Woodward Inc (WWD) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company third-quarter 2007 earnings conference call. At this time, I would like to inform you that the 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 is 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. Sir, you may begin.

Thank you, operator. We would like to welcome all of you to Woodward's 2007 third fiscal quarter conference call. In a minute, Tom will talk about our business and strong performance this quarter. I will comment on today's earnings release, and at the end of our presentation, we will open it up for questions. For those who have not seen the release, you can find it on our website at www.woodward.com.

I would also like to point out that we have included some visual presentation materials to go along with today's call that are accessible on our website. To access the presentation for today's webcast, 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, select the webcast link for today's call. You can view the slides onscreen or download the materials.

An audio replay of this call will be available through Wednesday, July 25, 2007. 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 webcast will be accessible on our website for 30 days.

Before we begin, I would like to provide our cautionary statement as shown on Slide 3. In the course of this call, when we present information and answer questions, any statements we make other than actual results or historical 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 material difference include, but are not limited to, future sales, earnings, business performance, and economic conditions that would impact demand in the industrial and aerospace 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 earnings release and our public filings with the Securities and Exchange Commission, including our 10-K for 2006.

Now I will turn the call over to Tom to discuss our progress toward achieving our strategic goals in the third quarter.

Thank you, Bob, and thank you all for joining us today. This quarter's strong financial performance is an outcome of our strategic direction and the execution of our business initiatives. Let me begin by highlighting our results in the third quarter.

Sales were up 24% over last year. Our earnings before income taxes increased to $37 million. Our net earnings were $0.68 per diluted share. Our Industrial Control segment earnings improved to 12.9% of sales, and our Aircraft Engine Systems segment earnings improved to 23.7% of sales.

Our markets continue to show strength, both in the Aircraft and Industrial segments. Global infrastructure growth in power generation, marine and air transportation, as well as global commodity demand, continue to drive our business. Our product portfolio, focused on energy control and optimization solution, is strategically placed to provide the types of systems being sought in our challenging but growing markets.

Woodward's previous investments in selected products and platforms to address the market challenges of efficiency and in environmental impact have allowed us to deliver the financial performance we are reporting today. Specifically, in our Industrial Control segment, sales were up 28%, including organic growth of 8.7% from the prior year this quarter. Segment earnings were 12.9% of sales, up from just under 12% in the prior year. This improvement is the result of increased sales levels and our focus on a product portfolio that delivers improved margin performance.

Power generation and marine applications within Industrial Controls were particularly strong this quarter. Also, the increase in use of CNG, LPG, and other alternative fuels resulted in higher demand for our gaseous fuel system products.

Our electronics portfolio, complemented by our first-quarter acquisition of SEG, also contributed to our continuing positive results. Increased electrical infrastructure demand is driving sales growth in our digital controls and AC measurement products, and the increasing use of wind turbines to satisfy a portion of the global demand for electrical power is driving significant growth in our inverter business.

As a whole, our Industrial Control segment earnings continue to improve. Productivity increases and a favorable product mix this past quarter helped us realize better margins. We've been able to leverage our increased sales and process improvements directly to the bottom line. We also continue to maintain and enhance our profitability through manufacturing efficiency on a global scale.

Our Aircraft Engine System segment had an excellent quarter. Sales were up 16% compared to the prior year's third quarter. Earnings were almost 24% of sales compared to slightly less than 19% for the prior year period. Sales remain strong for our system components in all aircraft market segments. Continuing strength in the commercial after-market helped our margins exceed their historical range.

We're in the midst of launching new systems on platforms such as the General Electric GEnx Turbine, GE's next-generation propulsion technology which has become GE's fastest-selling engine in their history. Our very light jet applications on the Eclipse 500 and the Cessna Citation Mustang are also now entering service. Our military aircraft sales remain strong as well. Our products support proven platforms such as the T-700 engine on the Blackhawk and Apache helicopters, as well as next-generation platforms such as Joint Strike Fighter.

In summary, our strategy to provide our customers with complete system solutions is proving successful and delivering improved financial performance. Now I'll turn the call over to Bob to review our third-quarter results and provide an update to our financial outlook.

Thank you, Tom. Good evening, everyone. At the Woodward consolidated level, net sales for the quarter were $269 million, a 24% increase over last year's third-quarter sales of $217 million. Consolidated earnings before income taxes for the quarter increased 72% to $37.1 million compared with $21.6 million in the same period a year ago.

Net earnings for the quarter were $24 million, or $0.68 per share compared with $28.9 million, or $0.82 per share for the same quarter a year ago. The items highlighted in the table in the earnings release are a favorable prior-year impact, for a deferred tax evaluation adjustment of $13.7 million, or $0.39 per diluted share, offset by an after-tax expense of $2.2 million related to a legal matter equating to $0.06 per share.

