Woodward Inc (WWD) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company, fiscal year 2003, second quarter earnings conference call. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are in a listen-only mode. Following the presentations, you’ll be invited to participate in a question and answer session. Your speakers today are Mr. John Halbrook, Chairman and Chief Executive Officer, and Mr. Steve Carter, Executive Vice President, Chief Financial Officer and Treasurer of Woodward Governor Company. I would now like to turn the conference over to Mr. Steve Carter. Please go ahead, sir.

Thank you, operator. We’d like to welcome all of you to Woodward’s second quarter, fiscal year 2003 conference call. I’m Steve Carter, Woodward’s Chief Financial Officer. With me today at our corporate headquarters in Rockford, is John Halbrook, Woodward’s Chairman and CEO and joining us from our Colorado location, is Tom Gendron, our President and Chief Operating Officer. Most of you have probably seen a copy of the earnings announcement we released at 5:30 PM yesterday, or you may have received a copy by email or fax. For those who have not seen a copy, you can find one on our website, at www.woodward.com. An audio replay of this call will be available through Thursday, April 24th. The phone number was on the press release announcing this call and will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our website for 30 days.

Before we begin, I’d like to provide our cautionary statement. In the course of this call, when we present information and answer questions, any statements we make other than actual results or business facts, may contain forward-looking statements. Such statements involve risks and uncertainties and may cause actual results to differ materially from those we currently anticipate. Factors that may cause a material difference include, but are not limited to economic conditions that would impact sales in both the industrial and aircraft markets, the ability of the company to successfully implement cost control measures, and to maintain and add to its customer base. We caution investors not to place undue reliance on these forward-looking statements as predictive of future results. In addition, the company disclaims any obligation to update the forward-looking statements made herein. For more information about the risks and uncertainties facing Woodward, we encourage you to consult the press release and our public filings with the Securities and Exchange Commission. Now I will turn the call over to John to discuss our second quarter results and progress toward strategic goals throughout 2003.

Thank you, Steve. We are midway through a challenging year. I’d like to first explain our strategy for navigating current conditions in the industrial and aerospace markets, then recap some of our achievements in the first half of the year, then outline what we plan to work toward in the second half. Steve, Tom and I, will be available for your questions following the call. I’ll address our business segments and consolidated performance for the quarter and first half, then outline the expectations for the remainder of the year on a segment and consolidated basis.

Let’s begin by looking at the industrial controls business first. With the first half of the year, sales are down 24 percent, due largely to declines in the large turbine power generation market, as well as most other smaller sized industrial markets. The earnings reflected a disproportionate decline, because of the reverse leverage effect of these lower sales numbers. Despite lowered forecasts, based on our customer input, sales and power generation in our other industrial markets did not meet our expectations. We remained the number one or two provider in most of our industrial markets, but the reduction in orders reflected the state of the markets we serve. In response we are accelerating and expanding actions to reduce costs and improve productivity in our industrial businesses. While we are taking steps to reduce costs, we remain committed to our long-term strategy of serving OEMs, investing in their new product programs, and increasing our market share.

The markets we serve are currently under pressure. But just as our customers are investing in the future of these markets, we too believe that these businesses are attractive and will recover. Using a product life cycle approach, we continue to invest with our world-class customers, in promising products to help them meet their objectives for emission controls, greater efficiency and next generation energy control systems. By working with customers in the creative stages of next generation products, we can be a driving force in helping them achieve their goals and we will be embedded in their product base as the economy recovers and orders increase. We anticipate that the return on these investments will be significant.

Another means of capturing market share is the development of our global base. This worldwide presence enables us to efficiently and effectively respond to the needs of our international customers. Our international capabilities are increasingly important, as more and more customers require our presence close to where they do business, to achieve shorter turn-around time and to support the customers investments they have in various geographical markets. We believe it is also important to maintain certain individual business locations where critical know-how is embedded in the capabilities of our employees. And yet, while some of these factors represent expenses, we believe our product development and global presence support long-term strategic growth for the company. We have the financial savings in the form of a strong balance sheet and demonstrated cash flow in order to weather this economic rainy day. It is also important to invest wisely, to benefit from the eventual return to a stronger economy.

Some of our recent wins in our industrial area demonstrate the gains that we are definitely making. We now supply the heart of the advanced fuel control system for the Caterpillar G3500 series generator set; a network solution that allows Caterpillar to offer one of the highest efficiency, lowest emission engines today. We introduced 15 new [industrial products] [ph] at the Power Gen International Conference recently, addressing needs in small and large industrial gas turbines, steam turbines, and gas and diesel engines. In the process industry market, we announced the GB-40 Gas Blower that enhances wellhead production from depleted natural gas wells and coal bed methane sources. The potential for this solution to increase production and profitability for gas producers has just been introduced, but it is an example of how we capitalize on our current technology to expand into new markets.

