Woodward, Inc. (WWD) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to this fireside chat discussion with the executive management team of Woodward. I am Noah Poponak, the aerospace and defense equity research analyst at Goldman Sachs, and I will be your host today for this discussion. Before moving ahead, we are required to make certain disclosures in public appearances about Goldman Sachs relationships with companies that we discuss. The disclosures relate to investment banking relationships, compensation received or 1% or more ownership. These disclosures are available in our most recent reports available to U.S. clients on our firm portals, and disclosures and updates to those disclosures are also available by ticker on the firm's public website that's gs.com/research/h. So with that, it's my pleasure to introduce from Woodward, the CEO, Chip Blankenship; and the CFO, Bill Lacey. Chip is the Chairman and CEO, a role he started in May of 2022, prior to that built a lot of experience in the aerospace industry, including over 20 years at GE, including in their engine business. And Bill became the Woodward CFO in May of 2023, and also had a long tenure at GE, along with other aerospace and industrial roles. So gentlemen, thank you so much for your time today and for being with us, excited to have this conversation with you. And Bill, I know you now also need to provide your cautionary statements. I'll turn it over to you.

Yes. Noah, I think we have some similar friends in the company, and I do have a brief cautionary statement. Elements of this presentation are forward looking based on our current outlook and assumptions for the global economy and our businesses more specifically. These can do frequently change. Forward-looking statements are subject to a number of risks and uncertainties, including the risks we identify in our filings. These statements are made as of today, and we do not intend to update them except as required. Noah, I hand it back to you.

Great. Thank you, Bill. So from my perspective, it's a management team of the company that's still fairly new, call it a blended 2 years, give or take. We've seen the operating performance and margins of the company definitively improve in that window. So I think the market wants to hear more about what you've done to drive that, what's left to do. So we'll talk about that. In aerospace, we have strong demand, but certainly some supply side challenges. Woodward, I think, has some pretty unique positions. It's unclear to me that, that's all fully understood. Let's talk through that. And then on the industrial side, certainly a lot of focus on China truck amongst some other things. One could argue maybe too much focus given its size as a percentage of the company, but maybe also some confusion around the numbers there, including the last earnings call. So perhaps part of today can be kind of a level setting there. So with that overview and the backdrop of what we want to discuss, let's start in aerospace and Chip and Bill, let's start by walking us through your content gains. And on the current generation of airplanes and engines, what are the content gains versus the prior generation, discuss them, size them, and what do they mean for the forward rates of growth in the aerospace business compared to what you're seeing today?

Well, first of all, thank you, Noah, for hosting us and for the opportunity to share progress we're making at Woodward as well as our views about our company's growth profile. And thanks for making your first question, a growth question. We have just about tripled the shipset content on both 737 MAX, A320 versus their predecessors. For the 737 MAX, that equates to around $350,000 of shipset content, 12 components on the LEAP engine versus 1 small component on the CFM56-7, so big change there. On the A320neo, that equates to around $250,000 per shipset. We also have around 12 components on the GTF engine versus 2 to 3 components on the V2500 and the CFM56-5 engines, which powered the A320 classic, the predecessor. So the bulk of the content gains are, in fact, propulsion system related. This high level of content on the MAX and NEO drives Woodward OE and aftermarket sales growth long term. Having significant content on all the engine choices results in a forecast of about 5x the service content of the legacy narrow-body fleet for Woodward, which is a big game that should bode well for us well into the next decade.

Excellent. And perhaps we could talk a little bit about the nearer term or sort of real-time activity in aerospace original equipment, maybe level set us on where you're producing today on the current generation of aircraft. What's the latest you're hearing from the OEMs? What are they pulling? What do they want to do into the end of the year and into next year? And Chip, I know on the call, you commented about the possibility of maybe some inventory destock in aerospace original equipment. Curious to kind of follow up, how much of that was you're really truly seeing that as a definitive red flag versus you were just kind of being balanced around all the different things going on in the sector?

Yes. Thanks, Noah, for the opportunity to address this one. On the earnings call, I didn't really directly come out a destocking comment to -- it was more of just a statement that inventory is building in the system, and we see ours building. As everyone online knows the airframe and engine companies have announced production target reductions this year as well as pushouts of their build rate breaks. Rate break is a planned, stepped increase or decrease in production rate where the airframer has to align the entire supply chain and prepare for such an activity and stock inventory and prepare to achieve the new rate. All these pushouts reductions and pushes to the right have been attributed to supplier performance. Woodward is now producing to our customer demand on all platforms. And this is great news for Woodward and our customers. It's taken some heavy lifting to stabilize our supply chain and increase our productivity and capacity to improve our delivery performance, thanks to our team for delivering such market improvement over these past few years. As I mentioned on the earnings call and other companies have as well, the aerospace supply chain currently has some elements and players that are out of sync with the airframe demand segment. What this does is it causes up -- it causes to certain inventories to pile up of certain components and systems, while there are gaps in other components and systems and supply that causes the airframer to have different production rates than they want to achieve. We believe this disconnect is temporary in nature. And because the demand is so solid based on passenger travel growth, and efficiency of the new equipment, we have confidence that the supply chain will align over time.

