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Woodward Governor Company (NASDAQ:WGOV)

Q2 FY08 Earnings Call

April 21, 2008, 6:00 PM ET

Executives

Robert F. Weber, Jr. - CFO and Treasurer

Thomas A. Gendron - Chairman, CEO and President

Analysts

Peter Lisnic - Robert W. Baird & Co.

Tyler Hojo - Sidoti and Company

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

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

William Bremer - Maxim Group

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company Second Quarter 2008 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 a question-and-answer session. 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. Sir, you may begin.

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

Thank you, operator. We would like to welcome all of you to Woodward's second quarter 2008 conference call. In a few minutes, Tom will talk about the highlights of our second quarter 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 one 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 Wednesday, April 23, 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 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 press release and our public filings with the Securities and Exchange Commission, including our 10-K for 2007 and 10-Q the quarter ended December 31st, 2007.

Now I will turn the call over to Tom to discuss our progress toward achieving our strategic goals in the second quarter.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Thank you Bob. Welcome to all of you who have joined us. I'll begin by highlighting our financial results for the second quarter.

Sales were up 19% compared to the second quarter of fiscal year 2007. Our earnings were $0.43 per share, up 48% from last year. Our operating earnings increased 38% over last year, and we generated $22.8 million in cash from operations during the quarter.

We experienced excellent growth in sales and operating earnings leverage this quarter. Our sales growth resulted from continued global growth in our key markets and increases in our market share. In particular, we're realizing the benefit of our expansion into global markets, whether directly through our overseas operations, or indirectly through our multinational customers, whose products are the key to expanding global energy transportation and commodity infrastructure.

Aerospace industry orders remained strong with continued growth expected in both backlogs and deliveries for the next four years. Boeing and Airbus are on track for growth of approximately 10% on their deliveries this year, and worldwide traffic remains on a growth trend of approximately 6%. We continue to see sustained growth in the business of regional jet markets with orders in these areas being driven largely from outside the U.S.

In military aerospace, we continue to see strength in the aftermarket support of the installed fleet. We are also making good progress on the Joint Strike Fighter program, where Woodward has significant content of both engine offerings. With respect to the new Boeing 787 Dreamliner, the GEnx test 1B engine recently received FAA certification.

To specifically address the recent delay announcement, first let me say, Woodward continues to ship product to GE although in small quantities. Our 2008 Turbine Systems' forecast included sales of prototypes, original equipment and aftermarket units for the GEnx. With the recent Boeing 787 extended delay, our total Turbine Systems' sales will be impacted by approximately 1% this fiscal year. Looking to 2009, the announced delay will impact Turbine Systems' sales by approximately 2%.

For both years, we believe this impact will be more than offset by strength in other OEM programs and aftermarket sales. The 2008 fiscal year impact is included in our updated outlook.

We have seen increase in shipments of our control systems for the Pratt 600 engine family for the Cessna Citation Mustang and the Eclipse 500. These control systems, together with our suite of components on the GP7200 engine for the Airbus A380 and the GEnx fuel system, will be contributors to our growth for many years to come.

In our other markets, industrial turbine demand continues to be robust, driven by power generation projects internationally. Diesel engine demand strength is being driven by large marine applications. This quarter, we also saw interests in alternative fuels driving greater demand for compressed natural gas engine systems. Investments in oil and gas, both expansions and upgrades, are driving turbine control sales to customers in the Middle East, Russia, India and China.

And global mission regulations continue to drive demand for enhanced inventory control solutions across all our applications. With this broad strength in demand for a variety of engines, we are seen major OEMs adding capacity and planning for increased production for the next several years. The ongoing growth and worldwide power generation, more specifically in distributive power and increased in demand for distribution products, incorporated in our AC measurement digital control technology.

In the wind power, orders and sales for the industry remain strong. We continue to expand our market share, including the addition of a major Chinese wind turbine manufacture to our customer base. We announced our attentions to built wind turbine inverters in Colorado for our customer's efforts to secure their North American market presence. We are strengthening our customer relationships in technical offerings to continue our success in this market.

