Woodward Inc (WWD) 2021 Q3 法說會逐字稿

Thank you for standing by. Welcome to the Woodward, Inc. Third Quarter Fiscal Year 2021 Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast. (Operator Instructions)

Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer; Mr. Bob Weber, Vice Chairman and Chief Financial Officer; Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer; and Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Mr. Guzzardo. Thank you. Please go ahead, sir.

Thank you, operator. We would like to welcome all of you to Woodward's Third Quarter Fiscal Year 2021 Earnings Call. In today's call, Tom will comment on our markets and related strategies, and Bob will discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions.

For those who have not seen today's earnings release, you can find it on our website at woodward.com. We have again included some presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available by phone or on our website through August 16, 2021. The phone number for the audio replay is on the press release announcing this call, as well as on our website and will be repeated by the operator at the end of the call.

I would like to refer to and highlight our cautionary statement as shown on Slide 3. And as always, elements of this presentation are forward-looking or based on our current outlook and assumptions for the global economy and our businesses more specifically, including the ongoing COVID-19 pandemic. Those elements can and do frequently change.

Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings. In addition, Woodward is providing certain non-U. S. GAAP financial measures. We direct your attention to the reconciliations of non-U. S. GAAP financial measures, which are included in today's slide presentation and our earnings release and related schedules. We believe this additional financial information will help in understanding our results.

Now turning to our results for the third quarter. Net sales for the third quarter of fiscal 2021 were $557 million compared to $524 million for the prior year quarter. Net earnings and adjusted net earnings for the third quarter of 2021 were both $49 million or $0.74 per share. For the third quarter of 2020, net earnings were $38 million or $0.61 per share and adjusted net earnings were $31 million or $0.48 per share.

Net cash provided by operating activities was $318 million for the first 9 months of 2021 compared to $212 million for the same period of the prior year. Free cash flow and adjusted free cash flow for the first 9 months of 2021 were both $297 million. For the first 9 months of 2020 free cash flow was $173 million and adjusted free cash flow was $169 million.

Now I will turn the call over to Tom to comment further on our results, strategies and markets.

Thank you, Don, and good afternoon, everyone. In the third quarter of 2021, we are pleased to deliver significantly improved performance compared to the prior year period. As our markets progress down the path of recovery, we do anticipate pandemic-related volatilities continue. The ongoing global supply chain disruptions, unpredictable impact of COVID variants and the varying pace of regional economic improvement, all contribute to future uncertainty. We continue to believe our markets will return to pre-pandemic levels in 2023, and we will see significant growth related to our market share gains and favorable fleet dynamics.

Moving to our markets. Commercial aerospace continues to recover as airlines begin to reactivate parked fleets, aircraft build rates continue to climb and passenger traffic increases. U.S. domestic travel is returning to near pre-COVID levels while international remains weak. Importantly, commercial fleet now being utilized has significantly higher Woodward content, which we believe will lead to strong aftermarket sales growth.

In Defense, markets overall remained favorable. However, as anticipated, the demand for guided weapons is softening. The sense aftermarket activity remained solid due to aircraft utilization and upgrade programs.

Turning to our Industrial markets. In Power Generation, demand for gas turbines is increasing. We expect further improvement in 2022, driven predominantly by growth in Asia and the continued replacement of coal power plants. Aftermarket activity is beginning to increase with volume anticipated to come back to pre-COVID levels in 2022. Backup power for data centers continues to be strong.

In Transportation, demand for China natural gas trucks softened significantly in the quarter as a result of the anticipated implementation of China VI diesel emission regulations, which drove short-term demand for China V diesel trucks. The natural gas truck market remained strong and has grown to approximately 15% in the total truck market. However, we do expect quarterly volatility to continue. The global marine market has seen improving ship utilization from the pandemic related lows, which will drive aftermarket activity. The oil and gas markets leading indicators have improved as crude oil prices and energy demand have increased.

In summary, we are seeing improvements in our markets year-over-year, and we delivered a solid quarter. However, the pace of global economic recovery and our financial results are being impacted by global supply chain disruptions, COVID-related impacts and regional market fluctuations.

As has been our priority throughout this pandemic, we continue to generate robust cash flow by leveraging our operational structure and optimizing working capital, allowing us to continue investing in growth opportunities. We remain steadfast in our commitment to developing innovative products designed to enhance emissions performance, reliability and fuel efficiency, which have meaningfully contributed to a cleaner global environment. As global demand for cleaner energy, renewable fuels and greater efficiency accelerates, we will continue to invest in these opportunities in both our Aerospace and Industrial segments.

Before giving the reins over to Bob for his final earnings call as Chief Financial Officer, I would like to thank Bob one more time for his tremendous contributions to the Woodward team. Over his 16 years at Woodward, he was truly an unrivaled counselor, partner and friend. And for that, we all wish him the best of luck in this next phase of his life.

During our next call, I look forward to being joined by Mark Hartman. I'll now turn the call over to Bob.

