Woodward Governor Company Q3 2009 Earnings Call Transcript

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 |  About: Woodward Governor Company (WGOV)
by: SA Transcripts

Woodward Governor Company (NASDAQ:WGOV)

Q3 2009 Earnings call

July 23, 2009 5:00 PM ET

Executives

Bob Weber - Chief Financial Officer and Treasurer

Tom Gendron - Chairman and Chief Executive Officer

Analysts

Tyler Hojo - Sidoti & Company

Peter Lisnic - Robert W. Baird & Co.

Gregory McKinley - Dougherty & Company LLC

J.B. Groh - D. A. Davidson

Fred Buonocore - CJS Securities

William Bremer - Maxim Group

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Woodward Governor Third Quarter 2009 Earnings Conference Call. At this time, I would like to inform you that this call is being recorded for rebroadcast and that all participants are on a listen-only mode.

On the presentation you'll be invited to participate in a question-and-answer session. Joining us today from the company are Mr. Tom Gendron, Chairman and Executive Chief Officer and Mr. Bob Weber Chief Financial Officer and Treasurer. I would now like to turn the conference over to Mr. Weber.

Bob Weber

Thank you, operator. We would like to welcome all of you to Woodward's third quarter fiscal 2009 conference call.

In a few moments, Tom will talk about the highlights of our third quarter and our markets. I will then comment on today's earnings release, and at the end of our presentation, we will take questions. For those who have not seen the release, you can find it on our website at woodward.com under our Investor Information tab.

As noted in the pres release, we have included some visual presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available through July 27, 2009. The phone number for the audio replay is on the press release announcing this call and will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our website for 14 days.

Before we begin, I would like to provide our cautionary statement issue on our slide 3. In the course of this call when we present information and answer questions, any statements we make other than actual results or business facts may contain forward-looking statements. Such statements involve risks and uncertainties, and actual results may differ materially from those we currently anticipate. Factors that might cause a material difference include but are not limited to future sales, earnings, business performance and economic conditions that would impact demand in the aerospace, power and process industries, and transportation markets.

We caution investors not to place undue reliance on these forward-looking statements as predictable future results. In addition, the company disclaims any obligation to update the forward-looking-statements made herein. For more information on risks and uncertainties facing Woodward, we encourage you to consult the press release and our public filings with the Securities and Exchange Commission, including our 10-K for 2008 and 10-Qs for the 2009 quarters.

Now, I will turn the call over to Tom to discuss our quarter's highlights, our markets and our progress toward achieving our strategic goals.

Tom Gendron

Thank you, Bob. Welcome to all of you who have joined us today.

I'll begin by highlighting our financial results for the third quarter. Total sales were up 17% reflecting the MPC and HRT acquisitions and the formation of our Airframe Systems segment.

Reported earnings were $0.36 per share. Excluding special items highlighted in the press release, adjusted earnings per share were $0.41 compared to $0.47 in the prior year.

Free cash flow generated during the quarter was strong at $61 million, and we reduced our debt by $64 million after taking on the additional debt following the April 3rd HRT acquisition. These results are generally consistent with our previous outlook.

Market highlights for the quarter included the following: our commercial aerospace sales, excluding business jets, were down moderately in the quarter but are sell-up somewhat for the year.

Sales related to business jets were again down significantly. Defense sales were again stable and we believe this will continue. Industrial gas turbine sales were again strong. Wind turbine converter sales volumes were up again in a flat market.

As anticipated and seen in the quarter's -- prior quarter's results, some markets were down significantly in particular reciprocating engines for power generation, transportation and industrial uses, and electrical equipment used in power generation, distribution applications.

Foreign currency was again a headwind. Our market outlook is little changed from last quarter. We continue to expect a challenging sales environment for most of our businesses in coming quarters.

While demand for our reciprocating engine products will likely face another sequential decline this quarter, we are seeing more signs of stability in these markets. While this is a challenging environment, we believe our more diverse portfolio of businesses and the applications reduces our exposure to any one market.

For example, our increased involvement in the wide range defense programs should provide a sale base of demand while our commercial markets are under pressure from the economic downturn.

Regarding our previously announced actions related to cost reductions, most actions have been implemented. We are confident that these actions have been appropriate. While such actions are always painful, if some of these actions with less severe as a result of our initiatives in recent years to reduce our manufacturing infrastructure and non-core activities.

