Woodward Inc (WWD) 2010 Q4 法說會逐字稿

Welcome to the Woodward Governor Company fourth quarter fiscal 2010 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 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 Chief Executive Officer and Mr. Bob Weber Chief Financial Officer and Treasurer. I would now like to turn the call over to Mr. Weber.

Thank you, operator. We would like to welcome all of you to Woodward's fourth quarter fiscal 2010 conference call. In a few minutes I'll cover the financial highlights of our fourth quarter and Tom will comment on our results, strategies and markets. I'll 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. 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 November 18, 2010. 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 and defense, power generation and distribution 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 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 fiscal 2010 which we expect to file on November 18, 2010.

Going forward, as we refer to net earnings on these calls, we are technically speaking to net earnings attributable to Woodward. In addition, segment earnings, EBIT, EBITDA and free cash flow are non-US GAAP operating measures that we use in the press release and during this call. A description of these measures and a reconciliation of each to the most comparable US GAAP measure is included in the appendix to our slide presentation and in our earnings release and related schedules, all of which are posted on our website. Management uses this information in monitoring and evaluating the ongoing performance of Woodward and each business segment. I'd like to now switch to our quarterly financial highlights.

This quarter is notable in that it reflects continuing evidence of improving markets. Sales for the fourth quarter were up both sequentially and over the prior year fourth quarter. Sales for the fourth quarter were $412 million, up 13% from $365 million in the fourth quarter of last year. Earnings before interest and taxes were up sequentially again at $56 million, a 33% increase from $42 million in the fourth quarter of last year, reflecting operating leverage on sales increases, partially offset by increased variable compensation.

Reported earnings per diluted share were $0.47 for the fourth quarter, compared to $0.34 for the fourth quarter last year. Free cash flow for the quarter was $14 million, reflecting increased investments in working capital. Our debt leverage ratio declined slightly to 1.8 times EBITDA. Overall, these results indicate that our business has continued to improve while our cash flow and balance sheet remain solid.

Now I will turn the call over to Tom to comment on our results, strategies and markets.

Thank you, Bob. And welcome the to those joining us today. We are encouraged by the solid financial performance of our fourth quarter, as Bob just highlighted. We are seeing continued improvement in our markets and are benefiting from increased leverage on previous cost reductions.

We continue to focus on leveraging sales growth through supply chain management and investment in growth opportunities. Our Turbine, Electrical Power and Engine Systems segments showed very good revenue and profits this quarter. These businesses are experiencing solid recoveries as well as market share gains resulting from the success of our strategic initiatives. Although our Airframe systems segment did not achieve our desired level of performance this year, we are confident about the ultimate success of our efforts to focus and grow this business and our ability to deliver on the synergies we identified at acquisition.

Turning to our markets, the commercial aerospace market continues to show signs of improvement. Commercial passenger and cargo traffic have increased significantly, returning to pre-recession levels. Business aviation utilization is improving. These traffic improvements are beginning to drive increases in our aftermarket sales as well.

Announced increases in commercial aircraft production are beginning to be realized with Woodward benefiting in general but particularly from the growth in the A320 production rates. The 787, and 747-8 continue their certification testing and are expected to enter service during 2011. The 747-8 offers the GEnx engine exclusively and the GEnx is one of two engines offered on the 787. In support of these programs, Woodward has been shipping low volumes of fuel systems which are expected to ramp up when production begins.

While large business jets have been fairly resilient through the downturn, production rates for regional and small business jets remain under pressure. While we believe that in the long term these two markets will return to growth, we expect flat 2011 production rates for business and regional jets. A key long-term Woodward strategy has been to invest proactively in research and development, understanding that these investments must be made over long periods of time. Our engineering teams collaborate closely with our customers to ensure alignment of our R&D with their new platform requirements.

New aircraft platforms such as the Comac C919 as well as the re-engineing or updating of the 8320 and 737 are potential growth opportunities for Woodward. We are well positioned to offer and compete for the system solutions required by these customers.

Defense spending in our markets, particularly for rotor craft, fighter jets and tactical weapons remains steady. While defense spending will likely come under pressure in the coming year, we expect that production, along with maintenance, repair and overhaul levels for our portions of the defense market will be steady.

Industrial turbine build rates are starting to recover. Asia and the Middle East are providing most of the demand for our customers while North America and Europe lag somewhat. The economic recovery is starting to drive some increased power demand and that bodes well for the longer term. We believe that electrical power generation and in particular generation from natural gas fired turbines will be a long-term growth opportunity for Woodward. We have also been successful recently in gaining content on a variety of heavy frame, aero derivative and steam turbine applications.

As we anticipated, wind converter deliveries were exceptional, being the primary driver behind the significant growth in our electrical power systems business, overall. This was driven by our share gains and some market recovery for our customer base. Woodward's recent announcement with REpower regarding increased market share has now come to our strategic focus to counter economic cycle related volume declines with customer share gains.

In addition to our renewables focus, Woodward produces controls that manage turbines and reciprocating engines for power generation, controls that manage the distribution of power on the grid and assist in the design and commissioning of large distributed power projects. As population growth and economic activity continue their upward progression, we are very optimistic on long-term growth potential for electrical power. Our key strategies of leveraging our global footprint in close alignment to large successful OEM customers, will allow us to capture a greater share of this long-term growth.