Overall our energy control strategy remains unchanged, and our focus will be on areas where we deliver the greatest value to our customers; typically in the areas of efficiency, emissions and control. Looking forward, slight problems in certain areas of the economy such as global financial services and the U.S. home construction market, our order volumes and other specific market information do not indicate that these difficulties have spread to our markets. Our sales growth has been robust so far this year and we expect this to continue at a strong but somewhat more modest pace for the remainder of the fiscal year.

Now I'll 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 second quarter and first half of 2008 for Woodward as a whole and each of its business segments. I'll then cover some specific financial measures of interest and finish by commenting briefly on our outlook for the future.

At the 2007 annual meeting of shareholders on January 23rd 2008, the two-for-one stock split was approved. The stock split became effective on February 1st 2008. The number of shares reported in the consolidated financial statements has been updated for amounts reported prior to February 1st 2008 to reflect the effects of the split. During the quarter, the dividend payment per split adjusted share was increased 9% to $0.06 per share. In addition to dividends, we have also been returning value to our shareholders by repurchasing shares. In the second quarter we repurchased over 1 million shares in the open market.

Turning to our financial results; at the Woodward consolidated level net sales for the quarter were $306 million, a 19% increase over last year's second quarter sales of $256 million. Approximately one quarter of the sales growth relates to the impacts of foreign exchange.

Operating earnings for the quarter were $44.2 million or 14.5% of sales compared with $32.1 million or 12.5% of sales in the same period a year ago. Net earnings for the quarter were $29.7 million or $0.43 per share, compared with $20.3 million or $0.29 per share for the same quarter a year ago. Foreign exchange accounted for approximately $0.01 of the increase year-over-year.

Net sales for the first half were $577.8 million, a 20% increase from $482.5 million for the first half of the prior year. Net earnings for the first half were $55 million or $0.79 per share compared with $38.1 million or $0.54 per share in the previous years first half.

At the segment level, let me first discuss our turbine system segment, which includes both aircraft and industrial turbines. Turbine systems net sales for the quarter, including intersegment sales, were $147.5 million, an increase of 13% over second quarter sales of $130.8 million a year ago. Turbine systems segment earnings in the second quarter of fiscal 2008, were $31 million, compared with $23.8 million for the same quarter a year ago.

Segment earnings as a percent of sales were 21% in the second fiscal quarter of 2008, compared to 18.2% in the prior year. Our sales performance reflects sustained growth across our portfolio of aircraft and industrial offerings. Earnings increased largely due to our ability to successfully leverage our fixed cost base for the increased volume. As in recent quarters our sales mix was moderately favorable to our long term experience and expectations.

Turbine Systems' net sales for the first half including inter segment sales were $278.2 million, an increase of 12% from $247.8 million for the first half a year ago. Segment earnings for the first half increased 35% to $58.2 million, up from $43.1 million for the first half a year ago. Segment earnings as a percent of sales were 20.9% in the first half of 2008, compared to 17.4% in the first half of the prior year.

Moving to our Engine Systems results; Engine systems net sales for the quarter, including intersegment sales were $125.8 million compared to $110 million a year ago, an increase of 14% reflecting the continued strength in demand for our customer's products outside the United States.

Segment earnings for the quarter increased 10% to $13 million, compared to $11.8 million for the same quarter last year. Segment earnings as a percent of sales were 10.3% in the second fiscal quarter of 2008 compared to 10.7% in the same quarter of the prior year.

Our results reflect higher operating costs, was slightly more than offset the leverage on increased volume. Some of these costs resulted from supply chain issues as we managed our increased volumes. Other costs resulted from our efforts to transition production locations and methods for enhanced long-term savings and efficiency. Going forward, we continue to focus on activities to reduce these costs and enhance margins in this segment over the longer term.

Engine Systems' net sales for the first half, including intersegment sales, were $239.9 million, an increase of 13% from $212.9 million for last year's first half. Segment earnings for the first half were up slightly at $25.1 million from $24.4 million for the first half a year ago. Segment earnings as a percent of sales were 10.5% in the first half of 2008 compared to 11.4% in the first half of the prior year.

