Woodward Inc (WWD) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company first-quarter earnings conference call. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all parties are in a listen only mode. Following the presentation, you will be invited to participate in a question-and-answer session. Joining us today from the Company her Mr. John Halbrook, Chairman and Chief Executive Officer; Mr. Tom Gendron, President and Chief Operating Officer; and Mr. Steve Carter, Executor 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 would like to welcome all of you to Woodward's first-quarter fiscal 2004 conference call. I'm Steve Carter, Woodward's Chief Financial Officer. With me today at our corporate headquarters in Rockwood 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 after 5:30 PM yesterday. You may have received a copy by e-mail or fax. For those who have not seen a copy, you can find one on our web site at www.Woodward.com. An audio replay of this call will be available through Friday, January 30. The phone number was on the press release announcing this call. It will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our Web site for 30 days.

Before we began I would like to provide our cautionary statement. In the course of this call we present information and answer questions. Any statements that we make other than actual results or business facts may contain forward-looking statements. Such statements involve risks and uncertainties that may cause actual results to differ materially from those we currently anticipate. Factors that might cause material difference include, but are not limited to; economic conditions that would impact sales of both the industrial and aircraft markets, the ability of the Company to successfully implement cost control measures, and to maintain an add to its customer base.

We caution investors not to place undue reliance on these forward-looking statements as predicted 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 in our public filings with the Securities and Exchange Commission.

Now, I will turn the call over to John to discuss our first-quarter results and progress towards strategic goals throughout 2004.

Thank you Steve. Welcome to all of you who have joined us today. I would like to discuss our first-quarter performance and then to give you are best insight as to what the rest of the year might hold. Steve, Tom and I will be available for your questions when we open the line following the presentations as well as after the call.

First, I will address our business segments and consolidated performance, then I will outline our expectations for the future. Let's begin with our discussion of the Industrial Controls business.

Sales for the quarter were up compared to the first quarter of last year. The increase was the result of our acquisitions in fiscal year 2003, and the effect of fluctuations in foreign currency exchange rates. Basically, our core business has remained fairly level, even though our primary markets have contracted significantly in the past year. Market share gains have been the reason we were able to hold the business levels fairly steady.

In addition, we saw activity related to the reconstruction in Iraq and some infrastructure development in China. Also, we signed a long-term agreement with Caterpillar to manufacture some fuel injection equipment for an existing product line with diesel engines which is entirely new business for Woodward. Some initial shipments of the contract occurred in the first quarter.

The improvement in earnings for Industrial Controls directly relates to margin improvements, the additional business from acquisitions and the cost reduction efforts that we initiated last year.

Since our last earnings release, we have seen an uptick in demand for large gas turbine products. First quarter levels are up somewhat from the fourth quarter levels, which may turn out to have been the cycle bottom for this market. The businesses we acquired in fiscal year 2003 are performing in step with our expectations. In addition, we are seeing results from our investments in research and development as we produce and ship new products to our customers.

We have increased confidence that some industrial markets are turning out and the bottom is behind us. This is based on a number of our customers' expressed sentiments that business will be improving.

Now, let's take a look at our aircraft business. Our Aircraft Engine Systems sales for the first quarter were down 6 percent from the same quarter a year ago. This decrease reflects the continued weakness in the commercial aviation market. Our military sales remain strong. We are seeing orders for components on the U2 spy plane and the F-15 and F-16 fighter jets. Our military aftermarket sales which include repair and overhaul work for the heavily used Black Hawk and Apache helicopters are also doing well.

The segment earnings declined for the quarter are related to the lower sales volumes and an adverse impact of product mix as compared to the first quarter of last year, which was extraordinarily strong. Despite its cyclical nature regarding revenues and earnings, AES has a very consistent reputation for quality, dependability and technological excellence. Finally, from a financial standpoint, Aircraft Engine Systems margins and free cash flow fundamentals, complement Industrial Controls, broaden our strategic options, and contribute to building shareholder value.