At this time, Woodward is focused on three key areas: delivery of strong cash flow, to aggressively reduce our leverage, to approximately 2.5 times EBITDA by the end of fiscal year 2009 and two times by the end of 2010.

Second, fully integrating MPC and HRT into a cohesive Airframe Systems business that offers broad system solution and achieves improved profitability and cash organic opportunities for growth and an eventual rebound while weathering the current environment with relatively steady consolidated operating margins.

Our Airframe Systems integration continues on its course to deliver better aftermarket presence and support as well as improved profitability and broader controlled system content.

Customers have responded favorably to the efforts made by the MPC and HRT teams to jointly offer a variety of technological solutions through a single Woodward channel.

Regarding our efforts to grow organically, we are pursuing three major areas of opportunity. First, we are improving our technology portfolio. For example, over the coming year, we expect to broaden our wind turbine converter offerings covering more of the market application.

Second, we are aggressively and selectively pursuing a variety of new system and component opportunities. In this area, we've recently won several moderately sized airframe opportunities and solidify the key reciprocating engine customer relationship with more opportunities to come in the next few months.

Third, we are working to improve customer satisfaction with manufacturing processes and the locations designed for better delivery time and responsiveness. For example, we recently shipped our first wind turbine converters from our Loveland, Colorado facility to better support our customer sale of wind turbines in North America. And in this quarter we will ship out of our Tianjin China location for Asian customers.

In summary, Woodward serves a variety of basic infrastructure needs, there must be still in both good and bad times, and we have opportunities for long-term growth on successful platforms.

We are working to have the current cash flow by aggressively managing costs and working capital allowing us to reduce leverage on our balance sheet. Same time, we're preparing for an industrial return to grow by developing new technologies, winning new business and improving customer satisfaction.

We remain confident that our current positioning and efforts will ultimately deliver significantly enhanced shareholder value.

I'll now turn the call to Bob to review our financial results in more detail and update you on our outlook.

Bob Weber

Thank you, Tom. At Woodward consolidated level, net sales for the quarter were 386 million, a 17% increase over the last year's third quarter sales of 330 million, 108 million of growth was attributable to the acquisitions of MPC and HRT.

Organic sales declined 16%. Foreign exchange rates negatively impacted quarterly sales comparisons by approximately $13 million.

Operating earnings, defined as earnings before interest and income taxes, for the quarter were 37.6 million or 9.7% of sales, compared with 49.7 million or 15.1% of the sales in the same period a year ago. This includes a one-time charge of $12.5 million related to the valuation of inventories associated with the HRT purchase account.

Net earnings for the quarter were $25 million or $0.36 per share, compared with $32.4 million or $0.47 per share for the same quarter a year ago. Net earnings included a $0.12 per share after tax charge for the HRT inventory matter just mentioned at $0.07 per share benefit for one-time tax items representing resolution of a prior year matter. These items are highlighted in the table on page three of our earnings release.

Free cash flow for the quarter was strong at $61 million compared to $48 million for the prior year's quarter, reflecting increased focus on working capital including better alignment of inventories and demand and a reduced need for capital expenditures in the current environment.

To finance the HRT acquisition, our debt increased by 325 million to 757 million on April 3rd. However, during the balance of the quarter, we utilized our cash flow to reduce outstanding debt by $64 million to $693 million.

Turning to our segments, Turbine Systems net sales which includes intersegment sales, for the quarter were 148.2 million, a decrease of 4% over third quarter sales of 153.7 million a year ago. Turbine Systems segment earnings in the third quarter of fiscal 2009 were 30.8 million compared with 29.3 million for the same quarter a year ago. Segment earnings as a percent of sales were 20.8% in the third fiscal quarter of 2009 compared to 19.1% in the same quarter of the prior year.

Turbine Systems sales performance reflects modest declines in OEM and after market commercial aerospace sales, a sharp decline in business jets, partially offset by strong industrial turbine sales. Earnings increased largely due to cost reduction efforts. Airplane systems comprised of MPC and HRT contributed 107.7 million in net sales for the quarter. The segment reported a loss for the quarter of $6 million. Excluding the impact of the item related to HRT purchase accounting for inventory, segment earnings were $6.5 million or 6% of sales.

Segment earnings also included 6.6 million in amortization of acquisition intangibles. All of these were non cash charges. This segment realized significant cost savings this quarter through actions taken in MPC. Staff productions to-date in MPC totaled approximately 300 members or about 25% of the work force. We expect the combination of HRT and MPC will continue to present opportunities for synergies that we will pursue.