Now turning to Electrical Power Systems. Electrical Power Systems' net sales for the quarter, including intersegment sales, were $64.9 million compared to $45.2 million a year ago, an increase of 43%. Again this quarter wind power sales were very strong. Power generation and distribution markets also experienced good growth as overall demand for power protection and power distribution controls was very good.

Segment earnings for the quarter were $9.5 million compared to $6.4 million for the same quarter last year, an increase of 49%. Segment earnings improved as a percent of sales to 14.7% in the second fiscal quarter of 2008 from 14.2% in the prior year, reflecting our ability to successfully manage the significant increase in volume across our fixed cost base and our efforts to improve our manufacturing processes, particularly at our Kempin [ph] wind inverter manufacturing facility.

Electrical Power Systems' net sales for the first half, including intersegment sales, were $122.4 million, an increase of 58% from $77.5 million for the first half a year ago. Segment earnings for the quarter increased to $16.7 million from $10 million for the same quarter a year ago. Segment earnings improved as a percent of sales to 13.7% in the first half of 2008 from 12.9% in the first half of the prior year.

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 31.2% in the second quarter of 2008, essentially flat with 31.3% in the second quarter of 2007. Gross margin as a percent of sales was 30.6% in the first half of 2008, also about the same as 30.8% in the first half of 2007.

Selling, general and administrative expenses as a percent of sales decreased to 10.4% of sales or $31.7 million in the second quarter of 2008 compared to 11.9% or $30.6 million in 2007. In the first half, selling, general and administrative expenses decreased to 10% of sales or $57.6 million in 2008, from 11.8% or $57 million in 2007.

Research and development costs were $18.8 million in the second quarter of 2008 or 6.1% of sales, compared to $15.9 million or 6.2% of sales in the second quarter of 2007. Research and development costs were $34.4 million in the first half of 2008 or 6% of sales compared to $29.9 million or 6.2% of sales in the first half of 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 the first half of 2008 increased to $18.3 million from $17.4 million in the first half of the prior year. Our capital expenditures was $16.5 million for the first half of 2008, compared to $13.1 million in the first half of 2007. We continue to expect capital expenditures to total approximately $100 million for the years 2008 and 2009 combined, with fiscal 2008 capital expenditures approximating $40 million, supporting our advanced test capabilities and core manufacturing process improvements.

Our effective tax rate for the quarter was 31.9% compared to 35.5% last year. As a result of certain favorable tax resolutions, we now expect our full year 2008 tax rate to be in a range of 33% to 35%.

To turn briefly to our balance sheet, working capital increased to $305 million at March 31st, 2008, compared to $276 million at September 30, 2007, supporting our increase... increasing sales volumes. Our total short term and long-term debt was $74 million at March 31, 2008, an increase of $7 million from September 30, 2007. Ratio of debt to debt plus equity was 11.4% at the end of the second quarter, compared to 10.9% at September 30, 2007, and 11.8% at March 31st, 2007.

Turning to our guidance for 2008, despite turbulence in the financial and consumer segments of the economy, we continue to see strong organic growth in our markets, although not at the almost 20% pace of the first half. We are increasing our expected full year company wide sales growth to 14% to 16% and earnings to $1.61 to $1.66 per share. That concludes our comments on the business and results for the second quarter of fiscal 2008.

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

Question And Answer

Operator

Thank you sir. The question-and-answer session will begin at this time. [Operator Instructions]. The first question comes from Peter Lisnic from Robert W. Baird. Sir you may ask your question.

Peter Lisnic - Robert W. Baird & Co.

Good afternoon, gentlemen

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Hello Peter, how are you doing?

Peter Lisnic - Robert W. Baird & Co.

Good. How are you?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Good.

Peter Lisnic - Robert W. Baird & Co.

Excellent. I was wondering if we could get behind the top-line forecast that you have. If we are going from 20% organic growth in the first half it sounds like the second half is somewhere around 10%. Can you just give us some of the pluses and minuses that sort lead to that more conservative growth outlook for the back half for the year?

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

Well I think some of that is comparable to second half of '07 where we started see a ramp up. We still believe that all those markets are strong. We just had real rapid growth here in the first half, so looking forward we are not really seeing any differentiation in terms of the outlook, and that the market are still strong, sales are still going up, the 20% is a tough rate for year-over-year comparisons to keep going on.

