Woodward Inc (WWD) 2014 Q3 法說會逐字稿

Thank you for standing by, and welcome to the Woodward Inc. third-quarter FY14 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.

(Operator Instructions)

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 FY14 earnings call. 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 woodward.com. We have, again, included 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 August 4, 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 third quarter of FY14 were $524 million compared to $484 million in the third quarter of last year, an 8% increase. Earnings per share were $0.69 for the quarter compared to $0.34 for the third quarter of last year. EBIT for the quarter was $68 million compared to $42 million for the third quarter of the prior year. Free cash flow for the first nine months of 2014 was $79 million compared to $55 million for the first nine months of 2013, with operating cash flow increasing approximately $51 million. Now I'll 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. This quarter was strong and in line with the increased full-year expectations we announced in June. During the quarter, we saw continued strength in commercial Aerospace, stabilization and recovery in Energy, and slightly reduced downward pressure in Defense. In addition, higher sales and ongoing operational improvements delivered strong earnings leverage in the quarter.

More specifically, in Aerospace, the commercial aerospace market remains robust as airlines seek enhanced profitability through higher levels of fuel efficiency. Backlogs for large commercial aircraft are at record levels, and passenger miles continue to increase at a healthy rate. The regional jet market is showing recovery as production rates increased due to aging aircraft, introductions of new platforms, and other economic factors. The commercial rotorcraft market continues to benefit from the expansion of the oil and gas industry and the improving economy. Defense continues to be a challenge due to budget constraints and contract issues, although we have seen some improvement sequentially. Our expectation for the fiscal year of approximately a 10% overall sales decline in Defense from last year is unchanged.

Woodward is beginning to benefit from our strategy of delivering expanded content on new programs such as the Boeing 787, and we believe our market share will increase substantially with the new aircraft launches such as the 737 MAX and A320neo which are approaching quickly. These platforms represent approximately two-thirds of the global commercial fleet and we have significant system content on both. We have been investing in these programs for many years and we expect to see significant returns as these programs launch. We are on track with systems testing and program execution to meet the delivery schedules.

Turning to Energy, many of our Energy markets are showing improvement as a result of the economic environment and increasing demand for clean burning natural gas. Power generation and compression markets are driving strong aero-derivative gas turbine sales. While the demand for new heavy frame gas turbines remains sluggish, the aftermarket is gaining momentum. Wind turbine activity continues to recover from the 2013 market collapse. Government subsidies related to renewable appear to have stabilized and we expect steady growth in the near term. Global investments are increasing related to natural gas and new oil sources through pipeline expansion, LNG processing plant and tanker construction, coal plant retirements and dual-fuel locomotives.

We are working with key industry players on important programs that are expanding or launching in the near future. Large gas and diesel engine markets are firming due to power generation requirements for marine vessels in the oil and gas industry. While the compressed natural gas engine market remains healthy globally, the Chinese market is experiencing volatility related to government incentives. Finally, regarding the recently announced GE/Alstom deal, we are closely monitoring details as they are disclosed, but at this time we do not expect to see a significant impact on Woodward.

In summary, we delivered a solid quarter in both sales and earnings and are on track to meet our revised FY14 financial targets. Our markets are generally showing improvement with the exception of Defense. Our earnings performance reflects the benefits of our continuing lean and cost control initiatives. We have made significant investments over many years relating to our growth in new aircraft platforms and the expansion of natural gas. The payback period is now approaching. Our strategy remains to provide improved profitability as we launch these exciting new programs in both Aerospace and Energy.

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

Thank you, Tom. In the quarter, we delivered significant earnings improvement over the prior year driven by increased sales, improved productivity, and cost control initiatives. The prior-year quarter included $15.7 million in specific charges related to the renewable power business. We've mentioned in the past that variable compensation would be a headwind in FY14, and this quarter reflects a significant increase in our Company-wide variable compensation expense, both sequentially and compared to the prior-year third quarter which is driven by our improved financial performance this year.

