Woodward Governor Co. F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

| About: Woodward Governor (WGOV)

Woodward Governor Co. (NASDAQ:WGOV)

F4Q08 Earnings Call

November 19, 2008 6:00 pm ET


Thomas A. Gendron - President & Chief Executive Officer

Robert F. Weber, Jr. - Chief Financial Officer


Peter Lisnic – Robert W. Baird & Co.

Greg McKinley – Dougherty & Company

J. B. Groh – D. A. Davidson & Co.

Tyler Hojo – Sidoti & Company

William Bremer – Maxim Group


Welcome to the Woodward Governor Company fourth quarter and fiscal year 2008 earnings call. (Operator Instructions) Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer, and Mr. Bob Weber, Chief Financial Officer and Treasurer.

I would now like to turn the conference over to Mr. Weber.

Robert F. Weber, Jr.

We would like to welcome all of you to Woodward's fourth quarter and fiscal year 2008 conference call. In a minute Tom will talk about our 2008 highlights and our markets. I will then comment on today's earnings release. And at the end of our presentation, we will open it up for questions.

For those who have not seen the release, you can find it on our website at www.woodward.com. As noted in the press release, we have included some visual presentation materials to go along with today's call that are accessible on our website under our Investor Information tab at www.woodward.com.

An audio replay of this call will be available through Friday, November 21, 2008. 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 webcast will be accessible on our website for 30 days.

Before we begin, I would like to provide our cautionary statement as shown on Slide 3. In the course of this call when we present information and answer questions, any statements we make other than actual results or historical 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, power and process industries, and transportation markets. We caution investors not to place undue reliance on these forward-looking statements as predictive of future results. In addition, the company disclaims any obligation to update the forward-looking statements made herein. For more information about the 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 2008, which we expect to file later today.

Now I will turn the call over to Tom to discuss our progress toward achieving our strategic goals in the fourth quarter and throughout 2008.

Thomas A. Gendron

I will begin by highlighting our financial results for the fourth quarter. Sales were up 21% compared to the fourth quarter of fiscal year 2007. Diluted earnings per share for the quarter were $0.50 compared with last year’s $0.51. Last year’s results included a $0.15 per share favorable tax adjustment. Our operating earnings increased 42% over last year’s fourth quarter.

Our continued excellent growth in sales and related operating earnings leverage allowed us to achieve the following full year 2008 highlights.

Sales were up $216.0 million, or 21% over last year. Our earnings were $1.75 per diluted share, up 26% from 2007. Operating earnings increased 38% over last year and we generated $125.0 million cash from operations during the year, an increase of 6% from the prior year.

Sales growth this quarter resulted partly from strengths, once again, in each of our core markets of aerospace, power generation, and process industries and transportation. Our three key strategic focal points of globalization, energy, and emissions, continue to position us well in our markets and with our customers. Our overseas operations and multi-national customers allowed us to capture opportunities in multiple markets and regions.

An example is our expansion to serve our wind customers in North America and China where our existing presence gives us an advantage.

Aerospace industry orders remained strong again in this quarter. Backlogs at Boeing and Airbus remain solid and are expected to hold over the next couple of years with stated production rates remaining at approximately current levels.

Resolution of labor issues at Boeing is a positive sign that production of current aircraft and the 787 development will return to levels that will drive growth opportunities for Woodward.

Business jet activity, however, has seen an order slowdown with a reduced production outlook.

In the aftermarket past quarters showed that airlines were following through on some of their announced plans to withdraw less fuel-efficient aircraft from service. We continue to expect some of these planes to in fact be removed from service, despite the potential for redeployment in other regions of the world or use in freight service.

It remains unclear what ultimate effect these actions may have on our overall growth, considering the more global nature of the fleet, the increased usage of narrow-body aircraft outside of the U.S., and out increased content on newer and more fuel-efficient aircraft such as the Boeing 777 and the Airbus A380.

This quarter we were certified as a UTC Gold Supplier by United Technologies and Pratt & Whitney. We received this award for achieving outstanding performance in the areas of delivery, quality, and customer satisfaction. We are proud of this recognition, which is given to less than 5% of the UTC supply base.

We also recently announced the execution of a long-term supply agreement with Pratt & Whitney which extends a key relationship for Woodward and secures our position on their geared turbo fan platform.

Internally, we are focused on business processes that drive our operational and financial performance. We believe that these processes are critical to retaining and adding to Woodward’s growth opportunities in both sales and earnings.

Industrial turbine demand remained robust, driven by international power-generation projects. Aero-derivative turbines are seeing continued growth related to back up power sources for renewable projects and in the oil and gas market.

