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Edited Transcript of WWD earnings conference call or presentation 18-Nov-19 9:30pm GMT

Q4 2019 Woodward Inc Earnings Call

FORT COLLINS Nov 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Woodward Inc earnings conference call or presentation Monday, November 18, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Don Guzzardo

Woodward, Inc. - VP of IR & Treasurer

* Jonathan W. Thayer

Woodward, Inc. - CFO & Vice Chairman of Corporate Operations

* Thomas A. Gendron

Woodward, Inc. - Chairman, CEO & President

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Conference Call Participants

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* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD & Senior Analyst

* George James Godfrey

CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst

* Huang Howe

Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research Analyst

* Karl Poehls;Poehls Associates;Analyst

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Peter John Skibitski

Alembic Global Advisors - Research Analyst

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Woodward, Inc. Fourth Quarter and Fiscal Year 2019 Earnings Call. (Operator Instructions) Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer; Mr. Jack Thayer, Vice Chairman, Corporate Operations and Chief Financial Officer; Mr. Bob Weber, Vice Chairman; and Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer.

I would now like to turn the call over to Mr. Guzzardo. Sir, you may begin.

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Don Guzzardo, Woodward, Inc. - VP of IR & Treasurer [2]

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Thank you, operator. We would like to welcome all of you to Woodward's Fourth Quarter and Fiscal Year 2019 Earnings Call. In today's call, Tom will comment on our markets and related strategies, and then Jack 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 December 2, 2019. 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. Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings.

Woodward adopted the FASB Accounting Standards update number 2014-09, revenue from contracts with customers for ASC 606, effective October 1, 2018. Accordingly, results for the fourth quarter and fiscal year 2019, including adjusted and organic amounts are presented under ASC 606. Prior period amounts are presented under prior accounting guidance for revenue. To better understand the impact of ASC 606 on Woodward, we have included additional materials in our press release, the presentation for this call and the annual report on Form 10-K to be filed on or before November 29, 2019.

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 information will help in understanding our results.

Now turning to our results for the fourth quarter. Net sales for the fourth quarter of fiscal 2019 were $737 million compared to $719 million for the prior year quarter, an increase of 2%. Net earnings were $67 million or $1.03 per share compared to $75 million or $1.16 per share for the prior year quarter. Adjusted net earnings were $79 million or $1.22 per share compared to adjusted net earnings of $89 million or $1.39 per share for the prior year quarter. And for the full year, net sales were $2.9 billion compared to $2.33 billion for the prior year, an increase of 25%. Organic net sales were up $345 million or 16% year-over-year. Net earnings were $260 million or $4.02 per share compared to $180 million or $2.82 per share for the prior year.

Adjusted net earnings were $314 million or $4.88 per share compared to adjusted net earnings of $246 million or $3.85 per share for the prior year. Net cash generated from operating activities for fiscal 2019 was $391 million compared to $299 million for the prior year. Free cash flow was $292 million compared to $172 million for 2018.

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

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [3]

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Thank you, Don, and good afternoon, everyone. Fiscal year 2019 was another strong year for Woodward. We continued driving solid sales, earnings and cash flow growth despite facing headwinds from the 737 MAX grounding and customer challenges within our renewables business. In terms of highlights, our Aerospace business continued to perform very well in both commercial and defense markets. Our industrial business also improved due to the addition of Woodward L’Orange as well as the return to -- to growth of our organic industrial business, which was partially offset by headwinds from our renewables business.

Now moving to our markets in more detail. In Commercial Aerospace, increasing global wealth and a desire for air travel continues to drive a strong demand for more fuel-efficient aircraft. The impact to Woodward of the 737 MAX grounding on our fiscal year 2019 was minimal from an OEM perspective, but we did see a more significant effect on initial provisioning sales. When the aircraft returns to service, we would expect to recover the initial provisioning that was delayed due to the grounding.

Legacy commercial aftermarket continues to benefit from high aircraft utilization, solid global passenger traffic growth and a high volume of engine shop visits.

In Defense, global budgets and spending remained favorable, driving demand for fixed-wing aircraft, rotorcraft and guided weapons. Military aftermarket is robust in support of the U.S. defense initiative to improve the combat readiness of the U.S. fleet as well as global aircraft upgrade programs.

Turning to our industrial markets. In power generation, we continue to see stabilization with the industrial gas turbine market and our content wins on new turbine programs are providing some lift as well. The launch of the Mitsubishi J class heavy frame combined cycle turbine represents a new program for Woodward and highlights our share gains and expanding content in this space. As we look forward, we remain confident in the long-term global fundamentals of natural gas power generation as well as our ability to drive share gains as we see continued recovery in the turbomachinery market.

