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Edited Transcript of WWD earnings conference call or presentation 19-Apr-17 8:30pm GMT

Thomson Reuters StreetEvents

Q2 2017 Woodward Inc Earnings Call

FORT COLLINS May 7, 2017 (Thomson StreetEvents) -- Edited Transcript of Woodward Inc earnings conference call or presentation Wednesday, April 19, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Don Guzzardo

* Robert F. Weber

Woodward, Inc. - CFO and Treasurer

* Thomas A. Gendron

Woodward, Inc. - Chairman, CEO and President

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Conference Call Participants

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* Andrew Jay Lipke

Stephens Inc., Research Division - Research Analyst

* Garo Norian

* Gautam J. Khanna

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

* Michael Frank Ciarmoli

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Peter John Skibitski

Drexel Hamilton, LLC, Research Division - Senior Equity 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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Welcome to the Woodward, Inc., Second Quarter Fiscal Year 2017 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, Chief Financial Officer and Treasurer; and Mr. Don Guzzardo, Director of Investor Relations and Treasury.

I would now like to turn the call over to Mr. Guzzardo.

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Don Guzzardo, [2]

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Thank you, Operator. We would like to welcome all of you to Woodward, Inc.'s, Second Quarter Fiscal Year 2017 Earnings Call.

In today's call, Tom will comment on our markets and related strategies, and then 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 May 3, 2017. The phone number for the audio reply is on the press release announcing this call and will be repeated by the operator at the end of the call.

Before we begin, 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 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.

We also direct your attention to the reconciliations of certain non-U. S. GAAP measures included in today's slide presentation and our earnings release and related schedules. Management uses these non-U. S. GAAP measures in monitoring and evaluating the ongoing performance of Woodward, Inc., and each business segment.

Now turning to our results. Net sales for the second quarter of fiscal year 2017 were $500 million, an increase of 4% compared to $479 million in the second quarter of 2016.

Earnings per share were $0.60 for the second quarter of 2017, compared to $0.65 in the second quarter of 2016.

Aerospace segment sales grew 10% and earnings increased 15%, while Industrial segment sales and earnings decreased 5% and 12% respectively, as compared to the prior year quarter.

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

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

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Thank you, Don. Good afternoon to those joining us today.

Halfway through fiscal 2017, our results are largely in line with our expectations. For the second quarter, Aerospace segment performance was very strong, offsetting somewhat weaker Industrial segment performance compared to the prior year.

As anticipated, we continued our shift from investment to cash generation cycle, delivering significant growth and free cash flow this quarter.

Long-term trends for our Aerospace and Industrial segments are in line with our growth strategies. Record commercial aircraft backlogs support healthy production levels for the next decade.

In industrial application, emission regulations, as well as increased availability and favorable pricing of natural gas, are expected to drive long-term growth in natural gas utilization.

Focusing on our markets in more detail, commercial aerospace markets remain strong. Our commercial sales are accelerating, benefiting from the introduction of the next generation programs. The Airbus A320neo continues to ramp up, and the Boeing 737 MAX is expected to launch in the coming months. Our content on both of these programs has more than doubled from previous generations.

Commercial aftermarket continues to be robust, driven by strong growth in global passenger traffic, which, through February of '17, was up 7% year-over-year as well as improving global cargo miles.

Initial provisioning for the new platforms was also a solid contributor.

Commercial rotorcraft and business jet markets remain weak, and we aren't anticipating a near-term recovery.

Defense activity, both OEM and aftermarket, continued to be strong, fueled by global unrest and growing international defense budgets. Defense OEM sales benefited from growth in smart weapons, while aftermarket sales were up as a result of rising maintenance budgets, aircraft service life extensions and major upgrade programs.

Turning to Industrial. Macroeconomic indicators continue to point to strength in industrial markets in the latter half of the calendar year, and we are seeing some positive order activity in our early-cycle product families.

In power generation, activity related to natural gas reciprocating engines showed improvement and our order volume is increasing. Industrial gas turbine OEM sales remained flat. Aftermarket sales for industrial gas turbines have been strong for some time now, but this quarter we saw some downward pressure. Wind turbine converter sales were also weak.

In transportation, we are pleased to see the second consecutive quarter of meaningful improvements in our natural gas fuel systems for trucks in Asia, and we expect this trend to continue.

