Woodward - Earnings Call - Q2 2021

Transcript

Speaker 0

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

Joining us today from the company are mister Tom Gendrick, chairman and chief executive Bob Weber, Vice Chairman and Chief Financial Officer and Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer. I would now like to turn the call over to Mr. Guzzardo.

Speaker 1

Thank you, operator.

Speaker 2

We would like to welcome all of you to Woodward's second quarter fiscal year twenty twenty one earnings call. In today's call, Tom will comment on our markets and related strategies, and Bob 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 05/17/2021. The phone number 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 three. 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 the ongoing COVID nineteen pandemic. Those elements can and do frequently change.

Please consider our comments in light of the 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 information will help in understanding our results. Now turning to our results for the second quarter. Net sales for the 2021 were $581,000,000 compared to $720,000,000 for the prior year quarter.

Net earnings and adjusted net earnings for the 2021 were both $68,000,000 or $1.04 per share. For the second quarter of twenty twenty, net earnings were $91,000,000 or $1.41 per share, and adjusted net earnings were $104,000,000 or $1.61 per share. Net sales and net earnings were up 864% respectively when compared to the first quarter of twenty twenty one. Net cash provided by operating activities was $219,000,000 for the 2021 compared to $52,000,000 for the same period of the prior year. Free cash flow and adjusted free cash flow for the 2021 were both $2.00 $6,000,000 For the first half of twenty twenty, free cash flow was $23,000,000 and adjusted free cash flow was $55,000,000 Now I will turn the call over to Tom to comment further on our results, strategies and markets.

Thank you, Don,

Speaker 1

and good afternoon, everyone. The 2021 showed improved results from our first quarter, and we believe our markets will continue to improve for the remainder of the year and into 2022. The aggressive actions we have taken to address this unprecedented crisis continue to drive strong cash flow, improve our liquidity and overall financial position, enable ongoing investments and opportunity for growth. While COVID nineteen vaccinations gain momentum, increases in cases persist across the globe, continuing to drive uncertainty with respect to the pace of economic recovery. Moving to our markets.

Aerospace continues to feel pressure, although it is encouraging to again see the sequential improvement from the prior quarter. The sustained depression of global passenger traffic resulting from the pandemic continues to impact commercial aerospace markets. However, we are seeing positive indicators such as improving passenger traffic, increasing aircraft build rates and utilization, and the return to service of the Boeing seven thirty seven MAX. Importantly, production rates of the MAX, on which we have significant content, are expected to increase during the year. We're encouraged by these trends and expect the continued vaccine roll up to have a positive impact on commercial aerospace.

Defense spending remains strong with respect to both OEM and aftermarket activity. We see continued strength in guided weapons through the remainder of this year with moderation expected next year. Turning to our industrial markets. In power generation, demand for gas turbines remained steady at historically low levels, although we anticipate a recovery in 2022. Aftermarket activity is starting to recover, largely driven by depleted inventories and resumption of maintenance projects.

Global energy production continues the shift to natural gas and renewables to support initiatives to reduce emissions. In transportation, China natural gas truck demand continues to be strong, driven by favorable pricing and increased regulations to improve emissions. Government initiatives supporting natural gas trucks are also emerging in several other countries. The global marine market is showing signs of improvement with increases in both demand for new vessels and global freight pricing. Repair and overhaul projects that were postponed due to the pandemic are also beginning to pick up.

The oil and gas market remains challenging. However, global demand and increasing oil prices are beginning to drive investment in drilling, fracking, and natural gas compression. In summary, we delivered strong financial performance as our markets showed signs of economic recovery. We will continue to closely monitor the situation as we progress through the back half of the year. As the pandemic unfolded, we reacted quickly to navigate the uncertain market environment, reduce our cost structure, increase our focus on operational excellence, and prioritize diligent cash management.

In addition, we continue to gain market share in both our aerospace and industrial segments, and we won new programs during the downturn. We believe Woodward is emerging from this unprecedented crisis an even stronger company. Now before turning the call over, Bob Weber announced his intention to retire in January. He will retire from his role as chief financial officer effective September 30 and will serve as a special adviser to me for an interim period. I wanna thank Bob for his dedication and valuable contributions during his more than fifteen year tenure at Woodward.

Under Bob's leadership, the company has grown tremendously, and we have delivered exceptional value to our shareholders over his career. I truly appreciate the partnership and friendship we have built over the years, and I'm excited for him as he enters this next phase of his life. Bob, we wish Patty and you all the best. We also announced that Mark Hartman, who is currently our senior vice president, finance and corporate controller, will be appointed as Chief Financial Officer effective October 1. I look forward to working with Mark in his new role and leveraging his extensive experience to drive Woodward's continued growth and success.

Now I'll turn the call over to Bob to discuss our financials in more detail.