We are currently experiencing an increased demand for our sensors and digital controls using grid related upgrades as well as infrastructure expansion, most notably in emerging markets. Increased power generation construction, again in developing markets, has driven increased demand for our services in electronic controls. Demand for industrial reciprocating engines and our clean engine technologies has continued to improve.

Early in the economic recovery cycle, we saw significant increases in demand for small diesel engine components and this continues. Larger engine platforms for power generation, mining and fossil fuel extraction, processing and distribution have also started to improve with increased activity in Brazil and Asia. A positive sign for 2011.

In summary, we continue to see improvement in our major markets. Our execution of our strategies through the cycle to expand our market share, maintain focused levels of investment and management attention to cost control and operational performance, and our aligned efforts with successful OEMs in attractive long-term growth markets has served us well and we will continue to do so. With the guidance we are providing today it should be clear that we expect continued market and operational improvement in 2011. Let me turn it over to Bob for the financials.

Thank you, Tom. At the Woodward consolidated level, net sales this quarter were $412 million, compared to $365 million for the 2009 fourth quarter. All of our business segments saw continuing improvement in top line growth in the quarter. Foreign currency exchange rates had an unfavorable impact on sales of approximately $5 million in the quarter.

Net earnings for the 2010 fourth quarter were $33 million, or $0.47 per share, compared with $24 million or $0.34 per share in the prior year fourth quarter. Neither quarter contained any special items affecting comparability.

EBIT or earnings before interest and taxes was $56 million for the quarter compared to $42 million for the prior year's quarter. EBIT was primarily impacted by the sales volume increases and operating leverage, partially offset by variable compensation and approximately $2 million of foreign exchange. Recent economic events have caused variable compensation expense, which is tied to relative financial performance, to vary significantly from period to period. For the fourth quarter of 2010, variable compensation expense was $4.2 million higher than the corresponding quarter in 2009.

Free cash flow for the fourth quarter was $14 million, compared to $92 million for the prior year's fourth quarter. As part of the general upturn in our businesses, some investment in working capital has been required. There was a lot going on in the past two years, so please refer to slide 20 in the website materials as I compare our full year 2010 and 2009 results.

Net sales for the fiscal year 2010 were $1.46 billion, compared to $1.43 billion for the prior year. Net sales for the first six months of fiscal 2010 include sales of $117.3 million for Woodward HRT, which we acquired on April 3, 2009, for which there were no corresponding sales in the first six months of 2009. The early part of 2010 saw declines in most of our businesses with recovery occurring largely in the second half of the year.

EBIT or earnings before interest and taxes was $184 million for fiscal year 2010, compared to $155 million for the prior year. Included in EBIT for 2009 were special charges related to workforce management of $16.6 million, as well as a $12.5 million charge related to the step-up of acquired inventory. Excluding these special items for 2009, EBIT would have been $184 million, essentially flat with 2010.

Cost savings related to workforce management were approximately $50 million in 2010, compared to $16 million in the prior year. These initiatives offset the significant impact of organic sales declines and increased variable compensation expense. EBIT for the first six months of fiscal 2010 included $14 million for Woodward HRT which we acquired on April 3, 2009, for which there were no corresponding earnings in the first six months of 2009.

Net earnings for fiscal 2010 were $111 million, or $1.59 per share, compared with $94 million or $1.37 per share last year. Earnings per share for fiscal 2010 included special tax benefits of $0.09, while 2009 included special items of $0.21 per share, as detailed in the table included in the press release. Foreign currency exchange rates had an insignificant impact at the Woodward level on both net sales and net earnings for fiscal 2010.

Turning to our business segments. Turbine System segment net sales for the fourth quarter of fiscal 2010, which include intersegment sales, were $170 million, compared to $148 million for the fourth quarter a year ago. Sales increased across both aerospace and industrial platforms. The upturn in industrial sales is particularly encouraging.

Segment earnings for the fourth quarter of 2010 increased to $43 million, from $32 million for the same quarter a year ago. As a percent of sales, segment earnings were 25.1% this quarter, compared to 21.6% in the same quarter a year ago. Our segment earnings benefited from increased volumes, improved operating leverage and a favorable sales mix, partially offset by increased variable compensation.

Moving to our Airframe Systems results. Airframe Systems segment net sales for the fourth quarter of fiscal 2010, which include intersegment sales were $103 million, compared to $110 million in the fourth quarter a year ago. Sales levels reflect volume declines in most of the segment's product lines, as well as the effect of the August 2009 sale of the fuel and pneumatics product line.

Segment earnings for the most recent quarter were $1 million, compared with $12 million in the fourth quarter of 2009. Segment earnings as a percent of segment net sales were 1.3% this quarter, compared to 10.9% for the prior year quarter. The sales volume declines continued to negatively impact earnings levels with cost reductions providing only a partial offset.

Segment earnings for the fourth quarter were less than expected, due to two significant factors. One, while certain segments of the aerospace market have strengthened, a number of market subsegments and platforms on which we have significant content remain depressed such as small business jets. Two, development funding in areas that we've made conscious strategic decisions to no longer pursue has declined more rapidly than previously anticipated. Strategic initiatives to refocus the business to commercial projects gives rise to negative earnings impacts as military and space development funding declines and associated resources are redeployed to new opportunities. As Tom mentioned, we believe these actions will improve profitability over the coming year.

