Woodward Inc (WWD) 2003 Q3 法說會逐字稿

Ladies and Gentlemen, thank you for standing by. Welcome to the Woodward Governor Company fiscal year 2003 third quarter earnings conference call. At this time I'd like inform you that this conference is being recorded for rebroadcast, and that all participants are in a listen-only mode. Following the presentations you will be invited to participate in a question and answer session.

Joining us today from the company are Mr. John Halbrook, Chairman and CEO; Mr. Thomas Gendron, President and Chief Operating Officer, and Steve Carter, Executive Vice President, Chief Financial Officer and Treasurer. 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 third quarter fiscal year 2003 conference call. I'm Steve Carter, Woodward's Chief Financial Officer. With me today at our corporate headquarters in Rockford are John Halbrook, Woodward's Chairman and CEO, and 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 of fax. For those of you 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 July 24. The phone number is 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 I begin I would like to provide a cautionary statement. In the course of this call 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 that may cause our actual results to differ materially from those we currently anticipate. Factors that might cause a material difference include but are not limited to economic conditions that will impact sales in both the industrial 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 predicted as future results. In addition, the company disclaims any obligation to update the forward-looking statements make 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 third quarter results and progress towards strategic goals throughout 2003.

Thank you, Steve. The third quarter saw persistent weakness in the major markets we serve, and a temporary decline in our higher margin commercial aircraft aftermarket sales resulting from reduced air travel in the face of the Iraqi war and the SARS health warnings during the quarter. These markets began showing weakness in the fourth quarter of 2001, and have steadily declined since then. Having experience a long contraction in our markets, we are beginning to see some signs that overall the worst may be behind us. While our ability to predict is certainly no better than others in our markets, we believe, with the exception of large gas turbines, the third quarter may have seen the bottom of the cycle, beginning a period of stabilization which will be followed by recovery. Although the timing of these phases is uncertain, and most likely will vary by end market. The large gas turbine business probably will not bottom out until later, perhaps in 2004. Because we have a strong amount of content on the most popular large gas turbines, and we are continuing to win new applications and new customers, our large turbine control business should recover somewhat better than the current market forecasts. Despite the down cycle we have experienced over the last two years, we have remained steadfast in executing our strategy to expand our product offerings. We have continued to invest in product development, acquisition, and joint ventures to accomplish that strategy. At the same time we have been working hard to take costs out of our structure through right sizing, plant consolidations and organization streamlining. Woodward previously managed its two business segments as complete, separate operations. More recently our goal has been to integrate key function between our business segments to realize strategic and financial benefits. Our goal of one Woodward allows us to leverage our technologies, better manage available capacity, reduce time to market, and make gains from collaborative teamwork across functions. We have also begun to integrate and consolidate global purchasing, which is improving efficiencies and driving costs out of our operations. The consolidation and move of our Buffalo operation to Rockford for the purpose of aligning capacity and sales volumes, and improving productivity, is on track to be completed by fiscal year-end. Another example of focusing on core technologies, reconfiguring operations to lower cost and improving productivity, is the agreement announced this quarter with Honeywell with the rights to repair, overhaul and exchange Woodward manufactured controls for turboprop aircraft.

The lower sales volumes and additional restructuring costs have severely impacted our earnings this fiscal year. We should begin seeing the positive impacts of restructuring on our costs beginning in our fourth quarter. With the active combat phase of the war in Iraq over, combined with the lifting of travel health advisories, air travel is beginning to recover. This should benefit Woodward's aftermarket business in the near term. As the global economy strengthens and commercial air travel and airlines continue to recover, our large installed base of controls and reputation for service excellence position us well for future earnings growth. In addition, when our industrial markets begin their recoveries, we will see positive leverage to our bottom line, as we have seen the negative leverage during the downturn. As we implement our strategy, we continue to see evidence of successful implementation and increased market share. We announced this quarter that Woodward controls were selected for the GE Pratt & Whitney engine alliance, GP7200 engines that will power the Airbus A380 Super Jumbo Jets. This high profile program holds great potential and demonstrates our ability to respond to customers with innovative world-class products at a competitive price.

The US government recently recognized three of our facilities for quality and delivery performance. It was the first year our Colorado operation was recognized. This enhances our relationship with our largest military customer, and I believe underscores the dedication with which Woodward serves all of its customers. We introduced the [MI-4] control system, which is designed to help engines and equipment manufacturers cost effectively meet the 2004 EPA emission standards in the US, and other regulatory standards around the world. The MI-4 is a tightly integrated system of fuel, air, and ignition control modules used on small, mobile industrial engines. We have recently signed an agreement with Daewoo Heavy Industries & Machinery Limited's industrial vehicle division to supply Woodward MI-4 engine control systems with Daewoo produced lift trucks for the North American and Asian markets. This contract is new business for Woodward and increases our share of this growing market.

