Woodward Inc (WWD) 2012 Q3 法說會逐字稿

Thank you for standing by. Welcome to the Woodward third-quarter fiscal 2012 earnings conference call. At this time I would like to inform you that this call is being recorded for rebroadcast and that all participants are in a listen only mode. Following the presentation you will be invited to participate in the Q&A session.

Joining us today from the Company are Mr. Tom Gendron, Chairman and Chief Executive Officer, and Mr. Bob Weber, Vice Chairman, 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 year 2012 earnings call. In a minute I will cover the financials for the third quarter and Tom will comment on our results, strategies and markets. I will then comment on today's earnings release and at the end of the presentation we will take questions.

For those who have not yet seen today's earnings release, you can find it on our website at Woodward.com. As noted in today's earnings release we have included some visual presentation materials to go along with today's call that are also accessible on our website.

An audio replay of this call will be available through July 28, 2012. 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 summarize 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 energy 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 earnings release and our public filings with the Securities and Exchange Commission, including our 10-K for fiscal 2011 and 10-Q for the quarter ended June 30, 2012, which we expect to file shortly.

Segment earnings, EBIT, EBITDA and free cash flow are non-US GAAP operating measures that we use in the earnings 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.

Turning to the quarter. Sales for the quarter were up 5% to $460 million compared to $438 million in the third quarter of last year. And earnings per diluted share were down 22% to $0.40 for the third quarter compared to $0.51 for the third quarter of last year.

A number of issues affected the results for the quarter and I will comment in more detail on these issues later in the call. Now I will turn the call over to Tom to comment on our results, strategies and markets.

Thank you, Bob. Welcome to those joining us today. I would like to reaffirm our strategy of balancing long-term opportunities with ongoing earnings growth. Disruptions in the quarter that have now been addressed, as well as lower defense sales, temporarily hampered our ability to deliver our expected earnings. We will continue to closely monitor both external as well as internal developments and take appropriate actions to restore this balance.

We believe our strategy of close collaboration with our customers on high-value system solutions build shareholder value, as evidenced by our recent press releases related to securing long-term opportunities with Caterpillar and United Technologies.

Turning to our markets. First on the Aerospace side, let me comment on the recently announced Pratt & Whitney PurePower award with UTC. We were recently awarded additional engine components, adding to our previous awards on this engine platform. This and previously announced program wins solidify Woodward's presence and increased content on both the Airbus A320neo and Boeing 737 MAX. We continue to pursue other opportunities on these two critical platforms through the program design freeze.

The Farnborough Airshow this year was successful for the aerospace industry and also for Woodward. Of the orders placed at the show we expect to have content on nearly all of the aircraft to be delivered.

With respect to defense, the industry is being negatively impacted by the threat of budget cuts and related program delays.

Turning to our Energy market, last week we solidified a long-standing customer relationship with Caterpillar with the announcement of the signing of a long-term supply agreement. The agreement includes design collaboration and the supply of natural gas engine control system components, in addition to diesel fuel injection systems and components.

The agreement enhances growth opportunities in our ability to work with Caterpillar to introduce new technologies on both new and existing platforms.

Natural gas continues to show excellent promise for the future, with the rising demand driven by new sources of supply and favorable pricing. We believe we are well-positioned to take advantage of this trend across our entire Energy segment, with critical system offerings on industrial gas turbines, reciprocating engines and compressors.

We expect our strong relationships with key customers to support significant growth opportunities. In addition to natural gas, many new applications are being explored for waste gas and mixed fuels, offering a broad range of opportunities for Woodward.

The global wind market has experienced anticipated regional volatility. In the US growth continues to be driven by the potential expiration of the production tax credit at the end of this year. Europe is feeling the impacts of reduced government subsidies and funding of projects as a result of financial uncertainty across the region.

We expect this uncertainty regarding government renewable mandates and subsidies will contribute to continued volatility in the renewable energy space.

Across Woodward's Energy business our customers are demanding higher efficiency and lower emissions for all types of energy control equipment. We are aggressively pursuing and winning these opportunities.

In summary, Woodward has been awarded significant content on important new engine platforms such as LEAP-X, PurePower, Passport 20, and SilverCrest. In our Energy segment we have secured many new awards as well. We will continue to invest in these and other important customer programs. Investments made in the past are delivering today's sales growth, and we will continue to pursue this strategic business model. Now let me turn it over to Bob for the financials.

Thank you, Tom. Woodward's net sales this quarter were $460 million compared to $438 million for the 2011 third quarter, an increase of 5%. EBIT, or earnings before interest and taxes, was $44 million for this quarter compared to $57 million in the prior-year's quarter.

Net earnings for the third quarter were $28 million or $0.40 per diluted share compared to $36 million or $0.51 per diluted share in last year's third quarter.

Free cash flow for the third quarter of 2012 was $38 million compared to $14 million in the third quarter of the prior year. Our Aerospace segment sales for the third quarter of fiscal 2012 were $214 million, essentially flat with the third quarter a year ago.

Commercial, OEM and aftermarket growth were largely offset by declines in defense sales, resulting primarily from delivery push-outs. Sales were impacted this quarter due to a number of the ERP system related issues that have been addressed. We experienced an enterprisewide IT system outage related to a hardware failure. Additionally, a faulty system interface with a new supply chain partner led to part shortages. And lastly, we were implementing a new ERP system for our Aerospace motion control business. As a result of these issues, we have experienced some unanticipated production delays.

