Woodward, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Incorporated second quarter fiscal year 2026 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 are invited to participate in a question and answer session. Joining us today from the company are Chip Blankenship, Chairman and Chief Executive Officer, Bill Lacy, Chief Financial Officer, and Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Dan Provaznik.

Thank you, Operator. We'd like to welcome all of you to Woodward's second quarter fiscal year 2026 earnings call. In today's call, Chip will comment on our strategies and related markets. Bill will then 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 included some presentation materials to go along with today's call that are also accessible on our website. And a webcast of this call will be available on our website for one year. All references to years in this call are references to the company's fiscal year unless otherwise stated. I would like to highlight our cautionary statement as shown on slide two of the presentation materials. As always, elements of this presentation are forward-looking, including our guidance, and are based on our current outlook and assumptions for the global economy and our businesses more specifically. These 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 with the SEC. These statements are made as of today, and we do not intend to update them except as required by law. In addition, we are 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. We believe this additional financial information will help in understanding our results. Now, I'll turn the call over to Chip.

Thank you, Dan. And good afternoon to all who are joining our second quarter 2026 earnings call. I'm pleased to report that Woodward delivered an exceptionally strong second quarter. Our team continues to execute with focus and discipline to meet ongoing robust demand across both our aerospace and industrial segments. Before we get into the results, I want to take a moment to acknowledge the complex global environment we're operating in. I'd like to thank our Woodward security professionals, our leaders, and members in the region for their vigilance in keeping our team members operating in the Middle East safe. I also greatly appreciate our customers in the region for their collaboration on safety and coordination as we adjust projects that are underway there. While the safety of our team is our first priority, we're also closely monitoring broader geopolitical developments and how those might impact defense spending, or airline traffic. If those impacts do occur, we expect them to be felt in fiscal 2027. Let me turn to a few financial highlights for the quarter. The second quarter marked a significant milestone for Woodward as we surpassed $1 billion in quarterly sales for the first time in our history. Sales increased 23% year over year, reaching all-time highs in both aerospace and industrial. We also delivered margin expansion, including record quarterly adjusted earnings per share, up 34% from the prior year. These results reflect the strength of our end markets, the benefits of our strategic focus, and the steady progress we're making in our operations. Our members' tremendous efforts and dedication to continuous improvement not only enabled us to deliver another quarter of outperformance, but also positioned as well for the second half of the year. While we are monitoring uncertainties in the geopolitical environment, we're raising our full year sales and earnings guidance based on our second quarter results and confidence in the remainder of 2026. Turning to our markets, here's a breakdown on what's driving the robust demand in aerospace and industrial and what it means to Woodward. In aerospace, commercial aircraft build rate increases are coupled with overlapping maintenance cycles of legacy and current generation fleets. In industrial, we see power generation demand expressed in both power gen and oil and gas end markets. These market drivers create durable growth opportunities for Woodward. Our challenge in this environment is to continue to expand our capacity and that of our supply chain. in ways that are well managed and resilient. We are doing the right work to achieve these outcomes. At times, however, we've seen demand outstrip our activities like dual sourcing projects or our additional test stand procurement, installation, and calibration, which are two real examples of what constrained output for us last quarter. In aerospace, we saw expected growth in both commercial and defense OEM along with continued strength in commercial services. Legacy services activity remains solid, and we're seeing steady increases in volume for our control systems on LEAP and GTF engines. Shop inputs remain steady, and we haven't seen any decreases as a result of airlines recently announced capacity and utilization reductions. In industrial, Momentum continued across all our major markets, including oil and gas, transportation, and power generation. Our ability to deliver on this robust demand reflects strong execution across the company. Moreover, our team is managing order growth while simultaneously undertaking numerous critical projects to optimize our portfolio, strengthen our competitiveness, and position Woodward for long-term growth. We remain focused on our value drivers, growth, operational excellence, and innovation. Our profitable growth pillar contains both organic and inorganic lines of effort, along with selective divestitures and investments in capability, efficiency, and capacity. These projects are changing the game in how we operate. They're also allowing us to focus on areas with the greatest potential to strengthen value creation. Our recent announcements reflect purposeful portfolio management decisions that our team has been working to activate over the last one to two years. In March, we closed the acquisition of Valve Research and Manufacturing, adding the premier designer and manufacturer of solenoids to the Woodward portfolio of control systems. These are critical enabling technologies for current and future aircraft, with next generation single aisle platforms clearly in our sights. We also see opportunities related to industrial gas turbine control systems. Integration is progressing well as we welcome our new team members in southeastern Florida. We also announced the sale of our Niles-based pilot controls product line to ONTIC, a mutually beneficial transaction that will enable us to refocus resources. In addition, we communicated the relocation of servo valve production lines from our facility in Santa Clarita to Rockford. Rockford