In oil and gas, the price of oil has settled above $50 a barrel, and we are seeing signs of stabilization.

In summary, as we look ahead to the balance of fiscal 2017, we expect the positive momentum in Aerospace to continue and the Industrial segment to have a stronger second half.

While uncertainty remains in many of our industrial markets, we remain confident in our overall fiscal year guidance.

Now let me turn it over to Bob to discuss the financials in more detail.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [4]

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Thank you, Tom. As Tom previously mentioned, our year-to-date results were largely consistent with our expectations. However, in the second quarter, Aerospace performance was stronger and Industrial was weaker than we expected.

In Aerospace, sales increased 10% this quarter, with strength across most of the segment. Rotorcraft and business jet sales were the only area of commercial weakness, consistent with our expectations.

Combined commercial aftermarket sales for the quarter, which includes aftermarket sales made through the joint venture, were up 12% compared to the prior year quarter, putting us at about 5% growth year-to-date. This is now more in line with our full year commercial aftermarket expectation of mid-single-digit growth.

Defense sales were also strong across the board with smart weapons growth accelerating in the quarter and anticipated to grow -- excuse me -- continue growing throughout the fiscal year.

Aerospace segment earnings for the quarter were 18.2% of sales compared to 17.4% in the same period last year. The improvement was driven largely by the higher sales volume.

Turning to Industrial. Second quarter Industrial segment sales of $180 million were down 5% compared to the second quarter of fiscal 2016. While we appear to be at the bottom of the cycle for a number of our end markets and see improving orders for the second half of the year, we still experienced some pockets of decline, most notably in wind turbine converters and aftermarket sales for industrial gas turbines.

In the quarter, we saw improved sales of natural gas fuel systems used on trucks in Asia and on reciprocating engine power generation applications. Second quarter Industrial segment earnings were 9.5% of sales compared to 10.3% in the prior year period.

Segment earnings were unfavorably impacted by lower sales volume and plant costs associated with the new facility, which collectively more than offset the cost savings from strategic initiatives previously implemented. We expect marked improvement in our Industrial segment performance in the second half of the year, largely driven by a return to sales growth in a number of markets.

We also continue to expect full year margin improvement of 100 to 200 basis points in the Industrial segment, on sales growth in the second half and as a result of various cost savings initiatives mentioned previously.

At the Woodward, Inc., level, gross margin percentage for the second quarter of 2017 was 27.0% compared to 27.8% in the prior year period. Research and development costs were 6.1% of sales in the second quarter compared to 6.6% in the prior period.

Selling, general and administrative expenses were 8.6% of sales in the second quarter compared to 7.7% of sales in the prior period, largely due to the timing of recognition of stock-based compensation expense. For the 6-month period, SG&A expenses were 8.2% of sales compared to 8.4% in the prior year period.

The effective tax rate for the second quarter of 2017 was 24.1% compared to 24.9% for the second quarter of 2016. Our full year effective tax rate is now expected to be approximately 22% on favorable outcomes of certain tax matters.

Looking at cash flows, we generated $130 million of cash from operations for the first half of fiscal 2017 compared to $362 million in the prior year period. Free cash flow for the first half of 2017 was $87 million compared to $262 million in the similar period in the prior year. The prior year period included $250 million from the formation of the joint venture with GE.

Capital expenditures were $43 million for the first half of 2107 compared to $99 million in the same period of the prior year. In the second quarter of fiscal 2017, we repurchased shares of our common stock for an aggregate purchase price of $37 million, for a total of $61 million year-to-date.

Lastly, turning to our 2017 outlook. As previously mentioned, our overall first half performance is largely as expected, with strength in Aerospace and some weakness in Industrial.

We anticipate, based on current order volume and other indicators that our Industrial business will improve in the second half. However, significant uncertainty remains in many of our industrial markets and we now expect industrial sales to be down slightly for the full year.

Overall, our fiscal year 2017 guidance remains unchanged. Net sales are expected to increase by approximately 4% to 6% from the prior year, and earnings per share are expected to be between $2.95 and $3.25.

This concludes our comments on the business and results for the second quarter of fiscal 2017.

