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Edited Transcript of WWD earnings conference call or presentation 5-Aug-19 8:30pm GMT

Q3 2019 Woodward Inc Earnings Call

FORT COLLINS Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Woodward Inc earnings conference call or presentation Monday, August 5, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Don Guzzardo

Woodward, Inc. - VP of IR & Treasurer

* Robert F. Weber

Woodward, Inc. - Vice Chairman, CFO & Treasurer

* Thomas A. Gendron

Woodward, Inc. - Chairman, CEO & President

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Conference Call Participants

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* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Gautam J. Khanna

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

* Huang Howe

Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research 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. Third Quarter Fiscal Year 2019 Earnings Call. (Operator Instructions) Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer; Mr. Bob Weber, Vice Chairman and Chief Financial Officer; and Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer.

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

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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 Third Quarter Fiscal Year 2019 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 August 19, 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 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 No. 2014-09, Revenue from Contracts with Customers, or ASC 606, effective October 1, 2018, and results for the third quarter and first 9 months of fiscal 2019, including adjusted and organic amounts, are presented on that basis except as specifically stated otherwise.

Prior period amounts are presented under the previous accounting standard, ASC 605. We believe the impact of adoption of the new standard will not be material for the full fiscal year. Although, there will be ongoing quarterly variability of the impacts of ASC 606 for both sales and net earnings. The primary impact of ASC 606 is anticipated to be the inclusion of customer-provided inventory in net sales with no related earnings.

To better understand the impact of ASC 606 on Woodward, we have included tables in the press release and additional materials in the quarterly report on Form 10-Q to be filed on or before August 9, 2019.

In addition, Woodward is providing financial information as reported under U.S. GAAP as well as on an adjusted basis and an organic basis. Please refer to our press release and related tables as well as the appendix of today's presentation for the definition of adjusted and organic. We believe this will help in understanding both historical results and future outlooks.

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.

Now turning to our results for the third quarter. Net sales were $752 million for the third quarter of fiscal 2019 compared to $588 million for the prior year quarter. Organic net sales, which excludes sales attributable to Woodward L’Orange, were $673 million for the third quarter of 2019 compared to $563 million in the prior year quarter, an increase of 20% from the prior year quarter.

Net earnings were $66 million or $1.02 per share compared to $49 million or $0.77 per share for the prior year quarter.

Adjusted net earnings were $84 million or $1.30 per share compared to adjusted net earnings of $71 million or $1.12 per share for the prior year quarter. Net cash generated from operating activities for the first 9 months of 2019 was $219 million compared to cash generated of $162 million for the same period of the prior year.

Free cash flow was $141 million for the first 9 months of 2019 compared to $72 million for the same period of the prior year.

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. Welcome to all of you joining us today. Our performance during the third quarter of fiscal 2019 reflects solid fundamentals in both of our segments. In Aerospace, we delivered strong results, despite continued uncertainty surrounding the prolonged Boeing 737 MAX grounding. While our Industrial segment demonstrated further year-over-year improvement in the face of headwinds related to our renewables business. As a result, we believe we will finish the year with sales and earnings on the upper end of our previous guidance.

Now moving over to our markets. Our Aerospace segment continues to perform well on the back of a strong market, coupled with the healthy narrow-body production ramp, increased market share and solid global passenger growth. Although the Paris Air Show was a little more subdued than prior years, we still added significantly to our backlog and have content on virtually all aircraft ordered.

Defense demand for Woodward programs continues to strengthen on the back of increased military budgets. Defense OEM and aftermarket performance is driven by continued strength in fixed-wing aircraft and guided weapons.

With regard to the grounding of the Boeing 737 MAX, we're experiencing softer initial provisioning as anticipated. As of today, we are supporting OEM production rates. Given what we know, we do not anticipate a significant impact related to the grounding, but we will continue to monitor the situation closely.

In spite of this matter, our Aerospace segment continues to deliver excellent financial results.

Turning to our Industrial markets. Within power generation, large natural gas engines and clean-burning diesel engines are gaining market share due to their lower emissions and increased efficiency. The industrial gas turbine market continues to stabilize, and as it recovers, our share gains and increased content will allow us to grow faster than the market. We remain bullish on the future of natural gas power generation, and we believe our strategic positioning will drive superior shareholder returns over the long term.

