Woodward Inc (WWD) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Woodward second-quarter 2014 earnings call.

(Operator Instructions)

As a reminder, today's conference is being recorded.

And now I would like to turn it over to your first host, Bob Weber.

Thank you, operator. We'd like to welcome all of you to Woodward's second-quarter FY14 earnings call.

In today's call, Tom will comment on our markets and related strategies and I will discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions. For those who have not seen today's earnings release, you can find it on our website at www.woodward.com.

We are again including some 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 May 6, 2014. 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 refer to and highlight our cautionary statement as shown on slide 3. As always, elements of this presentation are forward-looking or based on our outlook and assumptions for the global economy and our businesses more specifically. Those elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements.

We also direct your attention to the reconciliations of certain non-US GAAP measures included in today's slide presentation and our earnings release and related schedules. Management uses these non-US GAAP measures in monitoring and evaluating the ongoing performance of Woodward and each business segment.

Turning to the quarter, net sales for the second quarter of FY14 were $482 million, compared to $486 million in the second quarter of last year. Earnings per share were up 8% to $0.66 for the second quarter of 2014, compared to $0.61 for second quarter of last year.

EBIT for the second quarter of 2014 was $63 million, compared to $57 million for the second quarter of the prior year, an increase of 10%. Free cash flow for the first half of 2014 was $56 million, compared to $46 million for the first half of 2013, with operating cash flow increasing approximately $30 million.

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

Thank you, Bob, and welcome to those joining us today.

Our quarter was encouraging, as many of our markets are showing signs of recovery from depressed levels over the last several quarters, and operational improvements contributed to stronger earnings. Our defense markets remain weak, but we expect improvement in the second half of the fiscal year.

Now more specifically on aerospace, commercial aerospace, both OEM and aftermarket, remained solid on deliveries, backlog, and passenger miles, driven by the demand for more efficient aircraft and an improving economy. One particular bright spot is the regional jet market, where we have seen growing strength over the last four quarters.

This is primarily due to aging aircraft and introductions of new platforms. The commercial rotorcraft market is benefiting from the expansion of the oil and gas industry for both new and existing platforms.

While defense OEM and aftermarket was soft in the first half, we saw significant improvement in aftermarket this quarter from an unusual low first quarter. In addition, we believe order volumes and contracts in process support our full year expectation of approximately a 10% sales decline from last year.

Next generation aircraft engine and airframe platforms will drive significant growth for Woodward in the coming years, and we remain focused on program execution to meet milestones and deliverables.

Turning to energy, aero-derivative gas turbine sales remain solid as a result of strong demand from power generation and compression markets. Heavy frame gas turbines are showing signs of recovery that support improved sales for the second half. The demand for compressed natural gas systems for buses and trucks continues to be solid, although government incentive issues, mainly in China, have caused some volatility this quarter.

Power generation demand in both large gas engine applications and smaller diesel [gen sets] continue to strengthen as global economies recover and demand for distributed power increases. Our large engine fuel systems activity also benefited from increased ship building, as marine markets are showing signs of recovery on improved economic activity.

Wind turbine activity improved from a depressed prior year. We also received a new multi-year contract for converters in Brazil.

In summary, we've delivered increased earnings on flat sales as a result of continued emphasis on improved operating performance. We see substantial and exciting growth ahead of us with the upcoming launch of new aircraft platforms, expansion of natural gas usage, and continued global economic improvement. We believe the investments we are making today supporting this growth will continue to have shareholder value.

Now let me turn it back to Bob for the financials.

Thank you, Tom.

As you heard, Tom summarized the quarter pretty well, so I'll go straight into the segment results. Aerospace segment earnings continued to reflect lower defense sales and significant investments with respect to new product launches. Narrow bodied prototype hardware deliveries were up this quarter, and, as we've said in the past, will be a source of volatility going forward.

Aerospace segment earnings recovered from the first quarter and as a percent of sales were relatively flat compared to the prior year at a little over 15%. Segment earnings were favorably impacted by operational improvements and cost control initiatives, offset by the impact of reduced sales volumes and increased prototype deliveries.

