Woodward, Inc. (NASDAQ:WWD) Q1 2024 Earnings Call Transcript

Woodward, Inc. (NASDAQ:WWD) Q1 2024 Earnings Call Transcript January 30, 2024

Woodward, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. Welcome to the Woodward Incorporated First Quarter Fiscal Year 2024 Earnings Call. At this time, I would like to inform you that this call is being recorded for broadcast, and that all participants are in a listen-only mode. Following the presentation, you are invited to participate in a question-and-answer session. Joining us today from the company are Chip Blankenship, Chairman and Chief Executive Officer; Bill Lacey, Chief Financial Officer; and Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Dan Provaznik.

Dan Provaznik: Thank you, operator. I would like to welcome all of you to Woodward’s first quarter fiscal year 2024 earnings call. In today’s call, Chip will comment on our strategies and related markets. Bill will then discuss our financial results as outlined in our earnings release. At the end of the presentation, we will take questions. For those who have not seen today’s earnings release, you can find it on our website at woodward.com. We 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 our website through February 12, 2024. 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. 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. Those elements can and do frequently change. Our forward-looking statements are subject to a number of risks and uncertainties surrounding those elements, including the risks we identify in our filings. These statements are made as of today and we do not intend to update them except as required by law. 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, I will turn the call over to Chip.

Chip Blankenship: Thank you, Dan, and good afternoon, everyone. We delivered significant sales growth and margin expansion in the first quarter. The strong start to our fiscal year reflects our focus on operational excellence over the past 18 months, which enabled us to capitalize on continued strong end-market demand. We increased output due to improvements in our production planning, supplier performance and internal execution. We also achieved our commercial objectives, securing key long-term agreements that were available in the quarter for both Industrial and Aerospace segments. We made good progress consolidating Industrial catalogs, which allowed us to clarify pricing with global channel partners and certain end-customers resulting in better control and visibility for action.

Notably, net sales grew sequentially. which revealed successful implementation of our production system principle of consistent performance. Achieving and maintaining flow of supplier materials, production of parts in-house and feeding assembly test at the rate of customer demand is essential to hit customer and business targets. Quarter-end heroics are not welcomed as they destroy flow and introduce inconsistency to every aspect of the production system. While we have not yet achieved the labor productivity we believe we’re capable of, we are laying the foundation to achieve significant results. I want to thank all the analysts and shareholders who attended our Investor Day last month. For those who participated, you will remember that we laid out our three interconnected value drivers: profitable growth, operational excellence and innovation.

Our Q1 results show how the relentless pursuit of operational excellence can deliver both growth and margin expansion. Woodward’s profitable growth is fueled by robust demand in both Aerospace and Industrial end markets. We have made progress aligning price to the value of our products. We are still experiencing material cost inflation from our supply base and we forecast this to continue through calendar year 2024. Our price actions as well as our supplier simplification and in-sourcing efforts represent a two-pronged approach to mitigate some of the impacts of inflation. We are gaining momentum from our value stream transformation efforts and I’m very pleased with the progress we’ve made so far. We are increasing the number of value streams under transformation, engaging more of the team in the process.

Notably, a significant percentage of the Kaizen events associated with the transformations are being led by hourly members, which results in powerful and lasting talent development. We are expanding our automation project funnel with goals to improve quality and reduce future labor demand. We are putting our plans into action and you can see this in our guide for capital expenditures. We look forward to sharing more with you in the coming quarters. Our purpose is to design and deliver energy control solutions our partners count on to power a clean future. In both segments, we’re working closely with our customers to develop new technologies that reduce fuel consumption and emissions and enable multiple paths for a cleaner future. I recently spent a day in Zeeland, Michigan at one of our aerospace sites.

