Woodward Governor Company F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

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Woodward Governor Co. (NASDAQ:WGOV) F3Q08 Earnings Call July 21, 2008 6:00 PM ET


Thomas A. Gendron - President & Chief Executive Officer

Robert F. Weber, Jr. - Chief Financial Officer


Tyler Hojo – Sidoti & Company

Peter Lisnic – Robert W. Baird & Co.

William Bremer – Maxim Group

Greg McKinley – Dougherty & Company

J. B. Groh – D. A. Davidson & Co.

Ned Armstrong - Friedman, Billings, Ramsey & Co.


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

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

Robert F. Weber, Jr.

We would like to welcome all of you to Woodward's Third Quarter 2008 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 the 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, July 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 for the quarters ended December 31, 2007, and March 31, 2008.

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

Thomas A. Gendron

Welcome to all of you who have joined us. I will begin by highlighting our financial results for the third quarter.

Sales were up 23% compared to the third quarter of fiscal year 2007. Our earnings were $0.47 per share, up 38% from last year. Our operating earnings increased 31% over last year and we generated $56 million in cash from operations during the quarter, an increase of 54% from the prior year.

We experienced excellent growth in sales and operating earnings leveraged this quarter. Our sales growth resulted from continued strength in each of core markets of Aerospace Power Generation and Process Industries, and Transportation.

Our focus on global end markets and further increases in market share was reflected in our results. Our overseas operations in multi-national customers again contributed to our performance and positioned us well to take advantage of opportunities in multiple markets and regions.

We continue to focus on delivering energy-control solutions to our customers, who are providing much of the equipment that supports the global infrastructure. The continued high cost of energy and environmental concerns drive increased Woodward content in many of our customers’ applications.

Aerospace industry orders remain strong in this quarter, notwithstanding the announcements that some airlines were deferring delivery of previously ordered aircraft. The backlogs for Boeing and Airbus remain strong. The state of production rates will remain at current or increased levels. That said, we continue to monitor the pace of orders, deferrals, and cancellations while also pursuing activities that will lead to increased content and sharing key platforms.

This past quarter brought announcement by some airlines of their intention to withdraw less fuel-efficient aircraft to the surface. We do no expect these actions to impact our fiscal 2008 results, as the majority of the parkings are not expected to occur until after the summer travel season. Potential redeployment in other regions for use in freight service may create new opportunities, partially offsetting the overall impact.

Additionally, it is unclear what ultimate affect these actions may have on our overall growth, considering the more global nature of fleet increased usage of aircraft outside of the U.S. and our increased counting on newer and more fuel-efficient aircraft such as the Boeing 777 and the Airbus 8380.

We recently announced a long-term supply agreement with Pratt & Whitney, which extends a key relationship for Woodward and secures our position on Pratt’s geared turbo fan platform. Their engines, now renamed the PW1000G and PW810, will initially be on business and regional jets such as the Mitsubishi Regional Jet, the Bombardier C Series, and the Cessna Citation Columbus.

Our turbo combustion operation in Zeeland, Michigan, was awarded an Ace Gold Suppliers status by Pratt & Whitney, a select status in which we take great pride. At the recent Farnborough Air Show, Boeing announced that it is on target to fly the 787 Dreamliner in the fourth calendar quarter of this year and they completed a successful power on test this past quarter. As you all know, Woodward provided the control fuel system on the GNX engine offered on the Dreamliner.

Industrial turbo demand continued to be robust, driven by power-generation projects internationally. Additionally, aero-derivative turbines are seeing growth related to back up power sources for renewable energy projects.

Production at our key customers remains at high levels and demands for Woodward content improved during the past quarter. Emission regulations, growing global energy demands, and new projects such as coal gasification also provide opportunities for Woodward in the turbine industry.

Diesel engine demand was again led by strength in the large marine applications. Also, high commodity prices are driving demand for mining equipment powered by diesel engines. This quarter we saw continued interest in alternative fuels driving greater demand for compressed natural gas engine systems and a higher level of Woodward sales to existing and recently added Asian customers.

High oil prices are driving expanded investment in oil and gas production, which is leading to increased demand for steam, turbine, and engine controls throughout the world. In the steam and turbine controls market we are leveraging our control and actuation technologies to address opportunities such as the rapid expansion of coal-fired plants in China. With the strength of each of these engine markets, some of our customers have announced expansion of their capacity and continue to plan for increased levels for a number of years.