Speaker 3

Thank you very much, Tom. Aerospace segment sales for the 2021 were $365,000,000 an increase of 23% from the prior year quarter. Commercial OEM and aftermarket sales remain weak compared to the prior year as a result of the pandemic, with commercial OEM down 30% and aftermarket down 42%. On the bright side, sequentially, commercial OEM was up 34% and commercial aftermarket was up 18% driven by increasing build rates and passenger traffic. Defense OEM was down slightly in the quarter compared to a strong second quarter of the prior year, primarily due to lower sales of guided weapons, partially offset by higher sales in both fixed wing and rotorcraft.

Defense aftermarket sales were down compared to the prior year quarter, although activity and backlog remained solid. Aerospace segment earnings for the 2021 were $69,000,000 or 18.9% of segment sales compared to $118,000,000 or 24.8% of segment sales for the second quarter of twenty twenty. The decline in segment earnings compared to the prior year was the result of lower volume, partially offset by cost reduction initiatives. Turning to Industrial, Industrial segment sales for the 2021 were $217,000,000 compared to $246,000,000 in the prior year period. Excluding the renewable power systems and related businesses, which I will refer to as RPS, Industrial segment sales for the 2020 were $215,000,000 The slight increase in industrial sales excluding RPS was primarily due to strong demand in the current quarter for China natural gas engines and the positive effects of foreign currency exchange rates, partially offset by weak oil and gas and the ongoing impacts of the pandemic.

Industrial segment earnings for the 2021 were $28,000,000 or 12.9% of segment sales compared to $26,000,000 or 10.6% of segment sales in the prior year. The increase in Industrial segment earnings was primarily the result of cost reduction initiatives. For the second quarter of twenty twenty, Industrial segment earnings excluding RPS were $25,000,000 or 11.6% of segment net sales. Industrial segment earnings as a percent of sales for the 2021 were 14% compared to industrial segment earnings excluding RPS of 11.8% for the same period of the prior year. The improved earnings are a result of the many actions we have been taking to optimize our product portfolio and global footprint.

Non segment expenses and adjusted non segment expenses were both $10,000,000 for the 2021 compared to non segment expenses of $28,000,000 and adjusted non segment expenses of $11,000,000 for the same period last year. At the Woodward level, R and D for the 2021 was $28,000,000 or 4.8% of sales compared to $35,000,000 or also 4.8% of sales for the prior year quarter. The decrease in R and D was mainly due to quarterly variability of project expenses and customer funding. SG and A for the 2021 was $44,000,000 compared to $58,000,000 for the prior year quarter, which included $17,000,000 in merger and divestiture transaction costs. The effective tax rate and the adjusted effective tax rate were both 13% for the second quarter of twenty twenty one.

For the second quarter of twenty twenty, the effective tax rate was 14.8% and the adjusted effective tax rate was 16.2%. Looking at cash flows, net cash provided by operating activities for the 2021 was $219,000,000 compared to $52,000,000 for the prior year period. Capital expenditures were $13,000,000 for the 2021 compared to $29,000,000 for the prior year period. Free cash flow and adjusted free cash flow for the 2021 were both $2.00 $6,000,000 compared to free cash flow of twenty three million dollars and adjusted free cash flow of $55,000,000 for the prior year period. The increase in free cash flow and adjusted free cash flow was primarily related to effective working capital management and lower capital expenditures.

We have reduced our leverage to 1.7 times EBITDA at the end of the second quarter compared to 1.9 times at the end of the prior year quarter. Lastly, turning to our fiscal twenty twenty one outlook. The ongoing rollout of vaccines across many countries is driving optimism for economic recovery. But the enduring turbulence caused by the COVID-nineteen pandemic, including significantly reduced global passenger travel and new viral variants continues to cloud near term forecasts. While we believe many of our markets will improve for the remainder of this year and into 2022, we will continue to withhold guidance as we navigate the uncertain economic landscape.

This concludes our comments on the business and results for the second quarter of twenty twenty one. Operator, we are now ready to

Speaker 4

open the call to questions.

Speaker 0

Thank you. The question and answer session will begin at this If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your push button phone. Should you wish to withdraw a question, press the pound key. Your Your first question comes from the line of Robert Spingarn from Credit Suisse.

Please state your question.

Speaker 5

Good afternoon.

Speaker 1

Good afternoon, Robert.

Speaker 6

So I have a couple of questions, but I wanted to start with just on the aerospace margins. They're pretty good and they're almost back to where you've been. And with the tailwinds you have for the rest of the year, with just fundamentals improving, you're going to have a mixed tailwind. Can you hit 20% plus margins here in fiscal third or fourth quarter?

Speaker 1

You know, it's a it's a great question. You know, as we're highlighting, we're not giving guidance. We we definitely believe there will be an aftermarket tailwind coming, you know, as, more aircraft are brought online, the utilization goes up. So we're we're confident, you know, in our longer term guidance for both segments. So we're on the path to get there, Rob, you know.