Production at our key customers remains at high levels and demand for Woodward content remains at improved levels relative to the first half of fiscal year 2008.

Continuing global energy demands, both traditional and renewable, and more stringent emissions regulations, provide opportunities across Woodward. While uncertainty related to credit availability and lower oil prices could dampen growth in this area, we are encouraged by the more long-range views that appears to be developing in respect to energy policy in the U.S. and globally.

We continue to see strong interest in alternative fuels, driving greater demand for compressed and natural gas engine systems and a high level of Woodward sales to existing and recently added Asian customers. This demand, which can vary, is a function of local availability of natural gas, infrastructure related to fuel delivery and national policies with respect to dependence on foreign oil.

Large marine applications and mining equipment again led the demand for diesel engine systems products this quarter. While economic uncertainty and commodity prices will have an effect on demand in these markets, much of our infrastructure and related cost consolidation efforts have been focused in this area.

As a result, we believe Woodward is better positioned to deliver sustained profitability during a recessionary environment.

Steam turbine controls again provided strength in the quarter, where high oil prices have been driving expanded investment in oil and gas production.

I would now like to make some general comments about power generation and infrastructure projects. While global demand for electrical power continues to increase as world population grows, it is unclear what impact the current credit crisis will have in this area.

Consumers and governments around the world will continue to demand increasing availability and reliability, regardless of economic conditions, which may lead to government support of financing in this area.

Wind turbine sales continued to grow at a remarkable rate. We delivered our first NGX scalable inverter platform during the quarter, which will improve manufacturing efficiency, use a common platform for turbines of various sizes, and deliver solutions to a broader geographic market with a variety of grid requirements.

Additionally, we shipped the first 6-mega watt inverter in the industry for use in an offshore application.

We are expanding market share and continuing to execute on our plans to support our customers locally as they expand to both North America and Asia. We are on track to complete our expansion of wind turbine inverter production in both Colorado and Tianjin, China. While the current economic environment has raised the risk level with respect to large infrastructure projects, our customers continue to plan for significant growth.

Distributed powers are a growing trend with respect to electrical power. It can consist of stand-alone power sources or multiple sources serving a grid system. Distributed power brings with it more complexity and control requirements but Woodward’s sophisticated power management control technology helps solve these challenges.

As always, Woodward’s involvement in each of these markets is centered around energy control and optimization. Our strategy remains unchanged and our focus will be on areas where we deliver the greatest value to our customer, in the areas of control, efficiency, and emissions.

Now I will turn the call over to Bob to review our financial results and update our outlook.

Robert F. Weber, Jr.

I will comment on the fourth quarter and fiscal year 2008 for Woodward as a whole and each of its business segments. I will then cover some specific financial measures of interest and finish by commenting briefly on our outlook for the future.

At the Woodward consolidated level net sales for the quarter were $351.0 million, a 21% increase over last year’s fourth quarter sales of $291.0 million. This growth was attributable to the market strengths and Woodward positioning that Tom referred to, as well as the impacts of foreign exchange rates. Growth with the positive effect of exchange rates was approximately 17%.

Operating earnings for the quarter, defined as earnings before income taxes and interest, grew 42% and were $50.9 million, or 14.5% of sales, compared with $35.8 million, or 12.3% of sales, in the same period a year ago.

Net earnings for the quarter were $50.7 million, or $0.50 per diluted share, compared with $36.0 million, or $0.51 per share, for the same quarter a year ago.

Fourth quarter 2007 earnings benefitted from a $10.3 million favorable income tax issue resolution. Without the 2007 income tax benefit, same quarter per share results would have been $0.36.

Foreign exchange accounted for approximately $0.01 per share of the increase year-over-year.

Going forward, with the rapid weakening of the Euro and the British pound, we expect to see sales and earnings pressure, as compared to 2008. Our continuing growth in Europe, predominantly related to our wind business, will increase the effects of currency in 2009 as compared to 2008.

Net sales for the fiscal year 2008 were $1.258 billion, a 21% increase from $1.042 billion for the prior year.

Net earnings for the year were $121.9 million, or $1.75 per diluted share, compared with $98.2 million, or $1.39 per diluted share, in the previous year.

At the segment level, let me first discuss our Turbine Systems segment. Turbine Systems net sales for the quarter, including inter-segment sales, were $163.8 million, an increase of 14% over fourth quarter sales of $143.8 million a year ago.

Turbine Systems segment earnings in the fourth quarter of fiscal 2008 were $28.7 million, compared with $21.0 million for the same quarter a year ago.

