Woodward Inc (WWD) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor third quarter 2009 earnings conference 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 presentation you'll be invited to participate in a question-and-answer session.

Joining us today from the Company are Mr. Tom Gendron, Chairman and Executive Chief 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 quarter fiscal 2009 conference call. In a few moments, Tom will talk about the highlights of our third quarter in our markets. I will then comment on today's earnings release, and at the end of our presentation we will take questions. For those who have not seen the release, you can find it on our website at Woodward.com under our investor information tab.

As noted in the press release we have included some visual presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available through July 27th, 2009. The phone number for the audio replay is on the press release announcing this call and will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our website for 14 days.

Before we begin, I would like to provide our cautionary statement as shown on slide three. 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 aerospace, power and process industries, and transportation 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 on 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 2008 and 10-Qs for the 2009 quarters.

Now I will turn the call over to Tom to discuss our quarter's highlights, our markets, and our progress toward achieving our strategic goals.

Thank you, Bob. Welcome to all of you who joined us today. I'll begin by highlighting our financial results for the third quarter. Total sales were up 17%, reflecting the MPC and HRT acquisitions and the formation of our airframe system segment.

Reported earnings were $0.36 per share, excluding special items highlighted in the press release. Adjusted earnings per share were $0.41 compared to $0.47 in the prior year. Free cash flow generated during the quarter was strong at $61 million, and we reduced our debt by $64 million after taking on the additional debt following the April 3rd HRT acquisition. These results were generally consistent with our previous outlook.

Market highlights for the quarter included the following. Our commercial aerospace sales, excluding business jets, were down moderately in the quarter but are still up somewhat for the year. Sales related to business jets were again down significantly. Defense sales were again stable and we believe this will continue. Industrial gas turbine sales were again strong. Wind turbine converter sales volumes were up again in a flat market.

As anticipated and seen in the prior quarter's results, some markets were down significantly. In particular, reciprocating engines for power generation, transportation and industrial uses and electrical equipment used in power generation distribution applications.

Foreign currency was again a headwind. Our market outlook is little changed from last quarter. We continue to expect a challenging sales environment for most of our businesses in coming quarters. While demand for our reciprocating engine products will likely face another sequential decline this quarter, we are seeing more signs of stability in these markets.

While this is a challenging environment, we believe our more diverse portfolio businesses and end applications reduces our exposure to any one market. For example, our increased involvement in a wide range of defense programs should provide a stable base of demand while our commercial markets are under pressure from the economic downturn.

Regarding our previously announced actions related to cost reductions, most actions have been implemented. We're confident that these actions have been appropriate. While such actions are always painful, the extent of these actions was less severe as a result of our initiatives in recent years to reduce our manufacturing infrastructure and non-core activities.

At this time, Woodward is focused on three key areas -- delivering strong cash flow to aggressively reduce our leverage to approximately 2.5 times EBITDA by the end of fiscal year 2009 and 2 times by the end of 2010; second, fully integrating MPC and HRT into a cohesive airframes systems business that offers broad system solution and achieves improved profitability; and capture organic opportunities for growth in an eventual rebound while weathering the current environment with relatively steady consolidated operating margins.

Our airframe systems integration continues on its course to deliver better aftermarket presence and support as well as improved profitability and broader control system content. Customers have responded favorably to the efforts made by the MPC and HRT teams to jointly offer a variety of technological solutions through a single Woodward channel.

Regarding our efforts to grow organically, we are pursuing three major areas of opportunity. First, we are improving our technology portfolio. For example, over the coming year we expect to broaden our wind turbine converter offerings, covering more of the market applications. Second, we are aggressively and selectively pursuing a variety of new system and component opportunities. In this area we've recently won several moderately sized airframe opportunities and solidified a key reciprocating engine customer relationship with more opportunities to come in the next few months. Third, we are working to improve customer satisfaction with manufacturing processes and locations designed for better delivery time and responsiveness. For example, we recently shipped our first wind turbine converters from our Loveland, Colorado, facility to better support our customers' sale of wind turbines in North America. And in this quarter we will ship out of our Tianjin, China location for Asian customers.

