Woodward Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 1, 2023

There are 15 speakers on the call.

Operator

Thank you, operator.

Speaker 1

Thank you for standing by. Welcome to the Woodward, Inc. 2nd Quarter Fiscal Year 2023 Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast and then all participants are in a listen only mode. Following the presentation, you are invited to participate in a question and answer session.

Speaker 1

Joining us today from the company are Mr. Chip Blankenship, Chairman and Chief Executive Officer Mr. Mark Hartman, Chief Financial Officer and Mr. Dan Provasnik, Director of Investor Relations. I would now like to turn the call over to Mr.

Speaker 1

Provasnik. Please go ahead, sir.

Speaker 2

Thank you, operator. We'd like to welcome all of you to Woodward's Q2 fiscal year 2023 earnings call. In today's call, Chip will comment on our strategies and related markets. Mark will then discuss our financial results as outlined in our earnings release. At the end of the presentation, we will take questions.

Speaker 2

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 and on our website through May 15, 2023. The phone call for the audio replay is on the press release announcing this call as well as on our website and will be repeated by the operator at the end of the call. I would like to refer to and highlight our cautionary statement as shown on Slide 3.

Speaker 2

As always, elements of this presentation are forward looking or based on our current outlook and assumptions for the global economy and our businesses more specifically, including trends in our business, drivers in each of our segments, our updated guidance, the expected and potential effects of the ongoing supply chain and labor disruptions and net inflationary pressures. Those elements can and do frequently change. Our forward looking statements are subject to a number of risks and uncertainties surrounding those elements, including the risks we identify in our filings. In addition, Woodward is providing certain non U. S.

Speaker 2

GAAP financial measures. We direct your attention to the reconciliations of non U. S. GAAP financial measures, which are included in today's slide presentation and our earnings release and related schedules. We believe this additional financial information will help in understanding our results.

Speaker 2

Now, I will turn the call over to Chip to comment further on our results, strategies and markets.

Speaker 3

Thank you, Dan, and good afternoon, everyone. We delivered strong sales growth in the 2nd quarter, driven by robust demand for Woodward products and services across our end markets. Notably, our industrial business had a strong quarter driven by a sharp increase in shipments. The ongoing industry wide challenges, including supply chain and labor disruptions and inflation continue to impact our results. However, we are encouraged by the progress we're seeing from our strategic investments, resource reallocation and price realization initiatives.

Speaker 3

In our Q1 call, We announced streamlined aerospace and industrial organization structures designed to enhance the customer experience, simplify operations and increase profitability through improved execution. Our primary focus has been on transforming the Industrial segment where significant change is required to improve performance. I want to provide an update on the 3 main priorities that we outlined on our previous call. First was rightsizing the industrial business. We took the actions required to align our cost structure with current market conditions.

Speaker 3

You can see some of these impacts in the restructuring charges. 2nd was pricing. We are executing multiple work streams to capture prices that better reflect the value we deliver As well as offset significant inflation we have had to absorb from suppliers and our own wage rates. We are on track to achieve our 5% price realization target for fiscal year 2023. 3rd was product portfolio rationalization where we have made progress, but there is still more work to do.

Speaker 3

To provide some context, so far we have eliminated 5% of the approximately 60,000 SKUs in the Industrial segment. This is just one lever we are pulling to improve efficiency and expand available capacity. And the team did an excellent job executing this quarter, while continuing to take care of customers. In addition, across Woodward, we made notable progress on our efforts to develop and retain talent. We are benefiting from a more stable workforce in the form of productivity improvements and increased production output As our members become more proficient in their roles.

Speaker 3

Our rapid response machining centers are coming online with contributions made to our 2nd quarter output. We anticipate additional machines on the floor in May with contributions to output in June. We are also using capacity on existing machining centers to provide parts manufacturing support for both supplier bailout and permanent in sourcing While we have seen some improvement in supply based performance, we are still very active managing and problem solving with suppliers as well as their sub tiers. We're taking ground together and holding it, but we are still subject to shortages and unrealized recovery plans. Short summary, Woodward and our suppliers are getting better, but we are not out of the woods yet.

Speaker 3

I would like to recognize the contributions of our Woodward team. Our newer members have come up steep learning curves, while our experienced members have been good coaches. Many experienced engineering, quality and sourcing team members remain on temporary assignments to get us stabilized and on solid improvement paths. Thanks to our members for their efforts and results. Moving to our markets.

