Woodward, Inc.
Q2 2015 Earnings Call Transcript

Published: 21 Apr 2015

[Operator:]

Thank you for standing by. Welcome to the Woodward Incorporated second quarter fiscal 2015 earnings call. [Operator instructions.] Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer; and Mr. Bob Weber, Vice Chairman, Chief Financial Officer, and Treasurer. I would now like to turn the call over to Mr. Weber.

[Robert Weber:]

Thank you, operator. We would like to welcome all of you to Woodward’s second quarter fiscal year 2015 earnings call. In today’s call, Tom will comment on our markets and related strategies, and I will discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions. For those who have not seen today’s earnings release, you can find it on our website at woodward.com. We have again included some presentation materials to go along with today’s call that are also accessible on our website. An audio replay of this call will be available by phone or on our website through May 4, 2015. 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. Before we begin, I would like to refer to and highlight our cautionary statement as shown on slide three. As always, elements of this presentation are forward-looking or based on our outlook and assumptions for the global economy and our businesses more specifically. These elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements. We also direct your attention to the reconciliations of certain non-U.S. GAAP measures included in today’s slide presentation and our earnings release and related schedules. Management uses these non-U.S. GAAP measures in monitoring and evaluating the ongoing performance of Woodward and each business segment. Turning to our results, net sales for the second quarter of fiscal 2015 were $493 million, an increase of 2% compared to $482 million in the second quarter of last year. Earnings per share were $0.66 for the second quarter of 2015, comparable to the second quarter of last year. EBIT for the quarter was $63 million, also compared to the same quarter of the prior year. On a constant currency rate basis, compared to the prior year period, net sales for the quarter would have been $508 million and earnings per share would have been $0.69 per share. Free cash flow for the first half of 2015 was $13 million compared to $56 million for the first half of 2014, including $41 million of increased capital expenditures over the prior year. For the first six months of this fiscal year, sales were up 8% and net earnings are up 28% compared to the same period of the prior year. Now I will turn the call over to Tom to comment further on our results, strategies, and markets.

[Thomas Gendron:]

Thank you, Bob. Welcome to those joining us today. We delivered a solid quarter despite anticipated economic challenges in our energy markets, and we remain confident in our outlook for the fiscal year. Sales related to commercial and defense aerospace, as well as industrial gas turbine systems, remains strong. However, while the first quarter C&G sales were strong in Asia, this quarter was weak, continuing the volatility we have seen in this market. With respect to oil prices, we continue to believe that they will have a neutral to positive effect on our aerospace business and a slightly negative to neutral impact on our energy business for the full fiscal year. Turning to aerospace, our markets remain strong, with commercial deliveries up and anticipated production rates increasing. Demand remains strong for both the 737 Max, as well as the Airbus A320neo, which is nearing launch. We have expanded content on both aircraft and we expect significant revenue and earnings growth as they enter into service. Large cabin business jets continue to lead the business jet recovery. We are also seeing small cabin jets recover as new aircraft are being introduced. We continue to expect growth in this market. Defense sales were strong in the quarter compared to an unusually low prior year quarter. We have returned to a more normal flow of defense aftermarket activity with the resolution of contract timing issues late last year. We believe the increased amount of global defense activity supports a stable overall defense business. Even though our commercial aftermarket sales in the quarter were relatively unchanged from the prior year quarter, passenger miles continue to grow, supporting a strong aftermarket business. As expected, we continue to see softness in the commercial rotorcraft market, primarily as a result of the oil and gas industry lowering capital expenditures. With regard to our three new facilities, Niles is finished and we have completed the move of nearly all production lines. Rockford is almost complete, and we have started moving in. Our Fort Collins facility is on schedule for completion in early 2016. All three of these projects are on schedule and on budget. Turning to energy, three main markets impacted our energy sales in the quarter

[Robert Weber:]