So we'll just have to see how the market materializes. And as we get the sales growth, we're going lever that into improved profitability.

Speaker 6

Okay. Tom, can you give us any detail or Bob on in the aftermarket, if the improvement or how we think about provisioning versus regular spare sales as that improves?

Speaker 1

Yes. Is

Speaker 6

one stronger than the other?

Speaker 1

Right now, it's stronger on the repair and overhaul side than on provisioning. But we do anticipate as we move later this year into next year, we'll start to see provisioning recover.

Speaker 6

Okay. And then, Tom, I wanted to follow-up on your comment. I think it was your comment on MAX that the rates will rise throughout the year, throughout calendar 'twenty one. But I was hoping you could be a little bit more specific with your inventory position there and current rates. And then as demand recovers, I wanted to get a sense of how quickly you can ramp beyond '31 given that you're capacitized, I assume, for '52 or '57?

And at that point, is the gating factor just labor?

Speaker 1

Yeah. So you're you're correct on that. You know, that we we were sized and to support the higher rates both for the max and the neo. So one of the, you know, good news as we come out of the pandemic is we have the capital equipment to support the highest rates that we anticipate that Airbus and Boeing will be going to. So that that's good news as we go forward.

We are onboarding, new members, to support the ramp up. We put together some, you know, innovative and extensive training sessions to you know, some of them are members we're bringing back that were either laid off or furloughed. Others are new members, you know, moving forward. But we're confident in our ability to onboard, you know, members to help support the the ramp. The ramp, the other comment on inventory in the system, the inventory was depleted.

So there's a combination. We will see some inventory increasing. We're on track and ahead of the production we will be ahead of the production rate ramp. There is still a lot of uncertainty around the production rates. And so we're tracking with exactly what Boeing and Airbus are saying they want to achieve.

And but I think there's going be some volatility in those rates over the next you know, six, twelve months.

Speaker 6

Okay. And just normally, what's your lead time relative to Boeing's delivery to the end customer?

Speaker 1

Yeah. Normally, it's, you know, it's when when you're in normal circumstances, it'd be on the order of, like, you know, four or five months. Okay.

Speaker 6

Alright. Thanks, Tom. Appreciate

Speaker 1

it. Sure.

Speaker 0

Your next question is from Sheila Kahyaoglu from Jefferies. Please state your question.

Speaker 7

Hi. Good afternoon, Tom and Bob. Congratulations again.

Speaker 8

Thank you again.

Speaker 7

I'll maybe stick to one or two. Tom, I don't know. Maybe this is for you. A little bit on the aftermarket, we touched on it with Rob a little bit on the short term, but also the longer term on your aftermarket. How do you kinda think about it?

You know, what's provisioning been historically of your sales, and what what does it look like? Does the way you sell to airlines change because of the pandemic at all or because you've upped your max content, of course, in the a three twenty? So maybe if you could talk about aftermarket expectations both near term and longer term.

Speaker 1

Sure. I'll start, Bob chime in anytime. Sure.

Speaker 9

But, you know, Sheila, the first

Speaker 1

you know, I kinda wanna, you know, maybe lay some groundwork. As we look at the aircraft coming back into service, and I guess it goes without saying most everybody knows that they're bringing the newer, more efficient aircraft back in service. They're retiring some of the older aircraft. And as we look forward, if we call it the demographics of the fleet, are gonna be very favorable in terms of the aircraft we have more content on. And so we're starting to see that just in utilization and aircraft being returned to service.

So the point of that is, longer term, we we think we're gonna have tremendous aftermarket revenue coming in, you know, as the aircraft are brought in service, airlines start taking new deliveries of the, you particularly the new narrow bodies and the new wide bodies where we have significant content. So that's looking very favorable to us. And, you know, we anticipate as those utilization rates go up, we're gonna start seeing more maintenance. And I think as you're well aware of, you know, some of our what we call legacy products, that's, you know, pre neo and max narrow bodies, V2500, CFM56, some of those are just seeing their first shop visitor come into their second. So we think the maintenance activity will start picking up and again, favorable to us.

In terms of initial provisioning, as you would expect, the airlines have, you know, they're preserving cash and being careful about that. But as we start moving in out of the pandemic, they start putting the planes into service, they start taking more of the max aircraft out of storage into service, we think we'll start seeing initial provisioning pick up. And then, know, it's definitely a good part of our aftermarket mix. Maybe more in fiscal year twenty two than the remainder of '21. And I think it's gonna take a little time for all those deliveries and and for the airlines to start picking it up.

But when we look out, it's kinda going back pre pandemic. Our demographics are positive. Our market share has improved. Utilization of the equipment we're on is going up. That all that all signals improved aftermarket over the, you know, over the next years, and I think it'll be very favorable to us.

