Curtiss-Wright Corp (CW) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Curtiss-Wright fourth quarter 2016 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Jim Ryan, Senior Director of Investor Relations. You may begin, sir.

Thank you and good morning, everyone. Welcome to Curtiss-Wright's fourth quarter 2017 earnings conference call. Joining me on the call today are Dave Adams, our Chairman and Chief Executive Officer; and Glenn Tynan, our Vice President and Chief Financial Officer.

Our call today is being webcast and the press release, as well as a copy of today's financial presentation are available for download through the Investor Relations Section of our company website at www.curtisswright.com. A replay of this call also can be found on the website.

Please note, today's discussion will include certain projections and statements that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are not guarantees of future performance. We detail those risks and uncertainties associated with our forward looking statements in our public filings with the SEC.

In addition, certain non-GAAP measures will be discussed on the call today. The reconciliation is available in the earnings release and at the end of this presentation. Our discussions today of current and future results, except the cash flow, are on a continuing operations basis, which excludes all previously announced divestitures. In addition to any references to organic growth exclude the effects of foreign currency translation, acquisitions, and divestitures unless otherwise noted.

And finally, for the sake of a proper comparison when reviewing growth rates for 2016, we are comparing 2016 results to pro forma 2015 results which exclude the one time AP1000 fee of $20 million from both sales and operating income within our power segment and Curtiss-Wright overall. Now I'd like to turn the call over to Dave to get things started. Dave?

Thanks, Jim. Good morning everyone. For our agenda today, I'll begin with the key highlights for 2016 followed by Glenn, who will provide a more thorough review of our fourth quarter performance along with our initial 2017 guidance. Then I'll return to wrap up our prepared remarks before we move on to Q&A.

Overall, we're quite pleased with our full year 2016 results as our diversified portfolio businesses allowed us to mitigate headwinds in several of our commercial markets. We generated strong margin expansion in 2016, achieving an operating margin of 14.6% up 130 basis points when compared with pro forma 2015 results. We also delivered solid EPS growth of 12% year-over-year.

You're witnessing the tremendous benefits of our ongoing margin improvement initiatives driving Curtiss-Wright's profitability into the top quartile of our peer group well ahead of the five-year timeframe that we established at our 2013 investor day. I'm proud to say that we have accomplished this feat in only three years by effectively executing against our margin improvement plans.

In 2016, this included restructuring and facility consolidations as well as our enterprise-wide focus on lien and supply chain initiatives, all elements of our original long-term plan. While we are very proud of our team's ability to meet this goal on accelerated timetable, we do not intend to rest on our laurels. As we'll review in a few minutes, we expect to deliver another solid performance in 2017 with continued organic operating margin expansion.

We also generated very strong free cash flow of $376 million, one of the strongest performances in the Company's history led by efficient and effective working capital management. This led to nearly 200% free cash flow conversion. Glenn will provide a deeper dive into our performance in a few minutes.

Before handing it over to Glenn I wanted to cover a few of the exciting highlights since our last call. I'll begin with the AP1000 program and some updates on our reactor coolant pumps.

First, on the original China contract from 2007, we recently shipped the 16th and final RCP and have now completed that original production contract. Client construction continues in China as they draw closer to the startup of Sanmen 1, which is expected to be the first AP1000 reactor in operation in the world. We and the nuclear industry are eagerly awaiting this exciting milestone.

In addition, revenues on the 2015 China Direct Contract began to ramp up and will continue to accelerate through 2019 as we previously indicated. We expect to see strong revenue and margin contribution from this order over the next three years.

I want to reiterate that our pumps are being sold directly to the Chinese for insertion into the four new AP1000 plants that are being constructed in China. Over the long term, China has tremendous need for clean energy and increasing demand for nuclear power. It is the largest potential market in the world for the AP1000 reactor and continues to present Curtiss-Wright with the great opportunity to supply our RCPs.

Next, in the US, we have 12 remaining pumps to be shipped over the next few quarters, and we continue to make solid progress on this contract as it too nears completion. Note that revenue and margin recognition on this 2008 US contract will be essentially complete by the end of 2017.

In other news, we closed on the acquisition of Teletronics Technology Corporation, or TTC, in early January, and I welcome our new employees to Curtiss-Wright. While I intend to spend a few minutes on TTC later during our call, I wanted to emphasize that this acquisition is the ideal strategic and financial fit for Curtiss-Wright. We appreciate our investors patience as we searched for a suitable acquisition that met our criteria.

Now I'd like to turn the call over to Glenn to provide a more thorough review of our 2016 performance and 2017 financial outlook. Glenn?

Thank you Dave, and good morning, everyone. I will begin by spending a few minutes discussing the key drivers of our fourth quarter 2016 operating performance.

Starting with the commercial industrial segment, despite a 4% decline in sales, operating income was up 13% and operating margin was up 270 basis points to 17.4%. This performance was favorably impacted by improved profitability in our industrial vehicle products and the benefit from our restructuring and facility consolidations initiated in early 2016.

It is worth noting that industrial vehicle sales showed some signs of stabilization during the fourth quarter. Meanwhile, we continue to experience weaker sales in the oil and gas market, albeit less than the previous quarters.