Aerospace earnings were $22 million in the third quarter of 2012 compared to $35 million in the third quarter of 2011. As a percent of segment sales segment earnings were 10.0% this quarter compared to 16.5% in the same quarter a year ago. Segment earnings were negatively impacted by the ERP system related issues previously mentioned, as well as investments in both product development and improved production processes, partially offset by price increases.

The Aerospace segment has been awarded a substantial number of significant new system programs as previously announced. Many of the awarded programs have recently expanded in both content and complexity, requiring increased new product development. Additionally, production process improvements related to the significant future increase in narrow-body fuel system sales have resulted in increased manufacturing expenses. These investments will continue with quarterly variability as we proceed toward product launches.

To summarize, we experienced unanticipated earnings pressure this quarter due to lower sales volumes and the increased investments mentioned above.

Moving to our Energy results. Our Energy segment sales for the third quarter of fiscal 2012 were $246 million compared to $223 million for the third quarter a year ago, an increase of 10%. The sales increase was mainly driven by control systems for wind turbines and natural gas systems.

Energy segment earnings for the third quarter of 2012 increased to $31 million from $29 million for the same quarter last year. As a percent of segment sales segment earnings were 12.7% this quarter compared to 13.1% in the same quarter a year ago. Segment earnings predominantly benefited from the increased sales volume, partially offset by normal quarterly product margin variability.

Sales volumes and earnings were below our expectations primarily due to wind turbine order delays and macroeconomic headwinds.

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, was 28.4% of sales in the third quarter of 2012 compared to 30.6% for the third quarter of 2011. Gross margin percent decreased primarily due to investments in production process improvements related to recent wins and the impact of product mix in the quarter.

Research and development costs were $39 million for the third quarter of fiscal 2012 compared to $29 million for the third quarter of 2011. As a percentage of net sales research and development was 8.5% in the third quarter of 2012 compared to 6.7% in the third quarter of 2011. For the first nine months of 2012 research and development was 8% of sales compared to 6.5% for the same period of 2011.

While R&D as a percent of sales will vary with the level of sales in the near term we do not expect the absolute dollar amount of spending to significantly increase or decrease from current levels. As previously mentioned, we will see quarterly variability due to the timing of prototype hardware builds and other project costs.

Selling, general and administrative expenses were $40 million or 8.6% of net sales this quarter compared to $38 million or 8.8% of net sales in the same period of 2011.

Our effective tax rate for the third quarter of 2012 was 24.9% compared to 29.1% for the same quarter last year. This reduction contributed $0.02 to earnings per share when compared to the prior-year quarter tax rate. The tax rate for the third quarter of 2012 was primarily impacted by favorable adjustments related to prior years. We now anticipated a full-year effective tax rate of approximately 29.5%, down from the 31% projection from last quarter. Our anticipated rate continues to assume the US research credit is not extended during our fiscal year 2012.

Looking at the balance sheet, working capital, defined as current assets less current liabilities, was $616 million at June 30, 2012 and $537 million at September 30, 2011. We generated $64 million of cash flow from operations and $19 million of free cash flow for the first nine months of 2012.

In light of uncertainty with respect to the timing of anticipated sales increases for the fourth quarter we now expect full-year 2012 free cash flow will be in a range of approximately $30 million to $50 million.

Share repurchases were $32 million for the first nine months of 2012. Capital expenditures were $44 million for the first nine months of 2012 compared to the $33 million for the first nine months of 2011. For 2012 we now anticipate capital expenditures of approximately $85 million compared to $48 million in 2011.

Total debt decreased to $414 million at June 30, 2012 from $425 million at September 30, 2011. The ratio of debt-to-debt-plus-equity was 29.7% at June 30, 2012, compared to 31.6% at September 30, 2011.

Lastly, let me turn to our outlook. In light of macroeconomic uncertainty and the issues highlighted above, we have revised outlook for 2012. Net sales are now expected to be between $1.85 -- excuse me -- $1.85 billion and $1.90 billion. Fully diluted earnings-per-share for the full fiscal year 2012 are now anticipated between -- to be between $1.90 and $2 per share.

This concludes our comments on the business and results for the third quarter of fiscal 2012 and our 2012 outlook.

Operator, we are now ready to open the call to questions.

(Operator Instructions). Tyler Hojo, Sidoti & Company.

I Just first wanted to ask you just in regards to the new content wins that you announced today and some of the other ones that I think you alluded to in the prepared comments, where do we now stand? Can you give us an update just in regards to narrow-body content and what some of the future opportunities are out there?

Yes, we can. We are, I think, making good progress on the program wins. On the engine side we are getting close to -- on the narrow-body, those two programs -- getting close to locking in their designs. So there're not going to be too much more content released on those programs, so we're feeling pretty good with our position we have secured there.

On the airframe side, there is probably another 12 to 14 months before all the potential opportunities are locked in, and that means the designs are frozen and all the awards are made. So we still see more opportunities out there on the airframe side. Engine is quickly coming to a close.

Okay. Now one of the things that you guys had been alluding to in the past was next gen content was 3X what current generation content is. Where is that now? Is that 4X? Can you give us an idea of what you have won incrementally speaking? .

Yes, right now we are really on track if you look at -- if you want to take say the average on the narrow-bodies on the current generation to the new generation, we are on track for the three times.

Okay.

Some of the -- I think as we previously discussed on other calls, we have been working on these PurePower components for over a year. It was just nailing down the contract. So as we were talking to in the past we knew we were going to secure those. It just was we don't announce anything until we have a solid contract in hand, and we just achieved that last -- well, on Friday afternoon.

Okay, so what has been announced gets you to what -- where you thought you would be?

