Woodward Inc (WWD) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company fourth quarter and fiscal year 2004 earnings 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 presentation, you will be invited to participate in a question-and-answer session.

Joining us today from the Company are Mr. John Halbrook, Chairman and Chief Executive Officer; Mr. Tom Grendon, President and Chief Operating Officer; and Mr. Steve Carter, Executive Vice President, Chief Financial Officer and Treasurer. I would now like to turn the conference over and Mr. Steve Carter.

Thank you, Operator. We would like to welcome all of you to Woodward's fourth quarter and fiscal 2004 conference call. 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 Website at www.Woodward.com. An audio replay of this call will be available through Friday November 26, 2004. 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 would 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 actual results may differ materially from those we currently anticipate. Factors that might cause a material difference include but are not limited to future sales, earnings, business performance and economic conditions that would impact demand in both the industrial and aircraft markets.

We caution investors not to place undue reliance on these forward-looking statements as predictive of future results. In addition a company disclaims any obligations 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 including our 10K for 2004 which we expect to file by December 14.

Now I will turn the call over to John to discuss our progress towards strategic goals in the fourth quarter and throughout 2004.

Thank you Steve. Welcome to all of you who have joined us today. Tom, Steve and I will be available for your questions following the call. As many of you have read in our recent news release, Woodward announced plans for the transition of our Chief Financial Officer role. Steve Carter has decided to retire from Woodward. I would just like to assure everyone that Steve has given us ample notice and that he will remain in the CFO role until his successor has been appointed and a complete transition has been made. We are anticipating a seamless changeover.

During his 18-year tenure, Steve's achievements and contributions were exemplary including helping to manage our transformation to full Public Company status. Steve has been an outstanding colleague and adviser and we will miss his strategic insight, broad range of capabilities and professionalism.

Now I will cover the key issues that affected our performance and try to provide some detail on our progress this year. 2004 was a turnaround year for Woodward as we experienced solid growth in most of our markets. This growth enabled us to begin the return to profit levels more in line with recent historical levels but we are not there yet. We had excellent results in our aircraft segment as a result of an extremely favorable aftermarket mix and the efficiency improvements from the 2003 closure and integration of our Buffalo, New York servovalve operations into our Rockford, Illinois plant.

In our industrial segment while the increased volume enabled us to return to positive operating margins, we were unable to achieve our targeted levels. There are several reasons for this. First, the quick ramp up in orders caused supply chain problems and other operating efficiencies. Second, acquisition integration issues required some fairly costly investments. Third, infrastructure costs associated with acquisitions have increased our breakeven point. We are vigorously attacking these issues and they will continue as a primary focus in 2005.

Included in steps being taken to address our excess infrastructure situation are the recent decisions to consolidate two of our manufacturing operations in Europe and one in Japan into other Woodward facilities. And the reduction in our sales force in Europe in response to the market shift to North America and Asia. In addition, we are exploring other possible opportunities to further reduce our infrastructure costs.

We continue to be fairly aggressive in our new product development efforts. We have had good success at providing our customers with system solutions that help them produce more efficient, low emission, lower-cost engines and turbines. Most recently through the fiscal 2004 acquisition of Adrenaline Research which had developed proprietary combustion sensing expertise, we have added crucial technology to remain a leader in the energy control systems. To leverage this knowledge we have committed to investing in a new combustion test facility at our Zeeland Michigan location which we anticipate being completed by April 2005.

We believe that some combustion control is the key to achieving the emission regulations in 2010 and beyond. This world-class combustion test facility will support future systems development that focuses on components critical for aircraft and industrial combustion control.

The most recent example of our strategy at work is the selection to be the fuel systems integrator for the GEnx for the Boeing 7E7 Dreamliner. The GEnx win solidifies our role as systems integrator demonstrates the value of our new product development efforts and continues our strong position with GE on their aircraft engine product lines. This award along with several other systems wins that we've talked about in the past, validates that our strategy is working with our customers.