Thank you, Tom. I appreciate the kind remarks, and I have very much enjoyed my time with Woodward. Mark will be an excellent CFO and together with you and your entire senior leadership team I know I'm leaving the company in good hands.

Turning to our financial results this quarter. Woodward net sales increased to $557 million compared to $524 million for the prior year quarter. Sales in the third quarter of 2021 were negatively impacted by approximately $30 million as a result of global supply chain constraints predominantly impacting our Aerospace business. Although recovery plans are in place, we anticipate that these issues will continue beyond our fourth quarter. Accordingly, we are not providing more detailed guidance at this time.

Aerospace segment sales for the third quarter of fiscal 2021 were $341 million, an increase of 11% from the prior year quarter. Commercial OEM and aftermarket sales were up compared to the prior year by 51% and 11%, respectively, largely driven by the increasing build rates and domestic passenger traffic. Sequentially, commercial OEM sales were down 6% and commercial aftermarket sales were down 3%, both compared to a strong second quarter. The sequential declines were primarily due to supply chain constraints and normal quarterly variability.

Defense OEM sales were up 5% and defense aftermarket sales were down 17%, both as compared to the prior year period. Sequentially, defense OEM sales were down 14%, and defense aftermarket sales were up 5%, both as compared to a strong second quarter. Both defense OEM and aftermarket sales in the current quarter were negatively impacted by supply chain constraints. Defense order volume and backlog remain strong. We do anticipate a significant decline in guided weapons in fiscal 2022, more specifically, JDAM.

Aerospace segment earnings for the third quarter of 2021 were $53 million or 15.6% of segment sales compared to $41 million or 13.4% of segment sales for the third quarter of 2020. The increase in segment earnings was primarily the result of higher volume, predominantly in commercial OEM. The decrease in sequential earnings as a percent of segment sales was primarily due to the decline in defense OEM sales.

Turning to Industrial. Industrial segment sales for the third quarter of fiscal 2021 were $216 million compared to $217 million in the prior year period. Excluding the renewable power systems and related businesses, which I'll refer to as RPS, Industrial segment sales for the third quarter of 2020 were $210 million. The increased Industrial sales, excluding RPS, was primarily due to the impact of favorable foreign currency rates, which was partially offset by softness in China natural gas engines and global supply chain constraints.

The China V diesel truck prebuy negatively impacted natural gas engine sales more than we anticipated. Industrial segment earnings for the third quarter of 2021 were $27 million or 12.6% of segment sales, consistent with the prior year quarter. Nonsegment expenses and adjusted nonsegment expenses were $14 million for the third quarter of 2021 compared to nonsegment expenses of $15 million and adjusted nonsegment expenses of $17 million for the same period last year.

At the Woodward level, R&D for the third quarter of 2021 was $30 million or 5.3% of sales compared to $35 million or 6.6% of sales for the prior year quarter. SG&A and adjusted SG&A for the third quarter of 2021 were both $48 million compared to $57 million and $50 million, respectively, for the prior year quarter. The effective tax rate and the adjusted effective tax rate were both 16.8% for the third quarter of 2021. For the third quarter of 2020, the effective tax rate was 14.6% and the adjusted effective tax rate was 29.1%.

Looking at cash flows. Net cash provided by operating activities for the first 9 months of fiscal 2021 was $318 million compared to $212 million for the prior year period. Capital expenditures were $21 million for the first 9 months of 2021 compared to $39 million for the prior year period. Free cash flow and adjusted free cash flow for the first 9 months of 2021 were both $297 million compared to free cash flow of $173 million and adjusted free cash flow of $169 million for the prior year period. The increase in free cash flow and adjusted free cash flow was primarily related to effective working capital management and lower capital expenditures partially offset by lower net earnings.

Lastly, turning to our fiscal 2021 outlook. While we expect sales, earnings and free cash flow results for the fourth quarter to be higher than the third quarter, considerable uncertainty remains with respect to COVID variants, global supply chain disruptions, and regional market volatility, all of which are expected to continue. Accordingly, we are not providing more detailed guidance at this time.

This concludes our comments on the business and results for the third quarter of 2021. Operator, we are now ready to open the call to questions.

(Operator Instructions) Our first question comes from Gautam Khanna with Cowen.

And congrats Bob and best of luck. I wanted to ask, there was this announced transaction between Parker Hannifin and Meggitt. And I wondered if -- what your initial view is of the competitive implications, if any, to the actuation business or any other part of the Woodward business?

Yes. I don't really see the acquisition Meggitt by Parker changing anything in the competitive landscape. We have a few overlapping areas, but it's minor. Parker is a strong company, so I'm sure they'll help enhance Meggitt. But in terms of competitiveness, I don't think it will impact Woodward at all.

Okay. And I'm curious, is there -- where are the overlaps, if you wouldn't mind elaborating?