Our renewables business remains uncertain in part due to the ongoing bankruptcy proceedings of our customer, Senvion. In September, Siemens Gamesa announced an agreement to acquire part of Senvion, and we continue to closely monitor the situation. Senvion platforms remain an important source of aftermarket revenues for us. This has been a challenging market, and we are in the process of determining appropriate actions.

In transportation, consistent with our expectations, production of natural gas trucks was softer in the fourth quarter as the market absorbed the large prebuy of China V-compliant trucks in our third quarter, ahead of China VI regulations that were implemented in July. We started to see a strong recovery in China VI-compliant truck sales at the end of September and expect this positive trend to continue into the fiscal year.

China's rigorous enforcement of the new regulations, including the restriction of diesel from certain cities, is promoting the rapid transition to the new engines. We're also seeing natural gas engines secure a growing share of the on-highway market, with current share rising to approximately 20%. In addition to volumes recovering, we have a higher system content on the China VI-compliant engines.

In marine, we had a very strong year in 2019 mainly driven by aftermarket sales. We expect the strength in aftermarket to continue into fiscal year '20 as robust ship utilization rates drive the need for replacement parts and service.

Oil and gas markets are pressured due to global economic uncertainty, access to capital, oil price fluctuations and weaker demand. Our products are prevalent in the entire value stream at the wellhead as well as downstream applications, such as pipelines, processing plants and import/export terminals, where we have a large installed base that drives aftermarket activity. As the global economy has slowed, utilization, expansion of these facilities has also slowed.

In summary, we delivered strong results in 2019, which included robust revenue and earnings growth, significant free cash flow generation, deleveraging of the balance sheet, the addition of new members to accelerate our True North operational excellence journey and good execution on new platform wins, which all translated into strong shareholder returns.

Looking ahead to 2020, we anticipate continued growth in our Aerospace business as the 737 MAX returns to service. Defense is expected to remain strong in both OEM and aftermarket and commercial aftermarket is expected to remain solid.

In our Industrial business, we expect improved profitability in 2020 despite modest flat revenue growth. We see improving gas turbine market dynamics and accelerating natural gas truck sales in Asia, which will be partially offset by slowing economic growth, China trade headwinds and softening oil and gas investments.

We are optimistic about our ability to deliver another record year in 2020 and remain focused on driving long-term shareholder value through delivering on our financial targets. In particular, we expect a significant increase in free cash flow, again delivering greater than 100% conversion rate. After a significant period of investment to support new program wins in Aerospace and Industrial, we are entering a period of lower capital expenditures and higher earnings growth, which positions Woodward to deliver significant free cash flow for the foreseeable future.

Now before turning the call over, I want to thank Bob Weber, who'll be retiring in January, for his dedication and valuable contributions during his more than 14-year tenure at Woodward. Bob has been a tremendous asset to our company and has delivered exceptional value to our shareholders over his career. He's been a tremendous partner and friend to me. We are excited for him as he enters this next phase of his life. Bob, we wish Patti and you all the best.

I'd like to once again welcome Jack as our new CFO. And now I'll turn the call over to him to discuss further financials.

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [4]

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Thank you, Tom. Aerospace segment net sales for the fourth quarter of fiscal 2019 were $506 million compared to $461 million for the fourth quarter a year ago, a 10% increase. Aerospace segment sales benefited from strength in defense OEM and aftermarket as well as commercial OEM. Commercial aftermarket sales were up 9% in the fourth quarter of 2019 as compared to the prior year quarter. As anticipated, initial provisioning was softer in the quarter due to the grounding of the Boeing 737 MAX. Defense sales growth in the quarter was primarily driven by smart weapons, fixed-wing aircraft and aftermarket, which we anticipate will continue to benefit from increased military spending.

Aerospace segment earnings for the fourth quarter of 2019 were $111 million or 22% of segment sales compared to $105 million or 22.7% of segment sales for the fourth quarter of 2018. Segment earnings were positively impacted by higher sales volumes partially offset by increased capacity expansion costs.

For fiscal year 2019, Aerospace segment net sales were $1.88 billion compared to $1.56 billion for the prior year, a 21% increase. In 2019, commercial OEM sales grew 15%, commercial aftermarket sales were up 18%, defense OEM sales increased 33% and defense aftermarket sales grew 22%, all as compared to 2018.

