Woodward Inc (WWD) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you tore standing by. Welcome to the Woodward Governor Company third quarter earnings call. At this time I would like to inform you that this call 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. 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 third fiscal quarter 2006 conference call. Today, Tom will update you on our strategic and operational direction. I will talk about the April 25th earnings release and at the end of the presentation we will open it up for questions.

For those that have not seen the release, you can find one on our website at www.Woodward.com. There is also a slide presentation for a portion of today's call. To access the presentation that accompanies Tom's final comments, please go to our website, www.Woodward.com, select the Investor Information tab at the top of the page, select Presentations and Conference Calls from the left menu and select the webcast link for today's call.

An audio replay of this call will be available through Friday, July 28th, 2006. 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. In addition, a replay of this call will be accessible on our web site 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 then 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 the place undue reliance on these forward-looking statements as predictive of future results.

In addition, the Company disclaims any obligation to update the forward-looking statements made herein. For more information about the risks and uncertainties facing Woodward we encourage you to consult the press release and our public filings with the Securities and Exchange Commission.

Now I will turn the call over to Tom.

Thank you Bob. Welcome to all of you who have joined us today. We are quite pleased with the improvement of profitability we experienced this quarter. Let me first discuss our Industrial Controls business segment. At 11.9% of sales this quarter's Industrial segment earnings were strong. Our profitability continued to climb, due to operating improvements resulting from the actions we took to consolidate our European operations, as well as a positive sales mix.

Although Industrial sales were flat compared to the third quarter of last year, demand for our large gas turbine combustion products increased over the depressed level in the second quarter. The distributive power generation market has been showing strength. We've seen significant growth in our power management products, including those for nonutility distributive power application and emergency power.

Renewable energy related products, such as those related to wind and turbine power systems, have also increased. Our marine engine market continued to be healthy, with higher sales in our military marine products, which should continue into our fourth quarter.

CNG and LPG bus systems and certain diesel engine products for China, continued to be down compared to 2005. In the long-term, we are confident that these markets will rebound. In the process industries market we continue to see increased demand for oil and gas compression applications.

Now turning to our Aircraft Engine Systems business segment, commercial, military and aftermarket service and sales show healthy increases. Our investments in R&D, which are up significantly over last year, will begin to materialize in the sales this upcoming quarter, as new customer programs begin to enter service.

Future new program introductions, including the GEnx, the GE T700, both engine applications for the Joint Strike Fighter, and the GP 7200, will be phasing into service now through 2010.

Reflected on the first half of the year orders and having just concluded the Farnborough Air Show last week, our outlook for aircraft remains positive. Commercial orders, while not at last year's pace, continue to be strong. We believe the commercial order-up cycle will continue, as large US and European carriers have not yet ordered their future fleet replacements.

Our application base has proven to be an advantage, as our share of future orders in narrow body, wide body and regional jet applications continues to be positive.

Now I'd like to turn the call back to Bob, to discuss our financial results and outlook.

Thank you, Tom. Good morning, everyone. First I will comment on our third quarter results for fiscal 2006, followed by the year-to-date results. Then I will comment briefly on our balance sheet and our outlook for the remainder of the year.

Net sales for the quarter were 217 million, up from last year's third quarter sales of 210 million. As Tom stated, Industrial sales were relatively flat, with aircraft sales up almost 7.5%. Earnings before income taxes for the quarter were 21.6 million compared with 25.5 million in the same period a year ago.

These pretax results include three unusual items we would like to highlight. First, we accrued an additional 3.5 million this quarter related to the legal matters mentioned in the previous quarter. We believe this accrual should be substantially complete.

Second, last year's results included a curtailment gain of 7.8 million, resulting from changes to the Company's retirement and healthcare plan. And third, Woodward began accounting for stock compensation in this year's first quarter, using the fair value method, as required by recently released accounting standards. Had we accounted for stock compensation a year ago using the same method, employee compensation expense would have increased by 608,000 for last year's third quarter.

Net earnings for the quarter were 28.9 million, or $0.82 per share, compared with 19.7 million, or $0.56 per share for the same quarter a year ago. Net earnings included deferred income tax valuation allowance adjustments that reduced income tax expense by 13.7 million.

Industrial Controls net sales for the quarter were 138 million, essentially flat with last year. Industrial Controls segment earnings in the third quarter of fiscal 2006, were 16.4 million, compared with 9.5 million for the same quarter a year ago, an increase of over 72%.