Now, turning to Electrical Power Systems. Electrical Power Systems segment net sales for the fourth quarter of fiscal 2010 which include intersegment sales were $72 million, compared to $54 million for the fourth quarter a year ago. Deliveries of wind converters led the increase, and our power station project business also contributed significantly. Foreign currency exchange rates contributed approximately $4 million of negative sales impact.

Segment earnings for this quarter were $9 million, compared to $5 million for the same quarter last year. Segment earnings as a percent of segment net sales were 12.6% this quarter, compared to 9.5% in the same quarter for the prior year. Segment earnings were impacted most significantly by the increase in sales volumes and operating leverage improvements. Our strategies to increase market share and benefit from greater economies of scale as well as to improve our productivity across a broad front have been successful in maintaining our margins.

Moving to our Engine Systems results. Engine Systems segment net sales for the fourth quarter of fiscal 2010, which include intersegment sales, were $95 million, compared to $74 million for last year's fourth quarter. An increase of 28%. We saw continuing improvement in sales related to short cycle engine products and we are beginning to see some recovery in demand for large engine products.

Segment earnings for this quarter increased to $9 million from $2 million for the same period a year ago. Segment earnings as a percent of segment net sales were 9.3% this quarter, compared to 2.8% in the same quarter last year. Segment earnings improved due to the increased volumes and improved operating profitability.

Non-segment expenses for this quarter were $6 million, compared to $9 million for the same quarter last year. Non-segment expenses were 1.4% of external sales for the fourth quarter of 2010, compared to 2.5% in the prior year quarter. The prior year quarter reflected approximately $3 million in costs associated with a global manufacturing related project. Without these costs, non-segment expenses were 1.6% of sales in the fourth quarter of 2009.

Now I'd like to focus on certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, increased as a percent of sales to 30.2% in the fourth quarter of 2010, compared to 28.1% for the fourth quarter of 2009. Gross margin as a percent of sales increased to 29.9% for the full year fiscal 2010, compared to 28% in the prior year.

Selling, general and administrative expenses were $38 million, or 9.1% of net sales this quarter compared to $34 million or 9.3% of net sales in the same period of 2009. For the year, selling, general and administrative expenses were 9.3% of sales, or $136 million in 2010, compared to 9% or $129 million in 2009.

Research and development costs were $23 million for the fourth quarter of 2010, compared to $20 million for the fourth quarter of 2009. As a percentage of net sales, research and development was 5.6% in the fourth quarter of 2010, compared to 5.5% in the fourth quarter of 2009. Research and development costs were $83 million for the full year 2010, or 5.7% of sales compared to $79 million or 5.5% of sales in 2009.

Total depreciation and amortization expense for the fourth quarter of 2010 was $19 million, up slightly compared to the prior year quarter of $18 million. Total depreciation and amortization expense for 2010 increased to $76 million, from $64 million in the prior year, primarily related to the acquisition of Woodward HRT.

Our effective tax rate for the quarter ending September 30, 2010, was 34% compared to 27.3% for the same quarter last year. As noted in previous quarters, tax benefits related to resolution and revaluation of prior year issues have been recognized and produced quarterly variability in the effective tax rate. Our effective tax rate for 2010 was 28.2%, compared to 22.9% last year. Our guidance assumes that the US research and development tax credit will be reinstated and as such, that our effective tax rate for 2011 will be approximately 31%.

Capital expenditures were $9 million for the fourth quarter of 2010, compared to $11 million in the fourth quarter of 2009. Our full year capital expenditures were $28 million in 2010, compared to $29 million in 2009. As previously announced, we are in construction of a new $21 million systems test facility. Construction will continue through much of 2011.

Also, our Krakow, Poland facility is now up and running and we will not be incurring any significant, further construction costs. Krakow is one of many reasons for our improving operating profitability. In 2011 we expect capital expenditures of approximately $65 million, with the inclusion of the systems test facility, along with some significant IT systems initiatives.

Looking at cash and the balance sheet. Woodward generated $23 million of cash flow from operations for the fourth quarter of 2010, and $13.7 million of free cash flow. Free cash flow will remain strong with the sales increase requiring increased working capital utilization.

Our total debt was $466 million at September 30, 2010, compared to $572 million at September 30, 2009. From a high of $757 million, immediately after the HRT acquisition, the quarter end balance reflects total debt reductions of $291 million. The ratio of debt to debt plus equity was 36.7% at the end of the fourth quarter, compared to 44.6% at September 30, 2009. During the quarter we repaid $10 million of long-term debt and incurred short-term borrowings of $22 million. Our debt was 1.8 times EBITDA at September 30, 2010.

Working capital defined as current assets less current liabilities was $457 million at September 30, 2010, and $434 million at September 30, 2009. Lastly, let me turn to our outlook. We expect our markets to improve as the year progresses and share gains to continue in 2011. As such, we anticipate that our resulting earnings will reach a new Woodward high. As stated in our earnings release, we expect fiscal 2011 sales to be between $1.55 billion, and $1.65 billion, and fully diluted earnings per share to be between $1.75 and $1.90.