In summary, Woodward serves a variety of basic infrastructure needs that must be filled in both good and bad times, and we have opportunities for long-term growth on successful platforms. We're working to enhance the current cash flow by aggressively managing costs and working capital, allowing us to reduce leverage on our balance sheet.

At the same time, we're preparing for an eventual return to growth by developing new technologies, winning new business, and improving customer satisfaction. We remain confident that our current positioning and efforts will ultimately deliver significantly enhanced shareholder value.

I'll now turn the call over to Bob to review our financial results in more detail and update you on our outlook.

Thank you, Tom.

At the Woodward Consolidated level, net sales for the quarter were $386 million, a 17% increase over last year's third quarter sales of $330 million. $108 million of growth was attributable to the acquisitions of MPC and HRT. Organic sales declined 16%.

Foreign exchange rates negatively impacted quarterly sales comparisons by approximately $13 million. Operating earnings, defined as earnings before interest and income taxes, for the quarter were $37.6 million or 9.7% of sales compared with $49.7 million or 15.1% of sales in the same period a year ago. This includes a one-time charge of $12.5 million related to the valuation of inventories associated with the HRT purchase accounting.

Net earnings for the quarter were $25 million or $0.36 per share, compared with $32.4 million or $0.47 per share for the same quarter a year ago. Net earnings included a $0.12 per charge -- per share after-tax charge for the HRT inventory matter just mentioned, and a $0.07 per share benefit for a one-time tax item representing resolution of a prior year matter. These items are highlighted in the table on page three of our earnings release.

Free cash flow for the quarter was strong at $61 million compared to $48 million for the prior year's quarter, reflecting increased focus on working capital, including better alignment of inventories and demand and a reduced need for capital expenditures in the current environment.

To finance the HRT acquisition, our debt increased by $325 million to $757 million on April 3rd. However, during the balance of the quarter we utilized our cash flow to reduce outstanding debt by $64 million to $693 million.

Turning to our segments, turbine systems net sales, which includes intersegment sales for the quarter were $148.2 million, a decrease of 4% over third quarter sales of $153.7 million a year ago.

Turbine system segment earnings in the third quarter of fiscal 2009 were $30.8 million compared with $29.3 million for the same quarter a year ago. Segment earnings as a percent of sales were 20.8% in the third fiscal quarter of 2009 compared to 19.1% in the same quarter of the prior year.

Turbine system sales performance reflects modest declines in OEM and aftermarket commercial aerospace sales -- a sharp decline in business jets, partially offset by strong industrial turbine sales. Earnings increased largely due to cost reduction efforts.

Airframe systems, comprised of MPC and HRT, contributed $107.7 million in net sales for the quarter. The segment reported a loss for the quarter of $6 million. Excluding the impact of the item related to HRT purchase accounting for inventory, segment earnings were $6.5 million or 6% of sales.

Segment earnings also included $6.6 million in amortization of acquisition intangibles. Both of these were non-cash charges. This segment realized significant cost savings this quarter through actions taken at MPC. Staff reductions to date at MPC total approximately 300 members or about 25% of the work force. We expect the combination of HRT and MPC will continue to present opportunities for synergies that we will pursue.

Electrical power systems net sales for the quarter were $69.1 million compared to $77.2 million a year ago -- a decrease of 11%. Without the impact of exchange rates, sales were flat. Again this quarter sales volumes were led by wind turbine converter sales, but this volume growth was offset by declines in intersegment sales related primarily to power generation products and other products serving the same markets.

Segment earnings for the quarter increased 16% to $12.5 million compared to $10.8 million for the same quarter last year. Segment earnings improved as a percent of sales to 18.1% in the third fiscal quarter of 2009 from 14% in the prior year. The improved profitability is attributable to product mix and cost reduction initiatives.