And this visit was focused on both GTF fuel nozzle repair and overhaul rate readiness as well as a deep dive into our ignition systems and combustion control product development process. Our ignition systems development is maturing in preparation for the next single aisle aircraft, but it is ready now for applications that need the efficiency and reliability improvements it has to offer. This team has a great track record with automation, and it is a key driver to GTF fuel nozzle overhaul capacity expansion, which may be needed sooner than expected. While we did share our refreshed purpose and values on Investor Day, we recently rolled it out to our nearly 9,000 members around the world. It has been gratifying to see their reactions and the pride they have in Woodward.

After all, their aligned efforts enabled the performance improvements we delivered this quarter. The excitement is tangible. Our purpose video is on our website and I encourage you to take a look. It is an honor to lead the next chapter of Woodward building on the legacy set before us. Our entire leadership team is excited about our future and prepared for the challenge. Moving to our markets. In aerospace, commercial airline, domestic and international passenger traffic now exceeds 2019 levels, resulting in high aircraft utilization rates. Further increases in aircraft utilization are expected as international passenger traffic in Asia-Pacific still lags, yet offers opportunity as it recovers. Transatlantic traffic remains strong. In defense, geopolitical developments and government spending proposals indicate potential increased procurement and R&D spend, signaling potential opportunities for Woodward.

In industrial, demand for power generation remains strong, driven by growth in Asia and the Middle East. Global aftermarket activity remains high as does demand for backup power. In transportation, the global marine market remains healthy with elevated ship rates — ship build rates driving OEM engine demand and high utilization rates driving current and future aftermarket activity. Demand for alternative-fuels across the marine industry continues to increase. We are encouraged by the additional OEM and aftermarket opportunities as multi-fuel engines contain greater Woodward content. Demand for natural gas heavy-duty trucks in China increased significantly compared to last year. This current demand is being driven by a number of factors, including a favorable LNG to diesel price spread, a steady supply of natural gas and carbon reduction initiatives across China.

This market remains volatile and we continue to evaluate the durability of this demand. Last week, I would have said LNG infrastructure development continues to benefit from global investment, but some uncertainty has been injected into the investment equation with the recent U.S. government pause of further LNG export approvals. In summary, market signals indicate continued strong demand. The operational improvements we have made position us to capitalize on this demand. We remain focused on pursuing profitable growth, operational excellence and innovating for the future to deliver on our purpose and drive enhanced shareholder value. I’ll now turn it over to Bill to share our financial results.

Bill Lacey: Thank you, Chip, and good afternoon to everyone. Net sales for the first quarter of fiscal 2024 were $787 million, an increase of 27%. Earnings per share and adjusted earnings per share for the first quarter of fiscal 2024 were $1.46 and $1.45, respectively, compared to our earnings per share and adjusted earnings per share of $0.49. Aerospace segment sales for the first quarter of fiscal 2024 were $461 million compared to $396 million, an increase of 16%. Commercial OEM and aftermarket sales were up 23% and 9%, respectively, driven by higher OEM production rates, continued growth in both domestic and international passenger traffic, increasing aircraft utilization and price realization. Defense OEM sales were up 4% in the quarter due to increases in ground vehicle components and guided weapons.

Defense aftermarket sales were up 45%. Aerospace segment earnings for the first quarter of 2024 were $79 million or 17.2% of segment sales compared to $55 million or 14% of segment sales. The increase in segment earnings was primarily a result of higher volume and price realization. Turning to Industrial. Our Industrial segment had a record quarter for both sales and earnings. Industrial segment sales for the first quarter of fiscal 2024 were $326 million compared to $223 million, an increase of 46%. We saw growth in all markets from a combination of higher volume and price realization with an increase of 96% in transportation, 20% in power generation and 2% in oil and gas. Sales for on-highway natural gas trucks in China totaled approximately $75 million in the first quarter, driven by significantly higher demand compared to the prior-year quarter.

We do not expect this higher level of sales to continue in Q2 as demand signals indicate a return to previous peak levels of approximately $50 million. Industrial segment earnings for the first quarter of 2024 were $67 million or 20.5% of segment sales compared to $11 million or 5.1% of segment sales. The sharp increase in Industrial earnings was a result of operational improvements, including increased output and efficiency gains, favorable product mix and significantly increased demand for on-highway natural gas trucks in China. Excluding the impact of the China on-highway natural gas truck business, Industrial segment margin increased approximately 900 basis points compared to the prior year. We do not expect the overall first quarter Industrial margin levels to continue in the remainder of the year.