is our world-class servo technology design and manufacturing center where we intend to achieve the necessary quality and delivery improvements required for our customers and shareholders. In industrial, our actions to wind down the China on Highway product line remain on track and last-time buy volumes are reflected in our second quarter results. All of these actions streamline and strengthen our portfolio and sharpen our focus on our most attractive near and long-term growth opportunities. These decisions allow us to serve customers better on our current book of business. And by trimming product lines that don't have a path for us to be best in class, and by moving work to where we can be more effective and efficient, we can focus on partnering with our customers to tackle their biggest challenges with their next generation of products. Our two biggest construction projects, Spartanburg and Glotton, are both on track. Our new facility in Spartanburg, which will be the location for Airbus A350 spoiler actuation systems, is on schedule. Walls are erected and floors are being poured as we speak. We are on target to be operational in 2027 and begin deliveries the following year. Our Glotton expansion to deliver more diesel fuel injectors for data center backup power is almost complete. We have moved over 100 machines within the new hall and legacy areas to perfect flow. Our teams have demonstrated the major achievement of small batch flow and customers will see substantial capacity increases with reduced lead times. This will translate into cost productivity and better inventory turns. While I've been vocal with many analysts and investors that Woodward has the facilities and capacity to support the ongoing power generation demand and data center accelerator to that demand growth, multiple customers have recently shared potential increases to their forecasts. We are working with our customers to evaluate the opportunities and capacity options. Shifting to growth in Arrow MRO, the volume on LEAP and GTF is growing quickly. We continue to increase capacity at our Rockford and Prestwick sites with Kaizen activities focused on flow and turn time. We have added test stand capacity at Rockford and we are progressing with the expansion plans for Prestwick. As we've indicated in prior earnings calls, we have a strategy to perform repair and overhaul service in-house as well as through licensed providers that will deliver to OEM standards. This approach allows us to optimize our capital and internal resources and support our airline customers in the way they prefer to contract for maintenance and repair. It is a well-respected open maintenance model that we have refined to suit Woodward's strategy on LEAP Control's components. Last week, we announced new partnerships at MRO Americas, including new licensed repair service facility agreements with Lufthansa Technique and Air France KLM. as well as a new distribution agreement with AAR. We are thrilled to be partnering with industry leaders in MRO and material support. These partnerships expand our global service network, increase capacity, and give airlines flexibility in how they contract for service. Moving to our operational excellence pillar, investments in automation continue as we execute projects as simple as increasing the closed-door machining time as a total percent of the job and as complex as full assembly and test automation with vision systems and integrated inspection. We're also introducing repeat automation projects to additional sites, leveraging the automation lab in our rock cut facility. This lab was recently recognized by the Manufacturing Leadership Council as leading the way in manufacturing excellence. I see firsthand the results of continuous improvement nearly every day. I was recently visiting the industrial SOGAV value stream in our Fort Collins site and was impressed with an automated cell that allows one operator to manage three machines and turn a production bottleneck and staffing challenge into a high-speed machining cell that can outrun our current demand forecast. We need both capacity and productivity to achieve our goals in the long term. To us, it's equally exciting to create value for customers and for shareholders. As indicated by the list of projects I described above, our team is managing a high level of activity across the company, while at the same time improving delivery to our customers and our financial results. We continue to invest in our people and our talent pipeline to make sure we have the engineering, manufacturing, business support, and leadership needed to enable our growth trajectory. For example, We recently launched a rotational program to develop the next generation of Woodward leaders with the first cohort starting in June. Yet another step to build a high performing organization designed for the future. Turning to innovation. Innovation has always been and will continue to be a major competitive differentiator for Woodward. As I said last quarter, we're turning from pure technology development to more technology demonstration activities with our aerospace customers. We have entered into collaborative agreements with many of our current customers to work together on trade studies and demonstration programs. This is an exciting time to be an innovator with a track record of industrialization. We will speak more about this trend at Investor Day late this calendar year, but you will see aerospace R&D expenses beginning to tick up this year and more so in the years that follow as future aircraft timelines firm up. In industrial, one focus is on a new actuation platform to provide precise fuel and air control on reciprocating engines that will deliver more customer value and is designed for a more efficient automated production system. It is more compact in size and produces a broader torque range than prior models, which allows us to simplify the product portfolio and use this platform in many applications. The product will enter service in 2027. Our priorities remain clear as we head into the second half of the year. Meet OEM demand growth, deliver world-class service across our installed base, including legacy aerospace, LEAP, GTF, and industrial gas turbine systems, and demonstrate customer value on key technologies to position Woodward for increased content on next-generation single-aisle aircraft. We are entering the second half of the year from a position of strength and will continue to invest with discipline and focus to deliver long-term shareholder value. With that, I'll turn it over to Bill to take you through the financials in more detail. Over to you, Bill.