Speaker 3

In Aerospace, utilization rates for the commercial airline fleet continue to rise driven by increasing global passenger traffic. U. S. And European domestic passenger traffic has returned to near 2019 levels. Domestic travel in China is also increasing as restrictions ease.

Speaker 3

In addition, international travel continues to improve. In defense, we anticipate near term U. S. Procurement to increase slightly as the full year 2023 budget was approved at almost 10% higher than the previous year. In addition, rising geopolitical tensions may lead to increased international defense spending.

Speaker 3

In industrial, demand for power generation remained strong, Driven by LNG growth and continued demand for backup power at data centers. In transportation, Global Marine remains healthy with increased ship utilization and normalizing freight rates. Cruise and ferry operations have recovered back to pre COVID utilization rates, which should result in increased spare parts demand. Global marine interest in alternative fuels continues to increase, which should enhance OEM and aftermarket opportunities as multi fuel engines contain greater Woodward content. In addition, limited demand for natural gas trucks in China emerged second quarter, although future demand beyond Q3 remains unclear.

Speaker 3

For oil and gas, elevated commodity prices continue to drive higher equipment utilization, which should result in increased aftermarket demand. In summary, we believe our markets are strong as heightened demand for signals indicate continued growth and opportunity for Woodward. We remain focused on improving operational execution across the company, developing and retaining talent and innovation, All of which will position Woodward for long term sustainable growth and enhanced value for shareholders. Before I turn the call over to Mark to review our quarterly results and fiscal year 2023 outlook, I want to thank Mark for his many outstanding achievements and contributions to Woodward over the last 16 years. We wish him all the best in his future endeavors.

Speaker 4

Thank you, Chip.

Operator

Net sales for the Q2 of fiscal 2023 were $718,000,000 an increase of 22%. Sales were impacted by approximately $14,000,000 from unfavorable foreign currency exchange rates. Aerospace segment sales for the Q2 of fiscal 2023 were $437,000,000 an increase of 17%. Commercial OEM and aftermarket sales were up 30% 28%, respectively, Driven by continued recovery in both domestic and international passenger traffic and increasing aircraft utilization. Defense OEM sales were down 10% in the quarter, primarily due to lower sales of guided weapons.

Operator

With the exception of guided weapons, Defense OEM demand remained stable at elevated levels. Defense aftermarket sales increased 16%. Aerospace segment earnings for the Q2 of 2023 were $73,000,000 or 16.8 percent of segment sales compared to $60,000,000 or 16.0 percent of segment sales. The increase in Aerospace segment earnings was primarily a result of higher commercial OEM and aftermarket volume as well as price realization, partially offset by inflation, higher manufacturing costs and annual incentive compensation. Turning to Industrial.

Operator

Industrial segment sales for the Q2 of fiscal 2023 were $281,000,000 compared to $214,000,000 an increase of 31%. The increase was driven by volume increases across all markets. The sales increase was partially offset by the negative impact of foreign currency exchange rates of approximately $11,000,000 in the quarter. Industrial segment earnings for the Q2 of 2023 were $38,000,000 or 13.4 percent of segment sales, compared to $17,000,000 or 8.1 percent of segment sales. Industrial segment earnings increased due to higher volume and favorable product mix, partially offset by inflation, higher manufacturing costs and annual incentive compensation.

Operator

Non segment expenses were $58,000,000 for the Q2 of 2023 compared to $15,000,000 Adjusted non segment expenses were $23,000,000 for the Q2 of fiscal 2023 compared to $17,000,000 Adjusted non segment expenses for the 2nd quarter, excluding costs primarily related to specific charges for excess and obsolete inventory, product rationalization and restructuring to optimize the cost structure. At the Woodward level, R and D for the Q2 of 2023 was $38,000,000 or 5.3 percent of sales compared to $32,000,000 for 5.5 percent of sales. SG and A for the Q2 of 2023 was $76,000,000 compared to $44,000,000 The effective tax rate was 11.8% for the Q2 of 2023 compared to 11.4%. The adjusted effective tax rate for the Q2 of 2023 was 17.8% compared to 11.0%. Looking at cash flows.