We have also signed an extended and expanded agreement with the long-time customer, Dresser-Rand, to supply energy control technologies for gas turbines, steam turbines, and gas compression systems, and to collaborate on joint development projects. This agreement further demonstrates the way we work with our customers and our customers’ increasing dependence on us to help provide solutions for their process industry and power generation markets.

In all facets of our industrial business we are capturing market share through new products and systems and through expanding our customer base. We believe excellent opportunities exist for acquisitions of companies or technology that will contribute to the growth. We must recognize however, that the depth and the duration of the downturn in our industrial sales. We need to reduce costs and will do so in the form of integrating and streamlining our business units, globalizing our purchasing efforts, and attacking overhead costs, to get those costs more in line with the anticipated lower volume. Ironically, even while today’s volumes are down, we are dealing with an unprecedented demand from our customers to work with them on developing products to meet their future needs. It is essential that we maintain a balance between lowering costs and maintaining leadership in projects and markets that are critical to our long-term success. Therefore, we will keep on investing in our future through development projects with key customers. We are navigating the downturn according to our long-term strategy and will emerge as a much stronger competitor.

Now, moving on to our aircraft engine systems; our sales and earnings results do remain on track to end the year within the range we discussed at the end of the first quarter. On the commercial OEM side, sales related to production of new commercial aircraft are expected to decline somewhat further from current levels, and are anticipated to remain depressed for the next couple of years. The regional jet business, which has increased dramatically over the past several years, is readjusting to somewhat lower, more sustainable production levels. However, regional jets will continue to become increasingly important in the business models of most major airlines. In addition, according to our customers’ forecasts, business aircraft sales, which include jets and helicopters, are expected to remain weak until we begin to see signs of general economic recovery.

Commercial after-market sales have held up fairly well this year by comparison. We continue to benefit from the additional content and installed base that we have on newer commercial aircraft that airlines tend to continue operating, even as older equipment is grounded. And with the continued soft economy and the effects from the war with Iraq resulting in reduction in worldwide airline capacity, we will be watching our after-market revenues closely as we move into this coming year. Complicating our overall outlook even further, is the SARS outbreak, which is having a significant impact on air travel across the Pacific and within China and the rest of Asia. If the outbreak worsens, SARS has the potential to roll-over into and negatively impact both OEM production rates and after-market opportunities.

On the military side, our OEM and after-market sales have remained stable this year, after a build-up in 2002. We anticipate that this will continue throughout this year and into the next. Leveraging our core competencies into new products support this level of business. For example, by leveraging our turbine combustion capabilities, we recently have been successful in securing after-market military contracts like the afterburner flame holder for the Pratt and Whitney F100 engine. With our decreased commercial sales, our total military business, including the OEM and related after-market sales, now account for more than 25 percent of the total aircraft segment revenues.

Despite extremely challenging industry conditions, we are increasing market share in aircraft engine systems by expanding our content per engine, winning content on new programs, and capturing a larger portion of the lucrative repair, overhaul and spare parts business, on both the commercial and military segments. We continue to be the supplier of choice, because of our quality, cost competitiveness and responsiveness, as well as the breadth of innovative products we provide; all of which create long-term customer loyalty and generate competitive wins. Aircraft engine systems is focusing on expanded cost reduction programs and has a comprehensive commitment to productivity improvements. Our consolidation of the Servo valve production from Buffalo in to Rockford, is on track to have the move completed by the end of this fiscal year. Because we had visibility in our markets early on, we have been able to take cost out and maintain earnings at a respectable level, in spite of the reduction in sales.

I’d like to return to the business as a whole now. We started over a year ago, to restructure internal operations to capture the best technologies and practices for use across all of our product families. We have and will continue implementing initiatives, such as our global purchasing program, from which we anticipate significant savings. Our goal for the new Woodward structure is to develop technologies that can be leveraged across our business to meet all of our customers’ needs. Our renewed focus on our core competencies also means divestiture of product lines that are non-core or in decline, and outsourcing selected components. All of our business units are contributing to this integration process; manufacturing sales, marketing, engineering, corporate and support services. We believe these actions will result in a reduction of our operating costs in 2004, of at least $20 million on an annualized basis.