Aerospace segment earnings for fiscal year 2019 were $389 million or 20.7% of segment sales compared to $309 million or 19.8% of segment sales for the prior year.

Turning to Industrial. Industrial segment net sales for the fourth quarter of fiscal 2019 were $231 million compared to $258 million in the prior year period, a decrease of 11%. Industrial segment sales declined primarily due to the reduced demand for natural gas trucks in Asia, resulting from the large prebuy in previous quarters of China V-compliant trucks ahead of the implementation of China VI emissions regulations as well as the impacts to sales of the Senvion bankruptcy.

Industrial segment earnings for the fourth quarter of 2019 were $11 million or 4.8% of segment sales compared to $8 million or 3.3% of segment sales for the fourth quarter of 2018. Adjusted Industrial segment earnings were also $11 million and 4.8% of segment sales for the fourth quarter of 2019 compared to $35 million or 13.4% of segment sales for the fourth quarter of 2018.

The decline in adjusted Industrial segment earnings was mainly due to lower sales volumes, higher manufacturing costs and an engine product warranty expense. In the fourth quarter of 2019, we recorded a pretax charge of $13 million to write off assets related to the Senvion bankruptcy. These charges were recorded in non-segment and excluded from adjusted results.

As we mentioned last quarter, while the loss of this customer would have a substantial impact on our renewables business, it is not material to Woodward as a whole. On a prospective basis, we expect to continue to have aftermarket sales in support of the installed Senvion wind turbine fleet.

For fiscal year 2019, Industrial segment net sales were $1.02 billion compared to $768 million for the prior year, a 33% increase. Organic Industrial segment net sales for fiscal year 2019 were $688 million compared to $665 million for the prior year, a 3% increase. Foreign currency exchange rates had an unfavorable impact on segment net sales of approximately $21 million for 2019 and no significant impact on segment earnings. On a constant currency basis, organic sales would have increased approximately 7%.

Industrial segment earnings for fiscal year 2019 were $94 million or 9.2% of segment sales compared to $50 million or 6.5% of segment sales for the prior year. Adjusted Industrial segment earnings for fiscal year 2019 were $115 million or 11.2% of segment sales compared to $84 million or 11% of segment sales for the prior year.

As Tom highlighted, 2019 was a particularly challenging year for our renewables business. Adjusted Industrial segment earnings, excluding the renewable power systems business for 2019, were $127 million or 13.3% of Industrial segment net sales, excluding the renewable power systems business compared to $81 million or 12% of Industrial segment net sales, excluding the renewable power systems business in the prior year.

We are exploring other means of improving industrial profitability. We will leverage our True North process in addition to reviewing other opportunities for our improvement. This long-term effort should enable 16% or better sustainable industrial margins.

At the Woodward level, selling, general and administrative expenses were $51 million for the fourth quarter of 2019 compared to $53 million for the fourth quarter of last year. For fiscal year 2019, SG&A expenses were $211 million compared to $194 million last year. The increase in SG&A expenses for the full year was primarily due to the addition of Woodward L’Orange and an asset impairment charge related to the Senvion bankruptcy.

R&D spending for the full year 2019 was largely in line with our expectations at approximately 5% of sales. The effective tax rate for the fourth quarter of 2019 was 12.8% compared to 5.7% in the fourth quarter of 2018. The adjusted effective tax rate was 15.5% for the quarter compared to 18.9% for the fourth quarter of 2018.

For the fiscal year 2019, the effective tax rate was 19% compared to 17.9% for the same period of the prior year. The adjusted effective tax rate for the full year was 17.5% compared to 16.8% for 2018.

Looking at cash flows. Net cash generated by operating activities for fiscal year 2019 was $391 million compared to $299 million for the prior year. Capital expenditures were $99 million for 2019 compared to $127 million for the prior year. For fiscal year 2020, we anticipate capital expenditures to be approximately $80 million. Free cash flow for 2019 was $292 million compared to $172 million in the prior year. Free cash flow for 2019 was positively impacted by increased earnings and moderating capital expenditures.

During the fiscal year 2019, $150 million was returned to stockholders in the form of $40 million of dividends and $110 million of repurchased shares.