Moving forward, we expect margin pressure for the China on-highway natural gas truck business due to lower volume leverage and higher material costs, including spot buys and expedited freight. Outside of the on-highway natural gas truck business, we also expect margin pressure in the remainder of the year due to an anticipated shift in mix and cost increases. Nonsegment expenses were $26 million for the first quarter of 2024 compared to $24 million. Adjusted nonsegment expenses for fiscal year 2024 were $27 million. At the Woodward level, R&D for the first quarter of 2024 was $31 million or 3.9% of sales compared to $29 million or 4.6% of sales. SG&A for the first quarter of 2024 was $75 million compared to $63 million. Adjusted SG&A for the first quarter of 2024 was $70 million.

The increase was primarily due to higher annual incentive compensation. The effective tax rate was 17.9% for the first quarter of 2024 compared to 6.7%. The adjusted effective tax rate was 17.7% for the first quarter of 2024. Looking at cash flows, net cash provided by operating activities for fiscal 2024 was $47 million compared to $5 million. Capital expenditures were $42 million for fiscal 2024 compared to $24 million. Free cash flow was $5 million for fiscal 2024 compared to negative $19 million. Adjusted free cash flow for fiscal 2024 was $3 million. The increase in free cash flow and adjusted free cash flow was primarily due to increased earnings, partially offset by the above target payout for fiscal year 2023 annual incentive compensation as well as higher capital expenditures.

During the quarter, we repaid $75 million of long-term debt. Leverage was 1.3 times EBITDA at the end of the first quarter compared to 2.3 times EBITDA. $13 million was returned to stockholders in the form of dividends in the first quarter of fiscal 2024. Lastly, turning to our fiscal 2024 guidance, based on our strong first quarter performance and visibility into the second quarter demand for the China on-highway natural gas truck business, we are updating certain components of our fiscal 2024 guidance. Total net sales for fiscal 2024 are now expected to be $3.15 billion and $3.3 billion. Our Aerospace segment guidance is unchanged. For fiscal 2024, Aerospace sales growth is still expected to be 10% to 14% and segment earnings are still expected to be 18% to 19% sales.

Our Industrial segment guidance includes broad-based market strength and improving operational performance. Our guidance now assumes approximately $50 million for our China on-highway natural gas truck business in the second quarter. However, given the volatility and limited visibility into this market, our guidance continues to assume minimal activity in the second half of fiscal 2024. As a result, for fiscal 2024, we now expect Industrial sales growth to be 8% to 10% and segment earnings to be 14% to 15% of segment sales. At the Woodward level, the adjusted effective tax rate is still expected to be approximately 21%. We now expect free cash flow to be between $300 million and $350 million. Capital expenditures are still expected to be approximately $100 million.

Adjusted earnings per share is now expected to be between $5 and $5.40 based on approximately 62 million fully diluted weighted average shares outstanding. This concludes our comments on the business and results for the first quarter 2024. Operator, we are now ready to open the call to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Robert Spingarn from Melius Research. Please state your question.

Robert Spingarn: Hi, good afternoon.

Chip Blankenship: Good afternoon, Rob.

Robert Spingarn: Some nice numbers. I wanted to talk a little bit about Aerospace sales growth. Your commercial OEM sales were up 23% year-on-year and up quarter-over-quarter despite lower working days in the quarter. And at a more granular level, Chip, did you see significantly higher growth on wide-body programs than on narrow-body? And then, I want to ask a follow-up on the 737.

Chip Blankenship: The growth wide-body and narrow-body, they each grew according to their own kind. We saw growth in both, but at slightly different levels. I can’t make it more granular for you than that.