Yes, there's a little bit in the thermal management area at Meggitt. With Parker, we have some overlaps, but I think you're really asking about the Meggitt side, I believe. There's a little bit on thermal management. There's a little bit in the industrial gas turbine space. And there's some minor amount on their sensors business. And there's a little bit on some air valves as well, but it's minor and we don't really view them as a significant competitor.

Okay. And just maybe stepping back, just -- sorry, go ahead, Bob.

No. I didn't say anything.

Sorry. I was going to ask stepping back just what your view is in terms of just M&A and sort of how the -- a year ago, you were contemplating the Hexcel transaction with Woodward and what that might -- how the company might be different in 5 years. I'm wondering if you could just give us some direction on what you think, how the portfolio might change, how M&A may evolve as part of the Woodward strategy going forward? What are you looking at? What are you -- where are you hoping to get bigger, et cetera?

Yes. Well, first, when you look at our balance sheet and the like, I think all of you can see that we're strong. We're still -- we have a strong balance sheet. We're doing real well on cash flow. We're still in the pandemic, however, and that's why in the prepared remarks, we said we'll recover. Our estimate is we'll recover to 2019 level of sales in 2023. For the Aerospace market, I think that's most people's belief is that's the time frame. We, during the pandemic, have really been focused on ensuring the health of the company, continue to invest in the future. And in China, we have a strong cash flow and strong balance sheet.

We're in a position now where we feel highly confident of our financial position. I think what you're going to see us go back to is what has been a proven track record for the company. And that's bolt-on acquisitions that help fill in our system strategy, have good tie into the direction of the company. And we've had great success with that, and I think that's the way we're going to look at it going forward.

And your next question is from the line of Pete Skibitski with Alembic Global.

Bob, best of luck. I guess, on the supply chain issues, could you give us some more color on kind of what's going on there specifically? And the $30 million impact that you quantified, I can't remember if you said, was that all Aerospace or split and within Aerospace, was it split between defense and commercial? I'm just wondering if you could give us a little more color there.

Sure. It was predominantly Aerospace, but we did see shortages and disruptions on both sides. We've all read about the electronics, and that's probably the predominant area that we're seeing shortages come from, but there's a variety of things. We've got plant shutdowns or at least slowdowns related to COVID and related to other issues. So there have just been a variety of things that I think with respect to getting things back up and running. And with respect to the announced shortages that we're seeing impact us going forward. We do believe our supply chain, we stay very close to them. They have plans to alleviate the issues, but it's going to continue for a while here.

Okay. Would you expect kind of a similar negative headwind in the fourth quarter?

Too hard to say at this time. Like I said, they have plans. We have ramps. We have anticipation of improvement. But it's very, very hard to say with everything going on, in particular, with Delta and everything and all the talks about locking things down, et cetera, et cetera, too hard to say at this time.

Okay. Okay. I guess last one for me on the guided weapons. Did you say or could you say how much it was down in the third quarter? And do you kind of quantify all that within the defense aftermarket or both OE and aftermarket? And I think you said it was going to be down significantly in fiscal '22. Are we talking 20% plus? Or maybe some more color on that.

Sure. So not much aftermarket on guided weapons. So it's all in. defense OEM, just a little humor on that angle. But -- and overall, so there's more than the JDAM. So there's a mix inside of that. We have Small Diameter Bomb and AIM-9X as well. So for the quarter, flat to slightly down. As we go forward, though, and we've kind of called this out last couple of quarters, we do anticipate in 2022 that there will be a significant decline.

It's very hard to quantify at this point in time. Partially because, as we've said, we've had some shortages, some of that is getting pulled -- or excuse me, pushed into 2022. So it will not be insignificant. It will be sizable. But giving an exact amount at this time is very hard to do.

And your next question is from the line of Christopher Glynn with Oppenheimer.

Bob, thanks for working with us over the years. I appreciate that. So I was curious what the marine aftermarket in the IGT aftermarkets there. Just to what degree are you seeing them come back now? Is -- I mean the marine formula seems very good. I'm just curious if the rubber is -- what degree of the rubber is hitting the road there?

Yes, the order ramp to our customers and to the things like utilization rates and so on is improving. We have not yet seen that in sales but we are between future order discussions and so on, we're seeing a lot more optimism for 2022 in both of those areas. I think you saw the -- some of the announcements that came out from our customers saying order volumes in IGTs, for example, were improving. And so that's just a matter of timing in terms of the pull-through on our side. So we are bullish on it for 2022, not seeing a tremendous amount yet.

Okay. And is there anything interesting to relay in terms of Industrial book-to-bill, anything like that?

We're improving. The formal book-to-bill for us because of a lot of pull isn't necessarily a number that we track or publicly use because it's not that helpful. But it is definitely on the improving side of that equation in terms of the activity that we're seeing, orders in some areas. We mentioned that clearly, the China natural gas impact on Industrial was the most significant element this quarter.