Our variable compensation plan covers substantially all members and significantly impacts all segments this quarter. Aerospace continues to be mixed with commercial strong and defense challenging. Commercial OEM and aftermarket sales showed good growth compared to the prior-year quarter. Commercial aftermarket increased approximately 10% compared to the prior-year quarter. Defense sales, while improved sequentially, were down from the prior-year quarter. Aerospace segment earnings were up slightly, favorably impacted by lower research and development costs and cost control initiatives. While research and development expenses are reduced, prototype hardware deliveries related to new platform launches continued to negatively impact Aerospace earnings, and will be a source of volatility for the next several quarters.

Energy segment earnings were strong at 16.1% of sales compared to 5.9% in the same quarter of prior year. Excluding the renewable power business specific charges, segment earnings as a percent of sales for the prior-year quarter would have been 13.3%. Segment earnings for the quarter were favorably impacted by the effect of higher sales and related leverage, as well as continuing operational improvements. While we may see quarterly variability, this level of earnings demonstrates the financial improvement of our Energy segment as a result of several years of lean implementation, productivity improvements, and market share gains. At the Woodward level, research and development costs were approximately $35 million for the third quarter of both years, reflecting lower spend offset by increased variable compensation expense.

As a percentage of net sales, research and development was 6.7% in the third quarter of 2014 compared to 7.3% in the third 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 $40 million, or 7.7% of net sales for the third quarter of 2014 compared to $47 million, or 9.7% of net sales in the third quarter of 2013, primarily due to the renewable power business specific charges in the third quarter of 2013. The effective tax rate for the third quarter of 2014 was 26.4% compared to 33.3% for the third quarter of 2013. The lower tax rate from the prior-year quarter was primarily due to the favorable impact of foreign tax matters in this quarter. The effective tax rate for the full FY14 is now expected to be approximately 27%.

Looking at our cash flows, we generated $184 million of cash flow from operations for the first nine months of 2014 compared to $133 million for the same period of the prior year, primarily the result of improved earnings and working capital management. Free cash flow for the first nine months of 2014 was $79 million compared to $55 million for the same period of the prior year. Capital expenditures were $105 million in the first nine-months of 2014 compared to $79 million for the same period of the prior year, reflecting growth in 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.

All facility projects are on schedule with Rockford and Niles, Illinois expected to be completed by the end of this calendar year. Also in the first nine months of FY14, we repurchased $141 million of Woodward stock under our current $200 million share repurchase authorization.

Lastly, turning to our FY14 outlook, we are encouraged by signs of solid growth in many of our end markets and are seeing considerable momentum in our sales orders. As we stated in our press release on June 5, we expect sales to be in the upper end of the range of $1.95 billion to $2.05 billion, and earnings per share to be between $2.35 and at $2.45 per share for FY14. Our markets continue to strengthen and we expect increased sales growth and earnings leverage to positively impact our FY15 performance, as well. This concludes our comments on the business and results for the third quarter of FY14.

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

Thank you.

(Operator Instructions)

Peter Skibitski of Drexel Hamilton.

Hi, guys, nice quarter.

Hi, Pete. Thanks.

Just wanted to learn a little bit more about the Aerospace margin in the quarter. I think you were expecting it to be up sequentially. Is this something where maybe incentive comp came in higher than expected, and maybe some of the prototype R&D projects came in and impacted?

Yes, it is predominantly the latter that's giving us the variability. So, yes, the variable comp is a delta sequentially, but the one that gives us a little bit of unanticipated variability is more prototype and development program work.

Okay. Any way you can quantify that for us kind of ballpark?

No. The full year will be very hard to estimate, as well, but it is not inconsequential.

Okay. Got you. And just to follow up, guys, on energy -- it was kind of a blow-out quarter for energy. How should we think about the legs on this improved energy, particularly from a sales and order standpoint? It seems like we were in a modest global growth environment. So how are you guys thinking about this great revenue quarter and whether or not it has legs to it?