Lastly, turning to our fiscal 2020 outlook. Total net sales are expected to be between $3 billion and $3.1 billion. Aerospace sales are anticipated to be up approximately 6% compared to the prior year. While ASC 606 favorably impacted Aerospace sales growth in fiscal year 2019, it is expected to have an unfavorable impact on sales growth in fiscal year 2020 due to the timing of sales orders and inventory levels. With regard to the assumptions for the Boeing 737 MAX in our 2020 projections, we are estimating a return to service in the second quarter of our fiscal year, with production rates ramping in line with the Boeing build rates communicated at the end of September. We assume initial provisioning will not ramp up until the second half of the fiscal year. As a result, we anticipate a year-over-year headwind to commercial aftermarket in the first half of the fiscal year and a tailwind in the second half.

Industrial sales growth is expected to be flat to up in the low single digits compared to the prior year. We expect strong natural gas truck sales in Asia and an improving turbine market outlook to be somewhat offset by softening in our oil and gas markets as a result of economic uncertainty and reduced spending on equipment.

Aerospace segment earnings as a percent of net sales are expected to be approximately 21%, and Industrial segment earnings as a percent of net sales are expected to be approximately 14%. The effective tax rate for the year is expected to be approximately 22%. Earnings per share are expected to be between $5.30 and $5.60 per share based on approximately $64 million of fully diluted weighted average shares outstanding. The higher projected effective tax rate for 2020 represents an approximately $0.30 headwind to earnings per share. Earnings before tax is expected to grow in the mid- to high-teens range as compared to 2019.

For 2020, we anticipate free cash flow to be approximately 40 -- $400 million, in line with our long-term target of 100% or better free cash flow conversion. As you can see, we're expecting another strong year for Woodward as both our Aerospace and Industrial segments continue to improve operating performance, resulting in double-digit earnings growth and substantial free cash flow acceleration.

Before turning the call back over, I'd like to remind everyone that historically, our fiscal first quarter is sequentially lower due to normal business trends and fewer working days as a result of the holiday schedule and plant shutdowns. For 2020, we anticipate this similar pattern.

This concludes our comments on the business and results for the fiscal year and fourth quarter 2019. Operator, we're now ready to open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is going to come from Sheila Kahyaoglu with Jefferies.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [2]

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Congratulations, Bob and Jack. Jack, I guess the first question for you. Industrial earnings just below, you had some onetime items in there. How do you think about your guidance for 2020? And I think you talked about a 16% target you're holding to that long term. Just the puts and takes, and what are the options for the renewable business from here?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [3]

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Right. So Sheila, as you'll note from our prepared remarks, we're expecting margins of about 14% in that business versus the 11.2% in 2019. And of that improvement, we'd expect about half to be related to the renewables business, the other half to be True North improvements that we'll make to our operations. This really gets us back to the margins that we were experiencing in the first half of 2019. So absent these headwinds related to Senvion and some of the other issues, we're really getting back to where we'd expect the business to be longer term. And then we see, as Tom mentioned, we are accelerating our True North journey and that's where we'd really expect the longer-term improvement to 16% margins.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [4]

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And did you quantify the engine product warranty expense for the quarter?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [5]

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We did not. But it is a, relatively speaking, onetime item, and we wouldn't expect it to repeat.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [6]

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Okay. And then, Tom, you have -- you're guiding towards, I think 33% free cash flow growth, a big number out there with $400 million versus low double-digit EPS growth, still very good. I guess how do you think about what you do with all that cash? As you mentioned, you're coming off of major CapEx spend and investment period, like, how do you think about cash deployment from here?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [7]

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Yes. The first thing is we've got a commitment of returning 50% of net income to shareholders, so that will be the first use of the cash. Then we'd be looking at both organic growth and then potential inorganic growth if we see things that make sense and that can deliver our -- in excess of our cost of capital. So we'd probably lean more towards the growth side but if we don't have the growth opportunities, Sheila, we're going to return more to shareholders.

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Operator [8]

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And our next question comes from Peter Skibitski from Alembic Global.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [9]

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Bob, best of luck, it's been a pleasure. I mean just getting back to the Industrial margins and the engine issue. If we exclude the warranty expense, did you still come in below your expectations? And if so, I just want to understand what the biggest surprise was for you guys if it was kind of oil and gas or something else?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [10]

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Yes. We -- well, we definitely saw oil and gas drop. We did see some -- we highlighted headwinds in China, both from trade but also from the prebuy China V or China VI natural gas engines. And then we had the Senvion issues in renewables and then we had the warranty select combined headwind did hit us in the fourth quarter. Going forward, we see China picking back up. The trade war is still uncertain in our minds. But the China VI sales are growing nicely right now. We think we got the renewables under control. And as Jack already said, the warranty was a onetime thing that we won't see again in 2020. So that gives us confidence to get back on that 14% earnings on our path to 16%.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [11]

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Okay. And Tom, just one follow-up. Just given the importance of wind right now, can you level set us, what were wind -- what was the wind revenue in fiscal '19? And are you expecting it to get down again in fiscal '20?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [12]

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No, we're actually expecting wind sales to move up in 2019 -- or I mean 2020. 2019, we had a loss, and we're basically going to be breakeven in that business in 2020. It's a drag on the overall Industrial.