Segment earnings as a percent of sales, rose to 11.9% in the third fiscal quarter of 2006, compared with 6.9% in the prior year. Our operating margins this quarter benefited from favorable sales mix, previous investments in our product portfolio and the restructuring actions that were completed in March of this year.

Aircraft Engine Systems net sales for the quarter were 79 million, compared with 74 million a year ago, an increase of 7.4%. Segment earnings for the quarter were 14.8 million, or 18.6% of sales, compared to 14.3 million or 19.4% of sales for the same quarter last year. The 2.5 million increase in R&D impacted results.

Now let's look at the nine-month results. Consolidated net sales for the nine-month period ended June 30, were 622 million, up from 610 million a year ago. Consolidated earnings before income taxes for the nine months were 57.9 million, compared with 64.8 million in the same period a year ago.

This year's pretax results included 8.5 million in accruals for legal matters. Last year's pretax results included the 7.8 million curtailment gain mentioned earlier, and a 3.8 million gain on the sale of certain product rights. Had we adopted the new accounting standard for stock compensation last year, employee compensation expense would have increased by 1.7 million in last year's first nine months.

Consolidated net earnings were 52.8 million, or $1.50 per diluted share, compared to 44.7 million, or $1.28 per share last year. Net earnings benefited from the 13.7 million deferred tax valuation allowance change mentioned previously.

Year-to-date sales for Industrial Controls were 395 million both this year and last year. Industrial Controls segment earnings were 41.1 million, compared to 24.6 million in the first nine months of fiscal 2005.

Aircraft Engine System sales were 227 million, an increase of 6% over the prior year's sales of 215 million. The segment earnings were 45.6 million, compared to 48.6 million last year. Aircraft Engine System's 2006 earnings reflect higher R&D expenses of 5.5 million, due to investments in systems development programs for our customers. Last year's earnings included a 3.8 million gain on the sale of certain product rights.

Now I would like to focus on certain specific elements of our consolidated financial statements. Manufacturing margins, or net sales minus cost of goods sold, improved to 29% in the third fiscal quarter of 2006, up from 24.4%. This improvement is largely due to previous investments in our product portfolio, productivity improvements and the completed actions we took to consolidate European operations in our Industrial Controls segment.

Selling, general and administrative expenses increased from 9.2% of sales in the third quarter last year, to 10.7% in the current fiscal quarter. This reflects increased accruals for legal matters and professional services and the effect of new accounting standards with respect to stock compensation.

Research and development costs in the third fiscal quarter of 2006, increased to 16.8 million, or 7.7% of sales, from 12.8 million or 6.1% of sales in the prior year. This is a continuing result of our increased investment in systems development for programs for our customers in both segments.

Total depreciation and amortization expense decreased to 22.3 million in the first nine months of fiscal 2006, from 24.3 million in the prior year. The decrease in expense is primarily due to the effects of our European restructuring activities on capital investments in that region.

Our capital expenditures were 19.7 million in the first nine months of 2006, compared to 16.3 million in the prior year. We now expect our full year capital expenditures to be approximately 32 million.

Our tax expense in the current year included the valuation allowance change mentioned previously, which significantly benefited our third quarter and year-to-date effective tax rate. We expect our ongoing effective rate for the fourth quarter to be approximately 34%.

To turn briefly to our balance sheet, working capital increased to approximately 255 million at June 30, 2006, compared to 241 million at September 30, 2005. This reflects our continued strong operating earnings and resulting cash flow.

Our total debt decreased during the first nine months of this fiscal year by approximately 22 million, to 74 million at the end of the quarter. The ratio of debt to debt-plus-equity was 14% at June 30, 2006, down from 18% at September 30, 2005.

Approximately 452,000 shares of Woodward stock, at a total cost of 14.6 million were purchased in the first nine months of this year, primarily in the third quarter, under a Board authorized stock repurchase program. Yesterday, the Board authorized the additional repurchase of up to $50 million of outstanding shares over the next three years. This new authorization replaces the prior stock repurchase program.

In closing, I would like to comment on our outlook for the current year, fiscal 2006. We expect our Industrial Controls segment sales for fiscal year 2006, to be essentially flat when compared to last year. In our Aircraft Engine System's segment we continue to anticipate 7% to 9% sales growth for the full fiscal year.