Operator

Net cash provided by operating activities for the first half of fiscal 2023 was $40,000,000 compared to net cash provided by operating activities of $50,000,000 Capital expenditures were $44,000,000 for the first half of twenty twenty three compared to $24,000,000 Free cash flow was negative $4,000,000 for the first half of fiscal twenty twenty three compared to $26,000,000 Adjusted free cash flow was negative $1,000,000 for the first half of fiscal twenty twenty three compared to $27,000,000 The decrease in free cash flow was primarily related to increased capital expenditures. Leverage at the end of the second quarter was 2.2 times EBITDA compared to 1.8 times EBITDA. During the first half of fiscal twenty twenty three, dollars 51,000,000 was returned to stockholders in the form of $25,000,000 of dividends and $26,000,000 of repurchased shares under a board authorized share repurchase program. Lastly, turning to our fiscal 2023 outlook. We continue to expect year over year improvement in the second half of fiscal twenty twenty three.

Operator

Due to our better than expected results experienced in the Q2 as well as anticipated lower income tax rate for the full year, We are raising certain aspects of our full year guidance. Total net sales for fiscal 2023 are now expected to be between $2,701,000,000

Speaker 5

$2,810,000,000

Operator

Aerospace segment sales growth is unchanged at between 14% 19%. Industrial sales growth is now expected to be between 14% 19%. Aerospace segment earnings as a percent of segment net sales are still expected to increase by approximately 150 basis points to 200 basis points. Industrial segment earnings as a percent of segment net sales are still expected to be flat compared to fiscal 2022. The adjusted effective tax rate is now expected to be approximately 16%.

Operator

We still expect adjusted free cash flow to be between $200,000,000 $250,000,000 and capital expenditures to be approximately $80,000,000 Adjusted earnings per share is now expected to be between $3.50 $3.75 based on approximately 61,000,000 of fully diluted weighted average shares outstanding. This concludes our comments on the business and the results for the Q2 of 2023.

Speaker 3

Thanks, Mark. Before we open the call for questions, I want to share that our Investor Day will be held in New York on December 7, 2023. There will be more information to come and we hope to see you there. Operator, we're now ready to open the call to questions.

Speaker 1

Thank you, sir. The question and answer session will begin at this time. Your question will be taken in the order it is received. Please stand by for your first question, sir. And our first question comes from Rob Stinar, Melius Research.

Speaker 5

Good afternoon.

Speaker 3

Good afternoon, Rob.

Speaker 5

First, Mark, best wishes to you.

Operator

I appreciate that. Thank you, Rob.

Speaker 6

And

Speaker 5

Chip, I'm just going to focus at least to start here on industrial because I think we're all a bit surprised both at the sales strength And at the margins. So first on the sales, you talked about volume. What about price? If we take that Sales growth. Can we parse that out a little?

Speaker 3

We're not really we don't break out the price between the segments, but It was largely in line with the overall 5%, Mark.

Speaker 5

I mean, To what extent were you surprised by this? Because it just again, in both in terms of sales and margins, it's just it seems pretty strong.

Speaker 3

Well, from the sales side, it's what we've been working on since the challenges post COVID on trying to Achieve the Customer Demand. So every other conference call you were kind of making the point that we're Not making progress there, but it's starting to come through. The increase in output was really across the board Our Woodward L'Orange facilities are achieving top levels of shipments And our Fort Collins campus as well came on strong this quarter. We've made a number of changes in leadership. We have a lot of new members here in Fort Collins anyway that are getting more proficient at either machining or assembly and test.

Speaker 3

And so All these activities across the board with the supply chain getting healthier are contributing to our ability to increase the output. As far as profitability goes, it's a story of product mix. So we've had a better aftermarket Mix coming out of Woodward L'Orange and that's helped us along with China Oh coming back. Not to the highest levels you've ever seen, but some healthy orders that dropped in and were convertible inside the quarter because we had inventory prepared.

Speaker 5

Okay. And then just to close the loop on this, it seems just the way the guidance was adjusted here That the second quarter is we'll see some moderation in industrial in the back half of the year. In other words, Yes, the sales growth tails off a little bit, the margins come back down. Is that fair? Was Q2 just was it pent up shipments In addition to the everything else you said?

Speaker 3

As far as the I think it's fair to say we expect The second half to moderate on profitability in industrial, but we do we are seeing enough customer demand That if we can continue to have improvement in our supply chain as well as the output and In our factories, we'll be able to deliver largely at these kinds of rates.

Speaker 5

Okay. Thanks so much.

Speaker 7

You bet.

Speaker 1

Up next is Scott Deucho, Credit Suisse.

Speaker 4

Hey, good evening. Mark, can you say what China natural gas truck sales in the quarter and how that compares to a year ago? Also if you can give us a sense for how the China natural gas truck market is trending in 3Q so far that would be very helpful. Thank you.