We also released the [Easy Gen 1000]. This latest generation [Genset] control is a highly integrated and flexible platform for electric powered generation equipment, such as used in little generators and emergency power equipment. This product has been well received in the marketplace. Also this quarter we acquired Synchro-Start Products, to expand our presence in the diesel engine market. Synchro-Start manufactures actuators, solenoids and controls for small high-speed diesel engines, used in engines for all highway, agriculture, construction, utility, power generation, truck, bus and marine markets. We expect Synchro-Start to add in excess of $30m of revenue in fiscal year 2004. In addition to broadening our diesel product line, we anticipate that Synchro-Start, which has a plant and sales office in China, will help drive sales growth in Asia. This acquisition will be accretive to earnings in the first year.

So, to summarize. Our superior products, commitment to uncompromising quality, strong customer focus, and a reputation as an on time, on spec and on budget company, have enabled us to win an increasing share of OEM and aftermarket business. We have the financial strength to our balance sheet, cash flow and diligent costs management to support aggressive product development in anticipation of the normalization and growth of our end markets. We continue to explore acquisitions to compliment our technology, accelerate our entry into new markets, and reinforce our existing market leadership. We believe the worst of the downturn is behind us, and except for large gas turbines we are in the trough of the business cycle. Exactly when we will see an actual recovery remains to be seen. We continue to win market share, and should see some volume increases over the next two quarters. We should see cost benefits beginning in the fourth quarter from the restructuring that has been occurring. When the markets begin to recover, we will be able to leverage the volume increases for very healthy income improvements. Our market share gains, new products, and the market recovery will take time to build revenues and earnings. We do expect the fourth quarter to be profitable, and although we plan to review the outlook for 2004 more fully during the fourth quarter conference call, at this point we do expect 2004 earnings to exceed 2003 earnings.

Now, Steve, would you please review in more detail the quarterly financial results?

Thank you, John. Before I do financial items today, I will first talk about our third-quarter results, followed by the nine-month results, and comment on some balance sheet items.

Net sales for the third quarter of fiscal 2003 were $141.6m, compared to $171.9m in the third quarter a year ago. Net losses were $165,000 or one cent per share for the quarter, compared to net earnings of $14.6m or $1.26 per share last year. Third quarter sales for Industrial Controls decreased 21%, to $83.1m. The sales decrease was due to the overall decline in the industrial market. The segment recorded a third-quarter loss of $4.5m, compared to earnings of $12.1m in last year's third quarter.

During the third quarter this year we expect $1.1m to write off certain advanced license fees, and $1.1m for workforce management costs. We also recorded $700,000 for pension costs associated with the transfer to a different pension plan for one of our overseas subsidiaries. As John mentioned, on May 30, 2003 we acquired Synchro-Start Products Inc. to expand our position in the high-speed diesel engine markets. Synchro-Start's contribution to Woodward's revenues was approximately $3m in the third quarter.

Aircraft Engine System sales were $58.5m in the third quarter, compared to $66.1m in the third quarter of fiscal 2002, a decline of 11%. Sales reductions due primarily to weakness in the commercial airline industry, was further depressed in the third quarter by the war in Iraq and the threat of SARS. [indiscernible] earnings for the Aircraft Engine Systems decreased to $8.8m compared to $15.3m in the same quarter of last year. During the quarter we recorded approximately $1.9m in expenses related to integration of Buffalo operations into our Illinois facility. Now let's look at the year-to-date results. Net sales for the nine-month period ended June 30, were $432.6m, down from $527.4m a year ago. Net earnings were $10.6m or 94 cents per share, compared to $39.5m or $3.52 per share last year, before the cumulative effect of an accounting change. Lat year's cumulative effect of the accounting change resulted in a one time after-tax charge of $2.5m or 21 cents per diluted share. Year-to-date sales for Industrial Controls dropped 23% to $244m. Segment losses were $4.7m compared to earnings of $37.5m in the first nine months of fiscal 2002. The decrease in earnings was due primarily to the decline in sales in industrial markets. As we indicated last quarter, we expect that the broad market recovery may not return until 2005, although we are seeing positive signs in the market.