Thank you, Tom. Our first half was strong, with earnings per share of $1.32, up significantly from $1 in the first half of 2014, even with the foreign currency and Asian sales headwinds. In aerospace, second quarter sales increases were driven by higher commercial OEM and defense sales in both OEM and aftermarket compared to the same quarter the prior year. Commercial aftermarket was comparable to the prior year quarter, following an unusually strong first quarter of this fiscal year. As Tom mentioned, aftermarket drivers remain strong. Aerospace segment earnings for the second quarter of 2015 were 16.2% of sales, up from 15.4% in the same quarter a year ago. The higher segment earnings for the quarter were primarily the result of the increased sales volume and lower research and development expense. As we launch our new facilities, we will experience costs related to the move and ramp up of production for a period of time. We incurred some of these expenses for both our Niles and Rockford facilities in this quarter. In our energy segment this quarter, higher sales of gas turbine and wind turbine systems were more than offset by lower sales of natural gas bus and truck systems in Asia and a $14 million unfavorable impact from foreign currency exchange rate fluctuations as compared to the prior year quarter. Earnings as a percentage of sales were 12.9% this quarter, compared to 14.4% in the same quarter of the prior year. Lower segment earnings for the quarter were primarily due to a $4 million unfavorable impact from foreign currency exchange rate fluctuations. At the Woodward level, gross margin percentage for the second quarter of 2015 was 27.9%, compared to 29.5% for the prior year quarter. The decline was primarily due to quarterly variability as well as plant startup costs related to our new facilities in Illinois. More importantly, for the first six months of the fiscal year, the gross margin percentage was improved to 28.7% compared to 28.1% for the same period in the prior year. Research and development costs were $30 million for the second quarter of 2015, compared to $36 million for the second quarter of 2014, reflecting timing of project expenses and related milestones. As a percentage of net sales, research and development was 6.1% in the second quarter of 2015 compared to 7.4% in the second quarter of 2014. Selling, general, and administrative expenses were $38 million, or 7.8% of net sales, for the second quarter of 2015, compared to $35 million or 7.3% of net sales in the second quarter of 2014. The increase was primarily due to higher variable compensation expense. The effective tax rate for the second quarter of 2015 was higher, at 24%, compared to 21% for the second quarter of 2014. Tax rates for both years were favorably impacted by international tax matters and adjustments related to prior year’s tax issues. Our expected tax rate for the fiscal year remains at approximately 27%. Looking at cash flows, we generated $123 million of cash flow from operations for the first half of fiscal 2015 compared to $125 million for the same period in the prior year. Free cash flow for the first half of fiscal 2015 was $13 million compared to $56 million for the same period of the prior year. Capital expenditures were $109 million for the first half of fiscal 2015, compared to $69 million for the same period of the prior year, reflecting increased spending related to our capacity expansion projects. Lastly, turning to our fiscal 2015 outlook, we continue to anticipate full year sales to be between $2.05 million and $2.15 billion, and we are tightening our earnings outlook to be between $2.70 and $2.90 per share, reflecting our ongoing focus on operational performance and continuous improvement activities. This concludes our comments on the business and results for the second quarter of fiscal year 2015. Operator, we are now ready to open the call to questions.

[Operator:]

[Operator instructions.] Our first question comes from the line of Sheila Kahyaoglu from Jefferies.

[Sheila Kahyaoglu:]

I guess can you just talk about what you’re seeing in the aftermarket a little bit more? And you know, if you could just tell us what’s driving the strength by engine type, perhaps?

[Thomas Gendron:]

In commercial aftermarket, we’re seeing flight hours up across the board, and with the new programs going into service, such as the 787, we’re seeing good initial provisioning sales. So the combination of hours and new programs ramping up is fueling the commercial airliner side. We’re seeing more hours on business jets going up, and that, over time, hours drives revenue in the aftermarket for us. So collectively, those are the main things. It’s a strong market right now, and we’re well-positioned with our current portfolio and we’re anticipating even stronger aftermarket as the new programs launch.

[Sheila Kahyaoglu:]

And then just in terms of guidance by segment, in terms of operating margins, do you still expect 100 basis points within each segment, or is it more weighted towards aerospace, given the FX hit?

[Robert Weber:]

No, we’re still equally bullish on the 100 basis points for both segments. So at this point in the year, that still looks like a good target for us.

[Operator:]

Our next question comes from the line of Pete Skibitski from Drexel Hamilton.

[Pete Skibitski:]

I guess Tom, first half in aerospace has been excellent, almost 10% growth. And it looks like the comps in the second half aren’t that difficult, so are you coming in pretty hot the rest of the year in aerospace? And maybe just we stay at a more moderate level in energy? Because it seems like if you stay hot in aerospace, you could maybe even go through the top end of your revenue guidance, it would seem like.

[Thomas Gendron:]

Right now, we’re pretty confident in our guidance. Aerospace is doing well. We have a lot of focus on margin expansion, which we have been working on for a number of years, so we’re starting to see the results there. We do think this was a low quarter for energy, and we do see some recovery off this low. So we’re pretty confident in both markets going forward.

[Pete Skibitski:]

So Tom, on the energy side, right now, it’s more so economic weakness in Asia is impacting you more so than the price of oil declining? Is that a fair statement to make, would you say?

[Thomas Gendron:]

No, what really had the bigger impact in Asia, and particularly in China, we saw volatility really due to the fact that fuel type, between diesel and natural gas, the prices are set by the government versus the market. And for a while, they were out of balance. And the delta in price between diesel and natural gas drives a lot of the natural gas business. So for about a quarter, that was out of balance, and it’s now come back into balance. So we see that progressing for the rest of the year. As I said, when you have prices set somewhat artificially, it induces volatility. We always anticipate volatility in those markets and we did get it, but look forward, we think it will be more positive for the remainder of the year.