Okay. So my interpretation and read on that, just to, I guess, make sure I have it correct is Boeing and Airbus were pulling from the supply chain for higher rates. Clearly, they are ramping to those higher rates slower than recently previously expected. And we've all felt on our side, like that was a risk to the OE business of suppliers. Yet we've seen in a lot of the financial results recently that the OE revenue growth numbers are still pretty good. And that companies are talking about producing at rates that aren't really down from where you kind of entered 2024. And so I guess it sounds like Boeing, especially Boeing, but also Airbus are pulling from the supply chain because they don't want to slow the supply chain down because they have so much higher to go. And as long as they are able to actually now ramp into the end of 2024 and really make a lot of progress in 2025 and then obviously beyond, they can sort of thread the needle of yes, there will be periods where they're moving faster than the supply chain, but not necessarily a huge variance and everybody keeps growing and eventually just kind of link up somewhere on the path and then everybody keeps growing from there. That's sort of, I guess, the best case. Obviously, there's a risk if there's further setbacks.

Yes. I think Noah, that's a good way to characterize it. And that's kind of what I'm trying to say is I don't know what the top level of the supply chain will do with their demand signals going forward. But again, that's a management and judgment and risk management kind of decision to make about whether they're willing to keep building some inventory from some suppliers and let that level out over time or they'll take different actions. And we'll just have to -- we'll have to wait and see. We're prepared to meet the demand that we're currently producing to the demand, and we're ready to manage to whatever the leaders of the supply chain decide to do.

Okay. Great. That makes a lot of sense. All right. Let's maybe move over to the aftermarket side on aerospace. I guess the question is, today, what's the unit versus the price within the growth rate that you're seeing right now? And how are you thinking about the normalization of unit growth as we recover all of the prepandemic air travel if Boeing and Airbus successfully ramp, does that mean we're retiring things out of the back end of the fleet. And then on the pricing side, we know pricing was -- it's a business that always prices well, but pricing was elevated in the near peak inflation as inflation has decelerated, how do we expect the pricing to decel, maybe walk us through those moving pieces in the aftermarket?

Yes. Thanks, Noah. The aftermarket, as you've seen, as we've reported it and others have reported it in the commercial aerospace business has been performing very well. Passenger demand has been strong, and that's really the lynch can that starts the entire demand equation for all of us suppliers. While the OEMs work to ramp production, this legacy fleet is flying longer than forecast, longer than any of us thought it would because it has to based on the production rates for the new equipment. It may even do this through the end of the decade. What we and others are seeing is that with continued utilization of this legacy fleet and the fact that the MRO shops are actually quite full, this related aftermarket business associated with the legacy fleet has probably achieved a plateau. It may hold this level for a while. And we'll just have to wait and see how long that plateau can hold. In this environment, we do see opportunities for continued price realization. And as I indicated in our earnings call, the Woodward LEAP and GTF activity is increasing. In fact, last quarter year-over-year, that amount -- that work doubled for us, albeit from a low base, but we anticipate it to continue to increase and won't be really that meaningful til around fiscal year 2027 for us, but it's an important element of our future growth. The pace of retirements that you brought up among the legacy fleet, the way we think about that is it's really a combined effect of continued passenger demand as well as the ramp rate that the OEs achieve. These 2 factors will collaborate to decide what retirement rate of the old equipment fits the airlines' demand profile. So over time, the aftermarket opportunity for Woodward is much larger on the current generation due to the engine content wins you and I talked about -- just a few questions ago. So we believe Woodward can achieve outsized growth compared to the market in general as the LEAP and GTF volume picks up.

Have you guys ever put any numbers around? Or is there an opportunity to put some numbers around the current generation aftermarket contribution as it ramps. You just alluded to the year where it starts to really move the needle. It has a very high growth rate right now off of a low base. Yes. If you take that?

So we shared that at our Investor Day, and we showed sort of notional blocks of business from the legacy fleet and the GTF, LEAP aftermarket and where they sort of become equal is sort of in that '27, '28, '29 time frame, depending again on how the airframer rates go and pass through demand, but that's our current forecast is those businesses cross over in terms of content in about that 3-year time period, somewhere in there based on the assumptions.