For the Company as a whole we anticipate sales growth of 3% to 6% for the full fiscal year, as stated in our April 2006 conference call. We expect net earnings to be in the range of $1.67 to $1.75 per diluted share, as previously reported, exclusive of the legal matters and tax valuation allowance change mentioned earlier.

Now I will turn the call back to Tom.

Thank you, Bob. This part of our call, I'm going to be referring to the presentation that is out on our website. Frequently, Bob and I get asked, with your strong cash flow and strong balance sheet, what are you going to do with that? This presentation I'm going to walk through quickly, is about growth and about how we intend to invest the cash flow of the Company going forward.

If we start with the first page, which is labeled Our Strategic Focus, as we've shared with people in the past, Woodward's strategic focus is around energy control and optimization solutions. When we look here is that the control of fluid energy, combustion, electrical energy and motion control is critical to improving the efficiency, reducing emissions and the operability of power equipment. And as we refer to power equipment, that's engines, turbines, compressors, gen sets and industrial vehicles.

Where we're looking is the accurate and precise control of this energy is the focus we're going to maintain going forward. The way we go to market today is we leverage our technologies, which are listed here, with optimum components. We always look and say we want to have the best components in the industry, and then add value through systems integration, which has been a big strategy of ours.

Our prime path to market is through the OEMs and the equipment packagers. We continue to do that. And through those customers, we end up in the four key markets that we always report on; power generation, transportation, process industries and aerospace.

If you look at the following page, this is still our prime focus. Number one growth initiative is to strengthen and expand our core. We really look at two strategies here. The first is what we refer to as managing the core. And that really comes down to day-to-day activities and that's our multigenerational product planning, ensuring we have the right products for our customers' applications in the near-term.

Working to gain share with our current customer base and develop other customers in our core market and to attach ourselves to or customers in a partnership fashion to long-term agreements.

And one of the most critical factors in our industry is operational performance, as we always refer to as QDRC, which is Quality, Delivery, Responsiveness and Cost.

The second area we focus on in our core is growing the core. To date, our primary growth strategy in our core business is around implementing our system strategies in each and every market we participate in. Through that strategy we're developing new products to compliment opportunities and we're also creating new system opportunities.

So this is our prime focus we do intend to continue and see a lot of opportunity to grow within our core.

In addition to our core, if you go to the following page, we've launched into growth initiatives in market adjacencies. And really the way we're looking at growing into market adjacencies is to start in our served markets and look where we could apply energy control and optimization solutions that are adjacent to our current products.

And what I'm going to do on the next two slides is show you where we intend to grow in market adjacencies, so you have an idea of what our strategic intent is going forward. So if you go to the next page, on the far left-hand corner you should see Power Generation.

Before I start with this slide, I kind of want to explain a little bit. We're starting with the end-market that we report on, targeted market segments and applications, and then which energy control solution technologies are we applying into that market.

Secondly, if you look, areas that are highlighted in black or black lettering, those are areas we're participating in today. A light colored or gray lettering on the chart means areas we're not going to focus on and where you see the green-gray boxes, are areas we're identifying for growth.

So if you look at power generation, today we're very strong in what we would refer to as the generation side. This is really equipment used in distributed generation or base generation. Within these target applications, you could say the renewable market is something we're interested in, with our current prime focus being on expanding in the wind business. And this is what we would refer to as applying our electrical energy control solutions.

The generation business is large. We've been participating in it for many decades and we're going to continue to look in that area. But along with the generation of power, is the distribution of power. And this is a new area where we've started to explore, started to sell some products.

The best way to say distribution is taking the power from the generation source and bringing it to the user. And within there we're not really going to look at the transmission side of that, what we're going to look at is providing control solutions to equipment packagers that are doing power distribution applications in plant type of environments. So that's going to be a growth area.

We've looked at that market and we believe there's about a $2 billion market opportunity out there and it's one we're going to look to pursue. Again, the application of our technology will be around our electrical energy solutions and also motion control solutions.

If you go to the next slide, in the far left-hand corner you'll see process industries. Today, in the process industry market, we primarily play in the compression and the steam applications and as we've always highlighted, most of our sales are in oil and gas and that's all through the compression application.

A very large part of the process industries is the what would be designated the process automation market. It's a very large market, sometimes with a size put on it of about $50 billion. Within that market though, we're really looking at growing and leveraging our valve system and actuation technology. And that would be applied to balance a plant's equipment. And again, here we're going to look at how to bring these products to equipment packagers within the process industries market. And we see very sizeable opportunity for our technology.