Segment earnings as a percent of sales were 17.5% in the fourth fiscal quarter of 2008 compared to 14.6% in the prior year.

Our sales performance reflects sustained growth across our portfolio of aircraft and industrial offerings, with particular strength in industrial turbines and OEM aircraft offerings. Earnings increased year-over-year largely due to our ability to successfully leverage our fixed cost base on the increased volume.

Sequentially, the higher mix of OEM sales in both industrial and aerospace impacted earnings.

Moving to our Engine Systems results. Engine Systems net sales for the quarter, including inter-segment sales, were $128.5 million compared to $124.7 million a year ago, an increase of 3% reflecting favorable currency impacts and a continued strength and demand for our customers’ products outside the United States.

Segment earnings for the quarter decreased 16% to $14.4 million compared to $17.2 million for the same quarter last year. Segment earnings as a percent of sales were 11.2% in the fourth fiscal quarter of 2008 compared to 13.8% in the same quarter of the prior year.

Our sales growth this quarter came largely from our transportation market with marine and alternative energy leading the way. The decline in earnings as a percent of sales was primarily attributable to normal variation in the mix of our products sold during the quarter.

Now turning to Electrical Power Systems. Electrical Power Systems net sales for the quarter, including inter-segment sales, were $89.7 million compared to $54.6 million a year ago, an increase of 64%. Again this quarter, wind power sales were very strong.

Power generation and distribution markets also experienced robust growth as overall demand for power protection and power distribution controls continued. In this segment, without the effects of exchange rates, growth was approximately 53%.

Segment earnings almost tripled for the quarter, to $14.8 million compared to $5.1 million for the same quarter last year. Segment earnings improved as a percent of sales to 16.5% in the fourth fiscal quarter of 2008 from 9.3% in the prior year.

In this segment, too, we continue to focus on process and product design improvements that will further enhance margins.

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, as a percent of sales was 28.7% in the fourth quarter of 2008 as compared to 28.2% in the fourth quarter of 2007. Gross margin as a percent of sales was essentially flat at 29.8% in fiscal 2008 compared to 30.1% in the prior year.

Selling, general, and administrative expenses, as a percent of sales, decreased to 8.4% of sales, or $29.3 million, in the fourth quarter of 2008 compared to 9.3%, or $27.0 million, in 2007.

For the year, selling, general, and administrative expenses were 9.2% of sales, or $115.4 million in 2008, compared to 10.7%, or $111.3 million, in 2007.

Research and development costs were $20.0 million in the fourth quarter of 2008, or 5.7% of sales, compared to $18.4 million, or 6.3% of sales in the fourth quarter of 2007.

Research and development costs were $73.4 million in 2008, or 5.8% of sales, compared to $65.3 million, or 6.3% of sales, in 2007.

This level of spending is consistent with our expectations and longer-term requirements, although some quarterly variability will continue.

Total depreciation and amortization expense for 2008 increased to $35.5 million from $32.9 million in the prior year.

Our effective income tax rate for 2008 was 33% compared to 25.6% last year. Income tax expense for 2007 included adjustments with a net favorable impact of $10.3 million, or $0.15 per diluted share, which reduced our effective rate by about 8 points.

Specifically we received a favorable outcome related to prior-year tax examinations of $13.3 million, partially offset by a decrease in our deferred tax assets, resulting from a reduction in the German statutory tax rate, of $3.0 million.

We would expect that our effective rate for 2009 would be slightly below this year’s rate, reflecting the research credit extension.

Our annual capital expenditures were $41.1 million in 2008 compared to $32.0 million in 2007. We previously announced that we expected capital expenditures to total approximately $100.0 million for the years 2008 and 2009 combined.

Given the current level of economic uncertainty, we have recently reviewed our planned 2009 capital expenditures and will defer some of these expenditures where timing is not critical.

For 2009 we now expect capital expenditures to be closer to, or slightly below, our 2008 levels. In 2009 we will remain focused on our low cost strategy, continuing our expansion in Poland and supporting our wind growth through expansions in Colorado and China. We will continue moving forward with our systems test capability but at a more modest pace.

To turn briefly to our balance sheet. Working capital, defined as current assets less current liabilities, increased to $369.0 million at September 30, 2008, compared to $476.0 million at September 30, 2007, supporting our increasing sales volumes.

Woodward generated $125.0 million of cash flow from operations in 2008 and $84.0 million of free cash flow with increased capital expenditures over the prior year.

In 2009, we believe liquidity and cash generation will be critical and we plan to generate over $125.0 million in free cash flow, a 42% increase over the current year. We believe this level of cash generation, coupled with our strong balance sheet, adequately supports our operations going forward and the strategic initiatives we have indentified.