That is correct.

Okay.

And we still see more opportunities out there, but we are competitively bidding those. So we don't think we are done, but we do feel good that we have achieved everything we told you we were going to do up to this point.

Okay, all right, that sounds good. And the other question I wanted to ask you, just in light of what you are seeing in both the Aerospace and Energy business today, I am just wondering where you think you stand in regards to both the five-year sales CAGR for both segments that you provided and the margin targets. I'm most interested in the margin target for Aerospace, just given some of the hiccups that we have seen this quarter.

Yes, we are still confident in those margin targets, and we did have a disruption in our progress this quarter. I believe we will be back on those in the fourth quarter moving into next year. So we still believe we are on track for those, and the disruption this quarter we anticipate more of a blip than a trend.

Okay, very good. I will hop back in the queue. Thanks a lot.

Julie Yates, Credit Suisse.

So thinking about what was originally expected before last Monday, you guys essentially missed the quarter by about $0.20. And then when we take the tax rate into effect for the year, you guided down more than $0.35 at the midpoint. So there seems to be some lingering pressure as the year progresses. Can you guys quantify that and how we think -- opposed to how we think about that in the fourth quarter?

Yes, quantification is difficult, but at least we can give you general direction. First was the impact of the sales volumes that we missed. That was predominantly due to the ERP system related issues that I mentioned. So those are behind us.

We have talked about some delays in programs that we believe we will be back in in the fourth quarter, but there is a lot of uncertainty on some of these things.

So first and foremost was the sales volume issues. And then we get into the issues related with the increased investment. And the two parts of that are really related to investment in the programs themselves. So we have talked about the fact that there has been additional complexity as the programs are further defined and refined, combinations of functionality and different components and systems and so on.

And then, lastly, the production process improvements we have been making as we get prepared to ramp up for the narrow-body programs. So there is a lot that has to go on a number of years in advance of getting ready for those programs. We have talked a lot about lean initiatives and so on that are going on in the factory.

And when you upset a factory in fashions of moving lines around, redefining sales, et cetera, it creates a certain amount of slowness with respect to meeting some of the orders as you go through that. So quantifying is difficult, but those are the largest items in there.

Okay, Bob, thank you. And so if there are further delays on programs in Q4 if there incremental risk to the new guidance?

There would be. We believe we have covered all of that risk in our guidance. We are pretty confident, I would say, at this point that the delays that we had will materialize in the fourth quarter. Having said that, I just always like to cover myself from the standpoint things can happen and frequently do, but we do believe that we have pretty good visibility in the fourth quarter.

Okay, and that is both on the Aerospace and the Energy side?

Yes, I believe so.

The Energy side we have talked a little bit about industrial gas as kind of the growth has not materialized to the extent that we anticipated. We are seeing growth, but I think you have seen a lot of announcements that the long-term growth is still there, the timing is still open.

Okay, great. Thanks, guys.

Peter Skibitski, Drexel Hamilton.

Can you actually quantify how down defense was in the quarter?

Well, one way to look at it is on the percent of sales. And we have gone from where we were talking about defense being 20% of sales, it is now at 17% and dropping from there. So I think that is the best way to quantify it.

Okay. And for the full year you expect about that 17% as well?

We do. It could come down slightly more from that, but that won't have a big impact off of that.

Okay, okay. And you said commercial aft market was up 10% in the quarter. How about the OE side?

Our OE side was also up in the quarter. That one we have normally not quantified, but that tracks very closely with a lot of the deliveries and so on that you see publicly announced.

Okay, got it. And then, excuse me -- so the new R&D expectation for the year, I guess, you're expecting to be up from your prior guidance. I think you said, I don't know, 7.5% I think is what you said actually. It sounds like maybe you are thinking more like 8% plus is what you're expecting for the year now and over the midterm?

Yes, it is going to be up. Not quite to an 8% rate overall if things go according to plan right now, but it will be up from the 7.5%. If you recall at the second quarter, we thought we would see it moderate a bit in the third quarter related to hardware and so on and that did not materialize. And then, obviously, the sales decline contributed to that.

Okay. And that -- did you have a new kind of targets of opportunity pop up that drove that R&D, or could you talk a little more about what drove that?

It is predominantly related to -- I mentioned complexity and content. So each time -- as you noticed from the announcement this morning, there have been content increases. Those are staged as we go through the year in terms of beginning work on those programs.

The other is that the functionality of some of their systems does change from time to time, and the functionality of some of our components may be increased, and as a result we add development costs to increase functionality. Customers like to do that to go after weight reductions and increased efficiency in the programs.

Okay, understood. Thanks, guys.

Peter Lisnic, Robert W. Baird.

Just back on that R&D question, if I look at the run rate for this year it is trending toward, call it, $145 million to $150 million. Is that kind of the run rate that we should think about for next year as well? I think we're having a little bit of trouble with the percentage of sales method when it comes to the model.

The run rate what we would highlight is, if we look at our R&D and first think of it as engineering headcount or engineering people expenses, that is flattening off. So we are flattening and we feel like we are getting there.

You're going to see some volatility because we are going to have some very large prototype shipments and prototype work, and so from quarter to quarter we are going to see some volatility around hardware. But in terms -- I just want to say in terms of headcount and like we are flattening off, so we are getting to pretty much a plateau with some variability due to equipment in a quarter to support the development programs.

Okay, and is there a piece of the R&D that we should think about as being fixed versus variable?

