreciate the details. Thanks.

Thanks, Peter.

Our next question will come from Christine Liwak with Morgan Stamps. Your line is open.

Hey, good morning, everyone. Good morning. You know, Lynn, just want to go back in terms of the timing for the AP1000 order. If Bulgaria and Poland both want to have the power plant online in the early 2030s, I mean, it seems like they should have to order the reactor coolant pumps. like now. So just want to understand a little bit more on timing and regarding the progress of your discussion with them. Could this be, you know, a late 23 or even a 2024 order?

So, you know, we have a great relationship with Westinghouse. We have regular market update meetings with them and, you know, work very transparently on, you know, know what they're seeing, what they're bidding, et cetera. And so, you know, You know, they under, you know, as I think as the orders, they begin to have more security in the number of opportunities they're going to have that they're trying to build plants, you know, in that early 2030 timeframe. I think it does put pressure for us to make sure, you know, we can build the number of reactor coolant pumps to be in line with them to date. You know, what we've shared the two to four years is still the discussion we're having with Westinghouse. So this isn't really, you know, if this is you know, a very clear discussion with Westinghouse and what they indicate. But I know we feel, as we see the potential for orders and the number of plants, you know, being desired to build and know what that means for reactor coolant pumps, you know, we know that, you know, the order back in 2015 was for 16 RCPs. Between Poland and the first Bulgaria plant, that's 16 RCPs. So that's, you know, an order of that same magnitude. And, you know, it took us, you know, that was initially anticipated to be a five-year bell curve of delivery. So that, you know, has us putting pumps out, you know, over a five-year plan turned into seven-year. So, I mean, everybody's very aware of this. And, you know, really just at this point we don't want to speculate on it being earlier, but it clearly is. you know, the world evolves and there's more commitment to AP1000 plans, I would say it does put pressure on, you know, them trying to hold off. And, you know, they're obviously, you know, these are very costly pumps. And they're, you know, trying to control cash flow and all the things every company does. But, you know, at some point that tradeoff will move to getting us started earlier. But that, you know, is still a TBD.

I see. And then if I recall right, the RCP for the AP1000 is the same facility where you guys build the RCPs for submarines. With the two Virginias, plus you've got Columbia class as well, which is incremental capacity. Can you remind us what the capacity is for an annual build? I mean, You've also had your Romania and a few other countries who have put an interest in AP1000. And sometimes, right, when it rains, it pours. Should all these orders come through, what's your ultimate capacity that you could build if these orders all come in, you know, and they all want to have a plant opening in 2030?

We do have a lot of capacity to ramp up in our Tesla plant with, you know, adding shifts and adding staff to the current shifts, running two full shifts, and even potentially a third shift. So we are well positioned with the capital equipment we have to flex up. I mean, obviously that always has a limit. One of the things we are very much in the process of evaluating is as Broadly, our content across the various SMR platforms, we very notably talked about all our content with Xenergy as their line of sight on their customers continues to grow and be positive, whether we would need to do some footprint expansions later in this decade. And so that work is ongoing to, you know, consider if that is going to be needed. We're not there yet, but it's definitely something, you know, we're considering whether, you know, just like we built the plant in Somerville, you know, Curtis Wright's not afraid to make, you know, capital investments when you can see line of sight on, you know, important, meaningful business. And this clearly is for us. So, you know, we're not worried about what we can produce out of the facility in Cheswick. as of now, but there might be some expansion in the back half of this decade.

And I would just also add to that that, you know, those contracts are typically front-loaded with cash, right? So I think if there is any type of CapEx spike at this point, we wouldn't expect it to be significant. But, you know, we would expect the cash flows on those contracts to, you know, fully help us ramp up in those circumstances. And obviously it's very profitable business, so we think people will be really happy with anything that we do in that area.

Great. Thank you. I'll keep it to two. Thanks, Christine.

We'll take our next question from Nathan Jones with Stiefel. Your line is open.

Good morning, everyone.

Hi, Nathan. Good morning.

I'd just like to start off with digging a bit more into the margin profile and the overall margin expansion in 2023, you know, up 20 basis points on 8% organic growth is not huge operating leverage. And I know there's a number of puts and takes. I'd like to dig into those a little bit more. So maybe you could comment specifically on some of the headwinds like cap 1000 winding down. I know you talked about additional R&D investments. So maybe unpack that for us a little bit more and then talk about what may or may not repeat in 2024 as we're thinking about the margin profile out there.