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Operator [13]

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And our next question comes from Chris Howe from Barrington Research.

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Huang Howe, Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research Analyst [14]

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Just a few questions going off of some of your comments. In regard to the strong defense aftermarket that you're seeing, the strong growth there, as we think about the delay or the push in the timing of the initial provisioning revenues related to the 737 MAX, how should we look at the mix of aftermarket as we move into 2020? And do you anticipate recapturing all of the initial provisioning in 2020 or will some push to the following year?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [15]

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Yes. Well, I'll address that last one first is, none of the initial provisioning, in our view, is lost; it's delayed. And how fast we gain that will really depend on how fast the aircraft are turned back into service, in which operators, in which order. So it's a little uncertain. But I would say through 2020 and early 2021, we should gain back that initial provisioning. So we have to wait and see how Boeing returns the aircraft to get a firmer handle on that.

The remaining, what we would call legacy commercial aircraft is actually very robust. Shop visits are high, the MRO activity is strong, and all the market dynamics point to the continued strength of -- in that market. So that's looking good. And then in Defense, as we highlighted, with the Fed's budgets and the need to get aircraft back in service, we're seeing strong orders. And our order book this year is healthy already, and we look at that continuing through 2020 and into 2021. That's our line of visibility at this moment.

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Huang Howe, Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research Analyst [16]

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That's very helpful. And I have 1 follow-up question as it relates to your 2020 outlook and just as we move from the top line to the bottom line. How should we look at your outlook in terms of different opportunities that you see an increase in the operational efficiencies, whether it's through optimization of R&D spend versus SG&A? Just different leverage opportunities that may be on the horizon, whether near-term or long-term, for the company.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [17]

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Yes. So one of the points we've made over the last couple of years, we've made the large investment in facilities. We've added a lot of members to our organization to handle the volume increases. I would say our indirect spend on people, and then you'd also translate that to CapEx, it's kind of flattening. And that means that sales leverage through our existing plants will lead to higher margins as we lever that investment. So we are in that phase of the cycle, so I think those are positive. As Jack highlighted R&D, it's come to a point where we're looking at the...

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [18]

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5.5% of sales.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [19]

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Yes, 5.5% of sales for 2020, and we've talked about that between 5% and 6% is where we would see R&D going. So you can start seeing, as we increase sales, we're leveraged through the income statement on those dynamics.

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [20]

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And then, Chris, obviously, that's underpinning this, in part, the significant growth in free cash flow. So we're delivering the double-digit earnings growth in terms of cash conversion, spending less on CapEx, and then we're improving our working cap primarily through our inventory levels.

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Operator [21]

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And our next question comes from Robert Spingarn from Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [22]

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I'll add my congrats to you, Bob, and welcome, Jack. I guess it's not really welcome. But I'll start with you anyway. Could you bridge the cash flow from '19 to '20? Obviously, the CapEx improves, the taxes go up, I guess the net earnings go up. But could you just walk us through the big pieces? Going back to Sheila's question, $300 million to $400 million, just the big pieces there.

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [23]

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Right. So as you think about the $292 million growing to $400-plus million, primary driver is that double-digit earnings growth that I mentioned. In terms of CapEx, we'll spend roughly $20 million less this year, so $80 million versus $99 million in 2019. And then you should expect to see our inventory levels improve even with the 6% top line growth, so improving both in -- as a percent of sales outright but also in actual dollars as we leverage some of the True North improvements that we've made around build rates and operating efficiency within the plants that Tom's referenced earlier.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [24]

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Okay. And then just moving back to Industrial. You talked about 14%. Obviously, we had the tough fourth quarter, 11% this past year. What's the cadence of improvement? Do you come out of the gate at the -- below that and then rise throughout the year? How do we think about that from a quarterly perspective?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [25]

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So from a quarterly cadence, we're back to making money again in the renewables business. We will -- we won't have that onetime item related to warranty expense as well as you are seeing roughly a return to the margins experienced in the first half of 2019. So feel good about our visibility on 14%.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [26]

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Okay. And then 787, I assume that rate adjustment, how -- is that factored in? I know it's OE work but...