Well, we're bullish on our energy segment, and see continuing growth coming. And with increased sales, we're confident we'll be able to leverage into earnings and continue to have solid earnings growth.

Tom, is there any particular niche within energy that's just coming in way above expectations?

I think if we said one that came higher than plan was probably the recovery in our renewable business. It collapsed last year. We did a major restructuring. We repositioned, took a lot of cost out. And sales are ahead of our forecast on that. The others are all coming in kind of as we anticipated. And as we move into 2015, we do see some momentum in the energy business.

Okay. I'll get back in queue. Thanks, guys.

Sheila Kahyaoglu of Jefferies.

Hi. Great quarter. Thanks for taking my question. I guess, to elaborate on Pete's question a little bit, it seems like renewable came in better. Can you discuss what's going on in heavy frame turbines, and are you shipping out on a large order that might be helping the mix, or it's general lean and maybe some other practices that have been working? If you could elaborate on that a little bit?

Sure. On the heavy frame gas turbines side, we've actually seen some good momentum in the aftermarket, and that's what's been boosting. OEM's been fairly flat, a little down to flat. We do see the order books improving, and as we move into 2015, we do think the OEM will pick up and we do anticipate continued aftermarket growth.

Okay. And then, I guess on the commercial aftermarket, that was up 10%, and I know Q2 was up 3% but on a tough base. What's driving, essentially, 2 times passenger air traffic numbers -- the growth that's 2 times above that?

Yes, well, a little bit what you have is ongoing air traffic growth. We also are starting to see some improvement in initial provisioning from some of the programs that are -- the new platforms going into service. That's been anticipated for a while, and was kind of delayed due to the long delays on some of those programs like 787 and A380 and the like. So we're starting to see initial provisioning improve, repair and overhaul's doing well, and kind of tied to the growth in the airline sector.

Okay. And then, lastly, I guess, going back to cost control initiatives, it seems like SG&A has been below 8% of sales for two quarters now. Should we expect that outlook into 2015, or is it cost controls, or what's driving that?

It is the cost controls. We're a little early to be talking a line for 2015, but we see no reason in the longer term that we can't continue to get leverage on that line.

Okay. Great. Thanks.

Thank you. Julie Yates of Credit Suisse.

Good evening.

Hi, Julie.

Hi, Julie.

So it looks like if margin trends continue in the fourth quarter, and your tax rate's lower, the new, higher guidance range still looks pretty conservative. Is there any reason that aero margins won't recover on volumes similar to last year? Or the strength in energy won't continue, or is that just conservatism?

Well, we think the revised outlook in total, outlook is solid. We feel like we'll be solid in the range. And we do anticipate continued improvement, so we should be in good shape to deliver on those numbers, Julie. But at the moment, we don't see increasing them.

Okay. And then, can you guys quantify the defense decline that you saw in the quarter in OE and aftermarket, and just help us with the outlook for Q4? It looks like you're expecting a pretty healthy increase to keep the only down 10% for the year since you saw the 20% decline in the first half.

Yes, we are. Fourth quarter will be -- is historically, but that should be very strong for us. It was down about 13% overall. So the downward pressure has let up some. If you recall, it was almost double that number in the first quarter.

And as we mentioned, I think, last quarter, we are starting to see contracts flowing into defense, both the OEM, but also more importantly maybe on the aftermarket on the government sales. So that's going to flow into the fourth quarter. And then ideally, we think it will flow into 2015, as well.

Okay, so the fourth-quarter orders at least are pretty locked in at this point?

Most; we still have some pending.

Okay. And then just one last one: You've now reached your long-term margin target of 16% in energy. So how should we think about the margin potential in energy, especially if the strength continues?

What I'd say is: We want to have it consistently delivering at that number for full fiscal years. So we're pleased with where we are. We do see the opportunities to improve beyond that 16%. So there would be opportunities to go on the upside.

