Woodward Inc (WWD) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Inc. third-quarter fiscal-2011 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 will be invited to participate in a question-and-answer session.

Joining us today from the Company are Mr. Tom Gender, 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 third-quarter fiscal-2011 conference call. In a few minutes, I'll cover the financial highlights of our third 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 of you 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. If you have a copy referring to the second quarter, please refresh your version and you should be okay. An audio replay of this call will be available through July 29, 2011. 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 3. 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 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 fiscal 2010 and 10-Qs for the quarters ended December 31, 2010; March 31, 2011; and June 30, 2011, which we expect to file shortly.

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. The 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. Sales for the third quarter were $438 million, up 23% from $356 million in the third quarter of last year. Reported earnings per diluted share were $0.51 for the third quarter, compared to $0.45 for the third quarter last year, a 13% increase. Earnings in last year's quarter benefited from a $0.09 tax benefit. Free cash flow for the quarter was $14 million. Now, I will turn the call over to Tom to comment on our results, strategies, and markets.

Thank you, Bob and welcome to those joining us today. Woodward had a solid quarter, with strong demand for our aerospace and energy-control solutions across each of our businesses. Our increase in investment and research and development has been substantial this year, at over $20 million increase for the full year. While Woodward's market position continues to be enhanced by greater content on newer-generation products, our core businesses have also remained healthy, particularly in commercial aerospace where orders, deliveries, and after-market trends have all been positive.

While Bob will cover segment results in a minute, I'd like to highlight that our Turbine Systems segment delivered excellent results while pursuing new business opportunities in both aerospace and industrial markets. Our Airframe Systems business is making progress towards improved performance. Electrical Power Systems performance for the quarter reflected our globalization plans for this business, including revenue growth driven by market-share gains and the completion of a promising acquisition. Results, however, continue to reflect transitional margin pressures associated with investment and the dynamic hydro business.

In Engine Systems, we secured significant new positions on multiple high-pressure, common-rail, diesel-fuel systems for large reciprocating engines. Turning to our markets, the commercial aerospace market was -- has been very strong. High level of new orders, increase in build rates, and increased traffic are driving demand for our spares, repair, and overhaul services. Our presence on the Airbus A320 and Boeing 777 continues to drive demand for Woodward OEM and after-market sales. We anticipate a ramping of deliveries over the next several quarters related to the Boeing 787 and 747-8, as initial deliveries approach. The recovery in regional and business jet continues and is evident in our aerospace businesses, particularly at Airframe Systems.

Defense spending in our markets has remained relatively steady, with four military sales offsetting some declines in US government spending. Demand for our flight-control and weapons systems was up slightly this quarter.

Turning to industrial turbine, the industrial gas turbine industry is well positioned to deliver on the world's growing power needs. We believe that the availability and pricing of natural gas will drive industrial turbine growth in its share of the power generation market. Woodward has been steadily gaining share in the industrial turbine market, with increased content per application. At the same time, we are establishing new OEM relationships and broadening the existing ones.

Turning to renewable, we are delivering on the share gains we've have one in wind power, despite what has been a tough market. The IDS acquisition has allowed us to broaden our portfolio of products and customers while establishing a foothold in the solar market. We remain confident that renewable will be a growing part of the solution to the world's energy needs, and we see numerous opportunities to grow our content and share in this market.

In other electrical markets, electrical power generation distribution projects across the globe continue to grow. Also, the IDS acquisition expanded our capabilities in grid-related controls for energy storage and marine drives, areas where we believe there are significant opportunities for Woodward content. Industrial reciprocating-engine demand remained solid this quarter. We've also seen demand expand to include larger diesel, natural gas, and multi-fuel engines.

In summary, we continue an investment in technology that is closely aligned with our customer needs. This allowed us to provide the solutions our customers have demanded, both in aerospace and energy control. We have continued to balance our investments for the long term, with our objective to deliver consistently solid financial performance while keeping a careful eye on the dynamic economic environment around us. Now let me turn it over to Bob for the financials.

Thank you, Tom. At the Woodward consolidated level, net sales this quarter were $438 million, compared to $356 million for the 2010 third quarter. Growth compared to the prior year occurred across all four of our business segments. Net earnings for the third quarter of 2011 were $36 million, or $0.51 per share, compared to $32 million, or $0.45 per share in last year's third quarter. This improvement included the absorption of $6 million in variable compensation, as well as $8 million of increased research and development investments, focusing on new opportunities as outlined by Tom.