Operator

Yes. So we don't break China Natural Gas out specifically. It did recover some from the very depressed levels that it has been at for the last Year plus timeframe. We don't have much visibility. I think as most of you know, we don't have much visibility in that market Beyond really our Q3 at this point.

Operator

And so that's what we're Pausing on at this point, we don't really forecast continued improvement in China.

Speaker 4

For the other question. Are the natural gas price and diesel spreads basically the same now in that market as they were in Q2? Basically just trying to What's the underlying driver if that's changed at all?

Operator

Yes. I mean, they've been approaching the spread level that historically has Produced opportunities to capture some of the on highway heavy duty truck demand That's out there from the end truck buyers. And so it's been in that ballpark. That's been that spread's been appropriate to Potentially have that be some of the reason for the demand that's happened.

Speaker 4

Okay, great. And then Chip, another question just On the initial provisioning sales into China, I think you've called that out as a potential upside driver in the past. As they reactivate their MAX fleet, has any of that come through in Q2 so far Excuse me, in Q2 or is that still to come? Thank you.

Speaker 3

We haven't seen any activity on that. We're just we're waiting to see how that develops like everybody else.

Speaker 4

Great. Thank you, guys.

Speaker 3

Welcome, Robin.

Speaker 1

We'll go to Pete Skibitski, Alembic Global.

Speaker 8

Hey, good afternoon, guys. Nice quarter. Chip, I think Rob might have touched on this a little bit, but in terms of sales of Coriant Industrial, was this more You were surprised by your ability to deliver as opposed to end market demand. Is that the right way to characterize it?

Speaker 3

Well,

Speaker 8

in terms of supply chain,

Speaker 3

I would say we were pleased with our output versus surprise. We've been trying to get to these levels of flow in our factories for a few quarters now because the demand has been sustained and high. And so as far as that goes, we made progress each month. It wasn't a hockey stick kind of performance, so that gives us confidence that we are achieving a sustainable flow in our facilities. And As long as we can keep working with our suppliers and making sure we have the right parts at the right time, we can keep achieving these Kinds of levels because the demand is there.

Speaker 3

I can assure you that right now.

Speaker 8

Okay. Okay. So maybe a little bit both demand got better and your ability to Supply, the demand got better as well. Is that fair?

Speaker 3

Well, we've had the demand for a number of quarters now, but I'd say our ability to perform is what's improved. It's really largely what I've said before about our team members coming up to speed because Maybe even half of our direct workforce has less than 2 years in the role, but every quarter They get more proficient at their roles and that's really helping us to perform.

Speaker 8

Okay. And just curious, I think last quarter you had about $60,000,000 in revenue at industrial that was still kind of You kind of categorized it as a COVID disrupted revenue. Did you work down that $60,000,000 kind of I don't know disruption or backlog, however you want to call

Speaker 3

it. We're making progress on past due commitments to customers. So we're not really calling that out anymore because it got to be such a number that it doesn't really represent an in period Discontinuity. So we have plenty of backlog and which we're excited about, and we have past due backlog that we're trying to get current on. So all that's a function of our ability to Increase output and we made some really good progress on that this quarter.

Speaker 8

Appreciate it. Last one for me, sorry to be a pest everyone on this, but Chip, just given the market in China and kind of the political situation, are you guys reaching the point that maybe You're not all that interested in the risk reward in China anymore on the LNG side?

Speaker 3

It's a challenging market. I'll just say that right now. And we have our business and we're going to run it as best we can. And that's We have to say about that at this time.

Speaker 8

Fair enough. Thanks guys.

Speaker 6

You're welcome.

Speaker 1

Your next question comes from Sheila Kahyaoglu, Jefferies.

Speaker 9

Thank you, guys. Good afternoon, Chip and Mark, thank you for all the help over the years.

Speaker 3

Hi, Sheila.

Speaker 9

Hi. Chip, I want to talk about 2 things you mentioned in your prepared remarks. First, I guess, on the line of questions, Pete just had the rationalization, the 5% of SKUs in industrial. Sort of what are the metrics that you use to rationalize products and how do you think about like the portfolio overall?

Speaker 3

So some of the key metrics we've used to as part of the rationalization is Demand in terms of consistency of demand. Is there an alternative part that's a newer part? Where it is in its product lifecycle is it in the sunset period and there's an opportunity to Replace that with a newer part at that customer. So all that sort of product lifecycle type of metrics are what we're using As well as profitability. And so when you put all that together, that's how we're making our decisions.