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [27]

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Yes, it's in our outlook.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [28]

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So you -- and when do you actually expect that to start showing up in the factory given that it's, I guess a beginning of 2021 rate for Boeing?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [29]

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We usually see it about 6 months in advance, Rob.

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Operator [30]

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And our next question comes from Michael Ciarmoli from SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [31]

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Congrats, Bob and Jack. Guys, just on the MAX. Have you sort of looked at any other sensitivities or I guess what's implied in the outlook? Is it sustaining at that 42 a month or are you actually baking in some pickup in the production rates? Just maybe I missed it, but just for clarity there.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [32]

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Yes. What we were highlighting is we're tracking what Boeing has released. So we're in line with that subject to our lead times and also units that we produce for initial provisioning. So that's the best we can tell you is we're tracking with Boeing.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [33]

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Okay. Got it. And then just on the Aerospace margins. Guiding to the 21% next year, I know you guys have had the long-term 20%. I mean can you give us a sense of maybe -- is this -- is there a little bit of a disproportionate positive effect from the provisioning? Or is this 21%, I mean do you guys think you can sustain this on a go-forward basis? Just trying to get a sense as to what's driving the continued margin expansion there.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [34]

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Yes. I'd like to remind you, we always said 20% plus.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [35]

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20% plus, right.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [36]

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Yes. And so I think this is on the plus side. So we anticipate we can hold this margin.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [37]

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And even if the continued kind of ebb and flow in the aftermarket, you still think you'd be able to hold that level?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [38]

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Yes, I'd say so because the legacy MRO, the fleet's huge. A lot of the fleet has only seen like 25% of the fleet is -- the current narrowbodies have only seen their first shop visit. So there's going to be some good MRO. As you move further, the new programs we've won are going to start hitting the maintenance cycles. So we see consistent, solid commercial aftermarket and aftermarket growth going forward.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [39]

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Got it. And then just the last one, and I'll get out of the way. Just can you give us a little bit more color as it relates to the Industrial segment? Maybe what you're seeing in terms of some of the ordering trends in different geographies? It certainly seems like there's a lot of different cross currents out there. But I mean are you seeing any particular strength in any geographies? In product lines? And maybe any color on bookings? Have you maybe seen a bottoming in certain areas? Just maybe a general sense there.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [40]

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Sure. Well, I think in the prepared remarks, you heard from us that we actually were calling the bottom of the turbomachinery market in 2019, and we did see that. So we've been seeing slight -- so we're seeing the turn up in that market. Now you may see from some of the OEMs that they're seeing 2020 as the bottom. The difference between their outlook and ours is the new machines have a lot more Woodward content. So we've turned the corner there. So we're seeing that on the uptick and that we expect that to grow slowly over the next few years. We don't expect a V-type recovery but we do see some steady growth in there.

China, in general, has some uncertainty to it, like we're saying, in particular, where trade goes. However, when you narrow it down to some of the things regarding the new emission regulations, we're seeing that really positive for our small on-highway natural gas engines. And we're also seeing it positive for our larger fuel injection and diesel business and, in particular, our L’Orange business. So those are positives, tempered by the trade dispute so that's why we're going to -- we have some uncertainty in the outlook or -- up and down, it could go either way depending on how things materialize.

The other has been the renewables. We took big hits in 2019, as we described. Actually 2020 sales with some new programs are turning up but that's still a business that's under a lot of pressure and there's obviously uncertainty in that business as well. So that combination is a little bit why we said flat to up low single digits. The margin improvements will come, as we're highlighting, from improvements in our operations, improvements in product mix, improvements from these one-timers not being in there. So we have some good confidence in being able to achieve the margins.

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Operator [41]

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And our next question comes from Gautam Khanna from Cowen and Company.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [42]

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Congratulations to both Bob and Jack, and best of luck. I was wondering if you could disaggregate the guidance for next year at Aero in terms of is the aftermarket going to grow kind of in line with the segment average, above it? You mentioned defense, just if you could give us some color on the other pieces within the segment?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [43]

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Right. So on the back of, obviously, the strong growth that we saw across the board in '19, we continue to expect growth within each of those constituent segments, roughly in line with the 6% top line growth that we've signaled for the year so both across commercial aftermarket OEM as well as defense aftermarket OEM mid- to upper single digits but obviously, on top of very strong growth in 2019.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [44]