While we have previously commented on the full-year impact of increased variable compensation, research-and-development increases will also approach $25 million for the full year. Also included in the prior year's third quarter were $6.4 million of tax benefits or $0.09 per diluted share. EBIT, or earnings before interest and taxes, was $57 million for this quarter, compared to $45 million for the prior year's quarter. EBIT was favorably impacted by the sales-volume increases, but was somewhat offset by the increases in research-and-development and variable-compensation expense. Free cash flow for the third quarter of 2011 was $14 million.

Turning to our business segments, Turbine Systems segment net sales for the third quarter of fiscal 2011, which include inter segment sales, were $191 million, compared to $151 million for the third quarter a year ago. Both industrial and aerospace turbine original equipment and after-market demand increased.

Segment earnings for the third quarter of 2011 increased to $46 million, from $36 million for the same quarter a year ago. As a percent of segment net sales, segment earnings were 24.1% this quarter, compared to 23.8% in the same quarter a year ago. Segment earnings benefited from the increased in volume and price increases, partially offset by increased variable-compensation and research-and-development costs.

Moving to our Airframe Systems results, Airframe Systems segment net sales for the third quarter of fiscal 2011, which include inter segment sales, were $103 million, compared to $94 million in the third quarter a year ago. Demand for weapons systems, as well as business and regional jets, improved, but was partially offset by a decline in customer funding for development.

Segment earning for this most recent quarter were $6 million, or 5.4% of segment net sales, compared with $3 million, or 3% of segment net sales in the third quarter of 2010. Compared to the prior year's third quarter, earnings were positively impacted by increased sales volumes, partially offset by the effect of the reduction in customer funding for development and increased variable compensation. Segment earnings for both periods included non-cash amortization of $7 million.

Now turning to Electrical Power Systems, Electrical Power Systems segment net sales for the third quarter of fiscal 2011, which include inter segment sales, were $72 million, compared to $47 million for the third quarter year ago. Sales volumes increased across most product lines, particularly wind turbine converter sales, and were also favorably impacted by the recent IDS acquisition. Segment earnings were $3 million for both 2011 and 2010 third quarters. Segment earnings as a percent of segment net sales were 4.5% this quarter, compared to 6.5% in the same quarter for the prior year.

Segment earnings benefited from the increased volume, but were offset by costs associated with recently expanded production facilities and supply-chain requirements for serving the global customer base. Results were also negatively effected by product mix, increased variable compensation, and the integration of IDS.

Moving to our Engine Systems results, Engine Systems segment net sales for the third quarter of fiscal 2011, which include inter segment sales, were $104 million, compared to $86 million for last year's third quarter, an increase of 21%. Sales increased all across substantially all major markets and product lines. Segment earnings for this quarter increased to $10 million, from $9 million for the same period a year ago. Segment earnings as a percent of segment net sales were 9.4% this quarter, compared to 10.6% in the same quarter last year. Sales-volume leverage was offset by increased investments in product development and increased variable-compensation expense.

Non-segment expense for this quarter were $8 million, compared to $6 million for the same quarter last year. Non-segment expenses were 1.7% of external sales for both the third quarter of 2011 and 2010. The increase resulted primarily from increased variable compensation.

Now, I would like to focus on certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, improved to 30.6% of sales in the third quarter of 2011, compared to 29.9% for the third quarter of 2010. Research-and-development costs were $29 million for the third fiscal quarter of 2011, compared to $21 million for the third quarter of 2010. As a percentage of net sales, research and development was 6.7% in the third quarter of 2011, compared to 6% in the third quarter of 2010. The increase relates to our efforts on both previously-awarded programs and future opportunities with respect to new platforms and market share gains.

Selling, general, and administrative expenses were $39 million or 8.8% of net sales this quarter, compared to $31 million, also 8.8% of net sales in the same period of 2010. Our effective tax rate for the third quarter of 2011 was 29.1%, compared to 16.3% for the same quarter last year. Included in result for the third quarter of 2010 were $6.4 million of tax benefits. We now expect our effective tax rate for the full fiscal year to be approximately 30%. Capital expenditures were $13 million for the third quarter of 2011, compared to $5 million for the third quarter of 2010. As previously announced, we are constructing a new $20 million systems-test facility for our turbine segment. We expect full fiscal-year 2011 capital expenditures to be approximately $65 million.

