Woodward Inc (WWD) 2002 Q2 法說會逐字稿

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We were able to produce an increase in earnings despite adverse trends in most aircraft engine markets and the decreased sales. We believe in efforts to run a lean and productive business that helps us manage the challenge in this market.

New products development remains the major focus. We are pursuing our strategies of increasing content for engines, increasing market share, and remaining a supplier of choice for OEM customers. And these strategies are continuing to pay off.

As an example of our increasing content for engine, we recently went into production on the V2500 air modulating valve for engines on the Airbus A320 family. This adds to the fuel metering units and fuel nozzle products we already have on this very successful engine. In March, we announced the long-term agreement with GE aircraft engines, which secures our business with them under major aircraft engine programs, for the next seven years. An agreement estimated to have a value of about $350 million over its term.

While we had already been supplying most of these products, this long duration agreement provides stable revenue with the potential for some growth, and a planning horizon that facilitates efficient production schedules and . Overall, we have benefited from the diverse market reserve within aircraft engine systems. While civil aircraft sales have slowed, we have been able to partially offset that impact with our increased military sales and a demand for after-market services, which was stronger than we first anticipated.

We continued to capture market share across most of our aircraft segment, and will profit from the civil aircraft recovery, most of observers say is . We have already seen better than expected activity in commercial airline flight scheduling and after-market orders and are cautiously optimistic that this market may experience retreat sooner than first expected. Now, for some comments on the industrial controls, we are continuing to implement our growth strategies, both organically and through acquisitions.

We introduced over 30 products to-date in this fiscal year, and are on track to introduce a total of 70 new products, about half of those in turbines and half in the smaller diesel and natural gas engines. These new products allow us to increase the content for engines and, in many cases, provide our customers with a complete system solution rather than just individual components. We should see sales begin to ramp up on the product lines over the next 12 months, certainly, given the favorable feedback that we receive from our customers.

So we will continue to focus on new product development as an important source for achieving a long-term growth rate. During the quarter, we also announced the acquisition of two companies -- good examples of our strategy for growth. The first was , a company with whom we have had a very successful alliance over the past year. Adding new digital power generation and engine controls to our power management pro systems allows us to serve a wider range of power generation equipment, including simple, high value, cost-effective products for emergency or standby power equipment. During the quarter, we also acquired a small company, , and formed a joint venture with MotoTron, a subsidiary of Brunswick.

These latter two events allowed Woodward to accelerate its entry into the mobile industrial engine market as a supplier to engine manufacturers for lift trucks, aerial lift platforms, and other gas and diesel mobile engines. The market for these energy control products for gas and diesel mobile engines is about three hundred million.

Woodward has the technology and a total systems offering that allows us to continue effectively in these markets, where most of our competition cannot offer that full range of solutions. If we are hitting our strategic objectives, you might ask the logical question then, is why aren't we hitting the growth levels forecast for this year? The primary answer is that our plans were based on the belief that the power generation market would continue to be strong throughout 2002, declining in 2003, and then beginning to recover to a sustainable level over the next few years.

In the past few months, though, sales in large has turbines declined much more rapidly than we expected, which also had a negative impact on our product mix. We are addressing the reduced sales volume in large turbines for power generation by broadening our OEM customer base and increasing the contents for engine. This is a pretty powerful market force as an example in the midst of large sized industrial turbines.

We now have content that could range from half a million to about 1.2 million per turbine. And we believe that the fundamental global demand for power has not changed and the long term prospects for efficient, environmentally friendly power generation equipment remains robust. While we are doing strategically fairly well in the sizable distributed power, marine and oil and gas processing markets, the recent downturn in the economy has impacted our customers who ship these engine products, and as a result we are receiving fewer orders.

To improve market share, we continue to focus on new product development to increase engine content. As another example, a few years ago, on one smaller gas engine for power generation application, we provided only a . Today we provide the throttle body, the bypass and the weight belts including accelerators, gas metering valves and ignition systems on those same engines. An increase in content per engine for about $1,800 to about $10,000 per engine.

In this way we remain competitive, and as the economy improves we will reap the benefits of a larger market share. Finally, industrial controls has continued to implement six Sigma initiatives to increase productivity, and it's completing activities to consolidate overseas operations to eliminate redundancies in administrative and manufacturing operations.

