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spk07: Thank you for standing by. Welcome to the Woodward Inc. fourth quarter fiscal year 2022 earnings call. At this time, I'd 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 were invited to participate in a question and answer session. Joining us today from the company are Mr. Chip Blankenship, Chairman and Chief Executive Officer, Mr. Mark Hartman, Chief Financial Officer, and Mr. Dan Probasnik, Director of Investor Relations. I'd now like to turn the call over to Mr. Provesnik.
spk09: Thank you, Operator. We would like to welcome all of you to Woodward's fourth quarter fiscal year 2022 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've 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 through December 1st, 2022 or on our website. 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 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-US GAAP financial measures. We direct your attention to the reconciliations of non-US 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. Also, all comparisons made during this call are to the same period of the prior year unless otherwise stated. I'll turn the call over to Chair.
spk08: Thank you, Dan. Good afternoon, everyone. During fiscal 2022, our market strengthened and demand was solid with the exception of China. Challenges from supply chain and labor disruptions, record high inflation, and unfavorable foreign currency exchange rates negatively impacted our performance. We expect some improvements in fiscal 2023, and we are taking specific actions to manage key constraints that are within our control. We remain focused on operational excellence, talent development, and innovation to help drive the company's performance and create value for our shareholders. Orders are up in nearly all market segments, and we finished the year with a strong backlog. Moreover, our past due commitments to customers remain elevated as a result of part shortages and labor inefficiencies. On our last call, we discussed our strategy to mitigate supply chain risk and better position Woodward for long-term success. I'd like to update you on three actions we've taken. We have redeployed talent and added indirect resources to factories to stabilize the production environment. This support includes material planning resources, operations specialists, leadership support, and engineers. Secondly, we reinforced the global sourcing team to secure additional supplier capacity and allocated experienced resources to help suppliers resolve issues. We have also found and qualified a number of new quick-turn suppliers that we're using to augment specific supplier shortages. Third, our advanced Manufacturing engineers across the company are working to transfer selected machined components into our own plants. This insourcing activity leverages our substantial machining capabilities and capacity, which we expect will deliver improvements in quality, delivery, and cost, and reduce our lead times. To date, more than 2,000 parts have been transitioned to alternative sources either in-house or to a more capable third-party supplier. While significant work remains, we believe these investments will help stabilize our supply chain and improve output. To support the insourcing initiatives, we're more effectively utilizing existing equipment to relieve capacity constraints at suppliers. While we have the capital largely in place, we're investing $10 million of new capital to create rapid response machining centers at four of our sites. These machining centers include flexible CNC machines that will have a portion of their capacity available for rapid response when a supplier has unforeseen problems. That capital will begin arriving in our plants in the second quarter, and our target is to produce parts in less than 10 days from the time we identify a supplier shortage. I'd like to take this opportunity to thank our members for their efforts and commitment to Woodward and our customers. They have stepped up in the face of adversity to help us serve customers better and deliver for our shareholders. From members meeting elevated build rate targets, to engineers redeployed to assist problem solving its suppliers, and advanced manufacturing engineers bringing automation and insourcing initiatives online, just to name a few examples. Like others in the industry, we continue to grapple with the increasingly competitive labor market, challenging attrition rates, and skills gaps. Hiring, developing, and retaining talent are critical components to our long-term sustainable success and remain a top priority. We have initiatives underway to improve training and development. Our new machinists and technicians undergo a rigorous multi-month training and skills development process that enables them to perform to Woodward's high standards. We're focused on compressing the training cycle time to develop our members quickly and efficiently without compromising safety or quality. We're partnering with select technical schools to help augment our training bandwidth. We're also increasing our focus on automation with multiple technology paths, including expanded use of co-bots or collaborative robots. We're encouraged by the results and believe the increased use of automation will deliver productivity and mitigate risk in a difficult labor market. Turning to innovation, Woodward is committed to solving our customers' fuel and motion control challenges, enabling improved fuel efficiency and reduced emissions in both aerospace and industrial applications. While we are investing in and developing innovative technologies that reduce fuel consumption and associated emissions, we're seeing rising interest in the use of alternative fuels across both industrial and aerospace industries. Together with our customers, we are developing solutions that enable a wide variety of clean fuels to power the engines of tomorrow. Our focus on innovation enables multiple paths to a cleaner, decarbonized world, which we believe represents significant opportunity for our company in the future. Woodward has been selected as a partner to provide substantial content on a very large breakthrough aerospace project involving carbon emissions reduction that will be announced in the next few weeks. This is a significant project for Woodward involving resources and test facilities across both our aerospace and industrial businesses. Additionally, our industrial segment is working on projects with eight different customers on a variety of clean fuels, including ethanol, hydrogen, methanol, ammonia, and bio-derived natural gas. These projects are for a wide variety of applications, including power generation, marine, agriculture, and mining. targeting both new engines as well as conversion and upgrade opportunities for engines currently in service. Now moving to our markets. Demand from both aerospace and industrial customers remains strong. In aerospace, utilization rates for 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. International travel continues to improve, yet China domestic passenger traffic remains volatile. In the defense market, we anticipate near-term U.S. procurement to increase slightly, and geopolitical tensions may lead to increased international defense spending. In industrial markets, we are seeing robust demand and power generation, driven by strong growth in Asia, continued increases in global aftermarket activity, and ongoing demand for backup power at data centers. In transportation, the global marine market remains healthy with higher ship utilization, which drives increases in current and future aftermarket activity. Cruise and ferry operations are back at near 2019 levels which should result in increased spare parts demand. In addition, the global marine market interest for alternative fuels is increasing as more projects are announced and under development. Demand for China natural gas trucks remains at depressed levels. The oil and gas market is favorable as equipment utilization remains elevated. These factors should result in increased aftermarket demand. In summary, We believe our markets will remain strong as heightened demand signals for fiscal year 2023 continue to propagate throughout our markets as customers continue to increase orders. We remain focused on improving operations to catch up on past due orders and deliver on future customer demand. We are committed to operational excellence initiatives, talent development, and innovation, which we believe will deliver value to our customers and shareholders. and will position Woodward to capitalize on future market opportunities. I will now turn the call over to Mark to review our quarterly and full year results and our fiscal year 2023 outlook. Thank you, Chip.