Speaker 3

The biggest opportunity for us really is to move customers to parts that we have a better ability To supply to them at a lower cost to us and a better value to the customer. And if we stop introducing these discontinuities into our factory and our supply base, We can achieve more with our capacity.

Speaker 9

Okay, great. And then maybe just switching gears whether it's in aero or in an industrial. When you think about improving your labor pool, you mentioned you're seeing some improvement in the process. Where are you in terms of your improvement and when do you expect to be normalized whether that's 2019 levels or for current capacity outlooks that you have?

Speaker 3

So we've been forecasting sort of getting to that place you're talking about in terms of being At a level of proficiency and capability that we're targeting on a go forward basis by the end of this fiscal year. And so I feel like we're on track for that with our team. We've seen the supply base improve as well. But like I said in the prepared remarks, we're not out of the woods yet. We graduate some suppliers from the escalated watch list, but we add some to it as well.

Speaker 3

We graduated more this quarter than we added, That's a good sign. But we're forecasting, fighting through this, probably the rest of this calendar year at least.

Speaker 1

Okay, great. Thank

Speaker 3

you. Welcome.

Speaker 1

Next, we'll go to Christopher Glynn, Oppenheimer.

Speaker 6

Thanks. Good afternoon. I wanted to go back to the Industrial Margin Outlook. So in the back half, it implies about flat year over year for the back half. While you're making a lot of changes and improvements and certainly some evidence in the second quarter, So just wondering what's masking that read through?

Speaker 3

Well, we want to be we don't want to get ahead of ourselves, Chris, in terms of our capability to deliver. The mix was what it was in the 2nd quarter from a profitability standpoint and Q1, We were short on profitability. So we want to have a balanced view on the second half. We're doing everything we can to make it Better than plan. And if it flows through in a way that we get a favorable mix and we achieve the price levels that we want and we get the productivity, It could be better, but right now we're sticking with that forecast because there's a lot of ground to cover between now and then.

Speaker 6

Okay. Understood. And relative to the 5% SKU reduction, Any way to kind of ballpark or benchmark what the ultimate target is, what range of SKU reduction you might have in mind?

Speaker 3

Well, there really isn't because the number isn't necessarily the goal. We're trying to set up our ability to serve customers With the most profitable mix that we can supply so that our customers are happy and our shareholders are happy at the same time. That's what We're driving forward towards. And I just wanted to give those numbers not necessarily as a tracker, but Just to have everyone understand the size of the effort that is involved here because it is substantial. I think we've got a ways to go, but I wouldn't put a number on it because That's not

Speaker 10

really the goal.

Speaker 6

Okay. And then just switching to defense, Are you seeing actual RFPs or inquiries We're foreground shaping up for an international demand renaissance and And remind us what proportion you serve internationally?

Speaker 3

Well, as far as new business goes, We haven't really seen much along those lines. We've seen 1 or 2, RFIs, but nothing that we could really, point towards A change in demand levels associated with that. That's more of a sort of looking at the environment and saying that Something might develop there. That's what those remarks were about. So we haven't really seen that turn into any specific programmatic demand.

Operator

And related to the how much is international related, a lot of our sales do go Through the DoD directly. So we don't always have a specific number on that as it relates to just knowing that Some of our sales to the U. S. Government do end up with our foreign military partners.

Speaker 6

Got it. Thanks for the answers. Welcome.

Speaker 1

Your next question comes from David Strauss, Barclays.

Speaker 11

Thanks. Good afternoon. Good afternoon. And Mark, thanks for all your help and best of luck. Back on the defense side, I mean, the defense drawdown that we're Still seen on the OE side.

Speaker 11

Is this still JDAM? And if so, how much more downside is there to JDAM?

Operator

Yes. So the softness on the defense side is still the guided weapon programs. There is still some Softening based on the orders that we've seen from the DoD, if you will, on that. Now the upside always there is there if there are foreign military partners that put some orders in. But as Chip was just mentioning, we haven't seen anything on that front.

Operator

So There is still some softening there that we'll see going forward.

Speaker 11

Okay. The non recurring items you Call down the quarter, excess inventory, restructuring, so on. I assume most of this is related to the industrial business. Is that correct? And Should we expect to see more of these non recurring items as you go through kind of the rationalization there?

Operator

Yes. So on the obviously there was a few different ones on there. The rationalization Piece of it was mainly on the industrial side, as Chip mentioned, with the number of SKUs that we're looking at there. There were some other items that went Across the whole business, from that perspective, the restructuring charge was another one that was primarily on the industrial side of the business. We call those out.

