Title

Presentation

Woodward, Inc. beats earnings expectations. Reported EPS is $1.01, expectations were $0.72.

Operator: Thank you for standing by. Welcome to the Woodward, Inc. Second Quarter Fiscal Year 2023 Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast. Joining us today from the company are Mr. Chip Blankenship, Chairman and Chief Executive Officer; Mr. Mark Hartman, Chief Financial Officer; and Mr. Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Mr. Provaznik. Please go ahead, sir.

Dan Provaznik: Thank you, operator. We’d like to welcome all of you to Woodward’s second quarter 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. 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. 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. 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. Now I will turn the call over to Chip to comment further on our results, strategies and markets.

Chip Blankenship: Thank you, Dan, and good afternoon, everyone. We delivered strong sales growth in the second 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, continued to impact our results. However, we are encouraged by the progress we’re seeing from our strategic investments, resource reallocation and price realization initiatives. In our first quarter 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 three 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. You can see some of these impacts in the restructuring charges. Second 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. Third was product portfolio rationalization, where we have made progress, but there is still more work to do.

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. Our rapid response machining centers are coming online with contributions made to our second 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 actions. While we have seen some improvement in supply base 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. 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. 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. 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. In Industrial, demand for power generation remains 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 in second quarter, although future demand beyond third quarter remains unclear. 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 enhance 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.

Mark Hartman: Thank you, Chip. Net sales for the second quarter of fiscal 2023 were $718 million, an increase of 22%. Sales were impacted by approximately $14 million from unfavorable foreign currency exchange rates. Aerospace segment sales for the second quarter of fiscal 2023 were $437 million, an increase of 17%. Commercial OEM and aftermarket sales were up 30% and 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. With the exception of guided weapons, defense OEM demand remained stable at elevated levels. Defense aftermarket sales increased 16%.

Aerospace segment earnings for the second quarter of 2023 were $73 million or 16.8% of segment sales compared to $60 million or 16.0% 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. Industrial segment sales for the second quarter of fiscal 2023 were $281 million compared to $214 million, 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 million in the quarter. Industrial segment earnings for the second quarter of 2023 were $38 million or 13.4% of segment sales compared to $17 million or 8.1% 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. Non-segment expenses were $58 million for the second quarter of 2023 compared to $15 million. Adjusted non-segment expenses were $23 million for the second quarter of fiscal 2023 compared to $17 million. Adjusted non-segment expenses for the second quarter excluded 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&D for the second quarter of 2023 was $38 million or 5.3% of sales compared to $32 million or 5.5% of sales. SG&A for the second quarter of 2023 was $76 million compared to $44 million.

The effective tax rate was 11.8% for the second quarter of 2023 compared to 11.4%. The adjusted effective tax rate for the second quarter of 2023 was 17.8% compared to 11.0%. Looking at cash flows. Net cash provided by operating activities for the first half of fiscal 2023 was $40 million compared to net cash provided by operating activities of $50 million. Capital expenditures were $44 million for the first half of 2023 compared to $24 million. Free cash flow was negative $4 million for the first half of fiscal 2023 and compared to $26 million. Adjusted free cash flow was negative $1 million for the first half of fiscal 2023 compared to $27 million. The decrease in free cash flow was primarily related to increased capital expenditures. Leverage at the end of the second quarter was 2.2x EBITDA compared to 1.8x EBITDA.

During the first half of fiscal 2023, $51 million was returned to stockholders in the form of $25 million of dividends and $26 million 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 2023. Due to our better-than-expected results experienced in the second quarter 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 $2.70 billion and $2.80 billion. Aerospace segment sales growth is unchanged at between 14% and 19%. Industrial sales growth is now expected to be between 14% and 19%.

Aerospace segment earnings as a percent of segment net sales are still expected to increase by approximately 150 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%. We still expect adjusted free cash flow to be between $200 million and $250 million and capital expenditures to be approximately $80 million. Adjusted earnings per share, is now expected to be between $3.50 and $3.75 based on approximately 61 million of fully diluted weighted average shares outstanding. This concludes our comments on the business and the results for the second quarter of 2023.

Chip Blankenship: 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 are now ready to open the call to questions.

Operator: And our first question comes from Rob Spingarn, Melius Research.

Rob Spingarn: Good afternoon.

Chip Blankenship: Good afternoon, Rob.

Rob Spingarn: First, Mark, best wishes to you.