And what sort of cadence do you anticipate that secular growth of China natural gas engines returning to growth? I think you still have tough comps in the first half. But maybe override that, just curious how you think that linearity might feel to you at this juncture?

Yes. We think it's going to be challenging, because of the oversized China V buy. We think that will extend somewhat into the fourth quarter. As we mentioned in terms of the size of natural gas truck market vis-a-vis diesels, it's been improving. And we do continue to believe in the long-term secularity of that, that natural gas is a -- considered a clean fuel in China similar to EV. And so we do believe that, that has longer term legs.

Your next question is from the line of Matt Akers with Wells Fargo.

I have 2 questions. Can you talk about A320neo? And Airbus has talked about putting your rates up there kind of above what we were thinking last like, would you just talking about the capacity you have to kind of get to those rates? I know there's still a few output or if any other investment would be required to get there?

Yes. No, as you guys know, we invested a lot in the 2016 time frame and around those years towards the capacities. We kind of went into the COVID environment at some 60-plus for both of the narrow-bodies, plus 787 and so on. So we have significant capacity available. We are not, at this point in time, aware of any supply chain constraints directly associated with that. Obviously, they can develop as we start to ramp up, probably the most concerning, in some cases, is the electronic shortages. But plenty of capacity and no known issues with respect to ramping up in either of the narrow-bodies at this time.

Okay. And then I guess just on aftermarket, there's another aerospace supplier that kind of commented that we saw maybe like a little bit of a pull forward of kind of demand ahead of the summer ramp. Are you guys seeing any kind of just unusual seasonality in that? Or any indications on how that could kind of trend going into the fall and the winter?

Yes. We never know specifically about pull forward or anything. It's kind of a flow issue in terms of when parts arrive and so forth. So we did clearly see, when you look back at the history, the second quarter was a strong quarter. We do anticipate that, that will continue. As we've said, the aircraft that are flying have much more Woodward content. And a lot of the aircraft that were parked had less content. So we do believe that we have a systemic improvement going forward. But kind of, as we've mentioned, we just saw China traffic -- domestic traffic drop down a little bit. It's been kind of increasing most recently. We think that kind of volatility will continue. And that will probably impact what we see in terms of quarterly volatility on aftermarket.

Your next question is from the line of David Strauss with Barclays.

Congrats, Bob, enjoy retirement. Just wanted to ask where you guys are from a headcount perspective on the Aerospace side. Have you started to hire back? And if so, how much? And then maybe just an update on how much you think you've taken out in terms of structural costs through this period?

Sure. Yes, we have begun to bring folks back. I don't have an exact number for you, but it is significant in terms of the folks that we've been bringing back, predominantly, obviously, in the direct labor side of the equation. Not so much on the indirect side. So kind of related to the cost savings. We are beginning to get ramped back up from our shift standpoint. And that will cause us to bring back indirect labor into the form of supervisors, et cetera, et cetera. So we are seeing -- we have seen and are seeing increases there. And anticipate we'll continue to see that going forward. And I'm sorry, the second part of your question was?

How much do you think you've taken out in terms of cost savings?

Yes. So we called out about $100 million in total when we first went through that back in April of last year. We believe that approximately $50 million of that will be continuing. But we also believe, as many of you have seen in many announcements, there will be some inflationary pressure. So it will remain to be same where we'll end up in terms of total systemic cost savings. And then as you saw on some of the actions we took, whether it'd be the elimination of the annual bonus, some of the Officer and Director, the cost savings we took back. Some of those will be coming back on as we go forward into 2022.

Okay. And Bob, last one for you. In terms of the cash balance, can you maybe update us on how much cash you think you need to run the business? And I guess the reason behind why you've let that pass down build as high as it is today?

Yes. Maybe give you a little breakdown on the cash balance. So for the first time, since I've been in this role, we actually do have a fairly significant U.S. cash balance. In the past, it's largely been a regional cash balance, predominantly in Europe and now also in Asia. So in terms of having a significant immediately available cash balance, it may not be as significant, let's call it, roughly $250 million as the overall balance looks. So that's give you a little color on the way the cash is situated globally.

We do not believe we're at some point where we have a lot of excess cash, given our position of focus on growth. And we do believe there will be opportunities that will come forward, both organically and inorganically, to put that cash to work. We have said that we are on a path and are back to our pre COVID, 50% of net earnings being returned to shareholders, and we will continue to monitor the market. And as appropriate, probably do some share buybacks going forward. So we intend to kind of manage that on an ongoing basis and watch for both organic and inorganic opportunities as we go forward.

Your next question is from the line of Michael Ciarmoli with Truist Securities.

Bob, congrats. Thought for a while there, you might be sticking around as you guys pulled the trigger on Meggitt. So just on -- I mean, we've seen a number of aerospace companies report so far. I mean, you guys seem to have experienced here an outsized disruption in supply chain. I mean, is there anything unique or specific? I mean, certainly, we've heard about electronic shortages. But I mean, this just seems -- the magnitude you guys are being disrupted just seems to be a little bit bigger than anybody else. I mean, anything you can point to from specific products? I mean we didn't hear from -- obviously, none of the engine guys are kind of talking about potential pressures or challenges. So presumably, it's not having a widespread impact on the supply chain yet.