Engine systems net sales for the quarter were $84 million compared to $130.9 million a year ago, a decrease of 36%. The weakness was experienced broadly across our engine systems markets of transportation and power generation. Foreign exchange impacts provided additional downward pressure of approximately $3 million on sales.

Segment earnings for the quarter decreased 63% to $6.3 million compared to $17 million for the same quarter last year. The decline in segment earnings was attributable to the decrease in sales but was partially offset but cost reduction initiatives and reductions in freight costs. Segment earnings as a percent of sales were 7.5% in the third fiscal quarter of 2009 compared to 13% in the same quarter of the prior year.

Our previously announced restructuring actions yielded a little over $10 million in Company-wide savings this quarter. With a full quarter impact it will result in further savings to come in future quarters.

Now I would like to discuss certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, as a percent of sales was 25.7% in the third quarter of 2009 as compared to 29.7% in the third quarter of 2008. This decline was primarily attributable to the $12.5 million charge related to purchase accounting for HRT inventory.

Selling, general, and administrative expenses as a percent of sales helped steady at 8.6% of sales for $33.2 million in the third quarter of 2009 compared to 8.6% or $28.4 million in 2008.

Research and development costs were $20.7 million in the third quarter of 2009 or 5.4% of sales, compared to $19 million or 5.8% of sales in the third quarter of 2008. This level of spending is generally consistent with our expectations and longer-term requirements, although quarterly variability will continue.

Total depreciation and amortization expense for the first nine months of 2009 increased to $46.1 million from $27.2 million in the same period of the prior year. The increase is attributable to the acquisitions of HRT and MPC.

Interest expense totaled $10.9 million this quarter. This included certain costs associated with our committed financing arrangements for the HRT acquisition that will not recur. We expect interest expense next quarter to be closer to $9 million, subject to movements in interest rates.

Our effective tax rate for the quarter was 6.4% compared to 34% last year. This rate reflects a $5 million benefit resulting from the favorable resolution of a tax matter. We expect our rate in the near term to be approximately 33%.

Capital expenditures were $18 million in the first nine months of 2009 compared to $25 million in 2008. For the full fiscal year 2009, we anticipate capital expenditures of just under $30 million.

We remain focused on our manufacturing infrastructure cost strategy and we broke ground for our new facility in Poland in the third quarter. As Tom mentioned, we are now shipping wind turbine converters from the Colorado operations, and we are preparing to do so from China later this year.

As mentioned in last quarter's call, we closely monitor our financial leverage, measured as total debt divided by trailing 12-month adjusted EBITDA. At June 30, our financial leverage was 2.7 times, a decrease from 2.9 times at the time of our HRT acquisition.

The ratio of debt to debt plus equity was 50.1% at the end of the third quarter compared to 39.8% at March 31st, 2009. Approximately 55% of our debt is at relatively favorable fixed interest rates. We expect to further reduce our exposure to floating rate debt in coming quarters as we direct repayments to floating rate debt.

Turning to our outlook, as the current economic cycle transitions, visibility remains poor. We continue to believe the next 12 to 15 months will be challenging. We expect our end markets to be mixed with a slight overall decline in 2010. The full-year effects of our HRT acquisition should offset the impact of these declines on our sales. We believe the actions we are taking favorably position us in the face of ongoing volatility and will enable us to continue strong cash flow generation.

As we close out the current year and consistent with our previous guidance, we believe sales in 2009 will be approximately $1.45 billion and reported earnings per share will be approximately $1.35, which presently includes $0.21 of negative effects of the previously discussed special items.

I would like to close by emphasizing a few points about our balance sheet and cash flow. First, the financing we have in place will provide Woodward with flexibility and a competitive advantage. This financing reflects an average borrowing rate at June 30 of less than 5%. It provides liquidity with the flexibility to quickly reduce leverage and it staggers facility maturities from 2012 to 2019.