Operator

We consider them discrete and just trying to give a flavor for operationally what happened in the quarter. And so that's why we called those out specifically. Going forward, we would continue to call out anything that may come up. But obviously in the quarter, We had a lot of adjustments, a lot of items in this quarter that we would not anticipate that would be occurring again.

Speaker 11

Okay. And last one, I guess again for you, Mark. I mean, I was a little surprised given the sales growth in the quarter, we didn't see more of an inventory drawdown. When would you expect us to start seeing the inventory balance come down?

Operator

Yes. So as the year progresses and this is what we even called out even last quarter that this was going to be a second half improvement story. I think we even talked about in the last quarter that we didn't anticipate a significant inventory working capital improvement in the second quarter. And We do anticipate as part of our $200,000,000 to $250,000,000 guide on free cash flow that we will have Working capital improvement, including a decrease in inventory. And so that's what we always expected the year.

Operator

And I would say that we're on track with our expectation.

Speaker 11

All right. Thanks very much. Welcome.

Speaker 1

We'll now hear from Gautam Khanna, Cowen.

Speaker 10

Hey, good afternoon, guys.

Speaker 4

Good afternoon.

Speaker 10

And we'll miss you, Mark. Great working with you. Best of luck.

Operator

Thank you. Appreciate

Speaker 6

that. Of course.

Speaker 10

So I was wondering, I don't know if you said this, but Do you guys have any past dues at this point? You've quantified that level in the past couple of quarters by segment. Do you guys have that?

Speaker 3

We do have quite a bit of past due and we just don't think it's that helpful to quantify that going forward because it's not The past due isn't what's impacting our quarter sales. So, we are burning that down. We will we do forecast to Make improvements significantly on that in the second half. But as we go forward through the year, we've been I'm continually impressed with the demand that the customers are placing upon us. So as we improve our output, we continue to pile up some past dues in the backlog.

Speaker 3

So, like I said, we don't anticipate Quantifying that going forward.

Speaker 10

Okay. And this is always a tricky one for us. The non segment For the year, what do you anticipate that's going to be? Like what's implied in the guidance for the segment?

Operator

Recently, we've been 3%, 3.5% range is kind of what's implied in the guidance of sales.

Speaker 10

And I just curious of sales. Thank you. I appreciate it. And just on the portfolio review within industrial, Is it pretty much limited to SKUs or is it SKU rationalization or is it are there entire markets you're reconsidering participating in.

Speaker 3

At this time, Gautam, it's really just looking at the products and doing Good old fashioned product management, product lifecycle. Is this in early in its adoption phase? Is it at its peak? Is it on a sunset path? How should we treat it in the marketplace?

Speaker 3

How should we price it? Is there a product that comes behind it that is offers more value to customer that we can sell and get behind in a way. In terms of running our supply chain and our factories, you've got those Runners, repeaters, strangers and aliens in terms of like how often do you see this come through the factory and should we be thinking about Planning differently or eliminating some of our strangers and aliens as we say in the supply chain world and Having our operations be more efficient. There's a lot of hidden costs and a lot of hidden capacity tied up in running some of those through assembly lines. So it's really more about that than getting out of markets.

Speaker 10

Okay. And just last one Chip, One of the things, curious about is on the LEAP aftermarket, CFM talks about a 60% attach rate on OEM service contracts powered by the hour, which is about 2x what they did on the CFM. Does that have any different economic implications for Woodward, I. E. Is GE now just a CFM a bigger customer on these aftermarket sales than it was in the past and does that matter?

Speaker 10

I'm just curious how we should think about that OEM.

Speaker 3

The short answer for us about how we think about it is no. I mean, there may be some subtleties in there, but Frankly, we see the units come in from the same types of overhaul shops and that's where Things happen at the transaction basis for us. So we wouldn't really know the difference, I don't think, and we wouldn't treat it differently ourselves.

Speaker 10

The pricing would be similar in either case, in other words.

Speaker 3

Yes.

Speaker 10

Thanks, guys.

Speaker 3

You're welcome. You're welcome.

Speaker 1

Up next, we'll hear from Michael Ciarmoli, Truist Securities.

Speaker 12

Hey, good evening, guys. Nice quarter. Thanks for taking the questions. Thank you. Mark, best wishes going forward.

Speaker 8

Thank you.

Speaker 3

It's my pleasure.