Thank you, Chip, and good evening, everyone. As Chip mentioned, Q2 was a strong quarter. Quarterly net sales exceeded $1 billion for the first time in Woodward's history, coming in at $1.1 billion. in the second quarter of 2026, an increase of 23%. The significant growth reflects strong demand and increased output in both aerospace and industrial. We achieved earnings per share in the second quarter of 2026 of $2.19 compared to $1.78. Adjusted earnings per share were $2.27 compared to $1.69. We generated 38 million of free cash flow in the second quarter. At the segment level, aerospace segment sales for the second quarter of 2026 were 703 million, an increase of 25%. The strong growth was primarily driven by commercial aerospace. Commercial services increased 36%, reflecting higher repair volume to support the continued high utilization of legacy aircraft, as well as increased LEAP and GTF activity. In addition, spare LRU sales growth was strong in the quarter, with volume consistent with the previous two quarters. Commercial OEM sales were up 30%. We believe the stocking is largely behind us, as their output is now more aligned with current airframers' build rates. Defense OEM sales grew 9%, primarily due to increased JDAM pricing that took effect in the fourth quarter of 2025, and defense services grew 8%. Second quarter aerospace segment earnings were $158 million, or 22.5% of segment sales, compared to $125 million, or 22.2% of segment sales. While the strength in commercial services, higher commercial OEM volumes, and solid price realization drove meaningful margin expansion, this was largely offset by planned strategic investments to support future growth and inflationary pressures. This reduced the aerospace flow through in the quarter, resulting in a net margin increase of 30 basis points. These strategic investments included enhancements to our manufacturing capabilities to deliver the content on current platforms, incremental R&D tied to early stage efforts to compete for the next single aisle aircraft platform, and an enterprise-wide ERP upgrade. While these initiatives are impacting margins, they are critical to positioning a company for sustained long-term growth, and we expect these investments to continue. The flow through in the full year 2026 aerospace guide is expected to be at a targeted rate of approximately 30 to 35%. Turning to industrial. Industrial segment sales for the second quarter were 387 million, an increase of 20%. Core industrial sales, which exclude the impact of China on highway, increased 19% in the quarter, driven by higher volume, price, and favorable foreign currency impacts. Marine transportation sales were strong, increasing 34%, reflecting higher shipyard output and services activity. Oil and gas sales grew 18% during by higher volume, primarily related to greater midstream and downstream gas investment. Power generation sales increased 7%. Excluding the impact of the prior year combustion business divestiture, power generation sales grew in the high teens on a percentage basis. This was driven by increasing data center demand for both base and backup power generation. Outside of our core industrial business, China on highway sales were 29 million in the quarter. We expect approximately 30 million in sales in the third quarter and minimal sales in the fourth quarter. Industrial segment earnings for the second quarter of 2026 were 66 million, or 17% of segment sales compared to 46 million or 14.3% of segment sales. Within our core industrial business, margins were approximately flat at 14.7% of core industrial sales, as strong price realization and higher sales volume were partially offset by inflation. In addition, margins were negatively impacted in the quarter due to a reserve for a product performance claim. Excluding the reserve, core industrial margins would have been in line with Q1. The China on Highway business added an additional 230 basis points of margin growth in the quarter. Non-segment expenses were $45 million for the second quarter of 2026. compared to 27 million. Adjusted non-segment expenses in the second quarter of 2026 were 38 million compared to 34 million. At the consolidated Woodward level, net cash provided by operating activities for the first half of 2026 was 205 million compared to 112 million, largely driven by higher earnings. Capital expenditures total $97 million for the first half of 2026. We continue to expect a meaningful increase in capital expenditures over the next two quarters, consistent with our guidance for the full year. As Chip mentioned, construction of the Spartanburg facility to support future A350 production is progressing as planned. We remain on track to finish the building over the next few quarters and are beginning to purchase production equipment, with the site expected to become operational in 2027. In addition, we continue to make strategic investments to support growth related to current platforms, including automation, preparing for increased LEAP and GTF service activity, our ERP upgrade, and product line moves. We generated $109 million of free cash flow in the first half of 2026 compared to $60 million, driven primarily by higher earnings, partially offset by higher capital expenditures. As of March 31st, 2026, debt leverage was 1.4 times EBITDA. We continue to allocate capital according to our priorities, supporting organic growth, selectively pursuing strategic M&A opportunities and returning capital to shareholders for dividends and share repurchases. Regarding strategic M&A, we recently completed the acquisition of Valve Research in Manufacturing. Consistent with our strategy of pursuing targeted high return opportunities that enhance our capabilities and improve our position to compete for the next single aisle aircraft. In addition, in line with our portfolio optimization efforts, we recently announced the divestiture of our pilot controls product line, which we expect to close by the end of the year. We are building a stronger, more focused Woodward as we invest in high growth opportunities and expand in the right areas to position Woodward to create additional value for shareholders. In the first half of 2026, we returned over $355 million to stockholders through share repurchases and $36 million in dividends. Our strong balance sheet provides flexibility to move decisively as compelling opportunities emerge. Lastly, our fiscal 2026 guidance still assumes the return of between $650 million and $700 million through dividends and share repurchases. Coming to our 2026 guidance. Based on our strong second quarter performance and confidence in the second half outlook, we are raising our 2026 sales and earnings guidance. For 2026, we now expect the following. Aerospace sales growth between 21 and 24%, with margins increasing to be between 23 and 23.5%. Industrial sales growth between 18 and 20%, with margins increasing to be between 18 and 18.5%. We now expect total Woodward sales growth between 20 and 23%, and adjusted EPS between $9.15 and $9.45. Free cash flow is still expected to be between $300 and $350 million, and capital expenditures are still expected to be approximately $290 million. We expect to continue to maintain higher levels of inventory than previously anticipated as we prioritize mean customer demand while we strive for better alignment for the end-to-end supply chain. We have a number of inventory initiatives underway which should drive improved free cash flow generation in 2027. We now expect our average diluted shares outstanding to be approximately 61.5 million. Adjusted effective tax rate guidance is unchanged. This concludes our prepared remarks on the business and results for the second quarter of fiscal year 2026. Operator, we are now ready to open the call to questions.