Second, we now anticipate full-year 2009 free cash flow to be in a range of $140 million to $160 million. We are focusing on maximizing cash flow in coming quarters with the goal of reducing our leverage to approximately 2 times adjusted EBITDA by the end of this fiscal year -- excuse me, 2.5 times adjusted EBITDA by the end of this fiscal year and 2 times adjusted EBITDA by the end of 2010. These are challenging but achievable goals.

In summary, we are confident that our cash flows and capital structure are aligned. This alignment should deliver a more conservative leverage profile in coming quarters and allow for the enhanced shareholder returns Tom mentioned earlier.

That concludes our comments on the business and results from the third fiscal quarter of 2009. Operator, we are now ready to open the call to questions.

Thank you, sir. This question and answer session will begin at this time.

(Operator instructions).

Our first question comes from Tyler Hojo from Sidoti & Company.

Hey, good evening, guys. Can you hear me?

Hi, Tyler.

Oh, okay, hi. First question -- I just want to make sure I heard that right. Did you say free cash flow this year at $140 million to $160 million?

Yes.

Okay. And just for clarification, before you were saying roughly flat with last year, right?

No, last -- well, earlier we were forecasting $110 million to $140 million.

Right, okay. All right. Good clarification, okay, thanks. And then just on the guide, did the prior guidance include the inventory step-up that you spoke to in the press release there?

No, it did not.

Okay.

So that's a new item this quarter.

Okay, got you. And was it something that you were anticipating this quarter or was it something that was somewhat of a surprise or just an unknown?

We knew we would have the step-up. It was not completely valued at the time of the last quarter.

Okay, got you. And just in regards to the wind side of the business, I guess the new Poland facility is going to be up soon, but just in regards to what you're doing in Colorado, have you had any headway into GE there, because they seem like they're pretty optimistic in terms of seeing a back half pick-up on their wind business.

Yes, Tyler, we have not, on the converter side, have not made any sales to GE. We do have some sales on some digital electronic products sent to GE wind, so at the moment it's a pretty small level. It's still obviously a place we'd like to sell. As we said, we have shipped our first converter unit out of Colorado. We expect some increased sales coming out of the US, in particular because we have located the site here. We've been able to pick up market share with our current customer base and are trying to penetrate the US market.

So it's working as planned. We still are looking to capture more wind turbine customers. That somewhere we'll be concentrating on over the next year.

Okay and I guess last quarter the wind business was up roughly 25% and in your comments you said it was up again this past quarter. One, I guess could you quantify that, and two, what are you expectations there as we kind of move forward over the next, you know, 12 to 18 months or so?

Yes. Looking forward, wind was up again, again, as primarily market share gains. We expect the wind market to continue going well, but there could be some short-term financing issues on some of the wind parks. We're still monitoring that closely, so that's the risk factor that's out there.

But in terms of longer term over the next 12 to 18 months, we expect wind to do well. So we're watching the financing, because that's still an issue in the marketplace. Number of units were just up slightly year-over-year, so number of units delivered, and we think that we did pretty well with that because overall, the wind market's been kind of down the last two quarters in general.

Okay, great. I'll hop out of the way, thanks.

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

Good afternoon, guys.

Hi, Pete.

I guess first question, can you talk about the industrial gas turbine business and maybe talk about OEM versus aftermarket, what you saw in the quarter, and then just some of the commentary we've heard out of the big OEM manufacturers and the outlooks there? Seems like it's pretty negative, and what your outlook might be on that front as well.

Yes, the quarter-over-quarter from prior years, we were up about 16%, and a good chunk of that was really coming from the aftermarket. So what we have is -- and I go back, if you recall, during late '90s and the beginning 2000 time frame there was what they were calling the gas turbine bubble.

We delivered a lot of units in the field, and what we're really seeing is the wear-out of a lot of those parts that we delivered back then. So the aftermarket's holding. Deliveries on the OEM side were good in the quarter. We're monitoring the same thing. I have good contacts with our customers, so it could be on the new build side a little under pressure over the next six to 12 months.