Looking at the balance sheet, working capital, defined as current assets less current liabilities, was $524 million at June 30, 2011 and $457 million at September 30, 2010. Woodward generated $27 million of cash flow from operations for the third quarter 2011 and $14 million of free cash flow, with continued investments in inventories reflecting our anticipation of increasing sales in the quarters ahead. The ratio of debt to debt-plus-equity was 34.3% at the end of the third quarter, compared to 36.7% at September 30, 2010.

Lastly, let me turn to our outlook. We believe the economic environment, while dynamic, is one of continuing moderate recovery. As a result, we expect sales for fiscal 2011 to be approximately $1.7 billion, with earnings per share for 2011 to be approximately $1.85. This outlook continues to reflect an expected full-year increase in variable compensation from fiscal 2010 to 2011 of approximately $0.25 per share.

That concludes comments on our business and results for the third quarter of fiscal 2011. 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 your first question, sir. Tyler Hojo, Sidoti.

Hi. I just want to talk a little bit about the margin, in particular in Airframe and electrical power. On electrical power, were the expenses that you called out in the prepared remarks -- were those expected? And maybe you could quantify those. And then also maybe speak to whether you think you can get back to a double-digit rate in the near term?

I would say the majority were expected. I would say there's always quarterly variability that is not really expected, and the effects of the acquisition were not anticipated earlier on in terms of where we thought that would end up. But we do still believe in the -- we've called out a range of long-term earnings of between 13% and 16%.

We do believe as the economy continues to recover and the top line comes back, which it has been doing in that business, that we will be able to attain those levels. We've called out in previous quarters some of the effects of global expansion, and those are continuing. We see a path to getting those behind us, but at this point, those costs are continuing.

Okay. Are you on the wind-inverter side -- are you having to give up a little bit more price than you perhaps thought you did to give up that volume growth, or is that really not an issue?

Well, it can always be an issue. At this point, it's not as much price on the top line as it is regional impacts. There is some price on the top-line impacts across some of the customer base, but we're also seeing some regional impacts where China and Asia are growing. And I think we've called out in the past that at present, those are some of the lower-size megawattage units. And so, the western world if you will, the US and western Europe, are not currently in the market as much as Asia is, and that's having a little bit downward pressure.

Okay. That's fair. A couple more here. Would you be able to tell us what IDS added in the quarter in terms of sales?

IDS was slightly dilutive in the quarter, and we believe it will be neutral over the coming 12 months.

But what did it add to the top line?

Added approximately $6 million to the top line.

Okay. $6 million. All right, great. And then just lastly, I was hoping that you could comment on -- (inaudible) Street numbers pretty much all over the map here, but I think Street sales are implying something like 6% growth. Just in light of GE's commentary in terms of increasing outlook on the large gas turbine side, I was wondering if you could talk about that a little bit?

Yes, Tyler, the first -- the phone broke up on your first statement. Are you talking about 2012?

Yes, I am.

Okay. We haven't given any 2012 guidance, but we expect to have good sales growth in 2012 on a dollar basis, on a percent basis would be in double-digit growth going into next year as well. And some of the dynamics like you're talking about from -- it's really across all of our businesses. We feel good about incrementally going into 2012. We'll provide, shortly, further guidance, but it is solid moving forward.

Okay, great. I'll hop back in the queue. Thanks a lot.

Peter Skibitski, SunTrust.

I want to be sure I understood, you raised your sales guidance nicely, but broadened the top end of your EPS guidance. I just want to make sure I understood what drove that.

So, the -- you're right. We actually came a little bit ahead of our sales guidance, and then whether you want to call it the top third of our earnings guidance, I would say the biggest impact there is the R&D, research-and-development increases that we called out. And this time, we thought it would be of interest to call out the full-year impact of that, because it's probably lost sometimes when we only go through the quarterly impacts. But it is substantial and related to a lot of the opportunities that Tom has mentioned.

Okay. When you said $25 million, that's how much you except to be up year-over-year in R&D?

Yes. For the full year, yes.

Okay. Got you. And then just one follow-up. Can you give us a sense of the growth rates at turbine for -- I guess I have a question a couple different ways. Maybe the growth rates were aircraft versus industrial? And then within aircraft, for RJs and biz jets versus commercial and military?

Yes, if you look across -- obviously the commercial aircraft, if we talk about narrow body and wide body, the production rates are being increased. And then over time, we have picked up share. So, we're looking at those as increasing year-over-year. The regional are starting to come back, but -- so they're holding. You know, we finally started to see movement there.