Currency impacts, while impacting our reported earnings do not significantly impact our economic results, as we have strategic investment opportunities in Europe. Our total short-term and long-term debt was $49.0 million at September 30, 2008, compared to $67.0 million at September 30, 2007.

The ratio of debt to debt plus equity was 7.2% at the end of the fourth quarter compared to 10.9% at September 30, 2007.

As previously announced, Woodward acquisition MPC Products on October 1 of this year. During October we issued $400.0 million of additional long-term debt, which funded the acquisition. MPC Products is now our new Air Frame Systems segment. We remain confident that this acquisition, with annual sales of approximately $220.0 million, will be neutral to slightly accretive to Woodward’s earnings per share in fiscal 2009.

We expect that synergies and cost savings will be realized as originally expected and these will be significantly greater in the second half of fiscal 2009 than in the first half and with further benefits to be realized during fiscal 2010.

We also acquired MotoTron in early October, for $17.0 million. We expect this acquisition to be neutral to earnings per share in 2009. The integration is proceeding on schedule.

Turning to our outlook on the future. As we are all aware, the economy over the last several months has been significantly impacted by the financial institution credit crisis, ultimately affecting the broader credit markets and the financing available to many companies, both in the U.S. and abroad.

Additionally, the Euro has weakened significantly and given up ground that has been accumulated over almost two years. This historic drop, with a potential for further impacts, had a considerable impact on our 2009 outlook.

Preparation for the impacts of market fluctuations has been a strategic objective for a number of years and Woodward is well positioned to maintain liquidity and relative profitability throughout the business cycle. We have been investing more broadly, both regionally and across our markets, to reduce specific risks with respect to any one economy or market. Our focus on energy control and optimization, across a wide range of applications and resources, mitigates fluctuations in any one area.

Further, our products are key components of critical infrastructure projects where government backing of funding may supplement private investing. We are focusing on our core competencies to better serve our customers, driving improvements in the cash conversion cycle, reducing operating costs in many areas, and have locked in favorable long-term financing.

To summarize the outlook for our business segments, at this time our order volumes indicate a modest increase in sales volumes in 2009, with Turbine Systems being up slightly; Engine Systems, as our short-cycle business, seeing the impacts of the economic downturn earliest; and Electrical Power Systems still seeing strength and wind.

At the Woodward level, the significant effects of rapidly weakened European currencies may offset the modest volume increases that Tom and I mentioned and we now anticipate organic sales to be flat to slightly up, with overall sales, including our recent acquisitions, to be approximately $1.4 billion to $1.5 billion, and related earnings per share of $1.65 to $1.90.

That concludes our comments on the business and results for the fourth quarter and fiscal year 2008 earnings conference call. We are now ready to open the call to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Peter Lisnic – Robert W. Baird & Co.

Peter Lisnic – Robert W. Baird & Co.

On the organic growth forecast from flat to up 6%, you commented a bit about Turbine being up slightly, can you give us a bit more granularity there in terms of what you are expecting in commercial aerospace OEM versus aftermarket, and then just some more granular detail within the businesses in Engine and Electrical Power?

Thomas A. Gendron

I will start with our Turbine business, so if we’re looking at the aircraft market, and we’re really looking and the feedback we’re getting from the industry, we expect the civil aviation, the larger, from regional to the larger commercial aircraft, to remain pretty steady. In talking with the customers in the Air Framers we believe that the order book is still sound and that the financing is lined up to carry it through 2010. So we feel good about that in that area.

The one thing that I know you have seen out there is that the ramp ups like Airbus had planned are probably not going to occur but they are going to hold their rates steady, and Boeing is talking about pretty much the same thing. So from there we see steady production and then ongoing, some of the newer programs where we have gained market, are coming on line late in 2009, with shipments and start to pick up there.

The defense side, it’s our belief, and again, in talking to many in the industry, that defense spending will hold through 2009 and into 2010. I even believe this will hold with the change in administration. So from that standpoint that looks real good.

The aftermarket business for Woodward right now is still solid, still growing. The big question mark, if you look at the install base, we have got a great base, we are well represented on all the new aircraft. The one area we are keeping an on is the 737 classics. And this time we have not seen much impact from some of the announcements that they are going to park some of those planes.

What is happening right now is that parking those planes is being mainly driven by oil prices. Obviously everyone knows that oil has come down dramatically. What we are watching is economic issues now and we will keep our eye on are those planes actually going to get parked, or how many. And we still believe that our aftermarket will hold and not go down. That is our outlook at the moment.