The continued downturn in our key markets has been a catalyst in ensuring that we are as lean and efficient as we can possibly be and still maintain our superior service to customers. Based on our customers’ and industry data, we see the downturn for large turbine power generation and aircraft engine production continuing for the next few years. The steps we are taking to stay with our strategy, reduce cost and gain market share, will ensure that we can operate profitably and protect our customer relationships until those markets recover and return to higher growth patterns. We believe that staying on our strategic path is the best method to ensure that we remain on track during the hard times, and that we emerge as a stronger, more competitive leader. Our balance sheet and cash flow prospects remain strong. In addition to our dividend, we continue to repurchase shares in recognition of the value we see in Woodward stock. We have the resources to carry out our selective, highly disciplined acquisition program, expansion and growth in our global presence, and maintaining excellent service for our customers.

Woodward has weathered many tough storms over the years and we are committed to navigating through this one, with our strategic assets in tact. Now I will ask Steve to review, in a little bit more detail, the quarterly financial results.

Thank you, John. As I review financial items today, I will 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 of fiscal 2003 were 146.2 million, compared to 174.9 million in the second quarter a year ago. Net earnings were 4.5 million, or 40 cents per share for the quarter, compared to 13.6 million, or down 18 cents per share last year. Second quarter sales for industrial controls decreased 23 percent, to 82.3 million. The sales decrease was due to the overall decline in the industrial markets, most particularly in large turbines. The segment recorded a second quarter loss of 1.8 million, compared to earnings of 12.4 million in last year’s second quarter. During the second quarter this year, we recorded $1 million in expense for a lease termination cost and we accrued 1.4 million for work force management costs. In the same period last year, we recorded 1.2 million for work force management costs. Manufacturing and engineering expenses were maintained at about the same levels in both years. Despite the sales reductions, we remain committed to our strategy for growth.

Aircraft engine system sales were 63.8 million in the second quarter, compared to 68.4 million in the second quarter of fiscal 2002, a decline of 6.7 percent. The sales reduction was due primarily to weakness in the OEM market. Commercial after-market sales held up better than OEM sales levels, and military sales accounted for a slightly increased proportion of total aircraft engine system sales. Segment earnings for aircraft engine systems decreased to 12.2 million, compared to 15.1 million in the same quarter last year. During the quarter we recorded approximately 500,000 for the integration of Buffalo operations into our Illinois facility, and we accrued 500,000 in work force management costs. Last year in the second quarter, there were 400,000 in work force management costs.

Now let’s look at the six-month results. Net sales for the six-month period ending March 31st, were 291 million, down from 355.5 million a year ago. Net earnings were 10.8 million, or 95 cents per share, compared to 27.3 million, or $2.36 per share last year, before the cumulative effect of an accounting change. Last year’s a cumulative effect of the accounting change resulted in the one-time after-tax charge of 2.5 million, or 21 cents per diluted share. Year-to-date sales for industrial controls dropped 24 percent, to 161 million. Segment losses were 200,000, compared to earnings of 25.4 million in the first six-months of fiscal 2002. This year we accrued 1.9 million in workforce management costs and we expensed $1 million for lease termination costs. During the same six-month period last year, we recorded 1.9 million in work force management costs. The decrease in earnings is due, primarily, to the decline in sales that first occurred in the fourth quarter of fiscal 2002. At that time, market indications were that sales declines would be short-term. However, more current projections by industry observers indicate that the market recovery could be delayed into 2005. As a result, we are implementing additional cost containment measures designed to line our costs with the lower level of sales.

Aircraft engine system sales, year-to-date, were 130 million, a 9.2 percent decrease from 143 million in the first six-months last year. Segment earnings decreased 17 percent, to 25 million, compared to last year’s 30 million. In the first six months of fiscal ’03, we recorded 2.8 million in work force management costs, primarily related to the consolidation of Buffalo operations into our Rockford facilities. And we recorded an additional 500,000 in other costs related to the Buffalo transition. During the same six-month period last year, we recorded 3.8 million in work force management costs. Total company costs to goods sold increased to 82.6 percent of sales, up from 78.1 percent a year ago. The increase reflects the reverse leverage effect of the significant drop in sales, versus fixed costs and development costs necessary to satisfy core customers’ current and future requirements. SG and A expenses decreased about 600,000, or 2 percent this year, compared to last year. As a percent of sales, SG and A expenses are 10.3 percent this year, compared to 8.6 percent last year. The year-over-year percentage increase is primarily because SG and A expenses do not necessarily vary directly with changes of sales levels.