Next, in the defense segment which concluded 2016 with strong fourth quarter profitability as operating income improved 10% and operating margin was up 110 basis points to 25.5%. Though our overall sales fell short of expectations, principally due to timing within the Naval defense market, we experienced continued higher growth in sales and profitability within our COTS and betting computing business as well as the benefit of our ongoing margin improvement initiatives.

In the power segment, after excluding the one time AP1000 fee in fourth quarter 2015 results and as shown on the right side of the slide, operating income improved 54% and operating margin was up 700 basis points to 20.5%. These results reflect a strong improvement in operating income and margin on the AP1000 program due to higher production volumes on the US and China direct contracts. We also generated higher profitability in our nuclear aftermarket business despite relatively flat sales due to the benefits of proactive restructuring and cost reduction initiatives.

Overall, we generated a strong improvement in operating income and operating margin when compared to pro forma 2015 results. As you can see on the lower right side of the chart, overall Curtiss-Wright operating income increased 20% which led to a strong 320 basis point improvement in operating margin to 18.8%.

Through our ongoing and companywide focus on working capital, we substantially reduced our working capital as a percent of sales, 440 basis points from 25.4% at the end of 2015 to 21% at the end of 2016. Our focus in 2016 was on reducing past-due receivables, extending vendor payment terms, deploying the supply chain financing options, and aligning our inventory management with our Lean program.

Those working capital improvements contributed heavily to a strong 38% boost to our free cash flow compared to the prior year. We concluded 2016 with a very strong free cash flow of $376 million and a free cash flow conversion of 199%, both well exceeding our expectations. This is a fantastic achievement for Curtiss-Wright and the highest level in recent history.

This performance was driven by the significant reduction in working capital including higher advanced payments related to the new China Direct AP1000 order, a $20 million one-time benefit from unwinding our spots, and lower tax payments. We achieved this performance despite an increase in capital expenditures principally related to plan facility consolidations. Additionally, although we ended the year with over $500 million in cash on the balance sheet, we quickly deployed about half of that balance to fund the acquisition of TTC in early January.

Turning to 2017, excluding TTC, our outlook is in line with the preliminary guidance provided at our investor day with expectations for flat sales, modest operating margin expansion, and a minimum base free cash flow in conversion. We have expectations for solid free cash flow in 2017 ranging from $260 million to $280 million with an expected conversion rate of 135%, 142%. Also in line with our long-term guidance provided during our recent investor day which includes maintaining an annual base free cash flow of at least $250 million and an average free cash flow conversion of at least 125%.

Following strong 2016 performance, we anticipate our free cash flow to be lower in 2017 principally due to lower advanced payments on the AP1000 program as expected, the non-recurring swap benefit and increased tax payments. In addition, our guidance for capital expenditures remains consistent with 2016 while depreciation and amortization are expected to increase $10 million to $20 million primarily due to the addition of TTC.

Moving on to our 2017 end market sales guidance, on an organic basis, we expect increased sales to our defense markets and essentially flat sales through our commercial markets. Total sales are expected to grow between 3% and 5% including the expected sales from TTC up $65 million. A reference to majority of TTC's sales are to the aerospace defense market with the remainder to the commercial aerospace market.

In the defense markets overall sales are expected to grow between 7% and 9%. We expect the benefit to -- we expect the continued benefit from the favorable trends in defense spending and an anticipated higher based defense budget, which is especially true in aerospace defense where we are expecting higher demand from embedded computing products on several key fighter jet and C-4 ISR programs including the of F35 and Global Hawk UAV. Sales in this market are expected to increase 28% to 30% including TTC.

In ground defense, we expect increase international sales of our current drive stabilization systems to be more than offset by reductions in several US ground defense programs. As a result, sales in this market are expected to decline 4% to 6%.

Naval defense sales are expected to climb between 3% and 5%, principally due to reduced year-over-year revenues on the Virginia Test Submarine Program due to timing of production. For reference, this affects both our commercial, industrial, and power segments.

Moving on to the commercial markets where overall sales are expected to be flat to up 2%. Commercial aerospace sales are projected to be flat as improved demand for sensors and controls products are expected to be offset by lower sales of actuation systems and surface treatment services.

In power generation, we expect sales to grow between 3% and 5%, driven by higher revenues on the China Direct AP1000 revenue and higher valve sales supporting international reactors. However, those gains are expected to be partially offset by reduced demand in the nuclear aftermarket business in what we believe to be the trough year in the cycle.

In the general industrial market, we expect sales to decline between 1% and 3%. Starting with industrial valves, although a few positive industry trends have emerged in recent months, the overall environment continues to be challenging, and we therefore remain conservative with our outlook. As a result, we expect industrial valve sales to decline slightly.

Moving to industrial vehicle sales are expected to be flat to up slightly principally for on-highway vehicles. And the remainder of our industrial businesses which tend to be more economically sensitive are expected to be flat. Finally, staring on slide 15 in the appendix of our presentation, you will find detailed breakdowns of our full year 2016 sales by end market as well as our 2017 end market sales with a full chart.