This guidance reflects an increase in variable compensation from 2010 to 2011 of approximately $0.25 per share at planned levels of performance. Along with these factors remains the uncertainty of overall economic conditions, which are difficult to anticipate at this time. That concludes comments on our business and results for the fourth quarter of fiscal 2010. Operator, we are now ready to open the call to questions.

Thank you. The question-and-answer session will begin at this time. (Operator instructions) Please stand by for the first question. Our first question comes from Tyler Hojo from Sidoti.

Hi, good evening, guys.

Hi, Tyler.

Good evening.

First question, I was just hoping that you could talk a little bit about wind. I mean, you've had one seemingly significant win there, announced recently, and then you had the other one a little bit earlier. Are you guys sacrificing pricing at all to kind of take on some of these wins? And how should we think about growth prospects for your specific wind market as we go into fiscal '11? I know that's kind of a mouthful, but --

Yes, Tyler, we'll answer it -- try to take each one. In terms of capturing the share and competing, what I would say is we've been able to leverage our supply chain and our volume, hold margins constant or slightly up, while we've been gaining this share. So, I would look at it as long-term strategy of growing volume, leveraging that volume and being able to maintain margins is kind of the approach we're taking. We expect about a 19% sales increase for our Electrical Power Systems group next year, so you're going to see driven significantly by wind but also some of our Smart Grid technologies as well.

Okay. All right. And what does that assume just in terms of the market, the wind market? Is that assuming the wind market's about flat or -- ?

We feel globally, depends on which region you look at, that overall the wind market will be up slightly and our share gains will allow Woodward to be up for the percentage I gave you.

Okay. Got it. All right. Good. Just, if I could, just ask about the airframe margin. You know, obviously it fell short of what you guys were looking for in the fourth quarter. I believe, at least. So what gives you confidence that we're going to see some improvement next year? I mean, it just seems like we kind of went through the year and, you know, it was kind of one of those situations where every sequential quarter we expected things to get better and it just never did. So, what can you tell us to make us feel a little bit better that you are going to actually be able to see some sequential increases as we move into the next fiscal year?

Yes. Well, let me first say yes, indeed, it did not live up to our expectations for the fourth quarter. So, your first statement is accurate. The two main reasons that I pointed out, one is while our turbine business is seeing some nice increases in most of the pockets of aerospace, there are a couple that are not participating and most notably small business jets whereas large business jets are doing pretty well, and regionals. And that happens to be the sweet spot for our Airframe business.

So one of the things that we were counting on as we looked at the year was that those markets might start to participate along with the rest of the aerospace market. I think as we all were aware, that some of the reasons for some of the decline in small business jets or business jets in general were not entirely all economic related and so it's become extremely difficult to know when, at what point we will start to see those markets come back. So, that's number one. And because of that, there is a fair amount of uncertainty as we look through 2011 as to when that piece of the volume puzzle will come back.

The second part, we, as we've commented I think repeatedly, we have been refocusing this business. We talked about the fact that they were focused on many -- I'll call them one-off type projects. They had some excellent engineering talent and they helped out in NASA events and other space activities and they had a lot of engineering effort that was funded with development dollars. Those development dollars, as we've been refocusing the business on commercial projects, have, I'll use the term, largely dried up.

So, they decreased much more rapidly than we originally anticipated and as you can appreciate, we have not taken out costs related to that because we have been redeploying those efforts to commercial projects. The commercial projects themselves take longer to realize. So, again, none of this, next quarter will turn around, next quarter it will turn around, they will take some time for us to see the increases. We have, as we talked about before taken out considerable cost. We continue to make considerable improvements in the operating profitability of the organization.

But at this point, those are kind of overshadowed by the two items I've talked about. But we do believe as we see the year progress we will begin to see modest improvement and your guess is as good as ours when we start to see small business jets come back.

And is that kind of the biggest swing factor there in terms of seeing the demand pick up or can you see margin improvement within that segment, just if things are relatively stable for, say, the next 12 months or so?

Yes, we will see margin improvement. I would not hazard a percentage as we have done in the past, in light of the uncertainties surrounding some of these events.

Weren't you also having some supplier issues within that segment that was kind of impacting volumes, sales volumes?

Yes. As a result of obviously the integration of the two facilities and so on, some of our own integration issues associated with that -- we would not want to say this is all a supply chain problem. It is a supply chain problem that also includes our efforts with respect to that supply chain. So, right now there is still a continued, all of our businesses we see limited pockets of uncertainty with respect to adding capacity. And that is impacting the availability of parts in many cases.

Okay. Understood. I'll let somebody else ask a question. Thanks a lot.

Thank you. Our next question comes from Fred Buonocore from CJS Securities.

Yes, good evening.

Hi.

With respect to the guidance and the high end and the low end, can you talk a little bit about the most important or impactful levers within your business that would get you to the high end or get you to the low end?

I would say the range is a lot driven by the top line. We're looking there and at the ability to leverage. So, if you looked at three of the four business segments you saw really nice leverage on sales increases. We're anticipating some decent sales increases in 2011 and so the top line, we have a range there, if it comes in toward the high end we should be toward the high end of the range.

Makes sense. And kind of along those lines, Tom, you -- I think you had said for electrical power you were looking for maybe a close to a 20% increase there for next year. Any way you can give us a sense for the other segments of what sort of growth we're looking for?