Yes. Without -- maybe I'll answer the question a little bit. Without -- we don't want to name suppliers or anything. But we had a couple of suppliers that were providing our Aero segment that during the pandemic, they had closed plants, did some moves, and they did not go well. And the second part was hiring people back or staffing in new locations. And it had a major impact on some products that go across a lot of our other products. So it cascaded through more of our business than just a single disruption might.

That also impacted our aftermarket because we ran out of inventory and we weren't able to service some of the aftermarket. So we -- as Bob highlighted earlier, we've got all hands on deck working with the supplier, working on how to get this back on track. But that's the type of supplier disruption. I think we -- the whole industry may see more of them as we start to ramp and people had consolidated facilities or reduced workforce and they're trying to hire people back. It can hit you. And this one just happened to hit, like I said, component that goes across many of our products and we had an adverse impact because of that.

Got it. Got it. That makes sense. And obviously, if it hit your aftermarket, the more profitable. I mean, just looking at the margins, I mean the 18.9% you did last quarter, I mean, how should we, I guess, calibrate ourselves building off this 15.6%, if it sounds like these supply chain disruptions are going to -- I guess they're going to be unpredictable. But how should we be thinking about the margin cadence going forward here?

Yes. Well, one of the things that we highlighted before, Bob can jump in here, too, as we also need some of the volume to come back to get to our 20% plus target. And we do see that as you go through we're almost into fiscal year '22. So as we go through fiscal year '22 and into '23, we're confident that we'll deliver those margins in fiscal year '23 and improve as the volumes pick up during -- between now and then. So -- and as you could see, some of the markets coming back, the OEM rates are going up. Those are positives, not only for OEM, but for initial provisioning. And so we're confident we'll get there. But as we've been highlighting here, there may be some volatility quarter-to-quarter until we stabilize the whole supply chain.

Got it. Got it. And do you need the wide-bodies to come all the way back to get to those margins at 20%? Can you...

No. No. No, we don't.

Okay. Got it. Last one I had, just on the -- I know Pete was asking on the JDAM. I guess, I think in the DoD docs, volumes are down 10%. I mean are you guys thinking you'll see more of a headwind than that then kind of the 10% planned procurement volumes in '22? Or is that sort of the right number?

What we're looking at are the various lots that the DoD are ordering and exactly how they flow through. And as Bob highlighted, there may be some movement between fiscal years. And the lot that will come into calendar year '22 is at a much lower rate. And that could change with foreign military sales or others, but we're just trying to highlight to everybody that we do see something on the JDAM. Now some of the other programs are doing well and offset some of the JDAM decline. But overall, we'll have a year-over-year decline in '22 on guided weapons.

Your next question is from the line of Robert Spingarn with Credit Suisse.

Bob, I'll add my congrats to you. Just -- I really just have a couple of clarification questions or maybe a new one. We've talked a lot about aftermarket supply. How is demand trending? I think we know a little bit, because you said you missed out on $30 million in sales. But maybe, Tom, you can talk about what's happened since March really through July?

Yes. Well, we're actually seeing all signs of demand increasing. And as you know, a big part of our Aero aftermarket is associated with engines. And we monitor utilization, hours flown, the number of aircraft in the fleet back in service. We're also doing the best we can to monitor green time and I've complemented the airlines in the past, they did what they needed to do. And they've done an admirable job of rotating assets to keep green time, so that they could reduce near term maintenance expense. All that's going to come due here as we're seeing more of the fleet get back into service, more utilization. So we're optimistic about we're going to see the narrow-body, in particular, pickup.

The second part of that is we are seeing the MAX aircraft go back into service. We're seeing Boeing starting to move their production rates up on new builds. All that's very promising for initial provisioning sales. We anticipate that we'll see better initial provisioning sales in fiscal year '22 as well. So it's headed in the right direction and things are on a promising path, but still could be volatile.

Just on that, Tom. Bob talked about capacity in a prior answer. Is there any concern or should we have any concern that you all of a sudden get high demand for aftermarket a couple of quarters from now at the exact same time, you're hitting those higher rates. For OE or the aftermarket, things like CFM56 and the OE is LEAP and your turbofans, they don't really interfere with each other?

Yes. You know, Rob, we've been -- last fall, we started -- we were still going down because of the pandemic. But internally, we started an initiative, we just called preparing for the upturn. And in that, we were identifying long lead parts, training, where we would need to hire, to make sure that we would be ready for the recovery. And that has worked fairly well. Part of the -- preparing for the upturn to say was also working and trying to anticipate any supplier disruptions. We highlighted that we have had some. What we didn't highlight is how many we've resolved and fixed, before they became problems. So we have had success, but we've also been hit some that we weren't able to counter.