Okay. Thank you.

Sure. Thanks.

Thank you. Tyler Hojo of Sidoti & Company.

Yes, hi, good evening, everyone. So just a little bit more on the renewables business: Tom, I think you said that was tracking kind of ahead of plan a little bit. Could you maybe quantify what the plan was for the year, and basically where it's going, or where you think it's going?

Yes. We'll talk a little bit about it. Go ahead, Bob.

If you recall, Tyler, we had targeted that we thought it'd be in the slightly over the $125-million range.

Yes.

And we think it will be a pretty good increase above that. So it's recovering nicely, and it's still focused on our European customer base, as we said from our strategy realignment. So they are enjoying a pretty good year, and they are on track from the earnings perspective as well, and all of our manufacturing shifts are kind of behind us now. So they're able to just focus on getting the job done.

Okay. That sounds good. And just in regards to the GE/Alstom deal, I know GE is essentially vertically integrated, at least when it comes to wind inverters. You don't see that being any sort of risk with the legacy business?

Right now, as we fully understand exactly all the assets that are going and staying, our anticipation right now is it will have no impact.

Okay. That sounds good. And then, just as it relates to the share buyback, what does the guidance currently assume in terms of share count, and are you anticipating in the guidance any sort of incremental buyback in Q4?

We assume that we will continue to be in the marketplace. Whether it's higher or lower, sideways, from where we are today, that, obviously, remains to be seen. We're approximately in a 68-million share range for the guidance.

Got it. And actually just lastly, could you maybe just update us on 777X supplier decisions? Do you anticipate any sort of near-term decisions on that platform?

Right now, we're really in the throes of all-out competition on both the engine components and systems, as well as on the airframe. We kind of anticipate starting in -- August, September we start seeing announced orders, or announced awards, I should say. So we're working hard to have a substantial sales or dollar content per aircraft increase over the current 777 at Woodward. But that's still to be seen.

So I say, most of the awards for our type of products will occur over the next six months. So we'll be updating everybody as we go. But it's probably, to finish out the contracts, will probably be about six months.

Okay. Great. Well, that's all I had. I appreciate it.

Thank you. J.B. Groh of D.A. Davidson.

Hi, guys. Thanks for taking my question. Maybe, Bob, you could go into Q4 expectations on that aerospace margin? That's been, obviously, a little volatile. Is there any dynamics in Q4 that we should be aware of?

Nothing that we haven't called out as third-quarter dynamics. So the defense will continue to be a variability. The mix, aftermarket, we've talked about, having some strength from the commercial side and some downward pressure at this point on the defense side. We kind of hope some of those things even themselves out as we enter into the fourth quarter here, but -- so nothing outside of those continuing factors.

Got you. And then maybe you could refresh expectations for the LEAP ramp going into the end of this calendar year and into fiscal next year, or what you expect, how that expects to ramp up?

Just so I heard you, the LEAP engine, is that what you're referring to?

Yes, yes. Just MAX exposure, or I'm sorry, NEO and MAX exposure in general.

The real timelines -- we'll start to see some sales towards the end of the year, low-volume sales for the A320 NEO. And as we move into late 2015, early 2016, we'll start seeing sales coming online for the MAX. I think both Airbus and Boeing, I think, are doing an excellent job of managing their backlogs on the current generation so that they can do a fairly smooth transition as they bring up the new line as they take down the old line. So I think you're going to see a steady progression of sales starting really in -- towards late 2015 through late 2017, you're going to see this ramp. So it's going to be continuing ramp and growth rate for us. Hopefully, that answers a little bit there.

They haven't come out with specifics that they are talking about on how they're going to ramp the MAX and NEO up, and how they're going to ramp the current generation down, but I think it will be a smooth transition. It's not going to be a step change. And we're facilitizing to handle the growth, and it is a substantial amount of growth on those two platforms for us. So we'll be ready for the uptick.

Good. And then, so there you're talking calendar years, correct?

Correct.