We believe second-half segment earnings will improve sequentially, with anticipated increased overall sales volumes. In particular, we expect improved defense sales volume to contribute to the second-half segment earnings increase.

Energy segment earnings, as a percent of sales, were 14.4%, compared to 11.3% in the same quarter of the prior year. Segment earnings reflected the impact of operational improvements and improved wind turbine converter sales. This quarter reflects a continuing trend of improved earnings performance across our energy segment. We believe the second half will show continued progress.

At the Woodward level, gross margin percent for the second quarter of 2014 was 29.5%, compared to 28.3% for the second quarter of 2013. Gross margin percent increased primarily due to operational improvements in our energy segment.

Research and development costs were $36 million for the second quarter of 2014, compared to $34 million for the second quarter of 2013. As a percentage of sales, research and development was 7.4% in the second quarter of 2014, compared to 7% in the second quarter of 2013. We will continue to see quarterly variability, primarily due to the timing of achieving development milestones.

Selling, general, and administrative expenses were $35 million, or 7.3% of net sales for the second quarter of 2014, compared to $37 million, or 7.6% of net sales, in the second quarter of 2013, primarily due to cost control initiatives.

The effective tax rate for the second quarter of 2014 was 21.1%, compared to 15.7% for the second quarter of 2013. The tax rate for both quarters included favorable adjustments related to prior year's tax matters, which had a similar impact on both periods. The tax rate volatility that occurred in this quarter was anticipated in our outlook, and our full-year tax rate expectation remains unchanged at approximately 28%.

Looking at the balance sheet and cash flows, we generated $125 million of cash flow from operations for the first half of 2014, compared to $93 million for the same period of the prior year, primarily as a result of improved working capital. Free cash flow for the first half of 2014 was $56 million, compared to $46 million for the same period of the prior year.

Capital expenditures were $69 million in the first half of 2014, compared to $47 million for the same period of the prior year, reflecting growth and spending related to our capacity expansion projects. For the full year, we continue to anticipate capital expenditures to be approximately $220 million, subject to the inherent variability of large-scale construction projects. Also in this first half, we repurchased $100 million of Woodward stock under our $200 million Board authorization.

Lastly, our outlook remains unchanged. We continue to expect our FY14 sales to be between $1.95 -- excuse me, $1.95 billion and $2.05 billion and FY14earnings per share to be between $2.10 and $2.30 per share.

This concludes our comments on the business and results for the second quarter of FY14. Operator, we are now ready to open the call to questions.

(Operator Instructions)

Sheila Kahyaoglu, Jefferies.

I just wanted to call out aerospace margins again. They were very good, considering the sales drop you had in the quarter, and it was similar to the Q1 drop. Can you perhaps discuss the cost-cutting initiatives that you have in place and how sustainable they are? And also maybe discuss the impact of defense and how we should be thinking about it throughout 2014?

Yes. I think, Sheila, on the cost reduction we've been containing costs. We had a good mix. I really look at the first quarter was more of an anomaly than a trend. I think we're back where we really believe our margins should be, and that we are enhancing going forward in the second half as sales increase.

What we're looking at overall for defense? We talked about earlier that we believe defense is going to be in the flat/minus -- plus/minus 5% to 10%, and I think we last quarter talked about plus/minus 10%. We were really looking second half when we get sales in, because we're seeing increased orders and bookings coming in on the defense side that would be -- for the full year we'd be down about 10%, so we're seeing some recovery there.

Okay. I guess this leads me to my next question. In terms of -- the magnitude of the beat was pretty large in this quarter and it seems like things improve in the second half, both from a topline and operational perspective. Is there any reason that didn't adjust the EPS guidance for the year?

The guidance is a range, and we believe we'll still be in the range, in that we still have volatility in terms of our programs, the milestones in terms of NRE costs, and also we're looking at potential volatility still in some of our markets and we want to ensure that we get the defense.

