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Woodward Governor Company (NASDAQ:WGOV)

Q1 FY08 Earnings Call

January 22, 2008, 8:30 AM ET

Executives

Robert F. Weber, Jr. - CFO and Treasurer

Thomas A. Gendron - President and CEO

Analysts

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

J. B. Groh - D. A. Davidson & Company

Peter Lisnic - Robert W. Baird & Co.

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Woodward Governor Company First Quarter 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. Following the presentation, you will be invited to participate in the question and answer session. Joining us today from the company are Mr. Tom Gendron, President 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. - Chief Financial Officer and Treasurer

Thank you, operator. We would like to welcome all of you to Woodward's first fiscal quarter 2008 conference call. In a few minutes, Tom will talk about the highlights of our first quarter, our strategies and our markets. I will then comment on the January 21st 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 one 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, January 25, 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 call 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 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 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 press release and our public filings with the Securities and Exchange Commission including our 10-K for 2007.

Now I would like to turn the call over to Tom to discuss our progress toward achieving our strategic goals in the first quarter.

Thomas A. Gendron - President and Chief Executive Officer

Thank you, Bob. Welcome to all of you who have joined us today. I'll begin by highlighting our financial results for the first quarter. Sales were up 20% compared to the first quarter of fiscal year 2007 with our organic growth of 16%. Our earnings were $0.72 per share, up 41% and our operating earnings increased 43% over last year.

Our core markets showed continued growth in order volumes. Aerospace industry backlog continues to grow with strong deliveries forecasted through 2011 or 2012. The wind power market is growing at exceptional levels with our Electrical Power Systems business receiving orders into 2009. Power generation and marine markets continue to be driven largely by international growth.

We are pleased to see that demand for our system and components remained robust through this period. In addition to strength in our core markets of aerospace, power generation and transportation, we think these results reflect our successful selection of markets and applications for our offerings. Our energy control strategy continues to focus on technologies where we deliver the greatest value to our customers and achieve the greatest return on our efforts. Our product offerings are meeting the needs of customers that demand energy control and optimization where the concerns are for efficiency, emissions and performance.

Our priorities for 2008 continue to be improving customer satisfaction through activities such as the execution of our build to order lean production program designed to shorten lead times for our customers, improving our financial performance through efficient utilization of assets and cost control, implementing standardized world class processes across our growing global organization and executing our strategies for future growth.

Despite some developing softness in other areas of the economy such as home construction, we continue to see strength in our core markets. Our OEM orders are strong through the balance of the fiscal year and beyond due to our customers' international focus. While aftermarket sales may be more sensitive to current economic conditions, we continue to see increased global demand. Additionally, a number of our customers have been and are continuing to increase capacity. Most importantly, we continue to believe that we serve the right global markets for the long term.

As you know, our balance sheet and liquidity remain very strong. Together with ongoing investments and productivity and increased infrastructure efficiency, we believe we are well positioned going forward.

Now looking specifically at aerospace. We continue to see worldwide traffic growth approaching 6%, supporting continued growth in our aftermarket sales. On the OEM side, much has been said about the remarkable order levels at Boeing and Airbus for the past several years. Both aircraft makers are taking steps to increase production levels. We expect them to increase their deliveries by 10% in 2008. Similarly, we see sustained growth in the business in regional aviation markets. Business jet orders from customers outside the U.S. increased significantly, indicating a broad international customer base.

Our transition from development to production continues to go well for the GEnx fuel system for the Boeing 787, system components for the GP7200 engine on the Airbus A380 and a control system for the Pratt & Whitney 600 engine family for the Cessna Citation Mustang and the Eclipse 500.

All these programs are key to our future sales growth. Recent announcements regarding the Boeing 787 will have minimal financial impact on Woodward. Equally as important, these programs broaden our relationship with our key customers.

We continue to see excellent demand for industrial turbines and large gas and diesel engines used in power generation applications. We are also successfully transitioning from development to production on our next generation diesel common rail fuel pump for large, high speed engines. The same worldwide power demand is driving growth for power distribution products, which has supported our increased sales in AC measurement and digital control products.

In wind power, growth in both orders and sales continue at an exceptional rate and we have been able to increase market share with a number of our customers. Our customer relationships, global support and technical offerings have been key to our success, and we remain focused in these areas.

To summarize, we expect our markets to remain robust for the balance of the fiscal year. While market competition in the economy always present challenges, we are taking steps to increase the flexibility in our operations, maintain the strength of our balance sheet and take advantage of the investment opportunities as they may arise. We are confident we offer the right systems, products and technologies in the right markets to deliver optimum results over the long term.