Thank you. We'll now begin the question and answer session. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star 1 on your push button phone. Should you wish to withdraw your question, press star 1 a second time. Your question will be taken in the order it is received. Please stand by for your first question. And our first question comes from the line of Scott Mikus with Milius Research. Your line is open.

Good evening, Chip and Bill. On a sequential basis, your commercial aftermarket sales were up 12% in the opening remarks. I think it was mentioned that the LRU volumes were roughly consistent with the prior two quarters. Since the quarter has ended, have you seen a drop off in orders for spare LRUs? And are you concerned that if there is a broader slowdown in the aftermarket, the amount of LRUs in the field could result in destocking pressures in the back half of this year or early in 27?

Yes, Scott. Let me jump on the front part of that and then to maybe the second part. But as we head into third quarter, and as we've mentioned, these orders for these spare LRUs are rather short cycle, so we don't have a ton of visibility. but we're comfortable that sequentially Q3 spare LRUs are in line with what we've seen in the first two quarters. And again, from a financial forecasting standpoint, tough to say what Q4 looks like currently, but Chip, I don't know if you want to... Yeah, we've certainly seen some airline signaling that they're removing a little bit of capacity, they're parking some planes, but none of that, none of the

Parking activity exceeds any of the forecasts that were already in play, and we haven't seen any drop-off in inputs to our shop from LRUs for repair, and we haven't seen any slowdown in the order rate for spare LRUs. And so there's always assumptions in a forecast, but we haven't seen any indications in our direct connections with customers to indicate that we're going to see a slowdown inside our fiscal year. That being said, though, we are obviously monitoring the situation at the higher level, geopolitical and macroeconomic. And as far as what that means for FY27, we'll all have to ride a little further along to see where that goes.

Okay. And then a lot of energy infrastructure in the Middle East has been damaged in the ongoing conflict, and it will need to be rebuilt. Just curious how you're thinking about that opportunity for your industrial business. Are you receiving RFPs from your customers to support that reconstruction, fully understanding that that probably won't hit the P&L until next year, though?

I think we're a little bit further down in the supply chain to be seeing initial outreach on that for anything except service activity. So we have some ongoing projects, and a number of them are back up and running as far as service for our customers, be it on the valves-type equipment, or on the electronic control systems for gas turbines and power plants. So that activity is ongoing. Some of the things that need to be rebuilt as the customers and operators reach out to EPC-type companies, that will flow down to us, and we haven't seen anything along those lines yet, but there'll probably be some opportunity.

Okay, got it. Thank you.

You're welcome.

our next question comes from the line of sheila kiaglu with jeffries your line is open good afternoon guys and thank you um maybe if we could start thanks uh we could uh focus on margins for both aerospace and industrial so first on aerospace just um first half margins just under 23 with fiscal q2 at 22.5 yet you raised the full year um to you know, 23 and a half at the high end. Can you just talk about what drives that second half margin expansion? What are the puts and takes?

Yeah, I'll just let Bill start there, and I'll jump in at the end.

Yeah, so, you know, Sheila, we do continue to see good growth on the services side of the business. And obviously, that helps our margin rates while we continue to see the volume grow, which creates leverage. And then, as we've been talking about, Sheila, we've been investing and working hard on all of our lean activity. And that work is paying off as we see the shipments increase. So those are some of the Key things, we continue to have good pricing in Arrow and are managing our inflation well. So we're seeing that positive flow through to our bottom line as well.

Okay. And then maybe on industrial core margins, you know, they stepped down almost 300 bits. Yeah, sorry.

Sheila, you already asked that. Sorry. In Q... we did have a reserve that we put up, and that impacted Q2 margins for core industrial. If you back that out, the margin rates are about in line with what we saw in Q1, and we expect the second half to be more aligned to what we saw in Q1, and operationally what we saw in Q2, we expect that to continue in the second half.

Yeah, maybe just, sorry, can you expand on what that product reserve was? What drove that? How big was it?

Yeah, so it's simply a matter of a longstanding product development program with the results that we see a little bit differently than our customer sees it. And that's about all we're able to share at this time. It's a matter that's being discussed. undertaken to the legal process, so we're not going to comment much more on it.

Okay. Thank you. Yep. And our next question comes from the line of Noah Poppenrock with Goldman Sachs. Your line is open.

Hey, good afternoon, everyone.

Good afternoon, Noah. Big Noah.