Sure. If we look at the four segments, we expect Turbine Systems to have about 8% to 10% year-over-year growth. Electrical power, like I said, towards 18% to 20%. Engine Systems, between 10% and 12%. And Airframe Systems, we do expect to turn the corner here, between 6% and 8%.

Got it. And then just quickly on the Airframe Systems note, in the midst of the challenges and headwinds that you're continuing to see there, have you been able to make any progress in terms of capturing more aftermarket or I guess plugging up leakages that these businesses have had in their aftermarket in the past or is that really going to come after the volume improves?

You know, we're starting to see, a little bit, and I think if you remember from previous calls, part of regaining the aftermarket is a focus on the aftermarket which we're doing. It's putting more feet on the ground with that potential end users. And so that we've done. We've also had to improve our -- what we call our turnaround times on repair and overhauls and then also our ability to have more parts logistics. We've been putting in the planning. We've been improving our processes. We still have a ways to go there.

The encouraging sign is our sales force is out there. Customers are saying they would like to get their services from us as soon as we could get the performance there and we're making improvements. We expect probably another couple years because it takes a long time to get the momentum change. But we do expect to start seeing gains in aftermarket as we planned. So, it's encouraging but it will take some time.

Great. Okay. Thank you very much.

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

Good afternoon, gentlemen.

Good afternoon, Peter.

I guess first question, if we could just continue on Airframe. Understand that some of these items I guess are short-term or maybe temporary or driven by demand, but as you kind of look at the business, you've talked about it being solid double-digits margin-wise, has anything changed from that perspective? In other words as you get through some of these refocusing initiatives, should we think about this business being different from a structural profitability perspective than what we thought maybe coming into this quarter?

No, I think we're still -- we still believe it's an excellent business long-term. We believe that. We've got the products and the margin capability. I think if you look at the end of the PowerPoint presentation that's on our website, you'll see that we continued to highlight the margins which we think are healthy in terms of being in the mid-teens, when you take out the acquisition amortization costs. And we're seeing some good things happen with our strategies.

So, we do have some headwinds as Bob highlighted. The group is coming together well. We expect the aftermarket to pick up over time. We're doing better, I think, on packaging systems and component packages to our customers. So, we're starting to see some improvements and those will start coming in growth over the next few years. As Bob highlighted, commercial projects take a little time. We still expect this to be a healthy business with good mid-teen margins.

If you look at that top line forecast you gave us 6 to 8% growth for that segment, can you give us the puts and takes there? I'm just wondering what some of the assumptions are that go into that 6% to 8% growth, if you could talk about the smaller bis jet, military and some of those end markets.

We really have business jets in there flat year-over-year and 2010 was a pretty poor year. So, we're holding it flat. We have military basically flat, which is good. It's for us, that would be like the precision weapons business that we have, turrets, military helicopters. Commercial is up, so that's where we're picking up some sales gain and we probably get a little bit in aftermarket on a year-over-year basis. So, that's kind of the broad breakdown. And so we're encouraged by that.

There's some, if you want to say Honeywell and others that put out bis jet forecasts, looking at 2012 to start to be the turning point. The other areas that's under pressure, I think we said it in the prepared remarks, is regional jets, we have really nice presence in regional jets and as you're aware those are pretty pressured right now and we're expecting that to be flat through the whole 2011, so we're not expecting any gains there.

Perfect. And then I guess not to make you hazard a guesses about 2012, but I'll try, you mentioned military and obviously some of the wells seeing pressures there. How should we think about Airframe in exposure to the military side of the business as we kind of roll into fiscal 2012?

We play in some areas that -- we're looking at steady or flat and the reason -- there's two things that you've got to take into consideration. These guided munitions are still holding together. And we have a real nice share there. We also do pretty well on unmanned UAVs, unmanned aerial vehicles. We expect that to hold. So, not all defense spending is created equal.

We picked up a new turret business, if you remember the announcement on what we call the ILWS. So, that will go into production to offset some other areas. So, we're starting to see those holding together and we expect -- we're starting to expect some business jet increases coming into 2012, maybe slight, so we'll start to see a little bit of pick-up there.

All right. And I guess on the --

Peter, there was one other thing, I'm sorry. Watch for the foreign military sales, like you've seen there's been like to India, you got the Saudi Arabia. Across -- I'd say we looked at that, we have content on everything they've sold. So, if those hold together and start to sell in 2012, that's also going to provide a floor under our military sales. So, those are the factors to think about. The foreign military has got some really good programs for us in those big sales and also our mix is pretty good in what we expect to hold together in the defense budget.

All right. That is very helpful on Airframe. And then on Turbine, I just want to make sure I understand. The margin you put up, to just over 25% operating margin. I guess the best since you started reporting that segment. I'm guess that aftermarket contributed a bit now that that business is starting to improve. How do we think about the margin profile of this business as you kind of roll through 2011 when you've got 8% to 10% top line growth? Is this -- are we looking at a business that could kind of stay at that 24%, 25% operating margin run rate through 2011?