Interesting. Okay. And Chip, I guess you also on the earnings call referenced what we've seen from some of the airlines, where they've had some supply-demand mismatch and some pricing challenge. I think, again, people in the market interpreted that as a warning on your aftermarket in the near term potentially. How much of that was you're seeing red flags in your aftermarket demand versus, again, just trying to be balanced on all the things you're seeing in the market?

Yes. Those comments were in the balance category, Noah. Thanks for bringing that up. I mean, -- it's important to remember that even in great markets, sometimes the growth rate can flatten out a little bit and provide a 1 quarter or 2 quarter less of a growth rate than the prior sequential quarters. And so things can be a little bit lumpy. We love the overall demand curve. We think long term, medium term, even near term, this commercial aftermarket is great business. But we've been posting some pretty high comp numbers year-over-year. And we feel like it's more of a plateau than a continued up and to the right at that previous growth rate.

And do you guys have the rough number on how much aerospace aftermarket revenue there is in the current fiscal year?

I don't know if you have that, Bill or not, we?

Yes, Chip, I don't have it right off my hand here, but yes, we can get to that.

And so -- because I just wanted to make sure I understood the comment previously is basically you're saying that the LEAP and the GTF themselves will become as large as that number in 2027?

Well, the aftermarket -- the commercial aftermarket has more than just the narrowbody legacy fleet in it. So there's -- what we're talking about really is the -- it's just comparing the narrow-body fleet and that crossover happens in that '27 to '29 time frame. So the total aero commercial aftermarket, like I said, has a lot more content than just those elements.

Okay. Sorry. So that comment is the LEAP and the GTF crossover current narrow-body aerospace aftermarket?

Yes. correct.

Got it. Okay. And we could then do some math from there. So that's helpful. Okay. Great. So let's talk about the defense input. We have kind of the cross currents of the budget authorization, growth rate is sort of decelerating, but the outlays are pretty strong. There's been a gap between outlays and authorization. Curious how that's feeding into the business now, what you think the business does moving forward. You've had this somewhat sizable exposure to precision-guided munitions. Maybe remind us how big that is today? What are you seeing in terms of order flow in that business? And I guess, when you roll it all up, what kind of growth rate do we expect from defense in the medium term?

So Noah, we do, in fact, expect defense to grow in the near term. As JDAM decline turns around, we've seen over the last several years that on a negative trend, and we believe it's on the upturn. The growth from that and other defense programs, we think, will all become visible again in the near future. There's opportunity in guided weapons like you referenced, specifically JDAM, SDBs and AIM-9X. There's still a lot of details to be worked out in these order streams, but they should positively impact Woodward, just not sure how much and when at this point, though we think it's possible that these programs could contribute quite nicely to growth in FY '25. I'd like to highlight that the F-35, F-15 Black Hawk and M1 Abrams should also contribute to growth in the near term. So it's not just the guided weapons. These other fixed wing, rotary and ground platforms, we also think look like good growth in the near term. For Woodward, we also have sort of a unique opportunity in defense. Our aftermarket opportunities, as I've stated before, is a little bit unique. We were our own obstacle to getting more business there. Our focus on operational excellence has opened up more opportunity for Woodward in this space. We continue to reduce our turn times and improve customer satisfaction, which we intend to use as a platform for growth, actually multiyear growth in this space.

And in recent periods, your defense aftermarket growth rate has been quite high. I guess how much of that is that effort specifically versus just what the end market has been doing?

So, I guess, quite a bit of it is a result of that, Noah. We've had some in the engine side that is more related to the market, to your point. But all of our airframe defense aftermarket increase has really been our turn time reduction and output increase from our repair and overhaul facility.

Okay. Great. All right. Let's move to industrial. And I guess, I thought -- I tried to think of a million different ways to ask about China on-highway. But maybe I'll just sort of simply put to you, there was clearly a confusion on the call around revenue and margin levels for breakeven, non-dilutive and other moving pieces in China on-highway. Maybe I'll just open ended provide you guys the opportunity to clarify and level set some of the major aspects of the China on-highway business?