But we're optimistic that the aftermarket, that with natural gas prices where they are and large installed field, that we will continue to see the aftermarket revenue coming in.

Okay, and does the balance of that basically shake out to around flattish for 2010 over the next 12 to 18 months?

It'll be close.

Okay, all right.

We have to say -- it was in kind of all of our prepared statements, there's still a lot of uncertainty in the forecasting out there, so we did our best. We really do expect on the new side some decline, and then on the aftermarket side we have to see how the machines are being utilized, but should see pretty steady there, so a balancing effect of the two.

Okay. And then as long as we're talking about the next 12 to 18 months, I guess, the commentary is maybe slightly positive, slightly negative, I guess, is the way to read into it. Is that an organic number or is that after including HRT and MPC?

Yes, what you really see in that kind of discussion, that's after the acquisition. So basically, we will have had MPC for a full fiscal year and we'll have half a year of HRT. So organically, we'd be down.

Okay. And where's the big softness on the organic side? Engines continuing to be weak, I guess aerospace, and maybe the IGT OEM side? Is that?

Yes, it's everywhere. What you have is a little bit of weakness everywhere that adds up, and the acquisitions balance it off. So that's our current outlook. This is early for us to be talking about our 2010, but right now that's where we are. The engine systems business has been under a lot of pressure, as you can tell by the numbers. We're expecting another tough quarter in the fourth quarter. As I said, we were starting to see potential that we're bottoming, and so going into 2010 we're still cautious, but we may be at a bottom.

Okay. And then I guess one more quick one. In terms of aerospace, a lot of commentary out there about destocking in the channel. Can you maybe address that and what sort of impact that may have had on your numbers in the quarter?

You're talking spares and so on, or when you say destocking maybe you can elaborate a little, Pete.

Spares -- how's that for aberration?

Yes. Yes, okay.

On spares, our spare control sales for the year are pretty close on track to our forecast. So I guess from that standpoint -- that's usually with new fleets and fleet additions, and so we have a -- we're doing okay there because of the new programs we're on and so that's been holding up.

Where we've seen some decline is with some of the parked aircraft. We have not been hurt as much as other players in that it's really a fleet mix, but we've seen some reduction in repair and overhaul, which includes spare piece parts being down. So we're down slightly in that area.

Okay. All right, that is very helpful. Thanks.

Our next question comes from Greg McKinley from Dougherty.

Thank you. Could you talk a little bit about where you're at with extracting some operating synergies out of the airframe systems business? When I looked at the reported numbers and tried to reconcile out the inventory adjustment, et cetera, it looked like -- and correct me if I'm wrong -- it looked like maybe we didn't have meaningful sequential margin improvement in that division.

And I guess I'm referring more on a net sales basis, so I wonder if you could talk about that and what your outlook is for margin enhancement as you integrate those businesses.

Sure. Sequentially, we did see some sales decline. So you won't see as much of an improvement from the last quarter to this quarter. If you looked more from the first quarter on, and it gets obviously murky because we add HRT into the mix, but we are seeing operating improvements over the period and the cost reductions that we talked about we implemented into this quarter, so you're not really seeing a full quarter of benefit there.

So we anticipate that in the next quarter, subject, once again, to kind of the sales unknowns and the murkiness from that side, that you'll see sequential improvement again in their operating margins.

Okay. And is the progress you're seeing in that segment still on the trajectory to move you into call it a low-to-mid-teen type of margin environment in that segment end of next year, or are we maybe a little behind that progress at this point?

No, if anything we might be a little bit ahead of that.

Okay.

So, you know, the economy at the moment is kind of masking some of that, but if we get stabilized from that perspective we do believe we're on our plan from the operating margin standpoint.