We think that the guidance is good. Historically our second half is always higher than our first half. We believe that last quarter and we're holding to that. We think we're solid in the range.

That's great.

And just to clarify -- so both -- operationally, margins should improve in the second half for both segments.

We believe they will.

Okay. Thank you very much.

Thank you.

Thank you.

Tyler Hojo, Sidoti & Company.

I guess, just in regards to the military in the quarter, could you give us an actual growth rate for 2Q?

For Q2? We were down from the prior year, in mid-teens kind of rangish, and up slightly sequentially from a very depressed first quarter. We are seeing a little bit of a trend back up, which is giving us some support for that second half.

Just to add on to Bob's comment, if you remember from the last quarter, we said we saw quite a bit of defense sales being held up with the sequester discussion and other uncertainty, and we're starting to see those orders coming through as we anticipated. So we just were off to a slow start.

I think the market kind of froze there for a little bit, and now we're seeing it come in and the order book is filling in. And that's why we're confident in the second half defense will recover.

Okay. Is it safe to assume that the book-to-bill in terms of the defense product portfolio was north of 1 in the quarter?

Yes. It would be safe to say it was definitely positive. I think the other thing we called out earlier was a lot of contracts that will free up in the third and fourth quarter. There are systemic issues there because of the sequester concerns that Tom mentioned that will free up in the second half.

Got it.

And the sequential improvement in military -- would you say that was more predicated on aftermarket, which gave you the improved mix on a sequential comparison basis?

I think when we look at the improvement, we had an improved commercial aftermarket in the second quarter.

Okay.

And I think that, combined with cost focus and other improvement in the commercial OEM side, all combined to get us back. The way you've got to look at it is we got back to where we should be on the aerospace margins.

Right, but commercial aftermarket was only up, I think, 3% year on year, correct?

That's correct.

Okay. All right, that's fair enough.

And then the other question I had was just on the commentary, in your presentation around CNG bus being a positive but volatile. I'm assuming that's because of the new energy policy that's in place in China that went into effect last year, but is that indeed the case? And I guess, how is the volatility impacting you from that?

Well, with the volatility over [fresh] incentives is really on the price of natural gas versus the price of diesel fuel. And that range moves. It's somewhat set by the government in China, and that price volatility then drives volatility in demand and also volatility in the OEM supply chain.

That's a little bit what we're referring to. It moved through that period. We still anticipate some more volatility going in the second half of the year.

Okay. Would you -- if memory serves, these CNG buses have pretty good margins. Do you expect this to be a headwind or a tailwind for you in FY14?

Overall, closer to neutral in terms of sales.

Got it. All right, great. I'll jump back in the queue. I appreciate it.

Thanks.

Julie Yates from Woodward.

Good evening.

Good evening, Julie.

Just quick, on commercial aftermarket -- 3% on a relatively easy comp seems light relative to what other suppliers have been reporting. And I think comps get a little bit tougher in Q3. Any comments there? And what are you expecting for the full year in commercial aftermarket?

We see commercial aftermarket trending up in the second half of the year. Quarterly variability does occur on that, Julie, but we -- year over year, we're seeing sequentially moving up as we go in the second half here.

Okay. And then, are there any dynamics in the second half that we should be thinking about related to incentive comp or R&D?

Well, incentive comp is part of our cost structure and it depends on how -- if we perform better, there's always additional incentive comp tied to better performance. R&D -- as you know, we have a lot under development, and there is quarter by quarter fluctuations and we're in the period right now of a lot of prototype deliveries, and that may vary from quarter to quarter. Overall, we see it closer to flat, but there could be variability in there just on timing as the programs evolve.

There's always a little bit of -- we're trying to give everybody a little bit of word of caution on prototype deliveries as we go. We're entering into flight testing and the like on the big commercial programs.

Okay. And then lastly, on SG&A, it looks like it came in as a percentage of sales the lightest it ever has in the history of the Company. Is that just cost control?

Given that sales -- as we started off the year, we've been tight on cost control, and I think that's what you're seeing coming through.