As we look ahead to next fiscal year we see both aircraft and industrial markets continuing to strengthen. From what we can determine from our customers and other industry participants it appears this trend will continue through 2006. Our planning for 2005 anticipates further revenue growth in our business and continued improvement in profit margins as we work toward reducing our infrastructure costs and improving our operational performance.

Now I will turn it over to Steve to discuss the financial results in more detail.

Thank you, John. As I review financial items today, I will first talk about our fourth-quarter results followed by the results for the year, comments on some balance sheet items and our outlook for the future.

Our net sales for the quarter were 197 million, a 28 percent increase over last year's fourth-quarter sales of 154 million. Net earnings in the fourth quarter were 6.7 million or 57 cents per share compared to 1.7 million or 15 cents per share in the fourth quarter fiscal 2003. Fourth-quarter earnings in fiscal 2004 were impacted by workforce management actions that increased cost by a total of 13.1 million as measured before the effects of income taxes.

In the previous year's fourth quarter expenses associated with workforce management actions increased expenses by 3.1 million. I would like to point out that like many companies we have variable compensation plans for all of our members. In fiscal years 2003 and 2004, our variable compensation plans were primarily based on consolidated results. The impacts of workforce management costs on fiscal year 2004 earnings was mitigated by reduced variable compensation costs while there was an insignificant effect in 2003.

The workforce management actions for the fourth quarter were primarily related to the consolidation of manufacturing operations located in the Netherlands and in the United Kingdom with existing operations in the Germany and the United States.

In addition, we are also consolidating a small manufacturing operation in Japan with an existing operation in China and reducing our sales force in Europe. These actions are being taken to streamline the organization by eliminating redundant manufacturing operations and to adjust the sales force in response to recent market shifts from Europe to Asia and North America. We estimate that approximately 250 positions will be eliminated from the 3 locations. For these actions we recorded 13.8 million of the expected total expense in the fourth quarter of 2004. These expenses were related to benefits under ongoing termination benefit plans and contractual pension termination benefits.

In fiscal years 2005 and 2006 we expect to incur additional expenses totaling 3.2 million. These additional costs are for termination benefits that will be earned by members over their remaining service period and for other costs primarily associated with moving equipment and inventory to other locations. We believe annual cost savings resulting from these actions will range from 9 million to 11 million. The timing of the actions is such that we expect to realize about half of the savings run rate in the third quarter of 2005. Thereafter we expect the savings level to increase gradually through the second quarter of 2006 at which time virtually all of the savings are expected to be realized.

Net sales for Industrial Controls were 125 million in the fourth quarter compared to 89 million in the same quarter last year, an increase of 41 percent. This increase reflected increased market demand in Asia and North America and incremental sales associated with the manufacture of diesel fuel injectors and pumps for one of our major customers.

Industrial Controls segment incurred a segment loss of 6.2 million in the fourth quarter compared to segment loss of 6.9 million in the fourth quarter 2003. These results include expenses associated with the workforce management actions totaling 13.1 million in the recently completed fourth quarter and 2 million in the previous year's fourth quarter. The improved performance primarily reflected higher sales and the operating leverage effect of the increased sales versus fixed cost.

Aircraft Engine Systems fourth-quarter sales were 72 million compared to 65 million the previous year's fourth-quarter. The increases was due to higher revenue passenger miles experienced by the airlines which has driven greater use of aircraft and higher aftermarket sales for us.

Segment earnings for Aircraft Engine Systems were 18.9 million in the fourth quarter compared to 13.8 million in the prior year's fourth quarter. Segment earnings in the fourth quarter last year included approximately 1 million in expenses associated with workforce management costs. There were no workforce management costs in 2004 and the increased earnings were primarily driven by the increase in sales.

Now let's look at the full fiscal year results. Consolidated net sales for the full year were 710 million, up 21 percent from the 587 million in the previous year. Net earnings for the year were 31.4 million or $2.71 per share compared to 12.3 million or $1.08 per share in the prior year. Costs associated with workforce management actions totaled 12.9 million for the year compared to 12 million in 2003.