So for the Turbine side, we expect steady to slightly up sales.

Peter Lisnic – Robert W. Baird & Co.

And do you mind addressing industrial gas turbine in that before you go to other segments?

Thomas A. Gendron

I will. The only area of the aircraft we are keeping an eye on are the business jets. There we have seen the softening in some of the outlook. Production rates. I think what is really going on is the business jet manufacturers are going to keep their lines running so they are not going to ramp up, they are going to hold the lines at a rate that they feel comfortable with to allow the backlog to keep them in production through the next two years. So that’s the only area that we have seen a slight decline, but overall still looking positive.

On the industrial turbines, right now the order books are still strong. The backlog looks good. So we don’t have any question on that. Looking out into late 2009 when we go into 2010 what we have to watch is financing and I think Bob highlighted that in a number of areas in his prepared remarks. And the issue is if financing does not come through later in 2009 or 2010 you could see a reduction there. But the demand is there, the projects are still moving forward at the moment, but we are just putting a cautionary note on watching for financing.

Any of these projects are huge. They all are based on financing. So that is something we are watching. We don’t have any news that you don’t have, but we are being cautious on that.

Peter Lisnic – Robert W. Baird & Co.

And just to be clear, that means no cancellations out of your backlog? Is that a safe way of putting it?

Thomas A. Gendron

Yes, we have not had any cancellations. So the backlog still looks solid. It is more moving in to make sure that follow-on orders and the like will continue where the demand has been there.

On the Engine side, parts of our Engine business have a shorter cycle than aircraft- or turbine-type infrastructure projects. So we are starting to see, and our customer base is starting to see, some slowing in the short cycle. Now, long cycle would be things like the marine market where the order books are large and they have long, long lead times.

So we have a concern about the short cycle, with the economic conditions, and the other area that we have some concern on, though I think the order books will be fulfilled, is in mining, where we have had dramatic commodity price reductions.

So of all of our businesses, Engine is our shorter cycle and from what we are seeing right now, where we expect the feel the pressure the soonest. We are not seeing it exactly today but we are anticipating some downward order pressure there.

The last area is our Electrical Power Systems where the wind business is doing great. Our backlog is full. Talking to our customers, they believe the backlog is solid. You have probably seen the announcements from a number of the wind turbine manufacturers which are still seeing sizeable growth going into 2009. And we see that in our orders and our planning. As always, we caution, wind turbines require financing so anything that requires financing we are keeping an good eye on.

But the order books are doing well there. We have captured a lot of market share and as we bring on our lines in Colorado and in China we expect to see continued growth in that area.

Peter Lisnic – Robert W. Baird & Co.

This concept of maybe government picking up the tab in terms of if the financing market on the private side continues to feel pressure, in your forecast of flat to up 6%, what are you assuming in terms of financial market health? If that’s a fair question?

Robert F. Weber, Jr.

I think it’s too early for us to really understand what the impacts may be. I think we do view that possibility of government backstopping some of this funding as a global phenomenon, not only a U.S. phenomenon.

In some areas, for example, electrical power is very much a function of population growth and their governments may make policy decisions that the need is acute enough that they will not let financing get in the way.

So as Tom mentioned, so many of our businesses are a function of available financing to our customers’ customers and given all of the uncertainty in banks, at the moment, not really lending to their customers, it’s very difficult to see how that may impact us going forward.

Peter Lisnic – Robert W. Baird & Co.

In terms of the order book not really seeing cancellations, but are you seeing some projects move around because of the environment? In other words, are you seeing some customers saying they will take delivery at a later point in time and other customers moving up in the production slots, if you will?

Thomas A. Gendron

No, in terms that we’re a tier-1 supplier to primarily engine OEMs, or the turbine manufacturers, we have not seen any moving around of our order book. We know that in discussions with the air framers that they have seen a very little amount of that and since they had a movement, others moved up in their slots. But that has not trickled down to us in any order movement at this time.

Peter Lisnic – Robert W. Baird & Co.

And is that true in the wind business, too?

Thomas A. Gendron

In the wind business we have not seen any movement like that at all.


Your next question comes from Greg McKinley – Dougherty & Company.

Greg McKinley – Dougherty & Company

Could we get a little more color on your view for Engine Systems? Looking back to 2008, I think you even cited in your press release, you certainly enjoyed some business from natural gas vehicles. I think that’s the Asian bus business. I think you have previously talked about some contract manufacturing volumes from Caterpillar. What are you expecting from those contributions in 2009? Are those things that you would expect to recur and how much pressure could that cause on that segment if they did not?