Interest expense, year-to-date was 2.1 million, compared to 2.7 million a year ago. The decrease is due, primarily, to lower average outstanding levels of debt. Depreciation and amortization expense for the six-months were flat year-over-year at 15.7 million. Amortization expense increased slightly because of acquisitions made in 2002, but depreciation expense decreased, because of reduced capital expenditure levels. Capital expenditures were 6.9 million in the first six months this year. We currently expect capital expenditures for fiscal 2003 to be about 16 million, compared to 24 million in fiscal 2002. Depreciation expense is expected to be under 27 million. The effective income tax rate this quarter was 39.2 percent, compared to 38 percent in the first quarter, and 32.8 percent in the second quarter last year. Our income tax rate this quarter was impacted by losses in some foreign subsidiaries. In the second quarter last year, the rate was impacted by reduction valuation allowances provided on deferred tax assets. We expect our income tax rate to be about 38.5 percent for the rest of the year.

Now I’d like to make a few comments on the balance sheet. Comparisons are for the September 30th year-end amounts. Our accounts receivable decreased $2 million, to 74.3 million and inventories are down 2 million, to 125 million, both due primarily to low sales levels. Accounts payable and accrued expenses decreased 13 million, primarily because we made payments in the first quarter of fiscal 2003 for variable compensation retirement plan expenses accrued at the end of fiscal 2002. In addition, accounts payable reflect lower levels of business activity. And accruals for interest reflect lower levels of outstanding debt.

Our ability to provide guidance for the remainder of the year is severely impacted by uncertainties in our markets, including the war in the Middle East, the SARS outbreak, low capital investment levels, and evolving customer forecasts. However, we currently believe our 2003 earnings could be down at least 50 percent from 2002 levels. We believe the steps we are taking this year to reduce our costs will contribute to a better financial performance in 2004, barring additional extraordinary events, and will position Woodward for growth as our markets recover. That completes our comments on the business and results for the second quarter. Operator, we are now ready to open the call to questions.

Thank you. The question and answer session will begin at this time. If you are using a speaker phone, please pick up the handset before pressing any numbers. Should you have a question, please press *1 on your push button phone. Should you wish to withdraw your question, please press *2. Your question will be taken in the order it is received. Please standby for your first question, sir. Our first question comes from David [Gerell] [ph], from T. Rowe Price. Please state your question.

Hi. A couple of questions. Can you talk a little bit about the work force reduction costs and how that looks in the second half of the year, either by segment or just overall? I’m just wondering what kind of costs we should be seeing running through the P and L the second half.

At this point in time we are not ready to really differentiate or to be too much more specific about the $20 million annualized rate. A significant portion of that will be work force management costs or reduction in overhead costs. We probably will begin to see some of that beginning to show up late in the third quarter and some in the fourth quarter.

I apologize. I meant the – you show the restructuring [indecipherable] the restructuring that you’re running through the P and L. How much you had – 2.4 million and then another 500,000. What kind of expenses are you baking in the second half of the year, to get to the 50 percent decline in earnings?

Hi, David, this is Steve. Obviously, as we’ve indicated, we’ve recorded some additional costs in the first half of the year. We will have some additional the second half of the year, not totally defined yet. We’re still looking at some things and obviously, there’s some issues regarding when you make adjustments in, particularly, countries outside the US as to when you can recognize [things] [ph] in accordance with GAAP and that. But, we’re looking at that – not totally defined yet what it will be. We continue to look at opportunities as we talked about. The other thing, that is benefits that will be gained that do not incur the type of recognition of cost or things we’ve talked about such as deficiency gains and the global purchasing initiatives we have under way. So, it’s a little difficult to quantify some of the numbers that I think you’re looking for.

I guess, are we looking at the same type of ballpark terms or costs that we had in the first half of the year? I mean, to get the $20 million number for ’04, are we looking for dramatically increased restructuring that drives earnings in the second half of the year below what you’re expecting? Or are these costs somewhat closer to the first half levels? I’m trying to understand the difference between operational weakness and sort of what you’re doing on the P and L in terms of restructuring.

Dave, it’s a fair question. I don’t think – we would not see a dramatically increased number in the second half of the year.

Okay, thank you. Let me also ask about the industrial controls business. Given how weak the IGT market has bad – and the IGT used to be the biggest piece of that segment. If you look at Q2, how much is IGT as a percentage of industrial controls? Are we getting really close to the point where it doesn’t even matter – it matters less, because it’s down so much? Do you have any idea kind of idea in terms of how big the IGT business is today, as part of industrial controls?

It probably – maybe I’ll turn this over to Tom. But it’s probably – when you say IGT, you’re talking total power generation? Or you’re talking the large gas turbine segment of that?

I was talking the large gas turbine segment of that, as opposed to the diesel gen sys.

Okay. Tom, you want to tackle that one?