Peter Lisnic - Robert W. Baird & Co.

Okay, referring up on that one and then I guess if I look at the supply chain issues that you had again in this quarter... you had it was $1.3 million is what you quantified in the queue for the first quarter? Can you help us get a sense as to what the supply chain costs were or the expedited freight, those sort of things in the quarter?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

The number was, I think it was 1 if I recall. But basically what we are seeing is as we called... our last quarter we called out some incremental freight that we were experiencing related to some material product orders that came through that we had some expediting cost related to. So that was part of it. In addition we have a number of... we moved some product from our Niles facility to our China facility. So there has been some increased freight related to that and also we have some investments and efficiencies going forward that are impacting that number a little bit.

Peter Lisnic - Robert W. Baird & Co.

Is that the overall number then still $1 million, it that?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes, 4.25, yes.

Peter Lisnic - Robert W. Baird & Co.

Okay, all right. I will jump back in queue. Thanks.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes.

Operator

Our next question comes from Tyler Hojo from Sidoti and Company.

Tyler Hojo - Sidoti and Company

Hey, good afternoon guys.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Hi Tyler.

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

Hi.

Tyler Hojo - Sidoti and Company

I have a quick question actually in late March one of your local Colorado newspapers put something out just in terms of expanding the wind inverter business, I guess it specifically said you guys were looking to hire about a 100 new people. And I guess a couple of questions based on that. Is this going to be kind of complementary to what you already have or is it something new and how's that tracking just in terms of finding the new employees?

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

Yes, Tyler the reason we are expanding into the U.S. here, in Colorado site in particular is our customer base is predominately European today.

Tyler Hojo - Sidoti and Company

Right.

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

And they are looking... two hot growth market in wind are the U.S. and China, obviously Europe will continue to grow. We struck some arrangements with, with our customer base which allowed us to capture more of their business with the expectation that we would support them with local content local application support and local service. So it's really about helping them develop the U.S. market and for, for Woodward to capture more share. Our plans right now are to, to our initial units for certification type test in here in the fall and really start to get to full ramp up in 2009. We do anticipate this part of continuing the growth. It's not substituted incremental growth that our customer base is looking for U.S. penetration of the market.

We also will be and have made the statement to that we are also going to support the same customer base in China and that will be probably coming in late 2009, where we are, we continue as that market develops and localization is required that we intend to be there to support the wind business as well.

Tyler Hojo - Sidoti and Company

I see and just, just to get some sort of frame of reference, I think the acquisition made last year added some thing like almost $93 million bucks in '07, I mean, obviously electrical power system is seeing a pretty significant growth rate. I mean where do you think that, that 93 goes and maybe if you could give us some sort of idea of maybe just company wide. What portion of your revenue came from the wind market in the second quarter of the year?

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

For one the wind, wind business is ramping rapidly and I would give real complement to our, our German colleagues in terms their ability to ramp up with the market. We're anticipating annual sales to well exceed $100 million this year. You can see the growth and just the one piece has gone up dramatically. The outlook as we go forward, we intend to continue to grab share and the wind business is robust. So we expect rapid growth to continue in that market.

The other part of the power, Electrical Power Systems business as well as our power generation distribution controls and those two are going up. The rate is probably increasing at the same amount but the dollar content isn't quite the same as the wind turbine inverters. But the Power Systems business in the markets we're focused in are strong globally, and we are continuing to see good demand across all their products.

Tyler Hojo - Sidoti and Company

So if you were to look at that subsidiary, I guess you classified it as a subsidiary. Would it be more wind or more power distribution? I mean how we should look at that piece of the business?

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

Well, we started out, wind obviously was a fairly small portion of the overall entity when we first acquired it. And of the segment in total, that's gone significantly and if you take to the total now for the... that segment of the business, you can see, it's getting rapidly close to about a 50:50 sort of rate win to other parts of the business. So at those growth rates, you can kind of do the math on how it will end up. But clearly wind is becoming a very significant part of that segment as a whole.