The results of those efforts should become more apparent over the remainder of the year as the efficiency increases and because most costs associated with the consolidation were recognized in the first half of the year.

So to summarize for the quarter, in the first six months of this physical year, we remain on track with our strategic objectives. We are definitely increasing market share, introducing new products and providing innovative, cost effective, environmentally friendly system solutions for our customers. I believe Woodward has performed well in light of the unusual industry conditions in aircraft engines and power generation, together with this overall slower economic growth.

We reaffirm our previous guidance to get consolidated earnings of fiscal year 2002 -- are expected to approximate those of 2001 within a range of plus or minus five percent. However, as result of the economic downturn, having a lower significant impact on our customer's engine shipments than we had earlier anticipated, we expect that the earnings would more likely be in the lower part of that range. We strongly believe that we are doing the right things to achieve our long term goals and objectives.

Despite the current market, uncertainty and resulting growth interruption, the path that we are taking should assure we remain competitive and position ourselves very well for maximum opportunities as the economic growth returns.. Now, I'll turn it back over to Steve to give some more details about the financials -- Steve.

Thanks.

As I review this financial audit today, I'll first talk about our second quarter results, followed by the six month results and comments on some balance sheet items. Net sales for the second quarter fiscal 2002 were $174.9 million, up 2.8 percent from a $170.2 million in the second quarter a year ago. Net earnings were $13.6 million or $1.18 per share for the quarter compared to $13.4 million or $1.16 per share last year as adjusted to eliminate goodwill amortization.

The adjustment to eliminate goodwill related amortization increased last year second quarter earnings by $700,000 or six cents per share. Second quarter sales for industrial control grows 12 percent to $106.4 million. The sales growth was due to market share gains, new product introductions and sales of $6.8 million by acquired companies. Segment earnings were $12.4 million compared to $13.8 million as adjusted to eliminate goodwill amortization in last year's second quarter. This quarter, as in the first quarter, industrial control sales mix included significant revenues from alternative fuel systems for the transportation market very simply purchased and resold.

Margins on most products were less than those realized on a manufactured components and parts. We expect sales of these products to decline in the third quarter and to be at a much lower level by the end of the year. Earnings were also affected by our continued investment in new products development. Aircraft engine system sales was $68.4 million in second quarter, compared to $75 million in the second quarter fiscal year 2001, a decline of nine percent. We anticipated the decrease in year-over-year sales as a result of the industry-wide slowdown. And we expect the trend to continue over the remainder of the year.

However, segment earnings for aircraft engine systems increased slightly to $15.1 million compared to $14.8 million in the same quarter last year after adjusting for goodwill related amortization. Workforce realignment in first quarter continues improvement initiatives, cost containment measures, and a favorable sales product mix, preserved earnings despite the year-over-year reduction in sales.

Now let us look at the six month results. Net sales for the six months period ending March 31st were $355.5 million, up 11 percent from $320.9 million a year ago. Net earnings before the cumulative affect of an accounting change, the $27.3 million of $2.36 per share, compared to $25 million or $2.17 per share last year as adjusted to eliminate goodwill amortization, an increase of almost 10 percent.

The cumulative affect of the accounting change resulted in the one time after tax charge of $2.5 million or 22 cents per share in this year's first quarter. Year to date sales for industrial controls were up 19 percent to $212.2 million.

Segment earnings were $25.4 million compared to $26.7 million as adjusted to eliminate goodwill amortization. A decrease of almost five percent. The decrease in earnings was due primarily to reduced margins attributable to a change in our sales mix and investment and new products development. Aircraft engine system sales, year to date, were $143.4 million, a slight increase from a $142.7 million in the first six months last year.

Segment earnings increased 7.2 percent, $30 million compared to last year's $28 million as adjusted to eliminate goodwill amortization. Cost containment measures and workforce management initiatives implemented just after the events of September 11, favorable product sales mix, and continuous improvement initiatives contributed to the strength of the year to date earnings.