Yes. Noah, let me take a shot at that. And clearly, there was some confusion on the earnings call. And as I look back at the transcript, I think there's a couple of areas that we really should clarify, get some good operational definitions and establishing key benchmarks. First of all, when we talk about the breakeven point for the China on-highway, business, meaning at what point is that business at a 0 margin. We're talking about sales levels of around $15 million for the breakeven point for our China on-highway business. The second area that I wanted to take the time to define here is at what level of sales is China on-highway, not accretive or dilutive to our core industrial business that right now, Noah, is trending around 14%, and that number is $25 million. Now these are guideposts, rules of thumbs, obviously, in any given quarter, these numbers could fluctuate depending on the mix of product that is being sold, also what is the profit rate, the margin rate for the core industrial business. But again, we think these are good rule of thumbs to have, breakeven at $15 million and where it's non-dilutive to the core business $25 million. China on-highway business, Noah, is impactful, but it's a small part of our overall industrial business. The reality is, it is volatile quarter-to-quarter. But as you smooth out that volatility over the longer period, we have seen this business continue to grow nicely. So we think it's a good business for Woodward and for shareholders that generate cash that we can pipe that back through the core industrial business as well as aerospace. Regardless, Noah, I have to -- we have to do a better job of providing transparency and clarity in our communications about the China on-highway business in order to reduce the frustration and the confusion, but really also most importantly, so that we can focus the conversation on our core industrial business and our aerospace business where we do allocate the majority of our resource and our investments.

Okay. Great. That is helpful. I had those numbers wrong until right there. So I appreciate that clarification. And hopefully, that's crystal clear this time. So let's go a little deeper on a few of those pieces. You guys had talked about the effort to make this business and the revenue stream more predictable, less volatile and I don't know if that's through LTAs or what else you can do. But can you talk a little bit more about that? And has there been any progress made? Or is that something that's going to take quite some time?

Yes. Noah, we have done a lot of work in terms of getting closer to the end market, really working tightly with our customer base. And as a matter of fact, we were able to at least get comfortable with 3 months of visibility. And so we view that as good progress. However, it's a struggle with the dynamics that impact this area of the business for us to get visibility to sustain predictability much beyond that. However, what we can control is our team that supports this China on-highway business is to create a more resilient supply chain that's also more flexible, make sure that we can narrow our lead times as much as we can so that when we see these high swings up and swings down, we can either meet the customers' demand or make sure we don't get stuck with a bunch of inventory and not efficiently use our cash. So it is what it is. And so what we're doing is to try to make ourselves as efficient in this volatile area as we can.

Okay. That's good. And I guess, as we're sitting here almost September 1, and we're webcasting, any further clarity on fiscal 4Q and whether it's just activity or whether or not it is truly just 1 quarter of a destock? Any thoughts on fiscal '25?

Yes. So at the -- at our Q3 earnings call, we did guide Q4 to be in the range of $10 million to $15 million. As I stand here today, Noah, it looks like that is trending towards the upper end of that range, which means for the total year that implies China OH to deliver revenue in the $205 million to $210 million range, which would be a record for that business. As it relates to '25, and again, we're committed to provide you guys with greater transparency, visibility and concise messaging. So we will talk a lot about this during our guide on '25, but as I sit here today and think about how I would model it, I consider a few things. Look at -- first of all, look at the current secular trends, what's the price of natural gas? How does the spread between natural gas and diesel, whether the freight rates doing in the development of the China infrastructure to support natural gas trucks as well as the overall heavy-duty truck market. But I also have to remember that there's other factors that come into play that can supersede those tangible trends. So the reality is it's still unpredictable and volatile as we look out in '25. However, I do think those trends are favorable. And so I don't think it's right, as I'm thinking about modeling, to model this business at that breakeven point that we talked about Noah is $15 million. I think the right point to peg it to you right now is that $25 million number per quarter where it's not accretive or dilutive to our core industrial business when it's around 14%. So right now, as I say, I would think about that $25 million number a quarter for '25. We'll continue to monitor the trends, interact with the market, and we'll be back with an update at our Q4 earnings call on what we think the best way to think about the China on-highway business for fiscal year '25.

Okay. That's super helpful. So $15 million in the fourth quarter, so that will be breakeven for that business.

That's correct, as we currently talked about and also, again, in any quarter, there are some things that can fluctuate it, but that's the right takeaway from our discussion.

That was sort of like a bad joke. And I guess if I look at the spread of diesel versus natural gas right now, it's -- it's inconsistent with $15 million of revenue, if I just look at the correlation of your revenue to that spread over time, which would suggest there is an inventory destock above and beyond just the underlying demand?

Yes. you know they're -- Yes, I mean, China, their current economy, I think, has an impact on the market. Throughout the year, our customers have really -- were able to get their stock levels in a much healthier shape. We were able to deliver probably better than they thought we would do. And so given what we saw in the economy in China, where their inventory levels are, I do believe that this is a -- them getting things back in line, and we don't foresee that this will continue, however, Noah, it is China on-highway. So we will stay in touch and keep you up to date.