In regard to renewables, a significant reduction in government incentives related to renewable power is impacting the industry. The announced bankruptcy of our customer Senvion, a German wind turbine company, is an example of the challenges in this market. Although immaterial to Woodward as a whole, the loss of this customer would have a significant impact on our renewable business. We believe there is still considerable value in our renewable business with respect to our intellectual property and large installed base.

In transportation, 2 bright spots are China natural gas truck sales and global marine utilization. In China, increased emission regulations and enforcement are driving healthy natural gas truck sales. Specifically in July, the new China VI regulations were implemented. And as a result, demand for China V-compliant trucks was unusually strong leading up to the new regulations. As a result, we anticipate significant softness in the fourth quarter as the market absorbs the large pre-buy and next-generation China VI-compliant trucks are introduced. Despite this short-term transition, the regulatory environment and economics in China remained very favorable for natural gas trucks for the long term.

In marine, Woodward L’Orange continues to enjoy a strong aftermarket as global trade has remained strong. In addition, new equipment sales will benefit from IMO 2020 requirements.

Oil and gas markets are solid although some volatility exists related to fluctuations in both supply and demand. Specifically with respect to natural gas, globalization continues with increasing numbers of terminals, ocean-going tankers and miles of pipelines.

In summary, we delivered strong financial performance this quarter and 2019 is shaping up to be a good year. Our Aerospace business remains well positioned to benefit from the increased demand of commercial aircraft, while Industrial business continues to show improvement across most markets.

We remain confident in our ability to strategically navigate through a challenging market environment and deliver value to our customers and shareholders.

With that, I will turn over to Bob to discuss the financials.

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [4]

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Thank you, Tom. Aerospace segment net sales for the third quarter of fiscal 2019 were $499 million compared to $405 million for the third quarter a year ago, a 23% increase. Aerospace segment sales benefited from both commercial OEM and aftermarket as well as military OEM and aftermarket volume.

The third quarter of 2019, which is reported under ASC 606, included $51 million of Aerospace segment sales that would not have been recognized under ASC 605, primarily due to customer-provided components. Commercial aftermarket sales were up 9% compared to the prior year quarter. As anticipated, initial provisioning was lower due to the grounding of the Boeing 737 MAX and compared to a very strong third quarter in the prior year. Legacy aftermarket showed continued growth, more in line with historical trends.

For the full year, we anticipate commercial aftermarket growth to be approximately 15%, which includes the impact of customer-provided inventory as required under ASC 606. Aerospace segment earnings for the third quarter of 2019 were $103 million compared to $84 million for the same quarter prior year. The increase in Aerospace segment earnings was largely driven by the higher sales volume. Segment earnings as a percent of segment sales were 20.7% for the third quarter of both 2019 and 2018.

Turning to Industrial. Industrial segment net sales for the third quarter of fiscal 2019 were $253 million compared to $184 million in the prior year period. Organic Industrial segment net sales for the third quarter of 2019 were $175 million compared to $159 million in the prior year quarter, a 10% increase. The prior year quarter included 1 month of Woodward L’Orange sales.

Foreign currency exchange rates had an unfavorable impact on organic sales of approximately $6 million for the third quarter of 2019. On a constant currency basis, organic sales would have increased approximately 14%. Industrial segment sales were fueled by the addition of Woodward L’Orange and the strength in most markets, partially offset by lower renewables.

Industrial segment earnings for the third quarter of 2019 were $26 million or 10.4% of segment sales. Adjusted Industrial segment earnings were $29 million for the third quarter of 2019 or 11.4% of segment sales compared to $19 million or 10.5% of segment sales in the prior year period. Industrial segment earnings growth was due to the increased organic sales volume and the addition of Woodward L’Orange.

At the Woodward level, R&D and selling, general and administrative expenses were in line with our expectations and are increased slightly, largely due to the inclusion of Woodward L’Orange. Nonsegment expenses reflect normal quarterly variability. And for the full year, as a percent of total sales, we are largely in line with our expectations and historical run rate.

The effective tax rate for the third quarter of 2019 was 28.4% compared to 9.7% in the third quarter of 2018. The effective tax rate for the current quarter was impacted by $11 million of tax expense related to transition impacts of the change in U.S. tax legislation. For the first 9 months of 2019, the effective tax rate was 21.0% compared to 24.7% for the same period of the prior year. We expect our fiscal 2019 effective tax rate to be approximately 19%.