Continuing with our financial outlook for 2017, we expect full-year sales to range from approximately $2.17 billion to $2.2 billion up 3% to 5% including TTC. We expect TTC to be break even for operating income and EPS in 2017, and 50 basis points diluted to operating margin in the first year due to purchase accounting. As a result, total Curtiss-Wright operating income is expected to grow 3% to 5% while operating margin is expected to be flat to up 10 basis points to a range of 14.6% to 14.7%. However, organically, our margin will be more of 15%.

Continuing with our outlook by segment, in the commercial industrial segment, we expect sales to be flat to down 2%, primarily based on our outlook in the naval defense and commercial aerospace markets. However, the benefit of the restructuring and facility consolidation initiatives implemented in 2016, along with ongoing cost mitigating actions in 2017, are contributing to a slight improvement in operating margin to a range of 14.3% to 14.5% despite the lower sales.

Next to the defense segment where sales are expected to grow 2% to 4% organically or 16% to 18% including TTC lead by growth in the aerospace defense market. On an organic basis, increased sales and the realization of the benefits of our 2016 restructuring actions are projected to drive higher operating income in margins. However, we also anticipate increased investments in R&D in 2017 to support our high-tech and embedded computing products which will continue to drive organic growth. Overall, we are projecting segment operating income to grow 5% to 7%, but we expect a 190 to 210 basis point reduction in operating margin to a range of 19% to 19.2% after the 260 basis point margin dilution from TTC.

Next to the power segment where sales were expected to range from flat to up 2% primarily due to higher AP1000 revenues, partially offset by lower nuclear aftermarket and submarine revenues. We are projecting operating income with margins to essentially remain consistent with 2016, as increased profitability on the AP1000 program is partially offset by lower aftermarket and Naval defense sales, unfavorable overhead absorption, and increase investments in R&D. Therefore, our guidance for operating margin this segment is a range from 14.6% to 14.7%.

Continuing with our 2017 outlook, we expect pension expense in the effective tax rate to increase slightly compared to 2016, while interest is expected to remain relatively flat. In addition, we are forecasting $44.9 million in diluted shares essentially flat for 2016, which includes our expectations for $50 million in share repurchases to offset all dilutions from stock issuances in 2017.

Our guidance for diluted earnings per share is a range of $4.30 to $4.40 which represents EPS growth of 2% to 5% over 2016 results. Regarding TTC, as I noted earlier, we expect it to be break-even to operating income and EPS in year one. While it's not our practice to discuss the actual contribution, TTC otherwise would be accretive to 2017 Earnings per Share excluding the year one purchase accounting, which includes inventory step up and other short-term intangibles.

For 2018 and beyond, we expect TTC to be accretive to our overall profitability and EPS; and accordingly, we will include it as part of our 2018 guidance. For your EPS modeling purposes, please note that we expect approximately 35% of our full year of 2017 EPS to be in the first half of the year and 65% in the second half.

We expect first quarter earnings per share to be lower than last year and to range from approximately $0.50 to $0.60 primarily due to the purchase accounting costs related to TTC. We anticipate each quarter increasing sequentially in the fourth quarter being our strongest as we have done historically.

Now I'd like to turn the call back over to Dave to conclude our prepared remarks. Dave?

Thanks, Glenn. I'd like to continue with the discussion on the rationale and benefits of our recent acquisition of TTC. As discussed last year and illustrated in the presentation, we believe that we earned the right to acquire them based on our solid operation performance since 2013.

TTC fits the new Curtiss-Wright business model, both strategically and financially. We seek companies comprising high intellectual-property content with strong, competitive positions. TTC is a leading designer and manufacturer of high technology, comprehensive data acquisition and flight test instrumentation systems.

When combined with Curtiss-Wright's existing operations with similar expertise, it firmly establishes our position as a leading global supplier of these technologies in the aerospace and defense markets. The acquisition significantly increases our scale and diversifies our product portfolio, customer mix, and geographic presence in this niche segment.

Further, beyond year one, we expect this transaction to support our long-term financial objectives of margin expansion, strong free cash flow, and solid return on invested capital. I look forward to this business contributing to our future growth.

Looking ahead, we remain committed to growing the top line, both organically and through acquisitions to further enhance shareholder value. We will continue to review all acquisition opportunities with stringent scrutiny and financial discipline seeking deals that will contribute to our long-term profitability expectations.

In summary, we are well-positioned to deliver solid results in 2017, led by strong defense and AP1000 revenues. While we will continue to experience some headwinds in our industrial businesses, we are hopeful that those industries will turn the corner heading into 2018.

We expect our overall operating margin to be up slightly in 2017 despite the purchase accounting from the TTC acquisition. On our organic basis, we expect another 50 to 60 basis points in margin expansion driven by our team's ongoing solid execution. We also expect solid free cash flow generation this year with a free cash flow conversion rate north of 135%.

We remain committed to deploying a capital allocation strategy where our goal is to maintain a fair balance between operational investments including R&D, returns to shareholders, and strategic acquisitions. Overall, we look forward to continuing to deliver on our long-term strategy and driving solid value for our stockholders.

At this time I would like to open up today's conference call for questions.