Looking at the total business, the past two years have been very challenging for us. With major contracts in virtually all of the markets that use our products. Even though we saw huge decreases in our sales volumes, we continue to make progress in bundling our components to offer our customers systems solutions.

We continue to focus on developing new products and making acquisitions that have increased our market share and solidified our leadership position in our key markets.

In market after market, we have made steady gains in applying our products in broader applications. We have seen early indications that our key markets have reached the bottom of the cycles. However, we hesitate to forecast when and at what pace the recoveries will take place. When they do, we will be in a very strong position.

Competitive pressures compelling our customers to differentiate their products and deadlines for emission reduction requirements are approaching. We have the technology to help our customers meet their goals.

Over the last two years, we have been experiencing a perfect storm. Yet, during it, we have maintained our focus on our strategies and survived it in a very good position. I believe that in the next few years, as the recovery starts to kick in, and it is coupled with our very sound and broad technology position that helps our customers meet the new admission requirements, we will indeed have a strong favorable wind at our back. I believe our future is very bright.

I will turn it now over to Steve for a financial analysis.

Thanks John. As I review financial items today, I will talk about our quarter results first, followed by comments on some balance sheet items, then I will look for the future.

Net sales for the first quarter of fiscal 2004 were 159 million, a 9.8 percent increase from 144.8 million in the first quarter a year ago. Net earnings were 7.4 million or 65 cents per diluted share. An increase of 18 percent for fiscal 2003 first-quarter earnings of 6.3 million or 55 cents per share.

First quarter sales for Industrial Controls increased 23 percent or 18.3 million and $96.8 million. The increase is primarily due to sales by businesses acquired in 2003 and the effect of fluctuations in foreign currency exchange rates.

Industrial Controls segment earnings for the quarter were 4.6 million compared to 1.7 million last year. This increase was driven by the increase in sales and improved margins as a result of cost reduction actions. Also, in last year's first quarter, we expensed approximately half a million dollars for Industrial Controls workforce management activity.

Aircraft Engine Systems segment sales were 62.2 million, down 6.2 percent from fiscal 2003 first-quarter sales of 66.3 million. This level of sales reflects the continued weakness in the commercial aviation industry. Aircraft Engine Systems segment earnings were 11.4 million compared to 12.8 million last year.

Last year's first-quarter results also included 2.3 million for the consolidation of Aircraft Engine Systems servovalve operations. This year's first-quarter were affected by lower sales, and a less favorable sales mix as compared to the first quarter last year due to normal variability of sales.

Total company cost of goods sold in the first quarter decreased to 80 percent of sales from 82 percent last year. In the first quarter last year we recorded servovalve integration costs and workforce management costs that we did not occur in the first quarter of fiscal 2004.

SG&A expenses at 17.2 million were 2 (ph) million more than they were in the first quarter a year ago. The increase is due primarily to the SG&A expenses of businesses we acquired in the last half of fiscal 2003. In addition, we had increased expenses in the first quarter of fiscal 2004 associated performance driven by our compensation plans. As a percent of sales, SG&A expenses were 10.8 percent this year compared to 10.2 percent last year.

Interest expense for the first quarter in both fiscal 2003 and 2004, was about 1.2 million, reflecting lower average effective interest rate this year and a higher outstanding balance. Our outstanding debt at the end of the first quarter was about $27 million higher than it was at the end of last year's first-quarter, due to last year's acquisitions.

Interest income increased in this year's first quarter as compared to a year ago because of interest received on income tax refunds.

Depreciation and amortization were 8.3 million in the first quarter this year compared to 7.7 million a year ago. The increase is related to the amortization of intangible assets acquired as part of our business acquisitions of last year.

Capital expenditures in the quarter were 4.1 million. We currently expect to spend approximately $20 million on capital expenditures in 2004.

Effective tax rate was 38.5 percent this quarter compared to 38.1 percent for the full year last year. Our first-quarter rate reflects our current expected rate for the full year and takes into account the mix of earnings among various tax jurisdictions worldwide.

Now I would like to make a few comments on the balance sheet. All comparisons that I make are to the September 30 year-end amounts.