So all that being said is we've been preparing for it. I'm confident. Our constraint internally is going to be onboarding new members and training, and we're working really hard, and we've set up special training centers to bring on people and the question was asked earlier, but we are hiring right now hundreds of direct labor members as we see things starting to ramp. And so we're bringing them on to training. So capacity in terms of equipment and the like is not there. We're ensuring long lead time parts and we're ensuring we're bringing on new members as fast as we can in anticipation of the upturn. So that's what we can do to make sure we are ready.

Yes. Okay. If you can hear me pass the storm behind me. Just wanted one -- ask one more on defense aftermarket, not so much around the discussion we've had on JDAM and so forth, which sounds like it is OE. But we saw another supplier surprised with some softness in defense aftermarket on a year-over-year basis. And we're wondering if that just reflects DoD perhaps backing away from some of the behavior at the beginning of the pandemic to flush cash into the system. Do you think defense aftermarket elsewhere may be starting to fade?

We're not seeing that right now. So it's not something we're anticipating. We do recognize that, at the moment, we're looking at basically flat DoD budgets. But in terms of where we see our aftermarket and defense, we're not seeing any pullbacks at this time.

(Operator Instructions) And your next question is from the line of Chris Howe with Barrington Research.

Congrats again to Bob, and I definitely will miss our travels together. It's been asked several different ways, so I suppose I'll ask it another way. The $30 million related to supply chain, can you give any granular detail on kind of what you're seeing on a month-to-month basis? To be more direct, perhaps how has July fared so far compared to June as it relates to these supply chain disruptions?

And following up on that. If we think about the $30 million in the context of moving forward, let's say, for a hypothetical example, $10 million to $20 million is deferred in Q4. As this deferred backlog or deferred revenue continues to build, can you break out how you anticipate filling this? Will it all come back in a single quarter? Have you started to already fill in that $30 million that got disrupted in the third quarter? There's a lot there.

Yes. Well, I'll start, and then Bob, please chime in as well. The first, you asked about July. Our recovery on a couple of suppliers looks to be happening more August, September and moving into the first quarter of Q1 fiscal '22. So as we're saying that it's a little bit uncertain. But all the actions we've taken with the supplier internally to adjust for that, it's really going to start making progress really this month and moving forward. So it's a little difficult because some of it is based on our projections and commitments from the supplier of when we can get hardware and how we move through.

The electronics one, I'm sure all of you are well aware of, that the electronics one hit both Aerospace and, but it also hit our Industrial business, is a difficult one. And mainly because in our electronic controls, a lot of the ICs reviews are automotive based, basically automotive ICs have really good environmental capabilities. And I think you all realize how tight that market is. So that one is really hard to predict, and we'll probably carry forward into mid '22, maybe beyond. We are working that hard as well as working with our customers. But that's not on a 1- or 2-month solution path. So we got a mix here that's hitting us and carrying that forward is why we're not being able to give you guys all precise numbers. It's just all how uncertain is and how quick, but we're doing everything in our capability to try and recover.

The only thing I would add to that is we tried to kind of give you some color on. This won't be a sudden push of a balloon into a certain quarter, it will probably be a more gradual burn down as we go forward. And Tom gave you some idea of we see improvements here and there, but we're not going to see all of a sudden in the first quarter, there's a big balloon related to -- at least we don't anticipate that at this time.

Okay. That's helpful. And one last question, if I may. Tom mentioned the different recoveries that we're seeing. Domestic passenger travel looks to be healthy, returning to pre-COVID levels and then we have the other 2 buckets that are lagging domestic, which are international and business-related travel. As we look at those other 2 buckets, let's say, business comes back in mid-2022 and international comes back in the latter part of that year. Can you talk about, from a top-down perspective, what we should see on the business?

Yes. Well, maybe I'll start, Bob, and you can join in. We talked about positive fleet dynamics for Woodward products going forward. And as you look at when you -- how international or the wide-bodies, that's kind of how I correlate the 2. I mean, obviously, some narrow-bodies are used on international. But I do like our position. And if you look, the airlines are using heavily the 787, 777 will continue. These are aircraft, we have good content on. A350 will pick up. And so they're going to be using these newer aircraft, and we're seeing that even in the current utilization, it's more towards those. Those are good for Woodward. We see that we would have good aftermarket coming from those as they recover. And what comes out of service are some of the 4-engine wide-bodies, as you guys are aware of, and some of the older wide-bodies. So I think the wide-body fleet will be more oriented to those newer aircraft. And I think that's a positive long-term for Woodward, but it will take a little bit of time for those international markets to recover. So Bob, I don't know if you want to add anything on that?

No. I think you covered it, Tom. Clearly, any piece of the wide-body coming back is helpful. The timetable is probably pretty close to what we're hearing overall from a lot of different sources. And so that's why we are trying to highlight that we still believe 2023 is when kind of things get back to more normal across the spectrum. And until then, we anticipate we're going to see good quarters and lumpy quarters. It's just not going to be a nice straight line into the future with everything that's going on.