Mark Hartman: I appreciate that. Thank you, Rob.

Rob Spingarn: And Chip, I am just going to focus at least to start here on Industrial, because I think we are 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?

Chip Blankenship: We are not really – we don’t break out the price between the segments, but it was largely in line with the overall 5% mark.

Rob Spingarn: I mean, to what extent were you surprised by this? Because it’s just – again in both in terms of sales and margins, it’s just – it seems pretty strong.

Chip Blankenship: Well, from the sales side, it’s what we have 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 are not making progress there, but it’s starting to come through. The increase in output was really across the board at Industrial. Our Woodward L’Orange facilities are achieving top levels of shipments, and our Fort Collins campus as well came on strong this quarter. We have 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. 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 we’ve ever seen, but some healthy orders that dropped in and were convertible inside the quarter because we had inventory prepared.

Rob Spingarn: 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 will see some moderation in Industrial in the back half of the year. In other words, 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 everything else you said?

Chip Blankenship: 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 will be able to deliver largely at these kinds of rates.

Rob Spingarn: Okay, thanks so much.

Chip Blankenship: You bet.

Operator: Next is Scott Deuschle, Credit Suisse.

Scott Deuschle: Hey, good evening. Mark, can you say what China natural gas truck sales were 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.

Mark Hartman: 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 time frame. 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. And so that’s what we’re pausing on at this point. We don’t really forecast continued improvement in China.

Scott Deuschle: 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 the underlying driver if that’s changed at all?

Mark Hartman: Yes. I mean they have 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.

Scott Deuschle: 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 – or excuse me, in Q2? Or is that still to come? Thank you.

Chip Blankenship: We haven’t seen any activity on that. We’re just – we’re waiting to see how that develops like everybody else.

Scott Deuschle: Great. Thank you, guys.

Chip Blankenship: Welcome, Scott.

Operator: We will go to Pete Skibitski, Alembic Global.

Pete Skibitski: Hey, good afternoon, guys. Nice quarter.

Chip Blankenship: Thank you.

Pete Skibitski: Chip, I think Rob and I touched on this a little bit, but in terms of sales this quarter in 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 in terms of the supply chain?

Chip Blankenship: Well, 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. I can assure you that right now.

Pete Skibitski: Okay. Okay. So maybe a little bit of both. Demand got better and your ability to supply the demand got better as well. Is that fair?

Chip Blankenship: 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 to – us to perform.

Pete Skibitski: Okay. And just curious, I think last quarter, you had about $60 million in revenue at Industrial that was still kind of – you categorized it as COVID-disrupted revenue. Did you work down that $60 million kind of, I don’t know, disruption or backlog, how everyone you want to call it?

Chip Blankenship: We’re making progress on past due commitments to customers. 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.

Pete Skibitski: Appreciate it. Last one for me, sorry to be past 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?

Chip Blankenship: 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 as we can. And that’s all we have to say about that at this time.

Pete Skibitski: Fair enough. Thanks, guys.

Chip Blankenship: You are welcome.

Mark Hartman: Thank you. You are welcome.

Operator: Your next question comes from Sheila Kahyaoglu, Jefferies.

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

Mark Hartman: Hi, Sheila.

Sheila Kahyaoglu: Hi, Chip, I wanted to talk about two 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?

Chip Blankenship: 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 this product life cycle? Is it in the sunset period and there is an opportunity to replace that with the newer part at that customer? So all that sort of product life cycle 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. 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.

Sheila Kahyaoglu: Okay. Great. And then maybe just switching gears, whether it’s in aero or in 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?

Chip Blankenship: 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’re – 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. We graduated more this quarter than we added. So that’s a good sign. But we’re forecasting fighting through this probably the rest of this calendar year at least.

Sheila Kahyaoglu: Okay. Great. Thank you.

Chip Blankenship: Welcome.

Operator: Next, we will go to Christopher Glynn, Oppenheimer.

Christopher Glynn: 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 some – certainly some evidence in the second quarter. So just wondering what’s masking that read-through?

Chip Blankenship: 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 second quarter from a profitability standpoint and first quarter, 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 planned. 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, then it could be better. But right now, we’re sticking with that forecast because there is a lot of ground to cover between now and then.

Christopher Glynn: 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?

Chip Blankenship: 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 really the goal.