This year's results include $3.1m in workforce management costs, in addition to $2.9m in charges I mentioned previously. During the same 9-month period last year we recorded $1.9m of workforce management costs. Aircraft Engine System sales year-to-date were $188.7m, a 9.9% decrease on the $209.5m in the first nine months last year. Sales reduction is due primarily to weakness in the commercial airline industry as overall military sales remained relatively flat. Segment earnings decreased 25% to $33.8m, compared to last year's $45.3m. In fiscal 2003 Aircraft Engine Systems recorded $3.5m in workforce management costs, primarily related to the consolidation of Buffalo operations into our Rockford facility. It also recorded an additional $2m in Other costs related to the Buffalo transition. During the same 9-month period last year, Aircraft Engine Systems recorded $3.8m in workforce management costs.

We previously projected that the consolidation of Buffalo operations into Rockford would cost about $4m. Based on revised project plans to ensure a smooth transition additional costs have been incurred. We now believe the total cost will be approximately $5.5m. We are on schedule to complete the transition in the fourth quarter. We anticipate the annual cost savings will be at least [$2.5m] on an ongoing basis.

Total company cost of goods sold increased to 84% of sales, up from 78% a year ago. The increase reflects the reverse leverage effect of a significant drop in sales versus fixed costs and development costs necessary to satisfy core customers' current and future requirements. SG&A expenses increased to about $2.6m, 5.9% this year compared to last year. As a percent of sales SG&A expenses are 10.9% this year compared to 8.4% last year. Acquisitions account for slightly more than half of the increase. The main increase was related primarily to increases in bad debt expense and workforce management expenses, partially offset by reductions in deferred [compensation]. Interest expanse year-to-date was $3.5m, compared to $3.9m a year ago. The decrease is due primarily to lower average outstanding loans and debt. Due to the recent acquisition of Synchro-Start our debt now stands at approximately $130m, compared to approximately $96m at the end of last year.

Depreciation and amortization expenses for the nine months were $24m both this year and last year. Amortization expense increased because of acquisitions made in 2002, and depreciation expense decreased because of reduced capital expenditure levels. Capital expenditures were $12.1m in the first nine months of this year, so we expect capital expenditures for fiscal 2003 to be well under $20m compared to $23m in fiscal 2002. Depreciation expense is expected to be about $26m. Excluding for the reduction and valuation allowances last year's second quarter, effective income tax rate was 38% for the nine-month period in both 2003 and 2002. We can expect our income tax rate to be about 38% for the rest of the year.

I already commented on our debt level, and I have just a couple more comments on the balance sheet. Comparisons are to September 30, year-end amount. Accounts receivable increased $1.4m to $77.8m, and inventory has increased $4.3m to $131m. These increases reflect the acquisition of Synchro-Start and effect of foreign currency translation, which together more than offset decreases due to the reduced sales levels. Well that completes our comments on the business results for the third quarter. Operator, we are now ready to open the call for questions.

Thank you, sir. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star, one on your pushbutton telephone. If you wish to withdraw that question, please press star, two. Your questions will be taken in the order that they are received. Please stand by for your first question, sir.

Our first question comes from Tom Lewis of CL King Associates. Please state your question.

Good morning, guys.

Good morning.

First off, let me say relative to everything else that I've seen in the aviation world, congratulations on doing a really fine job on that part of your business. One of the things that I'm hearing there with respect of aftermarket demand, a pretty consistent pattern for doing your repair and overhaul type work that volumes really, really slowed down March and April, but there has been at least some pickup since then. Would your experience be consistent with that?

Yes, it's fairly consistent. We saw a little drop and right now we believe our commercial aftermarket is going to hold steady through the fourth quarter and into our next fiscal year is our prediction on that.

Okay. Were there any expenses incurred that related to the acquisition or the deal with Honeywell that were expensed as opposed to capitalized during the quarter?

There really was no costs related to the Honeywell agreement, and no unusual expenses related to the acquisition.

Okay. Well you had in your income statement what you classified as $1.5m in Other expense, can you tell us a little bit about that?

I'm not sure right off the top of my head what's in there, Tom. Give me a second to look at it and see if I can come back to that one.

Okay. And finally, if we're trying to get to an estimate for the operating profit in Industrial Controls, it sounds like -- and using the third quarter as a starting point, it sounds like we can consider your recent cost cutting activities to be the source of -- to be a positive impact there. How do you see volume shaping up? Is it negative or positive or neutral, fourth quarter versus the quarter just completed?

In the fourth quarter we expect sales to be up over the third quarter. And as John said during his briefing there, we are seeing some slight improvement in our bookings coming in, primarily in our ethyl and gas engine business. So we're anticipating that things have stabilized and a few of our customers have started increasing some orders. We're not making real comments on how rapidly they're going to grow, but we do expect fourth quarter sales in Industrial to be up over third.