Speaker 7

Just staying on this topic then,

Speaker 0

I guess, I I so I'm sorry if I

Speaker 7

missed it. Did you mention what initial provisioning is of overall aftermarket sales? And as these MAXs ship out of inventory, would you expect any initial provisioning with them, or those are all already allotted for?

Speaker 1

No. Sheila, most, let's phrase it this way. The the MACs that are in storage, at least for the most part, have not been provisioned of Woodward equipment.

Speaker 0

Okay.

Speaker 1

So, you know and it's it's kinda as they get taken up and, you know, the utilization starts going up, we we expect that to that to come. But, that's what I'm saying. It's more of a I think as we approach our fiscal year '22, we'll start seeing provisioning recover. It it's been very low during the pandemic.

Speaker 0

Okay. Alright. Thank you very much.

Speaker 1

You're welcome.

Speaker 0

Your next question is from Gautam Khanu from Cowen. Please state your question.

Speaker 5

Yes. Thank you, and congrats, Bob, again.

Speaker 4

Thank you.

Speaker 5

I we I guess we'll get you another comp on another call, though, still. So it's good time. That's alright. Yeah. That's alright.

You know alright. Okay. Good. Well, hey. I I was curious about if you could talk about the exit rate on the aftermarket.

You know, was it did it get did it get better through the quarter in terms of growth, or was it pretty consistent January, February, March? And and what have you seen so far through the second calendar quarter, you know, through April on the aftermarket?

Speaker 9

Yeah. We're we're seeing, I would say,

Speaker 1

month over month, the aftermarket improving. So, yeah, we're seeing the utilization. You know, we're tracking weekly utilization on all the aircraft we have content on and, you know, what's happening. We're seeing shop visits starting to increase. So it it's it's pretty much month over month, and, you know, we anticipate that continuing, kind of in conjunction with aircraft coming back into service.

So as long as, you know, we see the steady improvement, I think you're gonna see continued aftermarket growth.

Speaker 5

Okay. And could you say anything about, you know, the product types where you're seeing it? Is it on the activation? Is it on the engine components? Is it is it across both?

Any any skew either way?

Speaker 1

It's it's skewed towards the engines, Gautam. You know? So I'd say that's where, you know, traditionally, the engines are business supporting the engines has higher aftermarket than on the airframe. And and that's just truly that the engines are always running. So you generate, you know, more time and more aftermarket revenue from engines.

So so it is skewed that way.

Speaker 5

Okay. And then, you know, related to that, is there anything any between is it is it broad based, you know, or is it regionally stronger in The US? I mean, I just I'm curious. I imagine it is. It's just kind of we look at where the flight hours are

Speaker 1

are highest. Yeah. You know, that's sort

Speaker 5

of tracking to your business. Or

Speaker 1

Sure. As you're aware, you know, the hours are the most in The US and in China, and and and so that's definitely driving more of it.

Speaker 5

Okay. But forward visibility at this point, you know, into the second calendar quarter, is it is pretty good? I mean, can you see through June, you know, what the expected shop visits are supposed to be? Or or is it still kind of very, very short lead time in terms of aftermarket?

Speaker 9

We're, you know, we're seeing forecasts,

Speaker 1

from our customers and the like for shop visits.

Speaker 9

But I I would say there's still a

Speaker 1

fair amount of volatility in the market. And, you know, we're we're anticipating, you know, the aftermarket, increasing shop visits. We're planning for that. We're you know, we're doing our own internal provisioning demand planning for that. But it is still volatile and and there's still, you know, a fair amount of uncertainty around it.

But, you know, our belief is it's gonna continue to pick up and, you know, we're we're getting ourselves prepared for that.

Speaker 5

Thanks, guys, very much.

Speaker 3

Yeah. You're welcome. Thank you.

Speaker 0

Your next question is from Pete Skibitski from Alembic Global. Please state your question.

Speaker 10

Yeah. Good afternoon, Tom and Bob and Don.

Speaker 5

Hi, Pete.

Speaker 10

Hey, guys. I I just wanted to get a better sense, maybe, Tom, for you know, with two quarters left in the year, where your lack of visibility stems from? Because I think consensus, in general, expect revenue to be up in the back half of the year for you guys. You've lapped the tough COVID comps. So is it an issue where you expect revenue to be up in the back half of the year?

It's just hard to kinda ballpark a range around the revenue. And then because of that, it's hard to ballpark a margin around that. Is that kind of the logic that that drove you to not reinitiate guidance?

Speaker 9

It it you know, there's still

Speaker 1

even on the OE production rates, you know, we're still seeing you don't see variability in the rate, and we're we're still being cautious that all the rates are gonna be be met or achieved. So there's a little uncertainty there. And there's definitely uncertainty in the aftermarket. All indicators are pointing to improvement, but it's it's a challenging time, to really nail those down. Second thing, you you know, is the, definitely uncertainty wrapped around the max.

How fast will, you know, the planes get delivered? Will China approve the max? What will the utilization be on those? You know, there's a lot of factors that are still not solid. But as we're trying to say, the indicators and and the trend is going in the right direction, it looks positive.