(Operator Instructions)

We will be taking our first question from Michael Ciarmoli from SunTrust.

Good morning, guys. Thanks for taking my question; great free cash flow there.

Dave, definitely appreciate the color on the margin expansion excluding the impact of purchase accounting. How should we think about the trajectory of margins going forward? You haven't updated the long-term model from that original goal. Can you maybe give us a sense of what you think -- what levers you think you have left to pull?

And I know this year's pressured; but as we look into 2018, maybe you start to get back that nuclear aftermarket back, maybe the Navy revenues start to accelerate. How should we think about margins going forward, considering you're already above that target and above 15% this year?

Good question, Mike. We have been asked that. It was interesting that -- it was fantastic that we were able to achieve in three years what we set forth to do in five years. I think that if you listened carefully over the last three years and watched the actions, it has been underpromise and overdeliver.

We continued that culture in this Corporation, as well as, in line with that, the continuous improvement culture that we have as a Corporation. Every single one of our Vice Presidents have their plans in terms of expanding their margins, and gaining more foothold on what we have already achieved. We are not going to give up where we are at today.

What I have indicated in more recent calls over the last year has been that we've got to the top quartile that we aimed for. We are not stopping there. Our top quartile amongst our peer group is going to shift a little bit. It looks like this year we are going to be even higher than what we thought from the perspective of peer group comparison. I'm talking about 2016. So we are feeling fantastic over that.

In terms of going forward, our focus continues to be continuous improvement. It is about growth, and TTC is a great example of how we are going to grow the Business. We do see some organic opportunity, as you mentioned, the aftermarket nuclear back in 2018. So we are thinking that this will be basically the trough of that, from all indications, and we will start pulling back up out in that market toward the end of the year. The Navy, nuclear Navy, and so forth looks pretty strong for us, although it's all about timing.

So everything we're hearing about from the press from the Administration is very strong support in that regard. So we're real optimistic in that. That's great margin for us. AP1000 -- we've talked about that, with the margins that we expect there.

Generally, I think we are very well poised for any uptick in the general industrial. We are seeing a little glimmer of hope in the last quarter, fourth quarter of 2016, with some improvement on the valve side, a couple of orders that have come in that were a nice size for us. And that, along with some of our peers in that market segment have indicated that they are feeling pretty good as well. So those bring tremendous margins with them.

In terms of valves in general, like I said before, an acquisition target, candidates are inclusive of the valve industry as well. It's for that very reason that they are margin contributors. We are looking positively toward this year, and like I said, in many of the markets coming out in 2018. But we get any bump from general industrial, we are going to fare very well.

Got it. That's helpful. Just one more, and I will get out of the way here. Navy revenues, down in the quarter on timing, not as strong next year. It seems like, from all of the Washington, DC, rhetoric, Navy could be a big winner. What are you guys seeing out there?

What are the implications if the fleet goal goes to 355 or we get one or two extra subs per year? Just a little surprising that the timing is impacting both the current quarter and all of next year as well. When do you guys seeing that benefit?

What you're seeing right now, it's mainly in the subs there. The aircraft carrier is kind of flat, but in the subs right now we're right in the void between block IV and block V on the Virginia Class. Block IV has kind of dwindled down, and block V hasn't really started to ramp up yet. We're in that little cycle right now. And aircraft carriers are flat because CVNA hasn't kicked in yet either, which is also on the horizon.

So I think after we get through this year, it could be -- it could start early, later this year. We definitely don't have those orders yet. That's really what's happening in our naval defense right now.

Got it. All right. That's helpful. Thanks, guys.

Thanks Mike.

Our next question comes from Ryan Cassil, Seaport Global.

Good morning.

Good morning, Ryan.

I'm on the road here, so I apologize for the background. Could you talk a little bit about what you're hearing from the customer in China on the AP1000, whether the news out of Westinghouse has any impact on the orders that you already have with China? I know they are building their own, but could you just give us some color there?

And perhaps, could you just to talk about maybe where China is with being in the fuel holding stage on the original order and what that means in terms of the success -- potential successes and failures with getting that facility up and running at this point?

Great question, Ryan. I appreciate that. We've all seen the news recently over the last couple weeks that's coming out of Japan, and several news articles on the AP1000 and Westinghouse in specific. It's been certainly interesting times watching what's happening there. I can tell you that the way you phrased the question, you're familiar certainly with our contract. Our most recent contract, December 2015, was with China Direct.

We are shipping and selling directly to the Chinese, and we will continue to do so through -- that program has revenues through 2020. And although they taper off in the year 2020, but the heaviest now through 2019. And our expectation continues to be that is the most robust market in the world for the AP1000 nuclear power plant.

We don't see any -- from this perspective and at this point, we don't see any tie-in whatsoever from a negative perspective with regard to what's going on with the Japanese side of the issues facing Westinghouse and Toshiba. They are separate, and mostly, from what we can tell, tied to those plants that Westinghouse is constructing, and that's the Vogtle and Summer facilities in the United States. Those are continuing to operate as planned.