Okay. If we adjust the taxes and operating income on a pro-forma basis, it looks to me like your effective tax rate was more like maybe 29%. I think we're looking for more mid-30s. Am I reading that correctly, and can you tell me about what's driving that? And I believe I've adjusted for that tax change. Am I looking at that correctly?

You're pretty close. I would say probably around a 25% rate, so in that neighborhood.

Okay.

And then kind of the longer term, we said usually is in that 33% sort of range, but there are, from time to time, and there will continue to be from time to time, these kind of items that will bring the rate down like that.

So what are your expectations for a full year call it pro-forma tax rate? Can you share that with us?

Give me one second here. Yes, the average rate for the quarter, for the year -- you're saying after the adjustments?

Yes, so like if we take $0.41 as your pro-forma number.

I think if you used 33% again in the fourth quarter and then you could just work the math on the average of that. I don't happen to have it right in front of me, but I'll try to quickly work it up for you. But if you used an average of 33% in the fourth quarter you'd be able to come up with an overall average for the year.

Yes, okay. And then finally, can you talk a little bit about working capital, where you're seeing inventories -- where sort of your plan is for inventory levels as the businesses get more integrated over the next couple quarters?

Yes, as you probably -- we've commented from time to time. The HRT and MPC acquisitions carried significantly more inventories as a percent of sales than our average. We believe we have plenty of opportunities in our organic average as well. So we do believe that's still an area of opportunity.

Our engine business this quarter, both in receivables and in inventories, saw a little bit more improvement than we've had in the past, and in fact this is an area we called out as not being proud of, necessarily. We think we have lots of opportunity here.

We are beginning to see a better alignment of demand with inventories. It takes a lot of work to try to catch up with -- usually you see increases in your inventories as the demand comes down faster than you can catch up with that. We are seeing that we're getting better aligned.

Yes. Thank you.

Sure.

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

Afternoon, guys.

How you doing?

Hi.

Most of my questions have been answered, but maybe you could talk about 787, the push-out there, and sort of what that's meant for you recently or how you see that going forward in the next four to six quarters.

Yes, 787, obviously our main content on 787 is through the GEnx, but we do have, through our airframe systems business, some motors and sensors that will be also on that aircraft.

We really can't give you any better idea of when Boeing's going to fly and get their delivery dates than what Boeing's saying, which is they're being very cautious at the moment. We would expect -- and once they get moving, that's going to be a significant program to us.

The engine is also on the 747-8 aircraft, and that's moving along a little better if you saw the most recent Boeing report. So we'll probably start seeing 747-8 sales before 787 sales, and that'll at least get the ball rolling for us in terms of getting those products out and starting the fleet introduction.

And that's sure to -- a whole lot of help, but we're still watching closely (inaudible -- multiple speakers) progress.

Well, has it caused any kind of an inventory build-up, anything like that on your front? I know with the acquisition it's kind of hard to tell the inventory changes.

Yes, not significant. I mean, we had some, but no, so it's not a significant inventory build-up.

Okay. And then on the tax benefit, was that $5 million -- was contemplation of that $5 million in the old guidance range? When you have these things come up, do you sort of try and handicap when it's going to come? And was that included in the range, or that's kind of just out of -- I don't want to say left field, but that kind of thing?

No, it was not contemplated in the range earlier.

Okay, okay. All right, thanks a lot.

Sure.

Our next question comes from Fred Buonocore from CJS Securities.

Ah, yes, good evening, gentlemen.

How you doing?

Good, and you? Quick question on the aftermarket in terms of airframe. You'd talked about having an opportunity to improve your aftermarket penetration from MPC and HRT. Is anything under way there? Have you made any progress and can you talk a little bit about those expectations?

Yes. Our expectation is over a number of years. It's probably move the airframe systems segment aftermarket sales up about -- from about 20% of sales towards 35% of sales. And so the work we have to do there is on improving the operations, improving our repair and overhaul turn time, improving on our logistics, improving on our sales channel, which we think we can work with our current aircraft business.