spk11: Net sales for the fourth quarter of fiscal 2022 were $640 million, an increase of 12%. In the quarter, we realized $29 million in price gains or an increase of approximately 5%. Sales for the quarter were negatively impacted by approximately $85 million due to ongoing global supply chain and labor disruptions. Sales were also impacted by approximately $24 million from unfavorable foreign currency exchange rates. Turning to our segments, starting with aerospace, segment sales for the fourth quarter of fiscal 2022 were $408 million. an increase of 8%. Commercial aftermarket and OEM sales were up 34% and 24%, respectively, driven by continued recovery in both domestic and international passenger traffic and increasing aircraft utilization, as well as higher OEM build rates. The increase in segment sales was partially offset by delayed shipments of approximately $40 million caused by global supply chain and labor disruptions. Defense OEM sales were down 18%, primarily due to lower guided weapons demand. Defense aftermarket sales were down 7% due to global supply chain and labor disruptions. Aerospace segment earnings for the fourth quarter of 2022 were $63 million, or 15.5% of segment sales, compared to $66 million or 17.4% of segment sales. The decrease in segment earnings was a result of net inflationary impacts on material and labor costs, as well as increases in manufacturing costs related to supply chain disruptions and inefficiencies related to training recent hires, partially offset by higher sales volume. For fiscal year 2022, aerospace segment sales were $1.52 billion, compared to $1.40 billion for the prior year, an increase of 8%. Aerospace segment earnings for fiscal year 2022 were $231 million, or 15.2% of segment sales, compared to $234 million, or 16.7% of segment sales for the prior year. Turning to industrial. industrial segment sales for the fourth quarter of fiscal 2022 were $232 million compared to $193 million, an increase of 20%. The increase was driven by higher marine sales from continued utilization of the in-service fleet and strong industrial turbomachinery sales due to the growing demand for power generation and process industries. This increase was partially offset by delayed shipments of approximately $45 million due to global supply chain and labor disruptions and unfavorable currency exchange rate impacts of approximately $22 million. Industrial segment earnings for the fourth quarter of 2022 were $21 million, or 9.0% of segment sales, compared to $21 million, or 10.7% of segment sales. The favorable impact from higher sales was offset by increases in manufacturing costs related to supply chain and labor disruptions, costs associated with training recent hires, net inflationary impacts on material and labor costs, as well as unfavorable foreign currency impacts. Fiscal 2022 industrial sales were $863 million compared to $842 million for the prior year. an increase of 3%. Industrial segment earnings for fiscal 2022 were $83 million, or 9.6% of segment sales. Industrial segment earnings for 2021 were $109 million, or 12.9% of segment sales. Non-segment expenses remain consistent at $17 million for the fourth quarter of 2022 and 2021. Adjusted non-segment expenses for the fourth quarter of 2022 were $21 million compared to $12 million in fiscal 2021. Non-segment expenses were $81 million for fiscal 2022 compared to $64 million for 2021. Adjusted non-segment expenses were $78 million in fiscal 2022 compared to $59 million. At the Woodward level, R&D costs for the fourth quarter of 2021 were $30 million or 4.7% of sales compared to $28 million or 4.9% of sales. For fiscal year 2022, R&D costs were $120 million or 5.0% of sales compared to $117 million or 5.2% of sales. SG&A expenses for the fourth quarter of 2022 were $50 million compared to $38 million. For fiscal year 2022, SG&A expenses were $203 million compared to $187 million. The effective tax rate was 6.5% for the fourth quarter of 2022 compared to 18.2%. The adjusted effective tax rate was 5.3% for the fourth quarter of 2022 compared to 18.8%. The full year effective tax rate was 14.1% for fiscal 2022 compared to 15.1%. The adjusted effective tax rate was 14.3% for fiscal 2022 compared to 15.3%. Looking at cash flows. Net cash provided by operating activities for fiscal 2022 was $194 million. compared to $465 million. Capital expenditures were $53 million for 2022 compared to $38 million. Free cash flow was $141 million for fiscal 2022 compared to free cash flow of $427 million. The decrease in free cash flow for 2022 was primarily related to working capital increases as a result of production delays from supply chain disruptions as well as lower earnings. Leverage was 2.1 times EBITDA at the end of the fourth quarter. We also have significant liquidity consisting of $1.1 billion of combined cash on hand and revolver capacity. During fiscal 2022, $518 million was returned to stockholders in the form of $473 million of repurchase shares and $45 million in dividends. Lastly, turning to our 2023 outlook. Our fiscal 2023 outlook assumes improving operational