In terms of their outlook, we will complete our deliveries this year for AP1000 domestic RCPs, and Westinghouse continues to pay on time. We've not seen anything there. So there's no interruption from that perspective. Our future, as we've talked about with regard to green energy or clean energy and the biggest need in the world, has been and looks to be for the long term Asia/China predominately, and so we look forward to that.

In terms of the fueling up, they are on schedule from what we've been told to fuel up and hopefully start up in July. That's what news is coming out of China. So, Sanmen 1 looks to come online at that time. They've gone through hot functional testing, which is the key indicator for any anomalies that might come up, which nothing that we know of has. There doesn't appear to be any sort of interruption in that specific area. So we're looking forward to that.

I do believe once that occurs, once we get the news that they had a successful power-up and things are looking great, then I think that positive news is going to reverberate through China and with the other energy suppliers who are anxious to move ahead. There is significant interest in moving ahead, continuation of that nuclear energy, and specifically the AP1000. In that, to us, it all looks great. It still looks fantastic.

I've read also that -- and again, I'm just quoting from what I've read. You all have probably read the same thing. The Moorside project in Great Britain, from what came out of Japan most recently, in the last couple of days, was that -- from Toshiba that continues to be something that Toshiba and Westinghouse will support, along, of course, with the two domestic US plants. We are looking to that as being a possibility that continues.

And then India, we've talked about that a few times. What I said before and I will continue to say, and this really follows and tracks well with my conservative stance and our corporate conservative stance, and that is, the India plant was never in our strategic plan. What I indicated last time on the call was that the President and the Administration from India got together last June, and they put a line in the sand of having something accomplished by this June relative to the liability that they would -- the indemnification that they would allow. I don't know what's going on with that.

I would think that at this point, at least from what I've read, if someone comes in there with an opportunity to construct Indian power plants that, from what I've seen, Toshiba is interested in maintaining the design and maintenance side of AP1000 nuclear power plant designs. That still holds a positive for us. It was never in our strategic plan. We wouldn't count those chickens before the eggs were hatched anyway.

I said that, look, if it happens -- I think on the last call. If it happens, fantastic. If it doesn't, okay. We are still very well poised with the Chinese and the world's largest market.

So, a long-winded way of me expressing what I've read in the papers and our very positive outlook in terms of what we've got. Our facility in Pittsburgh is producing extremely well. They're producing our RCPs; they're delivering them. We are very pleased with the results.

As a matter of fact, a couple of our team members are going into China tomorrow, as a matter of fact. One of their planned trips, and just going to visit some of the sites and see how things are going. Just get a closer first-hand look to make sure that our folks that are in China that are providing us with all this information are accurate. We believe it will be a very positive trip.

Overall, looking good for us. Nothing's changed from that perspective. We never counted on the US market as being a huge growth market for OEM nuclear power plants. It's always been China One and other small (inaudible).

Okay, great. Appreciate all the color there, especially on India. I guess just to paraphrase it from my understanding, it seems like perhaps there is more scrutiny or pressure now for that Chinese facility to get up and running successfully, and that validates the design of the AP1000. But on the bright side, everything seems to be going to plan there, and you are not hearing any indications or hesitations from the Chinese customer based on what they are hearing from Westinghouse today. Is that fair?

Absolutely. We have not heard word one in that regard. Then, they are doing their own construction, and I am sure they have got some consultation and so forth tied into that. But, no, they're full steam ahead in that regard.

And as we said before, the need is absolute. There is no question about the need. It is not a competing deal with natural gas or diesel or coal. This is clean energy, which is in dire need in China.

It's absolutely very positive, everything that we have coming out of China. So, no problems at all that we've seen.

Okay. Just on the US plants, do you guys bear any liability at this point, or is it just shipping those last units? Just want to clarify that.

We have nothing to do with construction. Ours is simply to deliver the RCPs, and we purposely -- a while back a couple years ago, we sat down with WEC and the Chinese and figured out, all right, here's the best approach to deliver to the Chinese and then the domestic, finish those off on our old contract, and then resume with the new ones. So it's just now all about us wrapping up, putting a nice little ribbon around those RCPs and shipping them off to domestic. Those are on track, on schedule.

We visited the facility last November. If you were out there today, you would see the plant full of the same activity you saw back then, and in this case, directed to some of the builds for the domestic. As a matter of fact, I think we have four that are ready to go here pretty soon to domestic. Yes, no problem.

And like I said, good news, we're getting paid for it, so, no delay in that regard. We've gotten assurances that there won't be. So we feel very comfortable with where we're at in that space.

Great, look forward to seeing you guys soon. I'll pass it on. Thanks.

Thanks, Ryan.

Thanks, Ryan.

Thank you. Our next question comes from George Godfrey, CL King.

Thank you. Good morning, gentlemen.

Good morning.

I wanted to ask about the margin expansion as we go into the outer years. Dave, I heard you loud and clear that the organic margin would be up about 50 basis points this year. If we assume the top line expands organically in 2018 and 2019 as we look on, is it your thought that you put that incremental margin back into the Business in investment, or do we see continued margin expansion as we go to outer years beyond the 15%?

I think, for the most part, let's just say steady state where we are today. This is not foreseeing any change in our acquisition strategy, meaning that let's say nothing comes up that's a huge margin accretion for us. I do believe that it will be an incremental margin expansion sort of outlook for us, given that once we have some top-line growth and once we can integrate something like this TTC business into our system, we're going to continually see some expansion.