Some of you that have listened in on previous presentations we've made, you've heard us refer to the products called turbine auxiliaries. This is within this balance of plant process automation type area and it's a business we're already launching into.

The next page, on the far left-hand corner you see transportation. And in our transportation segment we always refer that we serve the locomotives, the alternative fuel market segment, off-highway and marine. What I'd ask each of you to do is go to the next page, because I really just want to highlight the marine market.

If you go to the next page where you see the marine market, what you realize is with ships, is that I always refer to them as floating power plants and floating process plants. So when you see this chart, what you see is that today we participate in the propulsion side. That's really on the large diesel engine or gas turbine applications. And we do participate in the marine market in the power generation, or what they would call the marine auxiliaries, to the generation side.

But just like in the power generation market, there is power distribution through a ship, and we're going to look to leverage what we're going to do in the power generation market over to the marine power distribution market.

And then also you see the same activity around the process automation side on a ship and we'll be looking, again, around valve systems and actuation systems and support of shipbuilders.

And finally, the last area where we'll be looking for [development] is in our aircraft segment. Really, this will be around our core activities tied to aircraft, which today is all on the propulsion side. We look to grow into some application that could be [entered] in the cells where we would have actuation of valve systems applied in the cell. We are very good at fuel systems. We'll be looking for opportunities to expand into airframe fuel systems and also, motion control applications around the vehicle. So this will be targeted areas.

It's a quick overview, but wanted to give everybody a little bit of a feel that we have some real ideas and opportunities at how to leverage our technologies, our core and be able to take us forward, both in expanding our core into some new markets to accelerate our growth rate.

So with that, that concludes our comments on the business and the results for the third quarter. Operator, I'd like to turn it back to you to open it up for questions.

[OPERATOR INSTRUCTIONS] [Ernie McIntyre] with Mirage Capital.

A couple of questions. How are you guys streamlining the selling process to reduce order inaccuracies?

Could you restate your question?

How are you guys streamlining the selling process right now to reduce order inaccuracy?

It's a question I guess I'd ask. I don't feel like we have a problem with order inaccuracies. So, can you elaborate on your question?

In terms of how are you now allowing your sales reps to provide better quotes, configure your products better for your customers, so they'll more effectively do business with you?

We have, obviously, a variety of tools. As you know, our products are usually involved with very large systems that are very closely engineered with our customers. So, normally, the types of issues you might see in companies with variety of products that could result in inaccuracies at the point of sales contact, isn't quite the same with us. We are very closely involved in the engineering process and by the time we get to an actual order, there's very little opportunity for inaccuracy in that order.

Okay. And regarding DSOs over the next year, how do you guys plan to reduce your DSOs?

Right now we think we run a pretty solid receivables program and that--we monitor and we work it every day, every week. We're not sure there's going to be a large change in our receivables, given our business and the performance we have today on it. Our goal is to keep it where it is, try to do slight improvements, but we think it's already in pretty good shape.

What would you say your top challenge is and how do you plan to tackle that [head-on]?

On receivables?

Just overall your top challenge as a Company?

What we always say, right now the top challenge for the Company is to profitably grow and ensure that we're in a good position for the future changes in our industry and that we're identifying profitable products and activities to pursue.

JB Groh from DA Davidson.

I just had a couple of housekeeping type issues. Could you give us the depreciation and amortization number for the quarter?

Yes, I thought I spoke to depreciation and amortization. Hold on one second. For the quarter it's 7.6 million.

And then would you mind repeating the stock repurchase in the third quarter? You gave some numbers.

The dollar amount was approximately 14.6 million.

Okay. That was how many shares?

452,000 shares, average price of about 32.30.

Okay. And this new authorization replaces the old? It's not in addition to what's remaining on the old authorization, correct?

Exactly. We were down below 10 million remaining, so we figured we'd just cancel the old and reinstate a new.

And then on the unallocated expenses that kind of popped up versus last year, what's that attributable to? I know last quarter you had the 5 million accrual. What happened this quarter in terms of year-over-year comparison?

It's largely the same items. The legal matter, so now it's a total of 8.5 million are in there. Our stock comp is there, so vis-a-vis the prior year, that's in there. And lastly, last year, the curtailment gain.

Right, that swung it the other way. So, in other words, to get your implied fourth quarter guidance, we adjust by 8.5 million, not 5 million for the accrual?