Yes, right now I would bring it back to more of our guidance, maybe on the high end of that towards that 22%. And it will be somewhat based -- we hit it a little bit again in the prepared remarks. We are right now investing heavily to win the competitions on the new narrow body engine. So, what you really have is GE, CFM with the CFM LEAP-X, Pratt and Whitney. We also have a new CF34 engine being produced. If we are successful in winning that, which we're driving very hard to try to win, our R&D spend will go up.

Okay.

Okay? So we're kind of -- before I factor that way up I'd be thinking more toward the top range of our traditional range.

Got it. And then one more, if I could. You gave us the earnings number for next year. What sort of free cash flow conversion should we be thinking about?

As we indicated, as sales come back, we will be seeing increased working capital investment. So, it will remain strong but we're looking at approximately $140 million, so that represents largely the same operating cash flow offset by working capital.

$140 million, that's free cash?

Down from about $190 million. Yes. We've been running in that range. $156 million this year, $190 million last year.

Okay. I got you. Okay.

CapEx as you noticed goes up significantly.

Yes, $65 million, I got it.

Right.

All right, thank you for your time and help.

Sure.

Thank you. Our next question comes from William Bremer from Maxim Group.

Good evening, gentlemen. Nice quarter.

Good evening, Bill, thanks.

Can you talk a little bit about some of the nat gas initiatives you're doing across your segments here?

Yes, as you're aware, natural gas applications using natural gas is quite large for us. So, if you want to start just with exploration, we always start that a good deal of equipment that we produce is used to help power, the drilling operations and you get into compression and in the compression market we play heavily there. So it's -- a lot of time that's reciprocated engine driven compressors but also gas turbine driven compressors. So, there in that supply chain of extracting and distributing natural gas you're going to find Woodward all through that chain. If you say there, that's good for us. Increases in exploration and demand for natural gas.

Then you go into the uses of it. We do quite a bit outside of the supply chain for the extraction and distribution and you get into vehicles like our on-highway natural gas vehicles, our activities around forklifts and lift trucks and the things are powered by alternative gas. We also will look at power generation applications and then you start going from reciprocating engines which are doing power generation from small to large reciprocating engines where we cover the whole range. And then you start getting into the gas turbines.

So, we start at a small gas turbines to the aero derivatives to the large frame and over the years we've been really building content per application in each of these areas. The fact that there's a t lot of natural gas available, the price is very competitive, we believe you're going to see a lot of demand increasing for those type of machines. We've expanding our presence in Asia and international markets so, we're doing well capturing share there on these type of machines. And I believe over the next few years you're going to see the gas turbine business really pick up and we're strongly positioned for that.

Tom, can you give us an idea of what capacity you're running at now on the nat gas side?

Yes, the one thing if you look at manufacturing capacity, Bob and I look at it, we don't have any need for any brick or mortar or beyond the capital equipment we have that we have in our CapEx plan. Obviously, we're going to need to hire people worldwide and to fill our shops, but we have plenty of capacity to handle significant growth rate for quite a few years to come. And a lot of that's been optimizing our supply chain, what we do in-house, versus our supply chain, getting a good group of partners. We call a lot of that, we've been for I guess about five years working on what we call core, non-core manufacturing, so we're really keeping the pieces that have real core technologies, high intellectual properties in house, working our supply chain to help us optimize our global footprint and our cost basis.

So we feel real good about that. The only capacity constraints that we've really encountered over the last couple quarters has been electronic components which you guys are pretty familiar with. They were a little slow to ramp up. That's starting to come in. We had some pressure there. That's starting to come around. We're expecting next year some of that pressure will ease a little bit.

Okay gentlemen, thank you.

Thank you. Our next question comes from Greg McKinley from Daugherty.

Yes, thank you. I'm wondering if you could help me a little better understand the diversification of your business within the Electrical Power Systems segment. Maybe you remind us how much of that is wind. And then within that wind segment, what's sort of the concentration risk in that business? Is it a high volume of moderate or low value projects or a small volume of high value projects? How do you look at that? And what is -- given that, how predictable is the growth in performance of that business for next year?

So, the mix is as we've described in the past very heavily oriented to wind. It's half, if not more, of that business depending upon the quarter and so on. And let me come back to the diversification of that.

The second part of the question, the other two parts of the business that we look at it as a thee part business. We've called this our Power Station Project business. So, we have engineering teams that are kind of turnkey distributed resources for power generation. So, for example, there's some large backup power plants that are large numbers of diesel power generation pieces of equipment. Our team does a lot of the commissioning and design of those power station projects.

The other area we've talked about is largely grid related. And that's our power generation and distribution business and that focuses on all of the power generation controls related to whether it's natural gas or reciprocating engines and so forth. As well as sensors, AC measurement and digital control in the grid environment and that is the second largest piece of our business, with the power station business running a third in terms of size.

On the wind diversification, we do not see any significant concentration from our standpoint. Tom referred to regions and our customer base is fairly diversified from that perspective and that's been helpful because the US and Europe have not been seeing a lot of wind growth, whereas the developing parts of the world have.

Okay. Great. That's helpful. Thank you. And then regarding -- you made a comment that given the anticipated revenue recovery next year, your variable compensation will increase $0.25 year-over-year in 2011 versus 2010. Are we going to see that primarily show up in segment level margins or is that going to have a more distinct impact on SG&A? How should we think about that optically on the income statement?