[Pete Skibitski:]

And if I could sneak in one more, on the A320neo, that, I think the entry into service of that is creeping closer and closer. Just wondering, what kind of ramp are you guys expecting on that program, because it’s getting, like I said, fairly close. Just wondering, kind of a slow ramp over a couple of years, or pretty dramatic? And will we kind of see that show through in aerospace in the near future?

[Thomas Gendron:]

The ramp is kind of set there of course by Airbus. And we’re not predicting anything different than they’re showing publicly. But because of the significant content gains, it is going to start impacting sales in 2016. The ramp will have a good sized effect on our aerospace business. So it’s a positive for us starting in 2016, and of course, in 2017, when the Max kicks in, it will have a ramp too, as they transition from next generation to the Max. So between those two, you’re going to see several years of ramping up. But because of the big content gains, it will be material for Woodward starting next year.

[Operator:]

And our next question comes from William Bremer from Maxim Group.

[William Bremer:]

In particular, you called out the second quarter is pretty much going to be the trough. What specific lines will lead you higher in the back half of this year?

[Thomas Gendron:]

You say specific line. I think obviously aerospace will remain strong. The defense side of the equation has been strong. We continue to believe that that will continue. Most of the areas within energy, we also believe will be improved. So it’s really kind of across the board. Third and fourth quarter are always strong for us. Usually, it’s the first quarter that’s down and the second quarter that’s back up. But this year, the two quarters have been more on a parallel.

[William Bremer:]

No, I was specifically asking in energy, Bob. I’m sorry if I wasn’t clear. In energy, what specific product lines or services do you feel will rebound into the second half?

[Thomas Gendron:]

As I said earlier, I think it’s primarily we’ll see improvements in Asia in total and China, and I think we’ll see improvement around the C&G business.

[William Bremer:]

And then in terms of just pricing right now in general, on the energy side, do you feel as though things are holding at this level, or do you feel as though you have to be more [commentative] to your clients?

[Thomas Gendron:]

Well, you know, we always work with our customers to try to help them drive cost. What I would say is that while we’re doing that and working to help our customers be more competitive, we’re going to continue to expand margins as we’ve highlighted, with the outlook for segment margin improvement this year. So that’s our balancing, that’s kind of the value we bring into the market. So we are doing that, but at the same time, we’re increasing our earnings.

[William Bremer:]

And lastly, very nice containment on the cost side on allocated expenses. Could you sort of give us a sense of what you’re looking for, for the year there?

[Robert Weber:]

We don’t anticipate anything significant in terms of up or down. Yes, we have been enjoying both leverage and cost controls. So we said that we’ve been employing Lean across the entire organization, including administrative functions. And so we believe that’s beginning to show some nice improvements from a continuous improvement perspective, and we anticipate that that will continue to be a tailwind for us.

[Operator:]

And our next question comes from the line of JB Groh from D.A. Davidson.

[JB Groh:]

To what do you attribute the strength in military? Is it OE, aftermarket? What’s driving that, and is that sort of unexpected considering your outlook maybe at the beginning of the fiscal year?

[Robert Weber:]

So, it is both aftermarket and OEM. And I think we called out kind of the increase in activity worldwide that I think is really driving most of that. So I think obviously, last year was kind of the trough as Bill mentioned, for defense, with all the sequestration and not a lot of foreign military sales having picked up yet. This year, and I think there’s been a number of articles about how foreign military sales are really picking up.

[JB Groh:]

And then could you give me sort of the detail on the tax rate? I think you said 27% for the full year. Why was it low this quarter, and do you have an EPS impact there? What would it have been?

[Robert Weber:]

I don’t, offhand, have the [unintelligible]. We’re up about 3 points from the prior year. We’ve had quarterly variability from time to time. We have settlement of prior year tax audits that take place, and then every now and then, there’s a particular tax planning strategy that is employed at a particular point in time. But usually, those are quarterly variability. We have been fortunate last several years to be down in that 27% to 28% range. And this year, we anticipate it will be in the same spot.

[JB Groh:]

But it was roughly 24 this quarter?

[Robert Weber:]

24 and 21 last year. Very similar types of items, just different magnitudes.

[Operator:]

Our next question comes from Michael Ciarmoli from KeyBanc Capital.

[Michael Ciarmoli:]

Maybe guys, just to elaborate on William’s question, in energy, what gives you the confidence in the Chinese market improving when their economy’s clearly starting to slow? Is there anything specific that you could point to, or even more broadly, in your energy customers, whether it’s Cat or [Huai Chay] or anyone, just the pipeline, the order books, is there anything definitive we can sink our teeth into there?