Yeah, I think when you look at Curtis Wright from an overall level, when you look at the absorption that we're getting on the sailfish here, it's fairly in line with what we've said we've experienced historically, which is in that 25% to 30% range. I think at the midpoint of our guide right now, we would say about 27% is incremental margin. But as we've talked about a number of times throughout the year, we have so many great opportunities to invest not only through IR&D but also contract R&D to continue this great growth trajectory that we're on. So when you look at just the incremental IR&D year-over-year, that's $5 million. And as we look at the total R&D, which includes contract R&D, and we've talked a little bit about things like advanced naval cots and subsea pumps and the various development contracts that are going on within the ANI segment across the actuation division. I mean, we're going to be spending in excess of $20 million of R&D this year, and that puts a little bit of pressure on margins. So, you know, I think as we go to, you know, capture these great growth sectors that we're on and push ourselves and our growth for the future, you know, it's important to maintain that investment. And then beyond that, we have had a reduction in AP1000 year-over-year. We've talked about the profitability of that contract. I won't get into the numbers again on that, but that's a $20 million year-over-year headwind that we're facing within the naval and power segments. Ten to 30 basis points year over year, if you pull back some of these items, there's a lot going on in the organization, not only from a pricing perspective and to push forward commercial excellence, but also operational excellence to support that investment that we're doing for the future.

So if we stripped out all of the kind of discrete things that are going on, your position is that you're still in that kind of 25% to 30% core absorption, core incremental margins on growth?

Yes.

And, I mean, the cap 1,000 headwind is going to decline year over year going into 2024 just because the contract's running out of revenue to decline off of. You guys haven't made a commitment to continuing to invest in growth. Should we expect further headwinds to the margin line? Obviously, I understand that they're getting paid back in growth. in 2024 from increased investment there? Just how should we think about the puts and takes there as we go into 2024?

Yeah, you know, we are certainly still on the journey and what we've set out to accomplish here in Investor Day. I mean, there's a lot that goes into answering the question as to where you're going to be in 2024. We're still actively engaged in our strategic planning process and evaluating some of these investment opportunities that stand in front of us this next year. But I mean, specifically, as you brought it up, I mean, as you look at naval and power, you know, margins going forward, I think the positives here are that we've got a real solid naval defense outlook, including a ramp on the Columbia-class submarine. You know, we've got this, you know, new business integration with our resting systems business that is going very well. We're seeing FMS sales growing significantly. We should have no AP1000 headwind this next year. I mean, boy, it would be nice if something happened a little bit sooner on those orders. We're still forecasting two to four years, but we know that will be an accelerant when it hits. And we'll have a tailwind and a benefit from this small naval contract adjustment that we had here in the third quarter. You know, we'll get through this strategic planning process here in the fourth quarter. You know, we're going to look at these R&D investment opportunities that are in front of us in advanced SMR, sub-C, advanced naval tech, you know, tech-type technologies. And, you know, absent investments in R&D or other factors, I mean, we'll get to that incremental 25% to 30% as we have in the past. So that's how I would look at that.

That's helpful. Thanks. I think important for people to understand what the call looks like. So thanks very much for taking the questions. Thank you, Nathan. Yep, thank you.

Our next question comes from Pete Osterland with Truist. Your line is open.

Hey, good morning. I'm on for much more this morning. Thanks for taking our questions. I first just wanted to ask, on the book to bill for the quarter, I was wondering if you could provide some more detail on what that looked like by segment or by end market. Just trying to get a sense for how strong orders were in defense electronics and if there are any markets you would call out where order trends are showing any signs of relative weakness. Thank you.

Yeah, so there's a lot to unpack in that question, so let me start off and say at the total purchase rate level, we were approximately a 1.2 times book-to-bill, and that's on very strong sales growth of 15%. As you look across the three segments, you know, aerospace and industrial was about a one-times book-to-bill. The defense electronics was It was 1.3 times booked a bill, and that's really the third consecutive quarter for that segment, you know, with very strong booked bills. I mean, they were 1.2 times in Q2, 1.4 times back in Q1. Last 12 months of orders, $983 million. So, you know, some very strong things happening there on top of very solid sales growth. And then the naval and power segment, about 1.2 times booked. You know, the bill is a little bit stronger, you know, in the defense markets. We're still at about a one point. one time in commercial aero. You know, the commercial markets are really kind of a balance, right? And, you know, we're seeing some very strong growth that's taking place in orders up 15% in our nuclear sub-market. We're seeing, you know, mid-single-digit growth here in Q3 in the process markets, but, you know, high above that on a year-to-date basis. So we've talked a little bit about the industrial market and what we're seeing there in the past. I think the positive is that while we've been in a fairly steady decline on a very strong order book since the highs of 2021, here in Q3, we flattened out a little bit as we had projected. You know, we're dealing with a little bit of slack in the and our customers' inventory. That seems to be balancing out. We've got some new product introductions, I think, that are going to help that going forward. And commercial aero continues to be very, very strong. So no concerns in that regard. Continue to produce and expect to produce in alignment with the trajectories that Boeing and Airbus have laid out for their critical platforms.