Electrical power systems net sales for the quarter was 69.1 million compared to 77.2 million a year ago, a decrease of 11%. Without the impact of exchange rates, sales were flat. Again this quarter sales volumes were laid by wind turbine converter sales. But this volume growth was offset by declines in inter segment sales related primarily to power generation products and other products serving the same markets. Segment earnings for the quarter increased 16% to 12.5 million compared to 10.8 million for the same quarter last year.

Segment earnings improved as a percent of sales to 18.1% in the third fiscal quarter of 2009 from 14% in the prior year. The improved profitability is attributable to product mix and cost reductions initiatives. Engine System's net sales for the quarter were 84 million compared to 130.9 million a year ago, a decrease of 36%. The weakness was experienced broadly across our Engine Systems markets or transportations and power generation.

Foreign exchange impacts provided additional downward pressure of approximately 3 million on sales. Segment earnings for the quarter decreased 63% to 6.3 million compared to 17 million for the same quarter last year. The decline in segment earning was attributable to the decrease in sales, but was partially offset by cost production initiatives and reductions in freight cost.

Segment earning as a percent of sales were 7.5% in third fiscal quarter of 2009 compared to 13% in the same quarter of the prior year. Our previously announced restructuring actions yielded a little over 10 million in company wide sales savings this quarter. With the full quarter impact, we result in further saving to come in future quarters.

Now I would like two discuss certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, as the percent of sales was 25.7% in the third quarter of 2009 as compared to 29.7% in the third quarter of 2008. This decline was primarily attributable to the 12.5 million charge related to purchase accounting for HRT inventory.

Selling, general and administrative expenses as a percent of sales helps steady at 8.6% of sales or $33.2 million in the third quarter of 2009 compared to 8.6% or $28.4 million in 2008. Research and development costs were 20.7 million in the third quarter of 2009 or 5.4% of sales compared to 19 million or 5.8% of sales in the third quarter of 2008. This level of spending is generally consistent with our expectations and longer term requirements although quarterly variability will continue.

Total depreciation and amortization expense for the first nine months of 2009 increased to 46.1 million from 27.2 million in the same period of the prior year. The increase is attributable to the acquisitions of HRT and MPC. Interest expense totaled 10.9 million this quarter. This included certain costs associated with our committed financing arrangements for the HRT acquisition that will not recur. We expect interest expense next quarter to be closer to 9 million, subject to movements in interest rates.

Our effective tax rate for the quarter was 6.4% compared to 34% last year. This rate reflects a $5 million benefit resulting from the favorable resolution of the tax matter. We expect our rate in the near term to be approximately 33%.

Capital expenditures were 18 million in the first nine months of 2009 compared to 25 million in 2008. For the full fiscal year 2009, we anticipate capital expenditures of just under 30 million. We remain focused on our manufacturing infrastructure cost strategy and we broke ground for our new facility in Poland in the third quarter. As Tom mentioned, we are now shipping wind turbine converters from the Colorado operations, and we are preparing to do so from China later this year.

As mentioned in last quarters call, we closely monitor our financial leverage, measured as total debt divided by trailing 12 month adjusted EBITDA. At June 30, our financial leverage was 2.7 times, a decrease from 2.9 times at the time of our HRT acquisition.

The ratio of debt to debt plus equity was 50.1% at the end of third quarter compared to 39.8% at March 31st, 2009, approximately 55% of our debt is a relatively favorable in fixed interest rates. We expect to further reduce our exposure to floating rate debt in coming quarters as we directly payments to floating rate debt.

Turning to our outlook, as the current economic cycle transitions, visibility remains poor. We continue to believe the next 12 to 15 months will be challenging. We expect our end markets to be mixed with the slight overall decline in 2010. The full year effects of HRT acquisition should offset the impact of these declines on our sales.

We believe the actions we are taking, favorably position us in the phase of ongoing volatility and will enable us to continue strong cash flow generation. As we close out the current year and consistent with our previous guidance, we believe sales in 2009 will be approximately 1.45 billion and reported earnings per share will be approximately $1.35, which presently includes $0.21 of negative effects of the previously discussed special items.

I would like to close by emphasizing a few points about our balance sheet and cash flow. First, the financing we have in place will provide flexibility and a competitive advantage. This financing reflects an average borrowing rate at June 30 of less than 5%. It provides liquidity with the flexibility to quickly reduce leverage and it staggers facility maturities from 2012 to 2019.