Total company cost to goods sold increased to 78 percent of sales , up from 75 percent a year ago. The increase was due to the marginal affect of new products with gradually increasing sales volumes, the purchase and resale of products at lower margins, expenses incurred in the first and second quarters for workforce management initiatives, and high engineering cost in both segments to support future growth to new product development.

We except cost of sales to remain at or near current levels as a percent of sales to the third quarter, and then to decrease slightly in the fourth quarter as product sales and exchanges. SG&A expenses decreased by $1.6 million or 4.8 percent this year compared to last year. As a percent of sales, SG&A expenses are 8.6 percent this year compared to 10 percent last year.

This improvement is primarily because SG&A expenses do not go directly with changes in the sales levels and also because of the cost containment and workforce management savings in the aircraft engine system segment. We expect SG&A expenses for the year to remain below the 10 percent level. Interest expense year to date was $2.7 million, compared to $4.5 million a year ago. The decrease is due to a lower average outstanding levels of debt and lower interest rates. Our level of debt did increase slightly at the end of the second quarter as a result of business acquisitions we closed in March. Depreciation and amortization for the six months was $15.7 million this year compared to $16.6 million a year ago. Without amortization of goodwill, last year's depreciation and amortization expense would have been $14.4 million.

This year's increase reflects additional depreciation expense for assets acquired last year and additional amortization expense for required intangible assets other than goodwill. Capital expenditures were $10.7 million in the first six months of this year. We currently expect capital expenditures for fiscal 2002 to be about $26 million compared to $27 million in fiscal 2001, and less than the expected depreciation expense of about $28 million.

The effective income tax rate this quarter was 35.5 percent compared to 38 percent the first quarter. We expect the rate for the rest of the year to remain at about the 38 percent level. In the second quarter, our rate was lower because we reversed certain evaluation allowances provided for the third tax . EBIDTA was about 60.4 million for the first six months of 2002 compared to 59.4 million a year ago. We computed this measure before the cumulative effect of the accounting change.

Now, I would like to make a few comments on the balance sheet. Comparisons are to the September 30 year end amounts. Accounts receivable decreased $13.3 million to $88.7 million as bulk aircraft engine systems industrial controls had experienced improved collections. Inventories were up $6.5 million to $138 million due in part to our acquisitions. Accounts payable and accrued expenses decreased $11.1 million, primarily because we made payments in the first quarter of fiscal 2002 for variable compensation and retirement plan expenses accrued at the end of fiscal 2001.

We reaffirm our previous guidance to consolidate earnings for fiscal 2002 are expected to proximate those of 2001 within a range of plus or minus five percent. However, as John previously mentioned, the economic downturn had a more significant impact on our customer shipments than we first anticipated. As a result, we expect the earnings will likely be in the lower part of that range.

For , earnings are measured before the cumulative effect of the accounting change and after adjustments to eliminate goodwill related amortization from last year's reported amounts. That completes our comments on the business and results for the seconds quarter and for the first six months. Operator, we are now ready to open the call to questions.

Thank you. The question-and-answer session will begin now. If you are using a speaker phone, please pick up the handset before pressing any number. Should you have a question, please press one followed by four on your push-button phone. Should you wish to withdraw your question, press one followed by three. Your question will be taken in the order it is received. Please stand by for your first question. Our first question comes from . Please state your affiliation followed by your question.

. Hi. Good morning, John and Steve.

Good Morning, Mark.

Good Morning, Mark.

keeler. Just some quick questions on the military aero side. Does Woodward -- do you have any content on some of the larger military programs that are starting to ramp up such as the F22 or joint strike fighter?

Yes, will have -- we will have probably content on those, but that's probably way over our horizon that we cannot really see very clearly.

OK.

Because we don't have content on those but I think we are talking several years before any kind of shipments on those ...

Surely. And, well, the F22 is just starting to ramp up now, so I was just wondering what you could see ahead of yourself. With industrial controls, you know, '03, mostly I guess the , they are turning down, getting a little softer sooner than we anticipated, but '03 was predicted to be a down year, but this really follows a couple of years of robust placements and I was wondering if you could give us any color about after-market services. I know you are having some kind of an agreement with GE on nozzle refurbishment. When do you expect that to really kick in, and could you give us some color on the growth rate there?