Okay. Thanks.

Thank you.

Pete Skibitski from Drexel Hamilton.

Nice quarter, guys.

Thank you.

Just on not moving up the bottom end of the guidance range -- is that concern over CNG? Or is it concern over R&D prototype timing? Is it incentive comp? Is there any one or two things you would point to, to not doing that?

You hit quite a few that we would put in that category. There's a variety of them. We still are watching carefully the order book and making sure sales come in. And we, from the beginning of the year, we believe that was good guidance and we were going to make that guidance and at this point we still think it's solid.

Got it, got it. And one follow-up, Tom.

When should we start seeing, in aerospace, your initial ramp on the 320neo.

We're start moving up in 2015.

Got it. Great. Thanks very much, guys.

Thank you.

William Bremer from Maxim Group.

Nice quarter, gentlemen.

Hello, Bill. Thanks.

Let's go to the operating margins on aerospace. Looking out to the third quarter, do we expect these margins to, now that we're starting to see more of the projects break loose, margins sequentially higher? Or do we fall back into what we did last year?

No. We do anticipate that we'll continue to see sequential improvement as we go forward. The larger sales volumes in the third and fourth quarter will contribute to that.

Okay.

Hopefully, the defense will come back as we've been talking about, and seeing it starting to trend up, and that will contribute.

Okay. And going to the energy side, did the weather have any impact on overall sales for the quarter?

I wouldn't be able to attribute it to that, Bill. If there was, we wouldn't be able to pull that out.

Any activity on the pipelines?

The gas compression, we called out in the prepared remarks, is improving. We are seeing pipeline activity and a lot of that is tied to the aero-derivative turbines. Those are driving compressors. We've seen that across the gas value stream.

Okay. And the stock buyback? Do you believe that you'll complete the remaining this year?

We have the authorization. It was a three-year authorization, so we're continuing to be looking at it, but we're not calling out whether or not we're completed this year.

Okay, gentlemen, thank you.

Thank you.

J.B. Groh from D.A. Davidson.

Thanks for taking my call. I had one left here.

On the energy margins, the incrementals were really strong. Is that a result of mix or cost cutting? Or what's driving that there? And I guess I'll ask the same question -- the sustainability of that for the balance of the year?

I think our energy business, we've been highlighting our lean manufacturing journey. We are seeing good productivity coming through. And on our energy side, we're getting the results of both the operational improvements, the margin improvements, and the leverage on sales. Even though the sales increase is slight, it does provide benefit to us.

As we move forward, I think if you recall, we're on our path to get to our targeted energy margins, which we had highlighted before. I think you'll see continued -- over the next couple years, continued margin enhancement in that segment.

Okay, great. Thanks. That's all I had.

Thank you.

Michael Ciarmoli.

Nice quarter, guys.

Bob, you talked about the cost containment, and I was wondering -- the cash flow, free cash flow was specially strong. Can you give us sense -- you mentioned some improvements in working capital. Should we think that those improvements and actions you've taken, is that going to be sustainable? Should we expect a shift here in your free cash flow generation?

You can tell from our expectation of $220 million for the full year, we've got a lot on our plate for the second half.

Sure.

Whether or not weather, et cetera, will allow us to spend all that, if we were to do that, obviously the free cash flow would come down considerably from where we're at. But at this point, probably staying on this path is more likely than degrading significantly. We believe that between improved working capital management and probably a little bit lighter on the overall spend, we should be in pretty good shape on the free cash flow.

Can you elaborate on the working capital management? What sort of areas? Was it inventory? Was it purchasing? If you can give us some kind of clarity on what exactly -- what measures you guys took there?

We have two main areas of focus. Both inventories and receivables are probably two. I should add payables in there as well. Predominantly, receivables and inventory management. Tom mentioned our lean journey, and we're seeing a lot of improvement related to inventory management associated with that. And then, sometimes just overall timing of sales can help you out on the receivables side. We continue to believe it will contribute.

Got it.