But it's really still, with all that variability, very difficult to pinpoint the exact forecast.

Speaker 5

And then

Speaker 1

as you pointed out with the mix issues that you can have on the aerospace side there, it's hard to pin down the the margins, but, we're encouraged by the outlook.

Speaker 10

Okay. Okay. Bobby,

Speaker 3

do you

Speaker 1

want to say something?

Speaker 3

The only thing I was going to add is we were kind of focused on the aerospace side, but there's a lot of equal uncertainty on the industrial side as well. We've got the oil and gas and pricing firmed up a little there. China natural gas is always kind of variable and so on. We're seeing the marine market and that's very impactful to L'Orange start to show some signs. But they're just too early to call even on the industrial side as well.

Speaker 10

That's funny. That was actually my second question. It was the marine market. Not a particular expertise of mine. But, you know, you read these articles about bottlenecks and ports and whatnot, and it's hard to know.

You know, it seems like that's short term negative, but it also seems like maybe a positive that there's a lot of, you know, ships out there, you know, with global global trade picking up. So, I I mean I mean, is order flow picking up for you guys in marine? Is visibility picking up? Is it I was just wondering if you could maybe give us some some clarity there and maybe how Laurent has done kinda through the down cycle. That that'd be great.

Thank you.

Speaker 1

Yeah. Well, one that you're seeing is, you know, the utilization is increasing in the marine market, in particular, you know, if you wanna say in the the freight carriers. So we're seeing that. We're encouraged by the order book. It's picking up.

And we're also seeing, LNG carriers order book picking up and utilization picking up on those. And and those are, very strong programs, for for Woodward. A lot of content on those. The cruise market, it's kind of been dead, and we we've got a lot of content on the cruise ships, particularly through L'Orange and and through our traditional business. We're encouraged to see that they may be allowing cruises in The US here.

I think, you know, latest is maybe starting in July. As that gets firmed up, we think there'd be some maintenance maintenance That'll be a positive. So those are things like Bob highlighted. We see them coming.

It's just exact timing's a little hard to predict. But, overall, the marine market is, you know, recovering. The order books are picking up.

Speaker 4

Now

Speaker 1

they're long lead time orders, just so you know. I mean, they're they're out, you know, the order book goes out a couple years, you know, lead time. So but

Speaker 5

it's in a

Speaker 1

positive trend. And, you know, most important thing for us right now is the utilization, which drives the aftermarket, and and that's encouraging.

Speaker 10

Okay. I got to understand. Cruise ships, it's a pretty good chunk of L'Orange's revenue?

Speaker 1

No. It's a good part of it's a good part of the business. Good high-tech products that go in there and, you know, good aftermarket associated with the cruise ships. And that, as you know, has been dead in the water. So Yeah.

Yeah. And along with that No pun intended. Would be yeah. No. Exactly.

It'd also be fair. You know, we always take cruise ships, ferries. All that has just been, you know, not happening to in the pandemic. And if that recovers, that'll be positive. And then, like I said, the the utilization of the the cargo carriers and the like is improving, so that that that drives good business.

And then we're encouraged by the order book. So it it it's it's on a good track. And, you know, hopefully, second half of this year and the next year, we'll start seeing some recovery in those, which will will be good for our industrial segment.

Speaker 10

Okay. Just last one for me. Just on the guided weapons comments, fiscal twenty two. Are are we talking, you know, substantial declines, you know, 50 type declines or, you know, lower double digit type okay. Go ahead.

Speaker 1

No. We we see some reduction in DOD orders for the smart weapons, which may be partially offset by foreign military sales. And the foreign military sales are not firm, but we anticipate, you know, moderation or or, you know, a reduction, but it's not that dramatic as you were highlighting. So Okay. Thanks very much, guys.

Yep. Thanks, Pete.

Speaker 0

Your next question is from Christopher Glynn from Oppenheimer. Please state your question.

Speaker 9

Thanks. Good afternoon, everybody. Bob, I'll hold on for a couple days on congrats. Okay. So, on the, just curious, you know, you had for industrial a number of positive comments on utilization across transportation, marine, and general turbo machinery, oil and gas, I believe, too.

Are those kind of the best directional kind of indicators to think of in terms of fiscal second half having a little stronger volume than the first half?

Speaker 1

Yeah. We we definitely anticipate, you know, improvements in those, you know, those subsegments in industrial, you know, again, with some uncertainty wrapped around it, but we we do see that. And then traditionally, you know, as we move into the fourth quarter of our fiscal year, it's generally one of our stronger quarters. So we don't see that changing this year either. So it it's positive on the outlook with uncertainty that, you know, those things materialize.

But right now, they're on a positive trend. And you you kinda saw that here in the second quarter where year over year, we're basically flat sales. So, normally, we wouldn't say that's real positive, but during a pandemic, we think, you know, that's a that's a positive trend with improvements coming.