Perfect. Thanks for that detail. And then just one follow-up on naval defense. Have you seen any signs of increased activity or conversations around AUKUS, and do you have any updated expectations around timing for when that could potentially be added to that business?

There's definitely a lot of activity happening in the background around AUKUS and, you know, figuring out how those submarines are going to be built and replaced. A lot of it we're not really at a free hand to speak to, but, you know, we've said, you know, kind of over the past year that the plan for AUKUS is not very clear. Well, it is becoming more clear. I can say that for sure that, you know, and, you know, we continue to know it's going to be a very good tailwind for Curtis Wright in our business, but really the timing and the details is not something we can freely speak to.

All right, understood. I'll leave it there. Thanks for taking the question.

Thank you. Once again, if you do have a question, you may press star 1 on your telephone keypad at this time. We'll take our next question from Miles Walton with Wolf Research. Your line is open.

Hi, good morning. This is Greg Dahlberg. I'm from Miles Walton. I just had a quick cleanup on SMR. I think previously you mentioned content on Xenergy. comments that we hear in discussions with Hitachi and Rolls-Royce. So, I don't know, maybe any updates on those discussions and maybe expectations for design revenues into 24 and beyond.

So, you know, we've been very public on, you know, we're over $100 million of content on the four-unit plant for Xenergy. You know, we continue to work with them and explore other systems that we can build. I would say, I don't know if you saw a press release we put out maybe a month or so ago for a major control system that we've won with TerraPower. So that was something we could go ahead and put out into the public. And so those are the things that we're okay to talk about at this point in time, but the activity is very steady across the board and all the major SMR And we're really hoping that, you know, as we move to our investor day next May, our goal is, you know, obviously we have to comply with what our customers want. But hopefully a lot of this will become a little bit clearer and we'll be able to really talk about some of, you know, where we sit across the various reactors by that investor day. So that's your tease to try to make you really want to come to our investor day. Great.

Great. Thank you. And one more quick one, anything on M&A, just broad color on expectations in the year end, what you're seeing right now. Thank you.

So we have quite a few very interesting properties in the pipeline. I wouldn't see their, well, I guess, you know, there's a chance it could be something yet coming by year end. But, you know, our pipeline is very healthy, and I feel optimistic that in 24 months, you know, we'll be able to have at least one announcement of, you know, a really good solid property that, you know, matches, you know, both the strategic and financial filters that I talked about. I will say that, you know, as we've said years in the past, we surely have evaluated a lot of properties this year, you know, small to some very large ones, but, you know, considering, you know, You know, the cost of capital right now is a pretty high bar to, you know, want to make sure, you know, the fit is really good, the forecast, all those things are really solid, and we passed on quite a few properties this year, but we have some we're very optimistic about.

Yeah, and just to that point, I mean, just relative to financing, I mean, back in June of 22, we completed that EAS acquisition, and then we paid down $200 million of notes in Q1. And I'm really pleased to report that based upon that strong free cash flow generation that we've shown year to date, we exited. the third quarter off the revolver. So, you know, those borrowing rates are approximately 6%. So with a strong fourth quarter finish, we'll be putting some cash onto the balance sheet here. Not too much, but certainly preparing ourselves for any of these opportunities that present themselves as we move into 2024. Great. Thank you. Thank you.

Once again, if you do have a question, you may press star one on your telephone keypad at this time. We'll take our next question from Louis de Palma with William Blair. Your line is open.

Lynn, Chris, and Jim, good morning.

Good morning.

Congress and Newport News and Electric Boat have referenced how the submarine industrial base remains very fragile, specific with the Virginia class. Has this impacted you at all? And in the context of how the contractors are ordering long lead time materials, is there the potential that your Navy business expands as Virginia class production expands?

So one thing we talked about back in our investor day back in 21 and continues to be true is we're a very solid supplier across the submarine programs and have a great reputation within the customer base for our ability to deliver on the submarine programs. And so we're always making it clear that we're interested in you know, expanding our content across those programs as potentially other suppliers fail. And we have instances of that over, you know, during the period and continue to have very proactive discussions with those customers that you referenced around that topic. It's something that, you know, again, I guess twice on this call, it's something we're not really that free to speak about the specifics of. But the other area associated with that is, you know, there's been money made available, you know, in the defense budgets, and then there's money in the, you know, the current plus-up that's being debated, you know, in Congress to support Israel and Ukraine, that there's actually money in that there for the submarine supplier base that we're considering, you know, how it might apply to us that, you know, is to make sure we are doing those things as things like AUKUS comes and, you know, Columbia ramps to about a year and they want to, you know, potentially ramp up Virginia that we're we're really prepared to do that. So we're very proactive about considering how we can pursue those funds to be a really solid portion of that supply base into those important submarine programs.

Thanks, Lynn. And across your industrial and defense segments, are you still seeing any supply chain headwinds? I know that several of your competitors have you know, referenced a new reality in terms of the supply chain on the defense side. But it seems you've been able to manage better than most. But if the supply chain improves, like, should that lead to, like, better output and potentially higher margins?