On the defense side, basically we like our mix in defense. The overall defense spending is dropping. We have quite an exposure to rotorcraft, UAVs, and smart weapons, all of which we expect to have closer to steady spending, and that's kind of what we see right now is that it's been steady. We haven't seen a decline, but we're not projecting any growth in those areas.

And we're starting to see recovery in business jets, so we're starting to see some order pickup and our sales pick up there, both on utilization of the current fleet, and we expect increases coming forward. So on the commercial side, the outlook as we move in the rest of the 2011 and the fiscal year 2012 is pretty positive.

On the industrial turbine side, so when we look -- a lot of times we like to talk gas turbines, but it's gas turbine, steam turbines, and compressors, we're seeing substantial growth coming over the next 12 months. So we expect solid sales there, and the market trends are very positive for that business.

Okay. And -- actually I'll get back in the queue. I asked enough. Thank you.

Thanks.

Fred Buonocore, CJS Securities.

So, you've addressed this in a few different ways in the prepared remarks and then some of the previous questions that were asked, but could you go through, using the fiscal Q3 results as a baseline, just segment-by-segment on margin again for us? Just a way to think about the segment margins heading into fiscal 2012, because you've given us a way to think about what revenue growth should look like. So if you could help us think -- sharpen our knives a little bit on margin, at least directionally from where we are now, that would be helpful.

Sure, Fred, we can give you maybe a little color. I think one of the things we would not be able to do at this time is we've talked more about the longer term, and we can color 2012 in terms of the path that we'll be on getting to those longer terms, but --

So the turbine business has been -- we've called it out as 19% to 22% sort of range for a long time, and we've actually been doing better than that for quite a period now. The after market has been healthy, and as long as that continues, there's -- we're very bullish on that outlook. There will be, as we've mentioned, some increases research and development as we get into 2012. And that could put some pressure on that rate that we've been achieving so far, but it should still be equal to or slightly better than that long-term rate.

Airframe Systems, what we'd like to say there is we're on the path, and I think we've called that out in terms of how we thought we'd end the year and how it was a two- to three-year of process to get ourselves back. We called out the need for significant improvement in Airframe. This need for improvement in regionals and business jets, we're starting to see that come back, so we're encouraged by that. And that business also is investing in R&D for future growth programs as well.

On the electrical power side, that's probably obviously the largest delta at the moment between where the business is performing and what we see in the longer term. That is a lot of top-line related as well and a lot of product mix. And some of the items with respect to the globallization and getting our supply chain aligned with the needs of our customers in each region, that will take a bit of time. So we will be back on a path, but it'll take a little bit for us to get there.

And then lastly, Engine Systems -- they were approximately 10.7% I think last year at this time? We believe that getting into the double digits as we go into 2012 and then the long-term rate of I think we've said 13% to 14%, very achievable as we go forward.

I'm sorry, what was -- remind me the long-term rate on Engine Systems again?

That long-term that we've highlighted is between 9% and 13% on Engine Systems. And as you can see, we're in there. As Bob said, be double-digits in 2012.

Great. No, that was very helpful. I thank you for that. And then just on the Turbines -- on Terbine Systems, as you've pointed out, margins have been running higher than what you have expected or what Wall Street has expected for several quarters, which is great. And you've talked about the R&D that you could potentially see in the coming quarter. Do you have any updates or any comments on programs that you're -- re-engining programs that you've been pursuing and when we might hear more about that?

Yes, obviously the re-engining programs have really taken off since our last call. The A320 NEO captured substantial orders. A lot of them were announced at the Paris air show, and that's offering the CFM LEAP-X engine and the Pratt & Whitney Pure Power. And then just over the last week -- last week really -- with the American order announcement, Boeing has decided to re-engine the 737, and that's going to be exclusive with the CFM LEAP technology.

As we've talked about previously, we've -- we are working to secure positions both those programs. We're very optimistic and would anticipate announcements in the four- to five-week time frame from now.

Sweet. Great. That's all I have for now. Thank you very much.

Sure.

Peter Lisnic, Robert W. Baird.

I guess first question, Bob, just on the forecast and specifically, free cash flow. Can you give us a sense as to what working capital use or build we should think about as you continue to grow? Obviously, conversion won't be like it was last year, but I'm just trying to get a ballpark for where we might end up cashflow wise this year.

We would estimate -- it has been, as we mentioned last quarter, it's been somewhat difficult, especially depending upon timing with receivables and so on. But we would say at this point, our full-year outlook is probably for $50 million or slightly less.