Speaker 9

Okay. And, are there any revenue recognition timing issues related to COVID and commissioning any any equipment or anything like that for industrial?

Speaker 1

Nothing that I would say is material.

Speaker 9

Okay. Last one for me on the aftermarket for aerospace. You had a real nice sequential pickup. Some a number of others were kind of flat, maybe even down a little ex business jet, including some of the bellwethers. So, is that just depict the volatility out there in the market?

Or is there a structural aspect to your is that the demographic shift already kind of being reflected?

Speaker 1

Yeah. I I would say because we're, you know, we're we're we're analyzing every week the fleet and the utilization of the fleet. And I definitely think it's the demographics, as we call it, of the fleet are favorable to Woodward content. And I think that's what you're seeing. And, you know, longer term, you know, we've highlighted that for years, you know, going back to when we secured, you know, all the additional content on these new new aircraft.

And I think you'll start seeing that materialize over the next number of years as they're in service and they start hitting maintenance cycles. So we think that's a positive for us.

Speaker 9

Interesting to see it out of the gate there. Thank you.

Speaker 5

Yep. Welcome. Thank you.

Speaker 0

Your next question is from Chris Howe from Barrington Research. Please state your question.

Speaker 4

Good afternoon, everyone. Thanks for taking my questions.

Speaker 8

Hi. First

Speaker 4

off, starting with the China six regulations, we've been talking about it a lot last quarter. I know it's hard to get into the weeds with it for cautionary reasons on a quarter to quarter basis. But perhaps with these going into effect in July, can you talk about your expectations in the second half for this business and your outlook in general once the regulations are going into place? I know you mentioned there were some limitations to the potential upside there on the last call. Just wanted to gain the right perspective on that.

Speaker 1

Yeah. No. Good question. You know, the the China six CECL regulations go into effect in July. The China six for natural gas are already in effect.

But what's happening and typically happens every time you have a new emission regulation, we call it kind of prebuy. So you're seeing China five diesels being purchased right now. And so that that's having a little bit of an impact, you know, and it did here in the second quarter. As we move forward, though, and you look at China six diesel versus the the China six gas engine, the cost difference has been brought closer together, and the fuel price is very favorable to natural gas. So the payback, not only in reduced emissions, but in operating cost to go to natural gas engine, truck is greatly improved.

We we have some you know, just to give you kind of ballpark, these are market forecasts for the truck, you know, the natural gas or for I'm sorry. All of the heavy duty trucks in China. Traditionally, over the last number of years, it might have been approximately 7% to 10% of the fleet was natural gas. Talking to our customers and our folks on the ground in China, believe that we might see on the order of 20% to 30% natural gas trucks as a percent of the total market going forward, which is a substantial market expansion. And, you know, we expect to do very well in holding our market share or even growing the share.

We have very, very high performing system for China six d or China six gas engines. So the the expansion of that will increase. And so as you go through the remainder of our fiscal year, but more importantly, as you go over the next couple years, we expect the natural gas percentage of the total market to improve. And that's a positive for our business longer term as that happens. So overall, the outlook's good.

A little volatility upfront, whereas Bob and I would say, there's always volatility in the China market. So we do see that, but the longer term trend is very favorable as well.

Speaker 4

Okay. That's very helpful. And I have one follow-up. You answered some of my other questions on industrial as it relates to perhaps areas that could recover in the future. Moving to aerospace though, Commercial aftermarket should recover first, narrow, then wide body.

As we kind of look at where we are now versus three months ago and we move to how we would turn a new normal, which seems to be changing on a daily basis. But how should we think about incremental margins? It's been discussed a lot. Perhaps there could be an outsized sequential improvement quarter to quarter. But as we move into fiscal year twenty twenty two and beyond, business is much stronger than it was pre pandemic.

What could we see as far as incremental margin in Aerospace? Thanks.

Speaker 3

Sure. I'll take it and Tom can jump in if he wants. From the margin standpoint, we've said the way you characterize it, aftermarket should come first followed by OEM, but the build rates are improving. So it's not a huge shift in overall mix between aftermarket and OEM. But we do believe it will be a tailwind.

We've kind of been looking at analyzing it a lot of different ways, and it's very hard to kind of triangulate on a lot of variables, obviously. But we do believe as we go into 2022 and beyond, we should see a tailwind. We've had people ask us if it's 25%, 27%, 30% segment margins. Extremely difficult to quantify, but we do believe it will be a tailwind.

Speaker 1

That's all I hear. Could you repeat that, please?

Speaker 4

That's all the questions I have. Oh, okay. Thank you. Thank you. Your

Speaker 0

next question is from David Strauss from Barclays. Please state your question.

Speaker 11

Thanks. Good afternoon.