So the supply chain is, you know, and it's interesting, I was talking to some of the team members earlier, just to get their latest perspective on it earlier this week. And the supply chain is nowhere near at the point it was in 2019. And that really is, as you just kind of referenced, there's no clear line of sight on when the supply chain would perform at that level again. It is largely stabilized. I'm very proud of how we have responded. The teams that are right in the middle of this have responded. implemented new systems, new tools, new approaches to be successful with the supply chain the way it is in its current state. And so I think we are being successful, and it isn't just that the supply chain is completely back to normal. It's how we've responded as a business. And, I mean, you can see that. Where we were hit the hardest was in defense electronics, and you can see that with the 12% to 14% growth, we're now projecting that segment this year. But just to put a little color on it, broadly, when we think statistically of what's going on in the supply chain, we look at a lot of different metrics across it. you know, in what's considered our long-league parks, which we consider anything over 40 weeks. There's pretty much stability in the lead times and some improvement on the on-time delivery of those parks. But, you know, there's still components that are out there at 52 weeks and some even greater of lead time. And, you know, nothing was that long. You know, 26 weeks would have been, you know, the longest we would have seen prior to the pandemic. So, you know, there's still that. And I will say that recently within the lead times of components that are less than that 40 weeks, some under 20, some in the 20 to 40 kind of category, we've seen some volatility in the lead times in those components and some of those going back up from how they had come down prior. So it's still a dynamic environment that the team is having to deal with. The areas where we see some of the lead times creeping back up is really around some of the older legacy processors and memory components, for example, that were brought to the market many, many years ago. That dynamic is true in our industrial businesses also, is where they have largely seen their lead times come back from the 52 weeks down to 10 to 14, but they still have some issues with, you know, where they have legacy parts. And, you know, part of our value proposition out of our defense electronics team is, you know, it's a combination of we bring state-of-the-art products to the market with the latest technologies, you know, across processors, GPUs, FPGAs, all the various, you know, ways you can do computing. But we also work with our customers to keep producing the same products that they build systems on, for many, many years, you know, 10 to 15, even up to 20 in some cases, years. And so we have a lot, you know, we're very dependent on some of those legacy processors and are working very hard to do that. So it's, you know, the team is managing it. I'm not foreshadowing any kind of, you know, change or problems going forward. I think we've got systems to manage it, but we're still dealing with a situation that isn't, you know, isn't the way it used to be.

Yeah, and I'll just comment really quickly on the margins there, Louie. I mean, I think as you look at, you know, 23.5 to 23.7 on the margins, I mean, we've been here before. You can back up and see it in 2020 and 2019. You know, a lot of what I said earlier on the call, you know, regarding our forward outlook in 24, it's really going to depend on where those investment, you know, opportunities are in defense electronics and, you But we will manage, as we have historically, the entire portfolio to continue to provide that incremental margin expansion.

That's good. Thanks for all the detail. Greatly appreciate it. And I guess one final one. It appears that IIJA infrastructure bill funding is hopefully set to increase next year. At least that's what some of the companies have been saying on their third quarter earnings calls. Can you remind investors, do you have any significant exposure on your industrial side and even a little on your federal side as it relates to the IIJA?

So we do, you know, not directly, we're not out building bridges and things, but we do have tentacles that a lot of that funding is a good tailwind from Curtis Wright. And whether that's, you know, we have a significant footprint across construction vehicles. And so as there is, you know, building of, you know, the various infrastructures that it's directly funding, that's driving, you know, increases in those areas that will come through to Curtis Wright with our content across those those types of customers. Inside of the bills, there are also, you know, investments for the civil nuclear fleet that is very much helping a lot of these plants, you know, go from their 60 to 80-year life extensions. And, you know, Chris talked about what we're seeing, you know, in our aftermarket sales, very, you know, very strong performance out of that team. And there's no doubt that, Some of that is clearly being driven by the money that's available in the infrastructure bill. And then broadly, there's support for various types of electric vehicles. We're not focused on automobiles or anything along those lines, but large trucks, buses, school buses, that type of equipment where there's funding for that is another place that we'll see the tailwinds from that. you know, we do, it is supportive of Curtis Wright's business broadly.

Great. Thanks, Lynn. Thanks, everyone. Thank you. Thank you.

There are no further questions in the queue. I will turn the floor over to Lynn Bamford, Chair and Chief Executive Officer, for any additional or closing remarks.

I'd just like to say thank you to all of you for joining us today, and we look forward to speaking with you again during our fourth quarter 2023 earnings call in 2024. So have a great day.

Thank you. This concludes today's Curtis Wright third quarter 2023 earnings conference call. Please disconnect your line at this time and have a wonderful day.