So, Woodward's variable compensation structure is very much established across the entire business. So, it will be in business segment margins. We do classify it within business segment margins so that, depending upon the type of area that you are working in, if your direct labor and so on it would be in margins. If you're in selling or administrative roles, it would be in SG&A.

So if the kind of direction is, is it a management top heavy sort of bonus structure that will all be in non-segment, no, I would not characterize it that way. As we've described in the past, Woodward's bonus structure is semi-egalitarian, I'll call it.

Okay. And then, finally, getting back to Airframe for a moment, when those two businesses were acquired I think certainly part of the support behind that was to extract some synergy value by integrating components that Woodward produced into sort of comprehensive solutions, sales and system sales.

Yes. Did we lose you or did you stop there?

I was asking have you felt like you accomplished what you wanted to in terms of systems integration on that business and is the pressure solely been sort of cyclical exposure in regional and small business jet or do you feel like there's been some executional hiccups to get those components integrated into system sales?

I think the systems strategy is beginning to work and it's going to take a little bit of time but we are getting good feedback from customers. We're working with them on putting a number of components either together in a package or approaching it as complete cockpit systems or actuation systems or sensor suites. So, that is working and we have been during the downturn, we have picked up a variety of programs, but they're all in development right now. That's kind of what Bob alluded to in his comments is that we're investing right now heavily because we've been winning. And so --

Yes.

And so that's been good. That will start showing up in sales in the next couple of years. More of the pressure's coming from a mix which is much, much lower in funding and a mix of volume and like we described earlier. So, I think the strategy is taking hold. I think customers are responding fairly well to it. And we've been -- we have been winning programs, so, from that stand point. And winning programs in aerospace is always -- at first a mixed blessing because you spend a lot of money up front before you get the revenue coming in, so that's where we are right now.

Thank you.

Thanks, Greg.

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

Good afternoon, guys. I just had a quick question on R&D spend and kind of how it relates to any re-engining programs. It sounds like both Airframers have sort of pushed out the re-engining decision at least for the time being. Does your R&D, in your guidance imply that you sort of just continue to spend and explore opportunities there or could that come down if we get a definitive answer from them?

What you have to look at, and I think this is really important from Woodward Turbine Systems standpoint, is there really are two engines or you can kind of say, three. But two engines in the narrow body market today that we really think are the platform for the next 15 years. And that's the GE CFM56, they call it the LEAP-X, but they've also just announced a CF34 TECH-X which is just slightly smaller. Those are platforms that are going to leverage together. And you've got the Pratt-Whitney PurePower line or platform.

Those engines are launched. They have customers. So, you got the Chinese, the C919 is a go project with the CFM engine on it. That engine is going to be the same platform that will be used for any re-engining or any new narrow body offering over the next 15 years. Same thing with the PurePower. It is launched. So from a Woodward standpoint, we've been saying a lot of R&D as we always do, it's been six years now we've been spending R&D in anticipation of these programs, getting the right -- thinking of what the engines would require, developing the technology.

We're now in what you would call the RFP stage. So, we're bidding on the programs. We anticipate we will l be successful, but that's not a given, and if that happens we will be launching because they do have committed programs today. Again, the Chinese aircraft, the C series, the Russian aircraft are all committed and we expect Boeing and Airbus will have something within either next year or the next few years and they will be based on those two engine platforms.

Okay. That's helpful. And then could you remind us of kind of the seasonality? I mean, if I kind of run rate your Electrical Power Systems Q4 number, I get a higher growth rate that you're sort of guiding toward that 18% to 20%.

Yes. The first quarter for us if you recall is usually our down quarter.

Yes, okay. Okay.

12/31 of course.

All right. Okay. Thank you very much.

Sure.

Thank you. Our next question comes from Gary Farber from CL King.

Good evening. Just a couple questions. Could you talk about your liquidity going forward if you're going to generate free cash, you have some cash, how you think about using it?

Well, we do have cash obviously. Our liquidity is I think in excellent shape. We've gotten our debt, to EBITDA leverage down to 1.8 times. We will continue to pay down the available debt for paydown as we go forward.

Kind of going to where I think you're headed, obviously we've said we're always -- we have a funnel process of looking at acquisitions. We analyze gaps in our portfolio, whether that's geographic or technical and so on. And there's always a number of companies that we are looking at. I can't say at this point that there's anything that we're actively pursuing. But that's always an opportunity that we keep our eye on.

I mean, how much debt is remaining to possibly be paid down?

We've only got about $70 million left.

Okay. Right.

Plus the short-term revolver that happened to exist at the end of the year was another $20 million, so roughly $90 million, call it $100 million.

Great. And then just a couple questions on the airframe business. Can you speak to -- compare sort of the capacity levels that business is running at versus your other businesses? Is there a pretty drastic gap?

Well, what I would say, it's got a lot of capacity.

Okay.

Okay? And to your question, you know, the volume is way down from what -- if you went back to mid-2008 to today, volume's down significantly. Capacity's there. We have been working to reduce some of the capacity and that's already in the plans and it's been happening. So, from that standpoint we've got a lot of capacity.

What we're looking at is that allows us to have positive leverage going forward. We do have orders coming in. We're confident in the top line going forward this year. So, as we get the volume back up, we should be able to leverage that capacity into higher margins.