We will spend more R&D money, like we started talking about last year. We are spending more this year. That is for the pure purpose obviously of growing the organic side. It really sticks to the ribs, if you will, once you do start gaining traction with organic order wins and so forth. We're going to maintain.

Here's the watch word of the day: We are going to maintain our top quartile amongst our peer group, and we're not going to relent from that. That's important for us because it's a metric that we strove for back in -- three years ago. We had to get there to show that we could do something with the acquisitions that we could acquire, turn them into a Curtiss-Wright type company.

And in the case of TTC, we are just very happy that we acquired that. I think it's going to be a fantastic one. I'm looking forward to others that mirror the sort of approach we took on that. That is an extremely diligent outlook in terms of what they bring to the table with proprietary products and so forth, that bring the higher margins than you would otherwise.

It's that kind of a strategy going forward. We're going to spend money in the right places to develop the growth side, but with a watchful eye on not relenting from that top-quartile status.

And I'll toss in something I left out with my response to Mike. That was, some of the tried-and-true measures of continuous improvement that are baked into our culture are the shared services. We are well on our way with that. We've talked -- we've beat that horse dead. It's really working well for us. We've got more room to grow there.

We have -- the consolidation that we started last year was a $12 million deal. It's going to generate $12 million in savings for us. That last half of last year we began; this year we pick up the other half, and then we start having run rate of that.

We have other consolidation opportunities that we look at that are smaller, but they continue. And that's just -- combine that with the lean supply chain initiatives and other margin improvement initiatives that we have, and you'd be surprised to see the different margin improvement initiatives that are under way, reverse auctions and -- like I said, the supply chain side there, they pay a little bit here, a little bit there. It all adds up to 50 basis points, 25 basis points, whatever, that gets in the big numbers for us. That's not going to stop.

So looking forward, 2018 turns around in some of our markets, it really picks up for us. We're feeling really nice. 2017 is going to be flat with some of the things that Glenn talked about, but some other nice opportunities that are lurking out there, including our most recent acquisition.

That all sounds really good. As you said, you feel you have earned the right to open up the opportunity on acquisitions, and I realize TTC just closed. Given the impressive free cash flow generation this year that just completed, and now looking ahead over the next two years, you intend to remain pretty steady on due diligence on doing more acquisitions as we move forward?

Yes, absolutely. We'll remain very diligent. This is a process that -- we were a serial acquirer, we lovingly refer to ourselves, in years past, and it took that to get us to a critical mass here. And that's fine; we got there.

Then we changed course. Three years, we focused on something that was extraordinarily important to us. And then we said in a, if you want to call it self-deprecating mode three years ago, look, we know where we've been, we know where we come from, and we know where we're going to go. Once we get there, then we're going to change a little bit of course. And that course is not going to be in giving up in the metrics that we just fought very hard to achieve. It's going to be in a focus on the growth side and coming in with opportunities that pay very handsome dividends for our shareholders.

So, yes, we're there. You saw TTC out of the gate. You're going to see more of that kind of stuff coming on board. We've got some that we continue to look at. They take a long time to happen sometimes. We look at a lot. And so, pipeline from that perspective is pretty decent for us. It's a much more of a high-quality pipeline than what we have seen in years past.

Understood. Thank you very much for taking my questions.

Thanks, George.

Our next question comes from the line of Myles Walton from Deutsche Bank.

Good morning. This is actually Lou Raffetto on for Myles.

Hi, Lou, good morning.

Thanks for the quarterly sequential increase. I guess I'm trying to figure out, is it volume based, is it mix based? I get the TTC impact. Just trying to figure out if we should expect such a ramp in margins throughout the year, specifically in commercial, and if power is more level now? Is this the new area with the new contract becoming more prominent and the old ones going out the door?

In our guidance, by walking through the OI, if you take out TTC from our sales, the remaining sales are going up about $11 million, and our OI is going up [$16 million]. There's our margin improvement for overall. Some of it comes from sales volume and absorption. Some of it comes from our margin improvement initiatives that Dave mentioned, mostly supply chain management. We have $6 million of net restructuring, which is the second half of the actions we took last year.

Then we have some benefit of mix. Mix is the China Direct contract and our [Cox] products.

But what is offsetting and somewhat offsetting that is we also are increasing our investment this year about $7 million. $5 million of it's in R&D, $2 million of it's in IT security.

When you add all that up, it kind of gets you, but you're seeing the benefit of our restructuring. In facility consolidation, you've seen our other operating margin initiatives flowing through as well. I can go by segment as well, but that -- .

I mean sequentially throughout the year. In commercial, you went from 11% in the first quarter to 17%. Sort of same idea in power. You went from 12% to 20% in the fourth quarter. So I just -- should we expect that same ramp on the margin front?

Yes, I'm sorry. As we have done in the past, this year, each quarter is going to improve sequentially. From a margin standpoint, first quarter this year -- and the fourth quarter being the highest, and the first quarter being the lowest. This year, it's a little bit lower than usual, mainly because of TTC and their purchase accounting. Their major purchase accounting costs occur in the first two quarters. Yes, you should expect, as in prior years, sequential margin improvement, absolutely.