Second, we now anticipate full year 2009 free cash flow to be in a range of $140 million to $160 million. We are focusing on maximizing cash flow in coming quarters with the goal of reducing our leverage to approximately two times adjusted EBITDA by the end of this fiscal year -- excuse me, 2.5 times adjusted EBITDA by end of this fiscal year and two times adjusted EBITDA by the end of 2010. These are challenging, but achievable goals.

In summary, we are confident that our cash flows and capital structure are aligned. This alignment should deliver a more conservative leverage profile in coming quarters and allow for the enhanced shareholder returns Tom mentioned earlier.

That concludes our comments on the business and results for the third fiscal quarter in 2009. Operator, we are now ready to open the call to questions.

Question-and-Answer Session

Operator

Thank you, sir. This question-and-answer session will begin at this time. (Operator Instructions). Our first question comes from Tyler Hojo from Sidoti & Company.

Tyler Hojo - Sidoti & Company

Hey good evening guys. Okay Hi. First question: I just want to make sure I heard that right did you say free cash flow this year at 140 to 160?

Bob Weber

Yes.

Tyler Hojo - Sidoti & Company

Okay. And just for clarification before you were saying roughly flat with last year, right?

Bob Weber

No, well, earlier we were forecasting 110 to 140.

Tyler Hojo - Sidoti & Company

Right, okay. All right, good clarification; okay, thanks. And then just on the guide, did the prior guidance include the inventory step up that you spoke to in the press release there.

Bob Weber

No, it did not.

Tyler Hojo - Sidoti & Company

Okay.

Bob Weber

So that's the new item this quarter.

Tyler Hojo - Sidoti & Company

Okay, got you. And was it something that you were anticipating this quarter or was it something that was somewhat a surprise or just an unknown.

Bob Weber

We nearly would have the step up. It was not completely valued at the time of the last quarter.

Tyler Hojo - Sidoti & Company

Okay, got you. And just in regards to the wind side of the business, I guess the new Collins facility is going to be up soon. But just regards to what you are doing in Colorado, have you had any headway into GE there, because they seem like they are pretty optimistic in terms of seeing the back half pick up on their wind business?

Tom Gendron

Yeah, Tyler, we have not -- on the converter side, have not made any sales to GE. We do have some sales on some digital electronic products since GE went. So, at the moment it's pretty small level, there are still obviously a place we'd like to sell. We had shipped our first converter unit out of Colorado.

We expect some increased sales coming out of the U.S. in particular, because we have located the site here. We have been able to pick up market share with our current customer base and are trying to penetrate the U.S. market. So, it's working as planned. We still are looking to capture more wind turbine customers, and that's somewhere to be concentrated on over the next year.

Tyler Hojo - Sidoti & Company

Okay. And I guess last quarter the wind business was up roughly 25%. And in your comments you said it was up again this past quarter. One I guess could you quantify that and two what are your expectations there as we kind of move forward over the next 12 to 18 months or so.

Tom Gendron

Yeah, looking forward wind was up again as primarily market share gains. We expect the wind market to continue going well. But there could be some short-term financing issues and some of the wind parks. We're still monitoring that closely. So that's the risk factor that's out there. But in terms of longer term over the next 12 to 18 months, we expect wind to do well. So we're watching the financing that's still an issue in the marketplace. Number of units were just up slightly year-over-year. So number of units delivered, and we think that we did pretty well at that, because overall the wind market has been kind of down last two quarters in general.

Tyler Hojo - Sidoti & Company

Okay, great. I'll have it that away; thanks.

Operator

Our next question comes from Peter Lisnic from Robert W. Baird.

Peter Lisnic - Robert W. Baird & Co.

Good afternoon guys.

Tom Gendron

Hi, Pete.

Peter Lisnic - Robert W. Baird & Co.

I guess first question: can you talk about the industrial gas turbine business and maybe talk about OEM versus aftermarket what you saw on the quarter and just some the commentary we've heard out of the big OEM manufacturers. And the outlooks there it seems like it's pretty negative on what your outlook might be on that front as well?

Tom Gendron

Yeah. The quarter-over-quarter prior years from, we are up about 16%, and the good chunk of that was really coming from the after market. So, what we have is and I go back if you recall, during the late 90s and beginning 2000 timeframe, those that weather -- gas turbine bubble. We delivered a lot of units in the field, and what we are really seeing is we're out of a lot of those parts that we delivered back then. So, the after market's holding. Deliveries on the OEM segment were good in the quarter, we're monitoring same thing that could confidence for our customers. So, it could be on the new build side on a level under pressure over the next six to 12 months. But, we're optimistic that the after market that natural gas prices where they are and large installed field that we'll continue to see the after market coming in.