Chip, you know, everyone's trying to figure out what's going to happen with aerospace aftermarket. I guess, as you describe not really seeing much yet, I'd be curious to just hear, given your experience in the market over a long time, why do you think you haven't seen anything yet? Why do you think the airlines are not responding that much yet? And when you talk about the possibility of there eventually being a response and seeing that in your fiscal 27, if it were to happen, what would make it happen? What's the threshold? Is it a higher fuel price? Is it the duration of fuel price, just what are your customers telling you? And then is there any way to frame or think about Woodward relative to the market because you have so much more content on newer product versus older product? If capacity is trimmed or things are retired out of the back end of the fleet, is it safe to assume you see much less of that than the average player in space?

Okay, no, I may ask you for a repeat of the second half of the questioning, but I'll jump on the first half. I think you used the word duration, and I think that's the main question that is unanswered at this time in terms of what happens to fuel prices. My experience in situations like this is the reason things haven't happened very quickly from a negative standpoint is that there's still a strong traffic demand out there. And then the airlines that have decided to try to pass along price to the airline customer, that has not resulted in destruction of demand. And so I think everyone's kind of a little bit walking on eggshells trying to see how much of this cost impact that airlines are seeing from oil prices can be passed on from passengers without reducing load factors on flights. They've taken some very smart decisions to take out some lower load factor midday, midweek city pairs, I think, and put some higher fuel burning aircraft to the side. So all those are sort of prudent actions to take a look and see what's going to happen next from a traffic standpoint. Demand is still strong. So I think people are continuing as they were with their maintenance programs to And if the duration and the price of fuel continues to climb, then load factor break-even points between city pairs is going to cause more planes to be parked and maybe there'll be some destruction of demand if prices go up too much. So none of those if statements that I said have happened yet. So I think it's business as usual a little bit in the maintenance side. Some of our peers, you know, may seem like they're being a little more cautious with their quarterly results announcements. But if I remind everybody, you know, we're halfway through our year. So we've got a little bit more in the rearview mirror already accomplished and on the books. We've got a little less in front of us to ride on this duration question than our peers do. So hopefully that sorts that out. Second question I think you asked was about what's specific for Woodward having higher content on the current generation of narrowbody, the higher technology fleet with better fuel consumption performance. I think, you know, from our standpoint, legacy narrowbody repair business continues to grow, much to my, you know, a little bit of a surprise here. We didn't forecast it growing quite as much year over year or quarter to quarter as it did in Q2, so things are still looking good on legacy utilization front. But if we come to an oil shock that's even more and longer duration than we see right now, if the newer technology fleet gets utilized much more than the older technology fleet for Woodward, it happens to be good math. It's not good for the whole industry. We don't wish that on the industry. But if that does happen, we have a little bit of a hedge there because we have a faster growing higher content position on that fleet.

Okay, that is super helpful. I appreciate all that. And then just to follow up on the aerospace margin, would it be possible to quantify the incremental investments you made in the quarter just so we can all sort of keep tracking the underlying trend you've been experiencing there? And then on the pricing front, you guys have been providing, you know, kind of total company and then directional within the aftermarket pricing. Any update you could provide on what happened there in the quarter?

On the first piece, Noah, what I'll say is, you know, we're focused on making sure that we've got the systems, the processes, in place for us to continue to execute on our key imperatives. We are going to be diligent and thoughtful about how we increase that investment, not getting too ahead of the volume, too ahead of the volume growth, but not being so far back that we can't execute on it. And so as you can C, there's still margin expansion that we're looking for in the results based off of our guide. And so I think we're being responsible and reasonable with how we are increasing the spin as it relates to those strategic projects.

Yeah, and I'll just jump in and say that, you know, Bill had alluded to this in some of his remarks, but we have... increased our R&D spend a little bit in aerospace. Much of that is aimed at the preparation, the technology demonstration projects we're working with our customers. We've invested in manufacturing engineering to accelerate our automation journey, which also feeds how we will industrialize for the next single aisle aircraft components that we win. And as well, we've been building that plant in South Carolina And we are starting to staff up there some of our very key positions like plant leader and value stream leaders and some advanced manufacturing engineers. And so some of these are longer-term investments. Some of the automation investments will provide returns sooner. But some of the staffing up that we're doing and the R&D expenses are really aimed towards the next generation.

And then, Noah, I think you had a question on that. price, if that's right. And the price in the quarter was around 6.5%, 7%. And that's roughly what we projected to be for the total year. Arrow being a little bit stronger on the price side than industrial.

Thank you guys so much. Thanks, Noah.

And our next question comes from the line of Gavin Parsons with UBS. Your line is open.

Thank you. Good afternoon. Hey, Gavin. Hey, Gavin.

What drove the arrow revenue guidance raise kind of between the subsegments and then within aftermarket? How much of that is kind of the spares provisioning drop-in versus repair and overhaul work?