Annual sales for Industrial Controls increased 32 percent from 333 million in 2003 to 440 million in 2004. Approximately half of the increase was related to sales volumes due primarily to production of diesel fuel injectors and pumps for one of our major customers that began late in 2003. We also experienced increased demand across many product lines in Asia and North America. Incremental sales on businesses acquired in fiscal 2003 and favorable changes in currency translation rates accounted for the remainder of the sales increase.

Industrial Controls segment earnings were 6.4 million compared to a segment loss of 11.6 million in fiscal 2003. Segment earnings included 12.9 million in workforce management costs in 2004 and 5.1 million in 2003. The improvement in Industrial Controls performances was primarily the result of higher sales and the lower ratio of fixed costs to variable costs associated with the higher sales volumes.

Aircraft Engine Systems sales increased over 6.3 percent this year to 270 million from 254 million. As mentioned earlier, the sales level reflects increase in commercial air travel with resulted in higher aftermarket sales for Woodward. We estimate that approximately half of our aircraft engine systems sales were aftermarket sales in both 2004 and 2003.

Aircraft Engine Systems segment earnings were 59.2 million for the year, up 24 percent from 47.6 million in the preceding year. The increase in earnings was the result of higher sales and the lower ratio of fixed costs and variable costs associated with higher sales volumes. In addition, Aircraft Engine Systems workforce management actions resulted in a recognition of 6.5 million of expense in 2003. There were no actions or expense in 2004.

Now I would like to turn to the consolidated financial statements for the year. This year we made a couple of changes in our financial statement presentation that we believe better illustrates our financial results. The most significant of these changes was to present research and development costs as a separate line item in our statement of consolidated earnings. These expenses were previously included in cost of goods sold. We've also separated other income and other expense.

Cost of goods sold on a consolidated basis increased 20 percent in 2004 as compared to 2003. The increase is primarily attributed to variable costs associated with the sales increase and to a lesser degree changes in segment sales mix and higher performance based variable compensation.

SG&A expenses increased by 5 percent in fiscal 2004 over 2003. The increase is attributable to incremental expenses of businesses acquired and higher performance based variable compensation. As a percent of sales, SG&A expenses were 10 percent in the year just ended compared to 11.5 percent in the previous year. We expect SG&A expenses to be at a similar rate next year.

The effective tax rate for the year was 36.3 percent compared to 38.1 percent in the previous year. The effect of rate change is due primarily to changes in the distribution of taxable earnings and losses by country. We currently expect our tax rate to be closer to 38 percent in fiscal year 2005.

Total depreciation and amortization expense remained at similar levels in each of the last 2 years, approximately 32 million. Our capital expenditures were 19 million this past year, about the same as the previous year's levels. We expect capital expenditures in fiscal 2005 to increase to around 26 million about equal to our level of depreciation.

Now I would like to make a few comments on the balance sheet. Accounts receivable increased 13 percent this past year to 99 million and inventories increased 10 percent to 139 million, both reflective of the higher levels of business activity. Accrued expenses increased 20 million over the previous year. About half of the increase is due to variable compensation expense and the remainder is due to the increase in accrued expense related to workforce management actions.

Other liabilities increased 11 million due to the increases in retirement healthcare and pension liabilities. Our total debt-to-debt equity at the end of the year was 20 percent, down from 26 percent last year. During the year we continued to pay down our short-term debt. At the end of the year long-term debt remained at approximately 90 million with the majority of it payable in equal annual installments beginning in fiscal 2006 through 2012.

In closing, I would like to comment on our outlook for the current year, for fiscal 2005. First, we are targeting sales growth in the 4 to 7 percent range. We anticipate higher sales volume as a result of improved market conditions for capital equipment purchases and power generation, transportation and process industries. For our Aircraft Engine Systems we expect sales volumes to be approximately the same in 2005 as in 2004.

From an earnings perspective, we are targeting a range of $3.50 to $3.70 per diluted share. Aircraft Engine Systems segment earnings could be lower in 2005 than in 2004 as a result of changes in sales mix and development expenditures for future OEM programs. However, we expect Industrial Controls segment earnings to increase as a result of higher sales and improving operating margins.