All right. And then just a follow-up: Thinking ahead a little bit, you've got the China 2000 contract behind you. You said you're winding down on the US contract. Looking to 2018 here, is the ramp on the new China contract enough to offset the other two being away?

Are you talking about 2018?

Yes. Again, not specific, but just thinking, broadly speaking, if you get the turn in aftermarket as well, is 2018 still looking like a pretty decent year on the newbuild side and potentially the aftermarket side?

Absolutely. We did say we do think this is the trough year for the aftermarket business, I think at our investor day. Our guy, Jim Leachman, got up and said pretty much the same thing, that it could start picking up the second half of this year. And then next year, it will be all China Direct. And if the aftermarket comes back, it's going to be a good year for power.

Great. Thank you, guys.

Thanks, Lou.

Our next question comes from the line of Kristine Liwag, Bank of America Merrill Lynch.

Hey, guys. I just want to follow up on the AP1000 questions. So from my understanding, Sanmen 1 and 2 in Shandong, 1 and 2 were built by Toshiba. I know that the $450 million contract you have with China is now going to be built with Harbin Electric and Shenyang Blower Works. So from my understanding, this is the first time that Harbin and Shenyang are building the AP1000. Can you provide some color on maybe contract milestones that you have, and if you have any downside protection if there are program delays for these new power plants?

What we've got so far is just the milestones. I won't get into very specific ones, other than to meet our shipment delivery dates, and also as we talked about -- I can't remember which call it was, but a few back, that we have -- instead of contracts for delivering early -- and as I indicated back then, we are making every attempt to deliver as early as we can.

At this point, it appears to be no holding back from anything having been received in China. So we're not seeing any of that. As a matter of fact, when we talk internally about, look, what if there was a holdup domestically, could we then ship some of those domestic RCPs over to China in advance? And our answer internally was absolutely. They are the same RCPs.

But there appears to be no holdup domestically either. From the standpoint that Westinghouse having the difficulties that they are, the customer still wants our RCPs as we've scheduled; and in China, same thing. So we don't see any interruption, and from a downside, it's nothing that we have seen would cause us to start building in a downside sort of plan of action.

It sounds like your RCP contracts will proceed until delivery into the 2020s, independent of what happens to the Chinese construction companies. Is that fair?

Yes. It's almost like -- pretty much like it is with domestic. We're continuing to proceed regardless of what's going on with the units that are already in place in the domestic sites.

Okay. And then for the India contract, do you have any indication so far of how the Trump Administration is viewing that, and whether or not that June 2017 deadline is still in discussion?

I can only speculate, Kristine, to tell you the truth. The situation as we've seen it with the news coming out of Toshiba, my speculation is based upon what I've read, and that is that the Chairman most recently said a couple days ago that they would be very interested in pursuit of the India and continuation of the project, if they could find someone to build the power plant.

Because they make all their money, basically the majority of it, on the maintenance side, and then, of course, on the design. They put in billions to get it there. So they're not going to -- at least we don't think they're just going to forget about the design they took all these years and time to get to.

So, they would be -- I'm speculating, again -- they would be looking for someone to come from the outside to construct it. It certainly won't be Westinghouse.

From the Administration perspective, I have not heard word one coming out of the Administration with regard to that. From my perspective, it's a matter of selling US products overseas into a market that is rather large. And do they need it? Yes. Would it be great for America? Yes. It also answers all the right questions.

Regarding a relationship, I couldn't give you even a clue as to that. I don't know what that is. I will say, from my point of view, it remains what we said before, and that was, India would be fantastic to realize. At this point, I've never looked at those chickens as being -- they hatched out of the eggs because I don't know that will occur.

I don't know if it will ever occur; on the other hand, I don't know if it won't occur. It would be fantastic for us, and we're the only ones building AP1000 RCPs. The Indians really want the nuclear power plants. So they've got a site located for it.

Money, I think, has been discussed with some people that would fund it. Everything from that perspective would be positive. It's the construction side, and then realistically, how long does it take any Administration, be it the Indian side or our side, to complete their discussions of indemnification.

Great. Maybe one last question from me, but from a different topic. So, surface treatment continued to weigh down your commercial industrial sales. At this point, can you quantify the size of this business today, and if there are any more downside risks that you're seeing for 2017?

We don't normally go down to the business unit level, Kristine. They are not down tremendously. They are down a little bit this year, going into 2017, a little bit in 2016, but it's not large. It's a bunch of different things. It's a little bit of auto, it's a little bit of commercial aerospace, it's a little bit of everything.

There's nothing major there, but they are the economically driven companies. They move with that, GDP and things. And small swings probably would mean more to them and we talk to them about because it may be large to them. But it's really not large.

I will add to that, from a color perspective, Glenn hit the nail on the head with this business. It's a great business when the market is robust. It's a great business when it's flat. It makes good margin. It contributes to our overall margin picture and drive.