All right, thank you.

Thank you. Steve Levenson of Stifel.

Thanks. Good afternoon, everybody.

Hi, Steve.

Just following up from the air show last week and the introduction or the announcement of the A330 NEO and Trent 7000. Do you see any opportunities on that aircraft engine combination beyond what you have on the current A330?

Yes, as you look, we have very little on the current A330.

Right.

And we do not have any significant content on the Trent. But we do see some opportunities, and we will be bidding some opportunities associated with the airframe and the nacelle. And anticipate that we will have better sales on the 330 NEO than the 320, but it won't be a huge program for us.

Okay. (multiple speakers)

Mainly because they're not changing enough to allow us to bid on a lot of new content.

Got it. Do you believe that they can sell -- if you're willing to comment -- that they can sell 1,000 or more A330 NEOs, or do you think it's going to push people towards A350 or even towards 787?

I think it's going to be a successful program. Whether it gets up to 1,000 aircraft, I'm not so sure, but I do think it will be a successful program, and we would like to be a part of it, and are going to -- like I said, we are going to bid on a number of the items.

Got it. Thank you very much.

Thank you. Michael Ciarmoli of KeyBanc Capital Markets.

Hey, thanks, guys. Good evening, nice quarter, and thanks for taking my questions. The fourth quarter, I guess, Bob, if you can just run us through -- what are the puts and takes to the $100 million high end and low end of guidance? What do you guys need to see outside of maybe some of the defense volatility, unless that is the sole driver of the range? But maybe if you can give us some color on what are the puts and takes there?

I think one thing we did say is we will be at the high end of the sales range. That maybe narrows it down from $100 million. (laughter)

Okay.

-- to half of that number. And so some of that is defense. Some of it's timing, on just -- as we hit the end of the fiscal year, it's always what orders are flowing in that will stay in the quarter or move into the next year. So there's always a little bit of timing on exactly how those shipments go. But we feel good about being in the upper end of that range.

Okay. And then just on the -- I think you said with the renewables, $125 million, at that range, that was for the break-even level. Can you give us a sense -- going forward, do you think -- it sounds like you're tracking to be ahead of that. With the new restructuring in place, will that still be a margin drag on the segment, or do you think you can -- with some uptick and just a little bit of resurgence there in that market, can that actually be in line to accretive to segment margins?

As we move into 2015 and with the current outlook and order book, we expect sales to improve in 2015 and continue an improvement in the margins. So we're also introducing a new converter platform, which we expect to get better -- to have better operating margins. So collectively, we think that it's going to get back to being close to in line with the rest of the energy segment.

Okay. That's helpful. And just the last one for me, Bob: How do we think about when the new facility -- you guys transition into the new facility, you come online, how should we be thinking about overhead absorption and, I guess, depreciation for some of the equipment in there? Is that just going to fall into the range of -- the aerospace margins are going to be a little bit bumpy and volatile, or is there any additional color you can give us as you guys support the ramp up of programs and you shift to that new facility?

We've commented that it is clearly our strategy, and everybody's been working very hard for a good number of years to make that, obviously, a very smooth and non-impactful event from the standpoint of earnings volatility. That's not to say with something of this size that you're not going to have some, but it clearly has been a lot of people working for a long time to make it as smooth as possible. And so with the increased revenues, the increased aftermarket, the increased initial provisioning, we do believe, and it's been our strategy, to absorb all that in our stride and continue to improve earnings.

Okay. Fair enough. Thanks a lot, guys.

(Operator Instructions)

We have a follow-up question from Pete Skibitski of Drexel Hamilton.

Yes, guys, a couple of follow-ups on energy. Tom, I think you mentioned part of the tailwind in wind is Europe. I was wondering if you could give us a sense of -- give us any color on what's going on over there? Were there any regulatory changes or tax changes that kind of drove that? And does it have some legs on it?

