Woodward Inc (WWD) 2005 Q4 法說會逐字稿

Welcome to the Woodward Governor Company fourth-quarter and fiscal year 2005 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'll be invited to participate in a question-and-answer session. Joining us today from the Company are Mr. Tom Gendron, President and Chief Executive Officer and Mr. Bob Weber, Chief Financial Officer and Treasurer. I would now like to turn the conference over to Mr. Weber.

Thank you, operator. We would like to welcome all of you to Woodward's fourth-quarter and fiscal 2005 conference call. Today Tom will update you on our performance and strategy and I will talk about the November 21st earnings release and financial outlook. After our presentation, we will open it up for questions. As a reminder, you can find a copy of the earnings release on our website at www.Woodward.com. Also an audio replay of this call will be available via telephone through Friday, November 25, 2005 and on our website for 30 days. The phone number for the audio replay was on the press release announcing this call and will be repeated by the operator at the end of the call.

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 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, 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, including our 10-K for 2005, which we expect to file by mid-December. Now I'll turn the call over to Tom to discuss our progress toward achieving our strategic goals in the fourth quarter and throughout 2005.

Thank you, Bob. Good morning and welcome to all of you who have joined us today. I would also like to welcome Bob Weber who joined us as Chief Financial Officer and Treasurer in August. Bob has come up to speed very quickly since joining Woodward and his experience in finance and general management has already proven valuable to our executive team. Bob and I will be available to answer your questions following the call.

Now I'd like to spend a few minutes updating you on our overall performance in 2005. Fiscal year 2005 was a year of broad strength in our markets and robust demand for Woodward products. We remain tightly focused on energy controlled solutions, which include advanced controlled solutions for combustion or thermal energy, fluid energy and electrical energy. Woodward is committed to investing in its broad portfolio of technologies to remain a leader in energy controlled solutions for engines and turbines. In 2005, we increased our investment of product development by 25% from a year ago to $50 million.

Research and development is a major contributor to our competitive strength, an important key to our future growth. An example of a major development opportunity for Woodward is our role as fuel systems integrator for the new GE GEnx turbofan engine for the Boeing 787, the Airbus A350 and the Boeing 747 Advanced, which we announced early in fiscal year 2005. This award solidified our growth in the commercial wide body market where we already supply applications on the Airbus A380 and the Boeing 777.

Most importantly, the GEnx program strategically positions Woodward as a preferred supplier of integrated systems confirming that our fuel system strategy is successful with our customers. GE expects the GEnx engine, which so far has attracted over $2 billion in orders, to enter service in 2008.

Competitive wins in the military market are also positioning us for the future. Woodward will supply components for the GE Rolls-Royce F-136 engine, one of two choices to power Lockheed's Joint Strike Fighter aircraft. GE also selected Woodward to provide fuel metering units for the T700-701D engine that will be used to upgrade Sikorsky Blackhawk and the Boeing Apache helicopters. During 2005, military aircraft OEM and military aftermarket business accounted for approximately 11% of Woodward's sales. These successes have added substantially to our development activity while strengthening our future.

We also increased development activities in Industrial Controls, most notably in combustion sensing technologies and in product development for the turbine auxiliary market. Turbine auxiliary applications offer multiple opportunities to leverage existing Woodward hydraulic and electric actuation and valve technologies for our off-engine applications.

In 2005, Industrial Controls launched the on-highway OH2.0 next generation system to enable heavy-duty natural gas engines to meet new and tighter emission requirements. This cost effective system solidifies our leadership role in natural gas controls and exemplifies our integrated systems solution strategy.

Consolidating our European and Asian operations is a key element in our plan to improve profitability. Early in the fiscal year, we announced the consolidation to rationalize production capacity, realign sales and service capabilities and reduce overhead. We will begin to see the benefits of these actions in 2006. In addition to the international restructuring, we remain focused on quality and efficiency improvements and in supply chain functions where operational excellence is critical to realizing our potential operating leverage. We use a broad set of continuous improvement tools supplied to all areas if our business to meet progressively more stringent operating targets.

We believe these strategic initiatives will improve our financial performance, our operating performance and our overall ability to provide quality products at competitive prices. Now I'll turn it over to Bob to discuss the financial results and our outlook.

Thank you, Tom. Good morning, everyone. I would like to talk first about our fourth-quarter results followed by the results for the full year. I will then comment on our balance sheet and the outlook for the future. Our net sales for the quarter were 218 million, a 10% increase over last year's fourth-quarter sales of 197 million. Earnings before income taxes for the quarter were 14.3 million compared with 9.5 million for the same quarter a year ago.