It is GDP-oriented. So if you have any growth in GDP anywhere in the world, it's going to be reflected in this division or in this segment of ours because we're located around the world in basically every country you can imagine. We touch the very beginnings of any industrial project or any automotive project. So if there is any nudge from any industrial market, military market or power side, or just anything in general GDP-wise, you're going to see this thing popping up. The beauty about it was, if you recall, if you tracked us five, 10 years ago, that we used to track the -- when all ships float, this ship is much more buoyant than any other that you have seen.

The dollar ratio of revenue to income and profitability isn't to scale. It's a much higher scale. It's a real lean operation. And when it does pick up, it picks up great.

So if anybody's anticipating pickup in 2018 or second half of this year or whatever, then we usually see it here first. And I've looked to that to be, like I've talked in years past, my weathervane in terms of where the globe is headed. I can do so regionally.

Great. That was very helpful. Thank you.

Thanks.

Our next question comes from the line of Sam Pearlstein from Wells Fargo.

Good morning.

Hi, Sam.

Glenn, can you talk a little bit about foreign exchange? I see in the fourth quarter it was a drag on the revenues, but helped on the profits. How should we think about the 2017 guidance and what you're thinking from a foreign-exchange perspective?

So, we did, as we typically do around January, we will set our rates. And I would say for 2016, we reduced the pound about 4%, the euro by about 2%, and increased the CAD to represent what's about current. If you look at what that means, if you go to 2017, it was probably about a $4 million headwind to sales compared to 2016, and a $3 million tailwind to operating income compared to 2016. That's what we had built into our guidance.

So if I were to take out the acquisition and put it on a constant currency, what does your 2017 guidance imply for organic sales?

About 1%.

Okay.

We said about flat at investor day. It's a little bit higher.

Okay. And then, was there any stabilization in terms of the industrial valves market in the quarter or any change -- ?

There was. Actually, in the valves, both from an order standpoint and a sales standpoint, has -- how do I put this -- got increasingly less worse compared to the prior year. They're still down, but each quarter has gotten better, and we are seeing somewhat of that, down 5% overall this year. But they were down 30% last year. That's moving in the right direction.

It's really especially good to see some order stabilization. We said in our prepared remarks we're going to stay pretty conservative with that because we just want to make sure it happens. So our outlook is we've been fairly conservative.

On the industrial vehicle side, it's very similar. We were down 5% overall last year. We're going to be flat to up a little bit this year. So we're seeing some signs of movement in the right direction, I guess.

Okay. Last question is just, thinking about the free cash in 2017 and how you prioritize acquisitions versus return of cash to shareholders. Obviously you just did an acquisition in the fourth quarter here; but just thinking about, right now your buy-back plan in terms of the authorization seems like it was going to be much smaller than what your free cash is. So should we presume the extra is going to be there for an acquisition? How should we think about that?

Again, going back to our balanced capital allocation, which is still our strategy, we're starting out with [50%]. We have CapEx somewhere around [50%]. You've got buyback right now about [50%].

We are still looking at acquisitions. Like we said in the last couple years, if we get later on in the year and they don't materialize, we would consider reallocating to shareholder distribution. But we're starting out a little cautiously this year because our pipeline is pretty good. We want to see what happens.

We still want to deploy a capital -- a balanced capital allocation. That is kind of where we are at right now.

Okay. Thank you.

Thanks, Sam.

Will be taking our final question today from the line of Jim Foung from Gabelli & Company.

Hi, good morning. Just sorry to revisit the nuclear -- China nuclear again -- but I just wanted to get some clarity. In your investor day, you presented a slide that showed your revenue projection for the AP1000 from the 2015 order, and it looked like this year you're going to book about $70 million of revenues. Is that still pretty much the plan? And that goes up to maybe, in 2018, like maybe $130 million of sales. That's just my estimate based on this graph here. I just want to get a sense, is that pretty much still in tact of your intent this year and next year?

It is. It may fluctuate somewhat, but that graph is still pretty much on target.

Okay. So your guidance for the power segment being roughly flat in 2017, that really all comes from the nuclear aftermarket, right, that being down then, right?

And the Summer, both. Overall, you take the AP1000, it's offset by -- partially offset by those two.

Right. Okay. I think you mentioned several times, I just want to be clear. Regarding the domestic power plant, Toshiba saying that gets pushed out to maybe 2020 in terms of final construction. That doesn't impact your shipments this year, right, to the [scanner] projects; and you've currently got the cash from that, correct?

We do, and it does not impact. We will be done with revenue and margin -- that contract for accounting will be done for us this year, regardless (inaudible) those plans go flat.

All right. Good. I just wanted to get clear on that. I think you have lots of potential here in the nuclear business. That's very promising. Good luck with India going forward.

Thanks a lot, Jim.

Ladies and gentlemen, this now concludes our question-and-answer session for the day. I would like to turn the call back over to Dave Adams, Chairman and Chief Executive Officer, for closing comments.

Thanks, Andrew. Thank you all for joining us today. We look forward to speaking with you again during our first-quarter 2017 earnings call. Have a great day.

Ladies and gentlemen, I would like to take the chance to thank everyone again for their participation in today's conference. This now concludes the program. You may now disconnect at this time. Everyone, have a great day.