Exactly.

Ian Fleischer from FBR.

Could you just touch on the weakness in China, you know, what specifically was causing that and how long you think it might last going forward?

The last part of that question, we really don't know. The weakness itself--and I'll call it hearsay from our sales teams talking with customers and others, are two main areas. One, that the order pace, the order volatility in China is much larger.

We had a fairly large order, I believe it was in the fourth quarter of last year, that really extended out in terms of their needs. And in addition, they're entering a new five-year plan, and as we understand it, there is kind of a period where they a lull, they initiate the new five-year plan and then they kind of take off from that point. We're kind of being hit with both of those items at the present time.

We wish we knew more about when it would come back. The underlying goal, which is a dramatic improvement in overall emission levels from old diesel engines in buses, is obviously still first and foremost one of the things that they're working on. So we anticipate that this will come back, but at this time we have no future guidance other than longer-term.

And is there anything else within the industrial segment that's causing sales to be flattish?

Right now it's really this mix of items that we have that are improved and growing nicely, offset by some items that are on the downside. So, in particular, power distribution is an area that is showing good improvement for us. Turbine auxiliary is showing good improvement. But they happen to be offset at this point by large gas turbines and the China issues.

We do see and expect the large gas turbine market to pick up in our 2007 year, based on our customers' forecast and activity. We kind of had a little bit of a slump here in '06 with that and as it's really, as Bob highlighted, attributed to those two main areas, while the other part of the business is growing in about the 5% range.

Okay. And just on the aerospace part of your business, what was the nature of the expenditures there? Is it just typical R&D items or is it something beyond that?

It's R&D. If you go back a little bit in my part of the presentation. We won a lot of programs over the last two years. And to support the development of those programs has required us to add significantly to our engineering and development resources. And so we're up at a level we think is sustainable. With the win rate, which is very good and we're very pleased with, we had to back it up with R&D expense.

Okay. And just one final question, so that I'm clear, with respect to your EPS guidance. How much do you attribute to the legal matters, as well as the tax valuation allowance? How much should I adjust your $1.67 to $1.75 guidance for?

Well, the $1.76 to $1.75 would be without those items. So, the legal matter itself, just kind of on a straight math basis, taking the 8.5 million and roughly the exact number, 35 million outstanding diluted shares--I think that number is actually disclosed in some of the other material, so you can see that number. That works out to approximately $0.24 for the year.

And that would be the same on the other items that we've called out, from a pretax basis. And then obviously taking the tax impact of those items as well.

The tax impact should be the 30-35.5%?

We're probably, in terms of what we use, a little bit north of that, call it in a 38% marginal rate sort of area.

Okay, thanks very much, that's helpful.

[OPERATOR INSTRUCTIONS] Tyler Hojo from Sidoti.

I was wondering maybe if you could talk a little bit about the margin in industrial? Obviously pretty strong there. I was wondering what the impact was as far as sales mix and if that's sustainable going forward or if you expect that to come in a little bit? Just your comments there would be helpful.

Tyler, we had a very good sales mix quarter, as you can see with the results. What we really are looking at would be--you know, I continue to use our guidance, which was for the year would be approximately 10% segment earnings. And obviously, year-to-date we're at 10.4. So, we're anticipating to not be a large deviation from that.

Going forward, obviously, we're looking to improve and return to our historical levels as we've stated in the past. So I feel real good that we're on the right track, but I'd use more of a gradual improvement. This quarter is a little more of a step change, but it should be more gradual over time.

Okay, good. And then, before, you guys mentioned large gas was expected to come back in fiscal '07. If you go back and listen to what GE said on their conference call, they essentially reaffirmed their outlook for gas turbines being back-half loaded for their deliveries. I was wondering why your expectation isn't that some of that hits in your fourth quarter?

It actually does and we actually saw--I think we made a comment that it up-ticked slightly this quarter as well. When they say their last half, they're out of sync with us by a quarter. So we are seeing the up-tick. It will not reach, for us, during our fiscal year, it will not reach, one, our original expectations, but it does come back and it will come back more in the first quarter of our next year.

Just out of curiosity, what do you think your normalized growth rate would be within that segment if you kind of include the demand returning for the alternative fuel buses as well as large gas turbines really starting to come in? Could you give me just a generalized growth rate?