Charges relating to work force management actions affected both quarters totaling 1.6 million for the fourth quarter of 2005 and 13.1 million for the same quarter last year. In addition, since the 2004 charge substantially reduced companywide variable compensation for the year, we have reversed reserves in the fourth quarter of 2004 that had been accrued earlier in that year. Net earnings after tax in the fourth quarter were 11.3 million or $0.96 per diluted share compared with 6.7 million or $0.57 per diluted share in the fourth quarter of fiscal 2004.

The effective tax rate for the 2005 quarter was 21.3% compared with 29.5% for the year-ago quarter. Industrial Controls' net sales for the quarter were 142 million compared with 125 million a year ago, an increase of 14%. Industrial Controls' segment earnings in the fourth quarter of fiscal 2005 were 4.2 million compared with a segment loss of 6.2 million for the same quarter a year ago.

The costs associated with work force management actions mentioned earlier were entirely attributable to the Industrial Controls segment and totaled 1.6 million for the quarter compared with 13.1 million for the same quarter a year ago. Operating margins were slightly improved in 2005 after considering the effects of performance-based variable compensation on the segment's quarterly results.

Aircraft Engine Systems net sales for the quarter were 76 million compared with 72 million a year ago, an increase of 4%. Segment earnings were 15 million compared with 19 million for the same quarter a year ago. In addition to the variable compensation comparison noted previously for the Company as a whole, another factor in lower aircraft segment earnings for the fourth quarter of 2005 was an increase in research and development activities on awarded programs.

As previously reported, the current work force management actions primarily relate to the consolidation of our Industrial Controls, European and Asian operations. These actions are proceeding as planned and should be substantially complete by the end of March 2006. We anticipate that we will realize gradually increasing annual cost savings, that once fully implemented, will range from 9 to $11 million when compared with amounts preceding these actions.

Now I would like to turn to the full fiscal year results. Net sales for 2005 of 828 million were a record for the Company. This is an increase of 17% from 710 million for the previous year. Earnings before income taxes were 79 million for the year compared with 49 million last year. Pre-tax results for the year included gains totaling 11.7 million related to the sale of certain product line rights and changes made to a retirement healthcare benefit plan. In addition, the pre-tax results for both years included the cost of work force management actions totaling 1.7 million for the year most recently ended and 12.9 million for the previous year.

The improvement in overall performance is largely the result of higher sales volumes and related fixed cost leverage. As I mentioned previously, we will begin to see impacts related to the work force management actions taken late this year throughout 2006. Net earnings for the year were 56 million or $4.78 per diluted share compared with 31 million or $2.71 per diluted share in the previous year. Our effective tax rate for 2005 was 29.2% compared with 36.3% last year. Changes in credits claimed and deductions taken for previous periods reduced the full-year tax rate by 2.5% or 1.9 million.

Additionally, the effective tax rate reduction was due to changes in the distribution of taxable results by country. We currently expect our tax rate in 2006 to return to a level approximating or slightly below our 2004 rate. Industrial Controls' net sales for the full fiscal year were 537 million, an increase of 22% from 440 million in fiscal year 2004. Industrial Controls' earnings were 29 million in fiscal year 2005 compared with 6 million for 2004. Expenses for work force management actions totaled 1.7 million for the year compared with 12.9 million for the previous year.

Operating margins were improved attributable primarily to higher sales and the operating leverage of fixed costs over the higher sales volumes. Aircraft Engine Systems' net sales for the full fiscal year were 291 million, an increase of 8% from 270 million in fiscal year 2004. Aircraft Engine Systems' earnings were 64 million in fiscal year 2005 compared with 59 million in fiscal year 2004.

Now I would like to focus briefly on certain specific elements of our consolidated financial statements. Cost of goods sold as a percent of sales improved from 76% in 2004 to 75% in 2005. On an absolute basis, while cost of goods sold increased in 2005 largely due to the higher volume of sales and performance-based variable compensation, it was reduced by lower work force management costs in 2005.

Selling, general and administrative expenses were fairly constant as a percent of sales at 10% in 2005 and 2004. SG&A expenses increased by 9 million in fiscal 2005 over 2004. The increase is largely attributable to higher performance-based variable compensation as well as costs related to compliance with the Sarbanes-Oxley Act. Research and development costs increased by almost 25% to 50 million in 2005 and from 5.6% of sales in 2004 to 6% of sales this year. This reflects our increased investment in systems development programs for our customers.

Total depreciation and amortization expense remained constant at 32 million for both 2005 and 2004. Our capital expenditures were 27 million this past year. We expect capital expenditures in fiscal 2006 to increase to around 30 million.