Okay. And last one here. I hear from people in the market, this is volatile -- it is volatile. I also hear it's over -- in some of these quarters where you've had higher revenue numbers recently, it's over earning. And that I dispute because to me, over earning is above and beyond normalized over a long period of time, shouldn't this business grow at a pretty good rate on a multiyear basis as we go very far into the future, right? 3 years from now, 6 years from now, 9 years from now, isn't this actually underpenetrated in the total fleet there where -- and then on top of that, they have directives to implement this into the fleet as part of the total overall emissions efforts. And therefore, yes, it can be volatile quarter-to-quarter, but is it -- could you actually make the case that it's under-earning relative to its longer-term potential? Or is that wishful thing?

Yes. Yes. About probably 18, 24 months ago, as you looked at the share of natural gas trucks in China and the overall heavy-duty truck market, it made its way up to be about 10% to 15% of the total heavy-duty truck production. In the last 18, 24 months, we've seen that shift to where natural gas is about 30% of the overall heavy-duty truck market. I'm not sure what entitlement is for this, but we do believe there's room to grow in this area. And again, as I look back historically, we have seen through the volatility, we have seen the trend be positive. We continue to have, again, limited visibility. But we think that, again, it's been a good business for Woodward and for our shareholders, and we'll see how it continues to play out.

Okay. If we take the rest of industrial, I guess anything you guys want to highlight, opportunities or risks? I know that the power gen growth rate has been pretty healthy; marine, pretty healthy; oil and gas, may be kind of stable off a bigger year last year. Anything that you think has a significant rate of change one way or the other in the medium term here?

Yes. I think, Noah, one of the strengths of our industrial product portfolio is the breadth of the end markets that we and our customer products serve. We see Power Gen is the biggest opportunity for growth. That's probably not a surprise based on all the articles that are out there in the news these days, driven in part by data centers. Data centers drive both standby and steady state demand, but also the needs of the global power situation to support electrification in developing countries as well as the energy transition everywhere. This offers growth to our turbine business and to our reciprocating engines, both gas and liquid fuel control systems and services. We focused our value stream lean transformations on SOGAV and gas turbine control valves for this very reason to prepare for this growth that we see and our customers see by reducing our lead times and increasing our capacity to serve. Oil and gas appears kind of flattish, like you mentioned. Some of our customers are actually up quite a bit in oil and gas, but that's offset by other areas being down. We feel like regulatory actions in some cases, and in action and others may dampen actual natural demand signal in the oil and gas market. Marine has been a good segment for us, like you said, over the past few years. The shipyards are booked solid and the utilization of the fleet that has Woodward content in it remains strong. Our dual fuel injectors are in high demand to provide alternate fuel capability to our customers' customers that they're demanding. So we like all 3 of these markets, but they're kind of in a little bit different parts of the cycle right now.

Okay. That is helpful. Let's talk about margins, and we'll talk about each segment. But first, just at the total company level, you guys are still pretty new in your seats at the company. We've seen a lot of margin improvement already. Talk about what you've done, how much is still left? I don't know if you have quantified in what inning you're in? You've talked about the SKU reductions in industrial. Are there still a lot of incremental efforts like that? Or are you kind of transitioning to the phase of a more steady continuous improvement. And specifically on pricing, there's been a lot of examples historically of companies in the aerospace supply chain where there is pricing power. And a given company or management team is maybe not fully utilizing all of that or getting all of the value out of that and a new team can discover a lot of latent pricing. Is there a lot of latent pricing in Woodward?

So we've made a lot of progress in margin expansion over the last 2 years, largely by focusing on operational excellence. And as you mentioned, we're still in the early innings of this journey. I don't know whether it's inning 2 or inning 3, but we're not at the halfway point, and we're not at the seventh inning stretch by a long shot. We have numerous value streams under transformation, and we're getting the newer members up to speed and they're becoming more productive. We've greatly improved our sales inventory operations planning process, which will pay dividends and how we reduce waste in our entire business process. It's been challenging work all the way so far as any of my teammates can attest. The good news is though that there's a significant additional opportunity within reach. We believe we can accelerate our improvement over time as our team learns and we mature our lean operating system. The industrial product portfolio rationalization that you referred to, this was sort of a sprint and it was very effective. We removed 25,000 SKUs from our product offering, and this eliminated a ton of waste and improved efficiency in our supply chain as well as inside our plants. Our focus has now shifted to a disciplined product life cycle management to ensure that we're actively managing product offering and process life cycle in a more sustainable way. I guess, Bill, do you want to talk about pricing for us?