Well, it depends on your definition. There are -- us accountants seem to like to come up with technical definitions of that kind of stuff. But normally our programs have allowed us -- some things drop off, some things come on, and overall you don't see a tremendous increase. I think over time we have seen a movement -- what -- 6.7% up to 7.5%, 7.7%. For the year we have seen an overall increase. I think that would say that a base level in that 7.5% range may be the new fixed level, right?

Okay. And then variability up to the 8.5%, which is where you have been -- or at least it was 8.5%, the prior quarter was 8%.

Exactly, we have spiked in a quarter, and those kinds of things. I think Tom called out a while back that because of the size of these programs that variability would be greater than we have had in the past.

Right, okay. All right, I got that part.

Yes, the only thing I would add to that is we have put -- we have emphasized quite a bit in the Aerospace segment on the narrow-body, but we have also won quite a few other programs that we have highlighted. Some of them are highlighted the prepared remarks.

So we actually have a very large development load going on in the Aerospace side. And at the same time we're been quite successful in the Energy side of our business, and have seen some of that load go up. So I think for a little while, as Bob highlighted, we are going to stay at a little higher level I would say for probably three, four years as all this development work really works its way through the system.

Okay, all right. And then if I could switch gears a bit. If you take out some of the operational items that you had to contend with in the quarter, the growth slowed, I guess, and then you compound that with macro, can you give us a feel as to what the near-term growth looks like? Has anything structurally changed in terms of how you're looking at the business over the next several quarters in terms of topline growth?

What I would highlight, looking forward, we actually have a pretty good order book. So if you wanted to look at the third quarter a lot of it was execution. It wasn't necessarily a lack of orders, that would be more on all the commercial business. We definitely did see some decline on defense sales.

So going forward, if I think in subsequent quarters, we will see probably continued pressure on the defense sales. One of our strategies anyways to get more commercial sales than defense. So some of it will be due to the market, another part of the decline in defense will be due to growth in commercial.

The other one that we highlight, and it is going to be volatile especially as we go into our second quarter of fiscal year 2013, will be the renewable industry, the renewal markets that we are in, primarily wind, we expect to see a drop-off in sales as everybody is pulling forward sales to get the production tax credit and subsidies in. So you will -- those will be the two that you're going to see some pressure on.

The other markets we see actually increasing sales going forward. Uncertainty in Europe, a lot of our customers are uncertain. So we see rest of world okay with uncertainty in Europe, pressure in wind and pressure in defense. So overall we are still seeing growth, but those are the pressure points.

Okay, but in terms of the five-year CAGR that you have laid out, 10% to around 13% I think it was for Energy, it doesn't sound like it has changed all that much. Maybe a little bit of near-term pressure for the next few quarters, but nevertheless sort of a double-digit compound growth outlook, correct?

We think that is correct, and we haven't pulled back from that five-year outlook.

Okay, all right. And then just last question on IGT can you give us a little feel for what the OE backlog looks like for you, in terms of is growing? Just some color commentary there would be helpful.

Yes, what we are starting to see is -- I think we have highlighted it in the past, we have long-term agreements with the big IGT manufacturers, but we are on whole systems with them. So we don't use a backlog number because we don't get firm long-term orders from them. We get kind of forecast.

And what you can see in the forecast is increasing orders. So we are starting to see some increase. There was a little -- Bob highlighted earlier, we were expecting it to come in a little earlier, but looking in the fourth quarter moving into next year we are seeing some order increases on the industrial gas turbine side.

Okay, perfect. That is very helpful. Thank you for your time.

Michael Ciarmoli, KeyBanc.

Bob, maybe just a different way to try and slice Julie's question on the outlook. In rough percentages it sounds like you obviously had some internal execution issues. How much of the reduction really stemmed from changes or more conservatism in the macro environment? And I guess you have clearly stated that defense is going to be headwind. There is some uncertainty in renewables. As I look at what is happening with Caterpillar machine sales, deceleration and other global CapEx concerns, how much did you really take off the table or handicap that macro side?

Again, it would be -- giving you an exact number would be impossible. The impact of the system related was significant related to the quarter, and then that flows obviously through the year.

The macroeconomic, I think we have called those out. The IGT side is obviously -- from expectations in terms of what we expected for the year, the second half originally we anticipated to see, as did a lot of others, more ramp up in IGT than we have seen.

Okay.

And I think we still anticipate, and Tom mentioned order volumes -- we still anticipate that that will continue to grow as we get into 2013 and beyond, that that the long-term is very positive. And I think you are seeing exactly those kinds of comments from our customers and even some of our competitors that are in the same space.

The other parts of the macro I would say are largely on track. We talked about some quarterly slowness vis-a-vis sequential on commercial aftermarket, but we are still up significantly on year-over-year. The OEM has been doing nicely on that side. It really was the defense. We do not believe that the defense sales are reflective of anticipated budget cuts or anything. At this time we believe what we are seeing are order delay related, not related to cancellations or anything like that.

So that -- kind of watch that space as we get towards the end of the year. And I know there're a lot of folks out there calling sequestration out. We have announced many times that we do not believe that that will take place, that cooler heads will prevail, and that the defense, while being down will not be some sort of massive decline in 2013.

Okay, that is helpful. Just on the commercial aerospace aftermarket, the up 10%, still pretty solid given some of the uncertainty out there. How much of those sales were pressured due to the internal disruptions? I am just trying to get a sense as we look at what is happening in Europe, other concerns about aftermarket spending, I mean, it seems to be a nice, solid growth number even with some of these internal distractions.

Yes, it was below expectations. The disruptions impacted the aftermarket sales as well.

Okay.