Thomas A. Gendron

They are kind of separate. The natural gas vehicles, there is a lot driving those due to energy independence, but also to emission regulations or the desire to reduce pollution in the cities, especially in the Asian cities, where most of our sales are.

As long as the regulations and the governments continue to support that, those sales should continue to come in. however, the lumpiness we have always referred to, you know, the production systems of our customers in Asia are not as sophisticated as the U.S. or Western Europe, so we get this lumpiness in orders, which we are anticipating still holding.

Now some of our other transportation products, and you highlighted some of the work to Cat, Caterpillar is not really defining their outlook at the moment. Some of that equipment is used on older machines and the outlook is very uncertain and that is why we are taking the approach we are and saying it’s a little uncertain and not anticipating much growth there and maybe even declining sales.

But it’s an environment where it’s a unique time where it is difficult to forecast those.

Greg McKinley – Dougherty & Company

On the wind market, could you give us a comment for what did your wind market revenues end up being for the year? And with your modular inverter product, are you seeing any opportunities to get your product involved in new customers? I know you have had certainly presence in the past with guys like REpower, etc., but have you found that some of the manufacturers who exclusively did inverter production in-house are more open to your modular solution?

Thomas A. Gendron

Well, the modular solution has definitely us to capture share with our existing customers, add on some new Asian customers. We have got some real active campaigns going right now to continue to expand our market share with additional customer base. Some of that is with the vertically integrated. Some is with the ones that are not vertically integrated, on inverters.

I think the product is being extremely well received in the market place. This year, as we get it onto more new turbines and also into the field, I expect that to help drive up our share.

Robert F. Weber, Jr.

I would want to give a specific number, we really don’t go down below the segment level, but I can tell you it is a substantial portion of our total EPS sales and it’s obviously the fastest growing of any portion of our businesses.

Greg McKinley – Dougherty & Company

I think you had previously mentioned an expectation for $100.0 million or a little bit north. Is that still sort of the ballpark that we should have thought about?

Robert F. Weber, Jr.

A little bit north is accurate.

Greg McKinley – Dougherty & Company

With your balance sheet changes here with the acquisitions, could you give us a sense for how much interest expense you are expecting and implied in your $1.65 to $1.90?

Robert F. Weber, Jr.

I highlighted the approximately $400.0 million, actually it was $400.0 million in debt that we took out related to the acquisitions. And we were very successful, previous to the major downturn, catching long-term rates at a very good position. So we are kind of around the 6% rate overall. So you can work that out. We are in the neighborhood south of $30.0 million forecasted for next year.

Greg McKinley – Dougherty & Company

In net interest expense?

Robert F. Weber, Jr.

That’s right.


Your next question comes from J. B. Groh – D. A. Davidson & Co.

J. B. Groh – D. A. Davidson & Co.

I had a question on the GE impact on the Boeing slowdown. Did you experience anything, that’s probably going to show up in Q1 or Q2. Is there anything you could share with us on that front?

Thomas A. Gendron

You have to look at it, Boeing and the reason why we have highlighted in past that it hasn’t impacted us too greatly is if you look at their existing in-production aircraft, which is really the 737, 777, 767, and 747, we are represented on the 777 and a little on the 767, depending on the engine choice. But we’re not on the 737, we’re on the A320 platform.

So with that coming down we saw a little reduction in G90 orders for the 777 but primarily, we’re still shipping those. So very little impact. My point of view is the delay with the strike and the delay in the 787, I think is actually going to smooth out the cycle because the 787 and 747-8 have move out to the right but they are kind of moving in an area that is not too bad and it’s going to smooth out the cycle, I think, in the airline acquisition area.

And we’re starting to see those kicking in in 2009 and 2010. So it’s going to be good for or 2010.

We had a great year in 2008, and this pushing to the right is just going to help our 2010.

J. B. Groh – D. A. Davidson & Co.

So in terms of your lead-time, it’s maybe 6 to 9 months pre-Boeing delivery?

Thomas A. Gendron

Yes, we are starting to see some shipments in our fourth quarter.

J. B. Groh – D. A. Davidson & Co.

But right now you’re doing pretty much nothing on GEnx?

Thomas A. Gendron

We’re doing a lot of work.

J. B. Groh – D. A. Davidson & Co.

A lot of work, not a lot of revenue.

Thomas A. Gendron

We’re doing a lot of work. And our products, just to highlight, are doing great. Everything is working well. We don’t have any issues with the certification activities and it looks like the products are going to go into service very nicely.