I think in the market if you had more of a steady--the thing I'm trying--if you recall from previous calls is they order in batches and then they bleed off the inventory. The Western companies don't do that, we're on just-in-time systems. So, if you put it all together, I'd be looking more like a 3 to 5 right now this year.

And improving that or staying constant?

It may tick up. We're going to give guidance later in the year.

Gregory Macosko from Lord, Abbett.

If you could, speak a little bit about the industrial demand and the economy here and the demand there? Are you expecting--has your outlook declined sequentially from kind of what you were expecting in the last three to six months or is this kind of as expected?

This is as expected, Greg. Well, if you say over the last three months, we started looking at the order cycle, when some of the stuff is going to rebound, the comparison to last year. And we started saying we'll be essentially flat.

As Bob highlighted a little bit during his discussion, really if we talked about these couple of applications in China in our large industrial gas turbine business, excluding those, we'd be more around a 5% growth rate. So the underlying industrial market is still moving along pretty well for us. We're pretty bullish on power generation. If you look at the off-highway industrial vehicle market and the marine market, we think they're going to continue on well.

So it's really the year-over-year comparison where we have some big orders this year and in fact, they dried up. So we think we're going to be back, looking at a reasonable level of growth on the industrial side with better than normal growth on the aircraft side.

Okay. And with regard to China, I guess there was a project that had been cancelled previously, I guess that's not coming back?

It wasn't really a project cancelled--well, there is Shanghai Diesel is one of our programs--is a program that is not continuing. It wasn't really cancelled, but it's just not continuing from our standpoint. And then the remainder of CNG and LNG in China is just this order volume issue.

Do they have--as I remember, there were some issues with they overbought previously, I guess inventory or not-needs and is that still the case?

That's what I meant by they're bleeding off the inventory, Greg. They ordered a huge amount, which we were able to deliver last year and those systems were sitting in inventory. They really didn't have their production line synchronized with their order practice. They are bleeding that off. So we still expect to--we are the system supplier for the CNG and LNG applications. We expect to start seeing them bleed the inventory down through the remainder of this year and we should start seeing new orders coming back.

And then you mentioned the European consolidation. I assume that's all done and that is really one of the things that's helping, I guess, industrial margins quite a bit?

That's correct.

Okay. And that was completed the second quarter or when was that done?

At the end of the second quarter.

So we should feel that for another three quarters, I mean the change year-over-year from that positive, is that correct?

The change is going to continue.

Okay. And I assume you'll never stop changing there and keep focusing. Okay. And then with regard to the R&D now, have the dollars peaked at this point?

That's a good way to phrase it, Greg. I believe the dollars in our Aircraft group are at a level that is sustainable for the development activity in our plate.

So they're going to stay at this level?

For a while. We have a lot of programs still and I think all of you know that these programs will really take about three to four years to go from when we get the development contract to entering production. So yes, it will be a couple of more years of this level of R&D.

And then the distributed power, you're still optimistic about that?

Yes, we see it right now--you know, I visited some customers in the last couple of weeks and without going into which ones, but some of the larger ones have their gen set business sold out for the next year. They've already got orders for the whole year. So, I just think it's a robust market and if you look worldwide.

When we talk distributive power, that's really the--primarily it's 10-megawatt below. By true definition it would be 50-megawatt below. But really the 10-megawatt, the 5-megawatt and below, that's where you're getting into diesel and gas engines and used extensively throughout the world outside the US and Europe, and it looks strong.

And the power demand in Asia, if you say China, India, Indonesia, is growing and we expect that they're going to continue to use more distributed power than putting in the grid system that we have over here. So, we're bullish on that market for the long-haul.

And then you mentioned, I believe last quarter, Eclipse. Are those orders continuing or did they take some inventory there or how's that?

I think as you've read, Eclipse has had a delay in the program and not due to Woodward. Our product is on the shelf in inventory.

Inventory at their location or at your location?

It's inventory at Woodward.

Okay, so you're holding that.

We're holding that at the moment, yes. So we're optimistic to start shipping, here in the fourth quarter.

Okay. Because there was an article this morning in the New York Times about how they're producing and I just--I mean, you have made deliveries, I assume?

We've made prototype deliveries and some of the early flight test deliveries. The production deliveries, as it was stated, were delayed for a little bit and we expect them to start here shortly.

Okay, good. And then finally, just with regard to the legal issues, I mean, you're saying that we're pretty much done with accruing for that or--explain that again, if you would?