Looking at cash flows. Net cash generated from operating activities for the first 9 months of 2019 was $219 million compared to $162 million for the prior year period. Capital expenditures were $78 million for the first 9 months of 2019 compared to $90 million for the first 9 months of 2018. For the full year, we expect capital expenditures to be slightly below $120 million. Free cash flow for the first 9 months of the year was $141 million compared to $72 million for the same period of the prior year. The increase in free cash flow was primarily driven by increased earnings.

During the first 9 months of 2019, we returned $139 million to stockholders, which included $110 million in the form of repurchased shares with the balance in dividends. This puts us on track to deliver on our commitment of returning 50% of net earnings to stockholders for the fiscal year.

Lastly, I'd like to return -- I'd like to turn to our fiscal 2019 outlook. We are confident in our ability to execute and deliver on our outlook for fiscal 2019. And although some uncertainty remains, we believe our guidance adequately reflects it. Total net sales are now expected to be approximately $2.9 billion for fiscal 2019.

Aerospace sales are now projected to be up approximately 19%, primarily due to higher customer-provided components at 0 margin. And Industrial sales are still expected to be up approximately 35%, both as compared to the prior year.

Aerospace segment earnings as a percent of sales remain unchanged and are expected to be approximately 20%. Adjusted Industrial segment earnings as a percent of sales are now expected to be slightly under 14%. We do anticipate a headwind to sales and earnings in our fourth quarter as a result of the timing of recognizing some revenue in earlier quarters under ASC 606.

For the full year, we continue to believe the difference between ASC 606 and 605 will not be material. Adjusted earnings per share is now expected to be between $4.70 and $4.80, based on approximately $65 million of fully diluted weighted average shares outstanding. Free cash flow is still expected to be approximately $300 million.

This concludes our comments on the business and results for the third quarter of fiscal 2019. 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 Sheila Kahyaoglu with Jefferies.

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

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You raised your revenue guidance for Aerospace, and I think part of that increase was aftermarket. If I recall, it was previously high single-digit, low double-digit growth. And now it's 15% growth for aftermarket. Maybe can you talk about what's driving that growth if initial provisioning is only 10%, and if you could elaborate on that a bit?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [3]

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Yes. A couple of things. One, obviously, the grounding of the MAX is one of the uncertainties. But really a lot of the growth, and that's what we tried to call out, is really related to ASC 606. And so it's the noncash consideration or customer-provided components that don't carry earnings. So that's a part of the growth that we're seeing.

The aftermarket has been strong. It has come down a bit in the third quarter and in the fourth quarter, and a lot of that also is related to 606.

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

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Okay. And then Bob, another one for you on free cash flow, which seems Q4 weighted, up year-over-year. So what are you looking for to meet that $300 million target for the year?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [5]

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Yes. It'll be a plain target, but we're confident that we've got a real shot at it. As you know, we had stronger sales in the first 3 quarters of the year than our normal pattern has dictated, and that's largely on the back of strong first quarter for L’Orange. So we anticipate that a lot of that cash will come in the fourth quarter. So that will also cause some increase overall in working capital.

And then in relation to the soft fourth quarter on our China vehicle sales, we believe that we're going to see some bank draft maturities in the fourth quarter that will also add to free cash flow in the quarter. And lastly, a little bit lighter on CapEx in the quarter, and all of those things kind of combining to give us some confidence on having -- delivering a really strong fourth quarter and hitting the $300 million.

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Operator [6]

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

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Huang Howe, Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research Analyst [7]

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Great quarter. I had 2 questions here. One, just touching on the Industrial segment and the second on Aerospace. In regard to the Industrial segment, can you perhaps parse out or break out in more detail the Industrial growth that you saw by end market, excluding L’Orange?

And then just following up on that quickly, as far as the wind turbine manufacturers. Is there any sort of timeline for this resolution, and how should we think about its magnitude or its percentage of mix for the renewables business?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [8]

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Sure. Let me start with the last one first. So the timeline is a little bit uncertain. We've already passed one date when we were promised further information, and the information that's been given so far is fairly unclear. They've kind of outlined a lot of different options, but some of them wouldn't have a very dramatic impact on our business -- from dramatic impact to no impact. So they're currently calling out a September date for further information. And so that's what we know with respect to what the courts and so on may announce.