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

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Thank you, Tom. I will comment on the first quarter of 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 $272 million, a 20% increase over last year's first quarter sales of $226 million with organic growth of 16%. Operating earnings for the quarter were $38.9 million or 14% of sales compared with $27.2 million or 12% of sales in the same period a year ago. Net earnings for the quarter were $25.3 million or $0.72 per share compared with $17.9 million or $0.51 per share for the same quarter a year ago.

At the segment level, let me first discuss our Turbine Systems segment which includes both aircraft and industrial turbines. Turbine Systems net sales for the quarter including intersegment sales were $130.8 million, an increase of 12% over first quarter sales of $117 million a year ago. Turbine Systems segment earnings in the first quarter of fiscal 2008 were $27.2 million compared with $19.3 million for the same quarter a year ago. Segment earnings as a percent of sales were 20.8% in the first fiscal quarter of 2008 compared to 16.5% in the prior year. Our favorable sales performance reflects sustained strength in both commercial OEM and military and commercial aftermarket portions of our business as well as steady growth in our industrial turbine product lines. Earnings increased in the quarter primarily due to the higher sales, our consistent fixed cost base, a favorable product mix and cost control activities.

Moving to Engine Systems' results. Engine Systems' net sales for the quarter were $114 million compared to $102.9 million a year ago, an increase of 11%, reflecting strength in Europe and Asia in both power generation and marine segments of the market. In addition, our sales in alternative fuel applications were higher this quarter compared to the prior year, primarily in our Asian markets.

Segment earnings for the quarter were down slightly at $12.1 million compared to $12.6 million for the same quarter last year. Segment earnings as a percentage sale were 10.6% in the first fiscal quarter of 2008 and 12.2% in the same quarter of the prior year. Earnings were impacted by an unfavorable product mix, incremental freight costs associated with the higher level of sales and supply chain part shortages.

Now turning to Electrical Power Systems. Electrical Power Systems' net sales for the quarter were $57.5 million compared to $32.3 million a year ago, an increase of 78% with organic growth of 50%. Wind power sales were exceptionally strong this quarter. Segment earnings for the quarter were $7.2 million compared to $3.6 million for the same quarter last year. Segment earnings improved as a percent of sales to 12.5% in the first fiscal quarter of 2008 from 11.1% in the prior year. Organic earnings growth was 65%.

Now I would like to focus on certain specific elements of our consolidated financial statements. Gross margin as a percent of sales was 29.9% in the first quarter of 2008, down slightly from 30.3% in the first quarter of 2007. The slight margin decline was due to overall product mix and incremental freight costs.

Selling, general and administrative expenses decreased slightly to $26 million or 9.5% of sales in 2008 from $26.4 million or 11.7% in 2007. The decline is largely due to a decrease in business development costs.

Research and development costs of $15.6 million in the first quarter of 2008 or 5.7% of sales compares to $14 million or 6.2% of sales in the first quarter of 2007. This level of spending is consistent with our expectations and longer term requirements, although quarterly variability will continue.

Total depreciation and amortization expense increased to $9.3 million in 2008 from $8.2 million in the prior year.

Our capital expenditures were $6.6 million in the first quarter of 2008 compared to $5.4 million in the first quarter of 2007. We expect capital expenditures in fiscal 2008 to be about $40 million.

As previously announced, we expect elevated capital expenditures in 2008 and 2009 as we add system test capability and execute on our initiative to focus on core manufacturing processes to handle our growth most effectively.

Our effective tax rate for the quarter was 34.2% compared to 32.9%. In our tax provision for the first quarter of last year, we included a benefit of $1.2 million or $0.03 per share related to the retroactive extension of the research and experimentation credit. We continue to expect the full year tax rate to be in the range of 35% to 37% for 2008, considering the recent expiration of the U.S. research credit.

To turn briefly to our balance sheet, working capital increased to approximately $297 million at December 31, 2007 compared to $276 million at September 30, 2007. Our total long-term and short-term debt was $55 million at December 31, 2007, a decrease of $12 million from a year ago. The ratio of debt to debt plus equity was 8.8% at the end of the quarter compared to 10.9% at September 30, 2007 and 12.7% at December 31, 2006.

In closing, balancing the strength in our core markets with overall economic factors, we are reaffirming our November guidance of companywide sales growth of 8% to 10% and earnings of $3.05 to $3.15 per share for fiscal 2008.

That concludes our comments on the business and results for the first quarter of fiscal 2008. Operator, we are now ready to open the call to questions.

Question And Answer

Operator

Thank you. The question and answer session will begin at this time. [Operator Instructions]. Our first question comes from Ned Armstrong with FBR Capital Markets.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Yes, thank you, good morning.

Thomas A. Gendron - President and Chief Executive Officer

Good morning.