Okay. And in the third quarter, and again the revenues were up sequentially, but even adding back your non-recurring items, the operating profit was down. Can you help us understand that a little better?

Specifically on the Industrial side?

On the Industrial side, yes.

I think what comment we have, in there we have two businesses that I'd say were struggling more due to the decline, the rapid decline in sales that they're experiencing. And one of them was the operation that we also have for the gas turbine [indiscernible] business, and the decline of sales has been more rapid there. And I think as you see that has pressured operating margins. And some of our others have had similar type of effect where the downward leverage has been more significant.

Well one other issue there too is that we did have one month of Synchro-Start numbers in our quarter for the sales line. So if you look at sales comparable second quarter to third quarter, okay it would really be down probably roughly $2m or $3m.

Yes. Okay. I'll let somebody else jump in, thanks, guys.

Tom, let me give you the answer to that one question you asked about Other expense. The main thing there was that I mentioned about that $1.1m write-off of advanced license fees, that's under that account.

Okay. And that was separate from or in addition to the understanding of the [depiction] of the operating profit of the Industrial Controls?

That would have been included in that line for industrial controls.

Okay. All right, thank you.

Our next question comes from David Jarreau (ph) of T. Rowe Price & Associates. Please state your question.

Hi. I was wondering if you could say a little bit on the Aircraft business in terms of in the quarter how the military business did versus the commercial [indiscernible] versus the OEM business? I think you gave some commentary about the military on a year-to-date basis, but can you talk a little bit more about what happened in Q3?

The Military part of the business has been flat, David. So even though we were at war in Iraq I think what you've seen is that the provisioning for the war took place previously. And our sales have remained basically flat there. The commercial aftermarket we saw a slight decrease. We've put that together, repair and overhaul parts, that all goes together. That's slightly down, and we see that picking up just a bit here again. And then we expect it to be stable going into next year. I guess on the commercial OEM they remain constant, and we're still looking out to truly understand what Boeing and Airbus are going to do with their production rates.

I apologize, what was actually in Q3 there? I mean if figures were slightly down and the military was flat in Q3, that would imply that the OEM business is down to the mid 20s. Is that in the right ballpark or is there something else going on in Q3 if you're down 11% on a year-over-year basis? I'm just trying to understand that?

What periods are you comparing?

The year-over-year Q3 '03 versus Q3 '02. Can you give a commentary in terms of what the military was, what the commercial spares was, and what the OEM was? I'm just trying to understand that [indiscernible] decline.

The majority is in the OEM. I'm trying to understand your question. But the year, quarter to quarter, the majority of that was in OEM sales.

Okay. If you look at the spares business, your spares business has done much better than a lot of your peers given your strong exposure to GE and their 737 engines. Can I ask you -- I'm surprised because they were up 10% this quarter on their aftermarket business, and I guess some of that's repair and overhaul versus spares. But for the first quarter we've seen a real big [indiscernible] [dichotomy] between their results on their spares and your results on your spares in military or in aerospace. Was there anything timing-wise that also impacted you in Q3 that was a little bit unusual?

One of the things that -- we have very strong exposure to GE as you're highlighting. But our mix is in 100% align with GE, so on some of that you could get a difference. And when they're selling spare engines some of their spares show up versus ours. Our mix of programs as you highlighted is very good. We've got, especially on the [CFMs] or on the D2500, the G90s and the like, [indiscernible], so we're on some of the best programs. And on the newest programs, that's why we had a little bit of a dip when we saw some of the airline and the SARS effect. But that's why we're stabilizing quickly, and we think that's going to be -- but we're not going to have the impact that some of our peers have when they have the big [GT-8] exposure that we don't have. So I can't really comment why GE's are up more than ours, but it could be that there is a mix difference between [indiscernible].

We do not have a lot of content on the [700 or on the 737], and that's a big engine for GE and Boeing. So that may explain some of the difference.

Okay, that's fine. Also maybe you could spend a minute just talking about the recent acquisition in terms of the margin structure, any ballpark, what kind of prices you paid? And are you going to combine this operation with the existing operation to take out costs, or is it sort of a standalone operation? Can you spend maybe a minute on that?

Let me take a few of the questions. Synchro-Start, one of the reasons we were attracted to it is it helped us better penetrate the small diesel engine market. What we mean by the small diesel engine is under 200 kW. We were not real strong in that area. We had some offerings, but this really filled out our offerings and complemented our business. And also tied into the acquisition we did over a year ago with [Nalse Corporation], which that was also targeting the same size engine range, but for propane and gas engines.