That concludes our comments on the business and results for the fourth quarter and fiscal 2004. Operator, we are now ready to open the call to questions.

(OPERATOR INSTRUCTIONS) J.B. Groh, D.A. Davidson.

Correction. We take our first question from John Householder (ph), Robert W. Baird.

Just a couple of questions for you. Of this 13.1 million that you guys saw in the quarter, how much of that was incremental that you wouldn't have done in Q4 of this year from standard operating? How much actually will be incurred in the future? From a cash standpoint?

Basically all of it will be in the future from a cash standpoint.

Okay. In other words if you guys exclude that, you really did about $1.37 in EPS for Q4, am I correct in thinking that? That 13.1 is about 80 cents?

One of the things you have to consider again, obviously as we talked earlier on, there are two items that impact that number. Both the income tax effect and also the variable compensation effect and you have to take both of those into account when determining the total impact.

Okay. Are you going to quantify what those were?

No, we don't intend to quantify.

Because it seems like if you take a number, both those would probably leave you north of a dollar still for EPS for Q4. It just seems like the guidance for '05 is a little bit conservative right now.

I guess the one thing we might say is -- and the reason we wanted point out the fact that the variable compensation impact is the fact that with our performance this year being as good as it was turning out to be, we are high in our performance level and our performance bonus plan so the impact was probably maybe greater than a normal impact might have been.

Okay. It looked like aerospace margins were about the best they have been since in Q4 of 2000. Is this sustainable or is this just really mix issued in the quarter?

I think it is primarily mix issues in the quarter. We had a very strong aftermarket shipment in a quarter and it drove that operating margin up, the percentage up.

Okay. And then can you give us cash flow from ops for Q4?

Just for the quarter?

Yes. Or for the full year. I can back it out.

For the full year, it was about 85 million.

Okay. Then something else we noticed, your other income was just -- it seemed a little bit high as far as the benefit. Was there anything special going on there?

You mean for the quarter or for the year?

For the quarter.

This year it just happened to be some -- we have some additional joint venture income that flowed in the quarter. If you look at it on the year-to-date basis, actually last year it was just kind of a timing issue there. So they were pretty similar for the year. This year we just had some additional flowthrough on the fourth quarter versus the fourth quarter last year.

Okay. Just curious, the growth in Industrial Controls, you guys talked about this diesel fuel injector. Are you not expecting that to have a similar boost in '05 because I mean your sales forecast seems kind of low given what you guys did in sales growth in the quarter.

I think that business we achieved probably the ramp up in the fourth quarter so we expect it to be about that rate, maybe slightly higher but not by a sizable amount.

So the Q4 run rate is kind of the appropriate rate to think about?

Right.

For the overall Industrial Controls or just for the diesel fuel portion?

Well, just for the diesel fuel systems portion. As I think John highlighted in his comments, we do see most of our markets strong in this fiscal year '05 and moving into fiscal year '06. So we expect that business to hold where it was and we expect the other markets to pick up slightly.

Thank you. That is it.

Tom Lewis, Rockhouse Research.

First off, can you tell us where your shipments into military aircraft programs above or below normal in the fourth quarter?

I think they are normal. Tom, do you have any --?

I think they are about -- they run about average of what we've been running.

As far as understanding the progression in aircraft controls margins over the last few quarters, did you get -- was some of that coming from the restructuring that you did last year finally kicking in?

Absolutely. That was a big piece of it. And that is exactly what we're aiming to achieve with the restructuring that we are doing right now in our industrial business.

Okay. Can you give us a little better sense of why you expect aircraft volume to maybe even be down given new bill rate projections likely to be up and all that?

I think on the volume, we're not projecting it to be down. We are looking at it close to flat. Part of that is due to -- if you recall we divested a small part of our business so that is factored out into fiscal year '05. A little bit we are looking at -- we are seeing a little bit of line rate increases on the aircraft build and we had a very strong aftermarket year in fiscal year '04. So we are looking at that. That is always a little harder to forecast, so maybe a little conservatism there. But our basic prediction with the synchronizer business out is approximately flat to slightly up.