Demand for wind turbines continues to grow at a remarkable rate. We continue to expand market share and execute on our plans to support our customers locally as they expand in both North America and Asia. Delivery to these key customers remains our primary focus.

In wind inverters, our team has successfully completed the design of a scalable inverter which will improve manufacturing efficiency, use a common platforms for turbines of various sizes, deliver solutions to a broader geographic market, with a variety of grid requirements. This advanced design should launch before the end of the calendar year.

In addition, concerns of power quality and security are driving demand for our sophisticated power management controls. We recently entered into a long-term supplier agreement with a key electrical equipment customer to provide protective relays, further expanding and securing an important relationship.

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

Looking forward, despite problems in certain geographic regions and segments of the economy, our order volume suggests continued strength in global infrastructure spending.

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

Robert F. Weber, Jr.

I will comment on the third quarter and nine-month period 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 my commenting briefly on our outlook for the future.

At the Woodward consolidated level net sales for the quarter were $330 million, a 23% increase over last year’s third quarter sales of $269 million. This growth was attributable to the market’s strengths and Woodward position that Tom referred to as well as the impacts of foreign exchange rates. Growth without the positive effect of exchange rates was approximately 17.0%.

Operating earnings for the quarter, defined as earnings before income tax and interest, grew 31.0% and were $49.7 million, or 15.1% of sales compared with $37.8 million, or 14.0% of sales in the same period a year ago.

Net earnings for the quarter were $32.4 million, or $0.47 per share compared with $24.0 million, or $0.34 per share the same quarter a year ago. Foreign exchange accounted for approximately $0.01 per share of the increase year-over-year.

Net sales for the nine-month period were $908.0 million, a 21.0% increase from $752.0 million for the nine-month period of the prior year.

Net earnings for the nine-month period were $87.5 million, or $1.26 per share compared with $62.1 million, or $0.88 per share in the previous year’s nine-month period.

At the segment level, let me first discuss our Turbine Systems segment, which included both aircraft and industrial turbines.

Turbine Systems net sales for the quarter, including inter-segment sales, were $153.7 million, an increase of 16.0% over third quarter sales of $132.3 million a year ago.

Turbine Systems segment earnings in the third quarter of fiscal 2008 were $29.3 million compared with $23.2 million for the same quarter a year ago. Segment earnings as a percent of sales were 19.1% in the third fiscal quarter of 2008 compared to 17.5% in the prior year. Our sales performance reflects sustained growth across our portfolio of aircraft and industrial offerings, with particular strength in industrial turbines and OEM aircraft offerings. Earnings increase largely due to our ability to successfully leverage our fixed cost base on the increased volume.

Turbine Systems net sales of the nine-month period, including inter-segment sales, were $431.9 million, an increase of 14.0% from $380.1 million for the nine-month period a year ago.

Segment earnings for the nine-month period increased 32.0% to $87.5 million, up from $66.3 million for the nine-month period a year ago. Segment earnings as a percent of sales were 20.3% in the nine-month period of 2008 compared to 17.4% in the nine-month period of the prior year.

Moving to our Engine Systems results, Engine Systems net sales for the quarter, including inter-segment sales, were $130.9 million compared to $117.6 million a year ago, an increase of 11.0% reflecting the continued strength and demand for our customers’ products outside the United States and positive impacts with foreign exchange rates. Without foreign exchange rate impacts growth was approximately 7.0%.

Segment earnings for the quarter increased 10.0% to $17.0 million compared to $15.4 million for the same quarter last year. Segment earnings as a percent of sales were 13.0% in the third fiscal quarter of 2008 compared to 13.1% in the same period of the prior year. Our sales growth this quarter came largely from our transportation market with Marine and Alternative energy leading the way.

Our improved earnings, relative to recent quarters, reflect the benefit of operational changes implemented to reduce some of the supply chain and transitional operating costs we experienced earlier in the year. Some of these costs will continue through the balance of the year, at a reduced rate. Going forward, we remain focused on activities to reduce these costs and enhance margins in this segment over the longer term.

Engine Systems net sales for the nine-month period, including inter-segment sales, were $370.8 million, an increase of 12.0% from $330.5 million for last year’s nine-month period.

Segment earnings for the nine-month period increased 6.0% to $42.0 million from $39.8 million for the nine-month period a year ago. Segment earnings as a percent of sales were 11.3% in the nine-month period of 2008 compared to 12.0% in the nine-month period of the prior year.