It was across the board. When we had systems go down and other disruptions, it impacted everything. So we are fortunate in that our mix in the Aerospace has got strong mix. This next year, B2500s, if you want to look on the engine side, is going to have very high engine shop visit rate. That is looking -- and we are seeing that.

So we are seeing things from years of putting product in the field now coming to fruition. And we do well at running the aftermarket and getting our -- if you want to say our entitlement of that -- and I think that is showing. So we have opportunity to continue to perform better in the aftermarket.

There is no doubt there has been some, if you want to say, pressure on the European airlines. That has been well-documented out there. We have probably seen a little bit of that, but overall we still feel pretty good about the outlook for commercial aftermarket.

Okay, great. And then last one and I will just jump out of the way here. The Aerospace margins, can we expect those margins to jump right back into that 14%, 15% or perhaps higher range in the fourth quarter, or will it take some time given the internal disruptions?

We expect a good increase in the fourth quarter and to get back on track towards our goal. So we really do expect to see an increase. Now we have to execute. We are digging out of a hole. So that is -- that has to happen, but we believe we will improve on margins.

Okay, perfect. Thank you very much, guys.

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

Bob, I think you answered my question on this defense weakness. Just to reiterate your point, you think it is just push-outs and delays, not an actual decline in the overall market?

Yes.

Okay.

We fully anticipate that there will be, and we have called that out as we go forward, but specifically during this quarter we don't believe we had an impact related to that. It was more related to the order push-out.

There is -- some of those are very specific, and the largest quantity of that was a specific item, but some of them are less quantifiable. We called out turrets vis-s-vis guided weapons. We said guided weapons was something that we say a very specific order delay. The turret side of the equation is a little less obvious in terms of how much push-out there has been.

But you haven't had changed -- haven't had significant changes to your scheduled items, (multiple speakers) forecasted stuff. Okay, good, okay.

And on aftermarket maybe a little more detail. I think you cited that in the prerelease, and then the eventual number actually it looked pretty decent. But can you give how things changed throughout the quarter, was it volatile? Did it get worse from say July or from May to June or can you talk about that?

On the aftermarket the biggest effect was the operational disruptions. We are seeing still -- we are still seeing good incoming units for repair and overhaul. Spare sales, initial provisioning orders are all coming in. So when we are looking at the quarter the biggest was the operational disruption.

Looking forward we still think the outlook is a along our plan. The European airlines are the only area we are seeing, I would say, real softness, but it is not taking us off the numbers yet. We have to watch it if the crisis gets out of control here, then we would be subject to change. But right now the outlook with the programs we are on and then some of the new programs ramping up is going to keep our aftermarket going in a fit fashion.

Okay. And then, maybe, Bobby, you could give us a help on run rate on the Nonsegment, how should we think about that looking into next year?

Yes. It should be fairly consistent. We had a number of small items that caused a little bit of an increase this quarter that probably will not continue. But it will stay maybe just slightly below the level of this quarter on average as we go forward.

Okay, thank you.

Gary Farber, CL King.

Can you just -- if you don't mind, just take your three major geographies -- North America, Europe and Asia -- and talk about what you saw in the quarter and how that compared to the prior quarter.

One thing we have mentioned is that our visibility on what the ultimate economies are doing there is limited because a lot of our shipments are, for example to Caterpillar, are basically US shipments, but we know they're being substantially impacted by regional activity.

So Europe being down; Asia who knows. They seem to be up and then everybody says that their numbers up aren't as much -- aren't as robust as they say.

So clearly I believe we are seeing European impact with respect to the willingness to spend on large projects. And a lot of what -- where our products go are related to large projects. So power generation, I'm sure, would be impacted by that. But in Asia we are still seeing a lot of increases in that area largely driven by the command economy side of the equation; they need the power. So US has been reluctant, I think, related to Monday Europe is crashing, Tuesday Europe looks okay. So a lot of uncertainty there.

Okay, all right. Thanks.

William Brammer, Maxim Group.

Can we get -- can we get into a little bit of the aftermarket on The Energy side? Can you give us a sense of how that was during the quarter?

Yes, I think it was -- we didn't see any change in normal patterns in the quarter. So from that standpoint it is moving on pretty consistent. In some respects as we have highlighted in past calls, some of the aftermarket on the Energy side goes through the OEM, some goes direct. So sometimes it is a little hard to nail it exactly.

But one thing we -- a positive note out there is a lot of the natural gas engines or turbines, they're getting a lot of use right now. And we have seen the usage go up and we have started to see some orders coming in in the aftermarket to support those.

So overall I would say it is consistent with a positive outlook because of the amount of hours being put on the machines for -- because of the low price of natural gas.

Okay, Tom. And with IGT in the field are you seeing more capacity issues or at this present point is it more pricing issues?

I am not following the question for sure. Are you talking about demand or are you talking about orders or --?

Just in terms of supply and, yes, thus the orders.

I think on the -- I think the demand is out there. We know talking with our customers the orders are starting to fill in. I think it is just maybe everybody was a little ahead of themselves on ramping up the demand and ramping up the supply chains and the orders. But we see it coming, and so I think we all anticipated it a little bit earlier. I don't think the change in the outlook has occurred. We see -- the demand is out there and we're starting to see the order book starting to reflect that. So moving into 2013 we think it is starting to occur.

So possibly just a six-month sort of deferral here?

Yes, maybe -- like I said, maybe we got -- Woodward, along with other companies in the industry, got a little ahead of the curve thinking it would ramp up a little quicker. But it is moving up. So it is not a bad comment. It is six months, maybe nine months behind what we thought it would be.