Net sales for the nine-month period were $752 million, a 21% increase over the same period last year of $622 million. Consolidated earnings before income taxes for the nine-month period increased [to] 64% to $95.2 million from $57.9 million in the same period a year ago. Net earnings for the nine-month period were $62.1 million, or $1.76 per share compared with $52.8 million, or $1.50 per share for the same period a year ago.

The earnings release table also highlights the 2006 year-to-date impact of the deferred tax valuation adjustment of $13.7 million, partially offset by after-tax expense of $5.3 million or $0.15 per share related to the previously mentioned legal matter. Our year-to-date results for 2007 include an after-tax expense of $2.5 million related to an adverse arbitration ruling.

Our Industrial Controls segment net sales for the quarter were $177 million, an increase of 28% over third-quarter sales of $138 million a year ago. Industrial Controls segment earnings in the third quarter of fiscal 2007 were $22.9 million compared with $16.4 million for the same quarter a year ago, an increase of almost 40%. This improvement is primarily attributable to continuous improvement efforts related to operating margins and the positive impact of higher sales on our fixed cost base, offset somewhat by higher research and development expenses in the quarter.

Industrial Controls' net sales for the first nine months were $489 million, an increase of 24% over the first nine months sales of $394 million a year ago. Industrial Controls segment earnings in the first nine months of fiscal 2007 were $63.3 million compared with $41.1 million for the same period a year ago, an increase of 54%. Segment earnings as a percent of sales were 13% in the first nine months of 2007 and 10.4% in the prior year.

Aircraft Engine Systems net sales for the quarter were $92 million compared to $79 million a year ago, an increase of 16%. Segment earnings for the quarter increased almost 48% to $22 million compared to $15 million for the same quarter last year. These results reflect a favorable product mix due to increased after-market sales, offset by slightly higher research and development expenses in the prior year.

Aircraft Engine Systems net sales for the nine-month period were $263 million compared to $227 million a year ago, an increase of 16%. Segment earnings for the nine-month period increased 34.7% to $61 million, compared to $46 million for the same period last year. Segment earnings as a percent of sales were 23.4% in the nine-month period compared to 20.1% a year ago.

Now I would like to focus on certain specific elements of our consolidated financial statements. Gross margin as a percent of sales improved to 30.8% in the third quarter of 2007, from 29% in the third quarter of 2006. In the first nine months of 2007, gross margin as a percent of sales improved to 30.8% from 27.9% in the first nine months of 2006. This increase reflects higher sales on our fixed overheads and the result of continued cost reduction initiatives.

Selling, general and administrative expenses increased to $27 million, or 10.2% of sales in the third quarter of 2007, from $23 million or 10.7% in 2006. Although selling and general administrative expenses increased to $84 million in the nine-month period from $70 million in 2006, they remained constant as a percent of sales.

Consolidated research and development expenses for the third quarter of 2007 were consistent with the third quarter of 2006. Research and development costs of $47 million in the nine-month period compared to $42 million in the same period a year ago. As a percent of sales, research and development costs decreased slightly period to period on the increased sales volume.

Total depreciation and amortization expense for the first nine months increased to $27 million in 2007 from $22 million in the prior year. Our capital expenditures were $23 million during the nine months ended June 30, 2007, compared to $20 million during the same period in 2006. We continue to expect capital expenditures for the full fiscal year to be about $32 million.

Income taxes for the first nine months of 2007 included a benefit of $1.2 million, or $0.03 per share, related to the retroactive extension of the research and experimentation credit. Income taxes for the first nine months of 2006 included a benefit from a change in the valuation allowance related to deferred tax assets of $13.7 million, or $0.39 per share. We continue to expect the full year tax rate to be in the range of 35% to 37% for 2007.

To turn briefly to our balance sheet, working capital at June 30, 2007 increased from September 30, 2006, primarily as a result of increases in inventories and accounts receivable, partially offset by an increase in short-term borrowings and accounts payable. Our total debt was $67 million at June 30, 2007, compared to $74 million at September 30, 2006. The ratio of debt to debt-plus-equity was 11% at June 30, 2007, compared to 13% at September 30, 2006 and 14% at June 30, 2006.

Turning now to our outlook. We currently anticipate that our financial results for the 2007 fiscal year will be at the higher end of our outlook of $2.35 to $2.45 per share last stated in April. Looking forward to 2008, we believe our sales in the aircraft and wind markets will continue to outpace relevant market growth rates, and our other industrial businesses will keep pace with their respective markets.