Operator, we are 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) Our first question comes from Gautam Khanna from Cowen and Company, LLC.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [2]

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So a couple questions. The first one, I was wondering if at either segment, but Aerospace in particular, if there were any one-time benefits as you had in Q1, and if in the guidance generally you're anticipating any one-time items that are either positive or negative in the remaining quarters.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [3]

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Yes. Nothing -- we noticed the small gain on sale of the product line in the first quarter. Nothing like that this quarter. There are always small, significantly small items that occur in any given quarter. We've had, most notably, maybe the facility expenses that are probably a good example of that, that we've been trying to call out and give you a feel for. Other than that, no, there's nothing significant.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [4]

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Okay. Obviously the tax rate previously was guided I think at 25%, and today it's been updated to 22%. I'm just curious about why not change the range, the earnings per share range, by the result in $0.10 variance or $0.09 variance. Was there anything else that changed in the guidance or below the line or elsewhere?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [5]

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Yes. We mentioned overall, at the Woodward, Inc., level, no change. Underneath that, though, we did mention that aero is looking stronger and Industrial is weaker at this point. While we do see signs of improvement in Industrial, that is where all the uncertainty currently lies and that's why we left the range where it is currently. So we do still see a lot of uncertainty on the Industrial side. I might want to also point out that we've been working really hard addressing the industrial recession. And many of the cost actions that we've been taking are focused on that. So we do still anticipate the 100 to 200 basis point improvement in Industrial earnings as we go through the year, even if we do end up being down slightly on sales.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [6]

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Okay. Could you also just maybe expand on your comments about the industrial gas turbine aftermarket being a little softer, maybe how much softer and are there any specific things we can attribute it to, be it advanced gas pass upgrade slowing or was it day-to-day maintenance or was it across all OEMs? Any flavor you can give us on that?

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

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Yes. Right now what I would say is we always have quarter-to-quarter variability in all of our aftermarket activities. It was primarily around upgrades and retrofits where we saw the decline year-over-year. It's uncertain that is this timing or where that market is going. So at the moment it was year-over-year down, and we're monitoring and working with our customers closely to see how the rest of the year will flush out.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [8]

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And was it across many OEMs or one in particular?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [9]

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It was, I would say across the market and weighted by our various market shares with each customer.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [10]

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Right. Okay. And just an update on the aero segment margin guidance. I think previously you said it'd be flat to slightly up. I just want to be clear. It's trending a little better, it sounds. So is there an update to that segment level guidance on margin?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [11]

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No update at this time. As you point out, we said up slightly to flat. We are currently up what I'd call slightly, and no reason to believe that that won't continue. But as you guys have always seen, aftermarket volatility can go both ways for us. So at this point, no change overall. Aero appears to be doing a little bit better than expected at this point in time.

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Operator [12]

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Our next question comes from Michael Ciarmoli from SunTrust Robinson Humphrey, Inc.

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Michael Frank Ciarmoli, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [13]

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Maybe just to follow up on what Gautam was going down here on the Industrial. So to get that 100 basis points of margin expansion, it looks like second half here's going to have to average roughly 13%. And I'm just trying -- obviously you've taken cost out of the business. I'm trying to gauge the confidence level there, especially in the context if, you know, now there's a little bit of weakness in the aftermarket and maybe thinking that those are sort of your higher margin sales. I mean, that run rate, you guys haven't been at that margin level in quite some time. And just trying to I guess calibrate the confidence level there.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [14]

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Yes. I'd say we're quite confident in achieving the margin expansion. It's second half, we'll see where the cost savings that we initiated come through. Secondly, sales in the second half will be higher than the first half, so we'll get positive leverage on that. And we continue with our new factories to drive productivity. So combination all those, we have confidence that we will deliver the number.

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Michael Frank Ciarmoli, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [15]

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Okay. Okay. I guess based on the filings from last quarter, I mean, those cost saves were getting you about $3 million run rate. Is that kind of what you guys were looking for in those cost savings? Should we see an acceleration of that?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [16]

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Well, you'll see some acceleration as kind of everything starts to flow through. But that's a reasonable number. It's not going to be significantly changed from that as we go quarter-to-quarter.

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Michael Frank Ciarmoli, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [17]

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Okay. Perfect.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [18]

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But we took the actions at different points in time during the year. And as Tom said, so they'll accelerate a little bit as we get into the second half.