Give you some idea of perspective. You will see in the Q where we break out in disaggregated revenue that our renewables businesses is approximately $14 million of sales in the quarter. That kind of gives you an idea where we'll end up for the full year. It won't be a significantly larger fourth quarter. So somewhere in that $50 million to $60 million range.

Senvion has gone from about 30% in last year's renewables sales to less than 10% percent in 2019. So it's been a dramatic drop. And so -- you can tell from that number, it's not as significant as it used to be. And so would not have a significant impact on Woodward, but would have a significant impact on the renewables business. So we're watching closely to see what happens there.

With respect to color on the other parts of the business, the Industrial business, in particular. We saw some nice growth this quarter because of the pre-buy in the small natural gas engines space. Large gas engines have been doing very well. Large diesel engines, particularly, those that have Woodward fuel systems and are clean-burning, have been really solid. Industrial gas turbines have been stabilizing. We saw a little bit of increase. I would not call that a trend necessarily yet, but we are encouraged that it has not gone down, and '21 -- 2020 and '21 look positive in terms of what our long-term view is. Obviously, the wildcard is the renewables business, and we'll have to see where that goes.

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Huang Howe, Barrington Research Associates, Inc., Research Division - Senior Investment Analyst & Research Analyst [9]

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Okay. Thank you for the color. And then secondly, on Aerospace. Previously, you had commented about it, but just seeking some additional color on the opportunity within Military Defense activity. What's -- how should I think of the upside here? And how material could this be in the interim and the long term as a growth driver for the Aerospace business?

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

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Yes. Right now, we're looking at the Defense market. We're seeing solid mid-double-digit -- teens type of growth rate, both on the OEM side and support of the installed fleet. So our anticipation with the defense budget that went through -- so we have got a good 2 years ahead of us with nice growth. So it's quite a positive tailwind to the business.

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Operator [11]

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

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [12]

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Just -- the accounting makes it a little bit tough to follow all of this. But I'm trying to figure out if there is some conservatism as I try to reconcile the guidance with the earnings guidance against the revenue and margins. And I'm wondering if it happens in nonsegment expenses.

What happens there? Because unless there is a market uptick there, I get above the high-end of your range by not a small amount.

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [13]

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Well, you're correct kind of on both fronts, and don't hold me to the half of it, 50-50 sort of thing. But there is an impact related to 606. We do anticipate that in the fourth quarter, that could be headwind to us and it all just a function of what orders do we receive in the quarter and what earnings are we able to recognize over time in that quarter. And so we do anticipate that could be a headwind.

On the operational side, it really kind of comes down to the impacts of the 737 MAX grounding. We don't really know what -- we have seen the news that you guys have seen in terms of what the impacts could be. Tom mentioned that we're currently supporting their production schedules and kind of remains to be seen where that goes. So that's still some uncertainty.

China trade and the impacts in the last few days and few months are also a point of uncertainty for us, and really the extent of the pre-buy and what impact that may have on natural gas vehicle sales in China. And then lastly, the renewables business.

So yes, there is some conservatism. There is some uncertainty I would say related to all of those events, including the accounting issues associated with it.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [14]

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And is this what brings that 14% number for Industrial margin down a little bit? Still seems to me you're going to have a pretty big fourth quarter. So just curious as to the volatility in all these quarters.

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [15]

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Yes. That's predominantly the renewables side and also the uncertainty on the natural gas in China.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [16]

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And then just one for Tom, high level. So 777X and the GE9X and potential delays there. To what extent does -- could this develop into an issue?

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

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Well, I think the issue we would have is just the later introduction into service. Obviously, that would impact sales, and obviously, those early sales include initial provisioning. So as we're watching that, we're putting together a long-range plan and outlook. We're going to have to push out some of that forecast.

But long-term, I think 777X is a great program, and it will materialize, I think, as planned. But it'll be a little delayed.

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Operator [18]

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And our next question comes from Pete Skibitski of Alembic Global.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [19]

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Couple of follow-ups, maybe for Bob first.