Speaker 12

I guess, just one question on industrial. Did the industrial backlog grow in the quarter? I mean, based on everything you're seeing, it sounds like You know, orders continue to be robust and even though there's lots of chatter of recession, it seems like you guys aren't seeing that. Just any color on the backlog there?

Speaker 3

Yes, we are not seeing the R word. We saw our backlog grow in spite of our record deliveries out of some of our plants.

Speaker 6

Okay.

Speaker 12

And then just shifting gears, Aerospace, the Aero margins, Pretty impressive this quarter, I think multi quarter high. Was there any benefit there? I think you Kind of mentioned maybe last quarter or the quarter before that there was going to be some SKU rationalization in aero. Any Color you could provide on maybe benefits there or was it just mix that kind of and volume that drove the margins?

Speaker 3

For Arrow, the margin improvement is largely getting the volume back, getting productivity with the learning curve of our Newer members, some price at the target we're trying to achieve this year, and that Price improvement and cost improvement delivered the margin improvement, really no rationalization going on in the Aerospace segment to speak of at this time.

Speaker 12

Got it. Last one, just in terms of OEM production rates, can you give us any maybe color in terms of underlying assumptions, what's in the guidance in terms of build rates by specific platform? What are you thinking in terms of LEAP? Are you Specifically aligned with GE and Safran right now on the narrow bodies or anything you can tell us there?

Speaker 3

Well, I think I'd like to say that we're somewhat removed from the published build rates that The airframers announce and support. We're depending on where we are in the tier, We're closer to it obviously on the engine components that we provide. We are right in line with the demand from GE and Saffron on the CFM side and Pratt and Whitney on the Pure Power side. So we just, they supply us the demand and we Do our very best to ship on time.

Speaker 7

Got it. All right. Perfect. Thanks, guys. You're welcome, Ella.

Speaker 1

We'll go to Scott DeChew, Credit Suisse.

Speaker 4

Hey, thanks for taking my follow-up. Chip, my understanding is that part of what's constraining profitability in aerospace is the long term agreements on the defense side, which It sounds like in many cases don't really have any inflationary protection on them. So I guess my question is, are we at a point where You're getting some of those contracts are in price now, but you still have cost increases. So defense profitability Is kind of stable from here? Or are you at an inflection point up or down that we should be aware of?

Speaker 4

Just Trying to think about defense profitability and how it trends in the near term and medium term?

Speaker 3

I think from a defense standpoint, you should stick with the idea that that's stable. I was referring to price actions on the commercial side.

Speaker 4

Okay. And then any preview for what's going to be the focus at the Investor Day?

Speaker 3

A preview. It's a little early for the preview. We're looking to deliver on the second And let's call that the preview.

Speaker 4

All right. Fair enough. Thanks, guys.

Speaker 13

Yes. You're welcome.

Speaker 1

Next, we'll hear from Noah Poponak, Goldman Sachs.

Speaker 7

Hey, guys. Thanks. Thank you for the time. How much of the adjustments between The GAAP earnings and the non GAAP earnings are cash. And which of those do you expect to

Operator

We had a minor difference between, I'll call it reported free cash flow and adjusted free cash flow. It was $3,000,000 or so. So in the quarter, there was not Much significance in cash. Going forward, there'll be some difference mainly related to some of the restructuring charge. But it isn't a sizable number.

Speaker 6

Got it. And Mark, To

Speaker 7

get to the full year, the back half is obviously pretty strong. You have that historical seasonality to some degree. Maybe can you just talk For a minute, we have the visibility into that and how much of that is working capital release?

Operator

Yes. So if you look at the back half compared to the front half, obviously, there's a Earnings component and earnings improvement component for the second half. And then the rest will be a working capital Improvement, which includes, as I was speaking earlier on the call, the improvement on the inventory side. So there's opportunity on the working capital side also as part of that $200,000,000 to 2.50 side also as part of that $200,000,000 to $250,000,000 guide

Speaker 14

that we gave.

Speaker 7

Okay. Chip, when you were speaking about the industrial revenue performance And kind of where it goes from here. I think you made I think you stated if supply chain improvements and the operational improvements you've made Keep up that you could keep running at these levels. The industrial quarterly revenue was kind of in low $200,000,000 for a while. It's a pretty significant step up to the 281.

Speaker 7

The guidance implies that steps down sequentially 3Q, 4Q. But are you saying I guess I just want to make sure if I take what you said literally, is it in your scenario analysis that industrial Works higher sequentially off of what you just posted for the Q2.