and financial performance throughout the year while navigating a challenging industry-wide environment. The supply chain and labor disruptions are anticipated to begin to subside during fiscal 2023 with the expected pace of improvement increasing in the second half of the year. However, the pace of improvement is uncertain and the results could be negatively impacted if supply chain and labor disruptions do not improve as anticipated. The strong demand environment is expected to continue with price realization ramping over the course of the year. We expect the full year price realization to be in the range of 5%, consistent with the fourth quarter of fiscal 2022. We anticipate total net sales for fiscal 2023 to be between $2.60 billion and $2.75 billion. Aerospace sales growth is expected to be between 14% and 19%. Industrial sales growth is expected to be flat to up 5%. Our aerospace outlook assumes increases in OEM build rates and overall global passenger traffic, as well as higher aircraft utilization rates. Military sales are expected to increase slightly as global military budgets begin to rise. Industrial sales are expected to be supported by demand for power generation equipment, rising oil and gas investments, and a stable global marine market, partially offset by continuing unfavorable foreign currency exchange rates. China natural gas truck sales are expected to remain at depressed levels. Aerospace segment earnings as a percent of segment net sales are expected to increase by approximately 150 to 200 basis points, driven by increased sales volume and price realization in both commercial OEM and aftermarket, partially offset by the return of annual variable incentive compensation costs. Industrial segment earnings as a percent of segment net sales are expected to be flat year over year due to increased sales volume and price realization offset by the return of annual variable incentive compensation costs. EBIT is expected to include approximately $60 million of annual variable incentive compensation costs, an increase of approximately $50 million over the prior year. We anticipate our interest expense will increase by approximately $10 million, primarily due to rising interest rates. The effective tax rate is expected to be approximately 19%. Free cash flow is expected to be between $200 million to $250 million. Capital expenditures are expected to be approximately $80 million. Earnings per share is expected to be between $3.15 and $3.60, based on approximately $61 million of fully diluted weighted average shares outstanding. The favorable earnings impacts of anticipated sales growth and price realization improvements, in addition to our ongoing efforts to improve operational performance, are expected to be partially offset by the anticipated return of full annual variable compensation costs. Finally, to assist in your modeling, a few reminders. Our fiscal first quarter contains fewer working days than the preceding and subsequent quarters due to the holidays. Therefore, we anticipate fiscal Q1 results will be lower sequentially and lower than the other three quarters in fiscal 2023. Second, many of our OEM contracts have price escalation clauses that go into effect on January 1st. And third, We anticipate the pace of improvement across the supply chain will increase in the second half of the year. This concludes our comments on the business and the results for the fourth quarter of 2022. Before we move into questions, I would like to announce that we will be holding our Investor and Analyst Day in early June 2023, and we will hopefully see many of you there. Operator, we are now ready to open the call to questions.
spk07: Thank you. If you would like to ask a question, please press star then one on your telephone keypad. Our first question is from Sheila Kayalu with Jefferies. Your line is open.
spk00: Hi. Good afternoon, guys, and thank you for the time. Maybe if you could talk about your guidance for aerospace of 14% to 19% growth and how you think about the different pieces, you know, and your expectations within that and you know, how you're thinking about price. Is that consistent with an aerospace five point in 22 and into 23?
spk11: Yeah, thanks, Sheila. I'll answer your last question first. The price increase I mentioned in the range of 5% is both across aerospace and industrial, you know, generally consistent across both of those. Related to the aerospace growth of 14 to 19%, We do anticipate continued growth on the commercial, both the OEM and the aftermarket side. On the commercial OEM side with some increasing build rates from the aircraft manufacturers. On the aftermarket side, we're anticipating the aftermarket continues to have strength related to the utilization of the aircrafts and the passenger miles mileage or passenger miles increase that we continue to see. So, you know, as we look across the, as we've talked in the past, we look across the aircraft that are flying that is favorable to Woodward based on the content on the dynamics of the aircraft that are flying. And so that has a positive effect for us also.