Tyler Hojo - Sidoti and Company

Okay. I see. And just kind of a follow-up to the first question. Do you have any... are there any opportunities for you just in terms of wind with maybe one of the U.S. customers that you have historically had a very good relationship with?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes, which I think you are referring to GE.

Tyler Hojo - Sidoti and Company

I guess I can say GE.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Right now, GE brought a lot of the inverter business in house, vertically integrated on it. I think at the time we weren't in the business and they were really looking at I think supply constraints and making sure that they could support their business. We always have ongoing dialogue with GE about every aspect of their business. And we are continuing to talk with them. And what we have done in other parts of GE is we always... this is the way I always refer to we complement them. We don't compete with them. And if there is a complementary turbine range that we can step in and help them, we're going to try and do that. But it will definitely be a strategic sourcing decision on their part. And so we can't really predict that very well.

Tyler Hojo - Sidoti and Company

Okay, great. I'll let somebody else ask.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Okay, sir.

Operator

Our next question comes from Ned Armstrong from FBR.

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

Thank you. Good afternoon. My first question that really entailed off your markets. I mean, it really looks like everything's for the most part hitting on all cylinders. So the first part of the question would be, is there any area that concerns you right now or what might come out of left field [ph] that could catch you by surprise?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Well right now I think you're asking a question we ask of ourselves regularly. And we're seeing the demand pretty strong, and mainly as we highlighted in our prepared comments was global demand is drawing through and overcoming the softness. And what I'd say in the U.S., some of construction equipment and some of the... that type of equipment is low but some of that demand is being picked by other countries around the world. So right now that would be one obviously, when we look at the construction equipment is more of a what I call short cycle. When you get in to some of our other major markets like marine, power and the like, there is a little longer cycle market. And we're seeing pretty steady there. So the first things if we felt anything would be in the construction equipment, but right now, the exposure we have has been pulled up by the global demand. The only other thing we always caution is that some catastrophe happens in the aircraft world, obviously that would have an impact. But today just in terms of passenger miles, the order books, the delivery rates, that looks really robust. So, right now, yes we do feel it's fairly strong outlook.

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

The second part of the question would be are there any adjacencies that to your existing markets that are particularly appealing to you right now, from a strategic perspective?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

There are and I take a little bit if we went back, to when we announced the segment, the change in segments

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

Yes.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Part of that was recognizing the electric power system market globally and we really look at that as three areas. One we call power conversion, that would be our Inverter business, and various applications in invertors. We look at the power protection and distribution that would be like our relays, our switchgear controls, as our gen-set controllers, that's what we've been in that we are growing. And we think there is market opportunity there. And a new... and another area that we are really focusing on which is, we would say is adjacency there would be power quality. And power quality we see is going to be extremely growing segment of electrical power systems market and what happens there, and one of the reasons we really focus on it is, the more renewable or variable type power applications you put on like wind or solar on to the grid, you really have issues with the quality of the power and we think the need for equipment to help with that is going to grow and grow and that's in adjacent to we are very attracted too.

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

And by power quality you mean the consistency of the voltage in that type of measure.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Voltage frequency, voltage sags, making sure that you don't get a voltage dips that would take out a plant, knock out your processes, that type of yes--

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

Okay.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Activity. So those are some adjacencies that we are very interested. And I guess the other one that we have spoken to that we think is a very positive one is in the after treatment area, where we're looking. Right now, we have development partnership with Tenneco on a system for diesel particulate filter and some of that adjacent area we think it's provide some nice growth opportunities for our Engine Systems business

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

That will be on the exhaust end of the engine business.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Correct.

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

Okay.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

But Stewart [ph], as you know we spent a lot of effort on what we would call primary emission controls and that's trying to reduce the emissions when it's in cylinder. But with the new rags the results are going to have to be secondary emission control, and that's really these after treatment systems. And there is a niche in there for some of our technology to be applied and also lot of control technology going into that. So we see, as I said, a nice adjacency that we are pursuing at the moment. So, those are kind of the big ones on our list at the moment.

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

Okay, thank you. I'll get back in line.

Operator

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

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

Afternoon, guys.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

How you doing.

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

Good. Congratulations on the quarter.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Thank you.