Peter Lisnic - Robert W. Baird & Co.

Okay. And the balance of that basically -- capital around flattish for 2010 over the next 12 to 18 months.

Tom Gendron

It will be close.

Peter Lisnic - Robert W. Baird & Co.

Okay, all right.

Tom Gendron

We have to say it was in kind of all of our compared statements. There is still a lot in the forecasting out there. So we're doing our best. We really do expect on the new side some decline and then on the aftermarket side, we have to see how machines have been utilized, but should be see pretty steady there, so announcing the regular too.

Peter Lisnic - Robert W. Baird & Co.

Okay. And then as long as we are talking about the next 12, 18 months, I guess that the commentary is -- maybe slightly positive, slightly negative I guess the way to read into it. Is that an organic number or is that after including HRT and MPC?

Tom Gendron

Yeah what you really see in that kind of discussion that's after the acquisition. So, we basically we will have had MPC for full fiscal year. And we have half year of HRT. So, organically, we'll be down.

Peter Lisnic - Robert W. Baird & Co.

Okay. And where is the big softness on the organic side and continuing to the week, I guess aerospace and maybe the IGT OEM side.

Tom Gendron

Yeah, it's everywhere. You have a little bit of weakness everywhere that adds up in the acquisition balance at all. So that's our current outlook; this is early for us to comment on our 2010, but right now that's where we are. The Engine Systems business has been under a lot of pressure, you can tell me the numbers, we're expecting another tough quarter in the fourth quarter. As I said, we are starting to see -- to show that we're bottoming. And so going in 2010, we're still cautious, but maybe at the bottom.

Peter Lisnic - Robert W. Baird & Co.

Okay. And then, I guess one more quick one in terms of aerospace, lot of commentary out there about de-stocking in the channel. Can you -- maybe address that and what sort of impact that may have had on your numbers in the quarter?

Tom Gendron

Are you talking spares or when you say de-stocking maybe you can elaborate a little bit.

Peter Lisnic - Robert W. Baird & Co.

Spares, how's that for aberration?

Tom Gendron

Spares are -- our spare control sales for the year are pretty close to on track to our forecast. So, I guess to that standpoint. That's usually with new fleets and fleet additions. And so we have -- we're doing okay there because of the new programs we're on. And so that's been holding up, where we've seen some decline is with some parked aircraft. We have not been hurt as much as other players and it's really a fleet mix. But we've seen some reduction in repair and overhaul, which include spare piece parts being down. So, it's down slightly in that area.

Peter Lisnic - Robert W. Baird & Co.

Okay, all right. That is very helpful thanks.

Operator

Our next question comes from Gregory McKinley from Dougherty.

Gregory McKinley - Dougherty & Company LLC

Thank you. Could you talk a little bit about where you're at with extracting some operating synergies out of the airframe systems business? When I looked at the reported numbers and tried to reconcile out the inventory adjustment et cetera, it looked like -- and correct me if I'm wrong, it looked like maybe we didn't have meaningful sequential margin improvement in that division. I guess I am referring the more on a net sales basis. So, one of you could talk about that and what your outlook is for margin enhancement as you integrate those businesses.

Bob Weber

Sure. Sequentially, we did see some sales decline. So, you won't see as much of improvement from the last quarter to this quarter. If you look more from the first quarter on, it gets obviously murky, because we have HRT into the mix. But we are seeing operating improvements over the period. And the cost reductions that we talked about, we implemented into this quarter. So, you're not really seeing a fourth quarter of benefit there.

So, we anticipate that in the next quarter subject once again referred to kind of sales unknowns and the marking as from that side that you'll see sequential improvement again in the operating margins.

Gregory McKinley - Dougherty & Company LLC

Okay. And is the progress you're seeing in that segment still on the trajectory that moves you into call it a low to mid-teen type of margin environment in that segment in the next year or are we maybe a little behind the progress at this point?

Tom Gendron

Well, as I said we might be a little bit of head of that.

Gregory McKinley - Dougherty & Company LLC

Okay.

Tom Gendron

So, the economy at the moment is kind of masking some that. But what we could stabilize from that perspective, we do believe we are on a plan from the operating margin standpoint.