Bob, just the way corporate expenses are running to follow up on Rob's question, is it looking like over $100 million on the corporate expense line for this year? And then, should we think directionally it should be down next year just on the lack of Duarte cost?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [20]

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That would be part of it, yes. Obviously, we continue to try to streamline the nonsegment area. We have had some quarterly variation, but we're always in around that 2.5% of sales. And we anticipate long term that we'll stay in that range.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [21]

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And then on the cash flow. You just saw a pretty big receivables bill this year. Is that -- were you kind of mentioning earlier on the call, is that mostly China? And are we nervous at all about collecting that in the fourth quarter?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [22]

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No. No nervousness about collection. Actually, it's kind of the other way around. We've talked about bank drafts and so on, and we never had any issues with them. They work just like cash, but they have a longer term on them. So we anticipate we'll see some net maturities in the fourth quarter, which is why that's a positive. And those net maturities are caused by the fact that because of the pre-buy, we think that the sales during the quarter will be down a bit in the fourth quarter.

And so -- we did -- it wasn't the only the sales -- the accounts receivables, excuse me. The impact so far has been -- L'Orange has increased that as well. So they had a very strong first quarter. And then in general, the business has had a strong first and second quarter strength, and so we see some of those receivables coming back down again in the fourth.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [23]

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Got it. And then just one for Tom. Tom, kind of top level. I've been seeing people write about things like some of these public utility oversight boards that a lot of the boards are kind of wanting to invest more in renewables so they're investing in battery farms for renewables and maybe less so in natural gas-type utilities.

Are you guys are seeing that? Does it concern you at all long term, in terms of -- you guys have talked a lot historically about the move from coal to natural gas. I'm just wondering about maybe what people's political views are that could kind of throw a wrench into that?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [24]

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Yes. I think -- our opinion on that is that you will see some batteries coming in to this battery storage support renewables. The economics, though, are very challenged on those. And I think it's going to be very much a niche and that you are going to definitely need to support the grid and power demand with natural gas. So we're still bullish on natural gas. We will see some of those come in, but unless there is a huge breakthrough in battery technology that we haven't seen, it's hard to see that really getting to be a large market.

[And all tip,] look at the rest of the world where natural gas turbines or natural gas engines are really the right emission-friendly power generation at the right cost. They can't afford these other technologies.

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Operator [25]

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And our next question comes from David Strauss of Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [26]

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I think on the MAX, you talked about supporting the OEM rate. But can you clarify? Are you still at 52? Or are you somewhere below 52 a month on the MAX?

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

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Yes. It varies based on the products we're supporting. As we move forward, we're looking at an outlook at the 42. That's how we're planning the remainder of the year and going into next year until we start to see the anticipated ramp up when it comes off of grounding.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [28]

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And then Bob, I think the plan was to delever down to 2x gross by the end of the year. Is that -- I don't think you're quite there yet. Is that still the plan?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [29]

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No, we're really close. We're at 2.1x at the end of this quarter. So we anticipate being there or a little bit ahead of target.

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Operator [30]

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

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [31]

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Just a follow-up on David's question. On the engine side, the CFM side, are you guys at 42? Or you at 52? I'm just curious what -- is this advanced caution? Or have you been actually been taken down in rate on the LEAP-1B?

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

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Right now, on the engine side, we're above 42. But -- what I was trying to say is we're above -- there's some movement. Really, what's happening is depending on inventory positions and the like, those numbers will fluctuate. For planning purposes, we're planning 42.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [33]

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42 presumably, the last quarter, you were below 52. Is that a fair assessment? I'm just trying to get the slope...

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

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Yes. It's fair.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [35]

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And then, the 42, that's -- you're expecting for all of fiscal Q4?

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

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That's what we're looking at, and as Bob highlighted. And as we look in the fourth quarter, we look as we move into next year, we're going to take conservative view on the rate and the ramp up. For planning purposes, we will plan accordingly so that we support our customers, no matter what rate they go to. So we will be able to support them, but what we are highlighting is that, given the unknowns and given that's production at Boeing, that's what we're looking at.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [37]

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And then just curious how fluid is it with your customer GE on this? Is it something where month-to-month, week-to-week, you get changes in orders? Or...

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

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No. They're very good with their planning and consistent, and we're constantly in dialogue with them on what's required, what they need.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [39]

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Bob, maybe for you. I'm just curious, what are the add backs this year? At one point, I thought, without the purchase accounting step that would be excluded would equate to about $20 million. But I want to make sure we have the adjusted EPS add backs correct in fiscal Q4. So what should we expect?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [40]

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The 2 main areas are our Duarte to Drake transition. And so we called that out as well as the backlog. And you're pretty much right on with the backlog amortization. And then we anticipate that Duarte to Drake is largely complete. There may be some spillover into the fourth quarter, but we're pretty much out of that facility. So most of those costs should be behind us.