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Michael Frank Ciarmoli, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [19]

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Okay. And then just on Aerospace, I mean, great performance there. Just can you maybe help frame us or frame the risk around what's been happening with the A320neo engine? I think around some of the -- that there's been some combustor, I think, issues there. And are you guys seeing any rework or are you guys seeing any risk to those specific components in the engine where they are having some, call them I guess growing pains or teething issues?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [20]

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I think the best way to look at the neo is in total the whole A320 program. I think everybody on the call recognizes we have very good content on the current generation A320 and increased content on the neo. We're on both the current generation and the neo, we're on both engines. Airbus is continuing to ramp their production. And where they have hiccups on the PurePower engine, they're substituting the other aircraft in. So we see that the full year outlook for sales will be holding. And anywhere we can be helping our customers with any of their problems, we are doing that. And that's probably about all I'll comment on that. But overall, we think 320 sales are going to hold for the full year based on the balance between the engines and the 2 generations of programs.

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Michael Frank Ciarmoli, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [21]

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Got it. And you don't really see any cost risk there?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [22]

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I don't.

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Operator [23]

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Our next question is from Robert Springarn from Credit Suisse, AG.

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

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At the risk of beating a dead horse on this industrial thing, I just want to understand where your visibility comes from for the second half. I mean, it seems like you're talking about up markets but down overall revenues for Industrial. It also seems like some of the pieces are moving in different directions than they were, so the aftermarket in gas turbine on the one hand going down sounds a little surprising, natural gas is up again, also may be a bit surprising. So if you could talk about the confidence and the visibility and where this comes from, that's my first question.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [25]

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Good question. We're happy to continue to take everybody's questions around this, because it's obviously a major item for us as well. I'm going to start first with, we do a lot of economic modeling and looking at a lot of economic data, in particular around industrial production in the U.S. and all the major countries in the world. What we are seeing is, industrial production's picking up. The leading indicators at a macro level are pointing to a strong second half of the calendar year for industrial applications. We then, with that data -- okay, that's the macro data. From that, we start looking and we do have what we would call fast cycle and long cycle businesses. Some of our fast cycle businesses are around our reciprocating engine application. The reason they're fast cycle is they go into -- some things go in light construction equipment or to truck, natural gas trucks, or items that don't take long-term projects and that's why they're fast cycle. If you take like big steam turbines or industrial gas turbines, they're long cycle because you've got the whole project cycle, okay. So that's the difference. So what we're seeing tied to that economic data is our fast cycle businesses, the order intake is rising nicely. And that's where Bob highlighted on our natural gas truck applications, our natural gas [reset] power gen, those are going up. Some of the retrofit activity is going up. So that would correlate in our mind very well and tracks our history of the economic indicators moving, our fast cycle moving, and then our longer cycle businesses trailing, okay. So that gives us a lot of confidence that we're seeing this turn and things are moving up. Our order --

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

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Tom, on the fast, if I could just interrupt there. On the fast cycle stuff, what's the duration of the backlog? I mean, can you see a quarter ahead? 2 quarters?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [27]

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No, we're seeing about 6 months on that, 6 to 9 months we're seeing that. And it is -- that business is rising. So now to continue to answer your question, our wind business did go down, as Bob highlighted. That, I would say, is primarily tied to market share of our customers. And we can't really go into individual ones. But we ride the market with our customers based on the applications we're on. And what I would say is, the overall wind market is doing okay, it just happened to be a poor quarter for our customer base and our sales into that customer base. The gas turbine aftermarket is probably the one that gets everybody's attention. And that's why we're saying, we had bigger first quarter and a low second quarter here. So it could be timing, but we're also concerned about the sustainability of the high rate we were running. And that one is a little harder for us to correlate to economic data and other activity. So if you look at the balance of our business, that's why we feel like we're seeing things turn up, but we do have issue we can -- let me back up one second on gas turbines. We [can’t] forecast OEM, how that tracks with economic indicators with power utilization around the world and things like that. But the aftermarket is a little more volatile. So that's the balance of what we're looking at and that's a little bit why we see the second half picking up. We got confidence in the fast cycle businesses and we do have confidence in the economic indicators. So we think we're seeing that turn. However, we had these 2 negatives, wind and gas turbine, aftermarkets that have hit us this quarter.

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

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Okay. And then just my other question, Bob, this is for you going back to cash flow. I thought your CapEx was a little lighter than expected in the quarter and maybe free cash flow's trending a little ahead. Are you still looking for the same components of free cash flow for this year? So I guess around $200 million for the year, CapEx around $110 million. Are there any changes there?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [29]

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No. All of the differences are just timing related. We're still kind of in a large project mode, and so timing of the payments and so forth. So no, those still hold.