And can we go into a little bit more depth on the wind front here and renewables? What type of anticipatory drop are you guys looking for for 2013?

That is a tough one right now. If you look year-to-date our wind sales are up over 70%, which gives you an idea how much has been pulled into this year. So now we are working and talking to customers and trying to get a feel going into 2013.

Now you guys all remember we are on a fiscal year, so we get one quarter still under people trying to get production -- get these installations put in place to get the production tax credit and other subsidies. So we really got three quarters of a fiscal year without subsidies and we are trying to figure that out, and we are giving you guys were color on our next call.

But it is going to go down, and we're just trying to gauge how much and get a good indication from our customer base. And it is little challenging in the wind history industry, that is all. We ramped up huge this year; we knew it. We also are managing it like a bubble. So we didn't put in fixed costs, so we are going to be able to manage it as it drops. So we will give you an update, I guess, on the next phone call.

So inventory management is key right now.

Inventory management, cost, supply chain.

Manufacturing (multiple speakers).

Manufacturing, everything. There're a lot of things we are managing knowing that this was a little bit of a bubble. We are trying to get everything we can out during this year. And it is very unfortunate that we don't have more stable policy on this, because it whips the industry around, but that -- unfortunately we can't do anything about that. We really need our political leaders to address that.

But we are trying to address everything we can as a company. And I think we have got good plans in place, and then we will give you a better feel, but like I said, actually it is going to be down next year.

Okay. And my final question, gentlemen, is on the stock buyback plan. You were a little more active this quarter. What should we be looking forward to going forward here?

As you know, our policy has largely been to try to offset the impacts and the volatility related to stock options and so forth. And we haven't had much of a program beyond that.

I don't know how things will look during the coming quarter, whether we will stay -- this was a pretty healthy nine months compared to what we have been in the past. I would not anticipate it would stay on that particular path for the remainder of the year.

Okay, thank you, gentlemen.

Steve McNeil, Jennison.

As it relates to the Hamilton Sundstrand announcement this morning, who has historically been the incumbent with them for these products?

It was vertical, Hamilton Sundstrand.

Okay.

And what we really see as a trend there is we do quite a bit of work with UTC, and it is growing, and we are becoming a complementary partner to them on these new programs.

Okay. And then I guess I understand the issues in Aero. I was trying to run -- I was running the math, and I guess it is at least $10 million. Is that a fair number, if you apply this to a regular margin on the segment?

We have really avoided -- it really depends. I think -- I see one of the things I commented earlier is I could ask four different guys on the floor that we get four different numbers on the impact of that. So it is extremely difficult to quantify any particular item.

That is just odd to me. I would think you would want more accountability from the people on the floor, so you understand this stuff, right? I understand you are rolling out SAP in California -- fine, a glitch just happened there. You guys had a systemwide hardware failure across the whole company, right, is that what -- right?

Well, we did have that, which obviously is an unusual circumstance.

Okay. Now is that -- I'm not trying to sell you any insurance here -- but is that something you would normally have insurance for -- business interruption insurance?

I am not sure we could get insurance. What we have is we have a disaster recovery contract with our hardware provider, and that disaster recovery was set up at 48 hours. We are now changing that to be more on the order of four hours. So if you want to talk about insurance, that is the insurance, we are going to increase our insurance on our hardware in that disaster recovery program so that we don't experience the amount of outage that we had at this time.

We are also refining our architecture and putting more redundancy into the architecture. We already had redundancy. We are just looking at, saying, okay, absolutely unacceptable to be having an outage -- any outage really. And we're not going to allow it, we're going to back it up that way.

So you are saying you are currently -- or you were previously insured for any outages over 48 hours, is that --?

It is not -- what I mean by insurance is we buy a program to ensure that we could be up and running in 48 hours again. That doesn't pay you -- that is what I mean by insurance.

Okay.

It is not paying us for disruptions, it is just -- if we have a total failure we could be up and running in 48 hours. The new plan we are going to is to be up and running in four hours. So that is -- there is degrees of cost to put these type of systems in and backups with the hardware providers, and that is what we are doing.

Okay, fair enough. And then on the -- you talked about these wins that you have gotten, which is great. But then on the other hand, you talk about more complexity, more functionality. Is that -- I'm just trying to understand that exactly. Does that mean your customers have come back to you and asked you to do things that you didn't originally contemplate as you constructed your bid with them, or have you won business and it is more complex to put the products together than you envisioned, and therefore you're getting more cost -- you are experiencing more costs?

No, it is a good question. Let me clarify a little bit. This is very typical what we have going on what we call a new centerline engine. It is brand-new from the start. So our customers and our folks do the best job we can defining the system upfront, working on requirements. But as the program proceeds things change, and sometimes -- well, they change and when we said complexity and more content, they realize, okay, I am not going to get the performance I was targeting, I need to add some extra functionality, and to this process we have gained additional content. Sometimes that content is on top of the products we are already making. Sometimes it is an additional LRU. So we see that happening.

What is a LRU?

I am sorry. Line replaceable unit, another complement.

Okay.

Sometimes, and this is why we are hesitant to give dollars right now until everything is locked down, on a new engine in there are ways overweight and over costs, always are.

So then there is going to be weight reduction, cost reduction programs. Sometimes they can eliminate one of the components we have. That has not occurred to date, but that happens on some programs. Other times they add more. Being in there and being the fuel system supplier and being a partner on these, we have through the last nine months gained additional content on the existing LRUs and additional components beyond what we thought at the start of the this fiscal year.