Christopher Glynn: Okay. And then just switching to defense. Are you seeing actual RFPs or inquiries or foreground shaping up for an international demand renaissance? And maybe remind us what proportion you serve internationally.

Chip Blankenship: Well, as far as new business goes, we haven’t really seen much along those lines. We’ve seen one or two 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, 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.

Mark Hartman: Yes. 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.

Christopher Glynn: Got it. Thanks for the answers.

Chip Blankenship: Welcome.

Operator: Your next question comes from David Strauss, Barclays.

David Strauss: Thanks, good afternoon. Mark, thanks for all your help and best of luck.

Mark Hartman: Thank you.

David Strauss: Back on the defense side, I mean the defense drawdown that we’re still seeing on the OE side, is this still JDAM? And if so, how much more downside is there to JDAM?

Mark Hartman: 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. So there is still some softening there that we will see going forward.

David Strauss: Okay. The non-recurring items you called out in 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?

Mark Hartman: Yes. So on – 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 called those out. 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.

David Strauss: 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 is. When would you expect us to start seeing the inventory balance come down?

Mark Hartman: 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 significant inventory, working capital improvement in the second quarter. And so we do anticipate as part of our $200 million to $250 million 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, and I would say that we’re on track with our expectations.

David Strauss: Alright. Thanks very much.

Mark Hartman: Welcome.

Operator: We will now hear from Gautam Khanna, Cowen.

Gautam Khanna: Hey. Good afternoon guys.

Chip Blankenship: Good afternoon.

Gautam Khanna: And we will miss you, Mark. It’s been great working with you. Best of luck.

Mark Hartman: Thank you. Appreciate that.

Gautam Khanna: Of course. So, I was wondering, I don’t know if you said this, but do you guys have any past dues at this point? You have quantified that level in the past couple of quarters by segment. Do you guys have that?

Chip Blankenship: 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 have been 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. So, like I have said, we don’t anticipate quantifying that going forward.

Gautam Khanna: 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 non-segment?

Mark Hartman: Recently, we have been 3%, 3.5% range is kind of what’s implied in the guidance of sales.

Gautam Khanna: Of sales, thank you and 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 are reconsidering participating in?

Chip Blankenship: At this time, Gautam, it’s really just looking at the products and doing good old-fashioned product management, product life cycle. Is this early in its adoption phase, is it at its peak, is it on a sunset path, how should we treat it in the marketplace, how should we price it up, is there a product that comes behind it that is offers more value to the customer that we can sell and get behind in a way. In terms of running our supply chain in our factories, you have got those runners, repeaters, strangers and aliens from it 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 is 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.

Gautam Khanna: 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 to see if I am a bigger customer on these aftermarket sales than it was in the past? And does that matter? I am just curious how we should think about that OEM?

Chip Blankenship: 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.

Gautam Khanna: The pricing would be similar in either case, in other words?

Chip Blankenship: Yes.

Gautam Khanna: Thanks guys.

Chip Blankenship: You’re welcome.

Operator: Up next, we will hear from Michael Ciarmoli, Truist Securities.

Michael Ciarmoli: Hey. Good evening guys. Nice quarter. Thanks for taking the questions.

Chip Blankenship: Thank you.

Michael Ciarmoli: Mark, best wishes going forward. It’s been a pleasure.

Mark Hartman: Thank you.

Michael Ciarmoli: I guess just one question on industrial. Did the industrial backlog grow in the quarter? I mean based on everything you are seeing, it sounds like orders continue to be robust. And even though there is lots of chatter of recession, it seems like you guys aren’t seeing that. Just any color on the backlog there?

Chip Blankenship: We are not seeing the R word. We saw our backlog grow in spite of our record deliveries out of some of our plants.

Michael Ciarmoli: Okay. 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 had 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 end volume that drove the margins?

Chip Blankenship: For aero, 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 are 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.

Michael Ciarmoli: 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 rate by specific platform? What do you think 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?

Chip Blankenship: Well, I think I like to say that we are somewhat removed from the published build rates that the airframers announce and support. We are – depending on where we are in the tier, we are closer to it, obviously, on the engine components that we provide. We are right in line with the demand from GE and Safran on the CFM side and Pratt & Whitney on the pure power side. So, we just – they supply us the demand, and we do our very best to ship on time.

Michael Ciarmoli: Got it. Alright. Perfect. Thanks guys.

Chip Blankenship: You’re welcome.

Operator: We will go to Scott Deuschle, Credit Suisse.