Without getting quantitative about it, I'd say that the – the commercial services is really the largest piece of the increased revenue gain. We had forecast the OEM to be growing, you know, substantially and maybe hedged it back a little bit in terms of how we were thinking about it based on, you know, what the aircraft and engine OEMs would actually come through with orders for and, you know, sort of meter us to. But it's been a little bit more on the demand side from the OEM, so it's driven a little bit of the gain and the forecast guide. But commercial services kind of look in the rearview mirror and thinking that that will sustain at least through 3Q, as Bill said, with the higher LRU orders. But the repair... is strong across the board in commercial services, wide-body, legacy narrow-body, regional, and the LEAP GTF all contributing to revenue and earnings growth.

Just to expand on that again, obviously the raising guide was partly recognizing the strong Q2 performance, but also second-half performance, commercial OEM, defense OEMs, On the industrial side, most of that OEM we see, especially in the fourth quarter, OEM growing nicely, and that's a big part of the raise for the second half. And obviously, that has a different kind of flow-through pattern than the services that we saw in the second quarter and in the first quarter.

Okay. That's very helpful. And then, Chip, you pointed out that airlines are maybe sidelining some of the least fuel-efficient aircraft. I think over the long run, you guys have talked about flight hours as being the key metric driving your aftermarket growth. But if it's those older or less fuel-efficient aircraft being sidelined, is the risk going forward more about accelerated permanent retirements, delayed shop visits, or maybe cut shop visit scope?

Just to clarify, are you talking about for the legacy fleet or in general?

In general, is the risk more about shop visits or retirements and less about flight hours?

Yeah, I think for the legacy retirement, for the legacy fleet, certainly the risk is about retirement and part out and not getting another shop visit on our LRU, whether it's a B2500 fuel control or a CFM 56-5 HMU. And so, you know, that risk, though, is like the end-of-life risk for the oldest part of that fleet. They're still, pick a number, 40% of airplanes with engines and LRUs that have only seen one shop visit and are, you know, quite capable assets that airlines are going to continue to fly. So, You know, flight hours is still going to correlate with how that equipment comes off and comes in for shop visits with us. But the sort of end of life for the oldest A320s, CEOs from our standpoint, you know, that's going to happen based on combination of traffic demand, price of fuel, and OEM delivery rates. And we'll monitor that closely. Thank you. Appreciate it.

And our next question comes from the line of Pete Skibitsky with Olympic Global. Your line is open.

Hey, good afternoon, guys. Great quarter. Thank you. Yeah, I just want to circle back to Sheila's question on industrial margin. I just want to think about the right way to think about it going forward. You know, if we exclude the provision in the second quarter, it sounds like you're maybe a tad over 17% on core industrial margin in the first half. with the new guide you know you get a little bit of a goose in the third quarter from china ohio on highway but then you know nothing in the fourth quarter but it seems like you'd still be exiting around 18 or so in the fourth quarter so you know it just seems like a lot of nice momentum in core industrial margin year over year and so you know is the right way to think about it that you know 18 18 and a half percent is a reasonable range to think about for 2027 or maybe 17.5% in the low end, or is there any logic wrong there?

Yeah, I'm real happy about 2026, Pete, and where that is, and I think how you laid it out is right. You know, we continue to work hard on all our margin and productivity, margin expansion, and operational excellence initiatives. And, you know, we'll be talking to you real soon about how that all comes to play. But I think if Randy was here, he would say he's not planning on giving up any ground. But we'll see how it all comes out in the mix as we start talking about 27.

Okay. Yeah, fair enough. Just one follow-up. On the pilot controls product line sale, is it fair to – To conclude that this product line has less aftermarket than the engine portion of aerospace. And so I'm just wondering if the divestiture is sort of margin accretive for you in aerospace and how much revenue is involved in that product line?

Well, I don't think we'll share the revenue specifics there, but it's not super significant. It is accretive to carve that out for us. That's one of the criteria we would use to examine a divestiture opportunity. You know, a while back in our strategic review process, we just identified this as an area where we would have to put a lot more resources into this to become a leader in the industry in this area. Where we are a leader is in some of the enabling technology components and subsystems that go into pilot controls like throttle quadrants. So some of the, you know, precise motor controls and motors themselves, as well as sensors and LVDTs and hall effect sensors and things like that, things that we we can bring to the party and we will remain a supplier of those components to the company that we sold the main business line to. So we'll retrench into the places where we're the most competitive and have the most value add for customers and pass that along. Now it does have a good amount of service business to it, which made it kind of an attractive product line to sell for the buyer. But still, from our standpoint, it's a creative to let it go.

Okay. So Niles will remain open. There are more production there than the pilot controls. That's right.

Yep. This was a relatively small value stream in the Niles facility.

Okay. Thanks, guys.

Yep.

And our next question comes from the line of David Strauss with Wells Fargo. Your line is open.

Thanks. Good evening. Chip, I think if I caught it correctly in your prepared remarks, you talked about additional or step-up in interest from your IGT customers and the potential that You might be looking at some sort of capacity expansion to be able to handle that interest. Did I get that right? And maybe if you could expand on that.