So that is a good thing, but it is also meant additional investment. Now as we go to design freeze we are going to try and win more content, but we could have some content disappear as they try to optimize these engines. So once the programs hit design freeze we are going to tell everybody what our dollar content is. But up to that point we prefer to make sure everything is locked in.

At the end of the day, Tom, do you think you will get paid for this additional complexity that you're dealing with?

We are going to have higher revenue per ship set and higher aftermarket revenue because of the more content and more complexity. So we are not necessarily going to get paid NRE, but we will make -- it is a good business, let me tell you that. So it is a good business case, Steve. Improvements are going to add to the long-term success of these programs and they are positive on a cash flow basis.

All right. So just to be clear, these are -- it sounds like it is more customer driven changes as opposed to we designed a product and we gave it to the customer, and now we are starting to make it and we figured out it is a lot more difficult for us to make, and we have to take it on the chin from a cost perspective.

No, what we were referring to was customer driven changes to support the development of the engine, support their performance criteria, support the installation onto the airframe. And it is very normal in a program. But once again I would say on a positive note we have more content than we ever had. We are working closer with these customers and that is driving some more requirements and more changes, which is in the long-term good from a revenue and cash flow perspective. Short-term it costs more R&D.

Okay. And then -- just on R&D, Tom, Pete mentioned like $145 million number. Is that plus or minus a good number to use for next year?

I think Tom mentioned, we will talk about next year, Steve, at the next call. We are not in a position at this point to talk about it.

Okay.

The one thing I would say is R&D is flattening out. So as you guys make your projections think about it flattening out with some volatility for hardware deliveries and the like. But we are pretty well-staffed across-the-board, both Aerospace and Energy for R&D there would be a little bit, but the significant adds have occurred.

So unless we win a bunch of new programs, which we will be more than happy to share with everybody and tell you that it's going to drive it up. But right now we think it is starting to flatten and we are going into this -- the big ramp has occurred, that is what we would say.

So as we look forward, what lessons have you learned this quarter such that you are able to grow your earnings? How do you prevent the things happening that happened this quarter? I mean I just -- it makes me wonder Woodward's ability to execute and grow your earnings. Are you going to snatch defeat from the jaws of victory here?

Well, hopefully, that will not be the case. I think if what you would look is -- lessons learned is we have introduced a lot of change very rapidly, both from staffing up very rapidly, bringing people on board, getting them trained. We are introducing a lot of changes to our factories. All I think will be long-term positive in terms of improving our value streams and implementing lean.

But there is a lot of change going on. And during that change and doing some of the system upgrades that we see for the future, we probably put maybe too much into one quarter, got some disruptions. And then we got thrown off with a crash -- a computer crash.

So the lesson there is to -- well, better -- you know what I said, better manage those change processes and to time phase them maybe little more than we did in the quarter. So going forward we are still going to have a lot of change coming, and I think our whole management team is aware of that.

And so it was how hard we drove that change in the quarter, and as I said, it caused disruption. We are confident in the outlook because we could see from our order book and our past-due orders that we have the sales. So it really was that execution on the change. And we are taking that to heart and we are going to work it harder not to have those type of disruptions again.

And I think Tom commented in his remarks regarding what our intent is. Our intent is to balance those things. Sometimes turning the knobs and dials to adjust the impact isn't as real-time as you would need. And so we're going to have this sort of fluctuation. But that is our intent, is to be able to absorb these kind of things and continue forward. That may not necessarily mean in any given quarter.

Yes, okay.

The last comment I will make. The margin targets we have out there are our commitment. That is where we are going. We know the business can get there, and we are just absolutely committed to getting those. So nothing has changed on that.

Thank you.

(Operator Instructions). Julie Yates, Credit Suisse.

So just a couple of follow-ups on aftermarket. Bob, can you parse out the performance between engine and airframe?

Between engine and -- clearly I think we have commented a lot that airframe, this is an improving area for them, that it has been substantially below the industry norms when it was acquired. They are making progress, they are improving. But the lion's share of aftermarket for us is in the turbine side. And so that is probably the way most of the impacts also flow is the lion's share of the impact is turbine oriented.

Okay, so was there a big divergence between the growth rates in the airplanes?

Not really, no. They're really very similar overall, driven by a lot of the economic factors that drive the aftermarket in total.

Okay. And then do you guys have a new percentage -- an update on the percentage of what aftermarket is as a percentage of airframe? I think you had said it has gone from 18% when you initially acquired the business to 21%. Is it still around 21% or --?

Yes, it is close to there. So it may improve a little bit as we go for the remainder of the year, but the low 20%s is accurate.

Yes. And I will just reiterate that that business, looking at the peer groups and what I -- again use the word entitlement of that business -- we do believe it should get into low 30%s. It is going to take a little more time to get there, but that -- it is on that path. And that is also part of the margin improvement and part of our margin targets that we have highlighted and that we are committed to achieving.

Okay, and then just finally, I recognize, and you guys are going to give guidance until next quarter for FY13. At this point with Europe -- with the uncertainty in Europe, with the headwinds in wind and defense, are you still confident that you can achieve double-digit growth on the top line next year?

We haven't -- you know, Julie, we haven't put that out, as you recognize. We still see good progress and a lot of our markets are going to be offset by some of these tailwinds, and we are going to have to quantify that later for everybody.

But some of the highlights that I think questions had, but I don't think I got to earlier comment -- we are seeing an increase in sales wrapped around the natural gas market. Our gas engine -- industrial gas engine sales are going up. Compressor sales are going up. We are seeing industrial gas turbines going up.