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Is the mix within the OE business improving as you move forward given you've gotten down the learning curve on the single-aisle stuff? Or can you comment on that?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [45]

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Yes, that's definitely part of the margin expansion that you're seeing. And if you -- and I know, Gautam, you've been tracking us for years. So if you watch, this is all part of bringing those programs online, getting through the learning curve, getting the leverage on the facilities. So that's a part of getting above in this 21% range, so feel good there. As we move forward, we're also, with the volume we're seeing in the aftermarket, we're also get leverage on the facility investment for aftermarket, so that also help with margins. So it's kind of working as we believed it would and is as planned, and it is sustainable, so that's the other thing to take away. So we're getting to the numbers we said, the volumes are coming through. We'll get more volume ideally as the MAX comes back to service and gets to the higher rates that Boeing wants to achieve, so we'll be in good shape for that. And we are facilitized already to handle those rates. So we just need them to get back in service, get moving, and we've got a lot of confidence in that aircraft, and I think the market will as well once it's in service.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [46]

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And just to be clear, were you guys at 42 through the quarter? And are you there now across the board on your products?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [47]

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Yes, we're operating to the 42 plus a little bit depending on the product, based on -- there is some inventory builds that we're working on with our customers or providing for aftermarket. So it's right about that number. And what we'll be doing is moving forward as they get back into service and then ramping, as you've seen their ramp rate. We're ready, we have our planning system in place to go to those volumes, and we'll work hand-in-hand with them to ensure we support that ramp.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [48]

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And one last one, I apologize for another question, but the 2-year stack on the aftermarket's pretty challenging obviously. Could you just give us any comments on the state of the aftermarket currently? What is your forward visibility on the commercial aerospace aftermarket? Because you guys have blown away all the targets. I thought you guys were guiding for down 15% in Q4 to get to the full year and you did better than that. So have you seen any slowdown whatsoever yet?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [49]

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As I was highlighting, the shop visit rate is very strong, and we did have good initial provisioning on programs other than the MAX. So those are still in there, the MAX was a headwind. But the other initial provisioning, that was strong. And so it's something we've been highlighting for quite a few years, we've got a great presence in the commercial market with products that are just coming up to their -- a lot of them, their first shop visits and then some second. So our market dynamics are quite good. And as we move forward on those legacy, that's what I'm highlighting, we're going to have the new ones coming behind it. So those are some pretty big growth numbers as you're highlighting. But we see good aftermarket, solid aftermarket and continuing growth going really for the long term just based on the products we've won, how many components you guys, I think can all remember from our investor presentations, we have a significant amount more LR used per application than we did in the past, which means more aftermarket as they hit their repair cycles. So the dynamics are good, we're starting to see them, and we think you can kind of count on good aftermarket for many, many years.

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Operator [50]

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And our next question comes from David Strauss from Barclays.

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Unidentified Analyst, [51]

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This is [Matt] on for David, actually. I may have missed this but you guys called out the ASC 606 flips to a headwind for Aero. Have you sized how big that is, the headwind?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [52]

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So for the full year 2020, it's a $0.07 headwind on the back of a $0.10 tailwind in 2019.

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Unidentified Analyst, [53]

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Got it. Okay. And then I guess just Industrial margins. I mean you guys, in the past, have talked about that business getting to 16% and I know some things have changed since then. But is that still a target that's out there? And how do you think about sort of what would have to happen to get to 16% on Industrial?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [54]

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It's very definitely a target that we're pursuing. And I think given the areas where we're seeing growth, those are good margin businesses for us. We have had some of our lower-margin businesses taper off. And maybe to clarify something I said earlier, I think we'll see a ramping of margin from -- throughout 2020 within the Industrial segment as we've seen an improvement in that throughout the year.

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Operator [55]

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And our next question comes from Karl Poehls from Poehls Associates.

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Karl Poehls;Poehls Associates;Analyst, [56]

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Great year. I'm just looking for some clarity on the commercial aftermarket. On a 605 basis, it appears that growth might have been negative. It looks like the adjustment to 606 added about $15 million in Aerospace sales this quarter. I think 9% growth is on a 606 basis. And in the first half of the year, you disclosed growth on a 605 basis. So if we -- just trying to compare apples-to-apples, on a 605 basis, if you had $420 million of commercial aftermarket sales last year, about $105 million per quarter, is it fair to assume that there's about 1,000 basis points of delta between the 9% that you're reporting, I think on a 606 basis and what it would be under 605?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [57]

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Commercial aftermarket would have been roughly 9% year-over-year. I mean the 605, sorry. The 605.