Same thing with the backlog on the amortization. That's behind us as well. So fourth quarter, hopefully, will be fairly clean. And 2020, those items will be gone.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [41]

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And then to follow on an earlier question, I think Sheila asked about the aftermarket. You mentioned that there was some real-time slowdown. Anything you can generalize about where, why, what might be driving that? And maybe geography, or product area or anything?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [42]

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Yes. Let me clarify, it's not a slowdown. Repair and overhaul type work is actually strong. We had very tough comps from a year ago. So if -- we didn't mean to signal that it's down. Actually, the market is incredibly healthy.

The 1 area that has slowed down for us is we had planned more initial provisioning tied to the MAX. And obviously, that has kind of ground to a halt until the aircraft is back in service. So those sales are not lost. They're delayed, and we anticipate we will see those next year.

But on the maintenance side, the MRO side, it's robust. And going forward, commercial MRO looks strong going into the next year as well -- beyond the -- the fleet dynamics, as we've highlighted for a while, are very favorable to our company. The shop visits are going up. It's just that we have -- as you could tell, in the last couple of years, we had a very strong performance here. So each year, the comps are tougher. But it's a robust number and there's no slowing down that we're seeing at the moment.

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Operator [43]

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And next question comes from Christopher Glynn of Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [44]

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So question, on the 737 MAX, is there any impact to your cash flows or cash timing that impacted your initial free cash flow outlook that maybe you're making up elsewhere?

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

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Well, the one that we were anticipating is what I was -- highlighted in the initial provisioning sales. Those are spare sales that airlines buy to support their new aircraft. Those carry a nice margin and those sales have -- primarily, have dried up. So those were in our free cash flow projections.

But at the same time, our MRO is doing well. And as Bob highlighted, we see working capital improvements happening in the fourth quarter and also slightly lower CapEx. So a combination of all that is how we're still holding on to the $300 million.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [46]

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And just curious how you're thinking about L’Orange cyclicality? I think it's been growing 15%, 20% range. How are you thinking about the kind of baseline run rates that you are exiting this year with in terms of what that business supports long-term in terms of cyclicality versus its maybe ongoing expansion prospects?

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

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Yes. Well, a lot of our markets are cyclical. Right now, as we're looking at that, the fundamentals for the L’Orange market are strong. What we anticipate being able to do is add some additional customers. We talked about that with L’Orange being part of Woodward -- being independent from any engine manufacturer. We are seeing a lot of customer interest. We're working on some new programs. that will start migrating into new revenue streams over the next couple of years because these programs take a while to develop.

In the meantime, tougher emission regulations around the world are driving for more complex fuel injection systems, control systems. That favors L’Orange. So we're seeing continued growth there and there's a very nice aftermarket. And as utilization goes up, we're seeing higher utilization driving spare parts. So overall, we're seeing L’Orange probably in the low double digits.

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [48]

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15% to 20%, we think the lower end of that range is probably where it will end up for the full year. And our accretion is still around that $0.60 target.

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Operator [49]

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(Operator Instructions) Our next question comes from Michael Ciarmoli of SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [50]

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Nice results. Bob, maybe housekeeping. Did I catch the tax rate, is that down 100 basis points now for this year? And it looks like in the quarter, I'm still shuffling through this, but there was a $10.5 million positive adjustment for taxes in the quarter. Was that all as expected? Or was there anything incremental that changed there?

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [51]

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Yes. Yes on the first, and reversed on the second part. So the -- we are 100 basis points roughly down in the overall rate. And for the -- I'm sorry, what was it? I just lost my train of thought on the second part of the question.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [52]

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Transition tax.

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Robert F. Weber, Woodward, Inc. - Vice Chairman, CFO & Treasurer [53]

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Yes. The transition tax was actually on hit to us in the quarter. It's noncash, there's an 8-year period. So eventually, there is cash related to it. But in the current quarter, it's a noncash increased tax expense.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [54]

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Got it. And just on the MAX. So just to, I guess, calibrate our expectations. As we go into next year, should we assume that you're keeping that rate moderated at 42? Because, I mean, it would seem like it would be a pretty decent headwind. I mean I don't know what your blended rates here might be for -- or your annual deliveries for fiscal '19. But assuming, for planning purposes 42, I mean, that could be a $30 million to $40 million headwind potentially. Is that how we should be thinking about next year with that conservatism in mind?