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Good morning.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

My questions are regarding some of the comments you made about the Engine Systems. First, with regard to the unfavorable mix, was that something that was just reflective of shipments in the quarter or is that reflecting some overall change in the demand in that business?

Thomas A. Gendron - President and Chief Executive Officer

Yes, we really see it as normal product mix variation and don't expect to see anything negative for the full year.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay. And then with the supply chain logistics that were a negative contributor, could you just describe what that was and what's been done to correct it and when you expect things to be worked out?

Thomas A. Gendron - President and Chief Executive Officer

Sure. Well what we really had seen there was very large demand for some mature products, primarily going to developing countries and activity going to China, India and other parts of Asia. The demand caught us off guard. If you want to say, it was much, much higher than we had forecasted for mature products and really that the engine family was selling well in those countries. It's our practice to respond quickly to our customers. With getting caught off guard a little bit, we had to expedite and we are catching up. So the positive was the demand was there; the negative was it wasn't in our forecast, so we had to rush through our supply chain a very high amount of product. We expect that to settle out here in the second quarter as we catch up.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay. And do you expect that demand to, not necessarily to go down, but to be more smooth going forward? Is that what you meant by the last remark?

Thomas A. Gendron - President and Chief Executive Officer

The last part of the remark --

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

When you said settle out --

Thomas A. Gendron - President and Chief Executive Officer

Well we'll catch up on demand and we expect it to continue. A lot of this is for equipment for either power gen or construction type equipment, and we expect that to continue. So it was a little bit of a surprise at the level all at once, but, as I said, we'll catch up and we expect to continue through the year. But what I was highlighting is I do expect the expediting in that type of constraint to ease up here in the second quarter.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay, good. Thank you.

Operator

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

J. B. Groh - D. A. Davidson & Company

Good morning guys.

Thomas A. Gendron - President and Chief Executive Officer

Good morning.

J. B. Groh - D. A. Davidson & Company

I had a question, you mentioned minimal impact from those recent 787 delay announcement. Could you give us maybe a little more color on that statement, perhaps discussing how many ship sets you have shipped and that sort of thing?

Thomas A. Gendron - President and Chief Executive Officer

Right now, we are continuing to maintain our schedule, and what you would see is, in particular with our customer GE on that, they are maintaining their schedules. So what we see as minimal impact is there is a delay in the final shipments. The delay on the production or what we would call our OEM shipments is going to be very minimal. Where we see a decline is in initial provisioning spare sales as the airlines won't have to buy as soon given that there is about a nine month delay. That's why we are saying it's minimal. We are going to continue to support the program where we will be shipping OEM units. And over the next two years, that's going to balance out and we expect it to be a superb program. So, right now, we don't see that combined with the other activity in aerospace. We don't see it affecting our financial performance or our sales line really.

J. B. Groh - D. A. Davidson & Company

And in terms of like where you are with a number of... there is obviously a lead time between Boeing and with your relationship with the engine guys. So I mean if you shipped 20, or I mean how do we look at that?

Thomas A. Gendron - President and Chief Executive Officer

Yes, right now... J. B., I am not sure of the exact ship sets that have gone out. It's minimal at the moment.

J. B. Groh - D. A. Davidson & Company

Okay.

Thomas A. Gendron - President and Chief Executive Officer

And what we have, though, is continued... we are going to continue to support the engine customer and ship. So it's not that we are on hold or anything. So we are going to continue to ship for the program. They are going to be building up... as you know, the plan there with Boeing is, I think it's pretty well communicated, is they are building up the airframes.

J. B. Groh - D. A. Davidson & Company

Right.

Thomas A. Gendron - President and Chief Executive Officer

So we are building up the engines. The real issue on our delay is going to be in the initial provisioning spare sales. And so instead of seeing some in the latter part of '08, those are going to go into '09.

J. B. Groh - D. A. Davidson & Company

Okay.

Thomas A. Gendron - President and Chief Executive Officer

I mean that's a big difference. And so in the grand scheme of our Turbine Systems sales, it's not going to impact that business this year.

J. B. Groh - D. A. Davidson & Company

And then explaining sort of the strength in margins in Turbine Systems, is that largely a function of lower R&D costs?

Thomas A. Gendron - President and Chief Executive Officer

No, I would say it's largely a function of robust aftermarket sales.

J. B. Groh - D. A. Davidson & Company

Okay, okay.

Thomas A. Gendron - President and Chief Executive Officer

And that's... there is a little bit of lower R&D, but we had, again, a good mix of aftermarkets' OEM. Right now, the airlines are flying the planes, and, as we always say, if the engines are turning, we are making money, so. And that's what's happening at the moment.

J. B. Groh - D. A. Davidson & Company

Okay. Thank you for your time and congratulations.