Yeah, not just our IGT customers. So gas turbine, reciprocating engines, diesel-powered, natural gas-powered, backup, prime power applications. So it's like across the board. Multiple OEMs in each of those categories over the last, you know, really month or so have come to us and said, you know, we want some capacity studies for these kinds of forecasts between now and 2030 plus. And so we've been sort of digesting those requests. And it's not one customer. It's not one technology. But it's largely driven by data center-caused power generation demand. And so we're looking to respond to these customers. But the reason I wanted to lay that out and what may seem like an early way in this earnings call is that as I've been meeting with investors and analysts, I've really kind of been firm that, you know, based on everything I see from our customers, we have the footprint and we have the ability to, through Kaizen and other continuous improvement, elimination of waste, you know, lead time reductions, things like that, we could make our way to, you know, solve for the capacity that's needed. But this new later breaking information says that maybe we need to consider capacity increases.

Okay. I guess we'll check back in on that later, see where you come out. Absolutely. If I missed, I apologize. Did you talk about where LEAP, GTF, aftermarket revenue volumes, however you quantify it, are relative to legacy at this point and where, you know, if the crossover point has changed?

Yeah, so I didn't mention the prepared remarks, but thanks for the question because it's one that we talk about quite a bit. What's really interesting interesting to to me and our team is that as we grow leap in a substantial way the legacy narrowbody fleet continues to provide inputs to our shop and we're like okay it's kind of growing you know at a at a at a good clip still uh for the the legacy uh fuel control units especially um i'm not changing the forecast right now we said sort of end of 26 begin you know sometime in 27 We still think that's a reasonable assumption. The things that could pull that in, you know, the fuel price shock that we talked about, you know, could reduce the rate of input for the legacy. And that would be like a not so interesting way to have the crossover be pulled in. We'd like it to go further to the right. The other thing I would say, just to give a little bit more color to what we're talking about, is that Right now, this quarter and even last quarter, the total amount of service revenue is about the same for LEAP GTF compared to the legacy narrow body if you include the spare LRU items. So from a repair standpoint is the crossover that we keep talking about looking for. It's a few quarters out in the future. But I just wanted to share that we're already kind of in the, you know, very similar numbers from LEAP GTF compared to B2500 and CFM-5, if you include all the different kinds of service products that we offer.

That's great. You predicted my next question, a follow-up question. Thanks a lot. You bet.

And our next question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Yeah. Good evening, Chip and Bill. Thanks for taking the question. I just wanted to maybe follow up on the free cash flow guide. It didn't change with the sales and EBIT increases. Is that just reflecting as you continue to talk about, you know, higher working capital spend or working capital as a percent of sales? Is that the right way to think about it? Is there anything else impacting on the free cash flow side?

No, Ken, I think that is the right way to think about it, to simply state it.

Okay, okay, that's helpful. And I wanted to follow up on the announcements with LHT and Air France KLM. How quickly will those scale as sort of third-party MRO providers, and should we expect, you know, maybe a movement of, a block movement of spare parts or inventory at some point in the next few quarters as they ramp or maybe as part of these agreements?

Yeah, so the rate limiting step for any of our licensed service providers is going to be getting test stands procured, installed, and calibrated. So that's nine to 12 plus months away, depending on where each of the folks are in the procurement cycle of that. So it's definitely not a 2026 kind of thing, and we'll give some color to how we expect the standing up of these partner providers to affect our service business, along with our Investor Day information late in the calendar year. Okay, great.

Thanks, guys. I'll pass it back there. You bet. Thanks, Ken.

And our next question comes from the line of Christopher Glenn with Oppenheimer. Your line is open.

Thanks. Good afternoon or evening. So I was curious if you've, hello. Curious, have you guys evolved any like different angles on visibility to the China LRU markets?

As far as new angles, I would just like the easy answer is no on that. But what I would say is that we're starting to see just like more across the board as expected based on airplane deliveries, customers ordering spare LRUs to provision for their fleet uninterrupted operations and the maintenance cycles that are coming. So I think we can kind of take the China moniker off the table for now. And they're ordering kind of like you'd expect them to order based on how many planes they have.

Okay, so maybe a little bit of a tempest in the teapot discussion for the past couple quarters, sounds like. And then curious on the L'Orealish business model, don't recall like really discussing if they have much military in there. I suspect they do. I don't think your guided missile program guided missile destroyers program was LaRange, but rather your PowerGen business. But just wanted to check in on that, you know, the military business pipeline overall for industrial and as it resides or doesn't within LaRange.

Yeah, so I would consider LaRange to be 99 point something commercial as far as I know. I don't want to say 100% here, but it's just it's not something we think about or consider for what our diesel fuel system business contributes to. As far as the destroyer DDG class that are powered by gas turbines, both for propulsion as well as for onboard power gen, that's really the business that we participate in. It's the electronic control systems for controlling the power

uh from the gas turbine as well as controlling the propulsion systems great thanks for the updates you bet and our next question comes from the line of louis raffetto with wolf research your line is open thank you good evening hello got him hey louis oh louis yeah oh um

Maybe, Bill, just on the China on Highway, I know you said $30 million of sales in 3Q. Should we expect to see similar levels of profitability that we saw in the last two quarters?

For Q3, that's correct. Obviously, there is going to be a restructuring charge that flows through. So operationally, Lewis, correct. But I do want to make sure I highlight that. there is going to be a restructuring cost that comes off. That will be separate as we go through the quarter.