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Operator [30]

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And we'll take our next question from Pete Skibitski from Drexel Hamilton.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [31]

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Tom, is wind fast cycle or long cycle?

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

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We would put wind more into the long cycle, that's from setting up -- the timing to set up a wind park does take -- that time is longer, and that's why we put it in the long cycle.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [33]

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Okay. So I'm guessing then you had some visibility into the quarter and maybe your visibility for the year isn't that bad either is, I'd assume wind would be maybe flat for the year. Is that a bad assumption now?

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

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That'd be a bad assumption. It's going to be down for the full year.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [35]

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Okay. Okay. So the gas turbine aftermarket is the real uncertainty factor here.

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

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Yes, that's good clarification. Yes. The wind, we definitely see being down for the full year. Gas turbine aftermarket, with the drop we had in second quarter, we're uncertain, it may be down for the full year. We just don't know at this point.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [37]

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Okay. Okay. Is there any way or should we extrapolate wind into '18 having another down year there or are there opportunities for regain share at the customer level?

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

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We see some opportunities. We're looking at new applications and new projects, and there's a good chance it'll pick up in '18 again.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [39]

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Okay. Okay. Just a couple last small questions, I guess actually, Tom. I guess the defense CR, the continuing resolution hasn't really impacted you yet, do you fear the potential for a full year continuing resolution or I guess maybe given your aftermarket exposure, is that just not a concerning factor for you?

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

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What I would say for when you're looking at fiscal year '17, we have a lot of confidence that defense will be up mid-single digits and we're confident in that with the order book and the like. If we get a better defense budget, that could improve and it definitely would be momentum going into '18.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [41]

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Okay, got it. And then just for Bob. Bob, the stock comp surprised me a little bit. What's your full year expectation for corporate expense now?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [42]

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Well, we're probably going to hold that rate a bit. It may come down a little bit in the second half. But the overall rate that you've seen now for the last couple quarters will probably hold. Year-to-date, you kind of saw the stock comp, it doesn't have that much of an impact; it's very small year-to-date. It's mostly something that was usually in the first quarter and ended up being the second quarter. It was not insignificant in the quarter. It was about $0.09, so it had an impact in the quarter. That's totally related to -- this time it had to go through a vote at our shareholder meeting, which is in the second quarter. So that's the reason why it changed. Normally it does not require the vote. And this time just for administrative purposes it did, and that's why it's in the second quarter.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [43]

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Okay. Okay. So you'd end up being around $60 million or so for the full year? That sound right?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [44]

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That's not too far off.

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Operator [45]

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Our next question comes from Sheila Kahyaoglu from Jefferies, LLC.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [46]

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I was wondering if you could quantify the commercial OE growth within Aerospace at all and just what you're seeing maybe with the different platforms on the 777 in particular.

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

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The commercial what? I'm sorry, Sheila.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [48]

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OE. The commercial OE growth.

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

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Oh, OE growth, yes.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [50]

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Yes.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [51]

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Well, overall we look at -- usually what we talk about is the overall OE side, and it's starting to pick up with the new platforms coming. As you know, the 777 has -- Boeing has called down the line rates. We don't see anything different in what they've called down. But overall OE's picking up and it's picking up due to the ramp and the launching of these new programs, and we're always a little ahead of the deliveries. We got to get our product to the manufacturers first. So we are seeing it pick up and we're going to continue to see OE pick up as we go through the year.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [52]

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So with solid growth maybe high single digits? Not putting words in your mouth, but just wanted to get an idea.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [53]

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Yes.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [54]

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And I know we might discuss this more at the facility visit. But just on the A320 and 737 MAX, can you talk about where you are in capacity utilization and maybe on the ramp as best as you could define it?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [55]

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Well, in terms of capacity utilization, the plants, and hopefully -- I'm glad to hear you'll be on the tour. All of us will be there. But the plants were designed, the physical structures were designed to handle the maximum volume in like 2021. So when you see the facilities, you're going to see that there's space and the like. We've put in -- our target is to be 6 to 9 months ahead of the ramps with the equipment and with our member hiring and the like. So when you get a chance to see it, you're going to see we're well ahead of the ramp and we'll be able to make all the deliveries comfortably as we go forward. No capacity concerns.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [56]