As discussed, we will continue to leverage our increased sales directly to the bottom line. We plan to provide a detailed outlook for 2008 when we report full year 2007 earnings.

That concludes our comments on the business and results for the third quarter 2007 earnings conference call. Operator, we are now ready to open the call to questions.

Thank you. (Operator Instructions.) Your question will be taken in the order it is received. Please stand by for our first question. We have a question from Ned Armstrong from FBR and Company.

Thank you. Good evening. My question involved the opportunities you have in wind power business. I mean, clearly, that's a very visible market to a lot of us, and it has a lot of opportunity. I'd just like to hear you comment on how you think you can grow in that market, what adjacencies to where you're already at are appealing to you, and how you intend to address that growth vis a vis acquisition or additional investments into the existing business?

Okay. Yes, we definitely find wind as an attractive market. Our products we're offering in there today are digital controls, protective relays, and the power inverter -- the main device that takes the electricity from the generator and puts it onto the power grid. One of the ways -- we increased our sales here dramatically with the acquisition of SEG, and the opportunity we have with SEG is that they have a good customer base. That customer base today is really looking to go global. I mean, they see huge opportunities in Asia, particularly China, and then also in the U.S.

As part of Woodward now, SEG is able to tap into our global infrastructure. And what we're seeing is the ability to use our infrastructure, our operations in these regions to support the customer base, and with that support, we're seeing increased market share. So what we're going to do is aggressively try to capture more share, which we think we can. At the same time, the market's growing very rapidly. So right now, that's where we're concentrating on -- the growth in the wind market, and we're continuing to look at expanding our control business into that market. But we see substantial growth going into 2008 and beyond.

Okay, so just to rephrase to make sure I understood. You're really using the existing Woodward infrastructure and channels to broaden the penetration of your existing product line. And to the degree that you develop new products, it would probably be on the control side of the business, where you'd have existent functionality, so to speak.

That's correct, and we will also continue to update and expand the inverter business and introduce new products to that, so what I would call that is product enhancements and product improvements. So I think you have it correct, that that's how we're targeting it, and we see substantial opportunity by doing that.

Okay. Good. Thank you.

Our next question comes from Peter Lisnic from Robert W. Baird.

Good afternoon, gentlemen.

Good afternoon.

If I could just follow up on that wind question. Can you give us a sense as to how big that business is right now and kind of how you foresee it ramping over the next, well, 12, 24, 36 months? I just, I mean, we know what the contribution was, or what percentage of SEG was wind turbine. I'm just wondering if there's another significant portion of the business that we're not thinking about and you've got more exposure there, or are we -- I mean, is the SEG business your main exposure to wind, I guess is what I'm asking?

Yes. The first -- to answer that last point, the SEG business really expanded our sales in wind. We were selling some digital controls and protective relays into the wind market prior to that acquisition. So today when you combine the two businesses, sales into wind will exceed $60 million this year, and the growth rate -- we're looking at it right now. We're going through future forecast. But it's going to be well in excess of 30%.

Okay. All right. Fair enough. And then I just want to, you've alluded to a lot of these cost reduction programs driving margin improvement across the business. I'm just wondering if you could give us a sense as to where you're at in terms of implementing all these cost reduction activities.

In other words, you've shown very good margin improvement over the past several quarters. What I'm wondering is, how much more is there to go? Are we still in relatively early days of kind of [weaning] things out, and kind of ramping up the margin in both of the businesses to what would be conceived as a peak operating margin? Or are we kind of middle or later innings of that game, if you will?

Let me take that one. I think where we're at, if you can imagine kind of the learning curve effects of, you know, it was easier to go from 10 to 12 than it's going to be to go from 13 to 14, for example, in the industrial business. So it gets much tougher from here on out. We, the significant change factors, the large restructurings in Europe and Asia and so on, those are largely complete. From this point on, there's a lot of individual product margin improvement that goes on, where it can, going to continue to look for and consolidate infrastructure, our overheads as we go forward. Those would probably not be of the same magnitude as some of the things you've seen in the past.

So at this point, we think we're more in a continuous improvement mode than we are in a large restructurings mode any further.

Okay. That clarifies that. If you could I mean if you kind of look at the wind business as being above end-market growth, if you will, from a mixed perspective, is that margin additive? Or how should we think about the profitability in that business relative to everything else in Industrial?

Yes, well, what we've said at this point is that the margins in total for SEG have been roughly equal to the Industrial Controls margins as a whole. That will vary. Right now, wind -- given trying to make some market penetration and so on -- is not quite as high as the rest of that business, but it's not substantially below, either.