Well, a little bit -- we have to all say it's the European customer base is where we are strong, and they do ship globally. So we've seen -- actually this year we're seeing strength in Brazil. We are seeing ongoing strength in Europe.

But in addition, we also are having a solid aftermarket for the wind converters -- that our fielded number of units keeps rising every year. And with some age, those do produce aftermarket revenue. So it's a combination of the Europe being solid, Brazil growing, and aftermarket.

Got it. And then on the CNG, it sounds like globally growth is good, except for China. When are you thinking that maybe the worst of the headwinds in China CNG are going to be over, and will that market come back, do you think?

The interesting thing is -- that comment was volatility, and you might want to take that as quarterly volatility. Overall, the China market for CNG is still good. But it does move and it flows a little different than western markets. So we just prepare ourselves and recognize that there's some volatility. But we, overall, see ongoing growth in China for CNG and all natural gas applications, as well.

But it's kind of like sometimes said -- we need to anticipate in the China market, as well as, I'll go back on renewables, those do have some volatility quarter to quarter, year to year, and that's kind of the nature of the market. So that's a little bit what we saw in the quarter, but we do see it turning back and going into 2015, China CNG will be a solid performer in 2015.

Okay. Very helpful. Thank you. Last follow-up, guys, just typically the fourth quarter you're up sequentially revenuewise in energy. Is there any reason not to expect that this year?

No. (laughter) The answer would be: You should expect something like that.

Super. Thank you.

Thank you. Gary Farber of CL King.

Yes, hi, I just had two questions. One, if you could just speak to, given the strength you're seeing in your end markets, just any thoughts on how you see the market for acquisitions, your own interest level, and just generally, are there a lot of properties out there for sale? And then if you could just comment a little bit more on just China generally how you see it?

Yes. On the M&A front, I think prices are high. So the valuations have gone up. However, recognizing that, and going back to previous conference calls, our focus right now is on delivering the new programs and the ramp up, and delivering on the investments that we have to make in new facilities.

Only if something very, very special comes up are we going to look at M&A right now. So for the next couple years, our focus is on delivering and executing on the ramp up, but keeping an eye on the market in case something special comes up. So always ensuring that if we do enter the market, that we do it at a reasonable price. So a little on the M&A front.

But China in general, we are seeing the stimulus starting to occur from the government. The order books going over the next 12 months look like they'll be positive, so we see some growth coming in China. So right now, I know there's been volatility in the economy there. But we are seeing some stimulus occurring. And based on the type of projects and where they're opening up the financing spigots, we expect that that will bode well for the type products we produce and what they would be buying. Overall, I think China will recover.

Okay, thanks. And then, just one last one, just on North America: Given that all the PMIs and the industrial production globally are at least headed in the right direction, what are your feelings just broadly on the North America market?

Low growth. Slow growth will be good for us. Bob highlighted earlier, we've been doing a lot of work getting our cost structure, controlling costs. So when we start seeing some sales, we'll be able to do a nice amount of leverage on that sales into earnings growth.

And similarly in Europe, low growth?

Yes. Very low growth.

Right. And the kind of leverage you had in the quarter, that would be -- the operating leverage you had in the quarter, that's indicative of what you're targeting or better than that, you think?

Targeting better. Yes.

Better? Okay.

And I think you have to take in the quarter, we did have the variable comp headwind in the quarter. That will diminish as we go forward. But there was -- when you look at year over year and sequentially, it was a headwind.

Right. Okay. Thanks.

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

Okay. Well, appreciate everybody joining today and thank you for your questions. And we look forward to seeing you over the next quarter for our year-end results. Thank you.

Ladies and gentlemen, that concludes our conference for today. If you would like to listen to the rebroadcast of this conference call, it will be available today at 7:30 Eastern daylight time by dialing 1-888-266-2081 or 1-703-925-2533, and by entering the access code 1640590. A rebroadcast will be available at the Company's website at www.woodward.com for 14 days.

We thank you for your participation in today's conference. You may now disconnect your line. Thank you.