Well, it is hard to give you a precise number about the growth rate there, but we have begun an after-market initiative on the nozzles basically developing a nozzle repair facility as part of our Greenville operation. We think we have very efficient processes and that we can attack that market fairly successfully. So it's sort of, it's hard to give a precise number of what that the magnitude of that is, but it will be meaningful and that's -- there is a large group of turbines out there that have nozzles, and these were wearing parts, and we think that is going to be a nice incremental business for us.

Well, will the margins be higher on that business?

I would expect them to be, maybe a little bit higher, but not greatly higher.

OK, now most of that business comes through GE, I understand. Do you have any kind of contractual agreement with them, or is it just at their whimsy?

Well, if you want to up -- you want to state it that way, at their whimsy, I guess that's OK, but you know, we have to win the business, you know, we have to provide good value, good service, good quality, competitive pricing and -- but we are very confident that we can and we will do that. Now they, as with most of our customers, have initiatives to decrease their supplier bases and Woodward, I think, is very well positioned to be one of the remaining few significant suppliers there.

Well, are you going to be competing against any in-house operation at GE?

Not that we are aware of, for the overhaul.

Right.

I think they really that out to some smaller shops.

OK, good. Proceeding on to some of the acquisitions, the acquisition that you announced, I am reading the press release which says the market is about $300 million, is that the addressable market for that technology?

Yes, that's the market that we have a chance to get.

Right.

Because we have content and technology and solutions that we think that is appropriate for us.

Well, itself at $6.5 million of revenues.

Right.

I guess last year is relatively small.

Right.

So did -- what do you acquire in that acquisition?. Did they have some kind of proprietary technology or patents that are particularly important?

Probably not a patent. But they have a very -- they have a product that competes very well, in that it is basically type products for natural gas -- small natural gas engines. So we take that technology that Woodward didn't have and we couple that with the MotoTron electronic control unit, MotoTron is a subsidiary of Brunswick. They have a very cost effective, very powerful electric control. When we combine that with the other value that Woodward brings; our name, our reputation, other actuation products, and basically, that is what positions us to compete very, very well in this market.

So do you have any idea what is realizable at the first year or the second year as far as revenues?

I am really not going to predict, you know, specific numbers, although I guess I will say the growth there, I believe, will be meaningful and reasonably significant to us.

OK. One last question, and this is on acquisition, you know, I guess they had $13 million in sales last year, but that would not be incremental to Woodward because Woodward had already been selling some other products?

Well, some of it -- most of it will be incremental. We have been selling off their products throughout distribution, but basically, most of the sales that they had were non-Woodward sales. So, I do not have the figure in front of me, but I'd say most of that sales level would be incremental to what our 2001 numbers were.

So you have been selling a relatively small amount of ...

Yes. We had just begun to ramp up that, and so, we had a few sales there but, you know, it does take a few months to develop customers, and so forth, and the amount that we had -- Woodward had sold directly of that was fairly small.

OK. Great. That does it for me.

Uh-hmm.

Thank you. Our next question comes from . Please state your affiliation followed by your question.

Company. Good morning, guys.

Good morning, .

You guys have the cash impact with your acquisitions you made during the quarter?

We do not release that at this time, . Obviously, as we have sent out our 10-Q, that will be part of that information.

OK. What is negatively impacting the other line during the quarter? I was negative a few hundred thousand dollars, pretty high -- is it higher than I had been seeing for the past year or two?

Well, I guess it is very realistically that thing -- the other category can flow up and down.

Right.

During the year, and I do not know exactly what it is. I guess looking at it must be right at a few hundred thousand dollars that really will explore just to see what was causing that, but that does fluctuate up and down. I guess if you look at it on a year-to-date basis, it is, you know, $800,000 this year versus $500,000 last year. So, relatively stable between the two years. And this may be to answer your real question. We don't -- there is no trends or anything going on that would make that number either probably go up or go down from what our current experiences has been.

OK. And I just have to clarify, the guidance you put out, that is assuming of 38 percent tax rate in 3Q and 4Q?

Yes.

OK. I guess, going over to aerospace a little bit. I mean, the margins did exceed 20 percent and I think that is probably a record.