Speaker 1

Good afternoon. So

Speaker 11

the 42%, I think, OE sequential growth that you saw this quarter, that was much stronger than what we've seen elsewhere. You know, was there any easy comparison issue or what what exactly drove that? Was there anything there besides just, you know, max being really low and starting to come back for you all, but, you know, we would have seen that with other other companies as well?

Speaker 3

Yeah. Just to check the numbers, what we gave, it was 40% 42% down year over year and 18% up for you're talking commercial aftermarket. Right?

Speaker 11

No. I'm talking actually commercial OE.

Speaker 3

Oh, I'm sorry. So that was down 30%, year over year and up 34.

Speaker 11

Up 30. Yeah. I mean, that's still yeah. I got the number. Pretty significant.

Yeah. It's still still a lot more significant than what we've seen elsewhere.

Speaker 3

Yes. And as Tom pointed out, it'll be kind of lumpy. The timing, all depends on a lot of the timing of shipments and so on and so forth. But I don't know that we would expect it to stay that that that level quarter to quarter.

Speaker 5

Okay.

Speaker 1

Yeah. You know, the only thing I would add is, you know, comparing to other companies, you know, as these rates pick up, they're definitely on the programs we have gained high market share. And so, you know, it's to me, it's not overly surprising that we have good recovery in there versus maybe somebody that is more heavily weighted to legacy programs. So that may be part of it. Yep.

Okay.

Speaker 11

How much, you know, how much of your new equipment commercial new equipment and aftermarket is is business jet related at this point? And, you know, what are you seeing on the business jet side?

Speaker 1

Yeah. Actually, business jets came through the pandemic a lot better than we thought sitting here a year ago.

Speaker 4

You

Speaker 1

know, we the the business jet market's a good market for us. We've got content, you know, I don't know, many, many of them or almost all the new aircraft out there. And that's actually held together pretty well. And, you know, the indicators are positive for increasing, OE sales. If you you know, one of the things we always track and is a good indicator is the used market.

And it's the used market available I wanna say the available early or the newer aircraft available in the used market is very low right now and surprisingly low in my my view. And so we're starting to see some OE activity, being forecasted and coming up. And, you know, right now, looks quite healthy going forward.

Speaker 11

How how much of your commercial, your aerospace business, Tom, is aftermarket, you think, at this point? Or sorry. Business shed. How much is business shed?

Speaker 1

Oh,

Speaker 5

probably,

Speaker 3

I don't know if we have that breakout, but we're somewhere in the, a little bit north of 10% overall business and general aviation.

Speaker 11

Okay. And then the last one, Bob, I guess, an update about, how you're thinking about your cash balance and what there is to do there. I assume you don't wanna be running with close to 300,000,000 in cash on the balance sheet for too long.

Speaker 3

Yeah. No. You know, we've kind of talked about, a, getting back to our pre COVID policies and directions, if you will, which is kind of 50% of net earnings being returned to shareholders and dividends and share buybacks. But most importantly, we're focused on growth. And we've talked a lot about having a number of both organic growth opportunities.

Space and missiles was one of them we called out. And also we have an inorganic funnel process like so many of our peers do and we're always looking at opportunities there. So we've always been our model is a growth model. We believe that brings the most value to our shareholders. And so no, we won't let the cash pile up for very long.

Speaker 11

Great. Thanks very much.

Speaker 0

Your next question is from Noah Poponak from Goldman Sachs. Please state your question.

Speaker 8

Hi, good evening, everybody. Congrats, Thank Bob and Mark, on the

Speaker 4

you.

Speaker 8

If I if just looked at the sequential growth rates you had in the quarter in aerospace original equipment and aerospace aftermarket, how would you expect the fiscal third and fourth quarter growth rates to compare to that just directionally? You know, about holding the same, faster, or slowing down.

Speaker 1

Well, a little bit Tim and Bob as well. But a little bit, I'd say the OE OE rates should pick up. The aftermarket, as I was highlighting earlier, is a little challenging to predict. Probably will not be as high of a growth rate as we just saw, but will continue to be, you know, very solid growth rate going forward. And hopefully, you know, in the next few quarters, we'll be able to give more color on that as we see things stabilize.

But we do anticipate, you know, continuing increases in both sides of the the market, you know, OEM and aftermarket.

Speaker 8

So, Tom, just to make sure we're we're speaking the same or talking about the same thing here, you saying you would expect that the rate of growth you had sequentially in commercial OE, which as David was just asking was surprisingly high, You're saying you expect that to stay the same or even pick up? Or or you're just saying more that, you know, production rates are gonna go higher, so that's gonna have some healthy growth rate for a while?

Speaker 1

Yeah. I think, you know, I guess what I'm saying is I think the production rates are gonna go up and we'll see overall still improved growth rate over the first or over the second quarter. Yeah.

Speaker 4

I think we're saying Okay.

Speaker 1

Yeah. I I expect the rate to improve.

Speaker 4

Yeah. Yeah.