And then, within aerospace, within the larger commercial transport side on the OE, can you give us a sense of -- you mentioned you're seeing strength on the regional jet, strength on the rotorcraft. What kind of revenue growth are you seeing within that OE split between some of the newer platforms, like 87, versus legacy? And you did mention you've got a lot of prototype revenues flowing through -- or prototype deliveries. Are those a meaningful contributor to revenues right now at this point?

I'll answer the last one first. Prototype -- a lot of these programs, we fund the prototypes with Woodward R&D dollars and so it's actually a headwind.

Okay. Got it.

On the rotorcraft and regional, feeling like regional was in a real trough. And what we're really seeing is coming off the trough, so when we're calling it out it's just -- we're pleased to see it coming off very bottom of the market. Rotorcraft was down and starting to improve.

Those are positives for us. We're even seeing hours and usage on business jets going up, and so we anticipate that over time that will mean the biz jet market will recover. We've got new and growing content on these platforms.

So it's all contributing. And as you saw, we don't have huge revenue growth yet, but we're seeing improvements coming in the second half and moving into 2015. We believe that will all contribute to the revenue side, but then positively impact margins as we move over the next couple of years.

Got it. And then, there have been a couple questions on the guidance range. The 777X -- is that something that -- you guys are probably spending already, but is that something that could ramp up? Do you see that ramping up this year? Or is that more of a FY15 event for you guys in terms of R&D, or just really getting the selection process whittled down here?

What's been our approach to our business -- we've been working on the technologies that we will be proposing on the 777 X for several years now, and so that R&D has been in our total R&D expenditures. And so today we are actively working both the airframe and the engine side --

Okay.

But right at this moment, it's in the RFP phase and we're actively bidding on that program. It's obviously, a tremendous program and we're going to try our best to secure improved content. So that's in the works, but that's already been built and has been in our R&D numbers for last couple of years.

Perfect. All right, great. Thanks for taking my question. Nice quarter, guys.

Steve Levenson from Stifel Nicolaus.

Thanks. Good afternoon, everybody.

Steve.

Just in relation to the prototypes again, in that it's creating a headwind for you now, are these pretty much finished designs? Or do you anticipate changes that result from the flight testing?

In the technical -- we produce, being control systems, generally we always get changes during flight testing. It's just part of the natural evolution of the development of an aircraft. That's all built into our plans, built into our outlook, so it's anticipated. We program Management for changes and so, yes, that will happen. I'm sure of it. We have it covered.

It's already provided for? Okay. That's helpful. Thanks.

And second, how do you see the actual delivery and lead times for a lot of these products, for leaping your turbofan? And do you have to build inventory? Is there much of an investment in working capital required?

Yes, but I really anticipate that working capital increase will be more late 2015, 2016 timeframe. It's not a 2014 issue.

Got it. Okay, thanks very much.

Thank you.

Pete Skibitski from Drexel Hamilton.

Guys, just a couple follow-ups.

Can you tell us, was incentive comp a headwind or a tailwind this quarter for margin rates? And then, can you just update us on what your expectation is for wind for the year? I might have missed that.

Incentive comp this quarter? Largely flat with the prior year, so not a lot of impact either way, tailwind or headwind. In wind, we are seeing on the path that we called out early in the year. Maybe slightly over that in terms of sales growth, so we're on our realignment path there.

And on the wind side, just to remind, we really thought last year, second, third quarter, particularly the third quarter was the trough. And we're confident that truly was the trough and we are recovering from that trough. So that's a positive for that product line for us.

So it should be up for the full year?

Yes, it will.

Thank you.

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

Bob and I appreciate the questions and we look forward to talking to you guys, everybody, over the following quarter and then next -- third quarter's conference call. Thanks for joining us again today. Bye.

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 7:30 PM Eastern Daytime Time by dialing 1-888-266-2081 for a US call or 1-703-925-2533 for a non-US call; and by entering the access code 163-5544. A rebroadcast will also be available at the Company's website at www.woodward.com for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your line.