So these are the positives offset by these negatives that you highlighted. We have to see how close we are on double-digit growth a little later, but we haven't locked that in yet -- the outlook we haven't locked in.

Okay, thank you.

Michael Ciarmoli, KeyBanc.

Just one for housekeeping. On the wind growth did you say the total wind is on track or is year-to-date up over 60%, or was that just the one inverter component?

That was total wind.

Total wind, okay.

So, no, not just the one component, that was total wind.

Okay, perfect. Thank you very much, guys.

Peter Lisnic, Robert W. Baird.

Just a couple of quick ones, I hope. In terms of the Aerospace, the execution items that you had in the third quarter, is it safe to say that some of that revenue clearly comes back here in the fourth quarter? I'm just wondering if you have some of these issues where the customers say, should we reconsider the relationship. Just does it mean anything strategically or competitively that you have had these issues?

No, not in the short term. The OEM side -- let me phrase this way -- the OEM side with the certifications on these programs, we are really locked into the long term. Now if you have consistent, poor performance over many, many quarters and years, you will lose future revenue because you won't get new programs. But you are correct in looking at -- what we didn't get out in the third quarter is opportunity for the fourth quarter, but we have to execute on that past-due plus deliver what is due in the quarter.

Yes.

So that is the case. The one area I do not believe this occurred is if -- the one area where we you have to watch your execution closely is on turnaround times for repair products, the aftermarket. And if you fall off your turnaround times you could lose revenue more quickly than you can on the OEM side. Our turn times are doing okay. We had a little disruption. I don't think we lost anything, at least nothing I can see. And our turn times are coming back and doing okay, all right?

So I don't think -- it is a long way to say I don't think we lost any sales, it is just was timing of them. We have a lot of execution to do in this fourth quarter to make up all the past-due and get the quarter -- the other orders out, so it is opportunity for us.

Okay, and we are three weeks into it, can you give us a feel for how the past-due realization is going?

Right now we are tracking on sales forecasts that we put together for the fourth quarter. We still are carrying a substantial amount of past-due, well above what we normally carry in this business. So we still have a lot of work to do to burn down the past-due.

Okay, so some of that could tail into the first quarter of next year, I presume, but --. Okay, all right, fair enough.

And then, Bob, just on the free cash flow forecast of $30 million to $50 million, I think is what you said, that seems a little bit bigger than I would have guessed given the earnings reduction. Is there a little bit more working capital being tied up in the business for any reason or am I just getting the math a little bit wrong?

No, you are probably right. And then take a look at CapEx too, so we have a significant amount of CapEx in the fourth quarter, and with the sales increase a substantial part of that, just by nature terms -- working capital will increase as well.

Okay, but nothing really structural, anything there, just --?

No, nothing structural. I think I have kind of from time to time that we see Asian sales sometimes that carry a little bit longer terms than some of the others. So as we grow in Asia that kind of has some pressure, but nothing substantial.

Okay, perfect. Thanks for your help.

Tyler Hojo, Sidoti & Company.

Just one follow-up for me on the wind piece of business. Did you say that you thought the wind business came in a little bit lower than pland this quarter? Is that what you said, Tom?

Well, yes, though the sales growth was quite high, we had actually anticipated even higher sales in the quarter that really moved out into the fourth quarter here. And possibly some of it will move into the first quarter of fiscal year 2013. And I just highlighted we have had over 70% increase in wind sales this year, but the numbers were even bigger.

And where do you expect it to shake out just in terms of a year on year growth rate for the full year?

Probably about that number.

Okay. And it just sounded to me like, just when you are commenting on wind and what it might do next fiscal year, it sounds like you are perhaps a little bit more cautious than you were last quarter. Go ahead. I am just curious if that is indeed the case, and if so what you're looking at specifically?

Yes, I would say we are more cautious on the outlook, mainly because we thought there might be a resolution to the subsidies before we got this late in the year.

Secondly, the pressure in Europe, we believe is slowing down some of the orders as well. So that combination is why we are looking into next year thinking it is going to be probably done more than we thought earlier.

But, again, as I highlighted, we have a lot of work to do with our customers, because there is really a lot of uncertainty in the market and trying to lock down what that fiscal year 2013 forecast -- and really what I'm thinking is that three quarters of calendar year 2013, trying to lock down what that is going to be is still open.

Okay, but just last point. Is it safe to say that there is still market share gain opportunities on the inverter side or how do you look at that?

Yes, we would say right now we have gained share. And a lot of the increase here is the ramp, but also I don't think you see too many people in the wind industry with the growth rate we have at the moment. So a lot of that is from the share gains. And we have locked in with a lot of customers for their future platforms, which is good. It is just we don't know for sure what the rates on those production platforms is going to be going into calendar year 2013.

So the share -- just the share side of the equation is pretty much set at this point, is that accurate?

There are always more opportunities. We don't have 100% share on every platform for every customer. So that has been -- I think we have called out in the past we have done what we would call a pretty good job of continuing to extend into a broader range of megawatt platforms and to acquire the lion's share of those platforms, if not sole source. So there is still more opportunity, so I wouldn't say we have capped out on the share side.

Okay, that is what I was getting at. That is all I had. Thanks a lot.

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

Okay, well, I appreciate all the questions, and hopefully we were able to clarify some of the questions and concerns you all had. We look forward to talking to you over the next quarter and at the next conference call. So thanks for joining us today.

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to the rebroadcast of this conference call, it will be available today at 7.30 PM Eastern daylight time by dialing 1-888-266-2081 for US call or 1-703-925-2533 for non-US call, and by entering the access code 158-1958.

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