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Okay. And you would say you're about 6 to 9 months ahead on the neo versus the MAX at this point, if you think [ahead]?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [57]

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No, because you have to see a lot of our equipment, a lot of it's going to run on the same lines. So we're building the line capacity toward the forecast and what I was trying -- maybe I wasn't clear -- we're trying to do is have the capacity on ready, 6 to 9 months ahead of the steps in the ramp rates. That way everything's there, we have no issue with meeting the committed ramp rates.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [58]

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No, understood.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [59]

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Okay.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [60]

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And then just, I guess lastly, just bigger picture stepping back, whether you think about the aero business or within Industrial, are there -- you've had significant air and wind. You won HA turbine last year with GE. Can you talk about what you're maybe bidding on or where the most RFP activity is that you're seeing throughout the company?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [61]

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Well, right now a great deal of our -- we have a lot of R&D going into the development of the 777X. We're also working on the next generation turboprop programs that are out there on the Aerospace side. We're doing some R&D on looking at our market share expansion and product line expansion. So that's, without going into detail there for competitive reasons, we are looking so that the next generation of programs that we can increase our content again. On the Industrial side, we're seeing a lot of activity around dual fuel and alternative fuel or variety of fuel types. So some of those programs are coming back and we're investing again in those areas. So those are some of the prime areas, plus some of our growth initiatives that, as I said, we're looking into how to expand the business on a organic expansion. Those are the prime ones. We're also participating in looking at both at Boeing and Airbus, their next generation aircraft or this middle of the market. But we are involved in those activities as they are trying to figure out where those planes are going to be positioned and what time they're going to go. But we're working on that activity as well.

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Operator [62]

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(Operator Instructions) I'm showing one question left from Drew Lipke from Stephens, Inc.

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Andrew Jay Lipke, Stephens Inc., Research Division - Research Analyst [63]

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Quick question on industrial gas turbine aftermarket again. I'm curious, is there historical correlation where when utilities see underutilization from abnormally warm weather, that maybe you see a correlation and a pullback in aftermarket demand? Is that something you've seen historically?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [64]

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Yes, there is a seasonality to the gas turbine aftermarket, which would be tied to planned outages, and those outages usually are before you get to summer season where you're going to have high power use, summer season driven by air conditioning. So usually you see it in advance of that. So that's usually the seasonality is around outages. And so we track outages to try to help our forecasting capability and working with our customers to see where they are. The other one is if people are working on emission regulations or if they are not compliant and they have to do an upgrade to be compliant, that could also drive the timing of the aftermarket.

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Andrew Jay Lipke, Stephens Inc., Research Division - Research Analyst [65]

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Okay. And then on the 12% growth in aftermarket, what would you attribute to legacy platform growth verse initial provisioning?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [66]

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We had a real healthy mix this quarter. We are, I think Bob mentioned this earlier. We are seeing initial provisioning for the new programs starting, which is as anticipated. And so initial provisioning's ramping up. But the programs we're on are just hitting some of the sweet spot in the aftermarket. We've talked about this before where the A320 program itself, the B2500, CFM-5, the GE90, all these are hitting great timing in their repair and overhaul cycles and we are seeing that coming through. And we have other legacy that's going well. So it was a mix across the board there. But as we were highlighting, we continue to see aftermarket being strong going forward, both tied to that shop visit rates as well as ongoing initial provisioning that will occur for a number of years here.

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Andrew Jay Lipke, Stephens Inc., Research Division - Research Analyst [67]

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Okay. And then just last one from me, in terms of capital deployment I think you got $500 million authorization in place. How kind of aggressive do you plan on being over the next 12 to 24 months? And any increased appetite to maybe actively start looking at M&A more?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [68]

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Well, both Bob and I will comment on that.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [69]

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Yes. Why don't you do the latter first?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [70]

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Okay. Well, on the M&A, our M&A approach is really targeted and with a lot of patience to get acquisitions that fit with our strategic plan that would either enhance our system strategy or bring key technologies to us. We're constantly looking, but we're extremely patient to get the right assets at the right price. So it's always really uncertain when you can time that. And we want to make sure that we have, if you want to say the balance sheet to be able to do that, but you can never exactly predict the timing. Outside of that, we're going to go back to our capital deployment strategy, which I'll let Bob make comments on.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [71]