spk00: How can we, just maybe specifically on the commercial aftermarket, you know, how do we think about that into 2023? And maybe can you talk about the aftermarket in the context of, like, supply chain issues, leap reliability, and just, you know, delayed deliveries, how that kind of combines into your aftermarket forecast?
spk08: So, Sheila, this is Chip. Good afternoon. How are you doing? Good, thank you. Good to talk to you. So we see strong inputs to our overhaul facilities right now from the commercial aircraft and the content that we have on them, both narrow body and wide body. So we feel strong about that continued strong inputs and our ability to deliver. So we have some supply chain challenges from part shortages, and that's created some past dues to customers. We're bringing more of the machine parts inside our own facilities, so we're able to support our overhaul with spare parts a little bit better as we forecast that into the future. We've had some of the same impacts in our defense aftermarket production and return to customers as well, and we're going after that problem solving in the same way by in sourcing and alleviating some of the supply chain challenges by moving the parts.
spk00: Okay, great. Thanks so much, Jeff. Thank you, Mark.
spk08: Yep.
spk14: Thank you.
spk07: The next question is from Chris Glynn with Oppenheimer. Your line is open.
spk04: Thanks. Good afternoon and appreciate the extensive detail on the guidance up and down the P&L. You know, the guidance came with, you know, some caveats to talk about, you know, relative to your expected pace of steady improvements and some of the supply chain and labor things going on. But what might be your ability on those efforts to kind of, you know, break through and beyond the guidance assumptions? You know, it doesn't seem like you're – you know claiming any victory but you have you know real deliberate efforts going on um so just curious about the sense that uh you know some of those things could could really kind of break through and normalize your operations a little more aggressively than you're indicating okay uh understand where you're coming from that question chris uh thanks thanks for that um what we see
spk08: right now like you said is we're taking very very specific actions going after the problems that we see and we've been able to show some progress in certain areas whereas we're reducing the number of suppliers that are having problems and behind on their deliveries to our input and we're reducing the number of parts that we're chasing but we continue to be surprised by other suppliers that fall down in in the process and So we don't feel strong enough and credible enough that we can claim a sustained ability to support the customer demand just yet. We would like to bring more parts inside. We'd like to have our machinists come up the learning curve a little bit more and have a demonstrated sustained ability to see that increased output before we would start to claim any victories on that front. We are taking the actions we think that are necessary and prudent, and we're even redeploying resources that would on normal days look like excessive to go after supplier improvements and internal factory optimization. But we believe that sort of resource over deployment is what's required right now.
spk04: Great. And then on the industrial side, uh margin profile and understand a lot of what we just talked about is germane to both segments um i i am curious one thing you didn't uh or i haven't heard you talk about is is there any issue with um skew complexity and breath or breadth or excess customization um you know maybe what what the front end's feeding into the factories is could be optimized a little more. I'm just curious, brainstorming if that is an article of discussion in your office.
spk08: Your curiosity is justified, Chris. Me being in the role now a number of months, still learning and coming up the learning curve, but that is one observation that I make is that we have a lot of complexity. We have a lot of aged components and systems that don't get a very steady stream of orders and our ability to look across the product line portfolios and potentially optimize that going forward. Simplification can drive velocity and focus, and that's one of the things that we'll be taking a look at in 2023.
spk14: Thank you. Yep.
spk07: The next question is from Pete Skibitsky with Alembic Global. Your line is open.
spk10: Hey, good afternoon, guys. Hey, guys, if I heard you right in terms of the COVID disruption, the way you quantified it for the fourth quarter, I think you said $40 million for aerospace. I think that was $55 million in the third quarter. So are things at least trending somewhat in the right direction in aerospace, but you're kind of in the same ballpark of $45 million in arrears and industrial. Is that right?
spk08: That's correct. We have seen some improvement, but as far as how sustainable that is and if that's a trend we can keep connecting the dots on, we haven't demonstrated that in a way that I could say with confidence our first quarter is going to be better than the fourth quarter of last year. We certainly have the momentum of resources in place, but being able to realize that and say we're going to continue to march that down right away here would be probably too optimistic. Saying that we're going to make progress throughout the entire fiscal year, we are making that commitment.
spk10: Okay. And then just what are you guys assuming for FX headwind in fiscal 23? Because it seems like you're talking about a pretty good demand environment for industrial, but obviously kind of a low single-digit type of average demand
spk11: guidance there for industrial side just trying to figure out if it's more so supply chain or more so fx or i don't know if you can bifurcate a little bit for us yep thanks pete let me give you a little clarity on on that so uh first just to remind everybody you know our fx is really what i call more just translation effects you know our our exposure to the euro uh is is naturally hedged. We have revenues in euros, we have costs in euros, so really it's just the translation effect of those euros translating into dollars that we continue to see, which does have, as you're pointing out, you know, that top line effect on the industrial side of the business. With where the euro is currently at about parity to the dollar, you know, it is a significant effect for us, you know, of about, you know, I'll say mid single digits, you know, five-ish percent of FX headwind if the euro stayed at parry to the dollar just from that translation effect.