Accounts receivable decreased $8 to 80 million in the first quarter. This decrease is attributable to the reduced shipment levels that occurred at the end of December partly due to the holiday shutdowns of our domestic plants.

Inventories increased about $6 million to 132 million in the first quarter, about a quarter of this increase is related to changes in the foreign currency exchange rates. The remaining increase is related to normal fluctuations in production schedules. Together, accounts payable and accrued expenses decreased 3.3 million. The most significant decreases were related to the timing of payments related to payroll, and certain employee retirement benefit plans.

Now, let's take a look at our outlook for the future. While we believe the weakness in the commercial aviation industry will continue through the end of 2004 and into 2005, many of our customers have expressed favorable sentiments about future demand in our industrial markets. Nevertheless, until actual orders begin to validate these indications, it's too early to be more specific than our previous guidance that earnings for fiscal 2004 will exceed those of 2003.

Actual earnings will be influenced by the timing and slope of recoveries in our power generation, commercial aviation, and other global markets.

That completes our comments on the business and results for the first quarter. Operator, we are now ready to open the call to questions.

A question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS) Mike Harris with Robert W. Baird.

Good morning gentleman. John, correct me if I'm wrong, but it appears looking at the commentary in the press release and what you said in your prepared comments that you are incrementally more negative regarding the outlook for commercial and aerospace. Am I correct in thinking of that that way?

I don't think we are more negative than we have been. Basically, we think it is probably pretty close to the bottom, and it is probably going to stay that way until it starts to uptick a little. But, I will let Tom maybe make a comment about that as well.

We are actually looking at this as the bottom and the expectations from what forecasts we get from our customers in the airline industry is that 2005 will be upwards from 2004.

Okay.

Our outlook hasn't really changed. I think most in the industry are expecting commercial to turn upwards in 2005 and we see that with the outlook on the production lines.

Sure. That's reasonable. You talk a lot about customers are sounding more optimistic in your industrial markets. Can you just get more detail here? I want to kind of dig into the layers within your transportation business, talk about what's going on in marine and locomotive and in off-highway equipment as well? Also what is going on in the process industries -- just looking for more detail?

Sure. One thing as we said in the prepared statements that has been a positive that we talk about is the reconstruction in Iraq. What you see in Iraq is things that play well to Woodward, the petrol industry, oil and gas. It's requiring a lot of equipment so what you see in there is you're going to see reciprocating engines, compressors, aero-derivative gas turbines and large gas turbines. I think as everybody has read, there are power issues in Iraq. So again you're going to see reciprocating engines and aero-derivative and large turbines. That has provided a boost and we were pleasantly surprised at how quickly that came.

As we said just for comments too, in China you got the oil and gas, PowerGen doing well and again all of the machine types we're on are there. The marine market is turning. We're starting to see signs of recovery there.

The marine market for Woodward that primarily means larger diesel engines. Once in a while you will see aero derivative in the marine, but that is primarily military marine and cruise lines. Military marine is doing quite well for us as well, so we're seeing some nice recovery there. Or not some recovery, some nice work coming out of the military marine and that does affect our aero derivative gas turbines.

Overall, the oil and gas industry is picking up. So that may be -- if we reclassify that under the process industry. So, there again, we're seeing work in gas reciprocating engines, diesel reciprocating engines, compressors, turbines. That is picking up. Locomotives is still flat to down on that -- that's another part of our transportation.

The PowerGen outside of what we're highlighting in China or Iraq, we're seeing some recovery starting in the distributor generation. That is in the smaller Gen sets. So that is primarily reciprocating engines Gen sets. We're very well positioned in distributor generation and we always say that is 15 megawatt and below. Above that is still flat. We're not seeing a recovery there.

Tom, speaking about the Gen set side, clearly there has been a number of high profile power outages within the last six months. We have been increasingly hearing that consumers and businesses have a really heightened interest in investing in backup power. And the need to invest in backup power. Is this what you are hearing from your customers as well?