Scott Deuschle: 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 are getting some of those contracts re-priced 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? Just trying to think about defense profitability and how it trends in the near-term and medium-term.

Chip Blankenship: 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.

Scott Deuschle: Okay. And then any preview for what’s going to be the focus at the Investor Day?

Chip Blankenship: Preview, it’s a little early for the preview. We are looking to deliver on the second half, and let’s call that the preview.

Scott Deuschle: Alright. Fair enough. Thanks guys.

Chip Blankenship: Yes.

Operator: Next, we will hear from Noah Poponak, Goldman Sachs.

Noah Poponak: 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 occur again in the back half, if at all?

Mark Hartman: Yes. We had a minor difference between, I will call it, reported free cash flow and adjusted free cash flow. It was $3 million, so in the quarter, there was not much significance in cash. Going forward, there will be some difference mainly related to some of the restructuring charge, but it isn’t a sizable number.

Noah Poponak: Got it. And Mark, the – to 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 about the visibility into that and how much of that is working capital release?

Mark Hartman: Yes. So, if you look at the back half compared to the front half, obviously, there is 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 is opportunity on the working capital side also as part of that $200 million to $250 million guide that we gave.

Noah Poponak: 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 have stated if supply chain improvements and the operational improvements you have made keep up that you could keep running at these levels. The industrial quarterly revenue is kind of in low-$200 million for a while. It’s a pretty significant step-up to the $281 million. The guidance implies that steps down sequentially 3Q, 4Q. But are you – 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 second quarter?

Chip Blankenship: No. I didn’t mean sequentially higher. And really, the other variable that I perhaps left off was the China on highway is quite lumpy, and we don’t foresee much demand in the second half. There is 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.

Noah Poponak: Okay. Great. That helps me better. I understand that. Okay. Thank you so much.

Chip Blankenship: Thank you. You’re welcome.

Operator: Your next question is Louis Raffetto, Wolfe Research.

Louis Raffetto: Hey. Good evening. Mark, best of luck to you as well.

Mark Hartman: Thank you.

Louis Raffetto: 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 are not going to guide to it in the back half that that’s what’s going to bring those margins, I guess back down?

Chip Blankenship: Yes. Louis, I would attribute it to two things. The China OH as well as the aftermarket 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.

Louis Raffetto: Okay. Great. And then maybe just with industrial, do you happen to have the segment growth between machinery and engine?

Chip Blankenship: I am sorry. I couldn’t understand the last few words.

Louis Raffetto: Sorry, just the growth of reciprocating engines and industrial turbomachinery in the quarter, so the underlying businesses of industrial?

Mark Hartman: Yes. They both grew very strong in the quarter. Recip engines was up over 30% and turbomachinery was up over 25%.

Louis Raffetto: Alright. Great. So, another real good quarter there. And maybe just one more, the interest rate guide or interest guide, is it still sort of plus-$10 million year-over-year or any change there?

Mark Hartman: That’s accurate.

Louis Raffetto: Alright. Great. Thank you very much.

Mark Hartman: You’re welcome.

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

Pete Skibitski: Yes. Thanks guys. Just one follow-up, industrial does have a lot of sort of short-cycle, economically sensitive businesses or early some proportion of it. Was wondering if you could characterize kind of what you are seeing in these short-cycle businesses. Are you seeing any kind of global economic weakness, or are things fairly steady state demand-wise for you?

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

Pete Skibitski: Yes. Okay. Appreciate it. Thank you.

Chip Blankenship: You’re welcome.

Operator: We will go to Tony Bancroft, Gabelli Funds.

Tony Bancroft: Thanks for taking my question gents. Chip and team, congratulations on the quarter. Mark, fair winds, thanks for all your support and hard work. Looking out farther, Woodward maybe look at – I realize different team, but Woodward looked at a merger a few years ago. Now that your markets are looking pretty healthy, you guys got good aftermarket condition, you have got good positions everywhere overall, 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 widebodies are looking more favorable, does excel still make sense, is that a possibility, could you just give me maybe any kind of update or change?

Chip Blankenship: 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 are focused on fulfilling our mission as the Woodward company right now, that’s where we are focused.

Tony Bancroft: Got it. Thanks so much.

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

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

Operator: 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 p.m. Eastern Time. The telephone number to access the replay is 1-800-770-2030 or 1-647-362-9199, reference access code 4278216. 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.