Okay. Perfect. And then I just want to make sure that I understand the EPS margins. It sounds like there's a little piece of that might be due to IDS. Are there any step-up charges or purchase accounting adjustments that are flowing through the numbers now?

They are. They're not significant, so we didn't call any of them out specifically. As I think you're recalling from the last acquisition, there was some fairly significant numbers that flowed through in the first quarter. While that is true here, I would not call it a significant element with respect to the overall EPS performance.

Okay.

There is an impact.

Okay. So it's mostly variable comp and R&D that's flowing through and compressing margins there, along with mix, I guess.

Exactly.

All right, fair enough. And then when you look at this R&D number, I guess $105 million to $110 million, if I'm doing the math right this year, I would imagine that the spigot doesn't exactly turn off after the end of the year. But that being said, if you're continuing to focus on growth, is that a new run rate that we should think about for the intermediate term for the business, or is there the potential for that number to ramp down a bit as we go through 2012?

As we move -- our thought right now as we move into 2012, the dollar rate will go up, but as a percent of sales, it would be pretty constant.

Okay.

So kind of use the percent of sales going forward. So, we have more investments to make, and if we are successful with some of these key new programs it's going to drive dollars up, but our growth is also going up nicely. So as a percent of sales, it should hold.

Okay. And then can you call out exactly where the bulk of that incremental spending is or for what program specifically? I'm guessing it's more on the commercial aerospace side. Is that right?

If w look at Turbine Systems, the commercial aero market is a substantial increase. On the industrial turbine, we're seeing sizeable new activity across the gas-turbine market, and then we're seeing substantial in steam turbines and compressor controls. So that's going up, so we are increasing R&D spend there. We've also got a sizeable investment going in high-pressure, common-rail systems for our engine systems group and continuing to invest in new technology and the renewable and power-generation side of Electrical Power Systems.

So, there is increase across all our businesses. They all have nice growth prospects as I highlighted earlier. As we move forward, we've been ramping up this year, so then you're going to get the full-year effect in 2012.

Okay, and then just if I could the last question on that. On the commercial spending side of the equation -- commercial aerospace spending side of the equation, is that for the programs that are soon to be awarded, i.e., the 737 and the 320? Or is this for what I'd call next-generation programs or future programs?

Well, we do have spend going beyond the next generation aero body engines, but I think as we have highlighted on previous calls, to enhance our position, we have been investing already in those programs -- to enhance our position to win the contracts. So, that rate is already started. With success, it will ramp up.

Okay. All right. That is very helpful. Thank you for your time.

Thanks, Pete.

William Bremer, Maxim Group.

Many of my questions have been answered already. Let's go into Electrical Power Systems. Can you give us an update on the power station projects there? They were essentially strong last quarter. How -- you didn't really call them out yet this quarter.

No, and that was because they were significantly down this quarter from last quarter. I think we've called that area out as having a substantial amount of variability quarter-to-quarter, both the top line and the bottom line, and this quarter it was top line variability on the downward side.

Okay, Bob. And just an update on the grid controls there? Same as power station, or was that slightly stronger?

They were up. The power -- we call it power generation distribution controls. So the power gene and the distribution side were both up quarter-over-quarter.

Okay. And then can you give us an update just overall on the after market? What did the after market on a consolidated basis make up for the quarter as a percent of sales?

On total Company, or are you referring to aircraft side?

I would like both if possible.

Yes, the aircraft side was very favorable in the quarter. Give you an idea -- and this is aerospace in total. Commercial after market was up 32%. So, it was sizeable and that's also why you can see it's driving margin improvements.

Total Company after market, I don't have that clear of a number but after market's been up, industrial, turbine, as well as in Engine Systems. So, definitely utilization rates of our type applications are up across the board.

Some of our other businesses, we don't track it because the deltas and the margins aren't as great as in the aerospace side of the equation.

Right, okay. All right, gentlemen, nice quarter. Thank you.

Thank you.

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

I think I got most of them answered. I heard GE mentioned on their call that they -- the GNex shipments had slowed down. I was curious if you had experienced that during the quarter. Has there been any shift in timing to your GEnx-related product?

It didn't have any impact in the quarter. We're seeing -- the big driver really is get two the aircraft certified and then get the production rates established. And on these 787, obviously, there's Rolls Royce and GE engines. On the 747, it's exclusively GE.

So as those get -- the production rates get established, we'll have a better outlook. Right now, it's been a lot of shipments to support the flight testing and early production, and then we're seeing the established rates. What we're positive about is it looks like it's very near, and as soon as those kick in, we believe the airlines will then starting doing their initial provisioning, and you'll start to see the sales blossom.