To turn briefly to our balance sheet, our working capital increased by 43 million with 36 million of that increase in cash and cash equivalents. While net sales increased 17% from 2004 to 2005, accounts receivable and inventories each increased by about 8%. During the year, a scheduled 14.4 million of long-term debt became current offsetting some of the working capital increases just mentioned.

Our total debt remained fairly constant at just less than 96 million. Our debt to debt plus equity at the end of the year was 18%, down from 20% last year. We are well-positioned to fund expanded research and development and to explore other investment opportunities consistent with our focus strategies.

In closing, I would like to comment on our outlook for fiscal 2006. First, we are targeting sales growth in the 3 to 6% range. We anticipate higher sales in all of our core markets; power generation, transportation, process industries and aerospace. From an earnings perspective, while we expect our first quarter to be challenging, we are targeting a range of $5.00 to $5.25 per diluted share for the full year. We anticipate that the Industrial Controls' segment earnings will increase to approximately 10% of sales with the effects of our performance improvement activities.

The Aircraft Engine Systems' segment earnings will remain solid while increasing our product development efforts. The 2006 targets include the effects of the adoption of new accounting rules regarding stock compensation. If these rules had been applied in 2005, the effect on earnings would have been a reduction of about $0.11 per diluted share. As you know, the Sarbanes (technical difficulty) of 2002 was legislated in response to weaknesses in the effectiveness of internal controls and lapses in ethical behavior. At Woodward, we have completed our assessment under the requirements of the Act and concluded that our internal controls were operating effectively as of September 30, 2005. Our management report to this effect will be included in our annual report on Form 10-K to be filed by mid-December. That includes our comments on the business and results for the fourth quarter and fiscal 2005. Operator, we are now ready to open the call to questions.

(OPERATOR INSTRUCTIONS). Brendan Brown (ph), Caris.

Congratulations on a strong year. Looking forward at the outlook, you said 3 to 6% revenue growth and if you look at your major customers such as GE and Caterpillar, aircraft engines are extremely strong. Caterpillar, their outlook is for very strong revenue growth, probably 15% per year. What is causing the slowdown in revenue growth? Is it in power generation or what exactly is that coming from?

We're very encouraged by the outlooks from our customer base that we have also just recently have seen them announce and discuss with them. We are looking at a couple of things on our projection forward. This year in 2006 in our Industrial segment, we're definitely concentrating on margin improvement and what we have seen is some maturing product lines decreasing faster than some of the new product lines are ramping up. So we're anticipating in the Industrial Controls segment that sales are going to be more in the 2% growth range. On our Aircraft segment, we're anticipating more in the 7 to 9% growth range. So we're encouraged by the outlooks of our customers and if that translates into increased sales, we expect to catch our fair share of that.

Thank you. Does that mean that the new products that you are working on are going to start ramping more in '07?

They will be coming online -- we have some in '06 '07 '08. There are products that we do on both sides of our business -- our Industrial side, 10 to 15 year life. So as they come up, we expect them to ramp up, stay steady for a while and then obviously as they mature to decrease.

Thank you very much. If I could just squeeze one more question in. You talked about the operating margin improving in Industrial Controls to about 10%. Where will that push the gross margin to overall for the Company? Is it going to move more towards 27%?

We actually focus -- you'll notice in our financial results that we report, we don't really identify a gross margin if you will. But obviously the impact on our segment earnings will translate. It is coming from the operating side of our financial results. So it is improvements in our overall cost structures as a result of the consolidation activities that we have been taking. So it will improve our gross margins. It will improve our contribution margin either way you look at that. But primarily we have focused on it from the standpoint of the segment earnings increase.

J.B. Groh, D.A. Davidson.

A question on Industrial Controls' margin goals. If you look back over time, this has been as high as a mid-teens operating margin business. What are your goals over the next couple of years in terms of turning that around and can you talk about the aftermarket opportunity? We have had some of the companies under our coverage universe talking about pretty nice aftermarket business in the turbine area and in the margins associated with that. Can you address those two things?

Sure. I think if you recall from previous conference call discussions, we do anticipate returning the Industrial Controls segment to the historical levels that you are referring to. What we would say is 2006 is just a good step towards that longer-term goal of achieving those numbers. We believe the business is capable of staying at the historical segment earnings margins and that's what we are targeting. On the aftermarket side, just to make sure I'm clear, you are referring to industrial turbines versus aircraft turbines?

Correct.