Gregory McKinley - Dougherty & Company LLC

Okay. If we adjust the taxes and operating income on a pro forma basis, it looks to me like your effective tax rate was more like maybe 29%. I think we're looking from our mid 30's. Am I reading that correctly? And can you tell me about what's driving that? And I believe I've adjusted for the -- for the tax change, am I looking at that correctly?

Bob Weber

You're pretty close. Say probably around a 25% rate, so in that neighborhood.

Gregory McKinley - Dougherty & Company LLC

Okay.

Bob Weber

And then in terms of the longer term we said, it usually is in that 33% sort of range. But there are from time to time -- and there will continue to be from time to time these kind of items that will bring the rate down like that.

Gregory McKinley - Dougherty & Company LLC

So what are your expectations for the full year call it pro forma tax rate? Can you share that with us?

Bob Weber

Give me one second here. Yeah, the average rate for the quarter... for the year, you're saying after the adjustments?

Gregory McKinley - Dougherty & Company LLC

Yeah, so if we take $0.41 as your pro forma number.

Bob Weber

I think if you use 33% again in the fourth quarter and then you can just work the math on the average of that. I don't have that in front of me but certainly I can quickly work it for you. If you use an average of 33 in the fourth quarter you'll be able to come up with an overall average for the year.

Gregory McKinley - Dougherty & Company LLC

Yeah. Okay and then finally, you talked a little bit about working capital, what are you seeing inventories what are sort of your plan is for inventory levels as the businesses get more integrated over the next couple of quarters?

Tom Gendron

Yes. As you probably, we've covered it from time to time. HRT and MPC acquisitions carried significantly more inventories as percent of sales than our average. We believe we have plenty of opportunities in our organic average as well. So, we do believe that's still an area of opportunity. Our engine business this quarter, both in receivables and in inventories saw a little bit more improvement than we've had in the past. And in fact, this is an area we've called out as not being proud of necessarily, we think we have lots of opportunity here.

We are beginning to see a better alignment of demand with inventories. It takes a lot of work to try to catch up with. Usually you see increases in your inventories as the demand comes down faster than you can catch up with that. We are seeing that we're getting better aligned.

Gregory McKinley - Dougherty & Company LLC

Yeah, thank you.

Tom Gendron

Sure.

Operator

Our next question comes from J.B. Groh from D. A. Davidson.

J.B. Groh - D. A. Davidson

Good afternoon guys.

Tom Gendron

Doing all right.

J.B. Groh - D. A. Davidson

Most of my questions have been answered but maybe if you could talk about 787 the push-out there and sort of what that's meant for you recently or how you see that going forward in the four to six quarters?

Tom Gendron

Yes, 787 RC are the main content on 787 through the GEnX but we do have through our Airframe Systems business some motors and sensors that will be also on that aircraft. We really can't give you any better idea of when Boeing is going to fly and get their delivery date and what Boeing is saying which is -- they've been very cautious at the moment.

We would expect what's -- they get moving, that's going to be a significant program to us. The engine is also on 747-8 aircraft and that's moving along a little better if you saw the most recent Boeing report. So we'll probably start seeing 747-8 sales before 787 sales. And that will I believe get the ball rolling for us in terms of getting those products out and starting the fleet introduction. So, and that's a whole lot of help, we are still watching closely Boeing --

J.B. Groh - D. A. Davidson

Has it caused any kind inventory buildup, anything like that on airframe and now with the acquisitions kind of hard to tell the inventory changes but --

Tom Gendron

Not significant. I mean, we had some but -- no, it's not a significant inventory buildup.

J.B. Groh - D. A. Davidson

Okay. And then on the tax benefit, was that 5 million -- I mean, was contemplation of that 5 million in the old guidance range? I mean, do you -- when you have these things, come up you sort of try and handicap when it's going to come. And was that included in the range or is there just kind of -- just out of the -- I don't want to say left field but that kind of thing?

Tom Gendron

No, it was not contemplated in the range earlier.

J.B. Groh - D. A. Davidson

Okay. Okay. All right. Thanks a lot.

Tom Gendron

Sure.

Operator

Our next question comes from Fred Buonocore from CJS Securities.

Fred Buonocore - CJS Securities

Yes, good evening gentlemen.

Tom Gendron

How are you doing, Fred?

Fred Buonocore - CJS Securities

Good, you? Quick question on the aftermarket in terms of airframe, you've talked about having an opportunity to improve your aftermarket penetration from MPC and HRT. Is there anything underway there? Have you made any progress and can you talk a little bit about those expectations?