So we believe the opportunity is out there to capture more of the aftermarket sales that our products are entitled to, but there's a lot of work to be done and so it takes operational performance as well as logistics and sales channels. So we're working it and so I would expect it'll be a gradual over the next few years. You're going to start seeing that move up. But there's quite a bit of opportunity there.

Great. And then moving over to your cost reduction initiatives, is there any way you can give us a sense for the total costs taken out, maybe on an annualized basis?

Yes. Total costs, and this includes kind of a variety of things, so we had early retirement, we had work force management, we took out a large number of temporaries and contract labor and so on. So we believe that overall that number could approach $60 million in the year, in a full year.

Excellent. And then following up on J.B.'s question about the 787, those delays and the delays in getting full production rate on the GEnx, is there a significant margin drag for you here? Do you have a lot of under-utilized equipment that kind of you're seeing those margin drag and the longer the delay goes on, the longer you'll have to bear it? Can you give us a sense of the magnitude of that impact?

Sure. There's a little bit of specialized capital equipment, primarily test stands and assembly and test fixtures that are unique to the 787 products. But the majority of the manufacturing processes and supply chain activities are common.

So, and total amount of capital is not very large relative to our total capital base, because it's a tight business we have. Most of these products are highly similar. We leverage across all of our capital equipment from program to program. So once again I would call it on the minor side in terms of dedicated capital to the 787 GEnx program.

Okay, got it. And then on your military aerospace business, or I guess just your military overall business, it seemed like that was flattish. Do you have much aftermarket business there, or is that also an opportunity to expand your aftermarket? Because a lot of companies with good military aftermarket exposure have been continuing to see good growth out of their defense businesses, even through this downturn.

Yes, we would actually expect the same thing to happen. We have a wide variety of products on military programs. Our traditional with the engine -- the turbine systems side but also with the airframe systems business, all these parts wear out, and in high utilization, give you an example, like all the helicopter applications, we see quite a bit of repair and overhaul work happening and we expect that to continue, and we expect all the other programs to continue to deliver.

So that'll generate spare piece parts, but also we work with the Army and the Air Force on helping with their maintenance depots to sometimes offload some of their work and do the actual repair work ourselves for them. So there's opportunities both ways -- parts and repair.

Excellent. And then just a final point of clarification, and sorry to make you repeat yourselves, but so kind of like what I'm hearing is just based on what you can see now, realizing that visibility is really murky, that slight overall decline in 2010, including the incremental contribution from the acquisitions. Did I catch that right?

No, we're closer to one offsetting the other, I would say. So we think that our markets will be mixed to down in the organic side and that the full year with HRT will offset most, if not all, of that decline. So we're looking more on a kind of a flat sort of scenario.

Okay, great. Well, I thank you very much, and we look forward to seeing you at our conference in a few weeks.

Great.

(Operator instructions).

The next question comes from William Bremer from the Maxim Group.

Good evening, gentlemen.

Good evening.

Let's just touch base on the Department of Defense. Can you give us a little clarity on what you're seeing? A lot of news out of Pentagon spending programs, et cetera, but maybe give us some inkling of some of the products that you have that may buoy this or potentially are affected by it?

Yes. We're on such a wide range of programs, and if you look, every fighter, helicopter, bomber, lots of the bombs, land-based equipment, has one or more Woodward components on it, and in particular now with the airframe systems business. So you see some things like the high-profile ones that are getting all the news, like the F22.

We have good content on F22, so that'll come down, but we would expect it'd be offset by either maintenance on the current fighter fleet or some additional traditional fighter sales or military sales.

Same thing with the helicopter -- the biggest one was the presidential helicopter. But when they don't use that -- they don't build that one and they're going to use the existing ones, and that means maintenance.

So all in all, we see -- we monitor all of that, and when we add it all up and look at the activity going on when those programs come in, what it means to the existing programs, we still think it's about flat sales for Woodward.