And your next question is from the line of Sheila Kahyaoglu with Jefferies.

Bob, I don't know if I could congratulate you for the second or third time. So I congratulate since he's retiring, and I'm pretty sure he actually will retire. Okay. In terms of the Aero margins from Q2 to Q3, can you maybe give us an EBIT bridge walk-through of the supply chain, but also like mix with defense down? How do we kind of think from that drop-down of 19% to 15% Q-over-Q?

Yes, it's predominantly driven by that mix element of aftermarket and defense, both being down quarter-over-quarter. Lots of other small items embedded in a lot of that. But those are, by far, the most impactful too, going from Q2 to Q3. And I think 18.9% on a 20% target in the middle still of this pandemic with still at that point in time being at 60% and no international. I think that speaks to itself. It was a good quarter. It had great mix. It came through in earnings, but it was kind of hard to hold on an ongoing basis.

I guess on that point, on your OE business, did you see -- do you have continued destocking on the 787 and the A350? And how do we think about how OE impacted you guys back in '18, '19 and how do we think about that OE impact as we head into your 20% target?

Well, we were -- '18/'19 OE was cranking. So obviously, we're -- just look at the build rates, we're nowhere near where we were when we went into COVID. And we were kind of at those 60 levels for a good part of that time. So -- and as you know, OE is not an earnings drag for us. It's obviously nowhere near as Tom, maybe comment. The aftermarket is by far the most predominant. So OE is also -- continues to be pressured. We're encouraged by the comments that have come out about increasing the build rates and so on and so forth, and we're encouraged that travel should support that and airline profitability, as we go forward, should support that. So that's what we're looking for as we go forward.

And then maybe just the last one is on defense, and I know everybody has asked, but can you size the defense business for us with an arrow, I think it's 40%. How big is JDAM and kind of what the normalized, whether it's a percentage of sales or dollar number we should expect for that business going forward?

Yes. It has been around the 40% level with commercial being what it's been. It's even growing from there. And on the JDAM side, it is a significant program. I don't think we call it out specifically, but it is a good chunk within that defense business.

Your next question is from the line of Noah Poponak with Goldman Sachs.

Congrats, Bob, on retirement. So just from a pure demand perspective, putting the supply chain issue aside, was commercial aerospace aftermarket softer in June and July compared to April and May? Or has it been fairly even through that period of time?

I would say it's been softer, but it's been mostly on the supply side that has been impacted. So I think we did have a strong second quarter, both from the demand side and not seeing as many of the constraints. Whereas in the third quarter, we saw some demand slippage in terms of that whether it's the pull ahead or not, we don't really know, but we can only assume that or push-outs or whatever, but most of the impact was on the supply chain side of the equation.

Okay. So it doesn't sound like you would necessarily say that there was a substantial pull forward from the airlines as they were getting ready to return aircraft to service, and now there's a substantial slowdown off of that, maybe a little bit, but it doesn't sound -- I'm sure what I'm going to hear out of you.

On the demand side, I think as we mentioned quarterly variability. I would say the demand side would be very normal, if you will, on quarterly variability comments, whereas the supply chain side was clearly outsized in relation to the quarter. So we are going to continue to see variability. As we mentioned, we think that the longer term -- medium term to longer term is very positive because of the aircraft that are flying and the content that they do have compared to the aircraft that were parked. So we're very bullish on aftermarket as we go forward. You guys have seen us some quarters put up some very high aftermarket volumes compared to some of our peers. And you can't hold that forever. I think we've actually had that discussion off and on that eventually that some of these things catch up a little bit. And I think that's all that happened this quarter.

Okay. I appreciate that. You've mentioned the initial spares provisioning related to the 737 MAX built, but not delivered inventory, basically hasn't happened for you yet. Any help you can provide on sizing that and how meaningful that can be for you in the coming quarters here as those are delivered?

Yes. Initial provisioning is -- carries good profitability with it. And a lot of the aircraft that were parked or, say, most aircraft that were parked weren't provisioned. And so we're going through and have calculated what that can look like, and I think it's a little bit of timing with airlines, their cash situation and when those aircraft get back into service. But we do expect a little or initial provisioning over the next 2 years, kind of tied to those aircraft coming back into service, but also as the build rates, both at Boeing and Airbus go up.

So for those all of you that have followed us for a while, initial provisioning is back to saying it's lumpy quarter-to-quarter. It's based on airlines, the route structure they're flying, how many new aircraft they're bringing on board. So we've got a pretty good handle on it, and we do see it as we go into '22 and then onto '23 that, that will be an increasing benefit to aftermarket. And like I said, it's a good margin part of the business.