Tom Gendron

Yes, our expectation is over a number of years is to probably move the airframe -- the Airframe Systems segment aftermarket sales up above from about 20% of sales towards 35% sales. And so the work we have to do there is on improving the operations, improving our -- preparing overhaul turn time, improving on our logistics, improving on our sales channel which we think we can work with our current airframe, our current aircraft business.

So, the opportunity -- we believe the opportunities out there to capture more of the aftermarket sales that our products are entitled to, but there is a lot of work to be done. And so it takes operational performances as well as logistics and sales channels. So we're working it and so I would expect it to be a gradual over the next few years, you're going to start seeing in that move up. But there's quite a bit of opportunity in there.

Fred Buonocore - CJS Securities

Great. And then, moving over to your cost reduction initiatives, is there any way you can give us a sense for the total costs taken out, maybe on an annualized basis?

Bob Weber

Yes, total cost and this includes kind of a variety of things absolutely, early retirement, we have workforce management. And we took out a large number of temporaries on contract labor and so on. So we believe that overall that number could approach $60 million in the year -- in a full year.

Fred Buonocore - CJS Securities

Excellent. And then following upon JB's question about the 787. Those delays and the delays in getting in full production rate on the GEnX, I mean is there a significant margin drag for you here? I mean do you have a lot of under utilized equipments that kind of -- you're seeing this margin drag and the longer the delay goes on, the long-haul you will have to pay for it. I mean can you give us a sense of the magnitude of that impact?

Tom Gendron

Sure. There is a little bit of specialized capital equipment primarily, test and simply in test fixtures that are unique to the 787 products. But the majority of the manufacturing processes and supply chain activities are common. So total amount of capital is not very large relative to our total capital base because in this type of business, we have most of these products are highly similar, we leverage costs all of our capital equipment from program to program. So what you're going to call it on the minor side in terms of dedicated capital to 787 GEnX program.

Fred Buonocore - CJS Securities

Okay, got it. And then on your military aerospace, so I guess just your military overall business. It seemed like that was flattish, and do you have much aftermarket business there or is that also an opportunity to expand your aftermarket because a lot of companies with good military aftermarket exposure have been continuing to see good growth out of defense businesses even through this downturn?

Tom Gendron

Yeah, we would actually expect the same thing to happen. We have a wide variety of products on military programs, our traditional with the engine, the turbine system side, but also with the airframe system business. All these parts were out. And high utilization to give you an example like all the helicopter applications, we see quite a bit of repair and over flow work happening and we expect that to continue and we expect all the other programs to continue to deliver. So that will generate spare piece parts, but also we work with the Army and the Air Force on helping with their maintenance depots, sometime offload, sometimes working through the actual repair work ourselves for them. So there is opportunities both ways, parts and on repair.

Fred Buonocore - CJS Securities

Excellent. And then just the final point of clarification; I am sorry make you repeat yourselves, but sometime like what I am hearing is just based on what you can see now realizing that visibility is really murky that placed overall decline in 2010 including the incremental contribution from the acquisition. Is that right?

Tom Gendron

No, we are closer to one offsetting the other, I would say. So we think that our markets will be mixed to down on the organic side and that the full year with HRT will offset most if not all of that decline. So we are looking more on a kind of flat sort of scenario.

Fred Buonocore - CJS Securities

Okay, great. Well, thank you very much. And we look forward to seeing at our conference in a few weeks.

Tom Gendron

Great.

Operator

(Operator Instructions). The next question comes from William Bremer from the Maxim Group.

William Bremer - Maxim Group

Good evening, gentlemen.

Tom Gendron

Can you just touch based on the Department of Defense? Can you give us a little clarity on what you are seeing a lot of news out of Pentagon's spending programs et cetera? But maybe give us something of -- some of the products that you have that may do this or potentially are affected by it?

Tom Gendron

Yes. We are such a wide range of programs and if you look, every fighter, helicopter, bomber, bombs, land based equipments has one or more Woodward components on it, in particular now with the Airframe Systems business. So, you see some things like the high profile once you're getting all the news like the F-22. We have good count in our F-22. So, that will come down, but we would expect it to be offset by either maintenance on the current fighter fleet or some additional traditional fighter sales or military sales.

Certainly with the helicopter, biggest one was the presidential helicopter, but when they don't use that, they don't build that one and then they're going to use the existing ones, and that means maintenance. So all in all we see -- we monitor all of that. And when we add it all up and look at the activity going on, we're in those programs come in will meet the existing programs. We still think it's about flat sales for Woodward.