spk10: Okay. That's great. Very helpful. I guess just last one for me on the incentive comp cost in fiscal 23, the $50 million increase. That's pretty steep. That's more than 20% of your EBIT this year, right? So pretty big jump there. Similar question. Can you kind of bifurcate that for us? Is it kind of linear between, if I look at the size of aerospace versus the size of industrial, and is that just kind of based on your expected results in 23?
spk11: Yeah, so just to do a little reminder for everybody, you know, during the pandemic, you know, I think we were pretty clear on, you know, we didn't have bonus, the variable compensation part of our membership incentive was not in our cost structure in 2020 and 2021. We did have a slight improvement and variable compensation was paid out at a very low level in 2022. So this is returning us back to the normal variable incentive compensation picture. If you look at the incremental of 50 million, you know, the other piece, you could break it down like you're talking, but the one other piece you have to remember is we do have variable compensation that would be in the non-segment segment also. And so it's really, you know, across those three, you know, aerospace would be the largest as you're kind of thinking about there.
spk14: Okay. Thanks, guys. Yep. You're welcome, Pete.
spk07: The next question is from Matt Akers with Wells Fargo. Your line is open.
spk03: Hey, guys. Good afternoon. I wanted to ask about share count and how you're thinking about repurchase. It looks like you're Assuming 61 million shares for next year, kind of flat off of Q4. So just how you're thinking about using what's left of the authorization there.
spk11: Yeah, so what we're thinking is at this point, we would be at the 61 million, which is generally flat off the Q4 like you're talking about. We'd have to offset some dilution. If we end up taking further opportunity to increase that over the offset of dilution, you know, that would be something that we would talk about in future quarters, you know, related to what the share count effect might be of any further repurchases over the dilution effect.
spk03: Okay, got it. Thanks. And can you give us any more help on just the pacing of kind of EPS as we go through the year? I know there's the pricing step up early next year, but, you know, I guess how much lower is kind of Q1 compared to the other quarters?
spk11: Yeah, so some of this is just a reminder. Our Q1 has always been lower than the other quarters. It's a working day type approach. And you look at our customer, their customer working days also are lower. And so, as we mentioned, that is kind of always there. Now, on top of that, you hit on a few of those. The pace of improvement that Chip was talking about related to our supply chain and labor disruption effect We're anticipating the rate of improvement to really increase in the second half of the year. Again, not being overly optimistic as to what we could do here in Q1. You mentioned the price, the OEM indices that the customers that are on indices-based increases typically go into effect on January 1st. Those won't come into effect here in our Q1 also. You know, that's kind of what we look at when we look at Q1. You know, the other piece of my prepared remarks was really talking about, I mean, we do anticipate it being lower than – lower sequentially than our Q4. And so, you know, that's kind of the ballpark that we're thinking about. Okay.
spk14: Thanks a lot. The next question is from David Strauss with Barclays. Your line is open.
spk02: thanks good afternoon um the um so the 60 million in in uh variable incentive comp can you mark can use level says what what was that number the last time you paid it in full in 2019 yeah it was in that that same general ballpark okay um and then on cash flow you know you had a fair amount of working capital headwind this year, you know, a pretty big headwind this year. It doesn't look like in the guidance for pre-cash flow you're assuming any sort of working capital. It looks like working capital is fairly neutral. Is that right?
spk11: You know, that would be fair. Now, there are some pieces that are going on underneath the working capital, you know, overall. You know, one with the sales growth that we are anticipating, you know, for the year. Obviously, that will have an effect on the receivables balance as we go throughout the year. We are anticipating some improvement in inventory, but also with some of the timing of payments to our suppliers and where the timing within the year and kind of where our payables balance was at year end, that would offset some of that inventory improvement that we see. And so really it's those three factors generally are kind of what's driving some of the working capital that we have. The other one that I do want to point out for everyone is with the current U.S. legislation around the ability to deduct the R&D expenses for U.S. tax purposes, and this isn't just a Woodward thing, this is for everyone, we will have higher tax cash payments in this year than we had in prior years because we have to in essence, capitalize that R&D cost for tax purposes, and you can only deduct it over a four-year time frame. So that also has a headwind in our free cash flow for 2023.
spk02: How much is that, Mark, R&D piece?
spk11: You know, we spend, you know, $120 million-ish this year on R&D, and so you think about a you know, a U.S. tax rate, you know, 25-ish percent, and you're only getting a quarter of that. So it's going to be, you know, $30 million, somewhere in that ballpark.
spk14: Okay. Thank you very much. You're welcome. You're welcome.
spk07: The next question is from Rob Spingarn with Melius Research. Your line is open.
spk14: Hi. Afternoon.
spk05: Mark, going back to this price realization of 5%, in 23, aside from the higher incentive comp, what's the cost inflation that you're anticipating in 23? Does it match the price or is it worse or better?