Okay. And what's your, if I could just could, one more. What's your visibility when we hear a lot of suppliers talking about -- and even some of the big turbine guys -- being sold out through '08 and into '09? Do you kind of have that same visibility?

They definitely, in terms of their order book, are booked, you know, and what we're seeing right now, though, is the expansion of a number of our customers where they are looking to open new operations both in Asia and in the U.S. And so as those plants open, they're going to expand their capacity. So they're looking to add capacity as we go forward here, so we think there's still expansion on that basis.

And by the same token, I would assume -- or maybe I shouldn't assume -- but are there any other capacity expansions that you would be planning to kind of address those customer needs as well?

Well, we're going to support our customers with operations in China, in the U.S., as well as with the present operations we have in Europe supporting the wind business. The positive thing going forward is we're able to not have to have a huge investment to do that, as we're going to be expanding that capacity within our existing facilities. So it's really more about putting the production lines in. We don't need to build buildings or do things like that, so we should be able to support that very quickly. And we also think that's going to be a big benefit to our customers, which, as I said earlier, I think will allow us to pick up some share.

Okay. Very good. Thank you for your help.

Sure.

Our next question comes from Tyler Hojo from Sidoti and Company.

Hey, guys. How are you doing?

Good. How are you, Tyler?

Good, thanks. I was wondering if you could provide a little bit more color, just in terms of the outlook. I know for the past couple of quarters you've been breaking it between Industrial Control and Aircraft, just in terms of year-over-year revenue growth and margin.

You mean for 2008, or just for the quarter?

Yes, just in terms of updating your guidance. You just updated the EPS, but not the revenue per segment or the margin.

Yes. If you take a look at the -- what is it? -- Slide 14, I think. There we kind of updated the individual pieces, and I would say from an earnings perspective, we went up slightly on Aircraft. I think last time we were 22. We've gone to 23.

Okay.

Industrial, 12 to 13, so you can see the other pieces, and same thing with the sales growth. Each of those is either at the top end of the range or slightly above where it was the last time we spoke.

Okay, but just in terms of 4Q EPS, it looks like you're -- I'm doing the math -- you're looking for a sequential decline in the EPS. Was there something one-time in nature that hit this quarter, or how should we be thinking about that?

Well, I think if you look at being at the higher end of the $2.35 to $2.45 --.

Right.

That should signal that we'd be flat to perhaps slightly up in terms of going for the remainder of the year.

Okay. And just in terms of SEG, would you say that that, to this point in your fiscal year, has exceeded your internal expectations?

Yes, without a doubt it has. We've been very fortunate that we picked up the business, we were able to secure some contracts with some of the major wind manufacturers, and locked in some additional revenue for the year. We have been able to put some resource on to that, and it has allowed us to capture higher sales levels than we planned at the beginning of the year.

Okay. And then I heard that correctly from the last question, or just in terms of $60 million in annual revenue for FY '07 in terms of wind?

Right.

With a growth rate in excess of 30%?

Right.

Okay. And do you have a free cash flow expectation for the year?

We don't have a expectation other than it will continue to increase. You can see on -- I think it's Slide 16 -- where we're at this quarter vis a vis last quarter. So -- last year quarter. We're up to $46 million in free cash flow at this point. There would be nothing to indicate that that won't just continue to grow.

Okay, great. And just one more for you. Just in terms of the alternative fuel buses, were there any delivered or ordered in the quarter?

Yes, we continue to ship every month on that. We have not -- you know, I think in previous calls, Tyler, we've talked about are we going to see a big order boom? We haven't. But we are shipping into Korea, into China, and it's continuing. So that business has come back some. It's doing fine.

Okay, great. Well, thanks a lot.

Okay.

Our next question comes from J.B. Groh from D.A. Davidson.

Afternoon, guys.

Afternoon.

A couple of questions. Some of them have been answered, but looking at the R&D kind of peaked out in Q3 and Q4 of last year. I mean, is it fixed -- say, they were past the peak on in terms of GEnx spending related to R&D spending?

I think a little bit, when you are seeing the quarter comparisons last year, we had what we call a lot of project expenses of material in the quarter, so we kind of had a spike. We do think we've come back to where R&D is going to hold, and one of the reasons we think it's going hold is that we see a lot of opportunities for organic growth. So we're going to continue to spend R&D to facilitate more organic growth, but we're not going to see any significant change off the rate we're at.

When you say rate, you mean as a percentage of sales or as a dollar volume?

As a percent of sales.

As a percent, so shooting for that kind of low 6%?

Correct.