Now turning to Electrical Power Systems: Electrical Power Systems net sales for the quarter, including inter-segment sales, were $77.2 million compared to $49.2 million a year ago, an increase of 57.0%. Again, this quarter, wind power sales were very strong. Power generation and distribution markets also experienced robust growth as overall demand for power protection and power distribution controls continued. In this segment, without the effects of exchange rates, growth was approximately 38.0%.

Segment earnings more than doubled for the quarter to $10.8 million compared to $5.2 million for the same quarter last year. Segment earnings improved as a percent of sales to 14.0% in the third fiscal quarter of 2008 from 10.6% in the prior year. In this segment, too, we continue to focus on process and product design improvements that will further enhance margins.

Electrical Power Systems net sales for the nine-month period, including inter-segment sales, were $199.5 million and increase of 57.0% from $126.8 million for the nine-month period a year ago. The vast majority of this growth was organic.

Segment earnings for the quarter increased to $27.5 million from $15.2 million for the same quarter a year ago. Segment earnings improved as a percent of sales to 13.8% in the nine-month period of 2008 from 12.0% in the nine-month period 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 good sold, as a percent of sales was 29.7% in the third quarter of 2008 as compared to 30.8% in the third quarter of 2007. Gross margin was negatively impacted by both product mix and inventory adjustments related to product line transfers mentioned in earlier quarters. Gross margin as a percent of sales was 32.2% in the nine-month period of 2008 compared to 30.8% in the prior year.

Selling, general and administrative expenses as a percent of sales decreased to 8.6% of sales, or $28.4 million, in the third quarter of 2008 compared to 10.2%, or $27.3 million, in 2007. In the nine-month period selling, general and administrative expenses were 9.5% of sales, or $86.1 million, in 2008 compared to 11.2%, or $84.3 million, in 2007.

Research and development costs were $19.0 million in the third quarter of 2008, or 5.7% of sales, compared to $17.0 million, or 6.3% of sales, in the third quarter of 2007. Research and development costs were $53.4 million in the nine-month period of 2008, or 5.9% of sales, compared to $46.9 million, or 6.2% of sales, in the nine-month period 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 nine-month period of 2008 increased to $27.2 million from $26.5 million in the nine-month period of the prior year.

Our capital expenditures were $25.1 million in the nine-month period of 2008 compared to $22.7 million in the nine-month period of 2007. We previously announced that we expect capital expenditures to increase to a total of approximately $100.0 million for the years 2008 and 2009 combined. We expect fiscal 2008 capital expenditures of between $[48] million to $45 million and 2009 to be somewhat above 2008.

This increase includes a $50.0 million investment over two years to modernize the Loves Park facility in Illinois. It includes a state-of-the-arts systems test facility for aircraft engine fuel control systems.

In addition to the Illinois expansion, systems test capability expansions in Colorado and a new facility in Poland account for the majority of the increase in spending from fiscal 2008 to 2009. We continue to support our advanced test capabilities and core manufacturing process improvements.

Our effective tax rate for the quarter was 34.0% compared to 35.4% last year. We expect our full year 2008 tax rate to be in this range, or slightly below.

To turn briefly to our balance sheet, working capital, defined as current assets plus current liabilities, increased to $342.0 million at June 30, 2008, compared to $276.0 million at September 30, 2007, supporting our increase in sales volumes.

Our total short-term and long-term debt was $47.0 million at June 30, 2008, a decrease of $20.0 million from September 30, 2007. The ratio to debt-to-debt plus equity was 7.2% at the end of the third quarter compared to 10.9% at September 30, 2007, and 10.9% at June 30, 2007.

Turning to our guidance for 2008, considering the outlook for the markets and Woodward initiatives described by Tom earlier, we believe that that our fiscal fourth quarter sales growth will remain strong, though somewhat more moderate than we have seen recently. We expect our full-year sales growth rate to be approximately 20.0%. We are also increasing our expected full-year earnings to approximately $1.75 per share.

That concludes our comments on the business and results for the third fiscal quarter of fiscal 2008.

We are now ready to open the call to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Tyler Hojo - Sidoti & Company.

Tyler Hojo – Sidoti & Company

In regard to some of the capacity reductions that we keep reading about in the papers. I know you don’t have exposure to CFM56 but what do you think, how do you think this plays out for you after Labor Day, just in terms of capacity coming off line?