William Bremer - Maxim Group

And maybe you can speak a little bit on the cost reductions that you're making in the airframe division, MPC and HRT. How much or more do we have to go in that?

Tom Gendron

You know right now, I don't know if I can quantify anything for you, but what we're doing right now is working on both operations and these will be in this next quarter. The two businesses will now be merged into a single entity operating entity. As then going forward there, we're going to be working on a lot of growth opportunities, but also a lot of operational efficiency opportunities that we see and it's -- let me say we have really on -- I guess we're on 84 days and we are working through it quickly and brining these together. And synergies and leverage we see come from operational efficiencies, supply chain and then market and growth opportunities. So that's what we are going to be working on. And we see in each area a lot of opportunity. And we will continue to give you updates by the quarter, but I don't have anything quantifying today for you going forward beyond what we said.

William Bremer - Maxim Group

Okay, Tom, thank you. One last regarding wind inverter side, specifically offshore just to make walk and just a little more color on that in terms of how many you have shipped and what the outlook looks there.

Tom Gendron

The outlook is positive. You've seen some of the orders and right now to the best of our market now, we're the only one shipping in that category. So, there aren't too many 6 megawatt machines out there. We've got real good presence on the 5, 6 megawatt. We're even talking all the manufactures out there that are even contemplating things up to 10 megawatt machines. But we're really well positioned in that category. And so the orders you've seen, we believe you're going to have the Woodward content on them.

William Bremer - Maxim Group

Great, Tom. Thank you very much.

Operator

(Operator Instructions). We have a follow-up from Tyler Hojo from Sidoti & Company.

Tyler Hojo - Sidoti & Company

Hey, I was hoping you could talk a little bit about the Engine Systems business, given that seems to be where most of your weakness is coming from. Maybe if could just talk about the margin expectations for that business and how you see that kind of playing out over the nearer/longer term?

Tom Gendron

Yeah, obviously as you see the numbers it's been under a lot of pressure that's reciprocating diesel and gaseous fuel, alternative fuel business. Just to remind everybody on the call that's lot of the business we ship to the construction market, the marine market, power generation and other industrial vehicles and also small GenX and parts.

So at the end marine has taken a pounding. So what I have to say is we are fairly proud of if you look at, we've not gone negative when you see that type of -- top lines are up. What I would say there is we do a lot of pre-planning to get ready as we're forecasting economic cycles.

Going forward though, we expect to see in the black and then as things start to recover, that business we've always said should be in the low double digit operating units. That's what we think it's capable of delivering, and I really do believe over the next few years we will be in back of those numbers -- or end of those numbers. But we still expect to top 2010 in the reset market, so.

Tyler Hojo - Sidoti & Company

All right and I guess what I'm trying to drive out at here is, I mean are there additional opportunities to take costs out of this business or if for instance just theoretically saying if sales have bottomed here and there is more cost to take out, we should expect that a 7.5 type margin is kind of trough for you guys.

Tom Gendron

Yeah, we will watch on sales, we're constantly looking at how to improve efficiency in this. We watched the fourth quarter. I think this is towards the bottom Tyler.

Tyler Hojo - Sidoti & Company

Okay.

Tom Gendron

And I do see recovery but the next two quarter are going to be -- can't tell us, what's really going to happen. And then you start seeing recovery from that.

Tyler Hojo - Sidoti & Company

Okay, great and just one more follow-up from me. I guess ForEx was about a $0.03 headwind in the quarter. Just wondering what you have baked into the guidance in terms of that for 4Q or for your full year forecast?

Bob Weber

Yeah, we're pretty much flat going from Q3 to Q4 from -- where we're looking at it now. So from this point to -- for our guidance was that there would be no further foreign exchange impact.

Tyler Hojo - Sidoti & Company

Fantastic. Thanks a lot guys.

Tom Gendron

Thank you.

Operator

I am showing no further questions. I would like to hand the conference over to Mr. Gendron for any closing remarks.

Tom Gendron

Okay. I just like to thank everybody for joining us and for your questions and look forward to talking to you in November when we release our end of the year results. So thank you.

Operator

Ladies and gentlemen this concludes our conference call for today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 8 p.m. Eastern Time by dialing 1-888-266-2081 or 1-703-925-2533 and by entering the access code 1370762. A rebroadcast will also be available at the company's website 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. Thank you.

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