The margins at Synchro-Start are very healthy. It has very good cash flow, which we were attracted to. I think we were able to get a good buy. We don't really comment on the price. We were able to get a good buy because we did pick that up from a private equity firm, so we think we got it at a good time. And very complementary. The customer base, this was our current customer base, many of the customers are the same. And we do anticipate combining and rationalizing product lines. A little bit further we're looking at rationalizing some of our operations.

And then the last thing that was very attractive, Synchro-Start headed a wholly owned facility in Gouzhou(ph) China, and we expect to expand that operation by combining more of our products into there. And it's a very well run operation that was very attractive to us as well.

Would you talk about double-digit -- this healthy margin, would it be fair to say that those are on an operating margin basis, double-digit operating margins?

Yes definitely.

But is there a purchase price [indiscernible] what you paid for it? Can you tell us what you actually paid for it?

It will be in the [indiscernible]. I think you will find it's a market type of a multiple and things like that when you look at it.

Okay. And just two really quick questions. The [IGT] business on a year-over-year basis, Q3 '03 versus Q3 '02, how much was it down on the quarter?

A lot. If we look at it year-to-date, or maybe I could do it year-over-year, we're down about $55m of sales year-over-year. I don't have quarter-over-quarter, but year-over-year. So we're in the 50% range.

Okay, that's fine. And my last question was if you could comment on the pricing environment in terms of perhaps in volumes, the biggest component of the negative 18% decline in revenues. I wonder if you could talk a little bit about is pricing -- you know, is it negative one is it negative two. Is it worse as volumes come down? Is it better if those volumes should come down? Can you just give us some brief comments on price?

What I would say is the market is very competitive today. Most of our -- the way we've set up most of our agreements with our major OEM customers is on long-term contracts, we have three to five-year agreements. These agreements usually don't have a deflator for decrease in volume. So unfortunately we can't increase the prices if volumes are dropping. The agreements are usually put together with competitive pricing. I think I would say in general we're doing pretty well on holding prices. We're not having to see a big impact due to sales decline or forcing pricing down. And also we don't have the ability to raise prices as the volumes drop either, that's not a real possibility the way most of our contracts are structured.

Okay. Thank you very much. I'll get back in the queue.

Thank you. As a reminder ladies and gentlemen, should you have a question, please press star, one on your pushbutton telephones at this time. Gentlemen, please stand by for any further questions. One again, should you have a question, please press star, one on your pushbutton telephones at this time. Our next question comes again from David Jarreau. Please state your question.

Just two short questions. [indiscernible] little bit bigger benefit in Q4 than Q3 from the Synchro-Start acquisition. Can you talk at all about -- I mean when you talk about Q4 sales being up versus Q3, is that exclusive or inclusive of the Synchro-Start acquisition?

Well we're highlighting that the Synchro-Start acquisition should add a little over $12m in sales fourth quarter. But in addition to that we also expect our other business to have a sales increase as well. This is on the industrial side.

And the last question was simply on the -- I apologize I've lost my train of thought. Thank you very much.

Okay, thank you.

Ladies and gentlemen, if there are any final questions, please press star, one on your pushbutton telephones. Our next question comes again from David Jarreau. Please state your question.

I've just remembered the last question. The expenses that you're expecting for the [indiscernible] of the Buffalo into Rockford consolidation as well as other [indiscernible] that you may take in Industrial Controls. Can you give us a sense of the ballpark, what you think that could be in Q4?

Really the expenses for Buffalo have in essence been basically recognized. That's why we brought up the point that now we're looking at about $5.5m. There's some additional expenses relatively minor compared with incurred so far. And I think it's limited amount of additional expenses be incurred in Industrial. Most of them have been incurred in the third quarter.

It's also fair to say that as we move into '04 that there won't be additional -- unless obviously the markets you serve take another nosedive, it's unlikely we'll see another significant reduction -- another significant expensing of severance or anything like that? That you basically take any actions that you need to take, is that a fair [indiscernible]?

I think you're right. I mean we're always at least working the fringes and getting our costs in line. But I think as far as major program, that's correct.

Thank you very much.

Mr. Halbrook, there are no further questions at this time. I will now turn the conference back to you.

Great. Steve, Tom and I would like to thank you for your interests in Woodward, and your participation in the call. The next call will be for the fourth quarter of '03. We look forward to reporting on our results, and providing additional information about the outlook. Thanks for joining us today.

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 9:30 am central time, by dialing 1-800-428-6051 or 1-973-709-2089, and by entering the ID number of 299739. A rebroadcast will also be available at the Company's web site www.woodward.com for 30 days. We thank you for your participation on today's conference call and ask that you please disconnect your lines.