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Yes. I wouldn't call us any more aggressive or non-aggressive in the second half or as we go forward. We've always had a strategy of offsetting dilution; we will continue that strategy. A lot obviously depends on where the stock price is as we go through the year. And we'd love to see it up high, and that kind of keeps us a little bit out of the market when it's up at the high level. So hopefully that'll continue. But a part of it is also, as we go forward, people ask, well, are you going to let the cash pile up on the balance sheet? And no. So then the balance between Tom's comments on M&A and availability of opportunities there and where cash sits will determine what we do with that, I'll call it, quote, excess cash, unquote.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [72]

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Yes. And we are committed to the dividend growth rate that we highlighted.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [73]

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Yes.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [74]

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And we're going to continue to make sure we deliver on that.

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Operator [75]

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Our next question's from Gautam Khanna from Cowen and Company, LLC.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [76]

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Couple follow-up questions. I was wondering if you could quantify how many LEAP equivalent ship sets you've already shipped into the channel and how that's going to progress through the year. So if you have a number that would be helpful. Like what the calendar Q1 rate was, how many you shipped? Secondly, on the PW1000, if you had any update on that as well, if you can quantify it for us.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [77]

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Yes. I guess a little bit -- that's sometimes sensitive information for our customers, and I'd rather defer that they provide that data, not us. What I can tell you is both programs are ramping up. Obviously the LEAP is ramping quickly on the neo. We're getting ready to launch the MAX, so that that's going to have a very steep ramp. The [Phat] engine, they're making progress on and we're planning and positioning ourself to handle the full ramp rate that Airbus is planning. So around that, I'm confident they're going to get over the issues they've had and going forward we're just preparing for the step change that both Boeing and Airbus are planning.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [78]

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Maybe if you're not willing to quantify it, could you at least give us some color on what the lead time is for Woodward? How far ahead do you ship relative to when they deliver, your customers [deliver]?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [79]

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Yes. When we're in full rhythm, it'll be 4 to 6 months in advance of the aircraft being delivered.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [80]

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And where is it now?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [81]

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Pardon?

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [82]

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Where is it now? Is it 4 to 6 months or you're saying down the road it'll be 4 to 6?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [83]

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Right now, we're more towards the 6 months. And basically we ship -- part of what I'm talking about is we do direct shipments to Airbus and Boeing. But the ones that -- when you're talking LEAP and PurePower, those first have to go to the engine manufacturers, go through their build cycle and then be delivered to the air framer. So it's a little bit longer on those. I hope you're going to come to our facility tour. You're going to get a real feel for how the rhythm of the production is and the flow and you get a feel for that if you are able to make the tour.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [84]

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I hear you. No, that's great. But to be clear, 6 months ahead is sort of where you are relative to where they're delivering? See, right now, you're delivering at GE's Q3 exit rate on the LEAP, approximately.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [85]

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Approximately, yes.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [86]

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Okay. I wanted to also just parse this IGT aftermarket dynamic, because you mentioned upgrades and aftermarket broadly. Just can you trace what is actually an upgrade shipment versus a day-to-day maintenance general service kind of a sale?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [87]

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We can, yes.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [88]

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And if so, where did -- you can. And so which stepped down most or did they both step down?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [89]

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No. The most -- they're all down; most was on the upgrades.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [90]

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Okay. And that's volume? That's not price. That's [needed] volume came down?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [91]

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Correct.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [92]

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Okay.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [93]

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And you have you to also understand you're looking at that, some of the times it's timing, because we had a big first quarter or good first quarter. We'll actually take the first quarter. And some of that first quarter could be in inventory that will then be going into the upgrade. So there is a timing issue that does occur, and it could be quarterly timing or orders [volatility]. That's what we're trying to highlight. So overall we don't want to color coat it. It's down, but there is some of that going on.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [94]

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I just I don't remember you guys ever calling this out. And so I'm wondering, is this the first quarter you've actually seen a sizeable step down sequentially in year-on-year in the upgrade market for IGTs?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [95]

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What we had is over the last couple years we've had a very strong upgrade market. And so, yes, this might be the first down in the upgrade market that we've had in the last couple years. So I think that's why we're highlighting it. So the OE side is relatively flat, as I commented earlier on the point in the cycle we are, we do see that going forward, increasing. But we have had a couple years of very strong aftermarket here, and this, I think, right, Bob, the first quarter we've had down?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [96]

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Right.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [97]

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So, yes.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [98]

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And we have called out that strength for the last 2 years.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [99]

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Yes.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [100]

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Absolutely. No, I agree. That's why it's surprising. In terms of the typical order to revenue kind of conversion timeline on one of these upgrade orders, is it several months? is it a month? Like I'm just curious how quickly these things can turn. Or what's the lead time? What's the backlog, if you will, going into any quarter on this stuff?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [101]

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Yes. You mean our lead time within Woodward, Inc.? Is that the question or you asking on the projects?