Speaker 8

Interesting. Okay. With the commentary around guided weapons in fiscal twenty two, are you anticipating that that will drive your total defense revenue to be down in fiscal twenty two or could it still grow?

Speaker 1

You know, it's gonna have a flattening effect on defense sales.

Speaker 8

Okay. Makes sense.

Speaker 4

Yeah.

Speaker 8

And then just one more on these aerospace margins. You know, if I look back over the last several years, there's there's some years where the second quarter is seasonally strong, third quarter steps back down, fourth quarter back up. It doesn't happen every year, but it happens a decent amount of years. Is there any seasonal strength in the second quarter here where 3Q had stepped down a little and then 4Q back up? Or is seasonality out the window at There's a

Speaker 1

little bit of seasonality, and it's really making sure the airlines are ready maintenance wise for summer season, and then later for holiday season. So you do see a little bit of seasonality based on that.

Speaker 8

So if I use that and then I use the type of incremental margins you were just talking about a minute ago, year over year, it would imply the third quarter aerospace margin down a little bit and then the fourth quarter, you know, maybe sort of in the zone of the second quarter. Is that

Speaker 1

and I guess you'd yeah. And and again, no. You know what I would say when I highlighted that? That's a normal year. Okay.

And, you know, with so many aircraft just getting back in service and I think, you know, I think the airlines you know, personally, I think they did a a brilliant job of rotating assets and managing their maintenance cost. And, you know, they they they did a, you know, best they possibly could during the pandemic. But there is a pent up maintenance bubble coming, and that's another thing that's hard to forecast. But I absolutely believe you're gonna see that hit, and it's just exactly when it hits. And I'm not sure it's gonna follow normal seasonality.

That seasonality is real, but I'm not sure it applies this year. So I'd just be a little cautious on that.

Speaker 8

Okay. Interesting. Okay. Thanks so much.

Speaker 1

You're welcome.

Speaker 0

Your next question is from Pete Osterland from Truist Securities. Please state your question.

Speaker 12

Hey, good afternoon. This is Pete Osterland on for Mike Ciarmoli. Is there any additional color you can provide just on directionally how you expect margins in industrial to trend during the rest of the fiscal year? I know you previously called out that margins would take a step back in fiscal 2Q, but do you expect that from this quarter's level, they should be able to start showing sequential improvement again over the next couple of quarters?

Speaker 3

They should. Yeah. I mean, we're we're gonna have variability as we've we've kind of always had in the business. But some of the structural, the actions we've taken as we go forward should definitely provide the tailwind side of the equation. Now the headwind side is we're still not seeing any sales increases.

And one of the things we said we really needed to get to our targets, targets being 16% to 16 plus percent, was some increase in sales. And so right now, we're you know, I I think the the buzzword is we are optimism optimistic with respect to the remaining quarters of the year and going into 2022. But we really need to see the sales increase to get any leverage to be able to enhance the margins. So I think we'll see a tailwind. I don't think we're going to see our targets until we start to see much greater sales increases than we're seeing today.

Speaker 12

Great. Thanks. And then just on costs, it looks like R and D was down about $4,000,000 versus the prior quarter and SG and A down about $12,000,000 Just wondering what was driving that decline? And what is a good run rate for us to use over the next couple of quarters?

Speaker 3

Yes, probably the midpoint between them. We've always got a lot of timing of things, project expenses and things like that that pop in and out of the quarters. And so we have some variability. So I would not say that the decline in both is sustainable. I think you'll see somewhere in the middle between the two as we go forward through the year.

Know, we're running at about a 4.8% rate. That's that's pretty low for us usually. So, you know, I think it was mostly timing this quarter.

Speaker 9

Alright. Thanks a lot.

Speaker 0

We do have a follow-up question from Christopher Glynn from Oppenheimer. Please state your question.

Speaker 9

Yep. Thanks. Also, just had a little housekeeping to close out. One was on the corporate spend, but I'll take your SGA comments as the answer to that. And then tax rate for modeling purposes?

Speaker 3

You know, the forecasted for the full year, we haven't that's a good one to always try to guesstimate. Tax rate adjusted was thirteen, sixteen two in the prior year. You know, we'll we'll probably be above that 13 in the quarter, but not necessarily significantly.

Speaker 9

Okay. Thank you.

Speaker 0

Mister Gendron, there are no further questions at this time. I will return the conference back to you.

Speaker 1

Okay. Well, thank you for everybody joining us today, and thank you for your questions. And we look forward to talking to all of you during our third quarter release. So have

Speaker 4

a good day. Thank you.

Speaker 0

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 07:30PM Eastern Daylight Time by dialing 505056 for a US call or +1 (404) 537-3406 for a non US call and by entering the access code 7934739. A rebroadcast will also be available at the company's website, www.woodward.com for fourteen days. We thank you for your participation on today's conference call and ask that you please disconnect your