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

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I don't know that, that's the exact number for the headwind. We're looking at supporting the line rates and planning for the announced 42 with material planning and production planning to support the higher ramp if it occurs, or be prepared if it goes lower. So -- go ahead.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [56]

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No, I was looking at your content. Assuming 290,000 and if shipped were at 120 fewer units, it works out to about $35 million or so.

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

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Right. That's [the math].

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [58]

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Got it. And then just a last one on L’Orange. Obviously, some global growth pressure out there. Anything you guys are seeing in the aftermarket? I know that they've got a big component there. Anything in the channel? Any update on ordering rates that would give you guys a reason for pause that there might be any de-stocking? Or are you seeing pretty firm trends out there?

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

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We're seeing pretty good trends. There is definitely variability in the aftermarket, especially if you go quarter-to-quarter. But the aftermarket is really driven by utilization. Utilization is still strong. With that overall, we see pretty good spare outlook -- spare parts outlook. So right now, that's going well.

And there's multiple end markets. As you know, L’Orange has a good presence in power, particularly data centers, very good presence in marine and we also have oil and gas. So you have to look at the dynamics in each of those markets, both from an OE and an aftermarket and utilization standpoint. The marine utilization has been good, oil and gas has been good. Data centers don't drive a whole lot of aftermarket. Good on the OEM side, though.

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Operator [60]

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

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

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Oh. It looks like a couple of questions have come up. Operator, do you have that in front of you?

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Operator [62]

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I'm sorry. Christopher Glynn, your line is open.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [63]

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I was just wondering on the China natural gas truck. If you think that the fourth quarter will have pretty much cleaned up the China V inventory clear the way for a China VI? Or if it's more likely to take a couple of quarters?

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

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I think a large part will be cleaned up in the fourth quarter. And as we move into fiscal 2020, that it'll start ramping. China VI will start -- China VI engines and trucks will start gaining in 2020.

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Operator [65]

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

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [66]

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One thing I was trying to understand was on provisioning sales, engine provisioning sales on the 737 MAX, do you know -- can you trace what is in fact a provisioning sale versus an OE sale? You're given the visibility by the customer?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [67]

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Yes. so we know exactly what it is. Yes.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [68]

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So one of the things I was trying to square is they've talked about -- they, General Electric, has talked about using -- part of the reason they were capped at 52-ish a month was to catch up on provisioning spares because they were lagging the rate, the whole supply chain. So I would actually think that in recent months, you get a richer mix. Yes.

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

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Yes. There is a little bit of difference, for clarity. As spare initial provisioning engine, if you want to say a spare engine, we do not have as a spare to Woodward. What we get is spare hardware Woodward are used to the airlines. Okay? So there is a little bit of difference. So what you are hearing is an engines spare, not a Woodward spare. Does that make sense to you?

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [70]

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Got it. So the airline buys the Woodward spare that goes in the engine separate and apart from what they're buying from CFM.

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

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Correct.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [72]

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Okay. And so that's what's actually changed. Because I would think the mix -- if you participate as a spare -- do you get better pricing on what CFM sells as a spare engine or not?

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [73]

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No. We do not.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [74]

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Got it. So that's an OE sale. Okay. Fair enough. That actually clarifies a lot.

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Operator [75]

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And there are no further questions at this time. I'll turn the conference back to you, Mr. Gendron.

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Thomas A. Gendron, Woodward, Inc. - Chairman, CEO & President [76]

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Okay. Well, I appreciate everyone joining us today, and thank you for your questions. And we look forward to seeing you between now and our next conference call at the end of our fiscal year. So thanks. Have a good evening.

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Operator [77]

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Ladies and gentlemen, that concludes our conference call today. If you would like to listen to the rebroadcast of this conference, it will be available today at 7:30 p.m. Eastern Daylight Time, by dialing 1 (855) 859-2056 for U.S. calls, or 1 (404) 3537-3406 (sic) [1-404-537-3406] for non-U. S. calls, and by entering the access code 459-2857.

A rebroadcast will be available at the company's website, www.woodward.com, for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your lines. Everyone, have a great day.