Absolutely. When the management team came into place here, it was just after the post-COVID hyperinflation was running rampant, and we were in a position where our LTSAs were not flexible enough to allow us to offset that inflation with pricing and we did see our margins erode. Pricing became a critical must-do initiative for us. And we took a war room mentality to it. First of all, we worked on our catalog pricing process to make it more nimble. And secondly is we looked at our LTSAs. And we kind of laid out all the LTSAs that were under stress because of the environment, and we calendarized every one of these negotiations and when they were going to come due and we took a strategy to make sure that in those negotiations, that we are able to recoup the margin that did erode and also create some flexibility to not be in the same position if we saw inflation in the future. Now based on the results that we've seen in fiscal year '23 and what we've seen so far in fiscal year '24 on pricing, I would say we've been pretty successful in running that play. Having said that, we've been through most of our LTSAs, but in '25, we still have some that we have to get to. We'll continue to focus on this pricing initiative through our catalogs, through value pricing initiatives and maintaining our disciplines as we negotiate LTSAs. So we feel that continued focus on pricing, also continue to focus on operational excellence initiative that Chip spoke about, we've made good progress. We feel like there is more to do, and that will carry us to our margin goals and objectives that we laid out in December at our Investor Day.

Excellent. Okay. I appreciate all of that detail. Really helpful. Maybe let's talk about where the margins can go in each of the segments. So I guess, in aerospace, the last quarter, prepandemic was just under 25% at the segment operating level. There were a few 21% to 22% a little more consistently just prior to that. You've now made it back to just under 20%. You've had a 40% or 50% incremental over the last 2 quarters. I debate, should I go into my model and just punch in 35% incrementals and you sort of slowly get into the low 20s and kind of hang around in the low 20s? Or is the entitlement of this business higher? I mean, actuations, controls, moving parts, a decent amount of aftermarket, pricing power. We certainly know of businesses in the supply chain well clear of 20% on the segment operating margin with similar characteristics. So I guess, should I just use a 30%, 35% incremental? Or is the entitlement of this business something much higher than what we're at today?

Yes. Let me jump in on this, Noah, real quick. First, let me speak to that 24.8%, just under 25% that we saw during that quarter. There's a lot of things that came together positive in that quarter. Some of those items were onetime benefits, are not reoccurring. So I would not have said that, that was sort of the run rate margin level it was really still -- the run rate was around that 21% to 22%. Now I do want to give the team a lot of credit for the margin expansion that we've seen coming out of COVID. In '23, the aero business improved margins by 120 basis points. And then based on our guide for FY '24, that implies that we'll see about 260 basis points improvement. So first, we feel very good that we're on track to get to our Investor Day call of the aero business being at the 20% to 22% plus range. And so -- and Chip, I'm not sure if you want to add anything else to this point?

Sure. Bill, thanks. I'll -- I'd just like to add that there are not any structural obstacles to achieving margins as good as the best of our peers, Noah, to your -- the point I think you're trying to make there. We'll simply continue to mine the productivity that our lean journey is going to uncover and deliver post 2026. These results will complement the beneficial growth in LEAP and GTF aftermarket that we forecast ramping up in that time frame.

Okay. So the '26, 20% to 22%, we're kind of flirting with 20 right now. We still have volume growth ahead. Clearly, we have the LEAP and the GTF shop visits ahead. We're talking about early innings of productivity. So without putting a time frame on it, it sounds like you feel like you have the potential to go north of the 22% beyond whenever you achieve that?

Yes.

Yes, I think it's fair to say -- yes, right. I think that's fair to say, Noah.

Okay. And then on the industrial side, you've referenced the 14x China on-highway. And so I think we all do the math of, let me use 14 for a while and then figure out how to model China on-highway. But -- what's -- what should we expect to happen with the 14? I assume you're not sitting still on the 14. What can you do? And where can you take the 14 while we then also model China on-highway?

Sure. As I think about the 14% margin, I do want to take a moment because we're talking about an industrial business and, Noah, you've covered us -- and so you know this, this industrial business was hanging in that 8% to 10% margin range for a period of time. So I do want to take -- give the team credit for showing a 200 basis points improvement on margins in '22 as well as another 200 basis points in '23, getting us to this range of 14%. It's also a testament to those operational excellence initiative that we just got through talking about and showing that we are making progress and that they are working. We believe there's plenty of room left in those initiatives. And so we expect our ability to hit our Investor Day guide of this industrial business being in the mid-teens as being very much in our grasp, and we'll continue to work and push towards that.

Okay. Excellent. I want to spend the last 15 minutes before the end of the hour on balance sheet, cash flow, how you want to deploy capital. I do have an e-mailed question from an investor that I think is a good one that's worth clarifying, some of which is in the aerospace aftermarket. So I'm just going to jump to that really quickly. And the genesis of the question is when you were discussing the aerospace aftermarket, you referenced a plateau in some context. And the question is asking, did you mean your aerospace aftermarket business is plateauing in the near term or that it doesn't grow next year. I interpreted, Chip, your comment there to be referencing specifically the age of fleet lack of retirement vis-a-vis Boeing and Airbus inability to deliver that, that dynamics favorability to the aerospace aftermarket is plateauing. And we -- I guess, in a way, we sort of all hope that, that's plateauing -- just -- is that all you meant? Or did -- or maybe just clarify how you meant that?