And then on the Aircraft side, it looked like the incremental margins were huge for the quarter. Is that all driven by the fact that after-market was really strong? Or were there other things going on there that account for that? And is there a way to break out the growth between what was after-market and what was OEM-related?

Well, the big margin boost in the quarter definitely had a lot of elements coming from the after-market, and there we had some higher spare sales, higher repair and overhaul activity, which comes with very favorable margins. So we're seeing right now with the fleet utilization and the activity that after-market has picked up, probably it's above our expectations when we entered the year. In terms of breaking out, and I am not sure what you are looking for broken out, we actually don't break out the profitability of either of those individually. But the after-market times when we sell spare controls, that can be kind of lumpy, if you want to set it in terms of when did it occur, because sometimes we get a batch of spare control sales, and then we don't get any the next month or the like. But overall, the after-market is doing real well, mainly due to fleet utilization.

So your OEM kind of mirrors production rates that we see at Boeing -- Boeing in particular, Airbus to a lesser extent -- and then the after-market's lumpy, but the driver there is still capacity?

Yes. But I think you have to do on, just for clarity, we do very well on Airbus aircraft, so our sales really do mirror Boeing, Airbus, Bombardier, and Embry Air. Okay? So we're very well positioned. And as the 787 and the new 747-8 come online, we're going to have better penetration on Boeing aircraft than we do today.

So looking forward, that would be a positive for us. Airbus, we're well represented, and definitely on the regional jets. So it's kind of you've got a little bit of a combination of all those on the OEM side.

Okay. And then to that end, it seems like there's been more of a push to be more systems-oriented than component-oriented, and maybe you could just review the risks and, more importantly, the opportunities that presents from, say, prior generations of aircraft.

Yes. I guess, maybe I'll address the risk first. In a lot of ways, the risk is if we don't embrace systems, we would probably lose market share and sales. And the reason for that is our customer base is now changed from where they, in the past, used to source individual components, to now where they request system bids or what we would call subsystem bids.

So today, and we believe going forward, we're going to have to bid like complete fuel systems or complete control systems. Fuel systems, electronics, and sensor packages, if we're going to win programs. Now, that trend we've been working on for 15 years, and have done a lot with our product portfolio. And as we always said in the past, today's good results in aircraft are definitely a payback to our shareholders for all the R&D investments we made over the last 15 years.

So we've expanded the portfolio, we're well positioned to do some of the systems work, and we're being pretty effective at winning system programs. So I see it as an opportunity and a way for us to continue to grow market share. With these new programs we've won and the aircraft programs that we're on, we definitely have picked up share. So I view it as an opportunity. If we do not pursue the systems, it's a big risk that we'll lose future program bids.

So it's an opportunity both from a revenue and a margin standpoint.

Well, I'd say it's definitely on a revenue. On the margin basis, I'd say it's probably neutral. But it gives you more opportunity to enhance margins in the after-market.

Got you. Okay.

So on the OEM side, I would not say we're getting better margins on the systems sales than we did on components, but with our bigger portfolio, the ability to package that in the after-market, we have better after-market opportunities.

Great. Hey, thanks for your time. Congratulations on the quarter.

Thank you.

Our next question comes from Matt McGeary from Sentinel Asset Management.

Hi, good afternoon, guys. Can you hear me?

Yes, thank you.

I just wanted to clarify the guidance. Unless my math is wrong, if you take the absolute high end of your guidance at $2.45, that implies a sequential negative quarter in your fiscal fourth quarter. But I think I just heard you say that you were thinking more of flat to slightly up sequentially. Am I miscalculating or am I mishearing you?

No, the only thing I -- first, let me clarify. So at the absolute, so if we were just to take the (multiple speakers) --

It's $2.45, right, in the first three quarters, [implying] $0.53 per quarter.

Right now, year to date, we're at $1.76. So that would imply another quarter of $0.69, if you were going to $2.45.

Got you. Right. My -- okay. My--.

What you might be missing was the subsequent event in the second quarter, where we announced the negative arbitration impact, and so if you add anything through the three quarters above $1.76, that might be why.

I've got you. That's it. Thanks so much. Good job, guys.

Okay.

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

Okay. Well, appreciate everybody joining us today, and we definitely will look forward to revealing our fiscal year 2007 final results with everybody in November. So thank you.

Ladies and gentlemen, that concludes our conference call for today. If you would like to listen to a rebroadcast of this conference call, it will be available at 9 PM Eastern Standard Time by dialing 1-888-266-2081 for domestic, and for international, you may dial 1-703-925-2533, and by entering the access code 1112145. A rebroadcast will also be available at the Company's website at www.woodward.com for 30 days.

We thank you for your participation in today's conference call and ask you that you please disconnect your line. Thank you.