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Karl Poehls;Poehls Associates;Analyst, [58]

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So would it be higher then on a 606 basis?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [59]

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On a 606 basis, 19%.

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Karl Poehls;Poehls Associates;Analyst, [60]

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Okay. And then for the full year, I think you guided to mid- to high single digits, excluding the...

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [61]

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Roughly in line with top line growth.

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Karl Poehls;Poehls Associates;Analyst, [62]

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The accounting change. What would it have been on a full year basis?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [63]

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I'm sorry, repeat that, please?

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Karl Poehls;Poehls Associates;Analyst, [64]

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Excluding the adjustment for 605 to 606, what would the commercial aftermarket growth been on a full year basis?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [65]

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Yes, we're not really forecasting in 605 anymore just because we've made the transition at the beginning of fiscal year 2019 to 606. So I don't -- I apologize, we don't have that from a comparability standpoint.

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Operator [66]

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And we have a follow-up question from Pete Skibitski from Alembic Global.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [67]

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Just one housekeeping question. Do you guys have a full year estimate for D&A for fiscal '20?

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [68]

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What was the...

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [69]

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Yes, D&A for...

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [70]

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Yes, depreciation and amortization for fiscal '20.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [71]

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Yes. We don't know it is. We didn't provide it but it -- yes.

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Jonathan W. Thayer, Woodward, Inc. - CFO & Vice Chairman of Corporate Operations [72]

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I think up modestly is probably the right way to think about it.

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Operator [73]

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(Operator Instructions) Our next question comes from George Godfrey from CL King.

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George James Godfrey, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [74]

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Tom, you touched on this, that you put the capacity in place to ramp up production as Boeing needs to take that higher. Are you anticipating or do you see any issues with the rest of the supply chain that could impact you that those production targets going from 42 to 52 to 57 could perhaps be more challenging to meet in 2020?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [75]

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Well, it's definitely -- George, as you probably know already, there's definitely pressure on the supply chain. If I was looking at some of the materials, whether forgings, castings, bearings, all those are some pressure on capacity, so we're trying to work that. But I think the whole industry is experiencing that. So everybody is working to make sure those capacity numbers are there for those type of commodities. But that's what I would say, there is some pressure. We're working it, but -- well, that could become a constraint and could temper the ramp rate, but I think people are working it really hard. And I think the ramp should be in line with what Boeing is projecting.

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Operator [76]

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And we have a follow-up question from Gautam Khanna from Cowen.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [77]

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Yes, I just wanted to ask where you are on L’Orange, bringing their technology to the U.S.? Have you had any revenue synergies yet there?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [78]

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Yes, we have. We've won a program and we've won some in China so we're starting to see that leverage. And we see more coming. And just as a reminder, those do have a fair amount of development cycle times, not as long as aerospace but the synergies are happening. And we're seeing also better support to customers, they like the fact that we're bringing not just the fuel injection system, but we're bringing the controls and actuation and valving as well. So that's progressing very well. We're really quite happy with the way L’Orange is moving forward with the company.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [79]

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What is L’Orange's growth rate implied next year?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [80]

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We haven't broken that out, so it's not a number we're providing separately at this time from the industrial. So it's embedded in the flat to slightly up. And mainly that's...

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD & Senior Analyst [81]

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Is it fair to assume though it would be more maybe up? It'd be up probably because of the share?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [82]

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Well, it's up a little bit. I mean you can look at it being up, but we also have the headwinds. They had -- they have strong oil and gas sales that are being tempered. Some of the sales on the large diesel engine power gen have tempered a little bit, so it won't be up dramatically more than the whole industrial group, be in line.

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Operator [83]

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Mr. Gendron, there are no further questions at this time. I would now turn the conference back to you.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [84]

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Okay. Well, I'd like to thank everybody again for joining us today. I would like to invite all of you to join us at our Investor Day in New York City on December 6. We'll have a little more in-depth discussion on our markets, our strategies and our longer-range outlook. So I hope to see you there, and thanks again for joining us today. Goodbye.

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Operator [85]

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Thank you. 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 at 7:30 p.m. Eastern Standard Time by dialing 1 (855) 859-2056 or 1 (404) 537-3406 for our non-U. S. calls, and by entering the access code 4382689. A rebroadcast will be available at the company's website, www.woodward.com for 14 days. We thank you for participating on today's conference call and ask that you please disconnect your lines.