Thomas A. Gendron - President and Chief Executive Officer

Thank you.

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Thank you.

Operator

[Operator Instructions]. Our next question comes from Peter Lisnic with Robert W. Baird.

Peter Lisnic - Robert W. Baird & Co.

Good morning gentlemen.

Thomas A. Gendron - President and Chief Executive Officer

Good morning.

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Good morning.

Peter Lisnic - Robert W. Baird & Co.

If we could just talk about the, I guess, the Electrical Power segment for a minute, it sounds as though, at least maybe relative to our forecast, the wind business seems to be doing a lot better than we would have thought. Can you just comment on, I think, Bob, in the past you'vetalked about this being potentially a $60 million business or so. Are we already at a run rate where we are going to be much stronger than that kind of number or can you give us some insight into how that Electrical Power segment grew at a 50% organic growth clip in the quarter?

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Yes. Maybe Bob and I will both comment on this. But what you see is... we've gotten into the wind business, and I think the acquisition we made of SEG is proving to be quite a good complement for both companies. We instantly stepped in, increased investments in R&D and also in customer activities. We have got some new technology that we are bringing online that we are trying to accelerate. With that, we've been able to grab more share at our existing base as well as add to our customer base, and with that, the customers' sales are increasing rapidly. So what we grab both is a rapid market growth rate and we have picked up share over the last year with the customer base. So that combined has taken us forward and we are looking at more like a $100 million business this year. So it's going forward.

The nice thing about the wind market today is the cost per installed, if you want to say, kilowatt is becoming competitive with other more traditional sources of power and with mandates around the world and like going, we see a pretty robust market. And so we think we are bringing the investments necessary for that business and also the global footprint that is helping us accelerate. And there we see wind really took off to, if you want to say, in Europe, Western Europe and now you see the next biggest markets are going to be the U.S. and China. And so we are able to support the customers with support, but we are also going to support them with manufacturing in China and the U.S. And with that type of support of investment, we are picking up share. So that's why we are growing so rapidly here.

Peter Lisnic - Robert W. Baird & Co.

Okay. And then you alluded to, I guess, my next question, and that is the cost competitiveness of wind generated electricity. Are there any concerns from your customers on the potential lack of extension of the PTC here in the states, and do you think that will be... if we don't get anything over the next quarter or two, are you going to maybe see some of the backlog that you have kind of fall off as customers kind of rethink that wind strategy?

Thomas A. Gendron - President and Chief Executive Officer

Well, personally, I think it will be renewed, and secondly, the costs are coming more in line with mandates by a number of the states I think people are going to have to install the power. And I am not sure we are going to see the drop off that you had in the past. Obviously, if the tax credit doesn't get renewed, it may have some effect, but I think right now I think it will be minimal is my personal opinion on that.

Peter Lisnic - Robert W. Baird & Co.

Okay. And then just last question on that one. Can you give me a sense as to what your geographic mix is in the wind business? How much of it is for U.S.-based turbines versus Europe versus emerging markets?

Thomas A. Gendron - President and Chief Executive Officer

Yes. What you'd have to look at right now is our customer base is predominantly European and we have picked up a Chinese turbine manufacturer. And when we talk about expansion, they are expanding their operations and their sales into the U.S. and China, and that's where it's going. So we expect over the next couple of years that may surprise a lot of people, but it's expected by about 2011 the U.S. will be the largest wind market in the world. And most people don't realize that, but that's the forecast and that's installed. So that's why we are making the investments to support the customer base here. But just for clarity, they are European-based turbine manufacturers, but they're going to expand here in China.

Peter Lisnic - Robert W. Baird & Co.

Okay.

Thomas A. Gendron - President and Chief Executive Officer

I don't know if that answers your question or not but --

Peter Lisnic - Robert W. Baird & Co.

No, that's fine. That is helpful.

Thomas A. Gendron - President and Chief Executive Officer

Okay.

Peter Lisnic - Robert W. Baird & Co.

That's all I had. Thank you very much.

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Thank you.

Operator

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

Thomas A. Gendron - President and Chief Executive Officer

Well, appreciate everybody joining us today and we look forward to reporting out our second quarter earnings to you in a couple of months here. So thank you.

Robert F. Weber, Jr. - Chief Financial Officer and Treasurer

Thank you very much.

Operator

Thank you ladies and gentlemen. That does conclude our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available at 12:30 PM Eastern Time by dialing 1-888-266-2081 or 1-703-925-2533 and by entering the access code 1184947. That number again 1184947. A rebroadcast will also be available at the company's website, www.woodward.com for 30 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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Source: Woodward Governor Co. F1Q08 (Qtr. End 12/31/07) Earnings Call Transcript
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