And maybe you can just speak a little bit on the cost reductions that you're making in the airframe division, in particular MPC and HRT. How much more do we have to go in that?

Well right now, I don't know if I can quantify anything for you but what we're doing right now is working on both operations and these will be in this next quarter, the two businesses will now be merged into a single entity, operating entity, and then going forward there we're going to be working on a lot of growth opportunities, but also a lot of operational efficiency opportunities that we see.

And so we always say we've really -- I guess we've only owned them for 84 days and we're working through it quickly and bringing these together, and the synergies and leverage we see come from operational efficiencies, supply chain, and then market and growth opportunities, so that's what we're going to be working on. And we see, in each area, a lot of opportunity and we'll continue to give you updates by the quarter but I don't have anything to quantify today for you going forward beyond what we've said.

Okay, Tom, thank you. One last regarding the wind inverter side, specifically off-shore, the six megawatt. Can you give us a little more color on that in terms of how many you've shipped and what the outlook looks there?

Well, the outlook is positive. You've seen some of the orders. And right now, to the best of our market knowledge, we're the only ones shipping in that category. So there aren't too many six-megawatt machines out there. We've got real good presence on the five, six-megawatt.

We've been talking to all the manufacturers out there that are even contemplating things up to 10-megawatt machines. But we're really well positioned in that category and so the orders you're seeing, we believe are going to have the Woodward content on them.

Great, Tom, thank you very much.

(Operator instructions).

We have a follow-up from Tyler Hojo from Sidoti & Company.

Hey, I was hoping you could talk a little bit about the engine systems business, given that seems to be where most of your weakness is coming from. Maybe if you could just talk about the margin expectations for that business and how you see that kind of playing out over the near/longer term.

Yes, obviously as you see the numbers it's been under a lot of pressure. That's the reciprocating diesel and gaseous fuel, alternative fuel business. Just remind everybody on the call, that's a lot of the business we ship to the construction market, the marine market, power generation and other industrial vehicles and also small jet sets and pumps.

So that market's taking a pounding, so what I have to say is we're fairly proud because we have not gone negative. When you see that type of top line drop, what I would say there is we did a lot of pre-planning to get ready as we're forecasting economic cycles.

Going forward, though, we expect to stay in the black and then as things start to recover, that business we've always said should be in the low double-digit operating earnings, and that's what we think it's capable of delivering. And I really do believe over the next few years we'll be back at those numbers, or into those numbers. But we still expect a tough 2010 in the reset market, so.

Right, and I guess what I'm trying to drive at here is are there additional opportunities to take cost out of this business or if, for instance, just theoretically saying if sales have bottomed here and there's more costs to take out, we should expect that a 7.5 type margin is kind of trough for you guys.

Yes. We're watching sales -- we're constantly looking at how to improve efficiency in this. We'll watch the fourth quarter. I think this is towards the bottom, Tyler.

Okay.

And I do see recovery. But the next two quarters are going to tell us what's really going to happen and then you'll start seeing recovery from there.

Okay, great. And just one more follow-up from me. I guess forex was about a $0.03 headwind in the quarter. Just wondering what you have baked into the guidance in terms of that for 4Q for your full year forecast.

Yes, we're pretty much flat going from Q3 to Q4 from where we're looking at it now, so from this point for our guidance wise, there would be no further foreign exchange impact.

Fantastic. Thanks a lot, guys.

Thank you.

Thanks, Tyler.

I'm showing no further questions. I'd like to hand the conference over to Mr. Gendron for any closing remarks.

Okay, I'd just like to thank everybody for joining us and for your questions, and look forward to talking to you in November when we release our end-of-the-year results. So thank you.

Ladies and gentlemen, this concludes our conference call for today. If you'd like to listen to a rebroadcast of this conference call, it will be available today at 8:00 pm Eastern time by dialing 1-888-266-2081 or 1-703-925-2533 and by entering the access code 1370762.

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