What -- how much, I guess -- what was the rate of the rate of the work force reductions on a year to year basis?

About 12 percent.

OK.

Well, it is not only work force management, it was, I mean, just all -- there is just -- there are several other dimensions to that. They are just some general belt tightening. OK. Only just don't some money -- some of that. But I think also very meaningful is our initiative to change our processes into more lean and using six Sigma. That's taking some, I think very meaningful systemic cost out of our operation.

You talked about the 20 percent year to year increase in military sales. Is there a way -- anyway, you can break that up between spares and OEM?

Let me characterize that it is probably more -- what we've seen is basically the government kind of replenishing, their stock of spare parts and refurbishing, some of the equipment that they had as far as, you know, that they knew Apache helicopters and in increase in that, I guess ...

Pretty small.

Pretty small. Right. So it is more of -- kind of provisioning and kind of getting their spare parts inventory up, it is enough.

Can you attribute it to a certain program or is it just wide -- wide based?

I'd say probably T700 which is -- that goes on the Apache and Blackhawk helicopters, probably some of the fighter refurbishment of some of those engines.

OK. I was just talking about the quarterly backlog trends at aerospace. Are you releasing those from -- let's say, at the end of December to the end of March?

No. You know, we -- I think we've talked a little bit about this before this. The backlog numbers aren't necessarily indicative of the what is going on because the short lead time. And so, really we do focus on backlogs on a annual basis, but don't get too intensive looking at them in the quarters.

Is your expectation for -- I guess, is a slow steady falloff in aerospace sales for the remainder of the year?

What we -- what we -- think we got a, what we think we probably had a greater than expected first half. We did have some -- we had a -- we did have a full pipeline, and so we had a pretty strong sales in the first quarter and sales didn't taper off too much in the second quarter, but probably the first half will be, have a greater sales volume than the second half for aircraft.

OK.

The one thing that has allowed to turn all that, too, is the fact that the to predict the return overall. We have to market part of that because those things are based on flying and like that so, that's a little bit hard to predict. (Inaudible) can change during the quarter and during those last six months.

OK. Just quickly moving over to industrial for a minute, I know you're attributing a lot of the margin erosion to product development and mix, what was the sequential increase in R&D at industrial because of the new products or if you have a year-over-year number that will be fine as well?

I am not sure I have the precise number , but I believe that the -- quarter over quarter, not sequential quarters, but year-over-year quarter, we got to be up probably 15 or 20 percent.

OK.

If not, probably more.

And we are not seeing any pricing erosion in the market at all?

No. Price erosion is a way of life in all of our businesses. And basically, you know, every customer is coming to us for price consideration and it's -- you know, that's just the way I think business is.

We've seen that for the last three or four years. And I don't expect that to change. However, we are implementing strategies that makes that a benefit for us. You know, we're trying to leverage on the consolidation by our customers or their supplier base.

So, we have been, I think, reasonably successful in trading off prices or volume as we increase our content and what we can supply to each of these engines. And I think we've come up with a pretty good way to give our customers some reduced prices and at the same time give ourselves more volume, and it all nets out to a positive situation for Woodward.

So, we've been able to meet those demands and still not really erode, I think, our margins, and I think the current margin erosion that we're seeing in this current periods is really, you know, we're really geared up, OK, for a higher level of business than what the general economy is, in essence, allowing us to achieve right now and -- we think that will turn.

: OK, thanks a lot guys.

OK, thanks.

Just a reminder, ladies and gentlemen, if you do have a question, you may press one followed by four now. Mr. Halbrook, there are no further questions at this time. I will now turn the conference back to you.

OK, thank you. Again, we would like to thank you for your interest and your participation, and we look forward to updating you next quarter, and I am quite sure we will have a report that says we are still on track. So, thank you very much.

Ladies and gentlemen, that does conclude our conference call for today. If you would like to listen to a rebroadcast of this conference call, it will be available at 10:30 AM central time by dialing 1-800-428-6051 or 1-973-709-2089 and by entering the passcode ID number of 238605. A re-broadcast will also be available at the company's web site at www.woodward.com for thirty days. We thank you for your participation in today's conference call and ask you that you please disconnect your line.

OK, thanks, .