Probably the operative word there being substantially complete. There can be--the matter is not--it is going forward, but we believe any adjustments to the accrual would be relatively insignificant compared to the balance already accrued.

Do you have any timeframe for when this is finally settled?

No, we don't at this time.

Matt McGeary from Sentinel Asset Management.

Could you talk a little bit about the marine market? I'm just trying to get a sense of sort of what size that market is and what specific applications you guys provide there or hope to provide there?

The marine market is quite large. So we really break it into a number of segments. What we're really looking at is commercial marine and military marine and you could also add on top of that the cruise market. So we're really talking about larger vessels. And the majority of the commercial marine market is powered by propulsion engines or diesel engines. And on diesel engines we provide a wide range of products to the manufacturers.

On every--if you want to say every commercial ship there would be 2 to 4 auxiliary engines and these engines are generating power electricity for basically running the ship, and we provide, on those applications, again, controls for the diesel engine and we do today, some gen set controls, so controlling the diesel and generator set. So that's our current business.

And then if you look at the cruise ship market, a lot of cruise ships have either diesel engines, but a lot of them use gas turbines, so that they have cleaner emissions. On any of these ships with gas turbines, Woodward is providing entire control systems for both the electronics, the fuel system and on some of them, the combustion system. Again, around the machine.

What we're looking to do is move beyond just the gen set, if you want to say on a commercial ship, and go into the controls that will be used to distribute the power around the ship. That's one of the growth areas we're talking about.

And then we're looking at opportunities for valve systems and actuation systems that would be used in the various processes on the ship. And a ship has a tremendous amount of--a thousand actuators to manage the ship processes. So, that's where we're looking to grow.

The first area on marine will be around the power distribution, because we're already in there and it's just a quick adjacency, so that's the primary first focus. And then we'll be further quantifying the process side here [soon].

Thanks. And can you also do sort of a similar--I'm also trying to understand this distributed power. Just give me a sense, if you would, maybe an example or two, of how these things are used, who are they used by?

Distributive power, one, you know, an application that gets talked about frequently is anything to do with telecommunications. You know, we had a big boom back when the tech industry was going up, so if you look at like datacenters, a lot of these are self-powered.

That would be called distributive power. They can't afford the reliability of the grid. So those all tend to have their own power, if you want to say, their own distributed power station.

If you get into like rural areas, and this is using an example like in India, you get out of the main cities, there is no power grid. So they're going to have to set up their own power, so they set up a distributed generation system. This could be a 2-megawatt diesel engine gen set and could power a village. So there's an extreme application there.

We also lump into this area backup power, if you want to say emergency power. Every hospital, a lot of factories, all have backup power. If you think of what happened down with the hurricanes, you know, that caused a boom in demand when the grids went down for days/weeks. People don't want to be caught that way anymore, so it's a side of distributed power which is we really produce backup emergency power, but it kind of gets lumped into that same category.

So those are some of the applications and if you start thinking about that, there's a huge demand in the Western world and then in the developing world. I always use the analogy, which I think helps a little bit. In the developing world, they're not really setting up telephone lines allover the country. They've jumped straight to wireless.

Distributed power is kind of the same thing. Are they really going to set up a power grid covering all these countries? We think that you're going to see a lot more, if you want to call it micro-grids or distributed power, where they don't put in all that transmission and expense.

Just lastly, how much visibility do you guys have in your large gas turbine business? I would think just the nature of that product you would have a fair amount.

There are really two parts to that business. If you say the new machine build, we have a pretty good idea, because the big turbines do have a long lead time. So we have a pretty good feel.

But, the nature of our product, and one of the major products we sell into the large turbine is fuel nozzles that go onto the combustion system. These products--we do like them, because they wear out, in effect, they burn up. The issue then becomes, what are the spare sales and it's referred to sometimes as capital spares. And that's going to depend on the amount of hours being run.

Sometimes the number of hours being run on a gas turbine is going to be determined on the price of fuel. Because some utilities and others can switch between fuel types in terms of I run my gas turbine, or I run my coal plant or other means of adjusting.

So, in the last year, we understood pretty well what the new build rate was, but the capital spares were down significantly, due to lower operating hours put on the turbines. Now we think with gas prices somewhat stabilizing, the demand going up, and then also the new builds going up, that's why we're looking and saying okay, we think, looking forward and taking the same public data you've seen from GE and others, that the demand is going up and it's going to increase.