J. B. Groh – D. A. Davidson & Co.

And when do you start to see a little bit of an R&D ramp done? Does that happen in 2010 or do you expect to spend the same amount in terms of percentage of sales or on a dollar basis, however you want to look at it, on R&D in 2009?

Thomas A. Gendron

I’m glad you asked the question because I want to answer it more generally across Woodward. We are definitely in a tough economic cycle, looking forward. We highlighted in our prepared remarks. We have never been this prepared for a down cycle. One of the things you are going to see Woodward do is continue our R&D through the cycle.

We have got financial strength, we have got a lot of opportunities, a lot of chance to gain market share, and so we are probably going to hold around that dollar amount, fairly close, may a little down, over the next two years.

And we are going to be very opportunistic, we’re going to go for share, we’re going to look at new business opportunities, and we’re going to look at acquisitions. We feel like we have the cash flow and the financial wherewithal.

We don’t know how much of a downturn we’re going to hit, but we’re looking into it the strongest we’ve ever been and we are really intending to grow organically and grow inorganically during this downturn. So that’s the philosophy we have taken and we are communicating to our leaders and driving into our business planning.

J. B. Groh – D. A. Davidson & Co.

So R&D wouldn’t go up even with the two acquisitions, on a dollar basis?

Robert F. Weber, Jr.

Yes, on a dollar basis, because of the acquisitions, it will go up.

J. B. Groh – D. A. Davidson & Co.

But percent of sales.

Robert F. Weber, Jr.

You have seen some slight fluctuation as we go from quarter to quarter and so on, but yes, the dollar amount of the acquisitions, it will go up for that.


Your next question comes from Tyler Hojo – Sidoti & Company.

Tyler Hojo – Sidoti & Company

I know you put the $220.0 million revenue expectation out there for the MPC acquisition. Just wondering if you could give us either what it was in fiscal 2008 or just kind of a ballpark, what kind of growth that entails year-on-year?

Robert F. Weber, Jr.

Roughly we were a little bit north of $200.0 million and it’s about a 7% increase, slightly less than 7% year-on-year.

Tyler Hojo – Sidoti & Company

And what are you looking at driving that for the acquisition? I think if I recall, I think when you announced the acquisition you said that they were up about 8% year-to-date in 2008.

Robert F. Weber, Jr.

Some of it is the mix of the calendar year and the fiscal year. So I think that’s causing the difference between the 8% and the 7%, but it’s right in that neighborhood.

Tyler Hojo – Sidoti & Company

And on the FX, you spent quite a bit of time talking about that, but just in regards to what the benefit to EPS was for the full year, I think you gave it for sales but not EPS. Do you have that number?

Robert F. Weber, Jr.

At an earnings level for last year it was fairly insignificant. Less than $10.0 million, about $7.0 million. And to elaborate on that a little bit, what we have seen over the last couple of years has been a fairly gradual, in hindsight, increase in those rates. And now we have seen a dramatic weakening in those rates. So what you are going to see is a much more dramatic impact in 2009 as a function of basically two years of currency growth has been wiped out.

Tyler Hojo – Sidoti & Company

If you wouldn’t mind just commenting, Electrical Power Systems saw a heck of an improvement in the operating margin. Just wondering what the expectation for profit is in that segment as we go into fiscal 2009 and beyond?

Thomas A. Gendron

A little bit what you could take and go across the three traditional segments within Woodward, Turbine Systems, if you look at the year and you look at the segment operating margins, for the fiscal year, Turbine will be relatively flat. We expect Engine to be flat to slightly up, and Electrical Power Systems the be slightly up, over the annualized percent on segment earnings.

Tyler Hojo – Sidoti & Company

Just going back, you touched on it a little bit, but I know one of the growth drivers for EPS is kind of making inroads into some of the more vertically integrated wind guys out there, namely GE. I know they do their own inverters in-house. Have you made any progress on that front specifically? I don’t know if you can talk to that, but maybe just broadly comment on it.

Thomas A. Gendron

I would rather not give a specific on any customer but I can tell you that we are speaking with several of the top manufacturers of wind turbines about the opportunity to use our NGX and those are kind of long-term campaigns and I believe we should be successful on one or more of those in 2009. But we have not factored that in and it’s very difficult to ever predict the outcome of winning new business like that.

But we are actively working it and we also are actively working continuing to pick up more from our existing customers.

Tyler Hojo – Sidoti & Company

But just to be clear, you said that was not included in the forecast you provided here today.

Thomas A. Gendron

That’s correct. Not included.


Your next question is a follow-up from Peter Lisnic – Robert W. Baird & Co.