The industrial turbines market -- we do see the installed base of applications during the bubble period is very large. Those machines are now operating and we do expect every 18 months to 2 years to start seeing a higher repair and overhaul cycle on some of the equipment. We're starting to see that. We do make better margins. Obviously every company does it on repair and overhaul in aftermarket. So we anticipate that will start ramping up starting this year and moving forward as those machines start generating hours. So that is in our business plan to see improvement there.

Addressing the R&D spending, it looks like that is running at between 6 and 7% of top line. Is that a good way to think of it in '07? Is that going to be higher dollar volume or pretty constant in terms of as a percentage of sales or how should we look at that?

You're right. It is around the 6% level for '06, '05 and we anticipate that would be fairly constant. We'll start to see some ramping up of the sales that will match the increases in the R&D. So we would think that that would be a fairly constant percent.

So look at 6% as a good number?

I think that would be a good target, yes.

Ned Armstrong, FBR.

Can you talk a little bit all about the part in your press release where you mentioned that some of the anticipated savings and benefits in your Industrial Controls segment were delayed from this quarter and what the cause of that was and why you think you will ultimately realize them over the course of next year?

The savings were tied to a major restructuring activity. We were consolidating facilities, moving equipment, both in Europe and in Asia and while we tracked pretty close to project plan, we had to hold onto some people probably longer than initially anticipated and what we were targeting there was to have absolutely zero disruptions to our customers, which is what I think we have pulled off. And from the standpoint of customers, I think they're very pleased with the way we executed the plan. And so it's really a timing of the savings kicking in and we know now they're going to start kicking in in fiscal year '06.

So it was really more timing than any execution issue.

That's correct.

And then you also mentioned that you were in the industrial arena developing some non-engine type of products. Could you elaborate a little bit on the type of products that you are working on? I mean just in general, certainly not into real specifics.

The one that we're highlighting is what we are referring to as turbine auxiliary. Up to this point on the Industrial segment, primarily everything we have done has been tied to on the turbine or fuel controls for the turbine. The turbine auxiliary market is all the supporting process equipment that is needed in a facility like a powerplant or a compressor station to allow the turbine to work. What we are targeting there are valve systems and these valve systems leverage off of our technology and our core competencies in valve, hydraulic actuation and electric actuation and controls. So what we're really doing, if you want to say, is moving to an adjacent field with our same customers. We're working with the major turbine manufacturers and we're going to be providing these additional valve systems. So it looks very promising. We bring some unique capabilities to that arena and the response from the customer base has been very promising.

(OPERATOR INSTRUCTIONS). John Hochhalter (ph), Robert W. Baird.

I'm curious if you could give some commentary on the strength you saw in particular end markets in Industrial, like your process industries, transportation and such?

Sure. What we are seeing today -- the power generation business is picking up and in power, I always want to make sure everyone recognizes, we provide equipment on gen sets that are built out of reciprocating engines as well as the larger industrial turbines that more people are familiar with. We did see a larger increase in the smaller generator sets and we are now starting to see encouraging signs from the turbine manufacturers that, with sales in Asia and Eastern Europe and Europe itself, that we are seeing the bigger turbine market start to pick up. So power gen looks solid.

The transportation, the way we define transportation is marine, locomotive, off-highway vehicles and alternative fuel vehicles and then I think most everybody recognizes construction equipment is still very strong. Marine is strong and we have done real well in alternative fuels, particularly the end markets in Asia where we are selling the natural gas systems for buses and trucks, had been robust for us.

The process market, the main areas in process industries that we currently participate in is around oil and gas and even though oil and gas companies' revenues have been skyrocketing, I think there is a little bit of a lag in the sales in terms of compressors and associated equipment for the oilpatch has been flat. So in that respect, that market has been flat. The other ones have been increasing.

To move over to the acquisition front. Can you comment on what you are seeing in the marketplace right now as your cash balance continues to build, should we expect something for '06?

We're definitely looking at how to grow the business. That's a big driver for us. We definitely have the financial wherewithal to do that. But what I would highlight to everybody is we don't have -- cash isn't burning a hole in our pocket. We're going to be focusing on something that builds on our strategy, that's in our area of competence, that we would know how to manage. We have an ongoing program to look at opportunities but we're looking at opportunities that would really build on our core. There are a lot of players out there today. I think everybody is aware of that. But we are out investigating. We're also investigating continued growth to organic means and other development activities.

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

Okay. I would like to thank everybody for joining us today. Bob and I look forward to meeting and briefing you after our first quarter. So thank you.

Thank you very much.

Ladies and gentlemen, that does conclude our conference call for today. If you would like to listen to a rebroadcast of this conference call, it will be available at 10:30 AM Central time by dialing 1-888-266-2081 or 703-925-2533 and by entering the access code 778577. 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.