So, the big fluctuation--I mean, just to summarize it, the big fluctuation was in capital spares.

And like on a normal usage basis, how long do those things last, those nozzles?

Normal usage, they're going to be 18-months to 3 years.

Peter Lisnic from RW Baird.

Sorry about that mix-up at the beginning there. I don't know what happened. Bob, if you could, just a couple of clarification questions first. The R&D spending that you've mentioned during the call, has any of that been capitalized or is that the actual expense number?

That's the actual expense number.

Okay. And then on the legal, is there a tax? Should we, I guess use a tax rate on that legal if we're going to back that out?

Yes, it would be the same marginal rate that I mentioned earlier.

Okay, so there is a deductible amount for it. Okay. And then if we can maybe just talk about the growth platform in terms of the presentation that you made, those growth opportunities that you talked about, how much of that is organic or where is the organic opportunity and how much do you think you have to acquire, I guess?

Thanks for the question. I probably should have stated this. Most of what I showed you, we can move into with some organic activity, but we definitely look at a combination of organic acquisitions and potentially joint ventures to accomplish those goals. So it's the full range.

Like today, I'll just use the example, we talked about the process automation market. We're in it today. We're shipping these large turbine auxiliary valves. By definition, those are process automation valves.

So we're in it today, but we definitely look at the fact that we want to accelerate the growth rate there, so we'll be concentrating on ways to do that. Same thing with the other categories around power distribution. We're in it today just slightly. We're going to continue to organically grow and we're going to continue to look to grow inorganically.

Okay and are there specific markets, I guess, where you don't have the core technology, where you actually have to go out and acquire it?

I would say the only one that I show today that would be very very difficult is the aircraft market. And the reason is not that we couldn't do it, but the industry is so consolidated, there are excellent suppliers in every category. The airframers are not looking for new suppliers and we would have to acquire our way into those businesses.

And it's probably pretty expensive to do so at this point.

Well, they get rich valuations. I mean, it's an excellence market and the categories I highlighted there are ones where we think we could leverage technology, products, manufacturing capability, so that if we moved into one of those categories you'd see some synergistic activity.

But that's the market that the barriers to entry, due to supplier consolidation and actually airframer consolidation alike, would require an acquisition.

Okay. And then I'm still a bit confused on the industrial, I guess. Maybe not necessarily confused, but how big of a decline have you seen in that bus business? Because I guess what I'm hearing is that the rest of the markets, outside of bus and large gas turbine are doing relatively well. So bus has to be down a very significant number, if I'm doing the math right.

I think, to use the numbers--and we did not--there really hasn't been a significant change. I think the number we used last quarter between the two of them was in the neighborhood of a 30 million annualized impact, kind of a two-thirds/one-third, two-thirds on the turbine side, which we're seeing come back slightly. It's not a huge comeback at this point, so that's slight comeback. And the balance being the China diesel.

[OPERATOR INSTRUCTIONS] Tyler Hojo from Sidoti.

I was just looking for a little bit of clarification here on the R&D. What has changed from essentially $13 million in the second quarter, which you guys thought was going to be kind of a go-forward number, to now, where you think almost $17 million is a go-forward R&D rate?

Well, maybe the first part of that, Tyler, is we would not want to necessarily indicate that's entirely go-forward. The R&D spending, first off, it's made up of both industrial controls and aircraft. We think that the dollar spend in the aircraft side is probably at a level that will continue. Not necessarily on the industrial control side.

There is some time period--there is a slight bump this quarter overall. There will be some moderation. I wouldn't want to take the 17 and extrapolate that forward.

Tyler, maybe to highlight, we expense all R&D, so we don't capitalize any. So I think that's good. It's conservative, but it's a good way to manage the business. What you have happen is--I would use more the nine-month run rate.

The reason being, we can get timing and actually if we have to produce prototypes of expenditures--you know, in the R&D world we could get a big expenditures and that's a little bit what happened in the third quarter. I would smooth that out and that's more of what we meant by those comments.

Okay, so something in the mid-13 or low-14 range going into the fourth quarter, you think was reasonable?

If you took probably somewhere between the 17 and the 13, it would probably be roughly where you're going to be at.

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

Okay. Thank you for everybody that joined us today. And we look forward to talking to you soon in the near future. Thanks.

Ladies and gentlemen, that does conclude our conference call today. You may now disconnect your lines.