Okay, great. Thank you. And then, Chip, maybe just to come back to what you just mentioned about the LRU. So obviously, as we get to your fiscal fourth quarter, you're going to be coming up on a tough comp. But what I'm trying to understand, based on what you just said, is are the LRU sales that you saw this quarter, are they not China? And you're kind of saying... Don't think of this as a separate bucket anymore and everything is kind of one big bucket nowadays? Or is there still sort of a China bucket out there that we need to be mindful of?

I'm saying the former, which is there's really not a China bucket anymore. That was when we had our first step up in LRU, unforecasted LRU sales within a quarter. That was due to a little bit of a surprise situation. order stream starting from China that lasted a couple of quarters. And then as I kind of was alluding to, the rest of the orders inside the quarter are more spread out to European and US and Latin America and every other airline that's ordering aircraft and provisioning to support their fleet. So I would put the China bucket behind us for now and kind of how we see the rest of the The year shaping up, as Bill said, we largely have the LRU orders in hand for 3Qs. We have good visibility to 3Q, and it is a good mix of customers, so less risk of being a non-repeat kind of thing. But our visibility into 4Q is what we would normally see at this point, not fully clear in terms of who's going to order and how much it's going to be. But we have enough confidence in all the different levers of our OE and service businesses in both segments to say we're confident in what we've put up for our guide.

All right, I appreciate it.

You bet.

And our final question comes from the line of Gautam Khanna with TD Cowan. Your line is open.

Now, Gautam.

Hey, thanks for getting to me, guys.

Good afternoon.

Yeah, good to talk to you guys. I was curious, just could you quantify what the guidance revision was for just China OH relative to the prior outlook?

What the guidance revision was for... You really didn't take that into account. Yeah. Yeah, Gotham, not much. I mean, I think the guide, the upper end to the lower end considered what we're seeing in there for China OH. I think at the beginning of the year, we said it was going to be around 60 million. And where we ended up with what we've had in these last time by, it'll probably be somewhere around 90 million in total. So that was sort of within the range of our guide. And so anyway, that's how we handled it.

Okay, and in terms of profit variance, when you had the 60, what was the expected profit? And then if it's 90, what's the new expected profit?

Yeah, so, you know, we talk a bit about, you know, at certain levels, it starts to go beyond breakeven. And then it, you know, it flows through quickly through that point. We are at that point. And so that's what sort of generated, I think in the comments, we said it was worth about 230 basis points this quarter to the overall industrial earnings increase.

Okay, I was just curious what the revision is related to that. We can take it offline. Thank you.

Yeah, I would just emphasize, Gautam, that The China OH wasn't really driving the revision to guidance. It's more the success we've had in the first half with commercial aero services and continued strong OE in both segments.

Yep. No, I got you. That's clear, too. Thank you. The question on industrial underlying margins, kind of over time, You know, how far along are you guys in that process of kind of, you know, looking at which skews to stock, which ones to retire, kind of the operational turnaround within the industrial business? How far along are you in that journey? Do you have any ballpark sense for where margins ultimately can get to in that segment?

Yeah, you know, so far I've always answered that question saying we're in the early innings. But I feel honestly like we're in the middle innings in the industrial portfolio rationalization turnaround. You used the word turnaround. I've not really used that, but I think it's an apt description. That team is just really – pulled together and made some difficult decisions. You see the China on highway exit that we're doing. That was a difficult call. Some of the product lines we've exited were difficult calls around small engine and other things like that. But what we're doing now and what you can see now is that we are more introducing a more standard, disciplined product management approach to the business. I talked about this actuator in my prepared remarks that is going to enter into service in 2027 that's now in the test phase and we're industrializing. That's going to replace a pretty complicated portfolio of actuation for reciprocating engines. It's not like we looked at the portfolio and said we don't want to be in that business anymore. We said there's a better way to serve customers here that's going to be more efficient in our factory. It's going to be more resilient in the supply chain. And the customers are going to get more value from a broader torque range and lower form factor. And so that's the kind of work that's going on in industrial right now. So that's why I think it's the middle innings because we've evolved from these are the things we want to stop. And these are the things we want to keep doing. And now we're just refining the approach within the places we want to compete.

And Chip, I'm going to add to that, as you're talking about where can it go. As Chip has spoken about previously, we're focused heavily on recouping our service franchise there. And we've got to see, we have a plan. We've got to see what the art of the possible is and how we can get there. But I think that will, if we're in the middle innings, we've got a half of the game to go on the productivity. The other piece of margin expansion will be how we can grow that service franchise. And I think we can talk more about that when we get to investor day and what's the art of the possible for industrial margin rates.

Appreciate it. Thank you, guys.

Thank you.

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

Thank you. I'd just like to thank everybody for joining our 2Q call and look forward to talking to you again soon.

And ladies and gentlemen, that concludes our conference call today. A rebroadcast will be available at the company's website, www.woodward.com, for one year. We thank you for your participation in today's conference call. You may now disconnect.