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

Wanted to check on the SG&A expense. You... relative to Q1 it was a little bit higher I know as a percentage of sales it's down. Is it... was Q1 kind of an anomaly or is Q2... what was going on there in particular? Was that just a function of the sort of big growth at Electrical Power Systems?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Somewhat, yes. You are looking at specifically SG&A?

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

Yes, correct.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Okay. Yes, we had... hold on one second here.

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

I mean it looks like last year in Q2 there was a about a $4 million bump, so I was wondering if it's a seasonal thing or something else. I mean Q2 last year was the highest quarter of the year.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes. If you recall last year, we had a subsequent event subsequent to the earnings release. We had a unfavorable

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

Right, okay.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

And that's really the big ticket item.

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

Okay. But now, this quarter it was up $6 million, quite [ph] unchanged from last quarter. But there wasn't anything in this quarter in particular that drove it up. I am just trying to figure out what the run rate we should look for the balance of the year. Is that very close to the $26 million we saw in the first quarter or close to the $32 million that we saw in the second quarter?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

We would say closer to the $26 million to be able to execute on everything. There are a number of items that we have. We kind of refer to the fact of continuous improvement activities, productivity enhancements and so on. We did have some IT costs, system costs in the quarter. We would anticipate that those would moderate as we go forward to the rest of the year, and you would see that percentage come down somewhat.

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

But things like your expedited shipping, those show up in cost of goods, correct?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes, those are all in cost of goods sold.

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

And then could you... is there anyway to quantify what you saw in aerospace on aftermarket growth? I'm just trying to kind of relate it to some of the other guides [ph] that leverage the aftermarket and compare there?

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

I guess what we would say is our aftermarket growth continues to be strong. And I guess as we have seen with it, we have ones of our [ph]... what I... how I did I think on past calls on variability in aftermarket which kind of comes around complete what we would call spare unit controls that are used for fleet expansions of our initial provisioning. And those kind are the ones that come in and out that can sway the aftermarket from quarter-to-quarter. The steady... I would say the steady repair and overhaul revenue and spare parts revenue that comes from the... what I would say when the engines turn we make money. That's pretty consistent and is really a basis of the size of our installed fleet which has... continues to grow and is quite good.

So, I think what we saw on the second quarter was slightly less initial provisioning type controls than we saw on the first quarter. But the demand on services in terms of repair overhaul spare parts was steady.

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

But does that grow at a little bit better rate than capacity would imply?

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

Then the capacity

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

Global available fleet miles that kind of thing that's probably the best driver, correct?

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

Yes, I think it's probably more consistent with that number, yes.

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

Okay. And then maybe some you could just address what you are seeing on the acquisition front, given you've got a pretty solid balance sheet and capability to do something there. As multiples come in, I mean is your deal flow stack on your desk higher or lower than it was 90 days ago?

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

I think what I would say is our opportunities have increased part of that is that we are pursuing, part of that as we put more resources to identify companies that would be a good fit with Woodward in our strategy, that would fit with our growth goals. And we're putting a lot more effort in there. So we're seeing opportunities out there today, and it's probably about the extent we can comment on it but it's more of internally focused allocation of resources to spend more effort in that area. Now that's increasing the opportunities we are looking at.

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

Okay, thanks a lot.

Operator

Our next question comes from William Bremer from Maxim Group.

William Bremer - Maxim Group

Good afternoon gentlemen. Great quarter.

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

Hi William, thank you.

William Bremer - Maxim Group

Excellent. Just can you touch base a little bit on the aerospace? There has been a few bankruptcies, mergers this last quarter. Just an update there, how that affects your business? And second any... I know international markets have been pretty strong but any of them in particular, have they surprised you in terms of the... not just the volume of orders but maybe the higher ticketed items there? And then third, know that the... know that some acquisition were possibly mentioned but looks as though if you can't pull off one in the wind division domestically. Then I guess will pretty much to a greenfield startup here. I just want to hear your comments on that.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Okay. Bob, chime in with me.