spk11: Yeah, so the price realization we're assuming and obviously the inflation effect that we had in 22 was pretty significant both on material and labor. We're not anticipating that inflation goes away in 23. But, you know, we are anticipating that price realization would more than offset some of the material and labor inflation that we're seeing. So it should be a tailwind to us.
spk05: Okay. And then going back to Pete's question, just the decrease in the – from 55 to 40 on the delayed – delayed shipments, if you will. It sounds like you could recover all of that in 23 if that kind of quarterly progress holds up. Is that fair?
spk08: We're not counting on reducing all of our past dues to zero in the fiscal year 2023. We're focused on making progress, but that would be overly optimistic in my opinion.
spk05: Okay. And then, Chip, just in terms of commercial OE, can you talk about what kind of rates you've embedded in your aerospace guide for the major programs, the MAX, the H-7, the NEO?
spk08: We've just taken what the airframers are publicly talking about as their rates. We're capacitized to deliver at those OEM rates, and we don't see a big challenge in front of us to achieve those. You know, we've been doing pretty well on those programs as far as delivery goes.
spk14: What's your rough lead time to when an aircraft gets delivered to the customer?
spk08: Well, it's hard to say that in these days where our, especially our engine OEM customers have the same problems that we do in terms of they have engines that have most of the hardware on them so we we don't have a great visibility to when the serial number of say our fuel metering unit is put on an engine serial number and then it gets attached to an engine or an airplane at boeing or airbus uh you know back in the day we would have said you know it's a six month or so cycle time but as of now it's hard to see how that how that's been going okay just the last thing um just given your background chip
spk05: Is it fair to assume that large structural castings, while they may be a major problem here, there are a lot of other issues, is it unfair to pin this whole thing on that, the OE delays?
spk08: For us, the castings isn't our biggest issue. I know you're asking that broadly. I just want to make sure I'm clear about woodwork versus industry. From a woodwork standpoint, From Woodward's standpoint, electronic components and machined parts are really our big two that we're tackling. We have a few casting issues. They're the smaller type castings, but really machined parts and electronic components are our biggest issues at Woodward. Across the industry, there are labor issues and materials issues at every step of the supply chain. You know, I think that the large structural and other investment casting is just, you know, one of the many issues out there. And, you know, some may be hiding in the shadow of those as those take center stage. And when you pull those constraints off, you'll find the others struggling. So I think it's a – my experience so far says this is a industry-wide multi-level of tier – issue in the supply chain.
spk14: Okay. Thanks very much. You bet.
spk07: The next question is from Gotham, Canada, with Cowan. Your line is open.
spk06: Hey, guys. This is Jack on for Gotham today. Hello, Jack. I guess just kind of piggybacking – hi there. Yeah, so kind of just piggybacking off Rob's question there, digging deeper into the aerospace guide for next year. Wondering if you can square or just quantify maybe some of the puts and takes of the 14% to 19% revenue growth by end market, like commercial OEM versus aftermarket. And, you know, I think your customer called out at one point last year 2,000 leak deliveries. At one point, you know, it's probably stale given the recent castings issues. But wondering if you could provide some perspective there with maybe initial provisioning starting to ramp. and then further off of commercial aftermarket, you know, I think, is it safe to assume that we get close to a pre-COVID sort of run rate revenue profile there?
spk14: Yeah, so I'll take the last one first.
spk11: Yeah, maybe take the last one first, and then we'll work back through the other pieces. So, you know, the revenue profile, pre-COVID for us, in our guidance, that's not the levels that we're actually at. So no, I guess would be the answer to that based on the sales guidance that we have as we're kind of moving through the year. Like Chip mentioned, we'll be aligned to Airbus and Boeing build rates as we kind of move throughout the year. And that's what we're anticipating. As he mentioned, we're fully capacitized for that to hit those levels You know, on the commercial aftermarket side of the business, as Chip mentioned, you know, the input's in for repair. And as I mentioned a little earlier, you know, the aircraft that are flying have higher woodward content, you know, now than they did pre-pandemic. So that's a positive for us and, you know, helps us on the aftermarket side. You know, initial provisioning, you know, continues on the LEAP engine side of the business. You know we aren't anticipating Significant initial provision in China as part of our guide And so you know that's we've talked previously over the last year or two that you know that was a watch item for us and with where the Situation is we're not anticipating. You know a significant initial provision in China, but we still have other airlines that taking initial provision units either because they're expanding their route structure or because it's you know a new airline you know increasing their their you know max or 320 meal you know aircraft so you know that's what's really driving a lot of the aftermarket side of it is you know really just the usage in the flying Aircraft today have a lot more Woodward content on than they had pre-pandemic. The other side of the aerospace is the defense side. We've talked about stability there, other than the guided weapons. We have seen on the guided weapons the last couple years some decreases, primarily related to the JDAM program. That's generally stabilized now, so generally on the defense side, we're generally stable. The defense aftermarket side, we've been impacted by the supply chain and labor disruption there. The demand has been strong, and we have not been able to get the product out. As we were mentioning, we would anticipate that some of that would be improving as we go into the second half of the year, and that's what we'd look for on the defense aftermarket side to have a little bit of growth there based on our improving operational capability.