Did you say what you thought, now that you're breaking it out as a line item, what you thought your R&D expense might be in the year ahead?

It's going to be very close to what it was in '04.

It will be very similar to what we were doing this year.

Okay. Is it going to start to be shifted more proportionately into aircraft? Are you going to start to -- the GEnx going to start to be a factor in the year ahead in '05, or is that --?

What I would say is it is a factor. We're probably going to have slightly higher expenses due to the GEnx program and some other significant programs that we have won over the past year and a half. The Pratt & Whitney 600 engine where you have both the 610 and 615. We have a significant amount of development effort going on those programs at the moment. But what I would say is we staffed up in advance of these programs, and we are anticipating securing them, which we did. So we are right now in full development with a full team on those programs. Obviously, we start incurring expenses due to tooling, test equipment and other expenses that go with the development activity. So we do see a slight increase, but I would say most of that was already in place as the fiscal year started.

From a manpower point of view, it will be fairly level.

Okay, great. Thanks a lot.

David Turrow (ph) with T. Rowe Price.

I just wondered if maybe we could look at this variable compensation issue one more time. If I am looking at the corporate expenses in the quarter for the difference between the operating income and the aircraft industrial controls, it looks to me like it is about a -3.7 million, and normally it is a little bit more than -- sort of 3 million per quarter. Is my math right? That was sort of equal, sort of a $7 million delta to normal. Is that the way we should be thinking about the order of magnitude of the issue we had in the quarter?

I'm not sure exactly whether we should look from a numbers standpoint, David. I think that's one thing I'd say, that our variable compensation is not focused on that non-segment area. It actually is spread out within all of the segments and everything like that. So it is calculated as part of wherever the members' costs flow through, whether it be a cost of goods sold item or an SG&A item, that's a line item that those costs flow through. So I'm not sure.

I guess what I was getting at was, if you look at basically aircraft engines and industrial controls, basically those 2 segments have about $12.7 million of profits in the quarter. Then if I go down and look at sort of the operating income before interest expense, interest income, it's basically about $9 million. So the corporate expense which is usually a negative, it looks like it was a credit in the quarter to the Company. Is that where the variable compensation flowed through? So that would be -- to your point that would seem logical, given that this was a corporate line or the other line was sort of a negative -- it was a credit as opposed to a negative.

I am trying to follow your numbers here. Give me a second here.

I think the answer to that is no. Any variable compensation cost is allocated to the segments or to the non-segment areas where the people accrue their expenses. So there was nothing companywide that went into -- extra that went into the non-segment areas.

Okay. We will follow-up off-line then on that. Thank you.

(OPERATOR INSTRUCTIONS) J.B. Groh with D.A. Davidson.

I think I had a little phone problem earlier there. Of that remaining 3.2 million in restructuring, can you give us some help as to how that comes out over '05 and '06? Is it sort of back-ended into '05 and then into '06, or is it even throughout '05 and then a little bit into '06, or how is that working through?

Probably, I think it really -- probably a little bit maybe after the first quarter, you will start seeing it, and then probably spread pretty evenly throughout. It's all related to, as we said, those kind of costs that relate to moving machines, additional severance type costs and that stuff. So it is hard to quantify exactly when they're going to be in, but I would say probably the beginning of the second quarter and on through the rest of '05 and into early '06.

If I just had to give you a ballpark allocation of that, maybe 75 percent in '05 and 25 percent in '06. Something in that -- something like that.

That makes sense. It looks like you're getting a little bit better cost savings than you had initially anticipated, bumped up by about a million?

Oh, yes, that is the result of the Japan consolidation which was not included in that original announcement. That is an additional cost and an additional cost savings.

Okay, so that makes sense. Thanks a lot. Good job, you guys.

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

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 first quarter of fiscal 2005, and we look forward to reporting on our results and providing additional information about the outlook. 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 10:30 AM Central time by dialing 1-888-203-1112, or 1-719-457-0820, and by entering the passcode 995626. A rebroadcast will 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 at this time.