Thomas A. Gendron

Tyler, first of all, we are on CFM56. What we are not on in any quantity or any significance is the JT8 fleet, so that would be like your MD80s, you DC9s, your old original 737s. Those are the worst fuel efficient of all the aircraft that are being parked. So those really have negligible to no impact on us.

What we saw here in the last quarter were some announcements for 737 Classics. That would be with the CFM56-3 engines. We do have good content on that engine. So that’s the one we’re referring to. Some of those are being parked.

Our anticipation is that those will be picked up elsewhere in the world, the leasing companies will place those elsewhere. So we think it is a temporary drop and we don’t think it’s going to be significant and we think the increase we’re seeing in the OEM side of our business will more than offset that.

So, right now we’re seeing continued growth in there. Under terrible scenarios, could we see a lot more aircraft parked? That’s possible, I guess. But right at the moment we’re not anticipating a dramatic increase in parked aircraft where we have high content.

Tyler Hojo – Sidoti & Company

Last week during GE’s report, they were saying they anticipated something like $100 million headwind in the back half of their calendar year. Do you think the impact would be somewhat similar to your business? Or you’re just not seeing what they’re seeing, is that what the read is here?

Thomas A. Gendron

Well, I think we see some of it. I think you probably have is the scale difference, on the engine manufacture side. They make huge amounts of their profit on the blades, blade replacements.

We make our money on repairing the control systems. It’s not the same order of magnitude that they have. Obviously we make good money on that. But we right now anticipating that we’re going to continue to grow, going forward into the next year.

So what we are saying is we will feel some, it will not be overly material, and we believe that the real ramp ups in the OEM business are going to offset it.

Tyler Hojo – Sidoti & Company

I don’t think you addressed it in your prepared remarks, but if you could just give us an idea of what you’re seeing just in regards to acquisitions. Obviously the balance sheet is in good shape. And what your plans are for that cash.

Thomas A. Gendron

Well, on the acquisition front, we’ve been putting more resources on what we call filling the funnel. We’re looking in to areas of interest. Obviously we would like to do something in aerospace. It’s a very difficult market, as everybody knows, it’s very consolidated.

We are looking a lot more in the supporting our Electrical Power Systems business, so we’re looking at ideas in that area. And we’re looking at whenever something does arise that would support our Engine business.

I would say with the bigger emphasis we put on it internally, we’re seeing a better flow into our funnel, but it’s M&A and that always means it’s totally uncertain to say when the timing or when the activity is. I would also like to just emphasis we’re very focused, we’re not going to do something that is out of energy control optimization. And so that’s what we will weight everything against. But that would be our prime choice of how to use our balance sheet strength.


Your next question comes from Peter Lisnic - Robert W. Baird.

Peter Lisnic – Robert W. Baird & Co.

I was wondering, I know in the press release you gave some color on OEM versus after market. I’m wondering if you could give us a little bit more detail in the aerospace business, what OEM was growth-wise versus after market and then maybe how that trends into next fiscal year, in your expectations.

Thomas A. Gendron

Yes. The split is still 50/50, approximately, on OEM to after market. Our after-market revenue is still ramping up. What we’re seeing on the OEM side, as we move into fiscal year 2009, is continued ramp up on some of the new wins that we had. So those are the Pratt & Whitney Canada projects. You are also going to see towards, the end of the year, shipments starting on the GNX. And so those will start bringing OEM sales up.

But right now, the production rates are doing well at our customers. I think you probably even saw Airbus announce that they’re going to even up some of their production rates, on the A320 family. So those are all drawing our OEM sales up, but our after-market sales are holding in and the split is still, like I said, 50/50.

Peter Lisnic – Robert W. Baird & Co.

Can you maybe give us just an order of magnitude as to what after market grew in the quarter, top-line growth? Mid-single digits, low?

It sounds like in the wind business, with this whole move to what would be a scalable inverter product, it sounds like one of the things you’re trying to target there is the margin or an improved margin profile for that business. Can you maybe give us a sense as to relative profitability of that business and then where you think it could go in terms of over the next 12-24 months?

Thomas A. Gendron

In terms of relative profitability it’s right in the haunch with the rest of our industrial businesses. So from that standpoint it’s not an issue there. We’re doing quite well with it. The highlight on that scale inverter is, the opportunity for us to grow and grow rapidly is to go more global and so what that’s going to do is reduce our overhead in terms of application costs, customization for local markets, and then that’s going to help us in that way.