Sure. I think the comment you made is pretty accurate. As the sales have dropped off – we break it into three categories when we talk about the industrial gas turbines. It’s the large, above 50-megawatt, and that’s the one that this year is still having a decline. You have your aero-derivitive, which we’ve classified in about 10-50 megawatt range, and that market evaporated last couple of years. So, to your point, there is no further decline. There’s barely anything being shipped. And then you have the other 10 megawatt range, which is pretty low at the moment. So, we expect there may be slightly lower decline, but as a percent of our total industrial sales, it’s becoming less and less significant.

Can you give us any idea, through the business, the ballpark size of the pure industrial gas turbine business now, within industrial. Just a ballpark. I mean, I know it used to be a much higher percentage, closer to 50, 60 percent. Are we in teens? Are we in 20s? Any kind of ballpark?

Yes.

Did that answer your question, sir?

We’re still doodling here. I’m looking at it. It’s probably still in the range of 25 percent.

Okay. Thank you very much. I’m going to get back in the queue.

Our next question comes from Steve [Richia] [ph], from Bear Stearns. Please state your question.

Hi, guys. A couple of questions. Your inventory levels, are you comfortable with those levels going forward, given your outlook?

Well, we’re never really comfortable with our inventory levels and we continue – we try to make improvements in our operations to get those turns up. But basically, based on our current sales outlook, we would anticipate that they’re probably going to stay in that same general range.

Just a reminder, ladies and gentlemen, if you do have a question, please press *1 on your push button telephone at this time.

I’m sorry. Does that answer your question? I guess he’s gone.

Once again, ladies and gentlemen, if you do have a question, please press *1 on your push button telephone. Our next question comes again, from David Gerell.

Just sort of actually a follow-up question on the $20 million savings. I know you haven’t defined where all the contributors to that $20 million in savings are coming from. But, should we think about that – I mean, how should we think about it? Should we think about that as, you’re running $5 or $10 million of restructuring through the P and L, and both the absence of those costs, in addition to the savings from those actions get to the $20 million? Or is the absence of the charge in this year, incremental to the $20 million next year? And is it the right way to think about that if the markets are flat in ’04, figure that $20 of higher earnings or $20 pretax high earnings?

I think the way to look at it is that we’ve defined actions that will generate $20 million of savings from our current running rate, excluding the one-time cost that it’s going to take us to get there.

Okay. So consequently, you have $20 million, plus the absence of the charges, as long as you don’t take another $10 million worth of charge?

Yes, that’s correct if you’re using this year’s – if you’re using, let’s say, the second quarter numbers as a starting point to forecast, that would be accurate, yes.

Okay. Thank you very much.

Once again, ladies and gentlemen, if you do have a question, please press *1 on your push button telephone. Our next question comes again, from David Gerell.

I apologize. This will be the last one. I guess I’m the only one on the call. Can you give us the cash flow for operations in the quarter?

Actually it’s – obviously, not all information is included in the earnings release, but the 10-Q, which will be released in about a week and a half will have all that information in it.

Okay, that’s fine. Thank you very much.

Thank you, our next question comes from Terry Raterman, from Kennedy Capital. Please state your question.

Just to let you know, there is someone else on the call. In all that discussion, which seems very interesting to me, the one thing I was surprised about was your gross profit margin percentage in this quarter, which I thought was pretty low. In all these things you talk about for next year, can you in any way, give me a goal for your gross profit margin for next year, percentage wise?

No, we’re really not prepared to do that. But, you do have to understand that many of our overhead costs that we are attacking, do show up as a cost inside that gross margin or that gross profit calculation. Not all, but many and probably the bulk of those costs that we’re talking about show up in the cost side of that gross profit calculation.

Would it be unrealistic to assume that you could get back to somewhere in gross margin, where you were in some year – ’99, 2000, before the big run in the big turbines, that you could get back to some gross profit margin, say other than ’99?

I believe that that’s certainly within what we feel capable we can achieve.

Okay, thank you.

I’ll now turn the conference back to Mr. Halbrook, to conclude.

Steve, Tom and I, would like to thank you for your interest in Woodward and your participation in the call. The next call will be for the third quarter of fiscal 2003. And we look forward to reporting on our results and providing additional information about the outlook. And thanks again for joining us today.

Ladies and gentlemen, that does conclude our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available at 9:30 AM central time, by dialing 1-800-428-6051 or 1-973-709-2089 and by entering the ID number of 288917. A rebroadcast will also be available at the company’s website, www.woodward.com for 30 days. We thank you for your participation on today’s conference call and ask that you please disconnect your line.