Exactly. That is what I mean by seeing the pickup in the smaller Gen sets. They are used either for backup or they can be used for prime power peaking, but that's exactly where the pickup is and if you get in the higher level, 15 megawatt and above, we're not seeing the recovery yet. But we expect it to come in the next few years, but the small Gen sets in particular in the one megawatt and below is where we are seeing more of the recovery.

You know, within transportation, you have exposure to off-highway equipment when you listen to market leaders such like Cat and Deere, it sounds like construction in equipment demand is picking up. Are you seeing any of that strength?

We have started to see some of that. Going from those construction equipment manufacturers.

Within Iraq, how long do you see that demand benefiting you in the next say two to three quarters?

If I was to say, I would say the next two to three years.

The next two to three years. Interesting. Okay. I just wanted, Steve, maybe you can add some clarity here. You talked in previous calls that you were targeting 20 million in cost savings. Fiscal '04? I just wanted to ask how much cost savings if you can quantify did you achieve in the first quarter?

I think it is difficult to quantify exactly the first quarter. How we been measuring some of it is that particularly in the areas where we had people reductions, those of course we obviously are enjoying the benefits of those at this time. We have taken out those costs. We're also working a lot in as I think that we mentioned earlier one of the areas where we're working on in some of the cost related to improvements in our global purchasing cycle. Those are accruing at different paces, but we're actively working out to achieve those things over -- some achieved them last year and some will achieve as we go through this year. We should be on pace by the end of the year. The total will be. But a good percentage have occurred already through the first quarter.

Okay, so regarding your goal for the year of 20 million plus in cost savings, is that still realistic at this point?

Very realistic and much of it again that 20 million recall we announced last year and we actually did a lot of that in a last year as I said with the headcount reductions and things like that to size the business appropriately. So it's more the activity related in the purchasing savings that are spread out over time.

Some of the changes we've made in particularly in overseas locations where there is social cost involved and that actually flowed into the first quarter this year, so we'll see those benefits in the second and third quarters.

That certainly is good news. Just last question here. Acquisitions benefited the topline. That was the majority of the year-over-year increase. Can you quantify the topline benefits due to foreign currency?

Well, what it is actually the whole benefit was due to the acquisitions and foreign currency and the acquisitions were around 12 million, the differential was foreign currency.

Okay. Fair enough. Thank you.

Tom Lewis of Risk Reward Advisory.

Good morning guys. First question. If one were to hazard a guess at what your aircraft engine revenues might be in the first quarter, or in the second quarter, and use the first quarter as a starting point, due to the -- there is a lot of the December quarter being a lot of downtime in the supply chain, the natural inclination would be the up some. Is there anything in the cards to offset the effects of seasonality if one is going to project second quarter using first quarter is a starting point?

I don't believe so. There will be just because we know what happened. There will be quarter-to-quarter fluctuations. Okay? It is not really seasonality. Just the way that the orders come in. Basically, I think we don't really expect to see any kind of significant improvement in those volumes until approaching 2005.

Okay. As far as looking at the both of the first quarter and the fourth quarter in aircraft engines, would you characterize the mix in business in 2004 as unusually broad, or the mix in the first quarter is unusually below average?

I think the way we have to characterize that is the first quarter in '03, okay, was extraordinarily a very good product sales mix in that quarter. I think what we're seeing in this quarter is what we would expect to be fairly typical.

Great.

Let me highlight, you see some of the fluctuations maybe I think if you understand aerospace industry, we cannot time the spare unit orders that we get, that come from the airlines. The spare unit's obviously carry a very healthy topline and a very healthy margin and so depending on the timing of those, it can affect it. And I think that is what you have seen quarter-over-quarter.

I suspect the tail end of last there was a bit of catch up going on there. Last question I guess, the big surprise here obviously is this tremendous pickup in your operating margins on the industrial side. Much more I would say than a prudent analyst would want to expect. Is there anything about this? Should I have any concern from this level about a meaningful -- I don't mean a few basis points, but I mean halfway back to zero retrenchment? Or I guess to put it another way, how comfortable are you that this kind of a baseline level of performance and by this I mean 4.8 percent operating margin going forward?