Speaker 3

No, I didn't mean sequentially higher. And really the other variable That I perhaps left off with the China on highway is quite lumpy and we don't foresee Much demand in the second half. There's a little bit in 3Q. So, taking that out would bring the top line down a little bit. But From the baseline products in industrial coming out of our Colorado facilities and Woodward L'Orange, We foresee the ability to deliver like we delivered in March.

Speaker 7

Okay, great. That helps me better understand that. Okay. Thank you so much. Great.

Speaker 7

Appreciate

Speaker 3

Welcome. Thank you. You're welcome.

Speaker 1

Your next question is Louis Raffetto, Wolfe Research.

Speaker 13

Hey, good evening. Mark, best of luck to you as well.

Operator

Thank you.

Speaker 13

Maybe if I just go back to the last question. Can we attribute some of the margin strength in the quarter to the China natural gas and that's kind of what the pop what drove the pop and then given that you don't Necessarily see a lot of it in the back half. You're not going to guide to it in the back half, but that's what's going to bring those margins, I guess, back down?

Speaker 3

Yes, Louis, I'd attribute it to 2 things, the China Oh as well as the aftermarket The product mix coming out of Woodward L'Orange and to some extent Colorado, but mostly from our German plants. So it was the combination of that aftermarket mix and the China Oh that made the quarter Better than predicted.

Speaker 13

Okay, great. And then maybe just to stick with industrial, do you happen to have the segment growth between machinery and

Operator

I'm

Speaker 3

sorry, I couldn't understand the last few words.

Speaker 13

Sorry, just the growth of reciprocating engines and industrial turbine machinery in the quarter, so the underlying The businesses of Industrial.

Operator

Yes. They both grew very strong in the quarter. Recip engines was up over 30% and Turbomachinery is up over 25%.

Speaker 13

Great. So another real good quarter there. And maybe just one more, the interest State guide or interest guide, is it still sort of plus $10,000,000 year over year or any change there?

Speaker 14

That's accurate.

Speaker 13

All right, great. Thank you very much. You're welcome.

Speaker 1

Next is a follow-up from Pete Skibitski, Alembic Global.

Speaker 8

Yes. Thanks, guys. Just one follow-up. Industrial does have a lot of sort of short cycle, economically sensitive businesses or at least some proportion of it. I was wondering if you could characterize kind of what you're seeing in your short cycle businesses.

Speaker 8

Are you seeing any kind of global economic weakness or are things fairly steady state demand wise for you?

Speaker 3

It's pretty steady state demand wise. We're looking really hard at that because we kind of are poking at the same thing you're hinting at there that That should be our canary. That should let us know that challenging times are coming, but we don't see Penny let up on the demand right now from the short or the longer cycle part of our industrial customer base.

Speaker 8

Yes. Okay. Appreciate it. Thank you.

Speaker 3

Welcome.

Speaker 1

We'll go to Tony Bancroft, Gabelli Funds.

Speaker 14

Thanks for taking my question. Gents, Chip and team, congratulations on the quarter. Mark, Fairwinds. Thanks for all your support and hard work. Looking out for farther, Woodward They did look at, I realize it's a different team, but Woodward looked at a merger a few years ago.

Speaker 14

Now that your markets are looking pretty healthy, you guys You got good aftermarket position. You've got good positions everywhere overall in Aerospace and Defense. Where do you see yourself in the next 5 years. Has anything changed your longer term strategic plan to be the leader in energy conversion, decarbonization? Now that wide Are looking more favorable.

Speaker 14

Does Excel still make sense? Is that a possibility? Could you just give me maybe any kind of update or change?

Speaker 3

Well, no update to announce at this time. You can tune in on Investor Day for how we see the Longer term future. But I would say we're focused on fulfilling our mission as the Woodward company right now. That's where we're focused.

Speaker 14

Got it. Thanks so much.

Speaker 1

And Mr. Krowzanich, there are no further questions at this time. I will now hand the conference back to you.

Speaker 2

Thanks, operator. We want to thank everyone for joining today's call and we look forward to continuing our conversations.

Speaker 1

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to an audio replay of this conference call. It will be available today at 7:30 pm Eastern Time. The telephone number to access the replay is 1-eight hundred 770-2030 or 1-six forty seven-three sixty two-nine199. Reference access code 4,278,216.

Speaker 1

It will also be available at the company's website, www.woodward.com for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your lines.

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Earnings Conference Call
Woodward Q2 2023
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