And then secondly we should have a better contribution margin on the product, too, because we have gone into designing it for lower cost. So this should be an upside as we go into 2009 and 2010.

And the second part of your question was the market growth rate?

Peter Lisnic – Robert W. Baird & Co.

No, I’m sorry. Just what the margin profile could look like a couple of years out with the implementation of this scaleable platform. But it sound like the scalability is just to address different turbine sizes and different markets more than it is a specific margin expansion opportunity.

Thomas A. Gendron

Yes. It will ideally help margin a little bit but when you wrap up all the costs applying the various turbines to the various markets there’s an expense there. So that’s what we’re trying to reduce as well. So that’s really the overhead area.

Peter Lisnic – Robert W. Baird & Co.

And are we still targeting wind at around $100.0 million of revenue for this year?

Thomas A. Gendron

Yes. It will be slight over that.

Peter Lisnic – Robert W. Baird & Co.

If you have that after-market number then.

Robert F. Weber, Jr.

It looks like it will be high single digits overall. There is a mix in there between commercial and military. We’re seeing slightly less growth on military that we’re seeing on commercial, so overall high single digits.

Peter Lisnic – Robert W. Baird & Co.

Is that for this quarter or for the year, Bob?

Robert F. Weber, Jr.

That’s for this quarter versus the prior year quarter.


Your next question comes from William Bremer - Maxim Group.

William Bremer – Maxim Group

Peter just touched on scaleable inverter. Can you give us a little color on whether or not that can be geared towards more the domestic market here and will you be manufacturing that here or potentially abroad? And then I just want to get a sense on in terms of Electrical Power Systems in terms of the ratio between wind and power generation. Are we getting closer to that 50/50 percent there?

Thomas A. Gendron

I’ll start with the wind inverter. First, the scaleable platform. We refer to our platform as the NGX. And the platform was designed to be a global product. And our intention is to produce it in Europe, the U.S., and in China. Right now all of our inverters are being built in Germany, at our Kempen facility that we acquired two years ago.

We announced that we’re also going to start production in our facility here in Colorado and what we were able to do is had leased out part of that facility because we had excess space. The lease expired on the tenant. We’re taking that space over. We’re going to use that space for inverter production. And we just recently leased a building adjacent to our building in Tianjin, China, to also build the inverters.

So, our plan is it’s a global product, that was part of the scalability and the architecture and we’re going to produce it in each region. And that regional focus is also what’s been allowing us to capture share and grow a little faster. Our customer base is expanding and putting factories in the U.S. and in China as well, so by being there we’re able to pick up more share and be able to grow with them.

Robert F. Weber, Jr.

[The second part of your question was] wind to total and it is getting much closer to a 50/50 out of the total business. Both are seeing pretty good rates of growth. Obviously power generation and distribution is nothing like the wind side but it will be slightly below 50.0%.

William Bremer – Maxim Group

And going into 2009, where do you think that ratio stacks up? Well, I should say the conclusion of 2009.

Robert F. Weber, Jr.

It will start to flip.

Thomas A. Gendron

Wind is going to continue to grow at really remarkable rates for us. So we would see the wind picking up going into the next year. A higher percent of the business.

William Bremer – Maxim Group

Let’s switch to Engine Systems. Had a real nice improvement in terms of operating margin, up 263 basis points. How much more do you think you can squeeze out of there or what should we be using there in terms of operating margin?

Thomas A. Gendron

Right now we’re pleased with, if you want to say our industrial business is the engine and the electrical power system that we’ve, we’re bringing the margin up. We think we still have several points of opportunity out there and we’ll be working on that over the next few years, continuing to improve our processes. And a lot of that, too, is we’re improving these margins even while absorbing some of the inflationary pressures that are out there today. So, we still think there’s margin expansion, even in this environment.


Your next question comes from Greg McKinley - Dougherty.

Greg McKinley – Dougherty & Company

Can you talk a little bit more about your operating expense trends? I know you’ve highlighted a couple items that drove some variance from quarter-to-quarter in recent quarters, but if we look at non-segment expense, those were down nicely sequentially, as were really operating expenses applied to your segments. And can you just remind us what are the big moving parts in those numbers and how should we think about that as a run rate moving forward?

Robert F. Weber, Jr.