Let me comment on that. If the volumes stay as they were in the first quarter, we feel very comfortable we can hold those margins. But, we are volume sensitive. As long as the volumes hold and our customers are on track to buy as much of our products in the last part of the year as the first part of the year, then we are comfortable with those margins. This is John Halbrook.

That is a good answer. Thanks guys. Keep up the good work.

Ladies and gentlemen the question-and-answer session is still open at this time. (OPERATOR INSTRUCTIONS) Tyler Hojo of Sidoti.

Good morning guys. I was wondering if you could comment a little bit on what is going on with commercial maintenance and repair business?

On aircraft you mean?

Yes.

Our repair and overhaul business I would say is moving along at a consistent pace. We have not seen a deterioration there. The airlines are still flying. The thing about the repair and overhaul is it is driven by flight hours, by revenue passenger miles, so if flight hours are still there, we're doing quite well. We capture quite a large percent of the repair and overhaul business. If this continues to come in at a good rate, then we are doing quite well with that business.

Do you see any market share gains coming any time in the near future?

On the current overhaul, I don't so. We have a high share of the repair and overhaul of our products today. It would be difficult to get a larger share. But, we do expect to continue to keep the share we have and do well on that.

One more question. In the press release, you mentioned that you saw some activity coming from infrastructure development in China. I was wondering if you could just comment on that a little bit?

There are several areas obviously. China is a big opportunity for us going forward. The reason we look at the infrastructure. If you start with developing infrastructure and that means any construction equipment and that is the off-highway stuff we are on. They're putting a lot of energy right now or a lot of development into oil and gas pipelines. You've got the major West-East pipeline going in, and so anything to do with these moving oil and gas and processing, it usually requires the type of equipment we are on.

In developing the airline, there is an airport infrastructure. There is a tremendous amount of airports being developed. They are adding aircraft as everybody knows, the biggest market. And we have very high percent of comps (ph) on the aircraft they're purchasing. So that is good news for us.

One of the real bright spots for Woodward is in anticipation of the 2008 Olympics. The Chinese are trying to clean up the air pollution. If you have been to China, it is horrible air pollution. One of the things they are doing is they are really on the high focus on C&G (ph) buses and we're capturing a great share of the C&G bus market over there. And that is just starting. We're seeing some of that come.

The rail market, we're making good inroads into the rail market, and they're trying to upgrade some of their locomotives. One of things you can watch going forward is China is going to be a big shipbuilder in the future. And many of our customers are putting joint ventures are putting engine manufacturing sites over there are we're working hand-in-hand with them. So, that is a little sampling.

It is about everything we touch going on over there and it is all growing and so we're trying -- we're investing in China, we have two operations in China today. We are aggressively going after the Chinese OEMs as well as any of the Western companies that are locating over there.

Great. Thanks a lot. I appreciate it.

Mike Harris of Robert W. Baird.

Yes, I just wanted to continue with the China theme. Can you quantify your current sales levels into China? Right now?

If you take all of our sales both what we produce in China and what we export into China?

Yes.

Right now it's probably on the order of $40 million.

In your internal budgeting on your forecasting, what type of long-term growth rate are you looking at for that market let's say over the next five years?

We anticipate sizable increases I guess what I would say. Asia for Woodward, so what we really look at is for Woodward, Asia so we throw in China, Korea, India, into there. We expect those sales to go up, orders of magnitude over the next five years.

That's fair enough. I actually wasn't expecting a specific percentage. So, just to clarify the 40 million is specific to China?

That is just in China.

Great. Thanks.

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

Thank you operator, and thanks all of you who are participating. I guess we will see you in three months. Steve, anything else to remind them of?

No. Just thanks for joining us today. We are glad you could be here.

Thank you.

Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a rebroadcast of this call, it will be available at 9:30 AM Central Time by dialing 1-800-428-6051, or 973-709-2089 by entering the ID number of 332472. A rebroadcast will also be available at the Company's Web site at 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.