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [102]

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Yes, exactly. So right your lead time to deliver the product. You get an order, how long does it take to deliver the product typically? Is it book and ship; is that -- ?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [103]

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No. No. These are -- I mean, I got to think about the exact lead time from if we take the full lead time. Probably 4-month lead time in there, maybe a little longer, depending on how we have the production line wetted. So if you just go to pure accumulated lead time, it's going to be much longer than that. So we do a lot of forecasting and planning to have material in the pipeline so that we can respond quicker. But you're talking pretty -- this isn't like book and ship really fast stuff; this is longer cycle.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [104]

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Okay. And how long would you say the order softness has been? Has it been through the first month of the current quarter as well; like all of last quarter plus the first month of this quarter?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [105]

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Yes, we ended with a very strong first quarter of our fiscal year, fourth quarter calendar year, and the softening started to occur really beginning of January, beginning of this year.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [106]

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And just to be clear, that's softness in orders? Because the sales were strong in the first quarter or (inaudible) because it's a 4-month lead?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [107]

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Sales were strong and orders declined as we moved forward into the calendar year '17.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [108]

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But they were strong in fiscal Q1, orders?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [109]

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That's what you're asking, right?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [110]

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On orders, orders started --

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [111]

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Correct.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [112]

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Orders started softening in the first quarter. And as you're going through the quarter, you could get orders dropping in or timing of projects and things. So we did -- if your question is, were we seeing some softening in the first quarter in orders, yes, because of the lead time. But as you go through the quarter, we're not sure exactly what you pick up in the next quarter. So we saw some softening. Our forecast, we had some concern, but we had a strong shipment first quarter. But the orders did not continue into our fiscal second quarter, and that's what you're seeing. So hopefully that clarifies it.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [113]

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Got it. No, that helps. That also explains a bit of the margin pressure. Okay.

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Operator [114]

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So we'll take our final question from Garo Norian from Palisade Capital Management.

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Garo Norian, [115]

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Just a couple model clarification questions. On the tax rate, the 22% for the full year, that implies kind of the first half of around 13%, so we're in the upper 20s for the back half of the year?

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [116]

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Yes. That's pretty close, yes.

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Garo Norian, [117]

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And then the second one was just in regard to a question earlier about kind of the non-segment or corporate expenses. I just wanted to make sure I understood kind of where that landed. Because if it's up close to, I think somebody threw out $60 million, that's a very significant assuming increase over last year on an adjusted basis at least.

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Robert F. Weber, Woodward, Inc. - CFO and Treasurer [118]

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Yes. So run rate's roughly in that 4% sort of area. And we will have some facility expenses and timing of some of those, we've got some that are in non-segment, we've got some in all of our segments. And so the timing of some of that will also determine, in terms of move costs and things like that, whether they're in the fourth quarter of this year or the first quarter of next year. So that will move around a little bit. It will be a little bit higher than it's been in past years, and then probably start to drop back down to where it's been more historically.

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Operator [119]

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

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO and President [120]

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Okay. I do appreciate everybody joining us today. I referred to it a couple times. But hopefully everybody saw the press release inviting them, all of you, our analysts and investors to our Aerospace Facility Tour on May 10. Don and I and Bob will be there joining the tour, and we're going to start at 9:45 Central Time in Niles, Illinois, and then from there we'll go to our new Rock Cut facility. A lot of you that have had questions about the program, the ramp rates, our productivity initiatives, I think this tour will answer a lot of those questions and I think it'll be enlightening to all of you about how we're going to handle this commercial aerospace ramp-up . So I hope to see you there. We're looking forward to showing off our new facilities to everybody. Again, thanks for your questions today and we look forward to seeing many of you on May 10. Thank you.

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Operator [121]

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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 a U.S. call, or 1 (404) 537-3406 for a non-U. S. call, and by entering the access code 47791154. A rebroadcast will be also 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.