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

Sure, I will.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

On the aircraft front, what I'd... we have to kind of look out with bankruptcies or airlines going out of business. I'll start with those. Generally and where we have seen some of these bankruptcies most of the time, they are still flying in bankruptcy. And I would go back as long... so I always say as long as the engines are turning, we are going to make money. And so we don't see an impact from that. The other is that these start to ground airplanes and right now what we're seeing just a little bit when you see some of the fleet announcements is that they're trying to take out the older, less fuel efficient airplanes. A lot of those are the GTA [ph] powered aircraft. And we really don't have much content on those. So in terms of those being parked is not really going to have any impact on us, and so, right now from those that the bankruptcy and the airplanes being parked really don't impact in our aftermarket. So we are on the newer fleets, the more fuel efficient fleets. And so far we're not seeing anything sitting. So... so far no impact on our aftermarket.

The mergers... that I think hopefully will create stronger U.S. airlines and finally get them around to ordering. So that's the big wild card that everybody talks about and how long the legs on this aircraft industry expansion will go. And it really kind of comes back to when will the U.S. fleet start to order? And the planes are old and they're going to have to decide. I think that's more of an opportunity that they get together, consolidate their fleets, look at some new orders and should be a positive to us longer term, as we are well positioned on all the newer aircraft. So from that point, we're still seeing things strong, the only thing as we said before... if there was a massive grounding of aircraft which we don't see or anticipate. So, other than that I think the aftermarkets continue in the good pace. In terms of international markets...

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

You want me to jump...

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes.

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

Probably two areas come to mind. One, you saw we mentioned some strength in the marine side of the equation there. That equates to some of our European customers predominantly. Obviously those are shipped worldwide... but so there are some strengths there. Also in China, we've seen some added strength in the alternative fuels area predominantly. So there are two areas that I would think of that, to kind of respond to specifically international. But by and large we've mentioned that across the board on the international side we have seen strength. So international in general has been a good area for us.

William Bremer - Maxim Group

Great.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

I think your third question was around market adjacencies or --

William Bremer - Maxim Group

Greenfield operations possibly.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Yes what we are looking and I would highlight some of those I mentioned earlier on attractive adjacencies, the after treatment for our engine systems group. That's all organic development, and we are bringing that activity up. It's not... it doesn't require a brand new facility of Woodward; it's been incorporated in our existing engine systems facilities. The power quality area, we find that a very attractive area and we are making plans for organic growth in there as well as looking for other opportunities. So those are ones that we will invest in and look to develop product lines from the ground up.

William Bremer - Maxim Group

Okay. Great, thank you. Congrats again.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Okay. Thank you.

Operator

We have a follow up question from Peter Lisnic from Robert W. Baird.

Peter Lisnic - Robert W. Baird & Co.

Hi. Any issues or concerns about materials cost going forward, or are we pretty comfortable being able to pass through price at this point?

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

It's kind of a, I would say a mixed bag. We do have some long-term supply agreements that do include banding and the ability to pass some material cost increases through. But we also have absorbed some. So when we kind of go back to those higher operating costs that we referred to there, they're clearly embedded in there. There are some and as I say some of which are offset.

Peter Lisnic - Robert W. Baird & Co.

Okay. Fair enough. And then on the... if you just look at the turbine segment, looks like through the first half of this year incremental are running around 50%, incremental margin rates, is that... can we just described that to just straight leverage or is there a price there or I'm just trying to figure out what the back half of the year could look like? Or should we expect the leverage to come down at all?

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

Well, what you have with that is leverage and the product mix will impact how much we can leverage through. What I'm trying to say that is we had very strong after market in the first half of the year, strong initial provisioning type spare sales and those are good margin products and we were able to leverage very well. So we will have a little bit... possibly lower on power with that depending on exactly how the aftermarket mix comes through.

Peter Lisnic - Robert W. Baird & Co.

Okay, all right. And then any commentary on the U.S. industrial gas turbine markets sounds like GE saw some orders at least this quarter. Can you give us an idea what that end market is looking like?

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

Yes, the industrial gas turbine markets doing well. We had good increase. So you saw the GE numbers in liking [ph] and we had good increase there. Some of the and we have talked about this in past phone calls, a fair amount of turbines are sold and what emission regulations they are being purchased under will determine how much content we have on the turbine. So every GE turbine has Woodward content, but it varies and with the high efficiency low emission turbines we have a lot more content. So they are doing well, we've gone up with that. So our industrial turbine business has increased.