Robert Spingarn: Okay. I’m just trying to get some insight into it, because the cycles are not exactly lined up. Narrow-body at least was a little bit ahead of wide-body, but wide-seems to be smoother based on what’s going on out there. And that leads to this follow-up question, which is when we think about the 737, how would you characterize your OE — what kind of rates you’re targeting given what’s going on in Seattle? And then, is there a difference in how you’re shipping to the engine OEM versus how you’re shipping to Boeing in terms of rates?

Chip Blankenship: So yeah, there are differences there and it’s hard to say because we go through a number of different folks in addition of straight to Boeing. So, we do some to Spirit, some to Boeing and some to the CFM. And the fact of the matter is we can’t see the rates very clearly in our demand from our customers for various reasons on inventory and things of that nature. But you’re pointing out probably the biggest volume risk that we’re looking at as a company on the aerospace side. And it’s an insightful question because we’re in a position where we’re making sure we have the capability to get to the advertised rates in terms of what we think the PO demand growth will be from each of those different customers associated with the 737.

But we’re also looking at what the financial impacts would be if they don’t get where they’ve advertised they’re going to go. And we believe we can manage that risk and we’ve looked very carefully at what we need to do to optimize if there are some signals that the rate is not going to go up as much as we thought it would. We’ve already seen some inventory maneuvers go on with other people’s fourth quarter last quarter. So, we don’t take those signals yet as a signal of slowdown, but we’re watching it carefully and we have internal plans to adjust.

Robert Spingarn: So Chip, just to clarify on that, does that mean that the lower end of your Aerospace guide contemplates this idea of a freeze at Boeing that we heard about last week? I know you’ve only had a week to think about this, if that.

Chip Blankenship: Yeah. It’s been a long week, just thinking about that, but we do — yeah, we do believe our guide, we can operate inside our guide that with that freeze to continue.

Robert Spingarn: Okay. Thanks so much.

Chip Blankenship: You bet.

Operator: Your next question comes from the line of Scott Deuschle from Deutsche Bank. Please go ahead with your question.

Scott Deuschle: Hey, good afternoon.

Chip Blankenship: Good afternoon, Scott.

Bill Lacey: Good afternoon, Scott.

Scott Deuschle: Hey, Chip, can you say what the price realizations were this quarter at Industrial?

Chip Blankenship: Go ahead, Bill.

Bill Lacey: Yeah. Overall, Scott, our price realization was $50 million and the Industrial represented a significant piece of that $20 million, so Aero — I’m sorry, of the $50 million. So, Aero and Industrial both contributed to that overall $50 million realization at the Woodward level.

Scott Deuschle: Okay. And then, Bill, just sticking with you since — sorry if I missed this. But what drove the 8% increase to the free cash flow guidance at the midpoint?

Bill Lacey: Yeah. So, as we saw — as we see the increase in OH and the earnings that flow through, we felt that — and what we sort of saw in the second half of our business, we felt that it was appropriate to raise our cash flow guidance.

Scott Deuschle: Okay. And then, Chip, could this closure of the Red Sea create any discernible benefit from marine aftermarket just due to the longer transit times and utilization rates for marine vessels?

Chip Blankenship: It’s hard to say exactly how that’s going to impact utilization, but the way I think about it is that longer routes, fewer transits and shorter routes, more transit. So, I think that there is enough demand out there to keep those ships moving. So, we’re not forecasting any steeper increase in utilization, but we’re comfortable with what we see.

Scott Deuschle: Okay. And last quick question. Chip, the grounding on the V-22 fleet, does that create any opportunity for defense aftermarket? I think your shipset content there was pretty high. Thank you.

Chip Blankenship: Yeah. The V-22 is a significant repair and overhaul program for us. And as you can see, the defense aftermarket as we talked about was significantly up. Some of that represents our ability to execute better at the facility that does the repair and overhaul on the V-22 and some of the other defense programs. So, there’s plenty of demand. Our execution had been historically getting in the way of some of that realization of that demand. So, we’re working as hard as we can with the defense logistics and other customers to support them.