Yes, that is all I meant. Just there's a natural situation where the MRO shops are full and the fleet utilization is at its peak that the airlines can utilize for those legacy narrow-body aircraft. And so that produces a plateau, which is a great plateau, by the way. We're very excited about that. But there's plenty of other opportunity in our commercial aftermarket business to capture additional shop visits of our LRUs as well as to take pricing and other opportunities to keep growing that commercial aftermarket business. While we bet on the come on the GTF and LEAP, there'll be additional business for that next year, and that will play in as well, although not as meaningfully as it will in the '27, '28 time frame, but we'll have that business growing next year compared to this year.

Got it. Okay. So the guidance for this year is now below 100% free cash flow to net income conversion. Obviously, there's movement in working capital. But maybe just walk us through the drivers that are pulling it below and sort of how and when you get back to 100 or better?

Yes. Noah, as we laid out on our Investor Day, our objective is to deliver $1.2 billion of cash over the period of '24 through '26 and to be greater than 100% free cash flow conversion. Our original guide for '24 had us right at slightly below the 100% cash conversion number, and what our current guide sort of hints towards in the midpoint is, as you spoke, we're going to be lower than that 100% conversion. And the primary driver that pulled us back from that 100%, Chip mentioned on our earnings call, we saw some customer shipments slip to the right. We will still recognize those sales in Q4, but the associated cash slight timing move shifted into Q1. So that was the primary driver that caused us to slip below that 100%. And in terms of talking about getting back to it, we look at, again, our operational excellence initiatives as it relates to improving our earnings, but also those initiatives going towards us improving our working capital, specifically inventory. And finally, as we look at these OE build rates continue to grow, we think all of that comes into play to help us get back into that 100% as well as, Noah, allowing us to hit those targets that we laid out at the Investor Day of delivering of $1.2 billion.

Okay. Great. And then maybe talk about your framework for deploying that capital as you generate it. Are we simply looking at mostly share repurchase and less acquisition opportunities come up? Have you been buying back stock with this pullback in the stock or not? And what is your appetite to do acquisitions? How do you see the M&A landscape and opportunity for Woodward?

Yeah, Noah, let me take the first couple of ones, then I'll pass it over to Chip to talk a little bit more about our acquisitions and our thoughts there. First of all, Woodward has, we continue to have a philosophy of being disciplined and balanced in our capital deployment framework. We focus on returns. We also want to make sure that we are funding our strategies and that where we put our money aligns with the strategy that we have set up. That creates a lot of optionality for us and some really good opportunities. So as you mentioned, we do have a good track record of returning capital back to our shareholders. Over the last 6 years, we have deployed about $1.3 billion through our shareholders, $1.1 billion of that being through share repurchases. Acquisitions, we will use it to fill technology gaps. Also work with our product offering and if -- it help us to open up markets as well as gain access to new customers. Also in the area of R&D investments, especially those that are related to us being able to deliver on the next-generation narrow-body and enabling us through this energy transition. Finally, we're working through capital -- CapEx investments, especially we've seen good opportunities and good returns to working on improving our production capability as well as automation. Chip, I know you've spent a lot of time in the automation space. Would you want to jump in here and talk a little bit about what we're seeing there?

Sure, Bill. Thank you. On the continuation of our strategic planning process, we're seeing a good number of automation and other productivity projects brought forward that offer attractive returns. We're evaluating these projects against other uses of capital, of course, but we like betting on ourselves as we did with the rapid response centers, the in-sourcing efforts and some of the early automation projects. So I'd say investing in automation will be a priority for us in 2025.

Excellent.

And then, Noah, I'm sorry, if I just jump back in and talk a little bit about, are we in the market there? As we -- again, another key part of our framework is to offset dilution. And you saw that in our third quarter. Woodward historically has been a heavy option house. And as a result, there's many members out there with our shares. So in the third quarter, you saw us buy about $300 million of shares, which equates to about 1.7 million shares. And that was really to deal with dilution, as we saw record stock prices and with those options out there, that also created a lot of dilution. Now when we bought those shares, it was towards the second half of Q3. So those 1.7 million, we only got credit for about half of that. And so that pretty much just sort of offset the dilution that we saw in the quarter. As we head into Q4, we will get credit for that full 1.7 million. And so that's why you saw us hold our guide of $62 million. Chip at the end of Q2 mentioned that we were going to prioritize share repurchases, we saw and as we just talked about, we did that in Q3. And so in Q4, we had a plan to be in the market. So yes, we have been in the market buying shares in Q4.