On the small business jets, what data points would be out there over time, would you say, that would suggest your business is doing better, worth tracking.

The thing we always look at or constantly watch is the parked fleet or utilization on the bis jets and there's some reports out there that will talk about utilization. The things that drive business jets first and foremost is corporate profits and then first you've got to see utilization go up for about 18 months and then you start to see new orders happening. So, corporate profits are going up. Utilization's starting to go up. So that's kind of why there's this idea that 2012 will start to be the turning point for bis jets.

The ones that have held together, Gulfstream has held nicely together and we do have content on Gulfstream and that high end of the market. But for most of the market, you're going to see probably 2012 turning point, based on the current data and trends.

Okay. Then just one last question on raw materials. Are you seeing any -- is there any issues with tha as far as the rising prices and things?

Right now we're okay. We used a lot of copper and we use a lot of exotic nickel-based materials. So, we watch those closely. Right now I think the price of copper is in our plan. If you all of a sudden saw a huge increase in there, that would put some pressure on us or if you saw a huge increase in nickel-based material, high nickel content, then we would see some pressure. But right now I think we're okay in what we're seeing ahead of us. But definitely with inflationary fears on the horizon, we're watching material costs as well.

Okay. Thank you.

Thank you. Our next question comes from Tyler Hojo from Sidoti.

Hi, just a couple of follow-ups here. The 18 to 20% growth in electrical power, does that assume any additional market share wins or is that just basically what you already have in hand today?

It's what we have in hand today.

Okay. Good. And in terms of commercial aftermarket, would you be able to kind of give us an idea of how much that was up in the quarter?

You would have to give us --

Are you asking sequentially or year-over-year?

Either, or. Preferably it would be year on year.

So, year on year for the quarter, so Q4 '10 to Q4 '09, I'll call it in the neighborhood of total increase of about 20%.

And we're just talking commercial aftermarket here, correct? Or is that including IGT as well?

No, that's commercial aftermarket.

Okay. All right. Great. And then just a clarification here. In your slide deck the slide anticipated long-term --

Tyler, for clarity. We want to make sure you understand. That was TS, Turbine.

Aftermarket for Airframe was down. So, it's weighted obviously by Turbine as we've described, but Airframe was down in aftermarket.

Okay. But in aggregate you were up 20%?

No, no, that's the Turbine up. So in aggregate we were probably, without doing the math, call it 15% -- 12% to 15%.

Oh, okay. Got it. Okay.

That reflects the portfolio.

Understood. Understood. And then just a clarification question. The slide 23 anticipated long-term targeted margins. Looks like those haven't changed since the last slide deck. Just what does long-term mean? Is that this upcoming fiscal year or what are we looking at?

Yes, I mean, what we're trying to say is this is where we believe we will reside over a cycle. Okay? And what you could kind of see is we're already entering those ranges on three of the four businesses or already, in the case of TS, above it. But that's what we expect to do.

Sometimes we look at the businesses with -- in the cycle, when we've got the volumes on a normal cycle, what can we produce and that's what we think we can produce and also across a normal cycle.

So, it's averaged from the low to the high basically.

Right.

Understood.

And the Airframe one is what we believe the entitlement of that business is. As you're all well aware of, that's where we think we can get it to, that's what we're striving for, but that will take probably a couple years on that. The other three are already in the range and with the sales volume we expect to move up the range.

Okay. Now, would you care to give segmented operating margin guidance for FY '11 or is there just not enough visibility there?

No, we were trying to give you the top line in these ranges and that we're moving through those ranges.

Okay. I get it. All right. Fair enough. Much appreciated.

Thanks.

Thank you. Our next question comes from William Bremer from Maxim Group.

Just a quick follow-up. Can you give us an idea of the aftermarket opportunities in Electrical Power Systems?

Yes, that's a great question. And we think they're going to be growing. The reason for that is we're installing every year more and more of the wind converters. The reason I say that is they -- high powered electronic devices like that do wear. And you do have a replacement and a repair cycle. So, we expect to start seeing some more of that.

And what we talk about for aftermarket for Electrical Power is really broken into a few categories. We help customers with application engineering. So, I call that kind of a service business. We help them with field commissioning. So, we help them get things up and running. And we get paid for r that. We provide spares, repair and overhaul type services. And then we also sometimes do field service for them. So, that is what we refer to as our whole aftermarket opportunity.

The installed base is growing nicely and as it ages, that will produce a nice aftermarket stream. So, that's over time, should start being a new revenue generator for us.

Would you say it's operating at around 20% of total revenue at this point or lower than that?

No, it's much lower.

Lower than that.

Okay. Thanks, gentlemen.

Opportunity.

Yes.

Thank you. Mr. Gendron there are no further questions at this time. I'd like to hand the conference back over to you for any closing remarks.

Well, I'd like to thank everybody for joining us today and thank you for your questions. We always appreciate them and we look forward to talking to you in January at the end of our first quarter. So, thanks.

Ladies and gentlemen, this concludes our conference call today. If you would like to listen to a rebroadcast of this conference call it will be available today at 8.00 PM Eastern Daylight Time by dialing 1-888-266-2081, or 1-703-925-2533. And by entering the access code 1492430. A rebroadcast will also be available at the Company's website at www.Woodward.com, for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your line.