I was trying to get a feel for how much inventory is out there related to those engine programs?

Well, I can't really -- I don't really know how much total inventory is built up. We've -- we just see that the rate, the production rates will start to increase here shortly. From our standpoint, it's going to be a positive impact to sales moving forward.

Okay. And then lastly, I don't think anyone has asked the acquisition question yet. So, what do you see on that front? You've done some deals, but still out there, or --?

What we see right now is it's very expensive. We -- and at some of the multiples that are happening today, we probably won't be active. We're always looking for the key strategic acquisitions that fit, but today's multiples, I'd say we feel like our organic growth has better opportunity for us, and we'll probably be invest heavier to pull the organic rate up.

Got you. Okay. Thanks for your time.

Become more sane.

Okay. Good.

Greg McKinley, Dougherty.

Yes, thank you. On Airframe Systems somewhere, if you could just catch up us on -- in past quarters, you've talked about some of the operational initiatives you've put in place there, the ability to turn around inventory more quickly, service the customer more quickly, and be more competitive. Can you catch us up how you feel some of the things you can control in that segment are going? And maybe talk about things you can't in terms of cycles of some of the major end markets you're exposed to there?

Yes. A little bit, I feel like we're making progress on the operational issues. One of the things that is helping the business is we're approaching the sales level for which we sized the business. When we brought Airframe Systems together, we had large downturn in business jets, regionals, and really hit the business. So we sized it at a certain level, which is in the low $400 millions.

We're starting to hit that sales level. So that's starting to say okay, we're getting to where we sized it. So I think that's going to be a positive headwind, or a positive tailwind going forward.

The operational issues, we're starting to make some progress. We still have a lot more work to do on the after market, and that's what you're referring to. Our turnaround times, making sure we have the logistics in place. I would say we made a little progress, but we've got a long way to go. And that after-market opportunity's out there. We said it would take a few years to capture, but we are making progress there.

So, the outlook moving from 2011 to 2012, we should see continued margin improvement and we're on the track we believe this business can do. I guess a little bit -- your question on the end market for Airframe Systems was also a second part of the question?

Yes.

The end markets that we have most exposure to are rotorcraft, smart weapons, regional, and business aircrafts, with less exposure to commercial aircraft. So, the rotorcraft market has been steady, the defense side. Utilization is high, so we're continuing to see revenue coming from servicing those aircrafts. Still feel UAVs are steady. Smart weapons are steady. So we're not seeing a lot of growth out of those, but steady performance.

We are seeing a pickup and seeing an improvement in regional and biz jets, so those are turning the corner. I wouldn't say any means rocketing, but they are turning the corner and starting to increase on a year-over-year and quarter-over-quarter basis. And then the exposure we have to the commercial market has definitely picked up. So we do sell a fair amount of components and others into that market, and that is picking up as well. The outlook moving into 2012, we see the end markets as positive on the commercial and steady on defense.

Okay, thank you. And then the Company has quantified for us the degree to which variable comp is impacting this year versus last. Can you just help us understand your variable comp structures so that as we think about growth into 2012, how will those expenses vary or not vary with additional earnings growth? Will that be a major source of earnings contribution next year as some of those hurdles were jumped in 2011?

I think it's a good question. Our variable comp system I'm actually pretty proud of. It's really tied to performance. We have several elements of it, but the largest is the annual incentive plan. And they're reset every year, tied to what we call our profit plan. And so what you have is we came off a year that was extremely small in terms of bonuses to what we would call target performance.

So that, going into next year, we reset targets and it won't be quite the headwind we have this year. The only thing that will obviously still be is increasing headcount with the growth we have and year-over-year wage increases, but as this large headwind it won't be there that large of a headwind going into 2012.

Thank you.

(Operator Instructions)

Pete Skibitski,

Yes, just wanted to follow-up on Airframe again on the margin rate. Can you quantity how much of the year-over-year and sequential margin improvements was from less tangibles amortization versus volume and other drivers?

Very little, Pete. In the early years, that will stay relatively flat in terms of the dollars. It will, obviously, as our sales come back -- climb back, it will be less as a percent of sales, but very little dollar impact.

Okay. So pretty much predominantly volume in the quarter?

Exactly.

Okay. Thank you.

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

Okay, well, appreciate everybody joining us today. We look forward to talking to you throughout the quarter and on next quarter's call. So thank you.

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