Okay. And then just last one on the Industrial side. How many more quarters do you have a tough compare on the China natural gas piece? And then just looking at the margin there, the revenues have stabilized sequentially a few quarters now, and the margins haven't picked back up yet. Is there just mix in there? And how -- and should we expect that to kind of remain stable until you fully annualize the China natural gas piece?

Go ahead, Bob.

I'll jump in and then you can pick up from me. So the China natural gas, it's -- the comp issue is kind of a very volatile moving target. I think as you follow us over time, there is some seasonality there has been. But predominantly, what we've seen is each time they have a new set of regulations, the last round, I think, last year was related to natural gas engines. This one is related to diesels. And that's really what creates the significant volatility. So I couldn't really tell you how many more tough comps we have, as much as we try to guide that we anticipate from an inventory standpoint and the return of natural gas, it will probably be late in the fourth quarter going into the first quarter. But we do anticipate that it will be significant increases as we go, just related to the overall systemic elements of that.

Yes. A little color maybe to add to Bob's comments. You're asking like kind of flat revenue, flat margins. What we do see coming as we move into '22 and '23, we talked around power gen, in some of the prepared remarks, we do see IGTs picking up. So year-over-year, we see that what we call our turbo machinery controls business picking up. One of the things that has -- plays into the mix has been Industrial aftermarket. And where we were pre pandemic seen some good aftermarket with both auto and marine as well as on the oil and gas segment. And as you guys are aware, marine utilization is picking up. It's not -- it hasn't driven the aftermarket quite yet, but it will happen. Oil and gas with the collapse of oil prices really shut down a lot of the activity and lot of the demand for aftermarket parts. But that's starting to pick up. We're seeing rig counts improve and the like. So we're starting to see some areas that will help not only on the sales side, but also will be positive for Industrial mix in terms of margin.

Your next question is from the line of Pete Skibitski with Alembic Global.

Just a couple of quick follow-ups. On the defense aftermarket this quarter, I think Bob you said it was down 17%. I just want to make sure I understand. Was that due to the supply chain issues or due to timing or something else we haven't talked about?

Mostly timing. Not a lot -- not as many supply chain issues in that area, but we did have some. Most of the supply chain were in the OEM side of the equation. So we do anticipate that, that will return. To follow-on that earlier question, we do not see at this point in time, anything with respect to changes in the DoD's posture with respect to defense spending. And actually, some of the stuff we've seen on the budget may speak more favorably to where we play.

Okay. So the supply chain issues mostly hit defense, OEM and commercial aftermarket. Did I hear that right?

That's right.

Okay, okay. And then you mentioned earlier also, you expect revenue up sequentially in the fourth quarter. Should we think that, that's true for both segments? Or not sure?

We believe at this point in time, both segments.

Okay. Okay. And then last one for me. I guess just getting ahead, Tom, when we get to the fourth quarter call, would you anticipate being able to give fiscal '22 guidance at that point?

Yes. We intend -- at this point in time, we intend to give guidance when we release earnings in November.

Okay. Back to regular order?

Back to regular orders, yes.

We hope so.

Your next question is from the line of Gautam Khanna with Cowen.

Yes. Just to follow-up on Pete's question. I'm curious, I mean, consensus numbers, not that you guys haven't guided this, but consensus numbers, nonetheless, looking for about $649 million of Q4 sales and $1.09. Obviously, you guys said sales will be up sequentially, hopefully, at both segments. I was wondering, obviously, there's a lot of -- to be better than Q3, you could still be well below consensus Q4. I'm just curious, like, can you give us some framework on how you think about where numbers are now, how quickly the $30 million catches up, the $30 million of supply-constrained sales. And over what period? Because I just wonder if we're going to have like a big -- an unusually large sequential pickup in maybe if not Q4 but Q1 or something because of the catch up. Just any sort of framework on how that plays out.

Yes, let me give you some color. So first off, let me say, we do not speak to consensus or other external estimates as a matter of policy. But what we've been trying to do is to give you some sort of framework for a lot of the uncertainty and the volatility, et cetera, et cetera, that are currently going on. So we mentioned, I think, a couple of areas that we do not anticipate recovering fully until late in the quarter or early in FY '22. And so from that, you may discern that the consensus or other comments that have been made externally are a little aggressive compared to what we see going on at the moment and some of the things that we see that are systemic and progressing into the fourth quarter.

And there are no further questions.

Okay. Well, thank you, everybody, for joining us today. We appreciate the interaction and the questions. But before we close, as I think most of you know, we normally have an Investor Analyst Day in December. However, going forward, we thought it would be better to move it, and we've decided to move the event to the March time frame. And hopefully, we'll be able to roll out our new strategic plan for everybody, and I hope we'll be able to see everybody in person. So thanks again for joining us today. I'll turn the call back to the operator.

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 7:30 p.m. Eastern Daylight Time by dialing 1-855-859-2056 for U.S. call or 1 (404) 537-3406 for non-U. S. call and by entering the access code 7551758. A rebroadcast will also be available at the company's website, www.woodward.com for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your line.