Yes. I recall there were questions on the earnings call about the share count math. I guess, every reported period is a weighted average. So any time you're buying back stock later in the period you don't reflect the full number for the weighted average of the period. So I assume that was the explanation for the 3Q kind of sequentially the same. And then if you simply take 4Q, even slightly below 62%, you would average 62% for the year because 2Q and 3Q were above 62%?

That's as simple as that. Yes.

As simple as that. Now will 4Q be 1.7 less than 3Q or some portion of that because some of that impacted 3Q?

Yes. So again, we'll get full credit for the 1.7, and then we have to just look at the stock price, how that moves, and that will also -- the dilution there will also impact the share count. But again, we expect it to be in that $62 million range.

Okay. So if 4Q is maybe kind of, I don't know, sub 62, maybe closer to 61, that's kind of the exit rate and the entry rate of 1Q '25, if you're buying back stock in the fourth quarter, if you -- absent major other capital calls on -- and whether it's acquisitions or something else in '25, we could take the '25 share count to, I don't know, sub -- maybe I'm getting ahead of myself here, but sub-61, I guess?

Yes. We'll get -- we'll obviously get to that in our Q4 guide. Noah, but kind of the way you laid out, it is logical. But again, we've got to see where that stock price ends up, how that impacts the options and dilution, but I don't disagree with sort of your line of logic here.

Yes, I'd say the one other item would be option exercises. That would be another variable that would create full weighted value for the option. So lots of moving parts, Noah. But I think between the 2 of you, you kind of put a bound around it.

Right. Okay. Okay. Great.

[ Can we talk about ] acquisition?

Yes, yes, go ahead.

So I think we do have an appetite for acquisition. I guess it's all relative, though. In my view, Woodward has historically been quite acquisitive. We completed 4 major acquisitions between '08 and 2018, and these brought us our electromechanical actuation business, our servo-hydraulic flight controls business, thrust reverser actuation system and a large portion of our diesel fuel systems business, making Woodward much more than a fuel control company over that time period. And the thought process that was used over these years in the past is relevant for us today, and we add some refinements to it. We've got a very active business development team, constantly identifying opportunities. But first and foremost, we're a controls company. We want to stay close to this core heritage. We'd like an acquisition to be accretive or at least have a path to it. We're not afraid of a fixer upper. But an acquisition has to bring something to the party for us. It must bring technology, better customer access, open up a new market or fill a gap in our product offering that's harder to fill organically than it is to acquire. Also having a high probability of providing a return to shareholders. That's the important sort of underscoring principle. And look, we have a great organic story. So we're being selective and focused on finding assets that will complement and support this organic story and strategy.

That makes a ton of sense. And Chip, in your strategic planning ongoing process, are you always evaluating the current portfolio and the opposite of acquiring new and the possibility of an asset that would maybe determine doesn't fit and is a divestiture candidate? Or would you say that's not really part of the picture right now, you're pretty happy with what you have?

Yes, we do that, Noah. In fact, we've been introducing more product management discipline into the company over this past year. And we've identified as part of the -- part of that portfolio rationalization process in industrial, we identified some product lines that we have divested of or in the process of divesting of. They're small. They're not material or not meaningful, but we're flexing that muscle and making sure that we've got an eye to managing a portfolio that's well positioned for profitable growth and good returns for shareholders.

Okay. Great. Well, we're just 2 minutes prior to the hour, and I have exhausted all of my questions. So let me thank you both again for spending this time with us. I really appreciate it. This was a great conversation. I learned a lot. Always a pleasure to speak with you both. And Chip, I'll turn it back to you if there's anything we missed that you want to touch on or any closing comments you'd like to provide?

Thanks, Noah. I'll just close with summarizing the strengths of our segments, which are well positioned now and for the future. Our members have delivered exceptional improvement over the last couple of years, as Bill and I both discussed today, and they're energized to continue the trend, I can assure you. In aerospace, we have a strong portfolio for growth. We're on the right customer platforms, and we're cranking up our margin expansion capability and our productivity trend is promising. Not only that, we see a future mix tailwind post this 2026 Investor Day outlook that we've shared. In Industrial, the energy transition favors both our current and future next-generation products. Our product portfolio is well positioned to grow. We have plenty of opportunity to mine this productivity, and our lean transformation is not only delivering today, but we're learning about more opportunities as we make progress on this journey. So Noah, thanks again for hosting us today, and thanks to all of you who joined us online.

Thanks, Noah.

Thank you so much.