I focused first on gross margin. We mentioned throughout the last couple of quarters that we were incurring some charges related to moving some product lines to other low cost locations. We had some freight charges, etc. related to that. We think we have moved through a good piece of that. There’s still smaller amounts that we will see in the fourth quarter, but that’s part of that improvement.

We also, as you move product lines and so on and you get completed with those, sometimes you have some inventory that needs to be written off. We had some of that during the quarter as well.

So, we believe that when you take out some of those items, and I don’t want to refer to them as unusual, but they’re not really recurring with respect to these types of activities, we expect to be slightly above 30.0% for the full year from a gross margin standpoint.

Also as we mentioned, we’ve been trying to really get some infrastructure reduction so we’ve been looking at a lot of facilities and consolidating some activities and so on. So that’s been conscious over a fairly long period, but a number of facilities this last year. And so we believe we will continue to see, whether it’s SG&A or some manufacturing expenses, fixed costs spread over our sales base. We’ll expect to see some continued decline there. So, as Tom mentioned, we expect there’s a couple of points of profit available to us and those are the areas we expect them to come.

Greg McKinley – Dougherty & Company

And is there a particular segment, from an operating expense standpoint, where you feel you have more of that available to you with the initiative you have on the table today?

Robert F. Weber, Jr.

Well, with Electrical we’ve mentioned that we have had some manufacturing process improvements that have been implemented over the last few quarters and that’s what has caused a fairly significant improvement in profitability there. I think we still have more of that, although the curve is probably flattening a little bit because if you look at the last three years it’s been pretty dramatic.

So I think that’s probably the largest opportunity we have. We still believe that getting all these costs of product line movements out of Engine is still also an opportunity. In the Turbine side of the business it’s probably more of a mix issue than it is having lots of opportunities for continued profit improvement from design changes or manufacturing process changes and so on. So you’ll continue to see the moderation there as OEM and after market move around that 50.0%.

I think in the past we’ve said that there is a plus or minus two points impact when we see these kinds of changes, so it’s not significantly more than that.


Your next question comes from J. B. Groh - D. A. Davidson.

J. B. Groh – D. A. Davidson & Co.

I have a question on R&D. Looking at the new turbo fan win. Is that going to trend up as a percentage of sales or dollar volume. How should we think of that? You’ve been running high 5.0%, low 6.0% over the last couple of years. And I think back in 2006 up a little higher. And maybe that was GenEx related but just curious as to how you see that panning out. Is it going to stay below 6.0%?

Thomas A. Gendron

The real nice thing about the timing of that new program is some of the resources that will be working on that. Right now it is primarily in our turbine combustion group. We have resources that are rolling off the JSF and so basically we’ll be on hold on our R&D expenditures. So it’s good timing for us on that. So we shouldn’t see much of an increase at all.

J. B. Groh – D. A. Davidson & Co.

So the dollar level would stay flat with this year?

Thomas A. Gendron

Yes. We expect close to that.


Your next question comes from Ned Armstrong - Friedman, Billings, Ramsey.

Ned Armstrong - Friedman, Billings, Ramsey & Co.

In your Engine Systems segment overview you noted that the transportation market was particularly good and called out the marine and alternative energy applications. Can you just touch on some of the other applications in that particular market and how they did during the course of the quarter.

Thomas A. Gendron

Another very large part of the engine market is power generation. A lot of these engines are used in stand-by or back-up applications. We also do a lot with natural gas engines and those are sometimes used in prime applications. The power side was growing, it was more like about 6.0%, so we’re still doing well. The transportation was our largest portion of that. And it’s to the highlight of what we had, the marine and then the CNG-powered vehicle is doing real well right now.

The other area where you’re going to see some of the applications, in Engine it’s what we call mobile/industrial. That would be for fork lifts or small vehicles. And that probably was the lowest performing in the area. And I think those are what we call more the short-cycle business, where they’re going to be impacted by the local economy, construction, or some of that type of activity.

But overall the two, or if you want to say the larger parts, the power, the natural gas and marine, are all doing well.

Ned Armstrong - Friedman, Billings, Ramsey & Co.

And just a small question regarding the turbine systems. Do you have an organic growth number for that business.

Thomas A. Gendron

It’s all organic.


Mr. Gendron, there are no further questions at this time.

Thomas A. Gendron

Thank you, everybody for joining us today. We will look forward to talking to you again, which will be actually our year-end results and we look forward to providing those to you and also our outlook for 2009. So thanks once again.

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