[Thomas Gendron:]

The first thing is they’ve adjusted the spread on natural gas between natural gas and diesel, and for a while, they were narrowed, and they’ve now adjusted so they’re a wider spread. So that spread supports the higher cost of the natural gas engine. And with that, it’s back into the range on the spread that drives the demand. Secondly, they’re driving for implementing Euro Six emissions standards, and that’s going to require natural gas trucks and buses will help. That will impact them, and so we’re going to see more, we believe, from those two. And then overall, the economy’s a little slower than it has been in the past, but it’s still growing, as you’re well aware. But the bigger drivers for us are the diesel gas spread and the emissions standards, and both those are going in a favorable direction for us.

[Michael Ciarmoli:]

And then just on the guidance, I know you lifted the low end. It would seem, though, I guess what gets you down to that low end as you look out the next six months? You’re going to be looking at maybe earnings being down year over year if you came out at that low end. What are some of the puts and takes in the low end versus the high end?

[Thomas Gendron:]

Well, it would be unanticipated volatility. We always plan for volatility. So that’s why we put out a range, just to ensure that we can get in those categories. But I think that would be it. If you saw huge currency moves. If you saw significant changes in natural gas prices, things like that, it could drive us down. Other than that, the low end of the range is low end.

[Michael Ciarmoli:]

And then just the last one, housekeeping. I think corporate expense down $2 million sequentially. What are we looking at for the remainder of the year there, and maybe what drove that decrease?

[Robert Weber:]

Nothing unusually large or notable. I think I mentioned earlier that we do anticipate continuing to be a little more efficient in some of those categories. There can be, from time to time, projects that are [unintelligible] in terms of both legal and consulting and things like that. And so there is some element of volatility, but other than that, no significant items of an unusual nature.

[Operator:]

And our next question comes from the line of Steve Levenson from Stifel.

[Steve Levenson:]

You talked about MRO on the large frame RGTs. Do you have any comments on the outlook for new large frame RGTs?

[Thomas Gendron:]

It’s been a little slow on that. We think as you move through this year and the next year, we think you do see some demand picking up. You know, slow pickup, but going in a positive direction on that, Steve. The installed base and the higher utilization of the installed base is a big driver for us, and positive driver. So we’re bullish on the large gas turbines with OE slowly growing over time.

[Steve Levenson:]

Just watching the engine choices on the A320neo, it seems that the mix is shifting a little bit towards the Leap and away from your turbo fan. Does that change the outlook at all? Do you favor one necessarily over the other? Or does the Leap being on 737 exclusively sort of outweigh the mix shift?

[Thomas Gendron:]

Obviously, the Leap being exclusive on the Max and traditionally they split pretty close, the A329 market. So Leap is very important, of course, with that type of volume. But we have very good content on the pure power engine as well, as well as nice situations where we do well, no matter which engine is chosen on that aircraft.

[Steve Levenson:]

And last is an update on GE9X, and what’s going on there?

[Thomas Gendron:]

If you take the 777X in total, we’re still finalizing, still in the RFP proposal phase. But I’m confident we’re going to do very well on that platform. But we won’t be having any announcements for a little bit yet.

[Operator:]

[Operator instructions.] Our next question comes from the line of Pete Skibitski from Drexel Hamilton.

[Pete Skibitski:]

A couple of follow ups for Bob. Bob, are you still expecting cash taxes to be heavily weighted to the second half of this year, like they were last year?

[Robert Weber:]

Yes. They will be, yeah.

[Pete Skibitski:]

And then any change in the capex outlook? It sounds like progress is going really well. Are you guys still expecting 270 this year?

[Robert Weber:]

It is. Right now, it will remain to see how the summer goes in terms of these projects. We’re on target, and so I would imagine it will be up to 270 or perhaps a little higher if the weather holds for us in the Midwest.

[Pete Skibitski:]

And then just one last one. Tom, with the rig counts coming down, I think that was a little bit of a fear in the market, that it could impact you guys. You’re just not really seeing much of an impact from that?

[Thomas Gendron:]

We’ve seen a little bit of an impact there, but it’s been offset by other parts of our energy segment that are up. And I think that’s one of the real nice things about our portfolio, is we got a lot of balance across it. So we have been impacted there, but more than overcome by other parts of the energy value stream. We’re seeing, and what we usually say the utilization of oil and gas, is strong. The lower prices are helping that part of the market. And so we’re seeing increased demand there. Obviously a little bit lower at the rigs. Overall, it’s a positive.

[Operator:]

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

[Thomas Gendron:]

Okay, well, appreciate everybody joining us today. Thank you for the questions. And Bob, Don, and I all look forward to seeing you over the next quarter. So, thanks for joining.

[Operator:]

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 7