Some of the... when you see some of the sales going to the Middle East and the like those generally aren't the high... they are the lower emission units. So we don't have as much content in those, but overall it is a positive outlook. Also on the what we refer to as the aero derivative industrial turbines, we are seeing a good ramp up there and those are used in compression, power gen and marine and those were up in the quarter and that's covering all three GE and perhaps rolls on those, so those aero derivatives are going strong as well.

Peter Lisnic - Robert W. Baird & Co.

Okay, can you giver us an order of magnitude of content on the high efficiency versus lower efficiency, IGT?

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

Well, yes I mean it's from the order of a million of chipset to 100,000 chipset.

Peter Lisnic - Robert W. Baird & Co.

Okay, all right, and then just to go back to the second half kind of revenue projection, what are you seeing in terms of order rates right now? Are we still kind of running at double-digit order growth rates or just trying to behind some of the conservatism outside of the top comps for the back half of the year?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

We are still seeing strong order rates. I think when you take a look at the comment we made regarding foreign exchange, obviously we don't forecast foreign exchange for the second half. So you can kind of modify a little bit based on that. We do... obviously we always plan for some degree of uncertainty, but I would say we were above the 10%, I think that was estimated slightly in the second half but other than that I don't think we see anything specific from the order rate standpoint.

Peter Lisnic - Robert W. Baird & Co.

Okay but that doesn't include FX which is an important assumption.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

That's right.

Peter Lisnic - Robert W. Baird & Co.

Assumption. Okay thank you very much.

Operator

Our next question is a follow up from Ned Armstrong from FBR.

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

Thank you, just a couple of quick fact that's here, do you have the FX effect on sales for each of the three segments?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

What I can tell you is that largely the impact is... our EPS, our electrical power segment is predominantly Euro based. So most of our impact is there.

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

Okay, but you don't have it broken up per se?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

It's not really significant to the other businesses.

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

Okay, thank you.

Operator

We have another follow up question from Tyler Hojo from Sidoti and Company.

Tyler Hojo - Sidoti and Company

Hi, I think back when you guys reported under the different business segments you always used to break the guidance per business segment. I was just wondering if would be willing to do that just in terms of revenue growth for the three business segments with the updated guidance range that you provided?

Thomas A. Gendron - Chairman, Chief Executive Officer and President

We predominantly because the wind is putting so much uncertainty with respect to the growth, I mean its obviously much higher than all of us originally thought it might be. We have not attempted in particular in the electrical power systems to call out what would be a long term growth rate on that, and that really was the only way we referred to in the past. We tried to kind of target long term growth patterns I don't think those have changed significantly from turbine going from aircraft to turbine going from aircraft to turbine

Tyler Hojo - Sidoti and Company

Okay.

Unidentified Company Representative

As I said we saw that, that there wasn't a significant change there. We also in the engine side of the equation, we targeted I think we said that could be in a 7 to 9 sort of long term. I don't think we see much different from that either.

Tyler Hojo - Sidoti and Company

I see. Okay and just one kind of follow up again towards just in terms of the guidance, do you have a diluted share count just in terms of what's implied in the updated EPS guidance?

Unidentified Company Representative

It's slightly under 70 million shares about 69.500 million roughly.

Tyler Hojo - Sidoti and Company

Perfect. Thank you.

Operator

And I am showing no further questions at this time. I would now like to turn the conference back over to you for any closing remarks.

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

Okay, Bob. Appreciate everybody calling in today and your questions and look forward to talking to you in July. Have a good evening. Thank you.

Thomas A. Gendron - Chairman, Chief Executive Officer and President

Thank you, everybody.

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 at 9:00 PM Eastern Standard Time by dialing 888-266-2081 or 703-925-2533 for a non-US call and by entering the access code, 1220291. Broadcast will also be available at the company website www.woodward.com for 30 days. Thank you for your participation in today's conference call we ask you to please disconnect your line. Thank you, and have a nice day.

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Source: Woodward Governor Co. F2Q08 (Qtr. End 03/31/08) Earnings Call Transcript
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