Peter Lisnic – Robert W. Baird & Co.

If I look at the Engine business I’m not sure that I understand why the fourth quarter was down as much sequentially as it was. It sounds like mix was one of the issues. Can you just help with that answer?

Robert F. Weber, Jr.

I think it was a combination mostly of the mix issue. We mentioned that we had some product mix issues. I think we have talked about some of those in the past in terms of lower-margin products that were expanded in the quarter.

During the year we had been calling out some operational cost increases related to the transfer of product lines from Niles to China. Those began tapering off in the fourth quarter and are no longer impacting us, but there was a tail to them, slightly, in the fourth quarter.

So that combination of those two are really what impacted the relative profitability.

Peter Lisnic – Robert W. Baird & Co.

And in the EPS segment, the impact of FX on the change in operating income there, did you disclose that or should we wait for the 10-K to get that number?

Robert F. Weber, Jr.

$1.4 million. And it will be in the 10-K.

Peter Lisnic – Robert W. Baird & Co.

If I look at that margin for that business, you’re getting good volumes and I imagine the leverage on those volumes is pretty good, but I also get the impression that there’s probably something there going on structurally, particularly in the wind product. Maybe it’s mix, maybe it’s just more efficient manufacturing. Can you talk about the structural changes that you have made in that business over the past two, three, four quarters to change the profitability profile of the business?

Thomas A. Gendron

What I will do is give credit to the management team that we put in place there. It’s primarily huge operational improvements. We’re moving the production from more of a job-shop-type approach to lean manufacturing. We have also done a tremendous job on our purchasing activities, our supply chain management. And with the growth we are able to get some leverage out of there.

Just to give you a flavor for what we’ve done since we picked up this business, we were below 25 inverters a month and we’re well over 110 right now and growing on that. And we’re doing it within the same facility. So it’s been tremendous operational improvements.

And what I would also like to highlight; it kind of goes with the question. We really never made much call outs through the year, and we’re not going to give out a number, but if you look at fiscal year 2008, we absorbed all the commodity increases, freight increases, oil surcharge increases, and what I always look at is kept our margins about flat, on a gross margin basis. And so that’s all was picked up through productivity. There is a lot of pressure out there.

Our challenge now is to, with all those things doing a reversal here, is to eke more productivity out of that. So I think we did a real nice job operationally during the year, which is kind of hidden in the numbers, but when you reflect on what was going on in the market place, I think those numbers came through well.

Peter Lisnic – Robert W. Baird & Co.

But I also imagine that this year with materials costs coming down you will get some benefit or some tailwind from that? Is that a good way of thinking about it?

Thomas A. Gendron

That’s the goal. You’ve also got to recognize it’s going to be a little slow because we have got supply chains with inventory already in place so we have to bleed off, both internally and at our suppliers, the higher cost of material. But we do see the opportunity in 2009 and 2010 to get improvements due to commodities.

Peter Lisnic – Robert W. Baird & Co.

And how much of your customers have come back and said to give back on price due to commodity declines? Have those conversations begun to occur?

Thomas A. Gendron

Not really because they didn’t come back and offer us price increases. We expect pricing to hold.


Your next question comes from William Bremer – Maxim Group.

William Bremer – Maxim Group

I want to go back to the Engine Systems segment with that drop off on the margin side. Were there a lot of one-timers there that potentially going into 2009 we get a more normalized type of margin, especially in the first part of it. I know you commented overall on all the segments, but really in the first of 2009.

Robert F. Weber, Jr.

I wouldn’t want to categorize some things as one-timers. Yes, there are costs that we do not anticipate recurring but we have been working on slimming the infrastructure in this business for quite some time and there are costs that will come up associated with that. And as we pointed out, the freight cost this last time around.

Maybe looking at it more on the long-term basis, we are still committed and we believe we are on an appropriate long-term path to get this back. I think we have called out a 13% to 14% sort of range, with potential upside depending upon product mix and efficient use of the infrastructure.

We believe we are still on that path, we believe it will have a quarterly fluctuation and has had that in the past and we think that will continue to some extent going forward.


There are no further questions at this time.

Thomas A. Gendron

Thank you for joining us today and appreciate the questions. Hopefully we were able to give you some clarity. We look forward to speaking to you in January at the end of our first quarter.


This concludes today’s conference call. If you would like to listen to a rebroadcast of this conference call, it will be available at 10:00 pm ET by dialing 1-888-266-2081 domestic, or 703-925-2533 international, and by entering the access code 1299787. A rebroadcast will also be available at the company’s website at www.woodward.com for 30 days.

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