spk08: Yeah, and just to add that I think, you know, some of that range there on growth, the 14 and 19%, depends on how well we do burning down the past dues. So it may not link exactly to demand. The demand is strong, and it's kind of on us and our ability to deliver the output.
spk06: Understood. Thank you. And then if I could just sneak one more in here, Chip. Kind of just bringing your new perspective to Woodward here. I guess, what's your view of the current portfolio today? Do you see anything non-core at the moment, or are you pretty content with the portfolio kind of, you know, as you see it today? Thank you.
spk08: I think from the macro perspective, I really like the portfolio of products that we have, the current set of products, as well as those in the new product development pipeline. So, very pleased with the overall product strategy and the execution and the vision of the commercial team to get these products on the right platforms on both the industrial and the aerospace side of the house. And frankly, there's work to do at the lower granular level of the product portfolio that I was referring to earlier in terms of looking at the health and and profitability as well as demand for certain SKUs that we carry and maybe moving customers along to the newer generation of products and things of that nature. There's some good work to be done there that will improve our ability to support customers and our profitability. So work to be done at the granular level, but overall at the macro.
spk14: I really like what I see. That's great. Thanks, Chip. You're welcome. The next question is from Noah Popanek with Goldman Sachs. Your line is open. Hello, everyone. Good afternoon, Noah.
spk13: Just following up on the defense business, you mentioned the guided weapons and the aftermarket. What rate of decline did those end up having for full year 22, and what are you assuming for those in the 23 assumption that the defense business grows.
spk11: So the rate of decline on the defense OE side for the year was about 17%. Defense aftermarket was about 12%. Two different reasons there, as we've discussed. There is still a little softness on the guided weapons side, just on the JDAMs, a little bit more softness yet in 23 compared to 22, but otherwise, as Chip was just saying, the demand's strong. It's really a matter of us being able to get that past due down to be able to show growth there.
spk14: Okay.
spk13: What are the drivers behind the lumpy to the upside growth rate at industrial in the fourth quarter versus the trailing several quarters and how you're guiding it for next year.
spk11: Yeah, so we had strong growth across all of our end markets and across all of our businesses on the industrial side in the fourth quarter. And really the other than the China natural gas business, which remains at these depressed levels. And so it was a strong fourth quarter on the industrial side. And then even on top of that, we had the headwind of the FX, which would even add industrial looking even stronger on the top line. And so the demand has been there. We've been, I think, saying that for a while now across all of our business, but specifically when industrial, we continue to call it out, the demand for power generation, across Asia power demand, replacing coal power plants here in North America. Backup power for data centers has been strong and continues to be strong. The marine side, we've talked about the continuing strength of both the OEM build rate has been at elevated levels and maintains at that level. The marine aftermarket side, we've talked historically that it was very depressed during the pandemic, that there was going to be this bullwhip effect of everyone needing to restock their shelves with spare parts and then also do repairs when the vessel is in port getting loaded and unloaded, and we continued to see that and strength there in the fourth quarter. And then, you know, the oil and gas side with commodity prices, you know, kind of at the levels that they are, both the utilization of the equipment that's out there and then, you know, even driving some new investment has really been, you know, what drove the industrial side. I would say it's just the continuation of what we saw on the demand side as we continued, you know, throughout the year.
spk08: So Mark covered the external, you know, demand side nicely there. And then additionally, we had strong performance from our Woodward-La Ronge facilities in Germany, serving those marine and industrial markets. And we had some outages from chips shortages and some other components that came in, and we redesigned some circuit boards to accept different types of components that we could find availability on. And so we had a strong finish there with lines that were wetted and ready to receive those components in September.
spk14: The next question is from Chris Glynn with Oppenheimer.
spk07: Your line is open.
spk04: Thanks. I think my follow-ups have been asked, but just wanted to clarify. Did I hear a 5% FX headwinds, which you have
spk14: baked in if the currency stays at Euro parity? On the industrial side, yes. Okay. Thank you. You're welcome.
spk07: Again, please press star 1 to ask a question. The next question is from Noah Poppenack with Goldman Sachs. Your line is open.
spk13: Okay. I think my phone might have picked up there. So, Chip, were you just explaining that 4Q Industrial had some you know, things kind of tucked into the end of the year that don't repeat? Or just why does the growth rate immediately decelerate? Because the compare in the fourth quarter wasn't that difficult. The compares don't really change. I guess why would all of those things Mark just described not kind of continue at a better than low single-digit growth rate?
spk14: A little bit of FX there, I think, is the big actor. Okay. Okay.
spk08: In the arrows? We intend to do better and get more delivered. There's plenty of demand. It's on us. We have to deliver to improve. Right now we're forecasting that we're going to be steady into the next quarter on deliveries. And if we can do better, we will.
spk14: Okay. That makes sense.
spk13: On the aerospace segment margin, You know, it's now declined year over year on growing revenue three quarters in a row. The guidance for next year, depending on where you put everything in the ranges, it seems to imply kind of a clean historical 30% incremental margin to the upside. How do we get confident that you can, you know, sort of flip that on a dime heading into the new year here?
spk08: I think the numbers that I'm more comfortable talking about are the 100 to 150 basis point improvement that is in our guidance for margins. So that's collecting some of the improvement that we've lost over the past quarter, saying that, okay, here are the things that we are working to improve. Number one, the efficiency of labor utilization number two having the the parts here on time so we can build and deliver on time and then also the price that we've you know shown in the fourth quarter that we plan on having you know come through this following year and then we'll have the escalation formulas and the other opportunities in the coming years so it's really you know just better cost and performance inside our four walls, supplier performance, and then the price that we've accumulated over the fiscal 2022 and then what's planned for 23.
spk13: Okay. Appreciate that. And I wanted to ask one more, if I may, which is back to free cash flow, Mark. You guys have talked about being able to have know multiple years of free cash well in excess of net income because you're coming out of a capex cycle so you'll have dna well in excess of capex um does this r d tax law change you know eat into that for a few years or how should we think about that and do you have an outstanding um target for cumulative two billion dollars of free cash is that is that still a good target
spk11: Yeah, so I'll take the second one first, then I'll go back to the R&D impact. Related to kind of our go forward look, I mentioned during the call that we're planning on an investor and analyst day in June of 2023. We'll update our forward look at that point. Related to the R&D, this year will be the biggest impact because the way that the law works is as you go every year, you get another 25% of the total you know, in essence, the one in four years starts accumulating over the four years. So 23 is the biggest impact. It will then be smaller in 24, you know, I'll say very minor in 25. And then by the time you get to 26, it flattens itself out. There is no impact because you're getting to amortize, you know, in essence, four years by the time you get there. So 23 is the largest impact, you know, and that's the headwind that, again, I think most companies are going to see here in the U.S.
spk14: Okay, thanks for taking my question. You're welcome.
spk07: The next question is from Michael Charmoly with Truist Securities. Your line is open.
spk12: Hey, good evening, guys. Thanks for taking the questions. Just some general follow-ups here, maybe Mark and Chip. Just to be clear, the past due from the supply chain, that's all included in the guidance. So even if you sort of catch up, that wouldn't maybe drive upside, but it would put you at the higher end of the guidance. Is that how we should think about kind of liquidating that balance?
spk08: I think the short answer is yes. We've assumed a certain amount of progress on eliminating past dues, but not completely. And if we can get more traction operationally earlier, we can eat into that more and head towards the high range of the sales number.
spk12: Got it. And then just in terms of raw materials and other kind of choke points, I know at one point I think you were having issues sourcing an aluminum billet for the fuel metering. Are you sort of caught up there, or do you have that part of the supply chain rectified?
spk08: Yeah, thank goodness. We do have plenty of 6061 billet there in Rockford, and the line is what we call wetted, so every station has the work in front of it, and For now, we've mitigated some of our risk by expanding our sources for the billet, and we're continuing to watch that very carefully. We're highly vertically integrated there in that plant. That's one of the last places I'd expect the supply chain issues to challenge us, but it did earlier in the year. But as of now, we've got plenty of material in front of the line.
spk12: Got it. And then just the last one, I guess you talked about the insourcing and some of the capital being spent. Are there any qualification or requalification requirements that you have to go through? And I guess should we, you know, some of the insourcing as that ramps up and maybe new equipment sort of comes online, is there any margin impact in either of the segments? And I guess I'll even throw in, you talked about some of these carbon emission projects, you know, or should we be thinking about that as sort of, you know, maybe a modest headwind to margins, you know, just everything you're spending on?
spk08: So I wouldn't think of the decarbonization, emissions improvement, alternate fuel projects as any impact on margins. That's, you know, our R&D is factored into the plan and the guidance that we've given on that. The other question was on how to think about insourcing. That activity should improve margins, and that's factored into our overall 100 basis point improvement for the year. The other thing to think about there is many of these parts we've made before, and we outsourced to maybe five or 10 years ago in some cases. And so we still maintain a qualification. What we'll have to do is run off some parts on the actual machine that we put on the ground. And the parts that we choose, we'll choose that we have design control over and we've made before, we've made like parts before to minimize that cycle.
spk14: Got it. That makes sense. Perfect. Thanks, Gus.
spk08: You're welcome. You're welcome.
spk07: We have no further questions at this time. I'll turn it over to Chip Blankenship for any closing comments.
spk08: I'd just like to thank everybody for joining us today. Good questions and good dialogue. We'll look forward to seeing you next time.
spk07: Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.
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